Leaders talk gas tax changes: Senate bill would lower tax rate, House democrats opposed

An effort to make a structural change in the state's oil and gas production tax law is gathering momentum in the state Senate and could become a pivotal issue as the 2010 legislative session enters its final weeks.

Democrats in the state House don't like the bill.

Senate Bill 305 is designed as a platform to make more significant changes, such as lowering the tax rate, once the Senate sends the bill to the House, lawmakers said.

In a signal that the Senate intends to fast-track the measure, Senate President Gary Stevens gave SB 305 a referral to only one committee, the Finance Committee, waiving the usual procedure of sending major bills to at least two committees. Ordinarily the bill would also go to the Resources Committee.

Hearings on the bill began March 10 in the Finance Committee. Sen. Bert Stedman, R-Sitka, the committee co-chair, said SB 305 would have the effect of separating oil and gas in the production tax law.

Oil and gas currently are combined for tax purposes, but the effect of the combination is to significantly lower state revenue from oil once commercial gas production begins on the North Slope, Stedman said at the March 10 hearing.

That won't happen unless a gas pipeline is built, and in any event it is 10 years or so into the future. Still, Stedman said he feels the time to make the change is now, before the start of a May 1 open season, when TransCanada Corp. will seek customers to buy gas from its pipeline.

The state is offering to lock in production taxes at current rates for 10 years for any gas producing company agreeing to lease capacity and ship gas in TransCanada's pipeline.

Stedman said he's worried about locking in the tax given the current configuration of the tax law.

Democrats in the state House are suspicious of the senate bill.

In the Democratic minority's weekly briefing, House Minority Leader Rep. Beth Kerttula, D-Juneau, said the broad title of the senate bill, "An Act Relating to the Tax on Oil and Gas Production," is a tipoff that there may be other agendas.

Usually the title of the bill describes the issue being dealt with in a more narrow fashion, and state law requires bills in the Legislature to deal only with the one subject described in the title.

Although the practice is discouraged, legislators sometimes get around this by writing titles that are broad enough so that language from other bills can be added as the bill moves through committees and from one body of the Legislature to the other.

Kerttula thinks this could happen with SB 305.

"A title that broad can lead to a lot of mischief," she said.

The House is now working on HB 308, sponsored by Rep. Craig Johnson, R-Anchorage, that would reduce the oil and tax rate. The bill is now in the House Resources Committee, its first committee in the House.

"If the issue could be kept to just 'decoupling' oil and gas in the tax law, we could reach a compromise on this, but I don't think that will happen," Kerttula said. "We're headed for a huge debate on oil and gas taxes again. I think we're headed for a meltdown."

The Legislature, meanwhile, has hired a powerful team of consultants, including three retired senior state revenue officials, to help with the legislation.

Former state tax director Dan Dickinson has been joined by former state chief petroleum economist Chuck Logsdon and Roger Marks, a former senior economist in the Department of Revenue.

All three were deeply engaged with petroleum tax issues in their years with the revenue department. They are working under a contract with the Legislative Budget and Audit Committee.

In the initial hearing on SB 305 in the Senate, Marks said the problem in the current tax law is that the state production tax is 25 percent of a producer's net profits, which is adjusted upward by a "progressivity" formula linked to oil prices when the market price of crude oil moves above $30 per barrel.

The tax now applies only to oil produced on the North Slope because there is no commercial gas sales from the Slope as yet. Gas produced and consumed as fuel there is taxed at a special rate, as is gas produced in Cook Inlet.

But if a pipeline is built, and when gas production starts, the tax would be on the combined oil and gas. That's because nearly all the gas, at least initially, would be produced with oil in the same wells.

The energy value of the oil and gas, computed in British Thermal Units, would be blended and used as a basis for the state net profits tax.

Combining the two this way solves a major problem in allocating fairly the production costs between gas and oil for the purposes of calculating the net profit.

The problem with that: the value of oil and gas varies widely, and the current progressivity formula in the tax law was designed for oil. And that affects the total revenues to the state, Marks said.

Marks offered an example: the 4.5 billion cubic feet of gas that producers plan to get out of the pipeline has an energy content equal to 900,000 barrels of oil a day. Once gas is produced, if there are 500,000 barrels of oil coming out of the Slope a day, producing companies would pay taxes on the combined equivalent of 1.4 million barrels per day of oil.

However, the gas has only one-tenth the value of crude oil, Marks said. Assuming a market price for gas of $6 per million British Thermal Units (this is 25 percent more than it is today, Marks said) the gas would be worth $1.37 per million British Thermal Units on the North Slope after all the pipeline costs are deducted.

The state tax is based on the net value of oil and gas on the Slope, after transportation costs are deducted from market sales prices.

When adjusted to the "barrel of oil equivalent" for comparison, the gas value is equal to a $7.54 per barrel of oil equivalent on the Slope, Marks told the Senate committee.

Crude oil is worth 10 times that, however, about $73.75 per barrel on the Slope. That is after transportation costs are deducted from an assumed $80 per barrel market price in the example Marks showed.

When the energy content of the two hydrocarbons are combined for tax purposes, the extreme low value of the gas has the effect of dragging down the value of the combined oil and gas below the $30 per barrel value that triggers the increase in tax rate under the progressivity formula, Marks explained.

Normally, crude oil with a value of $73.75 per barrel on the Slope would be taxed at a rate higher than the 25 percent base tax rate because of the progressivity formula. But by blending the oil energy value with the gas energy value, the value of the combined hydrocarbons drops, effectively lowering the tax rate, Marks explained.

The effect is heightened when crude oil prices are higher and gas prices are lower, as they are now.

The bottom line is that when oil prices are at $75 per barrel in the market and gas is selling for $6 per million British Thermal Units, the state would lose about $300 million per year in revenue compared to the effects if the two were taxed separately, Marks said.

If oil prices were at $100 per barrel, the state would lose about $1.1 billion a year. At $120 per barrel oil prices, the loss would climb to $2 billion annually.

Senate Bill 205 solves the problem by having the progressivity formula apply only to the oil and not the oil and gas combined, Marks told the Senate committee.

Kerttula, who worked with oil and gas taxation when she was an attorney in the Department of Law, said the proposed bill doesn't effectively separate the oil and gas streams, and could still leave problems.

"We've never been able to separate oil and gas values when they are produced together, and this bill doesn't do that," she said.

A significant loss of revenue would occur only in circumstances of high oil prices and low gas prices, she said, and it is difficult to predict what market prices will be in 10 years, and over the 30-year to 50-year life of a gas pipeline that would follow, she said.

The current tax does act as an incentive for producers to commit to a gas pipeline, however, and that's worth a lot to the state.

"I'm not concerned with the tax statute as it is written now. Is there a loss of revenue with the tax? I'm willing to take the risk," to get a gas pipeline, Kerttula said.