Legislature(2003 - 2004)

04/24/2003 03:16 PM House O&G

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
HB 198-ROYALTY REDUCTION ON CERTAIN OIL                                                                                       
Number 0463                                                                                                                     
CHAIR KOHRING announced that the  next order of business would be                                                               
SPONSOR SUBSTITUTE FOR HOUSE BILL  NO. 198, "An Act providing for                                                               
a reduction  of royalty on  certain oil produced from  Cook Inlet                                                               
submerged land."                                                                                                                
CHAIR  KOHRING, sponsor  of SSHB  198, explained  that he'd  been                                                               
approached  by people  who  own and  operate  facilities in  Cook                                                               
Inlet,  where  most  platforms were  constructed  in  the  1960s.                                                               
Production  is declining  significantly;  two  facilities out  of                                                               
thirteen  have  been mothballed,  and  others  may be  shut  down                                                               
because they aren't economically feasible.   He told members that                                                               
the intent  is to help  those platforms specifically.   This bill                                                               
provides a royalty  break on those platforms  if their production                                                               
drops below 1,200  barrels a day.  It lowers  the state's royalty                                                               
share,  now 12.5  percent, down  to  as low  as 5  percent, on  a                                                               
sliding-scale basis.   If  production were 750  barrels a  day or                                                               
less,  for example,  it would  be 5  percent, and  it would  rise                                                               
approximately 1 percent  for every additional 100  barrels, up to                                                               
the 12.5 percent.                                                                                                               
CHAIR KOHRING  offered the expectation that  with this provision,                                                               
production  on  those  platforms  would  be  extended  up  to  an                                                               
additional 14 months.   He called upon Mr. Carlson  of Forest Oil                                                               
Corporation, who he indicated had requested the legislation.                                                                    
Number 0789                                                                                                                     
GARY  CARLSON, Senior  Vice  President,  Forest Oil  Corporation,                                                               
noted  that his  corporation has  been a  major investor  in Cook                                                               
Inlet for five years.  He  told members his testimony would focus                                                               
on  the   maintenance  of  critical  and   scarce  infrastructure                                                               
associated with mature oil fields in Cook Inlet.  He said:                                                                      
     Platforms,  associated pipelines,  and related  onshore                                                                    
     facilities   represent   irreplaceable   infrastructure                                                                    
     which  may facilitate  the exploration,  discovery, and                                                                    
     development  ...  of  as-yet undiscovered  reserves  if                                                                    
     their  useful lives  can  be extended.    Any delay  in                                                                    
     abandoning    or    ...   decommissioning    of    this                                                                    
     infrastructure  will   provide  opportunities   to  the                                                                    
     industry   to  develop   smaller-scale   oil  and   gas                                                                    
     prospects  that  won't  stand   the  economics  if  new                                                                    
     infrastructure needed to be developed.                                                                                     
     As  the  mature  fields  approach [the]  end  of  their                                                                    
     economic life,  the operators need to  get creative and                                                                    
     manage  costs carefully,  which  [includes] changes  in                                                                    
     the way they operate and  the need for cooperation with                                                                    
     their  vendors  and  contractors   to  share  in  these                                                                    
     efforts.  I believe that  it is ... appropriate for the                                                                    
     state  to  step  in  as  a partner  also.    This  bill                                                                    
     provides a way for the state to do its part.                                                                               
     Keeping the  current Cook  Inlet oil  fields on  line a                                                                    
     few more  years will maintain good  jobs, provide local                                                                    
     taxes  and  the  possibility of  new  development  that                                                                    
     could  easily exceed  the anticipated  future shortfall                                                                    
     in state  revenues resulting from any  reduction of the                                                                    
     state's  royalty.   I  want to  commend  the chair  and                                                                    
     Representatives   Rokeberg  and   Chenault  for   their                                                                    
     leadership on this bill, and  to the administration for                                                                    
     supporting their efforts.                                                                                                  
Number 0902                                                                                                                     
REPRESENTATIVE HOLM  asked whether Mr. Carlson  maintains that in                                                               
order to  use the resource to  its final depletion, it  is in the                                                               
state's best  interest to  lower the  royalty [so  companies like                                                               
his can  continue to pump  oil economically].  He  also mentioned                                                               
current versus  future technology that may  allow extraction more                                                               
economically and thus provide better value for the resource.                                                                    
MR. CARLSON replied:                                                                                                            
     I think  the key to  keeping interest by  the operators                                                                    
     in  maintaining this  infrastructure and  continuing to                                                                    
     operate  it would  be to  fully  understand what  their                                                                    
     costs are  going to be.   And  some of those  costs are                                                                    
     associated with  personnel and  logistics, but  some of                                                                    
     them are actually  ... the money that's  pulled off the                                                                    
       top and given to the state as a result of ... the                                                                        
     state's ownership.                                                                                                         
MR. CARLSON suggested that extending  the life of these platforms                                                               
may help develop  other possible projects; if  additional work or                                                               
discoveries  occur  from  the  platforms,   their  lives  can  be                                                               
extended and there  will be a higher recovery.   He suggested the                                                               
formula devised  by the  state in the  bill protects  the state's                                                               
interests;  if for  some reason  the rates  from these  depleting                                                               
platforms  were to  increase, the  royalty would  return to  12.5                                                               
percent.    He pointed  out  that  Forest Oil  Corporation  isn't                                                               
currently an operator  of any of these facilities,  but is active                                                               
in  Cook Inlet  and  very concerned  about losing  infrastructure                                                               
that  may  be  available  to bring  new  discoveries  to  another                                                               
platform, instead of having to  build platforms to accept further                                                               
Number 1095                                                                                                                     
REPRESENTATIVE  HOLM said  he  isn't  knowledgeable enough  about                                                               
this area to know where the  law of diminishing return comes into                                                               
play.   As a  legislator, he  offered his belief  that it  is his                                                               
fiduciary responsibility to try  to protect the state's resources                                                               
and  extract the  highest  value possible,  keeping  in mind  the                                                               
desire to  retain the producers  as partners in order  to extract                                                               
them  expeditiously.    He  pointed  out  that  the  fiscal  note                                                               
intimates  that the  State of  Alaska will  lose $2.5  million in                                                               
proposed royalty  payments over the  next five or six  years, and                                                               
questioned the urgency of this action.                                                                                          
Number 1171                                                                                                                     
MR.  CARLSON   responded  that   he  believes   maintaining  that                                                               
infrastructure and keeping the fields  producing - for what could                                                               
be one to three years, depending  on what can be done to maintain                                                               
the rate  - could  easily offset  the fiscal  note estimate.   If                                                               
there  were a  discovery that  only could  be developed  by using                                                               
some  of that  infrastructure,  he suggested  the  return to  the                                                               
state would be many times that amount.                                                                                          
Number 1318                                                                                                                     
CHAIR KOHRING conveyed his belief  that encouraging the continued                                                               
production of  these facilities creates  potential for  the state                                                               
to generate even more money  in the future because these existing                                                               
facilities  represent  millions  of dollars'  worth  of  critical                                                               
infrastructure from which further exploration  can be done in the                                                               
future.    Even though  there  is  no  guarantee, there  is  that                                                               
potential  to  use  these facilities  to  engage  in  directional                                                               
drilling and find additional oil reservoirs.                                                                                    
MR.  CARLSON concurred.   With  regard  to urgency,  he said  one                                                               
platform  has been  shut in,  and another  is scheduled  for that                                                               
soon;  therefore, he  feels there  is a  sense of  urgency to  do                                                               
something before it's too late.                                                                                                 
CHAIR KOHRING  asked Mr. Myers,  in addition to his  testimony on                                                               
behalf  of   the  division,  to  address   Representative  Holm's                                                               
concerns  and whether  the amount  lost will  be gained  in other                                                               
Number 1356                                                                                                                     
MARK  MYERS,  Director, Division  of  Oil  & Gas,  Department  of                                                               
Natural  Resources (DNR),  advised members  that a  key goal  for                                                               
"incentivizing" oil  and gas  ought to  be looking  at incentives                                                               
that are efficient  and effective, and that  hopefully are direct                                                               
and measurable.  He offered his  belief that SSHB 198 meets those                                                               
criteria.  He  explained that the Cook Inlet  platforms have been                                                               
producing for a  long time; the state  has a lot of  good data, a                                                               
good understanding of the reserve  base, and a good understanding                                                               
of  the productions  costs.   In that  light, he  said, when  the                                                               
thresholds  for  royalty  reduction  were  chosen,  [DNR]  worked                                                               
carefully  with  data  from  Union   Oil  Company  of  California                                                               
(Unocal) and  Forest Oil  Corporation, as  well as  internal data                                                               
including  DNR data  and Department  of Revenue  (DOR) data  that                                                               
could be shared.                                                                                                                
MR.  MYERS  said this  was  modeled  accurately, using  long-term                                                               
production trends.   Two different trends were  found with regard                                                               
to when the  economic limit for particular  platforms is reached.                                                               
Thus  there  are  two  clusters  of platforms.    The  first  has                                                               
platforms  where the  wells produce  lots of  water that  must be                                                               
separated out  and that use  significant water flood.   They have                                                               
more  expensive  operating  costs  and,  therefore,  an  economic                                                               
threshold  of production  such that  operating  costs exceed  the                                                               
value of the oil production; more  barrels [of oil] are needed to                                                               
justify their  operating costs.   The  second has  platforms that                                                               
have a  limited amount  of water and  water handling,  and little                                                               
water injection; those have cheaper costs.                                                                                      
MR.  MYERS  told  members  the bill  therefore  was  designed  by                                                               
looking   at    those   factors   and   at    clustered   fields.                                                               
Appropriately, it  lists individual fields, but  it's truly based                                                               
on  economic   clusters  of  data,   not  just   targeting  those                                                               
particular fields.   He said  it was  easier to name  the fields,                                                               
but those fields represent  certain characteristics of production                                                               
and inherent reservoir characteristics.                                                                                         
Number 1491                                                                                                                     
MR. MYERS  remarked that  this is  a case when  it can  be argued                                                               
that royalty reduction is a  very appropriate mechanism to extend                                                               
field life.   He went  on to  say royalty reduction  is generally                                                               
asymmetrical   and  explained,   "Because   your  production   is                                                               
declining from  the field, the  period of  time in which  you ...                                                               
actively affect  the economics of  the field  and bring it  up on                                                               
line - when you're only  talking about a 7.5 percent differential                                                               
in the amount  of production - is limited."   He also pointed out                                                               
that  if the  desire  is to  use  this as  an  incentive to  keep                                                               
production   going  longer   and  possibly   to  get   additional                                                               
investment in the platforms, the  relief should be given slightly                                                               
before it  is absolutely,  critically needed.   He  added, "Plus,                                                               
then,  you're projecting  on certain  oil prices  to project  the                                                               
economic threshold."                                                                                                            
Number 1532                                                                                                                     
MR. MYERS continued:                                                                                                            
     We  used a  pretty  middle-of-the-road calculation  for                                                                    
     netback oil  price and  then ran  a bunch  of scenarios                                                                    
     ... on the  platform, and came up with  this cluster of                                                                    
     data.   So we feel  pretty good that our  fiscal [note]                                                                    
     accurately reflects the loss  in royalty, which, again,                                                                    
     we think is relatively small.  ... The first year, it's                                                                    
     about $220,000,  going up to  nearly $600,000  in 2007.                                                                    
     Those  are relatively  small  numbers  compared to  the                                                                    
     value of that infrastructure.                                                                                              
     One  of our  concerns is,  once you  start pulling  out                                                                    
     multiple platforms out of the  inlet, there's a synergy                                                                    
     between  the  platforms.    There's  piping  that  goes                                                                    
     between the  platforms.  There's common  use of onshore                                                                    
     facilities.   All those  additional costs  of rerouting                                                                    
     those  pipes for  existing  platforms  ... would  cause                                                                    
     additional  costs, as  well as  a lesser  throughput to                                                                    
     those  existing production  facilities  on shore  would                                                                    
     raise   the   cost.    ...   There's   an   interlinked                                                                    
     interdependency  of facilities  in  the  inlet, and  we                                                                    
     want to make  sure as much of that  [as possible] keeps                                                                    
     producing as long as it can.                                                                                               
Number 1585                                                                                                                     
MR. MYERS expressed optimism about  the exploration potential and                                                               
     We  know of  multiple  prospects that  exist off  these                                                                    
     existing  platforms, and  sometimes a  current operator                                                                    
     isn't  desirable  of  expending  the money  to  do  the                                                                    
     exploration,  but  a  new operator  might.    So  we're                                                                    
     buying time ... in case  there's sale or trade [of] the                                                                    
     platforms, et cetera - other opportunities.                                                                                
     So  while  we  lose  some  direct  revenue,  it's  very                                                                    
     quantifiable.  It's relatively minimal  on the scale of                                                                    
     the  potential  benefit  of  that  infrastructure,  and                                                                    
     we're  hoping  that the  upside  does  exist.   In  the                                                                    
     meantime,  you   have  preserved  jobs  and   you  have                                                                    
     preserved that oil  going to the refineries  ... on the                                                                    
     Kenai [Peninsula],  which are important to  the state's                                                                    
Number 1622                                                                                                                     
REPRESENTATIVE McGUIRE asked how 5 percent was arrived at.                                                                      
MR.  MYERS  answered that  there's  an  historical precedent  for                                                               
using  5 percent,  which the  state uses  for discovery  royalty.                                                               
It's  in existing  statute  for  six fields  in  Cook Inlet  that                                                               
weren't  producing.    It  also  leaves  enough  direct  economic                                                               
benefit to the  state.  If it's  set much lower or  at zero, then                                                               
the  fiscal note  becomes bigger.    He offered  his belief  that                                                               
5 percent  royalty isn't  a substantial  burden  on the  project.                                                               
"We might  extend it a few  months more by going  lower, but this                                                               
is a good number," he added.                                                                                                    
MR. MYERS also  pointed out that if these numbers  don't work, an                                                               
applicant [can seek] royalty reduction  under the current royalty                                                               
reduction statute; that can go down  to 3 percent and is based on                                                               
need, using technical data.   He also mentioned royalty reduction                                                               
under HB 28 if  that bill passes.  He added  that this [5 percent                                                               
in  SSHB 198]  is a  "pretty good,  standard threshold,  we feel,                                                               
that we  still are getting  direct revenue from the  platforms as                                                               
well as we're affecting the economics."                                                                                         
Number 1726                                                                                                                     
REPRESENTATIVE CRAWFORD asked what happens to platforms after                                                                   
they get shut in.  For example, can they be reconditioned and                                                                   
shipped elsewhere?                                                                                                              
MR. MYERS answered that it is  uncharted territory as to what the                                                               
state would do.  Initially,  production would be suspended; there                                                               
are  a  few  platforms  where  that has  happened.    He  further                                                               
     Initially, that would just be  plugging back the wells,                                                                    
     cleaning  the  surfaces,  keeping,  usually,  a  manned                                                                    
     presence or  in some  cases unmanned, if  they go  to a                                                                    
     total  cleaning  and  monitoring   system.    And  then                                                                    
     there's  a period  of time.    At some  period of  time                                                                    
     where  there  really   isn't  any  additional  economic                                                                    
     potential,  then  the wells  will  be  cemented in  via                                                                    
     AOGCC  [Alaska  Oil  and Gas  Conservation  Commission]                                                                    
     requirements, permanently  abandoned, and  the facility                                                                    
     will have to be abandoned. ...                                                                                             
     That  process of  what  is done  with  the facility  is                                                                    
     truly  going  to be  a  public  process, with  multiple                                                                    
     agencies looking at it and,  I assume, with stakeholder                                                                    
     influence  from   ...  all  sorts  of   other  outside,                                                                    
     nongovernmental organizations.   The "highest  and best                                                                    
     use" question, I  think, will really be put  there:  Do                                                                    
     you  want to  keep the  facility there?  ... Can  it be                                                                    
     reused?   There are certainly  options to cut  the legs                                                                    
     off of the platforms if  you bring in a (indisc.), move                                                                    
     it over  to another facility. ...  So there's potential                                                                    
     to   use  them.      There's   potential  for   various                                                                    
     dismantlement and  [removal], actually ...  moving them                                                                    
     out of the inlet, et cetera.                                                                                               
     So,   to   the   extent  of   the   final   abandonment                                                                    
     requirements  for a  platform,  we  haven't gone  there                                                                    
     yet.   It is something the  state will have to  face in                                                                    
     the  future.   And certainly  DNR will  play a  role in                                                                    
     that, but  other agencies  will as  well.   The federal                                                                    
     Coast Guard  navigation issues  will occur,  et cetera.                                                                    
     You can get  a long list ... of  potential actions that                                                                    
     would have to be taking place.                                                                                             
Number 1830                                                                                                                     
MR. MYERS continued:                                                                                                            
     We're  studying the  issue.   We sent  some folks  to a                                                                    
     conference  in California  - where  they're looking  at                                                                    
     abandoning some offshore platforms  - the MMS [Minerals                                                                    
     Management Service]  sponsored.   So we have  models to                                                                    
     go by  from the federal  [government] and ...  folks in                                                                    
     the Gulf of  Mexico and offshore California.   So we're                                                                    
     looking  [at]  that,  but  we   have  not  yet  totally                                                                    
     integrated what needs to be done.                                                                                          
Number 1852                                                                                                                     
MR.  MYERS, in  response  to  Representative Kerttula,  indicated                                                               
the fields listed in the  bill are the older, existing platforms,                                                               
rather  than newer  fields like  Redoubt Shoals.   He  added that                                                               
there  is one  onshore field,  West McArthur  [River] field,  and                                                               
said, "It's  onshore facilities  but offshore  fields."   He said                                                               
although all the fields are named,  the bill isn't designed to be                                                               
name-specific,  but is  an easier,  simpler  way to  look at  the                                                               
actual characteristics  and economic criteria.   "Again, we found                                                               
the  data clustered  nicely around  two types  of platforms,"  he                                                               
added.   "And when you use  a general bill like  this, unless you                                                               
wanted to  [have] specific royalty  reduction for  each platform,                                                               
you had to use  ... an amount."  He concluded  by saying that the                                                               
names are  there because it targets  certain characteristics, and                                                               
that it  is inclusive of all  those platforms in Cook  Inlet that                                                               
have those characteristics.                                                                                                     
Number 1938                                                                                                                     
REPRESENTATIVE FATE  asked what the average  daily production was                                                               
at midlife for these fields.                                                                                                    
MR. MYERS  said he didn't  know, but estimated perhaps  15,000 to                                                               
20,000 barrels a  day; he suggested Mr. Carlson  might have those                                                               
figures.   At the  peak, Cook  Inlet production  was an  order of                                                               
magnitude larger than it is now,  he said.  "So we're really down                                                               
near  the end,  ... and  Redoubt Shoals,  of course,  is a  great                                                               
success,  and  that's going  to  help  bring  us up,"  he  added.                                                               
Mr. Myers  said there  is some  other exploration  going on;  the                                                               
hope  is that  it will  lead to  new production  to substantially                                                               
revive the inlet.  Except  for that, however, these platforms and                                                               
reservoirs  are  largely  expended.   He  pointed  out  that  one                                                               
challenge for companies is that  they'll spend the money to drill                                                               
a directional well; if successful,  they may increase production,                                                               
but it's marginal.  "If this  tips the scale, we'll all benefit,"                                                               
he concluded.                                                                                                                   
Number 2025                                                                                                                     
REPRESENTATIVE FATE  referred to [AS 31.05]  and recalled looking                                                               
at royalty reduction specific to Cook  Inlet a year ago, with the                                                               
idea of perhaps broadening it  statewide, for example, and making                                                               
it  self-limiting with  a sunset  date.   He  asked whether  this                                                               
current bill  "will stimulate  the kind  of exploration  for more                                                               
oil  in that  area, which  will  take advantage  of this  royalty                                                               
reduction, above and beyond what we thought it would."                                                                          
MR. MYERS responded:                                                                                                            
     We  have multiple  programs, but  I  think the  program                                                                    
     we're referring  to is  the discovery  royalty program,                                                                    
     which  gives 5  percent royalties  to new  discoveries.                                                                    
     This  program, I  guess, is  more certain,  because you                                                                    
     have  all the  production data.   So  this extends  the                                                                    
     life  of  infrastructure;  that  greatly  improves  the                                                                    
     economics of  future exploration.   So I think  this is                                                                    
     actually  ... one  of our  more  positive moves  that's                                                                    
     clearly a  direct, effective  incentive, and  will, ...                                                                    
     if  explorers  are  out  there,   ...  give  them  more                                                                    
     opportunity  and more  time.   This buys  us time  with                                                                    
     existing infrastructure, ... because  once some of this                                                                    
     infrastructure  goes   away,  it's  not  going   to  be                                                                    
     replaceable   ...   unless   they   find   very   large                                                                    
     accumulations,   which   increases   exploration   risk                                                                    
     because they need  to find very large  fields, then, to                                                                    
     build ... the infrastructure in the inlet.                                                                                 
     Generally, in the inlet, to  put a new platform, people                                                                    
     typically  need probably  around ...  30 or  40 million                                                                    
     barrels of recoverable reserves.   So you need a pretty                                                                    
     substantial discovery  for the inlet,  though certainly                                                                    
     the prospects  are there  to find more  of those.   But                                                                    
     when you chance-risk it, it's  nice if that number goes                                                                    
     down a little bit  because there's an existing platform                                                                    
     for  development.  ... If  you  could  use an  existing                                                                    
     platform,  you  might  save  a  lot  of  money  on  the                                                                    
     development,  in  which  case,  then,  your  limit  for                                                                    
     exploration size might  shrink down by 5  or 10 million                                                                    
     barrels,  leaving you  to drill  a  lot more  different                                                                    
     types of prospects, or lowering your risks.                                                                                
Number 2134                                                                                                                     
MR. MYERS emphasized the synergies.   He said one of Cook Inlet's                                                               
real advantages  is the  existing infrastructure,  which probably                                                               
results in  a much higher  netback per  barrel than on  the North                                                               
Slope.  He added:                                                                                                               
     We  want  to  keep   that  advantage  there  with  this                                                                    
     existing  infrastructure.   And, again,  that will  get                                                                    
     more  people  drilling.    We've seen  a  lot  of  good                                                                    
     "independent action,"  as you've seen,  particularly on                                                                    
     the gas  side, with independents  in the inlet.   There                                                                    
     may  be  some  swapping  of  platforms  or  selling  of                                                                    
     platforms,  we  hope, in  the  future  with folks  that                                                                    
     might be a little more aggressive on exploration, say.                                                                     
MR. MYERS concluded  by saying this is truly a  very good, direct                                                               
incentive because  "we can  quantify the amount,  and we  can see                                                               
the direct effects of it."                                                                                                      
Number 2174                                                                                                                     
CHAIR KOHRING  expressed appreciation to  Mr. Myers for  his work                                                               
on  the  legislation and  for  working  with  the owners  of  the                                                               
platforms on this.                                                                                                              
Number 2197                                                                                                                     
MR.  MYERS informed  the committee  of  the following  [technical                                                               
changes] needed  in the  bill.  On  page 2, line  2, he  said the                                                               
phrase "field  or" should  be removed because  it is  specific to                                                               
those  platforms.    On  page  3, line  7,  "XTO.B"  should  read                                                               
"XTO.C".   On page 3, subparagraph  (E) is talking about  a field                                                               
in  this one  case; therefore,  "platform" should  be deleted  on                                                               
line 26  and replaced with  "field", and the words  "or platform"                                                               
should be removed on line 29.                                                                                                   
Number 2272                                                                                                                     
REPRESENTATIVE   HOLM  moved   to  adopt   the  foregoing   as  a                                                               
[conceptual]  amendment.   There being  no objection,  it was  so                                                               
Number 2287                                                                                                                     
REPRESENTATIVE FATE  moved to report  [SSHB 198, as  amended] out                                                               
of   committee   with    individual   recommendations   and   the                                                               
accompanying  fiscal   note(s).     There  being   no  objection,                                                               
CSSSHB 198(O&G) was reported from  the House Special Committee on                                                               
Oil and Gas.                                                                                                                    

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