Legislature(2015 - 2016)BARNES 124

02/26/2016 01:00 PM RESOURCES

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01:02:12 PM Start
01:02:52 PM HB247
02:59:39 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Heard & Held
-- Testimony <Invitation Only> --
enalytica Oil & Gas Tax Credit Overview
+ Bills Previously Heard/Scheduled TELECONFERENCED
           HB 247-TAX;CREDITS;INTEREST;REFUNDS;O & G                                                                        
1:02:52 PM                                                                                                                    
CO-CHAIR  NAGEAK announced  that the  only order  of business  is                                                               
HOUSE BILL NO. 247, "An  Act relating to confidential information                                                               
status and public record status  of information in the possession                                                               
of the Department of Revenue;  relating to interest applicable to                                                               
delinquent tax; relating to disclosure  of oil and gas production                                                               
tax credit information;  relating to refunds for  the gas storage                                                               
facility tax  credit, the liquefied natural  gas storage facility                                                               
tax   credit,   and   the   qualified   in-state   oil   refinery                                                               
infrastructure expenditures  tax credit; relating to  the minimum                                                               
tax for certain  oil and gas production; relating  to the minimum                                                               
tax  calculation for  monthly installment  payments of  estimated                                                               
tax;  relating to  interest on  monthly  installment payments  of                                                               
estimated  tax; relating  to limitations  for the  application of                                                               
tax credits; relating  to oil and gas production  tax credits for                                                               
certain  losses and  expenditures;  relating  to limitations  for                                                               
nontransferable oil and  gas production tax credits  based on oil                                                               
production  and  the  alternative  tax credit  for  oil  and  gas                                                               
exploration;  relating to  purchase  of  tax credit  certificates                                                               
from the oil  and gas tax credit fund; relating  to a minimum for                                                               
gross  value  at  the  point of  production;  relating  to  lease                                                               
expenditures  and tax  credits for  municipal entities;  adding a                                                               
definition   for  "qualified   capital  expenditure";   adding  a                                                               
definition for  "outstanding liability  to the  state"; repealing                                                               
oil  and   gas  exploration  incentive  credits;   repealing  the                                                               
limitation on  the application of  credits against  tax liability                                                               
for  lease   expenditures  incurred   before  January   1,  2011;                                                               
repealing provisions related to  the monthly installment payments                                                               
for  estimated tax  for oil  and gas  produced before  January 1,                                                               
2014;  repealing  the  oil  and gas  production  tax  credit  for                                                               
qualified  capital expenditures  and  certain well  expenditures;                                                               
repealing   the  calculation   for  certain   lease  expenditures                                                               
applicable before January 1,  2011; making conforming amendments;                                                               
and providing for an effective date."                                                                                           
1:03:40 PM                                                                                                                    
JANAK  MAYER,  Chairman  &  Chief  Technologist,  enalytica,  and                                                               
consultant to  the Legislative Budget and  Audit Committee, noted                                                               
he is before  the committee to advise on matters  relating to oil                                                               
and  gas,  particularly  commercialization  and  fiscal  systems.                                                               
Drawing  attention  to   his  PowerPoint  presentation  entitled,                                                               
"IMPACT OF  HB 247:   NORTH SLOPE  ASSESSMENT," he  continued his                                                               
analysis of  the projected impacts of  HB 247 on the  oil and gas                                                               
industry in Alaska, which he had begun on 2/25/16, 1:00 p.m.                                                                    
MR. MAYER  turned to  slide 13,  "MONTHLY GROSS  MIN CALCULATION:                                                               
NEUTRAL OR TAX  HIKE."  He reminded members that  at the close of                                                               
yesterday's presentation the committee  was looking at the impact                                                               
of  the bill's  proposed  change  to move  from  an  annual to  a                                                               
monthly reconciliation of  the tax system in terms  of the impact                                                               
of  various  credits,  particularly the  Per-Barrel  Credit,  the                                                               
Small Producer Credit,  the Net Operating Loss  (NOL) Credit, and                                                               
how those  credits interact  with the  hard gross  minimum floor.                                                               
He explained  that the top row  of the chart on  slide 13 depicts                                                               
this  calculation being  done on  an annual  basis [for  calendar                                                               
year 2014].   The calculation begins with the  Alaska North Slope                                                               
West Coast (ANS  WC) average annual price [$97.74]  from which is                                                               
subtracted  the transportation  cost, the  operating expenditures                                                               
("opex"),  and the  capital expenditures  ("capex") to  arrive at                                                               
the  production tax  value (PTV)  per  barrel [$47.73].   The  35                                                               
percent net  production tax  rate is  multiplied against  the PTV                                                               
[arriving at $16.71],  from which is subtracted  the sliding Per-                                                               
Barrel Credit, which is $0-$8  for an established producer on the                                                               
North Slope  and which was  $8 in the year  2014, to arrive  at a                                                               
net production  tax of [$8.71] per  barrel.  The $8.71  is higher                                                               
than is the 4 percent gross  floor [$3.49], so $8.71 would be the                                                               
tax paid per barrel using the annual system of current law.                                                                     
MR. MAYER  explained that  if the calculation  was to  instead be                                                               
done monthly  as proposed  in HB  247, then in  a year  like 2014                                                               
when there is a  lot of volatility in the oil  price, each of the                                                               
first 10 months would have used  the net tax calculation, but the                                                               
final 2 months of the year when  oil prices fell to $77 and $60 a                                                               
barrel would have used the 4  percent binding gross because the 4                                                               
percent  gross calculation  is higher  than the  net calculation.                                                               
The net  effect of a monthly  basis would be to  raise the amount                                                               
of production tax per barrel from  [$8.71] to [$9.31].  When this                                                               
tax is multiplied  by the number of taxable barrels  on the North                                                               
Slope, it  would result in  about $100 million in  additional tax                                                               
that would be  taken in by switching from an  annual to a monthly                                                               
calculation.   He  described  this  as a  tax  hike that  happens                                                               
because  the proposed  change  is  a situation  of  "heads I  the                                                               
sovereign win,  tails it's a draw".   If there is  no volatility,                                                               
the two things are the same;  the more there is volatility in the                                                               
oil  price, the  more  this  proposed change  would  work in  the                                                               
sovereign's favor and the taxpayer's disadvantage.                                                                              
1:07:17 PM                                                                                                                    
MR. MAYER pointed out that  because the calculation would be done                                                               
each month it  would mean that each month a  taxpayer must really                                                               
understand what its  costs are for that month and  do that entire                                                               
calculation.   It would  be almost like  the taxpayer  filing its                                                               
tax return monthly  rather than annually.  Some of  that would be                                                               
trued up at the end of the year,  but a taxpayer would need to be                                                               
very certain  of not understating its  costs for the month.   The                                                               
way  the language  is written,  the sum  of the  taxpayer's total                                                               
cannot be higher than the sum of  its monthlies.  So, if it turns                                                               
out at  the end  of the  year the  taxpayer's costs  were higher,                                                               
those credits would essentially be  lost to the taxpayer forever.                                                               
Mr. Mayer  further pointed out  that this analysis is  focused on                                                               
the sliding  Per-Barrel Credit of  $8 in  the world of  the large                                                               
incumbent oil producer.   However, the floor hardening  in HB 247                                                               
would apply  to both  incumbent and new  producers by  making the                                                               
floor  binding  on oil  that  is  eligible  for the  Gross  Value                                                               
Reduction (GVR),  as well  as binding in  that the  Net Operating                                                               
Loss  Credit and  the Small  Producer Credit  could not  be taken                                                               
away from the floor, which would  be a substantial impact on [new                                                               
1:08:57 PM                                                                                                                    
REPRESENTATIVE  HAWKER understood  that the  numbers on  slide 13                                                               
are the actual numbers as reported for the year 2014.                                                                           
MR. MAYER  confirmed that  to be correct,  broadly speaking.   He                                                               
explained it is a very  high level approximation that essentially                                                               
treats the North  Slope as if it were one  uniform taxpayer.  The                                                               
cost  numbers are  also fiscal  year (FY)  2014, whereas  the tax                                                               
year is  a calendar year;  so, it is  not a perfect  match there.                                                               
Those  are  actual  numbers  to  the  extent  that  a  reasonably                                                               
accurate picture  can be created  through "back of  the envelope,                                                               
high level numbers" versus individual taxpayer numbers.                                                                         
REPRESENTATIVE HAWKER  noted that  Mr. Mayer's calculation  of an                                                               
additional  $100  million  in liability  is  basically  the  same                                                               
number as presented  by Mr. Alper, Director of  the Tax Division.                                                               
He  requested Mr.  Mayer to  explain  how and  why the  operating                                                               
costs and  the capital  expense costs somehow  managed to  be the                                                               
same number for every single month.                                                                                             
MR. MAYER replied that in this  case it is taking the annual 2014                                                               
numbers and  spreading them in  even proportion across  the year.                                                               
In  practice as  a  taxpayer  there would  be  variation and  one                                                               
difficulty as  a taxpayer would  be the need to  understand month                                                               
by month what  those are.  The taxpayer would  want to be careful                                                               
to err on the conservative side  and overstate them and then deal                                                               
with that overstatement  at true-up rather than  be worried about                                                               
understating them,  in which case  the credits that  the taxpayer                                                               
potentially forewent because of  interaction with the floor would                                                               
never be able to be gotten back.                                                                                                
REPRESENTATIVE HAWKER  said that is not  where he was going.   He                                                               
asked  whether the  state requires  in the  calculation that  the                                                               
taxpayers use  a monthly estimate  based on a monthly  portion of                                                               
what  the   taxpayer  estimates   its  annual  expenses   to  be.                                                               
Therefore, he  surmised, it  would be mirroring  the way  the tax                                                               
calculation actually works in statute.                                                                                          
MR. MAYER, after confirming that  Representative Hawker is saying                                                               
that the calculation is supposed  to take the annual estimate and                                                               
divide it by 12, answered correct.                                                                                              
REPRESENTATIVE HAWKER  concluded, then, that the  numbers seen on                                                               
a monthly basis here do not  reflect the amount that was actually                                                               
being paid by the industry in that month.                                                                                       
MR. MAYER  replied that the costs  in the chart are  simply costs                                                               
from the Revenue Sources Book  spread evenly across the year, and                                                             
not actual data.                                                                                                                
REPRESENTATIVE  HAWKER asked  whether  that is  not  the way  the                                                               
calculation is done within state statute.                                                                                       
MR. MAYER responded that that is his understanding....                                                                          
REPRESENTATIVE  HAWKER observed  that Mr.  Alper is  nodding, but                                                               
said  he is  going  to miss  his whole  point  because he  cannot                                                               
validate it here.                                                                                                               
1:11:59 PM                                                                                                                    
REPRESENTATIVE JOSEPHSON  asked whether Representative  Hawker is                                                               
saying that  if the  opex and capex  actually reflected  what was                                                               
really  going on  in  the month,  then the  tax  depicted in  the                                                               
second to right column would be different.                                                                                      
REPRESENTATIVE HAWKER  answered that  that is exactly  his point,                                                               
it would be substantially different.                                                                                            
REPRESENTATIVE TARR  surmised that  because the  ANS WC  price is                                                               
different on a  monthly basis, the chart illustrates  some of the                                                               
variation in  the per-barrel price  but not a true  reflection of                                                               
opex and capex.                                                                                                                 
MR. MAYER  replied that the  point being  made is that  there are                                                               
various elements  of inter-year  volatility in the  system, price                                                               
and costs being  two of those elements.  He  explained that a big                                                               
part of the  reason for doing an annual calculation  is to reduce                                                               
that volatility  in the same way  a person calculates his  or her                                                               
entire income  over the  year rather  than what  was earned  in a                                                               
given month.   Rather  than having a  volatility smoothing  of an                                                               
annual  calculation,  he  advised,  this  proposed  change  would                                                               
assess month by  month and that can only work  in the sovereign's                                                               
favor.  Essentially it  can only ever be a tax  hike in the event                                                               
of price volatility.                                                                                                            
1:14:15 PM                                                                                                                    
MR. MAYER moved to slide 14,  "GVR RAISES NOL CREDIT ABOVE 35% OF                                                               
ACTUAL LOSS," and specified that  HB 247 also raises the question                                                               
of  how the  Gross Value  Reduction (GVR)  for new  oil interacts                                                               
with the  Net Operating Loss (NOL)  Credit.  He advised  that the                                                               
administration has  raised an important  and valid point  that is                                                               
useful  to debate.   Alaska's  Clear and  Equitable Share  (ACES)                                                               
[passed  in  2007, House  Bill  2001,  Twenty-Fifth Alaska  State                                                               
Legislature]  had a  hugely varying  rate of  government support,                                                               
from 45 percent to over 100  percent.  It could vary wildly month                                                               
by month depending on prices and  costs and all the rest.  During                                                               
consideration of  Senate Bill 21  [passed in  2013, Twenty-Eighth                                                               
Alaska State Legislature], the thinking  was to have a uniform 35                                                               
percent  support for  government spending  in all  circumstances.                                                               
The Gross Value  Reduction was a way to reduce  the effective tax                                                               
rate that new  oil pays by artificially lowering the  way the tax                                                               
systems treats the value at  the wellhead.  Because everything in                                                               
the calculation flows  on from that, it also affects  the way the                                                               
net operating loss is assessed.                                                                                                 
Mr. Mayer demonstrated how the  GVR works by drawing attention to                                                               
the scenario depicted  on slide 14 for an oil  price of $30 under                                                               
Senate Bill 21.   From the price of $30,  the transportation cost                                                               
of $10 is subtracted to arrive at  a $20 gross value at the point                                                               
of  production  (GVPP) before  factoring  in  the  GVR.   The  20                                                               
percent GVR is  then subtracted to arrive at a  GVPP of $16 after                                                               
GVR.   The opex [$18]  and capex  [$18] are then  subtracted from                                                               
the $16 to  arrive at a production  tax value (PTV) of  a loss of                                                               
$20.  Had there not been  a Gross Value Reduction the actual loss                                                               
at  the wellhead  would  have been  $16.   The  tax system  would                                                               
recognize the $20 loss.  That  is important at higher prices, and                                                               
at all prices,  in reducing the effective tax rate.   The purpose                                                               
of the  Net Operating Loss Credit  was to say 35  percent support                                                               
for  government  spending at  all  prices.    Because it  is  not                                                               
looking  at  the  actual  loss,  but rather  is  looking  at  the                                                               
production tax value  per barrel, the effect is  to overstate the                                                               
loss.  So in this scenario, instead  of a credit of 35 percent of                                                               
the actual production  tax value it is 44 percent  of that actual                                                               
number, because it is based on  the number after the GVR has been                                                               
1:18:43 PM                                                                                                                    
MR. MAYER continued discussing slide 14.   He said the aim of the                                                               
policy direction set  under Senate Bill 21 was to  have a uniform                                                               
35 percent  support of government spending  in all circumstances.                                                               
Between  passage  of  Senate  Bill   21  and  now,  a  number  of                                                               
investments have  been made under the  tax regime in place.   Any                                                               
change  such as  this would  seriously impact  those investments.                                                               
If it  is thought  that this  is a  substantive matter  of policy                                                               
that should  be addressed,  the question of  how to  address that                                                               
and the  timing and how that  applies and when that  applies then                                                               
becomes  critical.   This is  because  numerous investments  have                                                               
been  made under  certain assumptions  and  spending is  actually                                                               
happening  today.    Those  assumptions  included  modeling  this                                                               
exactly as  it was,  and those investments  would be  impacted by                                                               
any change like  this.  It is  one thing to look at  this and ask                                                               
whether this was what was intended  and should this at some point                                                               
change.  And  then another to think about if  that should change,                                                               
how that  should be  enacted, what  the applicable  timeframe is,                                                               
and  who  is  impacted  when.    Those  are  all  very  important                                                               
considerations  since any  change will  substantially impact  the                                                               
economics of ongoing investment.                                                                                                
1:20:19 PM                                                                                                                    
REPRESENTATIVE HERRON inquired whether  it could be created where                                                               
the current credit of 35 percent  stays with projects that are in                                                               
play, and  that any  future projects would  be under  a different                                                               
tax regime such as that under HB 247.                                                                                           
MR.  MAYER responded  that there  are ways  of achieving  exactly                                                               
that.   For  instance,  small producers  currently  on the  North                                                               
Slope could continue to receive  the Small Producer Credit and it                                                               
could be made so that this credit is not open to new entrants.                                                                  
1:21:08 PM                                                                                                                    
REPRESENTATIVE SEATON asked whether Mr.  Mayer is aware of anyone                                                               
who,  during the  discussion of  Senate Bill  21, was  planning a                                                               
project and was  counting on being able to  somehow leverage more                                                               
than the 35 percent.                                                                                                            
MR. MAYER  allowed that this is  an excellent question.   He said                                                               
that when  he was first made  aware of this issue  he was shocked                                                               
and  surprised  because he  thought  it  was very  clear  amongst                                                               
everyone that  the intent was 35  percent.  When he  went back to                                                               
his own models he found that  they produced exactly the regime as                                                               
it  exists, which  is in  effect a  higher level  of support  for                                                               
government  spending -  when  the  gross value  at  the point  of                                                               
production  is  tweaked,  the  rest  of this  falls  out.    This                                                               
oversight is not  the result of legislatively polar  or a strange                                                               
bit of  drafting, he said,  but rather  that it is  a complicated                                                               
system  and  when a  change  is  made  in  one place  it  affects                                                               
numerous things further  below.  So, whether it  was himself, the                                                               
administration's consultants,  or anyone else building  models at                                                               
the time,  or someone  assessing an  investment in  the meantime,                                                               
the pieces  of the system would  be assembled in a  model and the                                                               
settings would  be created.  The  economics that flowed out  as a                                                               
result  would  then be  assessed.    In  the  case of  a  company                                                               
assessing a  project, the  company would  assess things  based on                                                               
what it  sees.  While assessing  the economics, a company  is not                                                               
necessarily  asking what  was the  implicit  level of  government                                                               
support for  spending and whether  that was what  the legislature                                                               
intended.   He  said  he firmly  believes  that anyone  assessing                                                               
their  economics on  a project  on which  they took  sanction was                                                               
doing it  on the system that  existed and not necessarily  on the                                                               
basis of legislative intent.                                                                                                    
1:23:11 PM                                                                                                                    
REPRESENTATIVE SEATON  surmised that none of  the consultants who                                                               
were advising the  legislature at the time spotted  this and that                                                               
no one  testifying on  the projects  that were  under development                                                               
spotted  this.   If  someone  had spotted  this  they might  have                                                               
figured that they  could not address it or could  tweak it in and                                                               
not understand  the legislature's discussions.   He said  he does                                                               
not think [industry]  would be surprised if  the legislature came                                                               
back and  assessed the system that  it thought it was  passing at                                                               
the time.  He added he  is not suggesting that anybody knew about                                                               
it at  the time and  that when  talking to legislators  about the                                                               
system   the  companies   were   being   forthright  in   telling                                                               
legislators what they  thought it did, what the  support was, and                                                               
what the government take was.                                                                                                   
MR. MAYER further  suggested that when a company  is evaluating a                                                               
project to  take final investment  decision, a lot of  things are                                                               
being looking  at, such  as net present  value, internal  rate of                                                               
return [IRR], long-term cash flow,  and various risk and non-risk                                                               
scenarios.   He said he  would be  very surprised if  among those                                                               
metrics would be the question  of the implicit rate of government                                                               
support for spending.   In that sense he would  be very surprised                                                               
if a  company assessing  this would think  there was  something a                                                               
bit odd here.                                                                                                                   
1:24:54 PM                                                                                                                    
REPRESENTATIVE  JOSEPHSON  offered  his  understanding  that  the                                                               
prior administration did  identify this problem of  going under a                                                               
tax rate  of 4  percent as  well as under  a 0  percent effective                                                               
tax.   Two  things  strike him,  he said,  the  first being  that                                                               
everyone he has spoken to says  that the state is making slightly                                                               
more revenue  now than under the  prior regime.  Second,  what he                                                               
is sensing from  Mr. Mayer's testimony, and given  that the prior                                                               
administration understood this potential  problem, is that no one                                                               
foresaw this level of [low] price so it was not discussed.                                                                      
MR. MAYER  answered that the point  on slide 14 is  not about the                                                               
gross floor  and whether  one can  go below  that.   He recounted                                                               
that  it was  a deliberate  policy decision  to say  that because                                                               
gross taxes are effectively  distorting [the state's] investment,                                                               
a binding  4 percent floor was  not wanted on new  production.  A                                                               
deliberate  and  thought-through decision  was  made  to make  it                                                               
binding on the  legacy oil because that is where  the revenue for                                                               
the state  needs to be  protected, but  on new investment  it was                                                               
wanted to  minimize the distorting  impact and so that  floor was                                                               
not made binding in the same way as on the legacy fields.                                                                       
REPRESENTATIVE JOSEPHSON concurred.                                                                                             
1:26:57 PM                                                                                                                    
MR.  MAYER continued  his response  to Representative  Josephson.                                                               
He noted that  in 2013 [as a consultant to  the legislature while                                                               
employed  with  PFC  Energy  Oil  and  Gas  Research  Acquisition                                                               
(PFC)], he  presented analyses  over a range  of prices  from $40                                                               
per barrel  to $160, the same  range he is providing  today.  The                                                               
reason for  not going  below $40 was  because, frankly,  the math                                                               
did not  really work below $40  a barrel.  At  $40, he explained,                                                               
there  is  no   divisible  income  to  split   and  metrics  like                                                               
government take  do not mean  anything as they are  all infinite.                                                               
When sitting before the committee  three years ago as the initial                                                               
discussions around Senate Bill 21  were starting, he was asked to                                                               
prepare several slides around what  PFC saw as the short-term and                                                               
long-term likely  floor price for  Alaska North Slope  West Coast                                                               
(ANS WC)  crude.  Seen at  that time was unprecedented  growth in                                                               
North American  onshore production,  as well as  the Organization                                                               
of  the Petroleum  Exporting Countries  (OPEC)  and Saudi  Arabia                                                               
being increasingly  unable to manage  the market in the  way they                                                               
had in  the past.   There was  rising production from  Iraq where                                                               
the question  of what  happened with  Iran was  unknown.   All of                                                               
these things,  combined with  a weak  global outlook,  meant that                                                               
[PFC]  saw more  risks to  the downside  than the  upside.   When                                                               
asked what a  reasonable floor price might be, [PFC]  said in the                                                               
short  run  it  could  see scenarios  of  strong  oversupply  and                                                               
failure of management  by OPEC, which could reduce  prices to $30                                                               
a  barrel, and  that in  the  long run  there would  be a  strong                                                               
supply response,  particularly from  North America, were  that to                                                               
happen.  In the long run,  [PFC] could see somewhere in the range                                                               
of $50-$70  for the  long-term floor  price.  A  big part  of the                                                               
reason for some of the testimony  he gave back then was that much                                                               
of the debate in those times  focused on when the price was $140-                                                               
$150  a barrel,  how much  would the  state be  giving away,  and                                                               
should the  state be taking  more.   He recalled advising  in his                                                               
testimony  back  then,  "Remember,   the  commodity  business  is                                                               
cyclical; remember that times are high  now but there will be low                                                               
times as well and more than  anything else you need a system that                                                               
is capable  of protecting  the state's  interests in  those times                                                               
and that if you  have to fight about what are  you giving away at                                                               
$150 a barrel that's a really  nice problem to have."  Now, while                                                               
at the bottom of the cycle, he said he offers this advice:                                                                      
     Remember, again, take  that long-term view.   This is a                                                                    
     cyclical business  and the  problem now  is how  do you                                                                    
     maintain ongoing investment even  when times are rough?                                                                    
     And  yes, one  needs  to protect  the state's  interest                                                                    
     and, yes, one needs to do  what one can to plug a very,                                                                    
     very difficult  fiscal hole.   But if one does  that at                                                                    
     the  expense of  changes in  fiscal terms  that say  to                                                                    
     investors, "Sorry,  this isn't the  stable jurisdiction                                                                    
     you were hoping for,"  that potentially has a long-term                                                                    
     cost that one needs to think seriously about.                                                                              
1:30:09 PM                                                                                                                    
REPRESENTATIVE JOSEPHSON  posed a  scenario in  which there  is a                                                               
defined  time for  when HB  247's reforms  would take  effect and                                                               
asked  whether  even  leasehold investors  could  say  that  they                                                               
expected X  regime and  now the  state is  giving them  Y regime,                                                               
even though  the lease itself  is the birth  of the project.   He                                                               
said it strikes  him that the adjustment might not  be made for a                                                               
decade or more.                                                                                                                 
MR. MAYER replied it depends  very greatly on the specific nature                                                               
of the  change being made; for  example, who it impacts  and how,                                                               
and what the timeframe that works  through the system is.  If the                                                               
change  is  around credits,  in  many  circumstances the  capital                                                               
intensive  nature of  an investment  is in  those early  years of                                                               
constructing facilities  and drilling wells.   That tails  off at                                                               
some point, so  the impact is much more important  in those early                                                               
years than it is  later on.  If the change  is around the overall                                                               
rate of  tax, the overall rate  of tax in low  price environments                                                               
is a  change that hurts no  matter when in  time it is made.   It                                                               
comes  back  to the  question  of  changes that  are  fundamental                                                               
questions  of policy  and  wanting to  set  a sustainable  fiscal                                                               
system that  is sustainable for  all parties across a  wide range                                                               
of prices  versus changes that are  related to this year  and how                                                               
does the  state get a  little bit more  revenue.  Those  are very                                                               
different  questions  that have  very  different  impacts on  the                                                               
question of  how stable the  fiscal system  in Alaska is  seen as                                                               
1:32:19 PM                                                                                                                    
REPRESENTATIVE  HAWKER  cited  Alaska Statute  (AS)  43.55.023(b)                                                               
regarding  the  35  percent Net  Operating  Loss  Credit  carried                                                               
forward.   He  said  this  statute very  clearly  states, as  the                                                               
legislature wrote  it, that a  producer or explorer may  elect to                                                               
take  a tax  credit in  the amount  of 35  percent of  a carried-                                                               
forward  annual loss.   The  statute is  very clear  even if  the                                                               
intent was  not quite that.   He  asked whether it  is reasonable                                                               
for both [the  legislature] and industry to  expect that industry                                                               
will comply with the law as it is written.                                                                                      
MR. MAYER responded, "Absolutely,  industry takes the statute and                                                               
turns  that into  a model  and  assesses the  performance of  any                                                               
investment  they seek  to make  against what  their model  says."                                                               
Although the  statute says 35  percent of  carried-forward annual                                                               
loss, when  thinking about  how that annual  loss is  defined, it                                                               
turns out  it is defined based  on production tax value  and that                                                               
in turn is defined based on the Gross Value Reduction.                                                                          
1:34:10 PM                                                                                                                    
REPRESENTATIVE  HAWKER said  he understands  that at  these lower                                                               
prices there is  a problematic value translation  between the net                                                               
operating loss  and the value of  the credit carry forward.   The                                                               
legislature  passed  the  law,   the  legislature  said  go  make                                                               
decisions based  on it.  He  inquired whether it would  not still                                                               
be a tax  increase from the standpoint of the  people being asked                                                               
to rely on state statute, even  if [the legislature] thinks it is                                                               
fixing a mistake it made.                                                                                                       
MR. MAYER  answered, "Absolutely,  it is  without question."   He                                                               
added that the core of his point  [on slide 14] is about the need                                                               
to balance  two things very carefully.   The first is  the policy                                                               
point about  what one would  like the system  to be and  what one                                                               
intended the system to be.   The second is that industry has made                                                               
investment decisions  based on  the system  as it  is, not  as it                                                               
might  be in  an ideal  world  and any  changes have  substantial                                                               
impact.  This needs to be thought about very carefully.                                                                         
1:35:17 PM                                                                                                                    
REPRESENTATIVE HAWKER  stated that HB  247 is a  complex approach                                                               
that essentially restructures the tax  system.  He suggested that                                                               
rather  than  the  35 percent  carried-forward,  perhaps  a  more                                                               
targeted fix  - applied  prospectively -  could simply  be taking                                                               
the  value  of  the  net  operating loss  in  a  given  year  and                                                               
translating it  into a carried-forward credit  using the marginal                                                               
tax  rate  of  the  taxpayer.     This  would  provide  an  equal                                                               
translation  of  value,   he  posited,  so  there   is  not  this                                                               
circumstance of  a tax credit  that arguably has a  greater value                                                               
than the deduction was in the year it was incurred.                                                                             
MR.  MAYER replied  he will  think about  Representative Hawker's                                                               
suggestion and get back to the committee.                                                                                       
1:36:31 PM                                                                                                                    
MR. MAYER  returned to  his presentation.   Displaying  slide 15,                                                               
"HARDER, HIGHER FLOOR RAISES TAXES  ON LOSSES," he said hardening                                                               
of the gross floor is one  of the biggest of the proposed changes                                                               
in HB 247.  Under ACES,  he noted, the Capital Credit calculation                                                               
was applied  after the comparison  between the net and  the gross                                                               
systems  and  therefore  was   effectively  non-binding  in  most                                                               
circumstances.   Drawing  attention  to the  graph  on the  left,                                                               
"EFFECTIVE PRODUCTION  TAX RATE," he  pointed out that  at higher                                                               
prices  the  effective tax  rate  under  ACES (yellow  line)  was                                                               
substantially higher than it is under Senate Bill 21 (red line).                                                                
The  two rates  are relatively  close  [across a  broad range  of                                                               
higher  prices], he  noted, but  under  Senate Bill  21 the  rate                                                               
comes to a peak of about  35 percent at around $150, whereas ACES                                                               
went  up and  up  to much  higher levels  at  the higher  prices.                                                               
However,  in  the price  range  of  $120  down  to $30,  the  key                                                               
difference is that the effective  tax rate under ACES kept coming                                                               
down and eventually  came down to zero, whereas  the hardening of                                                               
the floor  under Senate Bill  21 essentially means that  it comes                                                               
down  to  about  a  10  percent effective  tax  rate  for  legacy                                                               
producers, then it bottoms out  and starts rising until about $60                                                               
where  it  goes up  and  very  quickly asymptotically  approaches                                                               
infinity.   That  comes back  to the  point about  the nature  of                                                               
gross taxes,  which is that as  the net value in  the barrel gets                                                               
smaller  and smaller,  anything that  is  a fixed  amount of  the                                                               
total  value takes  up a  steadily  larger portion  of the  value                                                               
until it takes up all of the value.   Once it takes up all of the                                                               
value,  the measure  of an  effective  tax rate  or of  effective                                                               
government take, becomes meaningless  since it is all essentially                                                               
infinite.   The  chart  depicts  the price  level  at which  that                                                               
happens versus the  price levels of today and,  he stressed, that                                                               
is a really important point to  be able to understand.  Mr. Mayer                                                               
said he  has heard far too  many people state that  the effective                                                               
rate  of production  tax comes  down and  the producers  are only                                                               
paying a 4 percent rate at the  moment.  But, he explained, it is                                                               
4 percent of gross  and as a share of the net  it comes down from                                                               
35  percent  to  around  10  percent and  then  it  very  quickly                                                               
skyrockets up towards infinity.                                                                                                 
1:38:58 PM                                                                                                                    
MR. MAYER continued addressing slide  15, stating that the effect                                                               
of HB  247 is  twofold and  particularly on  incumbent producers.                                                               
He said the  chart on the right, "PRODUCTION  TAX $/TAXABLE BBL,"                                                               
looks at  the absolute  dollars per taxable  barrel.   He pointed                                                               
out  that  in  the  price  range of  $40  [and  below]  there  is                                                               
literally no net  value left at all and in  fact the producer has                                                               
a net operating  loss.  Currently, net operating loss  can take a                                                               
company  down  below  the  floor, the  statute  is  very  clearly                                                               
written  that these  were specific  provisions.   The aim  of the                                                               
hard  floor under  the Dollar-Per-Barrel  Credit  was to  protect                                                               
some  of the  state's revenue  at  the lowest  prices while  also                                                               
being mindful that  gross taxes make life very  difficult for the                                                               
industry when prices  are low precisely because  gross taxes very                                                               
quickly take everything  and then more than everything.   Once in                                                               
an environment in which a company  has a net operating loss there                                                               
is  still the  regressive royalty  that is  taking everything  or                                                               
more than  everything.  In  that environment the state  is saying                                                               
that it is not  sure it should be adding to it  with 4 percent of                                                               
the gross  and so maybe the  Net Operating Loss Credit  should be                                                               
able to take a  company down to zero.  Whether  to change that is                                                               
a policy  question about the  balance of protecting the  state at                                                               
the low  end versus  what the  state takes at  the high  end, and                                                               
what a  sustainable and competitive  regime looks like in  how it                                                               
balances those things.                                                                                                          
1:40:45 PM                                                                                                                    
REPRESENTATIVE TARR, regarding going  to zero, posited that there                                                               
are two different scenarios.  One  would be just zero within that                                                               
calendar year.   But, she  said, the more problematic  thing that                                                               
the state  is experiencing  is what is  carried forward  into the                                                               
next  year so  that "we're  100  plus."   She said  she has  been                                                               
researching  how  Alaska  compares   to  other  jurisdictions  in                                                               
competitiveness and trying to find  other examples of a situation                                                               
where it goes  100 percent plus.  She inquired  whether Mr. Mayer                                                               
is aware  of any other  jurisdictions where this has  happened or                                                               
how other jurisdictions control whether they go beyond zero tax.                                                                
MR. MAYER  responded that  there are plenty  of tax  systems that                                                               
enable a  company to carry  forward losses.   That is  a standard                                                               
feature  of a  great many  tax systems,  with federal  income tax                                                               
being one.   Another is Australia's net  profit-based, cash flow-                                                               
based production  tax system which  provides some  protection for                                                               
the  sovereign  by saying  that  outflows,  namely the  sorts  of                                                               
things  that are  credits  here in  Alaska,  are carried  forward                                                               
against future  liability rather  than paid  out, but  that means                                                               
that  all negative  tax items  are  essentially carried  forward.                                                               
Thus, the  carry forward is not  unusual in that sense.   It must                                                               
also be remembered that unlike  many places, Alaska has the fixed                                                               
royalty that  is already taking  a substantial piece of  the pie,                                                               
in fact a zero or negative pie.                                                                                                 
REPRESENTATIVE TARR  offered her belief that  what is problematic                                                               
for  the state  is  having  the actual  expenditure  for the  Net                                                               
Operating  Loss Credits.   She  posited it  would give  the state                                                               
more  protection if  the credits  were  only allowed  to be  used                                                               
against future tax liability, which is contemplated in HB 247.                                                                  
MR. MAYER  answered that HB  247 does not contemplate  ending the                                                               
cash payout of  credits.  Currently, cash payout  only happens to                                                               
companies  with less  than 50,000  barrels a  day of  production.                                                               
The  bill would  put  some additional  restrictions  on the  cash                                                               
payout, including  that companies with  more than $10  billion in                                                               
revenues would  not get a  payout.  The  bill would also  cap the                                                               
amount that  any given  company can  claim.  He  said there  is a                                                               
strong case  for a sovereign  protecting itself through a  cap of                                                               
some  sort at  some point.   However,  whether it  should be  $25                                                               
million,  and what  timeframe over  which it  applies, is  a much                                                               
more  difficult  question  because  that has  some  very  serious                                                               
impacts, including  very serious impacts on  investments that are                                                               
being made at the moment.                                                                                                       
1:44:34 PM                                                                                                                    
REPRESENTATIVE  SEATON asked  what the  state's tax  regime looks                                                               
like on  federal or private  land from  which the state  does not                                                               
receive royalties, but for which the state has a liability.                                                                     
MR. MAYER  replied that Representative  Seaton's point  is valid,                                                               
however he has not done  much modeling on that specific question.                                                               
He advised that it merits  serious analysis particularly in those                                                               
instances of  new investment  projects to  which the  Gross Value                                                               
Reduction (GVR)  and other  things would apply.   In  a sustained                                                               
period of low prices the value  proposition to the state might be                                                               
a lot less than it is in  places where the state has the royalty.                                                               
He said he  needs to look at this very  legitimate concern before                                                               
he offers any detailed advice about it.                                                                                         
1:46:05 PM                                                                                                                    
MR. MAYER resumed  his presentation by turning to  slide 16, "HOW                                                               
DO CHANGES IMPACT NEW FIELD  DEVELOPMENT?"  He explained that the                                                               
two graphs  on the slide,  labeled "CASHFLOW AND  COMPONENTS" and                                                               
"PRODUCTION  AND DRILLING,"  depict  a  hypothetical North  Slope                                                               
project  that qualifies  for the  Gross Value  Reduction new  oil                                                               
regime under  Senate Bill  21.  He  outlined the  assumptions for                                                               
this  hypothetical  project:    cumulatively  recovers  about  80                                                               
million barrels  of oil; peaks at  about 20,000 barrels a  day in                                                               
production; total  capital spend  of about $1.3  billion; average                                                               
annual operating cost  of about $15 a barrel; 30  wells, of which                                                               
20 are producers and 10 are  injectors; and the wells are drilled                                                               
over 8 years.   He noted that  an analysis of this  sort is built                                                               
up from the  granular level, starting with what is  thought to be                                                               
a reasonable well cost to well  type curve drilling profile and a                                                               
reasonable cost of  facilities.  The ability to get  down to that                                                               
level becomes  very important  in assessing  some of  the project                                                               
economics.  He said the blue bars  on the cash flow chart are the                                                               
process  of facilities  development.   Before  a  single well  is                                                               
drilled,  about $400  million will  have been  spent on  a gravel                                                               
pad,  pipelines to  facilities,  and  such.   In  this model  the                                                               
drilling  begins   in  year  three  and   the  drilling  expenses                                                               
("drillex")  continue for  several years.    A lot  of wells  are                                                               
drilled  up front  to  get  production up,  he  explained.   Once                                                               
production is  up, drilling occurs at  a lower rate for  a number                                                               
of years and sustains a sort of plateau level of production.                                                                    
1:48:14 PM                                                                                                                    
MR. MAYER  continued discussing  slide 16,  pointing out  that in                                                               
the  earlier  years  the  investor  is  substantially  cash  flow                                                               
negative.   It takes a  good many years to  get back to  zero, he                                                               
said,  and then  the project  becomes cash  flow positive  and is                                                               
generating value.   There  is a  corresponding difference  in the                                                               
profile of government  take over the course of time  as a result.                                                               
Government take  is effectively negative  in the early  years and                                                               
that is the impact  of the credits being paid out.   In this case                                                               
it is the  Net Operating Loss Credits that are  being paid out as                                                               
cash.   In the early  years the costs  are high and  revenues are                                                               
low and  royalty is probably the  only thing being paid.   In the                                                               
later years  there is some  ongoing sustaining drilling  and from                                                               
this point  on the main  costs are simply operating  costs; there                                                               
is therefore a lot  more value and this is where  the bulk of the                                                               
production  tax is  actually harvested.    When thinking  through                                                               
these debates,  he advised, it  is useful to remember  that under                                                               
almost any regime  there are times when tax is  not paid or where                                                               
it is negative, as in this  example, and there are times when tax                                                               
is paid later in the tail.   Thinking through the time profile of                                                               
that  is really  important  in understanding  the  impact of  all                                                               
these sorts of things.                                                                                                          
1:49:51 PM                                                                                                                    
MR. MAYER  returned to  Representative Tarr's  question regarding                                                               
Net Operating  Loss Credits.   He pointed out  that a cap  on the                                                               
reimbursed Net  Operating Loss Credits  would have a  huge impact                                                               
on any new investment, particularly  any investment that is being                                                               
made at the moment.  He  brought attention to the cash flow graph                                                               
on slide  16 and explained  that the  [dashed] black line  is the                                                               
after tax  cash flow, the cash  that the producer receives.   The                                                               
green color within the bars is  the gross revenue, the purple and                                                               
blue are the costs, and the  red is government take.  Netting out                                                               
all of these things results in the after tax cash flow.                                                                         
MR. MAYER  moved to  slide 17, "CHANGES  BOOST CAPITAL  NEEDS AND                                                               
LOWER  IRR,"  and  addressed   the  graph  entitled,  "CUMULATIVE                                                               
CASHFLOW."   He  explained that  looking at  the cash  flow on  a                                                               
cumulative  basis tells  a company  how  much it  needs to  spend                                                               
before the project becomes self-financing.   In this hypothetical                                                               
scenario  the company  will spend  continuously until  about 2018                                                               
and production will begin about a  year before that.  In 2018 the                                                               
revenue from that production starts  to exceed the costs that the                                                               
company has in its ongoing  drilling and the cumulative cash flow                                                               
curve  starts to  turn  around.   When  contemplating whether  to                                                               
sanction  a  project one  of  the  first  things a  company,  the                                                               
investor, needs  to understand is  the capital structure  that is                                                               
going to  underpin the project -  how the project is  going to be                                                               
financed and what  the company can afford.  In  this scenario the                                                               
company is  assessing what is going  to be $1.3 billion  in total                                                               
spend.   But, the  company does  not actually  need to  have $1.3                                                               
billion ready  in the  bank to  make the  project happen.   Under                                                               
current  law [solid  black line  in the  graph], the  modeling of                                                               
cumulative  cash flow  for this  hypothetical project  shows that                                                               
the company  only needs  to be  able to  recover $300  million of                                                               
total outflow  before the project becomes  self-financing.  After                                                               
the  company has  spent $300  million, the  remaining $1  billion                                                               
will cover itself  because from that point forward  there will be                                                               
production  and positive  cash flow.    The company's  cumulative                                                               
cash out will switch around and start  to come back up.  So, when                                                               
a company  is looking at how  much equity does it  need, how much                                                               
debt  does it  need, it  is not  looking at  how to  finance $1.3                                                               
billion but  rather how to  finance $300  million, and that  is a                                                               
very  big  difference.   The  credits  have  a big  impact  there                                                               
because they effectively act to reduce that very strongly.                                                                      
1:52:37 PM                                                                                                                    
MR. MAYER then explained that the  dashed black line on the graph                                                               
for cumulative cash flow represents what  a cap of $25 million in                                                               
reimbursable credits would look like  for a company with no other                                                               
projects.  This line shows the  company would need a total outlay                                                               
of  $400-$425  million,  rather  than  $300  million,  before  it                                                               
becomes cash  flow positive,  meaning the  company would  have to                                                               
come  up with  this additional  capital.   It is  one thing  if a                                                               
company were  to just now  be starting  a project and  could take                                                               
this into  account as it  figures out what this  investment looks                                                               
like and how  to finance it.  However, it  is quite another thing                                                               
if the company  is a year or  two into its spend  and has already                                                               
told its equity  investors how much they would be  putting in and                                                               
what sort  of return they would  be getting, and the  company has                                                               
been to the  bank and knows what  line of credit it  has, and now                                                               
suddenly the company  needs to come back to all  of them and tell                                                               
them  it needs  $100  million more  than  it previously  thought.                                                               
That would be a very difficult situation to be in.                                                                              
MR. MAYER stated that the  aforementioned situation would be even                                                               
more difficult for a producer  that already has another producing                                                               
asset  that  still has  substantial  costs  due  to a  low  price                                                               
environment,  or  the  ramp-up   drilling  being  unfinished,  or                                                               
drilling needed  to maintain  the production  plateau.   It would                                                               
also be difficult  for a producer that may already  be claiming a                                                               
net operating loss.  If a $25  million cap per company were to be                                                               
implemented, a  producer may  already be up  against that  cap on                                                               
its  other producing  field, in  which case  effectively the  cap                                                               
would  be zero  for  a producer's  new  field.   In  that case  a                                                               
producer  could  go from  needing  $300  million in  capital  for                                                               
making  the project  work  to  over $500  million,  a 50  percent                                                               
increase  in the  capital  base required.   It  would  be a  very                                                               
difficult conversation  to have  if halfway  through the  spend a                                                               
producer must come  back to its equity investors  asking for more                                                               
capital.  Additionally,  a producer would find  that its internal                                                               
rate of return  (IRR) is worse because the numbers  under the new                                                               
regime look very different from  those under the previous regime.                                                               
Therefore,  concern  over  capping  credits  is  very  valid,  he                                                               
advised,  and  something  that  needs to  be  thought  about  and                                                               
addressed.   Making a change  like this and doing  it immediately                                                               
could  have  a  potential  chilling  impact  on  the  ability  of                                                               
investments to  occur and on  investments that have  already been                                                               
sanctioned or are already ongoing.                                                                                              
1:55:34 PM                                                                                                                    
REPRESENTATIVE  JOSEPHSON said  slide  17 is  very meaningful  to                                                               
him.   He recounted reading in  Petroleum News last year  that if                                                             
everything went  well on  the North  Slope, every  project played                                                               
out just  the way  it would,  and every  permit from  the federal                                                               
government was  received, that perhaps  there was  an opportunity                                                               
for  100,000 barrels  collectively.   Meanwhile,  he opined,  the                                                               
super-giants are less  and less super-giants.  When  he first met                                                               
with Pioneer Natural Resources Inc.  he was told that the company                                                               
was drilling  6,000 barrels  a day at  Oooguruk, and  what struck                                                               
him was  that he  was used to  2.1 million barrels  a day.   "Our                                                               
department says by 2022 we're  going to have 350,000 barrels," he                                                               
related.   Through  no  fault  of anybody,  it  is just  geology,                                                               
Alaska is not  producing as much oil.  So,  he said, his question                                                               
is what is he  investing in and how can he  measure the net value                                                               
of that to the people while he measures what is on slide 17.                                                                    
MR. MAYER  responded that more than  anything else Representative                                                               
Josephson is investing in a series  of projects.  Each one may be                                                               
small, 6,000 to  20,000 barrels a day in  initial production, but                                                               
each project is  a wedge.  The Department  of Revenue's forecasts                                                               
for  North Slope  production over  the  next four  or five  years                                                               
versus what the  forecasts were a few years ago,  show a striking                                                               
flattening  of  the  [downward]  curve, at  lease  for  the  next                                                               
several years.   The only way in which  that flattening continues                                                               
to occur  is if a  series of those  projects keeps coming  in and                                                               
each one is  another incremental wedge that takes  the state from                                                               
a 6  percent annual decline to  a 2 percent annual  decline to no                                                               
decline.  In  a world of higher prices and  higher investment, it                                                               
might  even ideally  see things  turning  the other  way.   Those                                                               
things require a coming together  of the right price environment,                                                               
right fiscal regime, and all the rest.                                                                                          
1:58:48 PM                                                                                                                    
REPRESENTATIVE HAWKER  stated that  the refundability  of credits                                                               
is simply  a matter  of shifting  the capital  requirement burden                                                               
from  the  state  providing investment  capital  to  the  private                                                               
sector  having  to  provide  its  own  investment  capital.    He                                                               
inquired  whether,  if   applied  [prospectively],  limiting  the                                                               
refundability of  these credits  could have a  desirable outcome.                                                               
For  example, he  recounted, some  of the  investors in  the Cook                                                               
Inlet  did not  succeed, were  undercapitalized, left  the state,                                                               
hung bad paper on everybody, and  then a bankruptcy court came in                                                               
and made  the paper  even worse.   Restricting  the refundability                                                               
could potentially  have the advantage of  resulting in attracting                                                               
stronger, more capitalized, more  qualified investors rather than                                                               
those that should not be in the state.                                                                                          
MR. MAYER answered that that is  an excellent question.  There is                                                               
no  question, he  said, that  the North  Slope and  in particular                                                               
Cook Inlet  are in the process  of evolution that is  seen in all                                                               
mature basins.   A series  of large established players  for whom                                                               
this becomes a  less material region are exiting  and new players                                                               
are coming in.   The combination of that basic  dynamic with very                                                               
generous and frequently  refunded credits has meant  that some of                                                               
the  players coming  in have  been much  more thinly  capitalized                                                               
than  they  might have  been  otherwise  because the  credits  so                                                               
dramatically reduced  the capital  requirements.  There  are many                                                               
cases  in which  refundable credits  have meant  that people  who                                                               
otherwise  need additional  working interest  partners have  been                                                               
able to get away without having them.                                                                                           
[CO-CHAIR NAGEAK turned over the gavel to Co-Chair Talerico.]                                                                   
2:01:20 PM                                                                                                                    
MR.  MAYER further  pointed out  that there  is also  the serious                                                               
question  of  the sustainability  of  the  refundable credits  in                                                               
numerous environments.   He said the nightmare  scenario from the                                                               
state's  perspective   is  a  price   environment  that   is  not                                                               
necessarily  as low  as today  but is  back above  $50 and  in an                                                               
environment where prices  have come down.  Should  a new Kuparuk-                                                               
sized field  be discovered,  there would be  the sheer  amount of                                                               
capital required  to develop a resource  of that size.   It would                                                               
potentially be  a very, very  large outflow  to the state  if the                                                               
people  doing  that   were  all  eligible  for   the  35  percent                                                               
refundable  Net  Operating  Loss  Credit.    Everyone  should  be                                                               
worried about  that scenario, he  advised.  He  further counseled                                                               
that having clear  rules is always essential in any  system.  The                                                               
nightmare   scenario  would   be   having  no   clear  rules   on                                                               
refundability.   As  was seen  last year,  there is  a degree  of                                                               
executive discretion to try to limit  the outflow and that is the                                                               
worst  possible case  because there  is this  uncertainty of  the                                                               
credit being there under statute  and refundable, but in practice                                                               
it is unknown whether the credit is  going to exist.  That is the                                                               
scenario  which  everyone  should  want  to  avoid.    It  is  in                                                               
absolutely  everyone's interest  to  have clear  rules where  the                                                               
state  has  said it  knows  that  there  are constraints  on  its                                                               
ability  to  fund  this  program  and  because  there  are  clear                                                               
constraints  the state  wants to  set  those rules  and set  them                                                               
MR. MAYER  added that he can  see lots of reasons  why refundable                                                               
credits  provide value  in enabling  investments  that might  not                                                               
otherwise  go ahead.   There  are companies  that are  not firmly                                                               
capitalized   that  have   solid  backing,   but  for   whom  the                                                               
combination  of the  lower capital  requirements  and the  higher                                                               
rate  of  return  that  is  received make  a  big  difference  in                                                               
enabling a project to be sanctioned.   Other than the question of                                                               
simply protecting people who have  already made an investment, he                                                               
said  is a  serious question  as to  whether $25  million is  the                                                               
right number, whether that could  be higher and still protect the                                                               
state  from  some  of  the  worst  possibilities  that  could  be                                                               
outcomes.  A system that makes it  clear what is the limit on the                                                               
state's exposure is very desirable.                                                                                             
2:03:54 PM                                                                                                                    
REPRESENTATIVE HAWKER stated it is  important that if a change is                                                               
made, that it  be prospective and not affect  decisions that have                                                               
already been  made.   He inquired  as to  how strongly  Mr. Mayer                                                               
would counsel  committee members  to be  careful in  that regard.                                                               
For example,  he recalled, last  year the legislature  passed its                                                               
budgets  and  made  the  commitment for  this  capital  to  these                                                               
entities.   The governor introduced  three separate  budgets that                                                               
included the  reimbursement for those reimbursable  credits.  So,                                                               
when they were  vetoed without any warning,  a significant amount                                                               
of  investment capital  that  was committed  to  this state  went                                                               
away.   He inquired as to  the balance between how  to smooth out                                                               
such a  transition so that the  rug is not pulled  out from under                                                               
people's feet.                                                                                                                  
MR.  MAYER  replied  that  moving   forward  it  would  be  quite                                                               
reasonable to  put in place  a series of  additional restrictions                                                               
on eligibility for  a refunded credit.  It  would not necessarily                                                               
have to be purely through a cap  per company, or if it were a cap                                                               
per company  it could be  higher than  $25 million.   Another way                                                               
could  be to  require  a  vetting process  by  the Department  of                                                               
Revenue (DOR)  or the  Department of  Natural Resources  (DNR) in                                                               
the  same way  that DNR  must  now approve  plans of  development                                                               
before a  development can occur,  or in the  same way as  all the                                                               
financials and the  models are required to be handed  over to DNR                                                               
in the case of royalty  modification assessments.  Looking at the                                                               
details of a project and approval  would need to occur before any                                                               
money was spent.                                                                                                                
2:06:33 PM                                                                                                                    
REPRESENTATIVE HAWKER understood Mr.  Mayer to be suggesting some                                                               
kind of a front-end due diligence process.                                                                                      
MR. MAYER responded, "Absolutely."                                                                                              
REPRESENTATIVE  HAWKER opined  that from  industry's perspective,                                                               
everyone collectively  as the state  can be held  responsible for                                                               
the  veto  of  the  credits  last year.    He  inquired  how,  if                                                               
legislation  is passed  that requires  a  due diligence  process,                                                               
assurance can  be provided that  the state  is not going  to pull                                                               
out  the rug  from  under  the industry  with  a  veto after  the                                                               
legislature apparently has made the commitment.                                                                                 
MR.  MAYER answered  that the  most important  thing that  can be                                                               
done in  both the North Slope  and Cook Inlet is  committing to a                                                               
regime  that  the  state  can   demonstrate  is  sustainable  and                                                               
sustainable at  the prices  that are being  seen for  the future.                                                               
That the  state has thought  through all the  potential scenarios                                                               
of  what could  happen and  has  committed to  a one-time  policy                                                               
decision to  create a sustainable  regime for the  future, rather                                                               
than incrementally saying the state  is unsure it can afford this                                                               
and so the credits might be there but not really.                                                                               
2:08:10 PM                                                                                                                    
REPRESENTATIVE SEATON stated his  appreciation for the discussion                                                               
and opined  that once  a project  is sanctioned  a company  has a                                                               
commitment,  not  when it  is  a  lease  sale  and a  company  is                                                               
exploring  and has  not reached  that  level of  investment.   In                                                               
regard to  a timeframe as  mentioned by  Mr. Mayer, he  agreed it                                                               
would  be much  harder  after  a project  is  sanctioned and  the                                                               
investment acquired,  and so  going forward  from there  would be                                                               
much  more problematic.    He said  slide 17  is  looking at  the                                                               
economic  impact from  a producer's  standpoint, not  the state's                                                               
standpoint.   He requested  that Mr. Mayer  develop a  slide that                                                               
looks  at the  state's investment  via the  credits in  the early                                                               
part  of a  project and  having  a reasonable  net present  value                                                               
calculation with a reasonable discount  rate so the committee can                                                               
see what the state's value is in the project.                                                                                   
MR. MAYER  displayed a  slide not  in his  presentation entitled,                                                               
"appendix," with two charts:  one  labeled "NPV 10 to company and                                                               
government: ACES" and  showing a comparison of the  old system of                                                               
ACES; and one  labeled "NPV 10 to company and  government: SB 21"                                                               
and showing  Senate Bill 21  with a  Gross Value Reduction.   The                                                               
charts  are not  finished, he  qualified,  but are  for the  same                                                               
project  as profiled  [in  slides  16-17].   He  said the  charts                                                               
depict everyone discounted at a  10 percent rate value overall to                                                               
company, to  federal government,  and to the  state.   He related                                                               
that under  the previous  system of  ACES there  was astronomical                                                               
value to the  state as prices went higher.   Relatively speaking,                                                               
things look  much more  similar at oil  prices below  $60 because                                                               
the effective  rate of support  for government spending  has gone                                                               
down from 45  percent to 35 percent, and [in  the current regime]                                                               
the state  is slightly better  protected on  the low end  than it                                                               
was under  the previous  regime.   He noted  that the  charts are                                                               
looking  at the  production  tax  as well  as  the entire  fiscal                                                               
system and assume a 16.7 percent  royalty rate.  The point of the                                                               
charts is to  look at the total fiscal system  and total value to                                                               
the state  across a really  wide range  of prices.   Under Senate                                                               
Bill  21 there  is  a  fairly even  split  of  value between  the                                                               
company and  the state, and the  state is always better  off than                                                               
is the company.   A concern under ACES was  that when investments                                                               
were  looked at  on an  incremental basis  there were  times when                                                               
investments  were   value  creating  for  a   company  and  value                                                               
destroying for  the state.  [Under  Senate Bill 21] the  split is                                                               
relatively  even  and  value  for  the state  is  higher  in  all                                                               
circumstances, subject  to the assumptions  he set out,  than the                                                               
value  is for  the company.   While  it can  be negative  for the                                                               
state, it is  only in sustained low prices that  it is much, much                                                               
more value destroying for the  company.  Overall, Alaska's regime                                                               
by and large works pretty well.                                                                                                 
2:12:52 PM                                                                                                                    
REPRESENTATIVE SEATON  said the  committee is  having to  look at                                                               
the investment of  the state and the full field  development.  He                                                               
questioned whether there are many  cases where the state has 16.7                                                               
percent royalty  and requested  Mr. Mayer  to look  at that.   He                                                               
further requested that  Mr. Mayer look at private  land where the                                                               
state does  not receive a royalty.   He said it  would be helpful                                                               
to  know  in  what  circumstances  the state  is  making  a  good                                                               
investment  and what  circumstances the  state may  be making  an                                                               
investment that is going to be a net loss to the state.                                                                         
MR. MAYER  replied that to the  best of his knowledge,  most GVR-                                                               
eligible production is  on leases that are either  a 16.7 percent                                                               
lease or  a profit-share lease.   By and large, the  12.5 percent                                                               
royalty rate is  in legacy fields.  However, he  allowed, it is a                                                               
valid point  about places where  the lease  is held by  an entity                                                               
other than the state and this should be looked at further.                                                                      
2:14:19 PM                                                                                                                    
MR. MAYER  resumed his presentation and  continued his discussion                                                               
of  slide 17.    He  advised that  in  addition to  substantially                                                               
increasing the  capital requirement, the  other big impact  of HB
247 would  be either decreasing the  rate of return at  any given                                                               
price  or substantially  increasing the  price level  at which  a                                                               
company in  assessing its economics  reaches a  particular hurdle                                                               
rate of  return.   Depending on whether  that $25  million credit                                                               
cap  is taken  or the  effective  lower bound  of many  companies                                                               
maybe  having   already  claimed  their  $25   million  on  other                                                               
projects, it would  be somewhere between a $5  and $15 difference                                                               
in the price  range at which at  which a company would  meet a 15                                                               
percent  or 20  percent internal  rate  of return  hurdle.   This                                                               
would have a  substantial impact on what  projects are sanctioned                                                               
and what projects are not.                                                                                                      
MR.  MAYER moved  to slide  18, "CHANGES  MAKE REGRESSIVE  SYSTEM                                                               
EVEN  MORE  SO," and  noted  that  both  charts depict  the  same                                                               
hypothetical new  project of  80 million  barrels.   He specified                                                               
that when the proposed changes  of the capped credits are stacked                                                               
with the more  binding harder floor at low prices,  the impact is                                                               
a series of changes that would  make the current system, which is                                                               
overall neutral across  a wide range of prices  but still heavily                                                               
regressive  when prices  are  below  $60 a  barrel,  into a  more                                                               
regressive  system.    He  said  each color  on  slide  18  is  a                                                               
different component of government take:   red = royalty, yellow =                                                               
property [ad valorum] tax that  goes to municipalities and to the                                                               
state, green  = production tax,  purple = state  corporate income                                                               
tax, and  dark blue = federal  corporate income tax.   When these                                                               
components of government  take are stacked together,  and as long                                                               
as they are  all positive, they add up to  the dashed black line,                                                               
which is the  total level of government take.   He recounted that                                                               
the idea behind  the Gross Value Reduction in Senate  Bill 21 was                                                               
that for  new investments  a system was  being targeted  that was                                                               
effectively neutral across  a wide range of prices  at an overall                                                               
level of about 62 percent government take.                                                                                      
2:16:53 PM                                                                                                                    
MR. MAYER  pointed out,  however, that that  starts to  change at                                                               
the  lowest prices  because of  the royalty's  regressive nature.                                                               
He explained that there is no  production tax at those prices and                                                               
at  those prices  production tax  is  even effectively  negative.                                                               
Effectively negative  does not  mean the  state is  always paying                                                               
out  money.   It means  that across  the cash  flow cycle  of the                                                               
project investment,  credits were  spent up front  and production                                                               
tax  is at  the tail.   If  the price  of oil  remained at  $40 a                                                               
barrel for  the entire life  of this  project the value  of those                                                               
credits would always  be bigger than the value  of the production                                                               
tax that  was generated in  the later years.   At a price  of $60                                                               
and above  the value of the  production tax is greater  than that                                                               
of  the credits  that were  paid up  front.   But, even  when the                                                               
effective net impact of the  production tax is negative, there is                                                               
still  at least  62  percent government  take  under the  current                                                               
system  due to  all of  the other  components, in  particular the                                                               
highly  regressive  royalty.   Starting  at  $50 government  take                                                               
begins curving upward,  and once at $40 government  take rises as                                                               
high  as 100  percent.   This is  because even  though the  state                                                               
effectively contributed  to the  producer through  the production                                                               
tax, the state is taking in  net through royalty all of the value                                                               
that  there  is  at  those   lower  prices.    Anyone  making  an                                                               
investment  is looking  at the  overall fiscal  system, he  said.                                                               
So, the impact of  the proposed changes in HB 247  is that at $40                                                               
it would  be more  like 150 percent  government take  rather than                                                               
100 percent.  Thinking about things  in that context will paint a                                                               
different and  clearer picture, he advised,  than simply thinking                                                               
about what  rate of  tax a  given taxpayer is  paying at  a given                                                               
price, particularly when those rates are quoted on the gross.                                                                   
2:18:52 PM                                                                                                                    
MR. MAYER, in response to  Representative Hawker, reiterated that                                                               
the  dark blue  within the  bars  of the  graphs on  slide 18  is                                                               
federal corporate  income tax and  the purple is  state corporate                                                               
income tax.                                                                                                                     
REPRESENTATIVE HAWKER  understood the point  of slide 18  is that                                                               
production tax is  positive and then reaches a point  at which it                                                               
becomes negative and  falls below [zero].  He observed  that at a                                                               
price  between $60  and $45  per barrel  there is  production tax                                                               
both above  and below  [zero].   He surmised  that what  is being                                                               
shown is  the increasing significance  of state  corporate income                                                               
tax and particularly the state ad valorum tax.                                                                                  
MR. MAYER responded that even more  than those two is the royalty                                                               
itself - royalty is the big regressive element.                                                                                 
2:20:31 PM                                                                                                                    
REPRESENTATIVE  SEATON, in  regard  to  comparing systems,  noted                                                               
that private  royalty in North  Dakota is 27-30 percent  and said                                                               
there are  areas in Alaska where  the royalty does not  go to the                                                               
state.  He  inquired whether who the royalty is  paid to would in                                                               
actuality change a company's decision.                                                                                          
MR.  MAYER  answered  that royalties  are  incorporated  for  the                                                               
perspective of  fiscal comparisons.   This would also be  true in                                                               
terms of  how a company  assesses an investment.   It is  only in                                                               
the Lower 48 that the  royalties go to private landholders rather                                                               
than to the  state.  Almost anywhere else in  the world royalties                                                               
go to the sovereign.   But, in any of those  cases the royalty is                                                               
effectively treated  as if it  went to  the sovereign even  if it                                                               
goes to  a private landholder, because  it is all cash  that goes                                                               
to someone  else.  In  terms of  a comparison with  North Dakota,                                                               
North Dakota tends to have  high fixed royalties which absolutely                                                               
means  that  at  a  given  cost  level  in  this  sort  of  price                                                               
environment  a company  is bleeding  even more  there than  it is                                                               
here.  The  offset to fixed royalties being  highly regressive is                                                               
that when  prices are better [the  company] is also taking  a lot                                                               
more of the cash.  It comes back  to the point that in any fiscal                                                               
system it  is all about  balance and  what the system  looks like                                                               
over a  wide range of  prices.  [A  sovereign] can be  Norway and                                                               
take  a large  share and  particularly  take a  large share  when                                                               
prices are high.   [A sovereign] can be North  Dakota and whether                                                               
it is the  state or the private landholder  really protect itself                                                               
on the  downside by having  a very regressive high  fixed royalty                                                               
and give away  a lot on the  upside.  That is all  about risk and                                                               
reward.  He elaborated:                                                                                                         
     The  high  fixed royalty  says  we  the royalty  holder                                                                    
     don't want  commodity risk or  we want as little  of it                                                                    
     as possible,  and because of  that we want to  push all                                                                    
     the risk onto  the private sector but  we're willing to                                                                    
     give  away a  lot  when  times are  good  as a  result.                                                                    
     Profit-based  taxation is  about saying  we don't  want                                                                    
     the  distorting impacts  at low  prices on  investment.                                                                    
     We want to  try to enable all resources  that should be                                                                    
     developed  to be  developed and  not have  our taxation                                                                    
     system be  a barrier  to that, and  we would  like over                                                                    
     the course  of the commodity  cycle to take more.   And                                                                    
     the  net profit  tax is  a way  that enables  us to  do                                                                    
     that, and  the tradeoff that  we make is in  doing that                                                                    
     we  understand   we're  going  to  have   more  revenue                                                                    
     volatility  and that  we as  a state  need to  have the                                                                    
     mechanisms  in place  to  manage  that volatility.  ...                                                                    
     What you can't do is be both at the same time.                                                                             
2:23:53 PM                                                                                                                    
REPRESENTATIVE SEATON  said Alaska has both  systems, royalty and                                                               
not royalty.   The  discussion is looking  at government  take on                                                               
these  figures  and  government  take  is  drastically  different                                                               
between the two systems.  He stated  that it seems there is not a                                                               
decision  point  in the  analysis  that  is being  presented  for                                                               
changing investment decisions based  on government take when they                                                               
are drastically  different between  those two kinds  of projects.                                                               
He requested Mr. Mayer to  prepare something for the committee in                                                               
that regard.                                                                                                                    
MR. MAYER  replied he will think  about that and do  what he can.                                                               
He said that  ultimately he will always come back  to the idea of                                                               
balancing risk  and reward.   If investing  in Norway,  a company                                                               
does  it because  the  company knows  it is  going  to have  less                                                               
upside when  times are good and  knows that things are  not going                                                               
to look  truly ugly when  times are bad.   If investing  in North                                                               
Dakota, a  company does it because  the company knows it  takes a                                                               
lot of risk.   In terms of the federal  offshore, a company might                                                               
have a huge  initial cash bid for  a block before it  has even so                                                               
much as drilled a  well.  All of the risk in that  case is on the                                                               
investor.  The investor further knows  that if it has a discovery                                                               
and wants  to go through to  production it will do  it under this                                                               
regressive  fiscal regime.    That means  a  company is  spending                                                               
billions  of dollars  and  when prices  are low  it  is going  to                                                               
really hurt,  but the company has  run its economics at  a really                                                               
wide  range of  prices and  has done  probabilistic modeling  and                                                               
thinks it is going to make  enough on the upside that across that                                                               
balance the  project makes sense.   In  that sense, it  is always                                                               
about balance of risk and reward.                                                                                               
2:26:05 PM                                                                                                                    
REPRESENTATIVE SEATON  said he  realizes the  aforementioned, but                                                               
pointed  out  that  this  is  again  being  looked  at  from  the                                                               
producer's perspective.   Whether it is a  situation offshore and                                                               
the state applies the same fiscal terms  to it or whether it is a                                                               
situation of  private royalty  that the  state does  not receive,                                                               
decisions are  being made  and a  lot of cash  is being  put into                                                               
credit  systems from  which the  state  may never  see any  basic                                                               
return even  in a  wide range  of prices.   If the  state expends                                                               
tremendous  amounts  on  credits  and  has  a  very  conservative                                                               
discount rate, the  state may still never  recover its investment                                                               
over the life of  the field.  He said he  is concerned about that                                                               
and therefore as the committee goes  forward he would like to see                                                               
whether  [the  legislature's] decision  making  needs  to have  a                                                               
bifurcation for when something has  a full economic return to the                                                               
state  or when  something does  not have  economic return  to the                                                               
state  but there  is  a huge  liability  to the  state  if it  is                                                               
extending credits  into an area  where the  state does not  get a                                                               
fiscal  return  from royalty.    He  requested  Mr. Mayer  to  do                                                               
modeling of these two regimes within the state.                                                                                 
MR.  MAYER  responded   that  if  he  understands   the  crux  of                                                               
Representative Seaton's concern, it  is really about the question                                                               
of, in  particular, new oil  under Senate  Bill 21 and  what that                                                               
looks  like in  places where  there is  no state  royalty but  is                                                               
either a  Native corporation  or federal  royalty, and  what that                                                               
looks like  in terms of net  present value to the  state across a                                                               
wide  range of  prices.   He  agreed that  that  is an  important                                                               
concern and said enalytica can do such an analysis.                                                                             
REPRESENTATIVE  HAWKER stated  that  what  the aforementioned  is                                                               
really getting  to is  the significant  distinction in  the state                                                               
between private royalty interests,  which is privately owned land                                                               
as  opposed to  state land.   The  state's production  tax credit                                                               
system provides  this whole systemic structure  across the entire                                                               
spectrum.   He pointed out  that Alaska has an  entirely separate                                                               
tax structure in statute for  private royalty interest.  There is                                                               
an entirely separate levy for  the separate landowner, which is 5                                                               
percent of  the gross value at  point of production, and  that is                                                               
the state's sum total production tax.                                                                                           
[Co-Chair Talerico returned the gavel to Co-Chair Nageak.]                                                                      
2:29:18 PM                                                                                                                    
MR. MAYER concluded  the North Slope portion  of his presentation                                                               
with slide 19,  "KEY QUESTIONS RAISED BY HB 247  RE NORTH SLOPE."                                                               
He advised that  while HB 247 is not a  tax overhaul, it includes                                                               
a series of  major changes that would have major  impacts.  There                                                               
are some  absolutely legitimate concerns,  such as:   whether the                                                               
potential liability from credits should  be capped and, if so, at                                                               
what  level,  and how,  and  how  should  that be  applied  going                                                               
forward; what the role is of  the gross floor; and how to balance                                                               
protecting the state  on the downside versus the  upside that the                                                               
state takes by having a net  tax-based system.  The bill also has                                                               
a  lot  of  incremental  revenue raising  measures  that  can  be                                                               
understood  in a  time of  strained finances,  but which  from an                                                               
investor's perspective get very scary  very quickly.  A series of                                                               
things in  the bill are  incremental revenue raising  rather than                                                               
putting  in place  a one-time,  thoroughly considered  piece that                                                               
addresses the question of the  sustainability of the system.  The                                                               
scariest for any investor is  when every year the sovereign comes                                                               
back seeking to take a bit more  here and a bit more there.  More                                                               
than anything else that is  what scares enalytica when looking at                                                               
the proposals in HB 247.                                                                                                        
2:31:17 PM                                                                                                                    
REPRESENTATIVE  HERRON  requested  Mr.  Mayer  to  discuss  three                                                               
examples:    something good  that  Mr.  Mayer  likes in  HB  247;                                                               
something bad that should not  be considered; and something ugly,                                                               
ugly meaning it  is not good and  it is not bad  but is something                                                               
that needs a lot of work.                                                                                                       
MR. MAYER answered that on the  good side he thinks the intention                                                               
behind  Senate  Bill 21  was  to  say  everyone gets  35  percent                                                               
support for government spending,  not in some cases substantially                                                               
higher because of the interplay of the  GVR.  It needs to be very                                                               
carefully  thought through  about  how that  is implemented,  but                                                               
from point of  policy it would be  wise to find a  way to address                                                               
in  a  way that  would  not  disadvantage  people who  have  made                                                               
investment decisions  assuming that to be  the case.  On  the bad                                                               
side are those things that are  easy to see as solely incremental                                                               
revenue raising  measures rather  than thought-through  pieces of                                                               
policy.   This is  chilling from an  investor's perspective.   On                                                               
the ugly side is  anything having to do with the  floor.  He said                                                               
he understands that protecting the  state in low prices is always                                                               
going  to  be  a  key consideration,  but  that  balance  between                                                               
protecting the state on the low  side versus what the state takes                                                               
on the  high side and the  inability to be both  Norway and North                                                               
Dakota, is a key challenge.                                                                                                     
2:33:21 PM                                                                                                                    
REPRESENTATIVE HAWKER  returned to  the earlier  discussion about                                                               
private royalty interests.   He said the question  raised went to                                                               
credits under  AS 43.55.023 and  AS 43.55.025 that  are available                                                               
for a  producer working  on state-owned  lands and  whether those                                                               
benefits would be extraordinary  and would completely distort the                                                               
state  ever  getting a  recovery  back  on the  "private  royalty                                                               
interest  royalties, which  are  by statute  AS 43.55.011(i),  65                                                               
percent."  He offered his belief that  all of the .023 and all of                                                               
the .025  credits are specifically restricted  to activities that                                                               
are conducted  on state  and federal  lands and  are specifically                                                               
not applicable to private royalty interest.                                                                                     
REPRESENTATIVE  SEATON responded  that  this is  a discussion  to                                                               
find out whether the state has liabilities, not an argument.                                                                    
2:34:51 PM                                                                                                                    
REPRESENTATIVE  TARR  returned  to  the chart  on  slide  13  and                                                               
recalled that  Representative Hawker had brought  up questions in                                                               
regard  to the  opex and  capex having  been an  average for  the                                                               
year.  She  requested Mr. Mayer to prepare this  same model using                                                               
a scenario  of a major  producer on the  North Slope that  is not                                                               
doing  much  capital  work  and  that the  model  have  a  modest                                                               
fluctuation  from month  to month  rather than  an average.   She                                                               
said she  is requesting this  because in running her  own numbers                                                               
it appears that fluctuations would  have a dramatic impact on the                                                               
way that the production tax would work out.                                                                                     
MR.  MAYER agreed  to do  so.   He  said this  is something  that                                                               
clearly requires getting  into the details of  the actual process                                                               
of filing  tax returns  and those things  that companies  have to                                                               
get into.                                                                                                                       
2:36:57 PM                                                                                                                    
The committee took an at-ease from 2:37 p.m. to 2:41 p.m.                                                                       
2:41:23 PM                                                                                                                    
MR. MAYER  began the  second half  of his  presentation entitled,                                                               
"IMPACT OF  HB 247:   COOK INLET ASSESSMENT."   Drawing attention                                                               
to slide  2, "THE COOK INLET  OIL AND GAS MARKET:   A SCORECARD,"                                                               
he explained that he will start  with a high level assessment and                                                               
will then  drill down into  the details.   He first  outlined the                                                               
recent history  of oil  and gas production  activity in  the Cook                                                               
Inlet and noted  that enalytica's analysis is based  on data from                                                               
the  Alaska  Oil  and Gas  Conservation  Commission  (AOGCC)  and                                                               
others.   Oil  production has  risen substantially,  he reported,                                                               
from a low of  7.5 thousand barrels a day (mb/d)  in 2009 and now                                                               
it is  as high  as 18.0 mb/d.   Gas production  has not  seen the                                                               
same turnaround as oil, but  has stabilized after years of steady                                                               
decline.  In  many ways it could be said  that gas production has                                                               
seen the  same degree  of turnaround because  it is  a restricted                                                               
domestic market that is limited  to the demand that is available.                                                               
More  than that,  the  Cook Inlet  gas market  has  seen a  major                                                               
adjustment  in  recent  years.    It  has  gone  through  a  huge                                                               
transition  in  the  supply  side,   the  demand  side,  pricing,                                                               
competition between  various players, and expectations.   Some of                                                               
these changes are seen in all  mature basins around the world and                                                               
some of the changes are specific to Cook Inlet.                                                                                 
MR. MAYER  reported that  DNR has  prepared several  studies, one                                                               
released  in late  2015  and  one to  be  released  in 2016  with                                                               
updated numbers  on potential resources  at the  Cosmopolitan and                                                               
Kitchen Lights  fields.  According  to DNR estimates,  just under                                                               
1.2 trillion  cubic feet  (tcf) of  proven and  probable reserves                                                               
(2P reserves) are  in the existing mature  producing fields, plus                                                               
about 400 billion cubic feet  (bcf) from Cosmopolitan and Kitchen                                                               
Lights.  Noting  that DNR's estimate is much lower  than what the                                                               
operators  of  those fields  have  stated,  he said  DNR's  total                                                               
estimate  of  1.6  tcf  of  gas  in  the  ground  is  clearly  an                                                               
intentional conservative estimate.   If development occurs at the                                                               
Cosmopolitan and Kitchen Lights  fields, the current market would                                                               
be well  supplied for the next  decade at the least.   This would                                                               
be subject  to two big  provisos:   the pace of  ongoing drilling                                                               
and  development  and  what  it  might  require  to  develop  the                                                               
resources that are not currently  developed; and what the role of                                                               
the credits in all of that is and what impacts that can have.                                                                   
2:44:56 PM                                                                                                                    
MR. MAYER  pointed out that at  current price levels in  the Cook                                                               
Inlet,  brownfield investment  in  drilling new  wells in  mature                                                               
producing fields  is pretty economic  and that would be  the case                                                               
even under  a system with  substantially less credits.   However,                                                               
he  added, the  economics look  very different  when it  comes to                                                               
developing new  resources, especially new resources  that require                                                               
major  facilities  to be  built.    Potentially, credits  have  a                                                               
strong  role to  play  there, particularly  when  looking at  the                                                               
difficult constraints  that limited  demand places on  what those                                                               
developments  might look  like.   The current  uncertainty around                                                               
the  future of  the fiscal  regime exists  for numerous  reasons.                                                               
One is  that the regime as  legislated expires in the  early part                                                               
of  the next  decade.    There is  a  sort  of envisioned  review                                                               
process between  now and then  to look  at what the  future would                                                               
be.  This has been made  even more uncertain given the governor's                                                               
line  item veto  last year.   But  even without  that, the  sheer                                                               
numbers of credits and outflow  occurring at the moment raise the                                                               
question of  sustainability of that  system.  From  an investor's                                                               
perspective there would be concern  as to whether the regime that                                                               
exists  on paper  today  is actually  going to  be  the one  that                                                               
exists when  it comes crunch time.   In terms of  enabling future                                                               
investment,  there are  places where  credits  are important  and                                                               
there are  places where they are  less so, he advised.   But more                                                               
than anything else,  a long-term sustainable system  that is well                                                               
thought through  is ultimately  going to  be paramount  to seeing                                                               
ongoing long-term investment in the Cook Inlet.                                                                                 
2:46:54 PM                                                                                                                    
REPRESENTATIVE JOSEPHSON remarked that it  sounds as if Mr. Mayer                                                               
is  saying  even  the  investors in  Cook  Inlet  themselves  are                                                               
questioning whether it is sustainable.                                                                                          
MR. MAYER replied  that the sheer amount of  credit outflows were                                                               
one thing when  the state was bringing in billions  of dollars of                                                               
revenue through the production tax  system and there were serious                                                               
problems with the  future of the Southcentral gas  supply.  Since                                                               
lots of money  was coming in through North Slope  taxes the state                                                               
could  afford to  incentivize activity  that it  wanted to  spur.                                                               
But now,  much less revenue  is coming  in from the  North Slope.                                                               
Displaying slide 4, "BIG DIFFERENCE  BETWEEN NORTH SLOPE AND COOK                                                               
INLET,"  he  said that  anyone  looking  at  the more  than  $400                                                               
million spent  in Cook Inlet  credits in 2015 would  question how                                                               
long that could go on in a constrained budget environment.                                                                      
2:48:16 PM                                                                                                                    
CO-CHAIR  TALERICO  inquired whether  he  is  correct in  reading                                                               
between the  lines that  Mr. Mayer is  telling the  committee the                                                               
clock is ticking  and the committee will be far  better off if it                                                               
focuses on this  and starts to structure  something sooner rather                                                               
than waiting until  the midnight hour.  He surmised  it is a good                                                               
idea  to begin  a focus  on what  legislators will  do when  that                                                               
expires since  good decisions are not  made while in a  panic.  A                                                               
system would  be well out in  front so that everyone  is aware of                                                               
what system will be in place.                                                                                                   
MR. MAYER  agreed, but recognized  that many factors will  make a                                                               
discussion  about the  Cook Inlet  fiscal  system more  difficult                                                               
this year than  in subsequent years.  Going back  to his previous                                                               
comments about  some of the  effective dates  in HB 247,  he said                                                               
changes  that   impact  July  1,  2016,   potentially  have  very                                                               
difficult  impacts.   Drilling programs  have  been committed  to                                                               
that rely on  some of the existing credits and  some of those are                                                               
developments that  one would  really like to  see happen  for the                                                               
pressing interest  of the state.   When an investor does  not see                                                               
this  as  a  sustainable  system,  it  is  really  hard  to  make                                                               
investment decisions  unless the investor  runs a range  of worst                                                               
case scenarios rather than the  actual existing statute scenario.                                                               
A conversation  needs to start  as soon  as possible on  a really                                                               
reasoned effort  that says not just  what happens if a  credit or                                                               
two here is scratched, but what  the fiscal system for Cook Inlet                                                               
should be to be both sustainable  and stable for the future.  The                                                               
right  balance  needs  to be  struck  between  incentivizing  the                                                               
activities the state wants to  see incentivized while doing so in                                                               
a sustainable way.                                                                                                              
2:50:41 PM                                                                                                                    
MR. MAYER addressed  slide 3, "REFUNDED CREDITS  REACHED NEW HIGH                                                               
IN FY  2015," and  slide 4, "BIG  DIFFERENCE BETWEEN  NORTH SLOPE                                                               
AND COOK INLET."  He explained  that all of this discussion stems                                                               
from  the credits  having grown  substantially.   In FY  2015 the                                                               
bulk of  the credits were  spent in  the Cook Inlet  despite Cook                                                               
Inlet bringing  in a bare fraction  of the revenues of  the North                                                               
Slope, something that will always be  the case.  While slide 4 is                                                               
a  snapshot of  a point  in time  and some  of those  credits may                                                               
produce additional revenue in the  future, the balance is clearly                                                               
off  in a  way  that is  difficult  to see  as  sustainable.   He                                                               
pointed out  that in the left  bar on the graph  the total credit                                                               
outflow of minus $628 million  was inadvertently omitted (the sum                                                               
of  the credit  outflows depicted  for the  North Slope  and Cook                                                               
2:51:53 PM                                                                                                                    
MR. MAYER  turned to slide  5, "ACTIVITY HAS RESPONDED  IN RECENT                                                               
YEARS," to provide  a basic history of the Cook  Inlet.  He noted                                                               
that  in 2010  there was  real concern  about the  future of  gas                                                               
supply  in the  Cook Inlet,  the  future of  overall activity  in                                                               
terms of the  oil and gas industry as an  economic basis for that                                                               
region.   Key changes  related to  pricing, storage,  and credits                                                               
were  made  and  resulted  in   substantial  response.    Drawing                                                               
attention to the left-hand chart  on slide 5 depicting the number                                                               
of exploratory  wells spudded each  year [since 1950],  Mr. Mayer                                                               
explained that the green bars are  the actual number of wells and                                                               
the  red  line  is  the three-year  rolling  average.    Bringing                                                               
attention to the right-hand chart  depicting the actual producing                                                               
wells in  the year  in which  they first came  on line,  he noted                                                               
that the  three-year rolling average  shows a  substantial uptick                                                               
[in  recent years]  to the  level that  was seen  briefly in  the                                                               
middle of the  last decade.  Otherwise, he added,  the only other                                                               
time  that level  of activity  was seen  was back  in the  1970s.                                                               
That is  quite striking and  all those things that  have happened                                                               
have had a substantial impact on activity in the basin.                                                                         
2:53:26 PM                                                                                                                    
MR. MAYER moved  to slide 6, "COOK INLET OIL  AND GAS PRODUCTION:                                                               
BASIC FACTS,"  to look at overall  oil and gas production  in the                                                               
Cook Inlet  using data from  the Alaska Oil and  Gas Conservation                                                               
Commission  (AOGCC).   He stressed  the importance  of separating                                                               
oil  from  gas  because  what  has  happened  in  each  is  quite                                                               
different.   Drawing  attention  to  the chart  on  the left,  he                                                               
pointed out that  oil production started in 1960,  peaked in 1970                                                               
at 226  mb/d, fell  to 7.5  mb/d in 2009,  and after  2010 turned                                                               
substantially  upward to  about  18 mb/d,  more  than double  the                                                               
production  in 2009.   Bringing  attention  to the  chart on  the                                                               
right, he  noted that gas  production has not seen  a turnaround,                                                               
but has seen  a stabilization.  Explaining  that gross production                                                               
is metered at the wellhead, he said  the red line on the chart is                                                               
gross  production, the  green  line is  the  gas reinjected  into                                                               
wells, and  the orange  line is net  gas production.   Separating                                                               
things out this way is striking,  because gross gas coming out of                                                               
the fields  peaked as  early as  1990 and  declined precipitously                                                               
from 1994 to 1998.   However, net production plateaued throughout                                                               
the 1990s, which was a function  of one thing alone - the Swanson                                                               
River Oil Field.  Swanson River  had a lot of associated gas that                                                               
was reinjected for many years,  and the green reinjection line is                                                               
all  Swanson River.   Then  in the  1990s, production  of Swanson                                                               
River gas began  and reinjection steadily decreased.   Instead of                                                               
a  crisis in  the  mid-1990s  there was  a  temporary plateau  of                                                               
stable production all the way through  to 2005.  It was not until                                                               
after 2005 that the declines in gas production began to be seen.                                                                
2:56:02 PM                                                                                                                    
REPRESENTATIVE OLSON recalled that a  lot of onshore and offshore                                                               
flaring  was going  on  during the  1970s and  1980s.   He  asked                                                               
whether flaring was kept track of.                                                                                              
MR. MAYER responded  that he will have to look  at the numbers to                                                               
see how flaring  is accounted for.  He deferred  to his colleague                                                               
at enalytica  to comment on  how flaring is  treated historically                                                               
in the data.                                                                                                                    
2:57:16 PM                                                                                                                    
NIKOS  TSAFOS,   President  &   Chief  Analyst,   enalytica,  and                                                               
consultant  to  the  Legislative   Budget  and  Audit  Committee,                                                               
answered he  is unsure about how  the flaring shows up.   He said                                                               
AOGCC has two data bases, one  on well production and one on well                                                               
reinjection, and  he is pretty  sure the  data is for  gross well                                                               
production  and does  not take  into account  whether the  gas is                                                               
marketed, used at the field, or  anything else.  There may be gas                                                               
that  does  not find  its  way  to  the  market due  to  flaring,                                                               
venting, or use at the fields.                                                                                                  
2:58:07 PM                                                                                                                    
MR. MAYER  addressed slide 7,  "OIL UP FROM WORKOVERS,  NEW WELLS                                                               
IN EXISTING FIELDS," pointing out  that oil production turnaround                                                               
in Cook Inlet  was a function of new wells  and, in particular, a                                                               
function of a  lot of well workover activity.   Drawing attention                                                               
to the  left-hand chart  depicting gross  oil production  by well                                                               
vintage,  he   explained  that   each  colored   line  represents                                                               
production from a well that came  on line in a particular decade.                                                               
For example, the  green line is production from  wells brought on                                                               
line between  1991 and 2000, and  the red line is  pre-1970.  The                                                               
green  line shows  a  striking turnaround  in  production:   from                                                               
about 2,000  barrels a day  in 2009 to  over 4,000 barrels  a day                                                               
today.   Wells that came on  line in the 1990s  are now producing                                                               
twice  what they  produced in  2009 due  to the  substantial well                                                               
workovers that were done to  make those existing wells much, much                                                               
more productive.                                                                                                                
2:59:17 PM                                                                                                                    
CO-CHAIR NAGEAK  announced that Mr. Mayer's  presentation will be                                                               
continued on 2/27/16.                                                                                                           
[HB 247 was held over.]                                                                                                         

Document Name Date/Time Subjects
HSE RES 2.25.16 enalytica Overview + North Slope February 2015.pdf HRES 2/26/2016 1:00:00 PM
HSE RES 2.26.16 enalytica Cook Inlet February 2016.pdf HRES 2/26/2016 1:00:00 PM
HSE RES 2.26.16 HB 247 J Rice Oppose.pdf HRES 2/26/2016 1:00:00 PM
HB 247