A Citizen’s Guide

Gas line contract is unconstitutional The gas line contact is unconstitutional, although not for the reasons most people state. According to Article VIII, Sections 1 and 2 of the Alaska Constitution, the state is required to develop its resources for the “maximum benefit of its people,” which would be the case if we create the fiscal certainty needed to build a pipeline.

Therefore, binding future legislatures’ taxing authority and taking an equity share may be within the law. However, the contract must still maximize benefits, and the current proposal does not.

The real constitutional problem is that the contract grants a roughly 20 percent royalty and severance equity share to the state for natural gas with no possibility for an additional production tax. What we must demand is an additional production profits tax for natural gas and a PPT base rate for oil that is progressive when natural gas and oil prices change. As long as these elements are missing, the contract can never “maximize benefits” to Alaska citizens; therefore, the contract is unconstitutional.

The crux of the issue has to do with risk. The relatively low equity share in lieu of taxes reduces the risk of a loss on the project—without which the pipeline may not be built. One key risk argument is that there are roughly 200 Prudhoe Bay-sized gas fields stranded worldwide. However, about 30 percent of that stranded gas is under monopoly control in Russia, where GazProm uses its power to supply subsidized energy to the Russian public. An additional 50 percent is under the control of individual OPEC national oil companies that have shown a reluctance to aggressively tap oil and gas.

This suggests few new supplies worldwide will be developed due to a lack of competition within producing regions. However, with oil prices set to go higher, and North American gas supplies on the verge of peaking and hurtling downward, there is great risk of a natural gas supply shortfall with very high prices. Alaska must capture that value.

We know that major oil companies enter other countries where taxation rates are as high as 80 percent on oil and gas. These projects are subject to world natural gas price decreases. Companies willing to spend $5 billion or $10 billion worldwide on new gas development subject to a potential natural gas price decline will incur no more price-side risk by developing an Alaska gas line.

On the cost side, there is a greater chance of cost overruns on other projects around the world than on the Alaska line. Our project will be a 2,000- or 3,000-mile pipeline where the chance to learn cost-reducing techniques and receive bulk buying power price reductions on piping is enhanced. This signifies that there is no need for one single equity share but that a progressive profits tax can also be added.

Most experts believe the future price of oil and gas is $50 per barrel for oil and $5 per thousand cubic feet for gas. Few expect it to go much higher, and in fact many experts and companies, including Exxon Mobil (see www.exxonmobil.com/Corporate/Files/Corporate/OpEd_peakoil.pdf) place an extremely low probability of oil and gas prices going much higher. If that is the case, why is there so much resistance to have a progressive tax above those prices? In my books, I explain exactly why oil and gas will be extremely valuable and high priced for many years to come. I think the state should prepare for that contingency, because without it we are giving away our oil and gas.

What elements should the gas contract contain? It should have a progressive oil profits tax rate that levies roughly 80 percent in government taxes for oil at prices above $100 per barrel. Starting at roughly $50, it should rise from its base rate. For natural gas, an additional profits tax should start at about $10 per thousand cubic feet and increase until the price is $20, where the effective government take should again be 80 percent. A low state equity share of 20 percent for natural gas less than $10 is OK to compensate for the risks.

Some may say that if we tax the oil and gas industry too heavily, we will ruin it. That is true when labor and capital are mobile, but oil and gas reserves are not mobile and the competition for alternatives to oil and gas is weak. Alaska is in a position to maximize its oil and gas wealth, and it is obligated to do so. A progressive tax on both oil and gas does this.

Doug Reynolds is an associate professor of oil and energy economics at the University of Alaska Fairbanks and author of “Scarcity and Growth Considering Oil and Energy” and “Alaska and North Slope Natural Gas.” His e-mail address is ffdbr@uaf.edu.