Anyone trying to figure out Alaska’s oil and gas taxes and the changes considered by the Legislature this spring had better reach for the aspirin bottle.
The issue is complex, arcane, and if anyone needs a late-night aid to sleeping, call up a video of one of the seemingly countless legislative committee hearings held on the topic this spring in Juneau.
Those feature consultants to the Legislature and Department of Revenue officials holding forth with PowerPoint after PowerPoint showing thin colored lines curving like strands of spaghetti across the screen. They mean something, of course, but not to most of us.
So, here’s the bottom line: It’s about money, of course.
A number of legislators, mainly in the state Senate, are loathe to reduce taxes on industry and give up any significant state revenue.
The industry is meanwhile worried about declining production and a high state tax that discourages new investments, which are going instead to North Dakota and Texas. Oil and gas companies want taxes to be lowered.
Gov. Sean Parnell and the state House agree with this. Last year the House passed House Bill 110, the governor’s bill that would change the state tax. The state Senate balked at HB 110, however, saying it gave away too much.
Late this spring the Senate developed its own idea in a separate bill, Senate Bill 192, which would reduce taxes to some degree — the companies said it was not enough — but which also proposed some structural changes in the state tax that would provide a better framework for pursuing certain goals, like heavy oil.
Here’s the monetary difference between the House and the Senate proposals: HB 110 would reduce taxes by about $1.4 billion a year in Fiscal 2017, the Department of Revenue has estimated.
The department also estimated that SB 192 would reduce taxes by about $450 million in the same year.
The new proposal introduced by the governor in the special session, which adopted an idea that came out of HB 276 in the final hours of the legislature, came down in the middle, reducing taxes just over $1 billion a year in Fiscal 2017, the department said.
For reference, the state will earn about $10.1 billion in all oil and gas revenues in its current budget year, Fiscal 2012, and is expected to have a $2.7 billion surplus.
The surplus was previously projected to be $1.7 billion for FY 2012, and legislators deposited that amount in the Statutory Budget Reserve in the 2011 session. However, an additional $1 billion in revenues for FY 2012 is now expected because of high oil prices, which brings the total surplus for the current year to $2.7 billion.
Besides the money, there were significant differences in the structure of all three approaches.
House Bill 110 reduced the rate of the tax increase in the “progressivity” formula by bracketing the progressivity portion of the production tax, a formula that raises the tax rate as oil prices rise, and made two other important changes.
HB 110 proposed to “bracket” the tax, similar to the federal income tax, so that as oil prices rise the higher tax rates apply only to the increments of production above certain price points rather than all of the oil production.
This change would provide an important effect of reducing the overall tax.
For background, Alaska has a net profits-type production tax of 25 percent on the value of the oil in the field after costs like transportation and production costs have been deducted.
The progressivity formula starts ratcheting the tax rate up when oil prices climb and the net production value of the oil, after expenses, climbs above $30 per barrel, which is roughly equal to a $60 per barrel market sales price. The per-barrel expenses of production and getting the oil to market, paying the pipeline and tanker costs, are now about $20 per barrel and rising.
Oil market prices are far above $60 per barrel now and the production tax rate of the state is now close to 50 percent of the net-revenue value.
When state royalty and other special taxes on oil – an oil properties tax and special corporate income tax – are included, along with the federal income tax, the total government “take” is in the range of 70 percent of the net value of the oil per barrel.
If oil prices go higher, the government take increases quickly. With this tax structure in place the companies are finding it difficult to get capital to invest in new projects. The adverse effect of the current tax as prices go higher is now widely agreed, even by many senators. The dispute is what to do about it.
Another change would be to allow higher tax credits for certain intangible drilling and other well expenses, expenses like labor and supplies, that are allowed in Cook Inlet but not on the North Slope.
There were other “levers” in the tax that could impact the tax owed. One is the oil price threshold at which the progressivity formula triggers. Currently it is $30 in net value, but there have been proposals to put the trigger at higher levels, which would reduce the tax, and to put a “cap” on the tax at different percentage points.
The objections from the state Senate to HB 110 in 2011 were mainly the amount of the tax reduction but also that the proposal had no guarantee that added investments would be made if the taxes were reduced.
The Senate struggled to develop an alternate approach all through the spring, not only to figure out how much to reduce taxes and when, but also how to build in mechanisms to ensure investments would be made. The last version of SB 192, developed unfortunately too late in the regular session, proposed a number of structural changes.
However, as the regular session ended the senate was unable to muster enough votes to actually pass its proposal and send it to the House. In the final hours of the regular session the Senate inserted a provision for new fields into another bill – HB 276 – which was later incorporated into the governor’s new proposal presented in the special session.
All along, an important objective for many senators was to provide incentives for new oil within the existing producing fields, but there was disagreement on how to do this.
There was more agreement on a reduced tax rate for entirely new oil fields outside of existing fields. HB 110 contained something similar for entirely new fields.
Setting up an incentive tax rates for new oil fields is relatively easy to establish, and for the revenue department to administer. The concept is also more accepted politically, partly because the impact on immediate state revenues is virtually zero because it takes several years to find and develop new fields.
Legacies left out
However, setting up a reduced tax for new oil in fields already producing proved to be more complicated. With existing fields the reduction in tax revenues will also occur more quickly, and would be significant.
That translates into political problems, and that was mainly the reason the Senate wasn’t able to pass its SB 192 at the end of the session.
Although many legislators resisted the tax break within existing fields, encouraging new oil from these is really the quickest way to bring significant new production into the Trans-Alaska Pipeline System, which is running at less than one-third capacity.
New wells drilled from existing facilities in the producing fields can bring on new oil within two or three years, for example, compared with 10 years or much longer for new oil from a brand new field.
Committees in the Senate did finally develop a way to give a tax break for new oil in existing fields, but it was complicated and in the end the Senate backed away from it when they did not pass SB 192.
The mechanism that was considered was a tax break for new oil produced above an existing rate of production, but determining those numbers proved to be tricky.
The method the Senate Finance Committee settled on in SB 192 was to establish a base rate of production with a decline rate that was a producer’s actual rate over three years of prior experience. Any oil produced in addition to that would get a reduced tax rate.
When the Finance Committee version of the bill went to the full Senate, however, its members balked.
Disagreements over the decline rate formula and the tax break to the producing fields was one of the reasons.
In the final days of the session the Senate did finally vote to send another tax proposal, a concept considered in drafting SB 192 but in a different form, back to the House attached to a bill that established new exploration incentives in the Nenana Basin and other unexplored regions.
The House balked at that, however.
The end result was that nothing at all passed in the regular session.
Parnell decided to have another go at it, and called lawmakers into special session. The governor’s proposal for the special session borrowed from the ideas the Senate developed.
For new fields, the most important provision is to allow an “exclusion,” or reduction in the gross value of production of 30 percent before calculating the production tax owed, for both the base tax of 25 percent and the additional tax due to the progressivity formula.
For existing fields, the exclusion would be 40 percent but only on the part of the tax obligation due to the progressivity formula. The 40 percent exclusion would not apply to the base rate of 25 percent of the net profits.
The 30 percent reduction for new fields would actually do more for industry in new fields because it is 30 percent off both the base tax and the additional tax due to progressivity.
In contrast, the 40 percent reduction for existing fields is only on the progressivity part.
The tax reform proposal was dropped from the special session agenda April 25 because of disagreement primarily from the Senate. The issue is certain to be back in 2013, however, in the new Legislature following the November elections.