Legislature(2003 - 2004)

05/20/2003 10:38 AM FIN

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
     CS FOR SPONSOR SUBSTITUTE FOR HOUSE BILL NO. 28(FIN)                                                                       
     "An Act relating to adjustments to royalty reserved to the                                                                 
     state to encourage otherwise uneconomic production of oil and                                                              
     gas; and providing for an effective date."                                                                                 
This  was the first  hearing  for this  bill in  the Senate  Finance                                                            
Co-Chair  Wilken  stated that  this  bill,  "addresses  oil and  gas                                                            
royalty  modifications  for marginal  oil  and gas  fields. The  new                                                            
modification  formula outlined in  HB 28 allows the commissioner  of                                                            
Department of Natural Resources  to negotiate a royalty rate that is                                                            
in the best interest of the State."                                                                                             
Senator Taylor  offered a motion to  report the bill from  Committee                                                            
with individual recommendations and accompanying fiscal note.                                                                   
Senator  Taylor  then objected  to  the motion  for  the purpose  of                                                            
taking testimony.                                                                                                               
Co-Chair Wilken ordered the motion out of order.                                                                                
REPRESENTATIVE  VIC KOHRING,  Sponsor,  testified that  in 1995  the                                                            
legislature  passed   a  law  that  provided  for   an  oil  royalty                                                            
reduction. He  relayed that the intent was to encourage  development                                                            
of  marginal  fields  that  are  not  profitable,   including,  new,                                                            
existing  and "mothballed"  fields.  He remarked  that this  statute                                                            
"just hasn't worked"  with the State receiving only  one application                                                            
for reduction  that was not approved.  He attributed the  failure of                                                            
the statute  to  its complexity  and because  it  did not  encourage                                                            
industry  participation.  As  a result,  he  sponsored  the  current                                                            
legislation, which simplifies and streamlines the process.                                                                      
Representative  Kohring explained this bill grants  the commissioner                                                            
of the Department  of Natural Resources  the authority to  determine                                                            
the level of  reduction of royalty  rates based on the economics  of                                                            
each field.  He specified the reduction  would be available  for any                                                            
marginal field or field  that is not profitable in Alaska that could                                                            
benefit from  a royalty reduction.  He noted the reduction  would be                                                            
applied  on "a sliding  scale basis",  generally  between three  and                                                            
12.5  percent,  based  on  the  profitability   of  each  field.  He                                                            
described the  internal or contracted study that would  be conducted                                                            
to analyze fuel recovery,  production rate and volume, and operating                                                            
costs upon which  the commission would base any decision  whether to                                                            
grant a reduction and at what percentage.                                                                                       
Representative Kohring  stressed the importance to provide incentive                                                            
to develop marginal fields to generate income for the State.                                                                    
MARK MYERS, Director Division  of Oil and Gas, Department of Natural                                                            
Resources,  testified  that  this  bill  would  modify  an  existing                                                            
royalty reduction  statute, AS 38.05.180(j).  He noted this  statute                                                            
had  been previously  amended,  although some  of  the changes  have                                                            
proven cumbersome  and unclear.  He stated  the existing statute  is                                                            
difficult to administer.                                                                                                        
Mr. Meyers  stated this legislation  would simplify the process  yet                                                            
still provide  the commissioner "the  necessary tools" to  evaluate,                                                            
condition   and  accept  or  reject   an  application  for   royalty                                                            
reduction.  He detailed  the application  and  approval process  for                                                            
participation.  He listed three cases for which a  royalty reduction                                                            
could be granted:  a delineated field  that a producer claims  would                                                            
be uneconomic  to develop, an existing  field that has proven  to be                                                            
uneconomic  possibly  due  to  declining  production  or  increasing                                                            
operating  expenses,  and  fields that  are  "shut in  already".  He                                                            
acknowledged that determination  of whether a field is uneconomic is                                                            
a complex process  that also must  factor the price of oil,  cost of                                                            
transportation, economics  and size of the reservoir and size of the                                                            
Mr. Meyers pointed  out that this legislation also  allows a royalty                                                            
structure  that could "recapture  dollars"  if the economics  of the                                                            
field change.                                                                                                                   
Mr. Myers  assured that  a royalty  reduction would  not be  granted                                                            
without  extensive   analysis  of   all  relevant  factors   and  an                                                            
understanding of the reasonable rate of return on the project.                                                                  
Mr. Myers  told of an application  submitted  by Unical, in  which a                                                            
reduction   was  offered   although   the  company   chose  to   not                                                            
participate, and another  application submitted by Conico, which the                                                            
Department denied because  it was not determined to be in the public                                                            
interest.   He  stressed   the   applications   are  given   serious                                                            
consideration  and that instances exist whereby a  royalty reduction                                                            
could  result  in  a field  beginning  production  or  remaining  in                                                            
Mr. Myers cited  current royalties are calculated  at 12.5 to 16.66,                                                            
and  occasionally 20  percent.  He recognized  that  a reduction  to                                                            
three percent would affect  the economics of a field, although would                                                            
not  "materially  change it  in a  very  large scope."  However,  he                                                            
emphasized the fiscal impact to the State is "very high".                                                                       
[Note: tape interruption]                                                                                                       
Co-Chair Wilken asked if this legislation allows for review.                                                                    
Mr. Myers replied  that this bill includes a provision  allowing for                                                            
a legislative  review of the preliminary best interest  findings. He                                                            
explained  that  the  Legislative  Budget  and  Audit  Committee  or                                                            
"designated members"  of the legislature to obtain  the confidential                                                            
data. Therefore, he assured  that the legislature could choose to be                                                            
directly involved  in the process.  He qualified that later  reviews                                                            
or changes  would be subject  to the terms  of the contract  between                                                            
the producers  and the State. He exampled  a provision in  contracts                                                            
allowing for periodic economic review.                                                                                          
KEVIN  TABLER,   Land  and  Government   Affairs  Manager,   Unical,                                                            
testified via  teleconference from an offnet location  in support of                                                            
the  legislation.  He  expressed  that  it would  help  clarify  and                                                            
provide  flexibility  for  the commissioner   to process  a  royalty                                                            
application.   He  remarked   that   current  statutes   create   an                                                            
"unworkable situation".                                                                                                         
Senator  Bunde  commented   he  was  encouraged  by  the   testimony                                                            
indicating  that in the event  of success,  the State would  have an                                                            
opportunity to "recover on the upside".                                                                                         
Senator Olson  asked the number of  wells and amount of revenues  in                                                            
Mr. Myers  replied  that the  extent of  this legislation  would  be                                                            
highly  variable   and  dependent  upon  companies'   submission  of                                                            
applications.  He knew  of no pending  applications.  He noted  some                                                            
fields  in the Cook  Inlet are "late  in their  life of production"                                                             
that would  receive  serious consideration  if  an application  were                                                            
submitted.  He  relayed  that in  review  of  other fields,  it  was                                                            
estimated that  the revenue amount "could easily be  in the hundreds                                                            
of millions of dollars"  over the life of the field to "as much as a                                                            
few tens of millions  of dollars differential in the  royalty rate."                                                            
He qualified  that the State could  recover revenue if the  contract                                                            
were "conditioned  properly".  He  stated that under the  provisions                                                            
of this legislation,  a contract could  be written to provide  a net                                                            
fiscal effect  of nearly zero. He  spoke to the need that  "the tail                                                            
be  very  long" and  the  royalty  managed  efficiently  to  recover                                                            
revenue resulting from  a royalty reduced from 12.5 percent to three                                                            
Senator  Olson  asked  the  outcome   if  the  results  are  not  as                                                            
Mr. Myers assured that  a full technical analysis would be conducted                                                            
to ensure  the  reduction  is warranted.  He listed  geological  and                                                            
geophysical  engineering,   studies  of the  reservoir,   production                                                            
history  and detailed  cost data,  as included in  the analysis.  He                                                            
furthered  that  this  legislation  allows  the State  to  engage  a                                                            
consultant to review the analysis.                                                                                              
Mr. Meyers emphasized this legislation is a policy call.                                                                        
Senator Taylor  offered a motion to  report the bill from  Committee                                                            
with individual recommendations and accompanying fiscal note.                                                                   
There was no  objection and CS SS  HB 28 (FIN) MOVED from  Committee                                                            
with fiscal note #2 for $150,000.                                                                                               

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