Legislature(2009 - 2010)BARNES 124

03/31/2010 01:00 PM House RESOURCES

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            HB 414-SEPARATE OIL & GAS PRODUCTION TAX                                                                        
                [Contains discussion of SB 305]                                                                                 
1:22:18 PM                                                                                                                    
CO-CHAIR JOHNSON  announced that  the next  order of  business is                                                               
HOUSE BILL NO.  414, "An Act relating  to the tax on  oil and gas                                                               
production; and providing for an  effective date."  He noted that                                                               
a committee  substitute (CS) had  been drafted that  is identical                                                               
to  the  bill  version  recently passed  by  the  Senate  Finance                                                               
REPRESENTATIVE  OLSON  moved  to  adopt  the  proposed  committee                                                               
substitute  for HB  414,  labeled  26-LS1592\E, Bullock,  3/31/10                                                               
("Version E"), as a working  document.  There being no objection,                                                               
Version E was before the committee.                                                                                             
CO-CHAIR   JOHNSON,  in   response   to  Representative   Seaton,                                                               
confirmed the forthcoming presentation is on Version E.                                                                         
1:24:15 PM                                                                                                                    
CHUCK LOGSDON,  Ph.D., Energy Economist, Logsdon  and Associates,                                                               
Consultant  to  the  Legislative   Budget  and  Audit  Committee,                                                               
introduced  himself and  deferred  to Mr.  Roger  Marks to  begin                                                               
their presentation on HB 414, Version E.                                                                                        
ROGER MARKS, Economist, Consultant  to the Legislative Budget and                                                               
Audit  Committee,   began  the  presentation  by   reviewing  the                                                               
rationale for HB  414 [slide 2].   He said oil and  gas are taxed                                                               
together under  current law.   Oil is  presently worth  much more                                                               
than gas and, while that could  change, the values of oil and gas                                                               
can diverge  quite a  bit.  Because  of the way  oil and  gas are                                                               
currently  priced, the  combining mechanism  in the  tax has  the                                                               
potential  to  materially  reduce  oil taxes  and  undermine  the                                                               
state's  interests  with  a  major  gas  sale,  even  though  oil                                                               
operations are  unaffected by a major  gas sale.  The  premise of                                                               
HB 414 is to address that problem.                                                                                              
1:26:50 PM                                                                                                                    
MR.  MARKS  explained  that  while   oil  and  gas  are  produced                                                               
together, their values are quite  different due to issues on both                                                               
the supply  side and the  demand side [slide  3].  On  the supply                                                               
side,  oil is  more geographically  concentrated than  gas, which                                                               
means fewer sellers, which makes the  value higher.  Oil has been                                                               
used for  a much longer time  so oil supplies are  more depleted.                                                               
Relatively more  lower-cost gas  is available  in the  world than                                                               
oil.   On the  demand side,  oil has fewer  substitutes.   In the                                                               
foreseeable future,  most automobiles will run  on gasoline which                                                               
can only come  from crude oil, which will make  its price higher.                                                               
Gas is mainly  used for powering power plants  or providing space                                                               
heat and  there are  many substitutes  for that.   The  result is                                                               
that oil  is worth more than  gas.  While the  future is unknown,                                                               
there are  reasons to believe  that this will continue  being the                                                               
1:28:01 PM                                                                                                                    
MR.  MARKS  compared North  Slope  oil  and  North Slope  gas  to                                                               
provide an  example of  how the values  are different  [slide 4].                                                               
Alaska North  Slope (ANS) oil delivered  to the West Coast  has a                                                               
current  market  price of  $80  per  barrel.   After  subtracting                                                               
shipping  costs of  $2.07 and  the  Trans-Alaska Pipeline  System                                                               
tariff of $4.18,  the gross value at the point  of production for                                                               
this  oil is  $73.75.   Each  barrel represents  about 6  million                                                               
British Thermal  Units (MMBTU), making  the oil worth  $12.29 per                                                               
MMBTU.  For North Slope gas,  Mr. Marks provided an example using                                                               
a Lower 48  value of $6 per  MMBTU.  He noted,  however, that the                                                               
current  value is  about  half  that.   In  response to  Co-Chair                                                               
Johnson, he  said today's  Lower 48  gas price  is just  under $4                                                               
[per MMBTU],  so if  [North Slope]  gas was  being sold  today it                                                               
would lose money because its gross value would be negative.                                                                     
1:29:53 PM                                                                                                                    
REPRESENTATIVE  GUTTENBERG commented  that historically  the gaps                                                               
in the  equivalents change  quite a  bit.   He asked  whether the                                                               
presentation   will  include   a  history   of  prices   and  the                                                               
equivalents and/or the coupling effect.                                                                                         
MR. MARKS  responded no.  He  added that there have  been periods                                                               
where the prices were closer than  they are now and periods where                                                               
they were  farther apart than now.   He said the  presentation is                                                               
not representing that  this relationship or prices  will be going                                                               
on  forever.   Rather,  the  point is  that  since  there is  the                                                               
potential  for divergence  of value,  it creates  additional risk                                                               
for both the state and producers.                                                                                               
1:31:36 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG inquired  as to what the  sweet spot is                                                               
or the relationship that the state is trying to be in.                                                                          
DR. LOGSDON  replied he has that  material, but did not  bring it                                                               
with him  for today.  He  said it takes  about 8 MMBTU of  gas to                                                               
give the same  energy as one barrel  of oil, so that  is a little                                                               
bigger than energy  equivalence which is about 6  million.  Since                                                               
1994, the  highest monthly price for  gas over that same  16 year                                                               
period was  $12 per MMBTU,  the highest  price for oil  was about                                                               
$120.   The point  is not  so much about  the averaging,  but the                                                               
variability,  and there  is a  great  deal of  variability.   The                                                               
presentation will  not focus on  particular prices, but  the risk                                                               
the state faces that prices can vary  a lot and when they vary in                                                               
certain ways they can have adverse effects on state revenues.                                                                   
MR.  MARKS  added that  he  and  Dr. Logsdon  would  characterize                                                               
future prices  as unknowable.   The reason to be  concerned about                                                               
this issue is  because of potential given that  future prices are                                                               
CO-CHAIR  JOHNSON   asked  that  the  information   requested  by                                                               
Representative Guttenberg be provided to members.                                                                               
1:34:37 PM                                                                                                                    
MR. MARKS  continued his  comparison of North  Slope oil  and gas                                                               
values [slide  4].  He assumed  a Lower 48 price  for North Slope                                                               
gas of $6  per MMBTU, an estimated tariff from  Alaska to Alberta                                                               
of $3.54 per MMBTU, a cost of 24  cents per MMBTU to move the gas                                                               
into and  out of the  Alberta Hub, and a  tariff of 85  cents per                                                               
MMBTU to move the gas from the  hub to the Lower 48.  Subtracting                                                               
the  transportation  costs  results  in  a  gross  value  at  the                                                               
wellhead  of  $1.37 per  MMBTU.    Thus,  on a  straight  BTU:BTU                                                               
comparison, $12.29:$1.37,  oil is worth  9 times as much  as gas,                                                               
which demonstrates  that the two  values can diverge by  a fairly                                                               
large amount.                                                                                                                   
MR. MARKS  pointed out  that many  things have  BTUs:   oil, gas,                                                               
coal,  wood,  asphalt,  shoe  leather,  rubber,  coffee  grounds,                                                               
citrus rinds,  corn cobs, and  dung [slide  5].  The  point being                                                               
that  just because  some  things  have BTUs  does  not mean  they                                                               
should be  coupled together  for taxation,  and coupling  oil and                                                               
gas together for taxation is a very similar thing.                                                                              
1:36:44 PM                                                                                                                    
REPRESENTATIVE  SEATON  inquired  whether the  presentation  will                                                               
address  what  the  carbon tax  currently  being  considered  [by                                                               
Congress] would do to the comparison values between oil and gas.                                                                
MR.  MARKS answered  this  was  not done  because  there is  much                                                               
uncertainty as to  whether there will be a carbon  tax, what form                                                               
it would take, and how it would affect these relative values.                                                                   
1:37:45 PM                                                                                                                    
MR. MARKS  reviewed the mechanics  of how the  current production                                                               
tax works  [slide 6]:  first,  the oil gross value  is determined                                                               
(market price  less transport  cost), as is  the gas  gross value                                                               
(market price  less transport cost);  the two are  added together                                                               
to  arrive at  the combined  gross value;  the upstream  costs of                                                               
[lease] capital and operating costs  are then subtracted from the                                                               
combined gross  value to arrive at  the combined oil and  gas net                                                               
value, which in the tax code  is called the production tax value;                                                               
the combined oil  and gas net value is then  divided by the total                                                               
oil and  gas barrel of  oil equivalents  (BOEs) to arrive  at the                                                               
per barrel of oil equivalent net value.                                                                                         
1:39:14 PM                                                                                                                    
MR.  MARKS described  how to  put oil  and gas  on an  apples-to-                                                               
apples basis  by using barrel of  oil equivalents [slide 7].   To                                                               
provide an example of how to  do this, he assumed a production of                                                               
4.5  billion cubic  feet  per  day (BCF/D)  of  North Slope  gas.                                                               
Because North  Slope gas is  rich with natural gas  liquids, such                                                               
as butane,  propane, ethane, and  other heavier  hydrocarbons, it                                                               
has  an  elevated  BTU  content  of  about  1,100  BTUs  per  MCF                                                               
[thousand  cubic feet],  as compared  to 1,000  BTUs per  MCF for                                                               
Cook Inlet gas.  Natural gas  is measured and sold in millions of                                                               
BTUs (MMBTUs).   The 4.5 billion cubic feet per  day of gas would                                                               
have 4.95 million MMBTUs (4.5 times  1,100).  A barrel of oil has                                                               
about  6 MMBTUs.   When  converting gas  to BOEs,  Alaska statute                                                               
specifies the use of  6 MMBTUs of gas to a barrel  of oil.  Thus,                                                               
4.5 BCF/D  of North Slope  gas would  have 825,000 barrel  of oil                                                               
equivalents (BOEs) (4,950,000 divided by  6).  If 500,000 barrels                                                               
of oil  was produced along with  the 4.5 BCF/D of  gas, the total                                                               
BOEs would be 1,325,000 (500,000 plus 825,000).                                                                                 
1:41:40 PM                                                                                                                    
MR. MARKS  returned to slide  6 and reiterated that  the combined                                                               
oil  and gas  net value  divided by  the total  oil and  gas BOEs                                                               
equals  the per  BOE  net  value.   The  progressivity factor  is                                                               
determined  by subtracting  $30 from  the per  BOE net  value and                                                               
paying  0.4 percent  per dollar  on  the amount  remaining.   The                                                               
progressivity factor  is then added  to the 25 percent  base rate                                                               
to arrive at the  single tax rate.  That single  tax rate is then                                                               
applied to the combined oil and gas net value.                                                                                  
1:42:45 PM                                                                                                                    
MR. MARKS,  in response  to Representative  Seaton, said  slide 7                                                               
illustrates how  to get oil  and gas  on a common  denominator so                                                               
the  per BOE  net value  amount can  be determined.   In  further                                                               
response,  he  returned  to  slide  6  and  reiterated  that  the                                                               
combined oil and  gas net value is determined  by subtracting the                                                               
lease capital and operating costs  from the combined gross value.                                                               
The combined oil  and gas net value is then  divided by the total                                                               
oil and gas BOEs to arrive at the per BOE net value.                                                                            
1:45:04 PM                                                                                                                    
MR.  MARKS  reviewed  the  mechanics  of  how  the  progressivity                                                               
calculation  works  [slide 8].    The  "trigger" equals  $30  net                                                               
divided by BOE value.  The  "slope" is how much the progressivity                                                               
goes up as  the net value goes up [the  0.4 percent slope changes                                                               
to  0.1   percent  after  $92.50   net  per  BOE  value].     The                                                               
progressivity  surcharge is  determined by  subtracting $30  from                                                               
the  net per  BOE value  and this  figure is  then multiplied  by                                                               
.004.  For example, if the combined  oil and gas net value is $50                                                               
the progressivity is determined by  subtracting $30 from $50, and                                                               
the resulting $20  is multiplied by .004 to arrive  at 8 percent.                                                               
The 8 percent progressivity is then  added to the 25 percent base                                                               
tax rate for  a total tax of  33 percent on the  combined oil and                                                               
gas net value.                                                                                                                  
1:46:01 PM                                                                                                                    
REPRESENTATIVE SEATON presumed  that all of the  lease costs have                                                               
been subtracted before getting to the trigger.                                                                                  
MR. MARKS  replied correct.   In further response, he  said three                                                               
different values can  be thought about:  the market  price in the                                                               
Lower 48;  the gross value at  the point of production,  which is                                                               
where the  oil or gas leaves  the lease and before  any operating                                                               
and  capital  costs   are  subtracted;  and  the   net  value  or                                                               
production  tax  value,  which  is  where  all  the  capital  and                                                               
operating costs have been subtracted out.                                                                                       
1:47:15 PM                                                                                                                    
MR.  MARKS discussed  how  gas could  impact  oil under  Alaska's                                                               
current tax  system [slide 9].   To provide an example,  he first                                                               
assumed a  West Coast market price  of $80 per barrel  for Alaska                                                               
North Slope (ANS)  oil with shipping and tariff costs  of $5, for                                                               
a  gross value  at  the point  of production  of  $75.   Assuming                                                               
upstream operating and  capital costs of $20, the  net value [per                                                               
barrel  or per  MMBTU] is  $55.   Progressivity is  determined by                                                               
subtracting  $30 from  the $55,  which equals  $25.   The $25  is                                                               
multiplied by .4 percent to  arrive at a 10 percent progressivity                                                               
surcharge.   The  10 percent  progressivity  is added  to the  25                                                               
percent base rate  for a total tax  rate of 35 percent.   He then                                                               
assumed  500,000  barrels of  daily  oil  production [slide  10],                                                               
which is 500,000 barrels of  oil equivalent (BOE), since 1 barrel                                                               
of oil  is 1 BOE.   Multiplying [500,000 barrels] times  365 days                                                               
results in an annual production of  183 million barrels of oil or                                                               
183 million BOEs of oil.                                                                                                        
MR. MARKS  next assumed  a Lower  48 market price  of $6  for gas                                                               
with a transportation cost of $4.50,  for a gross value of $1.50.                                                               
Assuming an  upstream cost  for gas  of $.50  per MMBTU,  the net                                                               
value of the gas is $1 [per barrel  or per MMBTU].  At an assumed                                                               
daily gas production  of 4.5 BCF, the MMBTUS per  day equals 4.95                                                               
million; dividing that  by 6 equals 825,000 BOEs of  gas per day.                                                               
Multiplying 825,000  BOEs times  365 equals  301 million  BOEs of                                                               
gas per year.                                                                                                                   
1:49:54 PM                                                                                                                    
MR. MARKS next combined the oil and  gas [slide 11].  For oil, he                                                               
noted that  multiplying the  net value of  $55 times  183 million                                                               
BOES  per  year  yields  a  total annual  net  value  of  $10.038                                                               
billion.   For gas,  a $1  net value  times 1.807  million MMBTUs                                                               
results in  a total annual net  value of $1.807 billion.   Adding                                                               
together the $10.038  billion for oil and the  $1.807 billion for                                                               
gas  equals a  total  annual oil  and gas  net  value of  $11.844                                                               
billion.   Adding together  183 million annual  BOEs for  oil and                                                               
301 million  for gas,  the combined annual  total is  484 million                                                               
BOEs.   Dividing  the  total oil  and gas  net  value of  $11.844                                                               
billion by  the 484 million  BOEs equals  a net value  of $24.49.                                                               
Thus,  combining  the  oil  and  gas results  in  the  net  value                                                               
decreasing  from $55  for oil  alone to  $24.49 for  oil and  gas                                                               
combined [slide 12].  The  progressivity goes from 10 percent for                                                               
oil alone  to 0, because  progressivity starts at $30.   Bringing                                                               
in  gas  with   oil  dilutes  the  net  value   and  dilutes  the                                                               
progressivity,   and  this   dilution  effect   is  critical   to                                                               
understanding the rational for HB 414.                                                                                          
1:51:37 PM                                                                                                                    
MR. MARKS  outlined the  magnitude of this  dilution in  terms of                                                               
taxation  [slide 13].   In  general, the  greater the  divergence                                                               
between oil and  gas, the greater their net  values will diverge,                                                               
the greater  the progressivity rate  will drop when gas  is added                                                               
to  oil, the  greater  the reduction  in tax.    He related  that                                                               
several  weeks  ago,  the Senate  Finance  Committee  brought  in                                                               
several folks  to explain this issue,  and all came up  with much                                                               
the same conclusion  and numbers given the same  assumptions.  He                                                               
said  he will  use  the same  numbers as  did  the Department  of                                                               
Revenue in its  presentation to that committee:   three scenarios                                                               
of oil  prices at $75,  $100, and $120,  with all scenarios  at a                                                               
gas price  of $8.   For each  scenario the department  assumed an                                                               
oil production of 500,000 barrels  per day, a transportation cost                                                               
deduction  of $6.50  per  barrel, upstream  capital  costs of  $2                                                               
billion [per  year], and upstream  operating costs of  $2 billion                                                               
[per year].                                                                                                                     
1:52:51 PM                                                                                                                    
CO-CHAIR JOHNSON  inquired whether it is  a reasonable assumption                                                               
that if oil  went to $120, gas  would stay at $8.   He understood                                                               
there used to be some correlation between the ups and downs.                                                                    
MR. MARKS answered there is  probably some correlation, but there                                                               
is also some independence for the reasons mentioned earlier.                                                                    
1:53:19 PM                                                                                                                    
CO-CHAIR JOHNSON,  for purposes  of discussion, asked  whether it                                                               
is reasonable to  use in a formula consistent gas  price when oil                                                               
has nearly doubled.                                                                                                             
MR. MARKS responded  this is for illustration.   Oil is currently                                                               
priced at $80  and gas at $4,  and it is not being  said that any                                                               
one of those scenarios is the  norm because any one of them could                                                               
be  the norm.   In  general, there  are reasons  to believe  that                                                               
prices move  together, but no one  can say which one  of those is                                                               
the norm.                                                                                                                       
CO-CHAIR  JOHNSON  said  he  wants to  ensure  that  when  making                                                               
assumptions  and  plugging  in  numbers, members  are  getting  a                                                               
realistic  look at  the back  end, because  what is  really being                                                               
dealt with is  that progressivity factor at the end  and it is an                                                               
algebraic equation.                                                                                                             
DR. LOGSDON advised the presentation  will get to the examination                                                               
of progressivity, as well.   The current exercise is specifically                                                               
designed  to examine  downside risk.   There  is upside  risk and                                                               
that gets towards how to deal with progressivity.                                                                               
1:54:47 PM                                                                                                                    
MR. MARKS  returned to outlining  the magnitude of  this dilution                                                               
in terms  of taxation [slide 13].   For its gas  assumptions, the                                                               
Department of  Revenue assumed a  gas production of 4.5  BCF/D, a                                                               
transportation cost to the Lower  48 of $4.50 per MMBTU, upstream                                                               
capital costs  of $200 million  per year, and  upstream operating                                                               
costs of  $200 million per  year.  In response  to Representative                                                               
Seaton, he  said the  Department of Revenue  used about  the same                                                               
transportation costs  as did Logsdon  and Associates.   [As shown                                                               
on slide 4], Logsdon and  Associates used a transportation tariff                                                               
to Alberta  of $3.54, plus the  Alberta Hub cost [of  $0.24], and                                                               
the [tariff] from Alberta to the  Lower 48 [of $0.85], which adds                                                               
up  to [$4.63]  as  compared to  the department's  transportation                                                               
cost of $4.50 to the Lower 48.                                                                                                  
1:55:57 PM                                                                                                                    
MR.  MARKS  reviewed what  happens  to  the progressivity  factor                                                               
under each  of these three scenarios  [slide 13].  At  a price of                                                               
$75, the progressivity  factor for oil by itself  is 5.38 percent                                                               
and  at  a  price  of  $120 the  progressivity  factor  is  23.38                                                               
percent.    When oil  and  gas  are combined,  the  progressivity                                                               
factor at an  oil price of $75  is 0 percent; at an  oil price of                                                               
$120 the progressivity factor is 6.79  percent, for a drop in the                                                               
progressivity  factor   of  5.38   percent  and   16.59  percent,                                                               
respectively.   Taxing oil  alone, the production  tax at  an oil                                                               
price of $75 would  be $1.7 billion per year; at  a price of $120                                                               
the production  tax would be $6.4  billion per year.   Taxing gas                                                               
alone, the production tax at a  price of $8 would be $1.1 billion                                                               
per year.   If oil and  gas were taxed separately,  the total tax                                                               
at  an oil  price of  $75 and  a gas  price of  $8 would  be $2.8                                                               
billion; at $120  for oil and $8  for gas the total  tax would be                                                               
$7.5 billion.  If  oil and gas tax is combined, the  tax at a $75                                                               
oil price  and $8 gas  price would be  $2.5 billion; at  $120 for                                                               
oil and  $8 for gas  that tax would be  $5.5 billion.   Thus, the                                                               
annual tax  reduction from  combining oil and  gas would  be $0.3                                                               
billion and $2.0 billion, respectively.   The context for dealing                                                               
with this issue now is  the Alaska Gasline Inducement Act (AGIA).                                                               
If  the AGIA  provisions that  lock in  taxes are  manifested and                                                               
this issue presents  itself, there could be a loss  of $2 billion                                                               
per year in  production tax for 10 years, which  would be a total                                                               
of $20  billion.  The AGIA  provisions begin May 1  when the open                                                               
season begins, so  the rationale for dealing with  this issue now                                                               
is to  avoid this possible  outcome, in-so-far as  the provisions                                                               
are  airtight.    In  response to  Co-Chair  Johnson,  Mr.  Marks                                                               
clarified  he said  "in-so-far"  as the  provisions are  airtight                                                               
because there are questions about whether they are.                                                                             
1:59:03 PM                                                                                                                    
MR. MARKS  continued, saying  there is  no way  to be  sure about                                                               
future prices  [slide 14].   Different price  relationships would                                                               
produce  different  outcomes.    If gas  prices  went  very  high                                                               
relative to  oil, the  inverse dilution  effect would  occur, and                                                               
the dilution effect  of combining oil and gas would  drag the oil                                                               
progressivity  up  rather than  down.    In that  situation,  the                                                               
producer/taxpayer  would   lose  money  under  the   current  tax                                                               
statutes.   Since  the potential  for these  outcomes exist,  the                                                               
current tax  structure adds another  level of risk to  an already                                                               
large amount of  uncertainty.  Not only is there  the worry about                                                               
the price risk itself, there  is the worry about the relationship                                                               
between  prices.   If  the  current  price relationship  endures,                                                               
there is the risk of undermining the state's finances.                                                                          
2:00:22 PM                                                                                                                    
REPRESENTATIVE SEATON  recalled conversations  at the  time [AGIA                                                               
was being considered] about trying  to build a robust system that                                                               
would self-correct as prices changed  and that some risk would be                                                               
absorbed so the state  would get a project to go  forward.  As he                                                               
sees these numbers, what is really  being talked about is that if                                                               
gas is  taxed alone it  would not be  taxed at the  current rates                                                               
because a  pipeline would not  be built due  to too much  risk on                                                               
the downside.   If oil and  gas remain combined, there  is a risk                                                               
of this dilution  effect if the gas price is  relatively low, but                                                               
that absorbs some of the risk  of the development of a gas field.                                                               
He asked whether the presentation  will look at what would happen                                                               
if there  is not  a large-diameter  pipeline and  the exploration                                                               
for gas, along  with the additional oil that would  come with new                                                               
gas fields.  He  maintained that if a tax system  is put in place                                                               
that does not absorb some of  the downside or low-price risk, the                                                               
state would be pulling the plug on North Slope development.                                                                     
2:03:20 PM                                                                                                                    
REPRESENTATIVE  SEATON, to  clarify his  question for  Mr. Marks,                                                               
said  he is  asking whether  the current  system of  combined tax                                                               
does not mitigate  the risk of building a  pipeline for low-price                                                               
gas.   He offered his opinion  that if there is  not something to                                                               
mitigate  that risk,  the state  would have  to negotiate  a much                                                               
lower  tax  rate  on  the  gas  because  otherwise  it  would  be                                                               
difficult to finance and build the project.                                                                                     
MR. MARKS surmised the question  is whether the tax system should                                                               
provide some cushion for low-price gas.                                                                                         
REPRESENTATIVE  SEATON said  yes, and  further asked  whether Mr.                                                               
Marks  does  not  believe  that   the  current  system  is  self-                                                               
correcting and robust so that it works at a variety of prices.                                                                  
2:05:23 PM                                                                                                                    
MR. MARKS responded that, first,  he thinks having taxation based                                                               
on net is  one way to address  the low cost issue;  there will be                                                               
no  tax  if  the  company  is not  making  money.    Second,  one                                                               
advantage of  separating oil and  gas is  that down the  road the                                                               
state can deal with gas by  itself and determine the taxation for                                                               
gas without  having oil affect things.   Third, at face  value it                                                               
is  easy to  say that  a taxpayer  could save  $2 billion  in oil                                                               
taxes by  undertaking this gas project  if oil is priced  at $120                                                               
and gas at  $8.  However, there are other  considerations, one of                                                               
which is uncertainty and investors  dislike uncertainty more than                                                               
anything else.   Taxpayers  understand that a  tax system  has to                                                               
work for both  sides.  An outcome of  the legislature's rejection                                                               
of  the  stranded  gas  development   contract  advanced  by  the                                                               
Murkowski Administration  is that  it displayed  the state  has a                                                               
bar it is setting for what it is expecting.                                                                                     
2:07:59 PM                                                                                                                    
MR. MARKS  said these conversations  and this bill  are occurring                                                               
because, as he has shown, it  is crystal clear that there is what                                                               
he would  call a  big crack in  the tax system,  which is  the $2                                                               
billion revenue loss.  Notwithstanding  any provisions for fiscal                                                               
certainty  in  AGIA,  which  may  or  may  not  be  airtight,  he                                                               
cautioned that taxpayers  will look at this crack as  an issue of                                                               
much volatility, given it is unknown  who will be governor or who                                                               
will  be in  the legislature  in 10  years.   While solving  this                                                               
problem now would not reduce  all fiscal uncertainty, he said his                                                               
personal opinion is that it would take a big piece out of it.                                                                   
2:09:34 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG understood Mr.  Marks to be saying that                                                               
the $2 billion less in tax  revenue that would be collected under                                                               
the current  combined tax  system, as  compared with  a separated                                                               
tax  system,  creates  volatility  for the  state  which  creates                                                               
uncertainty for industry  so that industry does not  know what to                                                               
do.  He  said many people believe that if  there are fiscal terms                                                               
on a  gasline, industry will  come back  to the state  to address                                                               
fiscal certainty.   In his opinion,  to "decouple" now is  to put                                                               
the state's  hand on  the table,  so it would  be better  for the                                                               
state to wait for industry to put its proposals forward first.                                                                  
2:11:31 PM                                                                                                                    
MR.  MARKS responded  he thinks  there is  a general  expectation                                                               
that  there will  be some  discussion down  the road  between the                                                               
state and the producers about  fiscal terms.  If fiscal certainty                                                               
is essential, it  is unclear whether the  constitution would have                                                               
to be changed to achieve that,  so it is unclear what the outcome                                                               
of a negotiation  would be.  This bill would  not preclude future                                                               
discussions; rather,  it is a  measure to protect the  state from                                                               
the scenario where the current tax  system is locked in place for                                                               
the  first 10  years  of production  under  the AGIA  provisions.                                                               
Even if the fiscal certainty proves  not to be airtight, a future                                                               
legislature may feel  committed to upholding the  terms that were                                                               
in place  on May 1, 2010.   However, the question  is what should                                                               
be upheld and whether today's  legislators would want the current                                                               
tax  system  upheld knowing  what  would  happen to  the  state's                                                               
finances if those prices materialized.                                                                                          
2:14:14 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG  proffered that the producers  may come                                                               
back  to  the  state  with fiscal  terms  that  are  considerably                                                               
different than  those in HB 414.   He said that  since this issue                                                               
is not  new and is something  being dealt with around  the world,                                                               
the state has the obligation to  find out whether there are other                                                               
possible scenarios,  even though the scenario  being presented is                                                               
very  legitimate and  appreciated.   He recognized  producers may                                                               
not come to the table at all  with fiscal terms and right now the                                                               
state is risking whether producers may even want any changes.                                                                   
MR. MARKS replied there are millions  of scenarios out there.  He                                                               
said  the  issue is  not  what  will  happen,  but what  has  the                                                               
potential to happen, and that is what needs to be thought about.                                                                
2:16:24 PM                                                                                                                    
REPRESENTATIVE P. WILSON  understood Mr. Marks to  have said that                                                               
producers  do not  like uncertainty  and the  more things  can be                                                               
locked in,  the better.   She asked  whether Mr. Marks  is saying                                                               
that if  taxes were separated  there would be  more participation                                                               
in an  open season because  producers would have  more certainty,                                                               
even though they would be paying more in tax.                                                                                   
MR.  MARKS  answered he  believes  the  producers would  love  to                                                               
proceed on a gasline under the  current system and have their oil                                                               
tax bill  reduced by $2  billion.  However, when  producers think                                                               
about  committing  gas at  an  open  season, there  are  numerous                                                               
considerations,  one  of which  is  the  tax  side.   Under  AGIA                                                               
provisions the current  tax system would be locked  in, but there                                                               
are a lot of reasons to  think those provisions are not airtight.                                                               
If people  are concerned now about  what will be happening  in 10                                                               
years, they  will be even  more concerned on that  first shipping                                                               
day.  Additionally, it is  unknown what the state's finances will                                                               
be  then.   Even if  HB 414  passes, a  tax system  is not  being                                                               
nailed down,  but having  a problem  will make  producers nervous                                                               
and  having  that  problem  fixed means  the  range  of  outcomes                                                               
narrows, which  could make them  feel more comfortable.   He said                                                               
this same kind of effect can  be seen when a corporation is sued.                                                               
Even  when a  large judgment  is handed  down, the  corporation's                                                               
share price will  generally go up after the  judgment because now                                                               
investors know the result and the uncertainty has been removed.                                                                 
2:20:07 PM                                                                                                                    
REPRESENTATIVE OLSON  inquired whether  any models were  run that                                                               
showed the  current system appears  to be working and  looks more                                                               
favorable than what is being seen right now.                                                                                    
MR. MARKS  responded that Department  of Revenue  modeling showed                                                               
that if  the oil and gas  are flip-flopped so that  the gas value                                                               
is very  high relative  to oil, a  reverse dilution  effect would                                                               
happen  with   a  major  gas   sale  that  would  drag   the  oil                                                               
progressivity factor up  rather than down.   In further response,                                                               
he said  the past  three years have  had relationships  where the                                                               
BTU value of oil has been much higher than the BTU value of gas.                                                                
DR. LOGSDON added that the  highest monthly average price for oil                                                               
over the  last 16 years  has been a  shade over $120  per barrel,                                                               
and the highest  monthly average price of gas has  been just over                                                               
$12 per  MMBTU.  On the  low side over this  same 16-year period,                                                               
gas has been  as low as $2 per  MMBTU and oil has been  as low as                                                               
about $30 per  barrel.  The average oil price  over that 16 years                                                               
is about $40  per barrel and gas  is about $5-$6 per  MMBTU.  The                                                               
statistical analysis  shows the one  thing that is  consistent is                                                               
the volatility  in oil prices.   In 2004,  oil was about  $30 per                                                               
barrel and recently it was as high  as $145 per barrel on a daily                                                               
basis.  If looked at statistically  there will be an average, but                                                               
the standard deviation, or the  measure of average volatility, is                                                               
extremely high.                                                                                                                 
2:23:35 PM                                                                                                                    
DR.  LOGSDON continued,  saying  that from  his  and Mr.  Rogers'                                                               
perspective what can be done now  before the lock-in period is to                                                               
put into effect  a kind of insurance policy against  this type of                                                               
thing happening in the future.   He agreed it is unknown how this                                                               
would   be  viewed   by  industry   and  how   it  would   affect                                                               
negotiations.   He said he  and Mr. Marks chose  these particular                                                               
numbers to show some of the down  side the state may be facing as                                                               
the open  season approaches.  A  $120 oil price and  $8 gas price                                                               
are plausible scenarios,  he stressed, although he  is not saying                                                               
there is a  100 percent chance this would be  the scenario for 10                                                               
years.   However, it  is one  reason why he  and Mr.  Marks think                                                               
that separating oil and gas  might be something that would ensure                                                               
safe financial stability for the state in the future.                                                                           
2:25:18 PM                                                                                                                    
REPRESENTATIVE OLSON asked whether over  the past three years the                                                               
ratio of oil to gas numbers has stayed relatively close.                                                                        
DR. LOGSDON replied  the average ratio has been 8.8.   Right now,                                                               
at prices of $4 and $80, it is  a catastrophic ratio of 20.  Over                                                               
the last  16 years, it  has been below 6  in a couple  of months,                                                               
but not very often.   It actually averaged close to  6 in 2005 or                                                               
2006.   He  said  Senator  Paskvan distributed  a  graph in  this                                                               
regard and  most of the  time the ratio has  been above 6  over a                                                               
fairly long period of time.   Generally speaking, 6 is the amount                                                               
of energy it takes to equal the BTUs in a barrel of oil.                                                                        
2:26:52 PM                                                                                                                    
REPRESENTATIVE  TUCK inquired  what  ratio is  the  point of  the                                                               
reverse dilution effect.                                                                                                        
DR. LOGSDON answered  the ratio is important, but  what is really                                                               
important is the taxable  value of the gas.  At  a fairly low net                                                               
taxable value for  gas and oil prices somewhat  higher than that,                                                               
there will  be dilution  because a  low-value substance  is being                                                               
added together with a high-value substance.                                                                                     
2:28:09 PM                                                                                                                    
REPRESENTATIVE TUCK asked what the  ratio would be to trigger the                                                               
reverse dilution effect, based on  all things being equal and the                                                               
tax structure of today.                                                                                                         
DR. LOGSDON  responded he  will have  to get  back to  members in                                                               
this regard.   However, once  the net  taxable value of  gas gets                                                               
into the  teens, the pipeline would  begin spinning off a  lot of                                                               
gas revenue.                                                                                                                    
[CO-CHAIR JOHNSON passed the gavel to Representative Olson.]                                                                    
REPRESENTATIVE  TUCK surmised  that at  gas prices  of $4-$5  per                                                               
MMBTU there would be more than a $2 billion giveaway.                                                                           
MR. MARKS nodded yes.                                                                                                           
2:29:59 PM                                                                                                                    
REPRESENTATIVE  TUCK proffered  that  the tax  incentive/giveaway                                                               
might be  needed to  get the  pipeline built if  gas drops  to $4                                                               
because at that price it may not be worthwhile for any company.                                                                 
DR.  LOGSDON replied  that  once  a gas  pipeline  is built,  the                                                               
investment is fixed.   He said the scenario Mr.  Marks was laying                                                               
out is  that a company or  investor wants fiscal certainty  so it                                                               
knows  that  once  $40  billion  has been  spent  on  building  a                                                               
pipeline  the state  will  not  come back  and  demand the  $2-$4                                                               
billion it is losing by changing the fiscal system.                                                                             
2:31:53 PM                                                                                                                    
REPRESENTATIVE TUCK  argued that would  be true of  any scenario,                                                               
not just this one.  Given  that oil and gas are produced together                                                               
on  the North  Slope, he  said he  does not  have a  problem with                                                               
allowing industry  to take advantage  of the combined  tax system                                                               
as a  way to  incentivize getting  the gas to  market.   He asked                                                               
whether gas is always valued in BTUs compared to oil.                                                                           
[Representative Olson returned the gavel to Co-Chair Johnson.]                                                                  
MR. MARKS  answered not that he  is aware of; gas  is universally                                                               
valued on a BTU basis.                                                                                                          
2:32:45 PM                                                                                                                    
DR. LOGSDON explained  that gas is valued and bought  and sold in                                                               
BTUs throughout  the world  market.   If, going  forward, members                                                               
want to focus on how to  make the gas pipeline robust, looking at                                                               
gas separately is  one way to seriously have  a policy discussion                                                               
about how to  do that.  He recognized  that Representative Seaton                                                               
considers the  combined system to  be robust  and said that  is a                                                               
decision  committee members  will  have  to make.    He said  any                                                               
scenario presumes there  is a pipeline, and he and  Mr. Marks are                                                               
trying to show  this potential downside that could  happen in the                                                               
future that could be avoided by splitting apart gas and oil.                                                                    
REPRESENTATIVE TUCK commented that the  dilution effect is to the                                                               
benefit of industry, but the  reverse dilution effect would be of                                                               
concern to industry  and that is why he wants  to know where that                                                               
ratio is going to be under  the current structure.  He would like                                                               
to know what  the possibility is of that happening  and how often                                                               
it might happen.                                                                                                                
2:36:17 PM                                                                                                                    
REPRESENTATIVE P. WILSON proffered  that gas prices are currently                                                               
low because of the current  oversupply, but this oversupply could                                                               
change  if hydraulic  fracturing is  disallowed.   Therefore, her                                                               
opinion is  that gas  is also  volatile, which  makes it  hard to                                                               
decide what to do.                                                                                                              
MR.  MARKS agreed  there is  uncertainty now  over gas,  but said                                                               
there will  always be  uncertainty over  gas and  oil.   He added                                                               
there is another consideration besides  the market.  Returning to                                                               
slide  [4]  he  pointed  out that  the  transportation  cost  for                                                               
getting  oil to  market is  about $6,  or about  $1 per  MMBTU as                                                               
compared to about  $4.50 per MMBTU for gas.   The reason for this                                                               
difference is physics.  The BTUs  in crude oil are very dense and                                                               
lots of BTUs can  be wrapped in a little bit of  metal.  The BTUs                                                               
in  gas are  dispersed and  less dense,  so it  takes a  lot more                                                               
metal to  wrap around  the same  number of  BTUs.   Therefore, no                                                               
matter the  ratio or  market price,  the transportation  cost for                                                               
gas will always unequivocally be much  higher on a BTU basis than                                                               
the transportation for  oil, which will exacerbate  this issue of                                                               
the difference  between oil and gas  even if the market  price of                                                               
gas comes up relative to oil.                                                                                                   
DR. LOGSDON interjected that it is the cost overrun risk.                                                                       
2:40:08 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG  understood the [5/1/10] lock-in  to be                                                               
for gas only, not oil.                                                                                                          
MR. MARKS responded  correct, it is the gas tax  that gets locked                                                               
2:40:22 PM                                                                                                                    
REPRESENTATIVE  TUCK   asked  whether  there  is   some  part  of                                                               
transportation  that needs  to be  considered that  is not  being                                                               
shown in slide 4.                                                                                                               
MR.  MARKS  replied  the [$6.25]  shown  for  oil  transportation                                                               
includes the  current Trans-Alaska  Pipeline System  and shipping                                                               
infrastructure.    To  line  up the  transportation  cost  on  an                                                               
apples-to-apples basis, this  cost would be divided by  6 to come                                                               
up with a  cost of $1 per  MMBTU for oil; the MMBTU  cost for gas                                                               
is about  $4.  In further  response, he confirmed that  this is a                                                               
9:1 ratio, all considered.                                                                                                      
CO-CHAIR  JOHNSON pointed  out  that the  tariff  for the  Trans-                                                               
Alaska Pipeline System (TAPS) is known,  but the gas tariff is an                                                               
estimate and could be more if there are cost overruns.                                                                          
2:42:07 PM                                                                                                                    
REPRESENTATIVE SEATON  said he is  certain that if gas  was taxed                                                               
alone  using  the calculations  shown  in  the presentation,  the                                                               
gasline  would never  be built  because  there needs  to be  some                                                               
absorbing of  the downside risk with  the oil tax.   According to                                                               
what he  has heard, gas  taxes structured under the  current base                                                               
rate and progressivity  would be a non-starter.   He surmised Mr.                                                               
Marks and Dr. Logsdon are  talking about an inflexible, gross tax                                                               
rate  on gas  and said  he thinks  those would  have to  be at  a                                                               
pretty low rate  to get agreement for taxing gas  separately.  He                                                               
inquired whether  Mr. Marks  thinks a gasline  would be  built if                                                               
gas was taxed separately.                                                                                                       
2:45:49 PM                                                                                                                    
MR.  MARKS answered  that regardless  of whether  HB 414  passes,                                                               
most people think there needs  to be a deliberative discussion on                                                               
gas  taxes down  the road.   This  bill will  not and  should not                                                               
supersede  that.   This  bill  is being  proposed  as a  backstop                                                               
measure in  case of a  lock-in of  AGIA tax provisions.   Members                                                               
need to decide  whether the current system  creates incentive for                                                               
the industry and  so HB 414 should not pass,  or that the current                                                               
system  undermines the  state's  financial picture  and the  bill                                                               
should pass.   He and Dr. Logsdon are laying  out the options and                                                               
it  is the  legislature's  decision.   He  said  even  if HB  414                                                               
passes, the state  will be far from a perfect  tax system on gas,                                                               
which is why further deliberation in  this regard is needed.  The                                                               
intent of HB 414  is to guard against what the  sponsor saw as an                                                               
unfavorable outcome  under a  certain scenario, and  it is  up to                                                               
other members to decide whether that is unfavorable or not.                                                                     
2:47:51 PM                                                                                                                    
CO-CHAIR JOHNSON said  he does not want anyone to  leave the room                                                               
thinking that if HB 414 does not  pass the state is going to lose                                                               
$2 billion in revenue; although that  could be the case, it is an                                                               
unknown at this  point.  This scenario may or  may not happen, he                                                               
continued, and  different consultants may come  up with different                                                               
outcomes.  There are a lot  of scenarios out there that would not                                                               
fit this.   In  response to  Representative Seaton,  he clarified                                                               
that  this  possible scenario  would  not  be  until there  is  a                                                               
pipeline and  gas is  flowing down  it.   He added  the committee                                                               
needs to  look at  whether there  is a  risk and,  if there  is a                                                               
risk, whether separating the taxes  is the solution to that risk.                                                               
He urged members to focus on  that rather than the numbers in the                                                               
charts that  are being  presented as facts,  because he  does not                                                               
think  they are  facts.   He  understood Representative  Seaton's                                                               
point that keeping the current tax system may be incentivizing.                                                                 
2:50:26 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG appreciated  Co-Chair Johnson's comment                                                               
because he thinks in many ways it  boils down to what is in front                                                               
of  the members  in the  bill  and the  bill plays  out in  these                                                               
charts.  Regardless  of what the legislature does  now, there are                                                               
other things that  will be happening, such as  elections and what                                                               
producers put on the table.                                                                                                     
CO-CHAIR JOHNSON  said that is  his point.   He does not  want to                                                               
get wrapped  around the numbers  or lock in the  next generations                                                               
of legislators;  rather, he  wants to look  at whether  this road                                                               
should even be taken.                                                                                                           
2:52:24 PM                                                                                                                    
REPRESENTATIVE P. WILSON, should HB  414 be passed, asked whether                                                               
the only thing that would be  provided between April 30 and May 1                                                               
is certainty for the gas producers.                                                                                             
MR.  MARKS responded  that a  section in  AGIA provides  upstream                                                               
resource inducements.   On the  royalty side, the  section spells                                                               
out  how  the royalty  oil  is  to  be  valued, along  with  some                                                               
provisions for  switching between in-kind  and in-value.   On the                                                               
tax side, the section provides  that anyone committing gas in the                                                               
first  binding  open  season,  which  is May  1,  2010,  will  be                                                               
entitled to a tax exemption for  the first 10 years of commercial                                                               
production.    That tax  exemption  is  equal to  the  difference                                                               
between what the actual tax would  be for that first 10 years and                                                               
the tax  that is  on the books  at the time  of the  open season.                                                               
For example,  if the AGIA  project started flowing on  1/1/20 and                                                               
taxes had been increased between  now and then, anyone committing                                                               
gas at  this summer's first  open season  would be entitled  to a                                                               
tax exemption of  the difference between what the tax  code is on                                                               
1/1/20  and what  it  was on  5/1/10.   He  reiterated there  are                                                               
numerous issues as to how  airtight the AGIA inducement provision                                                               
2:55:04 PM                                                                                                                    
REPRESENTATIVE P.  WILSON asked whether  a producer might  sue if                                                               
the state takes the position that the provision is not airtight.                                                                
MR. MARKS replied  that while he is not a  lawyer, he can explain                                                               
two of  the several issues  that have surfaced  regarding whether                                                               
that  provision  is  airtight.   First,  the  state  constitution                                                               
prohibits one legislature from binding  a future legislature; the                                                               
power  to tax  cannot  be  contracted away.    Second, the  early                                                               
versions of AGIA  stated the royalty and  tax resource inducement                                                               
provisions  are  contractual.   However,  some  legislators  were                                                               
concerned  about  the  constitutionality  of that,  so  the  term                                                               
"contractual" was  removed from AGIA.   Thus, there is  the stark                                                               
difference of  one inducement  saying it  is contractual  and one                                                               
that  does not.   According  to lawyers  he has  talked to,  this                                                               
leaves open  the door that this  inducement is not airtight.   He                                                               
allowed, however, that  it may be a moral  commitment that future                                                               
legislatures  are reluctant  to change.   He  said he  cannot say                                                               
whether producers  would argue that  the provisions  are airtight                                                               
and sue.                                                                                                                        
2:57:46 PM                                                                                                                    
REPRESENTATIVE P. WILSON  understood Mr. Marks to  be saying that                                                               
the gas of  any company signing up for the  AGIA open season will                                                               
be tax free for 10 years,  regardless of whether the state raises                                                               
the tax during that 10-year period.                                                                                             
MR. MARKS answered  that if taxes are raised during  the first 10                                                               
years, those companies  would pay the lower of the  tax on May 1,                                                               
2010, or the tax at the end of  those 10 years.  If that lower of                                                               
includes a $2  billion reduction because of this  effect, that is                                                               
what would be in there.                                                                                                         
CO-CHAIR  JOHNSON   interjected  that  that  scenario   would  be                                                               
accurate if  everyone bid  the 4.5  BCF/D on  day one.   However,                                                               
this AGIA provision  applies only to those that bid  in the first                                                               
open season; the provision does not  apply to anyone coming in at                                                               
a later time.   This would therefore reduce the  loss number that                                                               
is being presented.                                                                                                             
2:59:38 PM                                                                                                                    
REPRESENTATIVE  GUTTENBERG inquired  how long  the first  binding                                                               
open season is, how definitive the  length of that season is, and                                                               
whether  the  length  is  defined in  statute  or  determined  by                                                               
TransCanada's  negotiation  with  the Federal  Energy  Regulatory                                                               
Commission (FERC).  For example,  could someone claim the binding                                                               
open season is  not actually closed until all  conditions are met                                                               
for the firm transportation (FT) commitments.                                                                                   
DR. LOGSDON  responded that  according to  TransCanada documents,                                                               
the  open  season runs  from  May  1,  2010,  to July  31,  2010.                                                               
However, he said he does not know if that could be amended.                                                                     
CO-CHAIR  JOHNSON offered  his belief  that FERC  can drive  that                                                               
timeline somewhat.                                                                                                              
REPRESENTATIVE GUTTENBERG said that was  part of his point - many                                                               
of these hard and fast lines are not hard and fast.                                                                             
3:02:24 PM                                                                                                                    
MR. MARKS,  in response  to Representative  Guttenberg, confirmed                                                               
that [the original version of]  HB 414 would remove progressivity                                                               
on gas, but  the Senate committee substitute (CS)  [SB 305] would                                                               
not  [slide  15].    In response  to  Representative  Seaton,  he                                                               
explained  that while  the  presentation  addresses the  original                                                               
version of  the bill,  he will  be talking about  Version E.   He                                                               
said that  the Senate  CS and  Version E  would separate  out the                                                               
progressivity  calculation  for oil  and  gas  and would  include                                                               
progressivity on both oil and gas.                                                                                              
3:04:07 PM                                                                                                                    
MR. MARKS  related that as  the bill  evolved in the  Senate, two                                                               
issues   presented  themselves:     [cost   allocation  and   tax                                                               
neutrality on  current activity].  Regarding  the cost allocation                                                               
issue, he said  oil and gas are currently combined  and the costs                                                               
are  subtracted  to determine  the  net  value  [slide 16].    To                                                               
separate them, costs  would need to be allocated  between oil and                                                               
gas.   Right now, Prudhoe  Bay produces about 275,000  barrels of                                                               
oil a day, and this oil comes up  with gas.  The gas is separated                                                               
and re-injected  into the ground.   By 2020, when a  gas pipeline                                                               
starts, Prudhoe  Bay may  be producing  about 200,000  barrels of                                                               
oil a  day, and out  of 4.5 BCF/D of  gas, about 3.0  BCF/D would                                                               
come out  of Prudhoe Bay.   Thus, Prudhoe  Bay would truly  be an                                                               
oil and gas  field, as would most other fields,  and the costs to                                                               
produce oil and gas are truly joint costs.                                                                                      
3:06:04 PM                                                                                                                    
MR. MARKS  pointed out  that industry  separates these  costs all                                                               
the time  and there are many  methods for doing so.   The state's                                                               
current  tax code  has  certain situations  where  costs must  be                                                               
allocated  between oil  and gas  - in  Cook Inlet  and in  leases                                                               
producing   gas  that   is  sold   in-state.     Alaska   Statute                                                               
43.55.165(h)  gives the  Department of  Revenue the  authority to                                                               
adopt regulations for  allocating costs between oil  and gas, and                                                               
the Senate Finance Committee determined  it should stay this way.                                                               
He  explained   that  the  allocation   method  adopted   by  the                                                               
Department of  Revenue uses  the barrel  of oil  equivalent (BOE)                                                               
approach.  The rational for using  this approach is that the same                                                               
costs that produce oil produce  gas and, since produced together,                                                               
the costs are  allocated based on the amounts produced.   The BOE                                                               
method puts oil and gas on  an apples-to-apples basis in terms of                                                               
relative produced volumes, which he  and Dr. Logsdon agree is the                                                               
most reasonable approach.                                                                                                       
3:08:18 PM                                                                                                                    
MR. MARKS related  it was the Senate  Finance Committee's feeling                                                               
that  some  instruction should  be  given  to the  department  on                                                               
allocating costs.   Thus, the  committee's CS  provides authority                                                               
to the Department  of Revenue to develop  regulations to allocate                                                               
costs  and the  CS  states  that, at  a  minimum, the  department                                                               
should consider  the same BOE  approach, but that  the department                                                               
is free  to look  at other methods  as time goes  on.   This same                                                               
language is included in HB 414, Version E.                                                                                      
3:09:01 PM                                                                                                                    
CO-CHAIR JOHNSON noted oil is more  valuable than gas, but a well                                                               
is a well.   Someone exploring for gas would  have a lower profit                                                               
margin  than someone  exploring for  oil, yet  the two  are being                                                               
compared.   He inquired whether  this would be a  disincentive to                                                               
someone exploring just for gas.                                                                                                 
MR. MARKS replied  that when allocating the costs,  the costs are                                                               
independent of  the value.  The  BOE approach looks at  the costs                                                               
of producing the substances and  the costs are allocated based on                                                               
the  relative  amounts produced.    The  problem with  allocating                                                               
costs based on  value is that world events could  cause the value                                                               
of oil to skyrocket even though  the costs to produce the oil did                                                               
not change.  This  is why he and Dr. Logsdon  do not believe that                                                               
value is the  way to allocate costs, and that  the reasonable way                                                               
to  allocate is  by BTU  content independent  of the  value.   He                                                               
reiterated that  the proposed statute  would give  the Department                                                               
of Revenue the authority to  consider the BTU approach, but would                                                               
not require that approach to be adopted.                                                                                        
CO-CHAIR  JOHNSON  repeated   he  does  not  want   to  create  a                                                               
3:11:38 PM                                                                                                                    
REPRESENTATIVE  SEATON observed  that  no gas  would be  produced                                                               
during  the  10 years  of  constructing  the  gas pipeline.    He                                                               
presumed that  if gas  is now  segregated and  taxed at  base and                                                               
progressivity rates different than  oil, everything for gas would                                                               
be written off against oil  and oil progressivity until the start                                                               
of gas  flow because gas  would not be considered  produced until                                                               
it  is flowing  down the  pipeline, given  that the  provision in                                                               
Version E is for produced oil and produced gas.                                                                                 
MR. MARKS  agreed that  that is how  it would work.   One  of the                                                               
cornerstones of  the petroleum production  profits tax  (PPT) and                                                               
Alaska's Clear  and Equitable  Share (ACES)  was that  instead of                                                               
depreciating  costs  or  deferring  the recovery  of  costs,  the                                                               
producer receives  instantaneous deduction, and the  whole credit                                                               
rate  and  tax  rate  were  designed  around  that  instantaneous                                                               
3:14:13 PM                                                                                                                    
REPRESENTATIVE  SEATON   understood  the   current  instantaneous                                                               
write-off is  a write-off of  costs at oil and  oil progressivity                                                               
instead of gas tax rate and  gas progressivity because the gas is                                                               
not yet flowing.                                                                                                                
MR. MARKS agreed that is how it would work.                                                                                     
3:14:55 PM                                                                                                                    
MR.  MARKS  discussed  the second  issue  that  presented  itself                                                               
during  Senate  deliberations [slide  17].    Some producers  are                                                               
currently producing  both oil and gas.   If the oil  and gas were                                                               
separated  for calculating  progressivity, the  oil progressivity                                                               
would be  undiluted by gas so  the oil progressivity would  go up                                                               
and  taxes  would  increase  for  these  producers.    While  the                                                               
progressivity  would go  up by  a  fairly small  amount, the  tax                                                               
increase  would be  notable  when applied  to  the large  volumes                                                               
produced at today's relatively high  prices.  However, it was not                                                               
the intent of  this bill to raise the taxes  on current activity;                                                               
it was  to deal  with what  would happen with  a major  gas sale.                                                               
So, the  proposed progressivity  structure in  the Senate  CS was                                                               
designed  to not  increase taxes  on current  activity.   This is                                                               
done by providing  one progressivity on oil, Cook  Inlet gas, and                                                               
other  in-state gas,  like  what  is currently  going  on in  the                                                               
state.   A second progressivity  would be applied to  export gas.                                                               
This would replicate  the current situation so there  would be no                                                               
increase in  taxes on  current activity, while  at the  same time                                                               
preventing  the  major  gas  sale   gas  from  diluting  the  oil                                                               
3:17:53 PM                                                                                                                    
REPRESENTATIVE  SEATON  commented it  seems  the  proposal is  to                                                               
protect the state now by splitting  apart oil and gas so one does                                                               
not dilute the other; but, in  10 years, the effect of separating                                                               
oil and gas taxes to protect the state would be cancelled out.                                                                  
MR.  MARKS responded  a mini-dilution  effect is  going on  right                                                               
now.   Some producers have  North Slope  oil and Cook  Inlet gas,                                                               
and if  oil and  gas progressivity was  separated, the  oil would                                                               
not be  diluted and taxes  would go up  for those producers.   It                                                               
was the sense of the  Senate Finance Committee in developing this                                                               
CS that  the intent  of this  bill was not  to increase  taxes on                                                               
current  activity, but  to  protect the  state  on the  long-term                                                               
scenario what  would happen with  a major  gas sale, and  that is                                                               
why this is structured the way it is.                                                                                           
CO-CHAIR JOHNSON said he thinks Representative Seaton is right.                                                                 
3:19:33 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG understood the  bill's intent is not to                                                               
raise taxes  on current  activity, or lower  gas taxes;  the bill                                                               
would separate  oil from gas  and would have progressivity  and a                                                               
tax rate; and would  lock-in gas, but not oil.   He asked what is                                                               
changed if after May 1, 2010, something happens.                                                                                
MR.  MARKS  replied that  if  there  is  a  major gas  sale,  the                                                               
progressivity on  export gas  would be  calculated by  itself and                                                               
would not dilute the progressivity of the oil.                                                                                  
REPRESENTATIVE GUTTENBERG  surmised that  separating oil  and gas                                                               
changes the economics, but said he must be missing something.                                                                   
3:21:31 PM                                                                                                                    
REPRESENTATIVE SEATON  referenced charts previously shown  to the                                                               
committee that depicted progressivity  and the marginal tax rate.                                                               
He said he  thinks what is being  said is that the  effect of the                                                               
current system  of combined oil and  gas taxes is that  gas moves                                                               
the progressivity down  for certain companies.   The objective of                                                               
HB 414 is to  make it so gas will not  lower the progressivity of                                                               
oil.    However, the  Senate  CS  proposes  keeping oil  and  gas                                                               
progressivity together  for those  companies already  doing this,                                                               
so that an  oil company can lower progressivity  with its current                                                               
gas production.                                                                                                                 
MR. MARKS confirmed that that  is basically correct and suggested                                                               
this may become clearer once Dr. Logsdon explains the bill.                                                                     
3:23:01 PM                                                                                                                    
DR.  LOGSDON noted  that in  the CS  for SB  305, Version  T, the                                                               
title has  been tightened to  focus the bill's scope  [slide 23].                                                               
He explained that, under ACES,  Cook Inlet gas and non-Cook Inlet                                                               
gas used in-state are subject  to the economic limit factor (ELF)                                                               
tax  that was  in effect  in March  2006 [slide  24].   These two                                                               
elements of the  tax system result in  the current mini-dilution.                                                               
The notion behind HB 414 is  to separate the gas that is exported                                                               
out  of state,  which  would  primarily be  the  gas feeding  the                                                               
gasline  off the  North Slope,  and  it is  this separation  that                                                               
would get rid of the big dilution.                                                                                              
3:25:45 PM                                                                                                                    
REPRESENTATIVE   SEATON   inquired   whether  Dr.   Logsdon   has                                                               
confidence in  Alaska being able  to maintain a  differential tax                                                               
rate on producers  between the gas that is used  in-state and the                                                               
gas that is shipped to another state under the commerce clause.                                                                 
DR. LOGSDON said he does not know the answer to that question.                                                                  
REPRESENTATIVE SEATON  suggested that  if the commerce  clause is                                                               
ruled by the  courts to prevail and  the tax rate is  going to be                                                               
the Cook Inlet Sedimentary Basin  and the in-state tax rate, then                                                               
perhaps the thing  to do right now is to  remove the in-state tax                                                               
rate as  being the same as  the Cook Inlet rate  because then all                                                               
the North Slope sales would be  at the same rate whether in-state                                                               
or out of state.                                                                                                                
3:27:48 PM                                                                                                                    
CO-CHAIR JOHNSON  noted that another  option would be to  do away                                                               
with the North Slope rate and use the Cook Inlet rate.                                                                          
REPRESENTATIVE SEATON agreed.                                                                                                   
DR. LOGSDON  said the mini-dilution  he has described is  what is                                                               
in statute  right now and  was established  by ACES.   Cook Inlet                                                               
gas and any non-Cook Inlet gas, or  oil, that is sold for use in-                                                               
state, would pay the combined  oil/gas progressivity rate because                                                               
that is  how it works today.   By separating out  just the export                                                               
gas  from the  North Slope,  as proposed  by the  Senate CS,  the                                                               
state  would  preserve   the  combined  oil  and   gas  rate  for                                                               
progressivity for Cook Inlet and  in-state gas use.  The separate                                                               
gas  progressivity rate  would  only be  applied  to North  Slope                                                               
3:29:26 PM                                                                                                                    
MR.  MARKS  added  that  right  now  every  producer  computes  a                                                               
statewide  progressivity  factor with  all  its  activity.   Cook                                                               
Inlet  gas activity  goes into  computing a  producer's statewide                                                               
progressivity factor,  but the  tax that Cook  Inlet oil  and gas                                                               
pay  is based  on  ELF and  not the  progressivity  factor.   The                                                               
progressivity factor  that is  derived from  the Cook  Inlet oil,                                                               
Cook  Inlet gas,  North Slope  oil, and  North Slope  gas is  the                                                               
producer's statewide  progressivity factor for when  the producer                                                               
pays  tax on  progressivity.   So,  the "bucket"  with oil,  Cook                                                               
Inlet  gas, and  other in-state  gas, is  the activity  the state                                                               
currently has.   Under  HB 414, that  bucket would  still operate                                                               
the way it operates now -  that activity will go into computing a                                                               
producer's  progressivity for  where  progressivity applies,  and                                                               
the tax paid on Cook Inlet oil and gas will be based on ELF.                                                                    
3:31:43 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG recollected there  was a case that went                                                               
to court regarding  tariffs for oil used  in-state versus tariffs                                                               
for oil going all the way to the West Coast.                                                                                    
MR. MARKS replied that that was a tariff issue.                                                                                 
MR.  MARKS,  in response  to  Representative  P. Wilson,  further                                                               
explained that  the tax  paid on  Cook Inlet oil  and gas  is the                                                               
lower of  the ELF tax  or the ACES  tax.  The  ELF tax is  so low                                                               
that  the  producer  almost  always pays  on  ELF;  however,  the                                                               
producer must still  go through the exercise  of calculating what                                                               
its tax  would be using the  ACES progressivity and what  its tax                                                               
would be using ELF.                                                                                                             
DR. LOGSDON  added that a producer  may not pay tax  based on the                                                               
taxable value of oil and taxable  value of gas because of the ELF                                                               
limit.  However, there is still  some dilution of the North Slope                                                               
oil  tax because  the progressive  rate is  calculated using  the                                                               
taxable gas from  the Cook Inlet along with the  taxable oil from                                                               
the North Slope.                                                                                                                
3:35:01 PM                                                                                                                    
DR.  LOGSDON explained  that  under  HB 414  there  would be  two                                                               
"buckets" for  progressivity.  In  the first bucket,  the payment                                                               
of  taxes  would   be  the  same  as  it  is   now  in  that  one                                                               
progressivity is  calculated on  oil, Cook  Inlet gas,  and other                                                               
in-state gas, so there would be  no increase in taxes [slide 25].                                                               
The  second   bucket  is  for   a  major  gas  sale,   and  would                                                               
specifically  carve out  export gas  for separate  tax treatment.                                                               
He  noted that  a  pipeline  moving gas  for  in-state use  would                                                               
result  in a  bigger dilution  effect  than there  is right  now,                                                               
which may be a good thing.                                                                                                      
DR. LOGSDON pointed out there is  upside risk as well as downside                                                               
risk [slide  26].  If gas  prices went high under  the flat rate,                                                               
the state  would leave money  on the table,  which is why  HB 414                                                               
includes  progressivity   on  exported  gas.     The  bill  would                                                               
establish the  rates exactly like  they are  currently calculated                                                               
for the  combined substance:   every dollar above $30  per barrel                                                               
net taxable value would increase the  tax rate by 0.4 percent and                                                               
anything over $92.50 would increase it by 0.1 percent.                                                                          
3:37:15 PM                                                                                                                    
DR. LOGSDON said  the other element of HB 414  is the requirement                                                               
that  BTU  equivalent  barrels  be considered  as  a  method  for                                                               
allocating  lease costs  between oil  and  gas [slide  27].   The                                                               
Department  of  Revenue already  has  regulations  that use  this                                                               
method  for   allocating  joint  production.     This  method  is                                                               
straightforward, knowable,  and relatively  stable, and  is based                                                               
on production activity.   However, the bill recognizes  it is the                                                               
Department of  Revenue that has the  resources, time, procedures,                                                               
public   processes,  and   confidential   information,  and   the                                                               
department  may  ultimately  determine  that  another  method  is                                                               
3:38:37 PM                                                                                                                    
REPRESENTATIVE SEATON asked whether  Dr. Logsdon is confident the                                                               
state will  be allowed to have  different tax rates for  gas that                                                               
is used in-state and gas that is exported to the Lower 48.                                                                      
DR.  LOGSDON responded  his answer  as an  economist is  that the                                                               
value of  the substance being taxed  is not a pass  forward.  The                                                               
market will determine  the price, and the costs of  getting it to                                                               
market and  of producing  it will  determine the  tax base.   The                                                               
state's taxes have no influence on  the price that someone in the                                                               
Lower 48  is going to pay.   He allowed there  is another aspect,                                                               
however, which is whether this  is a violation of equal treatment                                                               
among taxpayers and he does not have an answer to that.                                                                         
CO-CHAIR JOHNSON  said it is  an answer that the  committee needs                                                               
to get.                                                                                                                         
3:40:48 PM                                                                                                                    
REPRESENTATIVE P. WILSON  observed that HB 414  would require the                                                               
Department  of Revenue  to consider  the  BTU equivalent  method.                                                               
She inquired  whether the  department could  jump back  and forth                                                               
between methods.                                                                                                                
DR.  LOGSDON  replied  the  language   is  what  it  says.    The                                                               
department  is being  seeded the  ability to  determine what  the                                                               
appropriate method  is, but it  is a recommendation that  the BTU                                                               
equivalent method be considered.                                                                                                
MR. MARKS, in response to  a further question from Representative                                                               
P.  Wilson, said  this  language is  in Section  8,  page 11,  of                                                               
Version E.                                                                                                                      
3:42:31 PM                                                                                                                    
REPRESENTATIVE P. WILSON surmised  from reading the language that                                                               
the bill  really does  not tell the  Department of  Revenue which                                                               
method to use.                                                                                                                  
DR. LOGSDON clarified  that the specific language is  on page 12,                                                               
lines 1-2.   In further response, he confirmed  the language does                                                               
not  say the  department has  to use  the BTU  equivalent method,                                                               
just that it must consider it.                                                                                                  
REPRESENTATIVE  P.  WILSON  asked  whether  the  department  must                                                               
decide on one method or another and then stick to that.                                                                         
MR. MARKS  answered the  current statute  says the  Department of                                                               
Revenue shall  adopt regulations on  how to allocate costs.   All                                                               
the  amendment in  HB  414  says is  that  when  doing that,  the                                                               
department  should consider  this BTU/BOE  equivalent method;  it                                                               
does  not  compel  the  department  to  use  it.    Whatever  the                                                               
department does,  it must go  through the regulatory  process and                                                               
if over time  the department decides that it does  not like how a                                                               
method is performing, it would have the freedom to alter it.                                                                    
3:44:26 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG  said the provision seems  ambiguous as                                                               
far as  which method  to use  and that the  method used  could be                                                               
MR. MARKS  responded the Department  of Revenue is  not compelled                                                               
to use  the BOE method, which  is the method the  department came                                                               
up  with  when it  had  the  authority  to adopt  regulations  to                                                               
address pretty much  the same question.  It was  simply the sense                                                               
of the Senate  Finance Committee that it would be  useful to give                                                               
the department some guidance as to how to address this issue.                                                                   
3:45:58 PM                                                                                                                    
REPRESENTATIVE SEATON  said he  is a bit  stuck because  it seems                                                               
the purpose of  HB 414 is the  worry about the May  1, 2010, date                                                               
and  that the  binding open  season  might be  something that  is                                                               
problematic for the  state.  He said  it seems to him  that a far                                                               
greater liability  than separating  oil and gas  is that  the in-                                                               
state usage and  ELF system could become the  required tax system                                                               
should the  state be sued  for commerce clause reasons,  and this                                                               
tax is essentially near zero.                                                                                                   
MR. MARKS replied  those are two different problems  that are not                                                               
related; solving one  does not solve the other.   The belief that                                                               
the current tax  structure for Cook Inlet gas is  defective is an                                                               
independent  issue of  what HB  414  is addressing  and could  be                                                               
rectified by other means.                                                                                                       
3:48:12 PM                                                                                                                    
REPRESENTATIVE SEATON  said he would  agree if it was  Cook Inlet                                                               
Sedimentary Basin  that was  being talked  about.   However, that                                                               
tax framework has  been expanded to North Slope gas  that is used                                                               
in-state; so, it  really is the state's current tax  rate for the                                                               
North Slope.   He said  it seems an argument  could be made  in a                                                               
court of law that  that was the tax structure in  place on May 1,                                                               
2010.   While he also  worries about progressivity, he  sees this                                                               
as a greater concern.                                                                                                           
3:49:32 PM                                                                                                                    
CO-CHAIR JOHNSON,  in reference to  the title, asked  whether the                                                               
bill would change the way revenue  sharing is done [page 1, lines                                                               
5-6, Version E].                                                                                                                
MR. MARKS  answered that when  the progressivity  provisions were                                                               
adopted this  community revenue sharing fund  was established and                                                               
funded  by  a proportion  of  the  progressivity revenues.    The                                                               
"bucket  one" progressivity  would be  under AS  43.55.011(g) and                                                               
the "bucket  two" progressivity would  be under  AS 43.55.011(p).                                                               
Section 1  of Version  E would  provide that a  share of  the new                                                               
progressivity  go  into the  community  revenue  sharing fund  as                                                               
well.   That  fund is  up and  running and  has been  receiving a                                                               
share  of  the progressivity  revenue  since  2006.   In  further                                                               
response, he said the only amendment  is that which is on page 1,                                                               
line 12.                                                                                                                        
CO-CHAIR JOHNSON said he wants  to make sure that revenue sharing                                                               
is not being codified.                                                                                                          
3:51:30 PM                                                                                                                    
CO-CHAIR JOHNSON  stated that HB 414  is a policy call  and it is                                                               
incumbent  upon committee  members to  exercise due  diligence by                                                               
going through the bill with a fine-tooth comb.                                                                                  
[HB 414 was held over.]                                                                                                         

Document Name Date/Time Subjects
HB 337 Amendment R.2 3.30.10.pdf HRES 3/31/2010 1:00:00 PM
HB 337
HB 337 Amend conceptual E 3.30.10.pdf HRES 3/31/2010 1:00:00 PM
HB 337
HB 267 Bill Packet 3.31.10.pdf HRES 3/31/2010 1:00:00 PM
HB 267
HB 365 Bill Packet 3.31.10.pdf HRES 3/31/2010 1:00:00 PM
HB 365
HB 365 Letters of Support.pdf HRES 3/31/2010 1:00:00 PM
HB 365
HB 414 HRES for 3.22.10.pdf HRES 3/31/2010 1:00:00 PM
HB 414
CS HB267(TRA)-DOT-CO-03-26-10.pdf HRES 3/31/2010 1:00:00 PM
HB 267
Signed SRA-Trident-Ocean Beauty MOU re HB365 SB255.pdf HRES 3/31/2010 1:00:00 PM
HB 365
SB 255
HB 414 work draft v.E.pdf HRES 3/31/2010 1:00:00 PM
HB 414