Debate over ‘fair share’ of oil makes a comeback

  • ConocoPhillips Alaska Vice President Scott Jepsen speaks to members of the Anchorage Daily News and Alaska Journal of Commerce editorial staffs on Aug. 9, 2018. At a Sept. 12 presentation to the trade group Alaska Support Industry Alliance, Jepsen said raising taxes by more than $1 billion per year will jeopardize large investments in new projects outside the major legacy fields. (Photo/Loren Holmes/Anchorage Daily News)
  • Former state Sen. Joe Paskvan, attorney Robin Brena and former state Rep. Paul Seaton are seen at a Sept. 9 press conference kicking off their campaign to support an initiative to raise oil production taxes by $1 billion to $2 billion per year. Behind them is a chart showing production tax revenue that declined as oil prices crashed from more than $100 per barrel to a low of $26 per barrel from 2014 to 2016 before rebounding to the mid-$60 range over the past year. (Photo/Elwood Brehmer/AJOC)

Alaskans, it’s time to dust off your economics textbooks and dig the calculators out of the back of your junk drawers because the arcane issue of oil taxes is again about to be a hotly contested topic going into the 2020 elections.

The sponsors of the Fair Share Act all but assured oil taxes will be a central debate point over the coming year when they filed an initiative petition Aug. 19 with the state Division of Elections to put a major production tax change the ballot next year.

The aim of the Fair Share Act is to raise the production tax rate on the three largest and generally most profitable North Slope oil fields of Prudhoe Bay, Kuparuk River and Alpine.

Initiative sponsor and longtime Alaska oil and gas attorney Robin Brena, who chairs Vote Yes for Alaska’s Fair Share, said during a Sept. 9 press conference to officially kick off the campaign that under the current oil tax system Alaska is “giving away $1.5 (billion) to $2 billion in tax breaks and getting nothing in return.”

That system, best known by its legislative title Senate Bill 21, would return Alaska to being a competitive oil region and spur additional investment and eventually reverse the long trend of declining North Slope oil production industry advocates said at the time.

However, a host of lawmakers and interested citizens — including many who were not fans of the former oil tax system called ACES — saw SB 21 as swinging the tax pendulum too far towards industry’s side and launched a referendum to repeal it.

The referendum made it to the 2014 primary election ballot but ultimately failed by more than 10,000 votes, or a margin of 52.7 percent to 47.3 percent. That loss hasn’t stopped the debate over the system, though.

Brena was blunt in his assessment of the way the state calculates its oil production tax.

“Senate Bill 21 is an abject failure for Alaska. It’s giving away massive tax breaks for no particular reason,” Brena said Sept. 9.

“As an overall matter there’s no better deal for the oil industry than Alaska. They make more money in Alaska than they do anywhere else in the world that matters with significant oil production.”

Alaska Oil and Gas Association CEO Kara Moriarty said total oil revenue still accounted for roughly $2.6 billion in fiscal 2019, which ended June 30.

The tax would hit 90 percent of North Slope production activity that helps support almost 100,000 jobs, she said.

“You’re targeting three of the largest investors in Alaska. I mean, what kind of message does that send? I think it’s punitive; it just doesn’t make sense to me,” Moriarty said. “Why would we want to double or sometimes even triple production taxes on three of the state’s largest investors? To me, it just doesn’t make any kind of sense for the economic well-being of the state.”

While the tax increase may bring in additional short-term revenue, it will discourage the investments that translate to oil production, which also generates royalty revenue for the state’s General and Permanent funds, she said.

“We want to continue to have a strong partnership and presence in the state of Alaska, but if voters decide that they want another billion dollars-plus from the industry, companies will make a business decision and will start shifting their investments elsewhere,” Moriarty added.

Brena contends that Alaska has historically received about 28 percent of the gross value of produced oil, which includes royalty payments, while in the nearly six years since SB 21 took effect the state has received less than 20 percent of the gross value of oil. The gross value is the market price at the time the oil is produced minus the pipeline and tanker transportation costs required to get the oil to West Coast markets.

Both are less than the oil revenue split envisioned by oft-invoked former Gov. Jay Hammond, who suggested the oil companies and state and federal governments should each get approximately one-third of the value of the state’s oil. Hammond was governor during the late 1970s when North Slope oil production was just beginning and, for better or worse, Alaska became inextricably linked to the oil industry.

Brena also points to a slide from a January 2018 presentation to the House Resources Committee by ConocoPhillips representatives that shows the company’s share of oil at current prices of roughly $65 per barrel is 48 percent, compared to 39 percent for the state and 13 percent for the feds. The state’s share of oil matches ConocoPhillips’ at prices in the $90 when each takes 44 percent, according to the company’s chart.

The change in the split of revenue is a result of a decline in the federal government’s share after the corporate income tax rate was cut from 35 percent to 21 percent in the 2017 federal tax overhaul.

The state’s share includes royalty, corporate income tax, production tax and oil and gas property taxes.

“It doesn’t matter what metric; by any metric you choose Alaskans are giving away our oil and we cant afford for it to continue to give away our oil at substantially less than fair rates,” he said, stressing that the intent of the initiative is to add equality back to the financial relationship between the state and its big oil producers.

Those against raising oil taxes regularly cite the need to remain competitive with Lower 48 shale oil basins that are often significantly less expensive to operate in than Alaska. The North Slope’s remote location, harsh weather and sensitive environment mean permitting a large oil project can take years and cost millions of dollars, even before sometimes billions of dollars are spent for development.

Brena counters that argument by noting that North Dakota — which has led the shale boom along with Texas and produces about 1.4 million barrels per day, nearly three times the amount Alaska does — levies a 10 percent gross tax on most of its oil. The tax increases to 11 percent at prices greater than $90 per barrel.

North Dakota producers also pay an average royalty of 18 percent, according to a May 2017 North Dakota State University report on the industry’s economic contribution to the state. The report authors surveyed companies to obtain the figures, as royalty payments are made to private landowners and generally remain confidential.

At current oil prices the major North Slope producers are near the gross-net crossover point of Alaska’s hybrid production tax, meaning they are paying the 4 percent gross minimum tax or just slightly more if they are profitable enough to move into the net tax.

SB 21 calls for the companies to pay the larger of the 4 percent gross tax or the 35 percent net profits tax after application of the currently $8 per barrel production credit.

Several years ago the crossover point was in the low to mid-$70 per barrel range, but it has fallen as companies have reduced their operating costs, partly through workforce reductions but also through lower cost contracts with service companies, according to industry representatives.

The historical average oil price since 1980, adjusted for inflation to today’s dollars is approximately $55 per barrel, according to the Energy Information Administration.

Alaska’s 4 percent gross tax combined with a primarily 12.5 royalty on state leases in the legacy fields adds to a state take — less corporate and property taxes — of 16.5 percent. The comparable rate in North Dakota is 28 percent, Brena notes.

He also emphasizes that ConocoPhillips 2018 Alaska net income of more than $1.8 translates to $27 per barrel of oil equivalent when spread over its share of oil and gas produced in the state last year.

“There isn’t any place in the world that has substantial reserves of oil where you can make the $27 per barrel ConocoPhillips made from our oil in 2018,” Brena said in an interview.

He also cited multiple references to Alaska being the company’s “low cost of supply resource base” in reports and investor presentations.

Much of the broader oil tax discussion is centered on ConocoPhillips, Alaska’s largest oil producer, as the company is required to break out results of its Alaska operations in its regular financial reporting to the Securities and Exchange Commission because its activities in the state account for significant segment of its worldwide business.

Company officials dispute the claim as being overly simplistic. They point out that North Slope production is dominated by oil, which is more profitable on an equivalent basis than the natural gas that is produced and sold alongside oil in many other basins.

Additionally, the net income calculation includes deductions for reservoir depletion, facility depreciation and other items that are not cash costs and therefore do not represent cash flow, which is what economic decisions are usually based on.

An April 2018 ConocoPhillips investor report says the company had an operating margin of $27 per barrel at $50 per barrel prices to start the year. Texas oil averaged $64 per barrel last year.

“That is our competition,” ConocoPhillips Alaska Vice President Scott Jepsen wrote via email. “We continue to invest in Alaska because we have been able to stay competitive on costs, and that includes the production tax framework. If the proposed tax initiative were to become law, it would jeopardize North Slope investments.”

According to Brena, the state’s production tax revenue averaged $12 per barrel in 2009 under ACES when oil prices averaged $68 per barrel and fell to about $2 per barrel at $72 oil in 2015.

“The Fair Share Act will add $6 to $7 per barrel so we will be back up to $9 to $10 per barrel,” he said, adding that the average tax would still be less than it was under ACES.

The Fair Share Act would increase the gross minimum tax to 10 percent at prices less than $50 per barrel. It would continue to increase 1 percent for every $5 bump in oil price until hitting a 15 percent cap at $70 per barrel.

The tax change would also repeal the per barrel credit, a key part of SB 21, which is up to $8 per barrel at current oil prices and steps down to zero at very high prices. The per barrel credit is used as a means to increase the effective net tax along with oil prices.

When the monthly production tax value of oil is equal to more than $50, an additional tax that would be the difference between the average production tax value and $50 multiplied by 15 percent.

The new taxes would only be levied on fields with average production of more than 40,000 per day and cumulative production of more than 400 million barrels, meaning it would apply to the big three fields — Prudhoe Bay, Kuparuk and Alpine — owned by ConocoPhillips, ExxonMobil and BP (soon to be Hilcorp Energy).

Brena stressed it would do nothing to companies developing and producing oil from new fields unless they eventually reach those high production thresholds. Therefore, it should not discourage new entrants to the North Slope, which he hopes the state can attract.

According to documents provided by Vote Yes for Alaska’s Fair Share, the act would increase the state’s production tax revenue by approximately $1 billion per year. That money could be used to help resolve some of the state’s biggest challenges, Brena said.

“We are talking about changing the entire quality of life in Alaska and we haven’t even touched half of the deficit,” he said. “In addition, we’re getting half of our PFDs, and we haven’t had a meaningful capital budget in years.”

The state’s production tax revenue went from $2.6 billion in 2014 to $381 million in 2015, the first full year under SB 21, but also at a time when average oil prices also fell by approximately one-third. SB 21 brought in $125 million in 2017 after prices bottomed out at $26 per barrel before somewhat higher prices helped the state bring in $741 million in fiscal 2018.

The producers have also lowered their operating costs significantly since oil prices started collapsed in late 2014, which can improve the state’s net tax take.

Brena disputes that the Fair Share Act will discourage investment. He contends that the “vast majority” of investment over the history of North Slope oil has occurred when the state’s tax rates were higher.

Supporters of SB 21 often pointed out as it was being debated that exploration activity was almost nonexistent in 2012 with just one well drilled over the winter despite prices greater than $100 per barrel.

According to a February report by Department of Revenue economists, capital spending within Prudhoe Bay has declined each year since it totaled $877 million in 2014 to $210 million last year.

Overall North Slope capital spending has been on a decline as well. According to the report, after hitting a near-term peak of more than $4 billion in 2015 it has fallen to $1.5 billion in 2017 and $1.7 billion in 2018.

Brena and others have been critical of the stagnant levels of North Slope oil production despite numerous claims at the time SB 21 was enacted that it would lead to more production.

With minor fluctuations, North Slope production has generally declined slightly since 531,000 barrels per day were produced in 2013 when SB 21 was passed; though the overall trend has slowed greatly versus the steady year-over-year declines of 5 percent to 6 percent since production peaked in 1988.

Despite the low prices at the time, production increased year-over-year in 2016 and 2017; the year-over-year increases were the first since 2002 when the Alpine field came online.

Production averaged approximately 498,000 barrels per day in fiscal 2019, the first fiscal year it was less than 500,000 barrels since North Slope oil started flowing; however, the 2013 state production forecast estimated 2019 production to be about 426,000 barrels per day.

ConocoPhillips’ Jepsen noted during a Sept. 12 presentation during a meeting of the Alaska Support Industry Alliance that simply holding production relatively flat means producing more oil to counteract the natural decline of Alaska’s old, large fields.

SB 21 backers insist the large North Slope projects in permitting — ConocoPhillips’ Willow and Oil Search’s Pikka developments, each with the potential to generate more than 100,000 barrels per day — along with several other smaller projects are proof the current tax system is working.

The Fair Share Act would also reinstitute the mechanism known as “ring fencing” which requires companies pay their production taxes on a per-field basis. Brena said ring fencing would prevent the large producers from reducing their taxes on the three large fields by applying deductions earned through capital expenditures on other not yet producing projects.

As it stands now, ConocoPhillips will be able to deduct 35 percent of the $4 billion to $6 billion the company is expected to spend developing Willow over the next 7 to 8 years. That could reduce its production tax obligation on the profitable legacy fields, all of which ConocoPhillips has a significant stake in, by several hundred million dollars per year, Brena said.

Act sponsors note that ring fencing was a part of Alaska’s tax system for years until 2006, when the ongoing back-and-forth over oil taxes really began.

Producer officials say it was workable in part because the state had a more simple gross system and incorporating net profit tax elements to a tax system fundamentally requires at least a portion capital investments be deductible across fields in a given region.

Finally, it would make “all finings and supporting information provided by each producer to the (Revenue) Department relating to the calculation and payment of (production) taxes,” the initiative states.

The act would also require the cost, revenue and profits for each company in the legacy fields be made public. He said regulations would determine what specific information is made public, but he doesn’t believe there is a need to see details that could jeopardize competition among producers and service companies on the Slope.

Alaskans, who own the oil and gas resources, should be able to know how their partners in the effort to develop those resources are doing, he said.

Moriarty said it’s unclear at this point if the provision to make tax records public documents would violate federal SEC laws or not, but she said the concept of making oil tax records public should be cause for concern for everyone in business in the state.

“It pretty much blows away every confidentiality statute on the books,” she said.

Legislative reaction

Anchorage Democrat Sen. Bill Wielechowski has been at the front of the push in the Legislature to change SB 21 and specifically repeal the per barrel credit. He has said the simple change could generate up to $1.2 billion per year and has submitted legislation to do it. The bills have not been considered in the Republican-held Senate.

Wielechowski said he supports the Fair Share Act and it might be a better way to deal with oil taxes because it removes the per barrel credit but also addresses the low minimum tax.

“If we’re going to fix the tax system, let’s make it durable,” he said.

Senate President Cathy Giessel, R-Anchorage, said she thinks the sponsors paint an inaccurate portrayal of SB 21. She stressed that production and the associated state royalty revenue — significantly less for oil from federal lands — is what truly generates revenue for the state and more taxes will simply discourage it.

“It will be another battle to defend the reasonable, competitive tax structure we put in place,” Giessel said in an interview.

The Legislature could kick the initiative off the ballot, presuming it makes it, by passing a law that is “substantially similar,” but just defining the term is nearly impossible, she said.

Lt. Gov. Kevin Meyer has until Oct. 15 to rule on the initiative petition application, a decision usually made via guidance from the Department of Law. If the application is approved the sponsors can begin gathering signatures. A rejection is appealed through the court system.

Senate Minority Leader Tom Begich, D-Anchorage, said over the summer that he was discussing modest oil tax changes with lawmakers of both parties.

It seems likely the issue will be more of a debate than it was in 2019, which has been consumed by the budget and PFDs. However, Giessel said its difficult to make tax changes with significant implications in just a single session, especially when there are many new House members likely unfamiliar with the highly complex issue as there are this Legislature.

Democrat members of the bipartisan House Majority said they are happy the initiative addresses the minimum tax rate, while some said the progressivity it adds to oil at higher prices is fairly aggressive.

The House Majority formed last year to counter Gov. Michael J. Dunleavy’s plans for more than $1 billion in budget cuts with far more modest reductions, but part of the deal was also that the issue of oil taxes would be set aside by the caucus.

“It’s like Alaska is burning and our political leadership has decided not to talk about water,” Brena said.

Updated: 
09/18/2019 - 9:32am

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