Legislature(2003 - 2004)

05/19/2003 10:35 PM RES

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
         CS SSHB 28(FIN)-OIL & GAS ROYALTY MODIFICATION                                                                     
REPRESENTATIVE NORM  ROKEBERG, co-sponsor of HB  28, told members                                                               
that HB  28 is a  "tune-up" of  AS 38.05.180(j). That  section of                                                               
statute pertains to royalty modifications  of marginal fields. In                                                               
1995, the new Governor brought  forth this legislation as a major                                                               
centerpiece  of  his  Administration   to  try  to  increase  oil                                                               
production in  Alaska. That bill was  crafted in such a  way that                                                               
it created impossible barriers for  it to work. During that nine-                                                               
year period, no grants of  royalty reduction have been granted by                                                               
the state.  This bill modifies  that statutory section  to remove                                                               
some  of  those  barriers  and it  simplifies  the  language.  He                                                               
directed members' attention to the  language on page 2, beginning                                                               
on line 24. That particular  language embodies, in one paragraph,                                                               
the discretionary ability of the  commissioner to grant a royalty                                                               
modification  under  the terms  set  forward  in it.  It  deletes                                                               
language  that  indicates  that  if  a  royalty  modification  is                                                               
granted, the state  would have to ultimately  recover. The intent                                                               
was to  increase oil exploration  but it required that  the state                                                               
recover its  money even  though it  was reopening  a dry  hole by                                                               
royalty reductions.  He said  the provisions  of the  bill became                                                               
almost unintelligible.                                                                                                          
TAPE 03-49, SIDE B                                                                                                            
REPRESENTATIVE  ROKEBERG said  HB  28 removes  that language  and                                                               
provides  for a  sliding scale  royalty to  be determined  by the                                                               
commissioner who,  under the Constitution,  must act in  the best                                                               
interest  of the  state.  It provides  that  relevant factors  be                                                               
taken into  consideration, such as a  change in the price  of oil                                                               
and  gas,  in  production rates,  production  ultimate  recovery,                                                               
development costs  and operating  costs. Therefore, if  the price                                                               
of oil  increases, the state's  share will increase on  a sliding                                                               
scale basis.  It contains  other provisions  that remove  some of                                                               
the   oversight.  He   said  the   Administration  supports   the                                                               
CHAIR  OGAN said  he instantly  recognized this  legislation from                                                               
his participation on  the House Oil and Gas  Committee years ago.                                                               
He asked if there has been any use of the statute.                                                                              
REPRESENTATIVE  ROKEBERG  said  there was  one  application  from                                                               
Unocal that did not go  through. Although the public believes the                                                               
legislature gave  big incentives to  the oil industry,  the North                                                               
Star modification  was the only  thing that occurred.  He pointed                                                               
out that  other specific royalty  bills targeted  certain fields,                                                               
particularly  in the  Cook Inlet  area,  that had  to be  enacted                                                               
because the statute did not work.                                                                                               
11:30 a.m.                                                                                                                    
REPRESENTATIVE  VIC KOHRING,  co-sponsor of  HB 28,  told members                                                               
the sliding  scale would  likely be between  3 and  12.5 percent.                                                               
The general royalty rate has  been 12.5 percent. The commissioner                                                               
is  granted discretion  to determine  the rate.  The commissioner                                                               
can  make  that decision  based  on  an in-house  evaluation,  or                                                               
through an  independent contractor. The evaluation  will consider                                                               
operating costs, field recovery, production rate and volume.                                                                    
REPRESENTATIVE ROKEBERG commented that  the fiscal note indicates                                                               
program receipts at $150,000. He stated:                                                                                        
     I caution you  - it's just program  receipts because of                                                                    
     the requirement  of a maximum ceiling  on any applicant                                                                    
     where  they   can  hire   a  third   party  consultant.                                                                    
     Actually,  I think  the fiscal  note's not  correct. It                                                                    
     should  be  a zero  fiscal  note.  Only if  there's  an                                                                    
     application  would   there  be  any   program  receipts                                                                    
     generated. So  I just  wanted to  point that  out. This                                                                    
     bill is not going to cost  the state anything - only in                                                                    
     foregone  royalties   that  we  wouldn't   perhaps  get                                                                    
     otherwise if  they're bringing a  shut-in well  back on                                                                    
MR. KEN BOYD,  an oil and gas consultant, said  he was testifying                                                               
on  behalf of  the  Alaska  Oil and  Gas  Association (AOGA).  He                                                               
stated support for CS SSHB  28(FIN) and said he participated with                                                               
Representative Rokeberg and  Senator Ogan and a  cast of hundreds                                                               
seven or eight years ago who  worked on the existing law. He said                                                               
the  current royalty  reduction statute  is awkwardly  worded and                                                               
very difficult to implement.                                                                                                    
SENATOR SEEKINS asked  if a model already exists  for the sliding                                                               
scale  or  whether  this  bill will  give  the  commissioner  the                                                               
discretion to set a sliding scale for each particular field.                                                                    
REPRESENTATIVE  KOHRING said  it is  his understanding  this bill                                                               
gives the commissioner that discretion.  He deferred to Mr. Myers                                                               
for an answer about an existing model.                                                                                          
SENATOR SEEKINS  asked if  a cap exists  for the  state's overall                                                               
agreement  with an  oil  company  or whether  there  is a  seller                                                               
MR. KEVIN BANKS,  Division of Oil and Gas,  Department of Natural                                                               
Resources (DNR) said, regarding whether  a model exists, DNR uses                                                               
fairly standard  discount cash-flow  models. DNR would  more than                                                               
likely tailor a sliding scale  royalty provision to the specifics                                                               
of each applicant. He said he  can't say the bill contains a cap.                                                               
DNR could conceivably trade a  12.5 percent royalty for a royalty                                                               
modification that would  allow for some sliding  scale that could                                                               
exceed, in rare  instances, the 12.5 percent  rate. However, that                                                               
would depend  upon the kind  of project  and the unknowns  at the                                                               
time of application.                                                                                                            
SENATOR SEEKINS asked  if the oil companies will  pay more during                                                               
the "boon" years.                                                                                                               
CHAIR OGAN  said as memory serves  him, he believes there  was an                                                               
upside in the original legislation.                                                                                             
MR. BANKS  said the  original HB  207 contained  some complicated                                                               
language that directed the commissioner  to develop a system that                                                               
would pick  up on  the upside. Unfortunately,  it was  written so                                                               
that it  removed any projected  royalty modification  benefits to                                                               
the  applicant.   In  CS  SSHB  28(FIN),   the  commissioner  can                                                               
negotiate an upside but is not required  to do so. He said he can                                                               
think of cases  where a sliding scale between 3  and 12.5 percent                                                               
would  provide sufficient  incentive to  get production  on line.                                                               
The  state's reward  for giving  up some  of its  royalty on  the                                                               
front end would be to get more production out of the prospect.                                                                  
CHAIR OGAN  said subsection (3) on  line 24, page 2,  seems to be                                                               
the key  to the  legislation. It says  "sliding scale  royalty or                                                               
other mechanism" so it provides  broad latitude. He added that it                                                               
provides for an  increase or decrease and asked if  it gives that                                                               
discretion to the commissioner.                                                                                                 
MR. BANKS said that is correct.                                                                                                 
SENATOR BEN STEVENS asked if  this legislation prevents or allows                                                               
the commissioner  to make rate adjustments  to specific platforms                                                               
[in   Cook  Inlet]   without  coming   to  the   legislature  for                                                               
REPRESENTATIVE  KOHRING   said  the   answer  is  yes   but  this                                                               
legislation does  not apply  to platforms. He  noted that  SB 185                                                               
pertains  to platform  royalty reduction  and  differs from  this                                                               
legislation. He explained  that the intent of CS  SSHB 28(JUD) is                                                               
to  encourage  the industry  to  develop  three types  of  fields                                                               
because they are not profitable:  new fields, existing fields, or                                                               
mothballed fields.                                                                                                              
SENATOR  BEN STEVENS  said if  this legislation  is not  enacted,                                                               
separate pieces of legislation would  be brought forward, such as                                                               
SB 185, asking  for royalty rate reductions  for specific fields.                                                               
He  said   instead,  CS  SSHB  28(JUD)   defers  all  legislative                                                               
authority for rate reductions to the commissioner.                                                                              
REPRESENTATIVE KOHRING said that  is correct, for marginal fields                                                               
only. He said the legislation  is not specific to certain fields;                                                               
it  applies  to   any  field  in  the  state   considered  to  be                                                               
unprofitable. He  said the commissioner will  determine whether a                                                               
field is profitable after doing an analysis of each field.                                                                      
SENATOR BEN  STEVENS asked  Mr. Myers to  describe what  kinds of                                                               
fields fall under those three categories.                                                                                       
MR. MARK  MYERS, Director of  the Division  of Oil and  Gas, DNR,                                                               
told  members  this bill  amends  an  existing royalty  reduction                                                               
statute.  It  does  not  create  a new  program;  it  fixes  some                                                               
problems in the  existing statute. That statute  was modified but                                                               
the  last set  of modifications  created unintended  consequences                                                               
that  were   problematic.  CS  SSHB  28(JUD)   applies  in  three                                                               
situations: to  new fields that  are not economic  where reducing                                                               
the state's royalty  share would make the field go;  to fields in                                                               
a  later stage  of production  where operating  costs exceed  the                                                               
value  of production;  and to  fields that  have been  physically                                                               
shut in so  there is no production flowing.  Reducing the royalty                                                               
would change  the economics sufficiently  to start  up production                                                               
of  the field  again.  This  bill gives  broad  authority to  the                                                               
commissioner to set terms to recapture upside.                                                                                  
MR.  MYERS said  once a  field is  in development,  a few  things                                                               
might improve  its economics  - operating  costs remain  the same                                                               
but  an increase  in oil  prices creates  a dramatic  increase in                                                               
profits. Under  this bill,  rising oil  prices can  be structured                                                               
into the  royalty rates. Second, if  production itself increases,                                                               
which is only likely in a  new field, the state needs a mechanism                                                               
to capture  the upside as  more data  comes in. This  bill allows                                                               
for all  of the adjustments by  giving the commissioner a  lot of                                                               
flexibility.  However, the  agreements still  require legislative                                                               
approval.  He said  an example  of  a field  that is  not yet  in                                                               
production would  be the small  field at  Umiat; a field  that is                                                               
producing but is  close to shut-in is Badami,  which is currently                                                               
producing  about  1400 barrels  per  day.  He  said SB  185,  the                                                               
platform bill,  addresses a unique  set of circumstances  in Cook                                                               
Inlet  where  some  fields  are  late  in  life  with  a  30-year                                                               
production history. DNR was comfortable  with the data about that                                                               
area  and did  not  feel it  needed a  mechanism  to recover  the                                                               
upside. That legislation contains  a customized approach for Cook                                                               
Inlet  platforms  that do  not  require  this same  process.  The                                                               
advantage of  that approach  is to  retain the  infrastructure in                                                               
Cook Inlet.                                                                                                                     
SENATOR  WAGONER  asked  how  CS   SSHB  28(FIN)  will  apply  to                                                               
abandoned oil wells.                                                                                                            
MR.  MYERS  said they  could  fall  under all  three  categories,                                                               
because of  the term "field or  pool." A deeper reservoir  of oil                                                               
under  a shallow  gas reservoir  could be  a separate  reservoir.                                                               
Depending on whether  that gas had been produced  before by field                                                               
or pool, it  could qualify under any of the  three categories. He                                                               
said the  operator would have  to justify that the  economics did                                                               
not  support   operation  without   the  royalty   reduction.  He                                                               
explained that  the process for approving  the royalty reductions                                                               
would be  a little different.  The preliminary decision  would be                                                               
submitted to  the legislature during  the public  comment period,                                                               
however  the  legislature  does   not  vote  to  approve  royalty                                                               
reduction under this bill.                                                                                                      
SENATOR BEN STEVENS asked if that provision is in Section 8.                                                                    
MR. MYERS said that is correct.                                                                                                 
CHAIR OGAN  pointed out  there is  a $150,000  cap on  the amount                                                               
that can be  paid by the lessees and asked  whether that reflects                                                               
program receipts. He also asked  if that amount is appropriate or                                                               
whether it will cost DNR more than $150,000 to administer.                                                                      
MR.  MYERS said  that money  would  come from  the applicants  so                                                               
there should  be no additional cost  to the state if  the program                                                               
receipts are authorized. He said  that amount was negotiated with                                                               
the sponsor and he cannot say  whether it is totally adequate. In                                                               
the  past,  all  of  the royalty  reduction  requests  have  been                                                               
handled internally.  DNR recognizes that  a lot of  analysis will                                                               
have to  be done on new  fields, where little data  is available.                                                               
DNR believes $150,000 is an adequate amount.                                                                                    
CHAIR OGAN  asked what  fields this  might apply  to. He  noted a                                                               
bill just passed the Senate  that deals with severance tax breaks                                                               
for  certain  wells.   He  questioned  how  the   two  pieces  of                                                               
legislation  dovetail and  whether  CS SSHB  28(FIN) is  targeted                                                               
toward heavy oil.                                                                                                               
MR. MYERS  said it is  targeted at  any producing field.  He said                                                               
fields go  through various  stages. At a  field's end  stage, the                                                               
operator   and  the   state  must   determine  when   it  becomes                                                               
uneconomic.  He said  royalty reductions  are truly  effective at                                                               
the  very  tail end  of  declining  production. He  expects  this                                                               
legislation to  eventually apply to  all fields in the  state. He                                                               
pointed out  in the  other cases,  DNR will have  to look  at the                                                               
individual economics  of each field.  He said with heavy  oil, as                                                               
the technology  changes, the economics have  vastly improved. DNR                                                               
would have to take a serious  look at the detailed economics, the                                                               
engineering  and  the  reservoir.  He  indicated  the  heavy  oil                                                               
reserves  are just  being tapped  now  and are  in their  initial                                                               
stages of  production. He pointed  out the  exploration incentive                                                               
is specifically  crafted to not  include wells within  units that                                                               
are producing or any units that have a plan of development.                                                                     
SENATOR DYSON asked if anyone is opposed to CS SSHB 28(FIN).                                                                    
MR. MYERS said he is not aware of anyone.                                                                                       
REPRESENTATIVE KOHRING  said he was  not aware of  anyone either.                                                               
The bill  had three committee referrals  in the House and  he did                                                               
not recall any negative testimony.                                                                                              
CHAIR OGAN  noted this bill  is extensive  and he has  some angst                                                               
about the short timeframe for study.  He asked Mr. Myers if he is                                                               
aware of any flaws that committee members' may not be aware of.                                                                 
MR.  MYERS  said  he  believes the  bill  improves  the  process.                                                               
Although  compromises are  made in  every bill,  he believes  the                                                               
compromises are balanced and that  the interests of the state are                                                               
well protected.                                                                                                                 
SENATOR  WAGONER   asked  if  Swanson   River  has   any  royalty                                                               
incentives right now.                                                                                                           
MR. MYERS said  he believes Swanson River is  primarily a federal                                                               
SENATOR BEN  STEVENS noted that  Mr. Myers said  that application                                                               
is  determined on  the end  of life  determination of  the field,                                                               
which he  believes is a trigger  to the possibility of  a royalty                                                               
reduction. He  expressed concern  that any  operator could  say a                                                               
field is  at the end of  production life. He asked  how DNR would                                                               
determine whether a field is at end of life.                                                                                    
MR.  MYERS said  this  bill allows  those  royalty reductions  to                                                               
occur at any  stage of a field's life but,  to determine the true                                                               
economics of  a field takes a  lot of work and  is more difficult                                                               
the further  it is  from the  end of field  because later  in the                                                               
field life  there are more  well and seismic data  and production                                                               
profiles. He  said the  calculation is  very technical,  which is                                                               
why the fiscal note contains funds for outside experts.                                                                         
CHAIR OGAN asked why the language  on page 2, lines 5-9, is being                                                               
deleted. He stated:                                                                                                             
     I remember  we had  a lot of  discussion with  the bill                                                                    
     that  originally passed  about delineation  of the  oil                                                                    
     and gas  field or pool  and, instead of  delineating it                                                                    
     to allow  the commissioner  to conduct an  analysis and                                                                    
     make  the findings  required by  the subsection,  we're                                                                    
     eliminating - we're just letting  them delineate to the                                                                    
     satisfaction  of the  commissioner and  it doesn't  say                                                                    
     anything about findings. Why are we doing that?                                                                            
MR.  MYERS said  they  wanted the  delineation to  be  done on  a                                                               
technical basis. Representative Rokeberg  was concerned about the                                                               
level of legislative input and  cleaning up the cumbersome nature                                                               
of  the  mechanism.  He  said   the  original  royalty  reduction                                                               
required two years of production. There  was a push at that time,                                                               
primarily by  BP, to allow  a reduction before  production start-                                                               
up.  BP  then  asked  for the  royalty  reduction.  However,  the                                                               
reality is  that some  production is  necessary to  determine the                                                               
economics  of the  field. The  legislature at  that time  said as                                                               
long as the  reservoir was delineated, it was willing  to grant a                                                               
royalty reduction.  He said this  bill establishes  the necessary                                                               
level of  data and  who gets  to decide  whether a  reservoir has                                                               
been sufficiently delineated.                                                                                                   
CHAIR OGAN said  the bill contains no sunset  data or requirement                                                               
to report to the legislature.                                                                                                   
MR. MYERS clarified that  the commissioner's preliminary decision                                                               
will be presented to the  legislature. The House amended the bill                                                               
to provide the legislature with access to confidential data.                                                                    
REPRESENTATIVE   VIC  KOHRING   said   regarding  the   potential                                                               
Permanent Fund earnings  that this bill will  generate, this bill                                                               
essentially  deals  with  three  fields. Two  are  not  producing                                                               
anything at  all. One way  to look at  the economics is  that the                                                               
state could  get 12.5 percent  of nothing, or  3 or 7  percent of                                                               
something, by virtue of the sliding scale.                                                                                      
CHAIR  OGAN asked  if there  is as  much known  heavy oil  on the                                                               
North Slope as has already been discovered.                                                                                     
MR. MYERS  said that  is correct but  the recoverability  of that                                                               
heavy oil will be much lower, probably 10 to 15 percent.                                                                        
MR.  KEVIN TABLER,  Manager of  Land and  Government Affairs  for                                                               
Unocal,  stated support  for CS  SSHB 28(FIN).  He said  it is  a                                                               
substantial  improvement  to the  1995  legislation,  in that  it                                                               
provides clarification and predictability for an applicant.                                                                     
CHAIR  OGAN asked  Mr. Tabler  if  Unocal applied  for a  royalty                                                               
reduction but did not complete the process.                                                                                     
MR.  TABLER  said  Unocal  pulled  out  after  18  months  and  a                                                               
significant amount of cost.                                                                                                     
CHAIR OGAN commented  this bill is extensive,  however the policy                                                               
decision  to allow  royalty  reduction was  already  made by  the                                                               
SENATOR  WAGONER  moved  CS  SSHB  28(FIN)  from  committee  with                                                               
individual recommendations and its attached fiscal note.                                                                        
CHAIR OGAN announced that without  objection, the motion carried.                                                               
He then  recessed the meeting to  the call of the  Chair at 12:10                                                               

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