State Revenue Commissioner Pat Galvin says an analysis of the state’s new Petroleum Profits Tax, or PPT, underway in his department shows no fundamental flaws so far in the state’s controversial petroleum tax law.
However, a decision on whether to hold a special session of the Legislature this fall to reconsider the PPT will likely be made on issues outside the tax law itself, Galvin said in an interview.
Those include public concerns over whether key votes in the Legislature were influenced by corruption when the tax was passed in 2006, as well as whether expenses related to replacing pipelines damaged by improper maintenance should be allowed as deductions under the tax.
Alaska oil and gas producers meanwhile are concerned that a special session will result in changes to the PPT, increasing the amount of tax they pay. Alaska’s oil taxes are already the highest in the nation, and the PPT itself added almost a billion dollars a year to the industry’s tax burden.
Alaska Revenue Commissioner Pat Galvin is leading a study to determine whether the newly passed, yet controversial, petroleum tax law should be reviewed.
Galvin said the department is doing a second research project comparing Alaska’s level of taxation on the petroleum industry against other producing regions. While it is still incomplete, it is proving to be difficult. “An apples-to-apples comparison between Alaska and other producing regions may not be possible,” he said.
Gov. Sarah Palin said June 29 that she would wait on a recommendation from Galvin on results of the revenue department studies before deciding whether to call a special session in the fall to reconsider the PPT. Palin made the comment during a press conference on budget vetoes.
In an interview, Galvin said he expects to have some results of the department’s modeling within a month and that a decision on the special session will be made later this summer.
He acknowledged that a special session could be conducted in a highly charged political atmosphere in which outcomes could be unpredictable. He said he wouldn’t want the session to result in punitive-type actions against the industry.
Meanwhile, the uncertainty over whether Palin will call the special session and the likelihood that the law will be changed if one is called is already affecting some companies’ plans for exploration and new development.
“We really don’t know how to run the economics on our projects in this situation,” said Ken Thompson, managing partner of a group of independent companies exploring the North Slope.
Thompson’s group, Brooks Range Petroleum LLC, drilled three exploration wells on the Slope last winter and found oil in two. Further work is needed to see whether the discoveries can be developed.
Whenever it is uncertain whether investment tax credits will be allowed for new wells and projects, an important element of the new PPT, companies planning new projects must assume the credits won’t be there, said Jack Griffin, ConocoPhillips’ vice president for external affairs. “Uncertainty on taxes disrupts investment decisions. For example, if you don’t know whether exploration credits will survive a special session, a company is likely to run its economics assuming there are no exploration credits, just to be safe. The same will hold true for heavy oil,” Griffin said.
“It’s the worst of all worlds for the state, really. The incentives are on the books, but the looming threat of tax changes means companies will be more conservative, and the state may not get the benefits of the investments it was trying to encourage.” he said.
A key objective of the new PPT is to use tax policy as a way of stimulating new investment by the companies, which the revenue department concludes, based on earlier studies, is inadequate to stem a steepening decline of production from the maturing North Slope fields.
Galvin said it is far too early to know whether the PPT’s incentives are working as intended or whether an alternative might be better.
“The PPT is in place now. It’s the system we have. At this point we haven’t developed an alternative that is better, and we are not assuming that we will find one as the end result,” of the department’s studies, Galvin said.
The department is about a year away from beginning audits of returns the companies are filing under the new tax, which will make actual cost information available to the state. The studies now underway are based on models that make estimates of companies’ investment behavior under the PPT, Galvin said.
In terms of assessing actual responses to incentives, the department can rely on data from an exploration tax credit program that has been in place for several years, Galvin said. “We do have data for several years when the exploration incentive was in place,” he said. This incentive applies only to exploration wells and allows up to 40 percent, in some cases, of the cost of the exploration to be credited against state taxes.
The PPT allows investment tax credits for a much broader range of industry investments, including new field development, heavy oil or high-risk projects involving very small, economically marginal developments.
Galvin said an important part of the department’s study focuses on whether tax credits on particular types of investments will be more effective.
“We might want put our money toward encouraging activity at the riskiest stage of the cycle instead of activity where there is already a high likelihood of success,” Galvin said. “We might get more bang for our buck with exploration, for example, than with in-fill development in a producing field,” where the producers already have sufficient incentives to invest.
Galvin considers investment in heavy oil as something the state would want to encourage because it is high-risk, similar to exploration.
Trying to target certain kinds of developments could, however, put the state on a trail of making its tax incentives too complicated to be effective, Galvin acknowledged.
“If you spread the incentives across a broad range of activities you assume every investment is of equal value. But if you try to focus the incentive on certain types of investment you risk missing opportunities and creating complexity, which is when the uncertainties in the system can overwhelm its effectiveness,” he said.
“In any event, its way too early for us to reach any conclusions,” Galvin said.
“The goal is to have a tax incentives that are straightforward and easy to understand, and that target investments that hit the mark,” stimulating new oil discoveries and production,” he said.
Even if a special session of the Legislature is not held this fall, some debate over the PPT is likely during lawmakers’ 2008 regular session, although attention to the oil tax issue will not be as intense as it would be during a special session.
State Sen. Tom Wagoner, R-Kenai, will promote a bill he introduced last session to discard the PPT, which is based on industry net revenues, after production expenses are deducted and eligible investments credited, and return to the previous production tax, which was based on gross industry revenues.
Criticism of the PPT by Wagoner and other critics is that it is a more complex tax that will be more difficult for the state to administer and audit, and provide opportunities for taxpayers to “game” the system to the disadvantage of the state.
Galvin said the PPT has presented some challenges. Development of regulations to administer the tax has been extremely difficult and some regulations are still not done, he said. Hiring new auditors is also proving difficult.
Auditing industry tax returns under the PPT will also be more challenging for the state because state audits of industry tax returns under a special corporate income tax on oil producers are somewhat easier as the corporate income tax is linked to the taxpayer’s federal income tax return.
The PPT will require state auditors to work extensively with industry cost data for the first time, Galvin said. However, the PPT law also allows the state to gain access to inter-company audits of production operations where several companies jointly own producing fields but one company is the operator.
Several companies own most producing fields on the Slope. Audits of the operating companies’ expenses by the partners are routinely done.
When the PPT was enacted in 2006, former Gov. Frank Murkowski said he favored the new approach because the previous incentive formula in the production tax, the Economic Limit Factor, was no longer effective.
Murkowski said he favored a tax based on net revenues because it rewards oil producers that reinvest in the state while taxing to the maximum producers, which do not reinvest. The new system also provided an effective incentive for costly oil and gas projects like heavy oil, the former governor said.