Legislature(2003 - 2004)

05/09/2003 08:45 AM House FIN

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
HOUSE BILL NO. 198                                                                                                            
     An Act providing for a reduction of royalty on certain                                                                     
     oil produced from Cook Inlet submerged land.                                                                               
REPRESENTATIVE  VIC KOHRING  commented  that the  goal of  HB
198, which amends existing statutes  in Title 38, would be to                                                                   
provide  for a  narrowly  defined and  specifically  targeted                                                                   
reduction of royalty  on oil produced from Cook  Inlet fields                                                                   
and  platforms as  they approach  the end  of their  economic                                                                   
lives.   Plans to idle  two of the  13 current oil  producing                                                                   
platforms in the Inlet act as  a reminder of the certainty of                                                                   
decline  and ultimate  end of  production  for those  fields.                                                                   
Premature  abandonment of those  fields would  not be  in the                                                                   
State's best interest.   The infrastructure created  to serve                                                                   
those fields  is extensive.   Decreasing the State's  royalty                                                                   
share from  12.5% to 5%  near the end  of field's  life would                                                                   
improve  the  economics  of the  aging  platforms  and  could                                                                   
result in a 14-month extension in production.                                                                                   
Representative Kohring  suggested that prolonging  production                                                                   
would help to achieve several important policy objectives:                                                                      
   ·    Use of critical infrastructure to support new                                                                           
       exploration or development of adjacent lands,                                                                            
   ·    Delaying loss of industry jobs, and                                                                                     
   ·    Increasing the total amount of oil and gas produced                                                                     
        through the aging facilities.                                                                                           
To protect the  State's economic interest,  royalty reduction                                                                   
to 5% on oil produced from the  targeted fields and platforms                                                                   
is  designed to  occur only  when  production declines  below                                                                   
1,200 barrels per  day for the Dolly, Grayling,  King Salmon,                                                                   
and Steelhead Platforms  and continues at that  level so long                                                                   
as production  does  not go above  that threshold.   For  any                                                                   
quarter, should production go  above 750 barrels per day, the                                                                   
State's royalty share would increase  1% with each additional                                                                   
100  barrels up  to 1,200  barrels.   The  royalty share  for                                                                   
production over 1,200  barrels would return to  12.5%.  Those                                                                   
trigger production  rates generally  correspond to  different                                                                   
economics  of the  two  sets of  platforms.   By  encouraging                                                                   
continued  production  of  marginal   fields,  HB  198  would                                                                   
benefit the  State and local  economies through  taxation and                                                                   
royalties,   encourage   future   development  of   new   oil                                                                   
discoveries    by   lowering    the    costs   of    industry                                                                   
infrastructure,  as well  as taking care  of preserving  jobs                                                                   
for Alaskans.                                                                                                                   
Co-Chair  Harris  pointed  out  that  the  legislation  would                                                                   
extend  rig life  in  the Cook  Inlet  area.   Representative                                                                   
Kohring acknowledged  that it  would exclusively  affect Cook                                                                   
Co-Chair  Harris inquired  if there was  any indication  that                                                                   
the rigs would be "shutting down"  without the passage of the                                                                   
legislation.   Representative Kohring explained  that most of                                                                   
the rigs  are getting to the  point where they are  no longer                                                                   
profitable,  at which  time, the  industry  will "moth  ball"                                                                   
Co-Chair Harris mentioned  the possible loss of  revenue in a                                                                   
year  and  asked  the  types  of  royalties  that  the  State                                                                   
receives  from these  breaks.   Representative Kohring  noted                                                                   
that Mr. Meyers  would be best to address that  question.  He                                                                   
added  that if  the facilities  become  "moth balled",  there                                                                   
will be no royalties received by the State.                                                                                     
Representative Stoltze  asked if these platforms  were within                                                                   
the  Kenai  Borough taxation  jurisdiction.    Representative                                                                   
Chenault replied that they were.                                                                                                
GARY  CARLSON, (TESTIFIED  VIA  TELECONFERENCE), SENIOR  VICE                                                                   
PRESIDENT,  FOREST   OIL,  focused  on  the   maintenance  of                                                                   
critical  and  scarce  infrastructures  associated  with  the                                                                   
mature oil fields  in Cook Inlet.  Platforms,  the associated                                                                   
pipelines   and   related   on-shore   facilities   represent                                                                   
irreplaceable  infrastructure,   which  may   facilitate  the                                                                   
exploration,  discovery and development  of the  undiscovered                                                                   
reserves.    Any  delay  will   provide  opportunity  to  the                                                                   
industry  to  develop  smaller  scale  oil  and  gas  product                                                                   
prospects  that  would  not  stand the  economics  of  a  new                                                                   
infrastructure  being developed.   The operators need  to get                                                                   
creative and  they need the  cooperation of their  vendors to                                                                   
share the in those efforts.                                                                                                     
Mr. Carlson  believed that it  was appropriate for  the State                                                                   
to step in and act as a partner  also.  He commended the bill                                                                   
sponsor   for  the   foresight   used  in   support  of   the                                                                   
MARK  MEYERS,   (TESTIFIED  VIA  TELECONFERENCE),   DIRECTOR,                                                                   
DIVISION  OF OIL AND  GAS, DEPARTMENT  OF NATURAL  RESOURCES,                                                                   
ANCHORAGE,  stated that  the  agency had  extensively  worked                                                                   
with the  bill's sponsor.   The  plan is  modeled closely  to                                                                   
when the operating  costs exceeded the revenues.   The fiscal                                                                   
note describes  individual platforms  and what their  current                                                                   
production is and what their future  production might be.  He                                                                   
reiterated that  the legislation  had been carefully  modeled                                                                   
to minimize the  negative fiscal impact while  continuing the                                                                   
life of  the platform.   It  is estimated  that reducing  the                                                                   
royalty  share by  7.5%  could extend  the  economic life  by                                                                   
approximately 14 months.  There  is a period of time when the                                                                   
operations could be  profitable for a longer period.   At the                                                                   
current rate of production, they  are old infrastructures and                                                                   
the production  is in a  steady state  of decline.   Once the                                                                   
platforms  are pulled  out, the  overall  economic costs  and                                                                   
viability of the projects increases  on these platforms.  The                                                                   
value of  the entire  industry rests on  these dates  and the                                                                   
hope is that future exploration  will offset other quantities                                                                   
of oil  to offset  the date.   The  bill does  not "fix"  the                                                                   
issue  of  aging   infrastructures  but  it   does  help  and                                                                   
postpones  it in order  to buy  more time.   New  discoveries                                                                   
need to be found.                                                                                                               
Mr. Meyers continued  that the incremental benefits  would be                                                                   
in  sustaining jobs  and overall  production  refined in  the                                                                   
Cook Inlet area.                                                                                                                
WILLIAM NEBESKY,  (TESTIFIED VIA TELECONFERENCE),  COMMERCIAL                                                                   
ANALYST,  DIVISION  OF OIL  AND  GAS, DEPARTMENT  OF  NATURAL                                                                   
RESOURCES,  ANCHORAGE, advised  that the  bill would  provide                                                                   
economic benefit  to the State.   It has been  estimated that                                                                   
there could be  as much as $2.2 million dollars  per month in                                                                   
royalty revenues, $26 million dollars per year.                                                                                 
Representative  Whitaker  asked  about the  costs  associated                                                                   
with the  fiscal note.   Mr. Meyers  responded that  the note                                                                   
was modeled from triggering the  lower royalty at the trigger                                                                   
price,  assuming the  normal decline  of the  field with  the                                                                   
incremental benefit  of extended life, platform  by platform.                                                                   
The royalty  would  be reduced  and would be  less but  would                                                                   
also be adding an incremental  wedge of royalty for the extra                                                                   
time the platform is in production.                                                                                             
Representative   Whitaker  interjected   that   there  is   a                                                                   
"possibility of  an increase" to  State revenues.   Mr. Meyer                                                                   
acknowledged  that  was  correct, commenting  that  it  would                                                                   
extend  the life  of  the platform.   It  could  act like  an                                                                   
"insurance policy"  and that an incremental  assessment would                                                                   
be made,  keeping the entire  infrastructure in tact  as long                                                                   
as possible.                                                                                                                    
REPRESENATIVE ETHAN  BERKOWITZ asked  if the premise  for the                                                                   
legislation was that  production costs were too  high and the                                                                   
only way to keep  wells going was if costs were  reduced.  He                                                                   
questioned if the only way to  reduce costs would be to "give                                                                   
away" royalty  oil.  He  requested some assurance  that other                                                                   
factors relating  to operating  costs would still  be managed                                                                   
in a  prudent manner.   Representative Berkowitz  inquired if                                                                   
there had  been consideration  given to removing  the royalty                                                                   
reduction  if operating  costs  were somehow  reduced in  the                                                                   
Mr. Meyer responded  that these platforms are  "late in their                                                                   
life"  of  production.   The  level  of production  does  not                                                                   
provide a lot of  space to do major operations  on the wells.                                                                   
He surmised that the State was  looking at "skinny" economics                                                                   
in  the first  place, which  drives smaller  operators to  be                                                                   
more efficient.   There are considerations in  the bill under                                                                   
Section G(ii), which guarantees  that protection be reservoir                                                                   
related and not a mechanical problem.                                                                                           
Representative  Hawker  pointed   out  the  loss  of  revenue                                                                   
indicated in  the fiscal  note.  He  asked what the  benefits                                                                   
would  be to  the State.   Mr.  Meyer  acknowledged that  the                                                                   
largest benefits  are speculative.   As the economics  of the                                                                   
platform changes and gets smaller,  the larger companies have                                                                   
more overhead.   They may abandon the platforms  earlier than                                                                   
another company.   If the  State provides incremental  value,                                                                   
that  might entice  another operator  to come  in and  invest                                                                   
more money  in the  facility, in  looking at the  exploration                                                                   
potential.   It is  hoped that  notice will  be taken  of the                                                                   
advantage  of such a  prospect and  drilling the  exploration                                                                   
wells.  Mr.  Meyers commented that what the  State "gives up"                                                                   
is  relatively small  in comparison  to  the exploration  and                                                                   
operation  of  the  wells.    At  some  point  in  time,  the                                                                   
platforms  will be abandoned.   The  integrated economics  on                                                                   
the Cook  Inlet are operating  efficiently and the  State can                                                                   
extend their  life by buying enough  time for the  next stage                                                                   
of exploration.  That economy cannot be quantified.                                                                             
Representative   Hawker   summarized    previous   discussion                                                                   
regarding reduction to the royalty  rate.  He inquired if one                                                                   
premise  was  that  there  would be  some  extension  to  the                                                                   
productive life of  the wells.  Mr. Meyer responded  that had                                                                   
been modeled  into the numbers  and that there  clearly would                                                                   
be  an  extension  to  the  life   of  the  platforms.    The                                                                   
legislation  will  clearly  lead   to  an  extension  of  the                                                                   
ultimate  production  of  the  wells; however,  what  is  not                                                                   
included in the  note, is the current production  decline and                                                                   
that royalty benefit is not known.                                                                                              
Representative  Hawker commented that  the model and  the net                                                                   
change in  revenue do factor  into the Department's  estimate                                                                   
of the extended production.  Those  numbers do not offset the                                                                   
revenues given up by reducing  the royalty rates.  Mr. Meyers                                                                   
acknowledged  that was correct,  however, the Department  has                                                                   
not  captured the  up-side.   The  negative  effect has  been                                                                   
minimized  regarding the  up-side potential.   He  reiterated                                                                   
that it  is very important  to buy  time for the  facilities.                                                                   
If  there  was  a  shut  down,   domino-effect  data  is  not                                                                   
available  but   is  definitely   of  concern.     Experience                                                                   
indicates  that a  30-40 million  barrel  field discovery  is                                                                   
needed to  offset another platform.   Those numbers  could be                                                                   
lower if  an existing  platform was used.   He admitted  that                                                                   
the tangible benefits  cannot now be proven but  that they do                                                                   
Representative   Hawker   reiterated  that   the   Department                                                                   
believes  that there  are benefits  but that  they cannot  be                                                                   
proven, hence, members need to make a judgment call.                                                                            
Representative  Berkowitz pointed  out  that the  legislation                                                                   
asks that  the State share in  the downsize.  He  inquired if                                                                   
thought had  been given  to doing a  "price trigger"  for the                                                                   
royalty reduction.  If the price  of the product is high, the                                                                   
State  should not  have to  forego  the royalty  share.   Mr.                                                                   
Meyer replied that  under AS 35.05.180, a mechanism  had been                                                                   
written  and  would  improve  that process.    If  a  typical                                                                   
economic  platform  was  developed,   then  the  State  could                                                                   
customize it for that field.   The problem remains that there                                                                   
is  high  administrative  overhead   with  no  certainty  for                                                                   
results.   One  advantage of  the current  type mechanism  is                                                                   
that it  provides relative certainty  for operating  value in                                                                   
the royalty production.                                                                                                         
Mr. Meyer  continued, the  State has attempted  to look  at a                                                                   
mechanism  that  was simpler  and  more predictable  for  the                                                                   
company with little downside for  the State.  When looking at                                                                   
individual  platforms, it  does not  take into  consideration                                                                   
structure  questions.    Mr. Meyers  noted that the  language                                                                   
would bring the  royalty rate back to 12.5%  under successful                                                                   
production increases.                                                                                                           
Representative Berkowitz questioned  if there were mechanisms                                                                   
in place that would allow the  State to share in the up-side.                                                                   
He noted  that if the  price was at  $35 dollars  per barrel,                                                                   
the  State should  not forgo  its royalty  percentage.   That                                                                   
could be  a lot of  money and could  serve many of  the State                                                                   
funded programs.                                                                                                                
Mr. Meyers  explained that HB  198 would provide  the average                                                                   
price  used for  planning purposes.   The  advantage to  that                                                                   
mechanism is  that it is  appropriate for royalty  reductions                                                                   
and  projects  out  a  certainty   for  operating  value  and                                                                   
profitability to the company,  given the production forecast.                                                                   
The Division  is attempting to  stimulate more activity.   If                                                                   
the company  knows that there  are set royalty costs,  it can                                                                   
provide a  clear quantifiable  number of  how much  profit is                                                                   
left in the platform.   Mr. Meyers noted that  it is indented                                                                   
to provide a thirty-year life to the platforms.                                                                                 
TAPE HFC 03 - 85, Side B                                                                                                      
Mr.  Meyers thought  that  there would  be  an overall  yield                                                                   
price  of  $23  dollars  per  barrel.    The  price  was  not                                                                   
customized platform  by platform  but rather as  a reasonable                                                                   
assumption for the oil price.                                                                                                   
Representative  Whitaker  asked  if a  fair  characterization                                                                   
would be  that the State would  be "giving up  some 'upside',                                                                   
insuring  against the  downside".  Mr.  Meyer responded  that                                                                   
sharing in the upside has two advantages:                                                                                       
   ·    The State will return to the 12.5% rate with                                                                            
        increased production.                                                                                                   
   ·    If new oil is developed, the State receives the                                                                         
        12.5% royalty on a larger pool of oil that would not                                                                    
        have been developed if the infrastructure had been                                                                      
Representative  Moses  injected that  the  bill  acts like  a                                                                   
"subsidization";  he  voiced  concern  with  a  formula  that                                                                   
presents a  net loss to the  State.  Alaska cannot  afford to                                                                   
subsidize  any  industry  while  at  the  same  time  cutting                                                                   
services.   Mr. Meyers  acknowledged that  the State  needs a                                                                   
diversified oil  program with as many producers  as possible.                                                                   
He pointed out how extending the  life of the platforms would                                                                   
encourage  newer,   smaller  companies   to  invest   in  oil                                                                   
exploration  in Alaska.   He suggested  that the bill,  while                                                                   
proposing an  initial possible loss, also  provides insurance                                                                   
for further  developing of the  industry.  He  concluded that                                                                   
the  investment  in the  "up  side"  was worth  the  possible                                                                   
return.  He  emphasized that once a platform  is closed, they                                                                   
cannot  be replaced.   In  the  current configuration,  these                                                                   
platforms have  been loosing approximately fifty  barrels per                                                                   
day.   The bill  presents a customized  version to  encourage                                                                   
Representative Moses  responded that with the  new methods of                                                                   
drilling,  there is  a possibility  that  platforms might  be                                                                   
obsolete before  long.  Mr.  Meyers responded that  there are                                                                   
economic  and   environmental  advantages  to   drilling  off                                                                   
platforms.   New  technologies  have improved  in the  Inlet,                                                                   
however, for bonding,  operating platforms and  the costs are                                                                   
on a  thin margin,  which is  the reason  that the  State has                                                                   
compromised with the various groups.                                                                                            
KEVIN  TABLER,   (TESTIFIED  VIA   TELECONFERENCE),   LAND  &                                                                   
GOVERNMENT  AFFAIRS MANAGER, UNION  OIL, voiced  appreciation                                                                   
for HB 198,  which specifically targets those  platforms that                                                                   
are approaching their aging life.   He provided his companies                                                                   
perspective and the benefits of  the legislation.  Unocal Oil                                                                   
is the predominate operator in  Cook Inlet and operates 10-15                                                                   
platforms in that area.  It is  the place where the company's                                                                   
infrastructure,   manpower   and  capital   investments   are                                                                   
continually  threatened  by  global   competition  investment                                                                   
dollars.     For   the  last   several   years,  Unocal   has                                                                   
consolidated  and restructured  their  Alaskan operations  to                                                                   
focus on becoming the lowest cost  producer in the Cook Inlet                                                                   
area.  The Cook  Inlet area, with their mature  and declining                                                                   
fields  and   low  margin  properties,  has   extremely  high                                                                   
operating  costs and  the  regulatory uncertainty  creates  a                                                                   
challenging environment.  The  cost of cutting is a temporary                                                                   
fix.    Mr.  Tabler  maintained  that  the  only  sustainable                                                                   
solution to longevity would be  to increase the reserve base.                                                                   
HB 198  would not necessarily  increase that base of  a field                                                                   
or platform,  but it will  sustain the economic  viability of                                                                   
the  existing  infrastructure.     That  could  lead  to  the                                                                   
ultimate  recovery of  more  reserves, having  an  offsetting                                                                   
Mr. Tabler  added that equally  important is the  possibility                                                                   
for oil  reduction to increase  the attractiveness  of making                                                                   
additional investments  in the field.  These  properties have                                                                   
to compete  internally with  other opportunities  that Unocal                                                                   
has.  It  is certain that  if the economic viability  is left                                                                   
unchecked,  shut  down would  be  accelerated,  leading to  a                                                                   
lower tax  base, unemployment,  and loss of monetary  support                                                                   
throughout the community.                                                                                                       
Mr. Tabler referenced that the  cost analysis provided by Mr.                                                                   
Meyers, which had  been based on an analysis  supplied by the                                                                   
companies.   He  spoke to  the  "sub-economic" platforms  and                                                                   
that the only thing that allowed  those platforms to continue                                                                   
production comes from other platforms.   Operating costs have                                                                   
to be spread across the rest of the platforms.                                                                                  
Mr. Tabler acknowledged that lay-offs  have occurred and that                                                                   
it would only  be a short period before  additional platforms                                                                   
will  be suspended.   With  the mature  fields, when  royalty                                                                   
relief is  justifiable, the life  extension of  facilities is                                                                   
important  to the overall  infrastructure  and is of  primary                                                                   
benefit.   In reviewing the  language of the  bill, different                                                                   
platforms have  different thresholds for  economic viability.                                                                   
Although  each platform  is different,  the State should  not                                                                   
loose site  of the  overall economics of  Cook Inlet.   Those                                                                   
economics  are  sensitive to  not  only  price but  also  the                                                                   
impact  cost sharing.    Additional  costs place  an  initial                                                                   
burden  on the  remaining  facilities and  therefore  shorten                                                                   
their life.  The  time to give relief is when  they are still                                                                   
economic and there is still potential  to extend the field to                                                                   
increase production.  He maintained  that the bill is a clear                                                                   
and concise  vehicle to support future  exploration projects.                                                                   
Mr. Tabler encouraged passage of the bill out of Committee.                                                                     
HB 198 was HELD in Committee for further consideration.                                                                         

Document Name Date/Time Subjects