Bradner: 'New oil' vs. 'old oil' is issue for state

EconomyFebruary 23, 2014 

With all the political acrimony over oil taxes in the last two years, it's amazing there are a few things that Democrats, Republicans and the petroleum industry actually agree on.

One is that the former oil tax, known as ACES, had problems and needed to be fixed. It was over the "fixes" that people disagreed.

Second, Democrats and Republicans agreed widely that oil from new oil deposits (so-called "new oil") deserved a tax break.

There was sharp disagreement, however, over whether or how the tax reduction should apply to the large existing fields and existing production ("old oil"). Democrats argued the old fields were profitable, the investment was sunk and those wells didn't need a break.

However, most of the new oil to be developed is in the big existing fields, industry argued. The tax reduction should apply to existing fields, they said, because it would create incentives to find and produce new oil from small deposits bypassed earlier, or to apply new technologies to squeeze more oil out of the rocks.

As the oil tax legislation evolved in 2012 and 2013, legislators did recognize that much of the untapped oil was in existing fields and the debate shifted to how to give incentives to this "new oil." Democrats fiercely resisted giving a break to the "old oil," the existing production, claiming it would just hand industry a windfall.

But how do you distinguish between "new" and "old" oil in existing fields? New oil from brand new, separate fields is easy to distinguish but sorting things out in an older field when new and old oil share the same production facilities is pretty tough.

Some Democratic legislators put forward ideas, such as measuring production from each field and granting a tax break for any new barrels measured above that production, but that would be administratively complicated because there are many, many separate reservoirs that would have to be measured, with most of them declining.

As the oil tax legislation, SB 21, progressed through the Legislature, no one developed a good way to do this. What was finally adopted goes partway but is still less than perfect.

When new oil reservoirs are tapped within producing fields -- but geologically separate from the older, larger reservoir -- production can usually be measured and state Division of Oil and Gas geologists can verify that the oil will come from a separate formation ("new oil") and not an existing production reservoir ("old oil").

Now came a tough part. What about new oil produced by drilling new production wells or applying new technology to squeeze more oil from existing, older reservoirs? There can be a lot of this but how do you measure it?

These sorts of tax administration details, which are extremely important, are typically worked out in regulations by the revenue department. In this case, the department decided that this "new oil" has to be measured, and set out requirements but left the choice of methodology to the industry. In doing so, the department granted leeway to the companies but requires them to convince state the measurement is valid.

It will take a while to see if this works, because the new tax regime is only 7 weeks old, having become effective on Jan. 1.

Meanwhile, what about the tax reductions themselves? Legislators tried to satisfy competing views in SB 21, the new law, and when that happens things generally get complicated, which is what has occurred.

For oil production that would clearly be determined as "new oil," the new tax is very generous. A flat 20 percent reduction of the oil value for tax purposes (30 percent in some cases) is allowed. In addition, a $5-a-barrel tax credit applies.

A per-barrel tax credit also extends to "old oil" from producing fields but the 20 percent reduction in taxable value is not extended to "old oil." "Old oil" however, is eligible for a production tax credit on a sliding scale (up to $8 a barrel if oil prices are low) but also pays a minimum 4 percent tax on gross value to protect the state if prices crash.

The Department of Revenue says that at present oil prices, the sliding scale for "old oil" works out to about $6 a barrel.

What will this cost the state? The revenue department estimates the cost of all production tax credits at about $950 million next year, in terms of revenue lost to the treasury. It is expected there will be "new oil" production, however, which will offset the loss of tax income, but it will take time to see out how much.

Also remember that a flat 20 percent capital investment tax credit in the former law, ACES, is gone. That tax credit, which was not linked to new production, was costing the state about $1 billion a year.

The department has estimated that the new tax overall will bring in more money than ACES, at current oil prices. It also appears that new industry activity on the North Slope will result in enough "new oil" to soften the field decline rate from 8 percent last year to 4 percent this year and 2 percent next year.

The numbers could get even better, because the revenue department now uses a conservative method of forecasting production. Any "new oil" resulting from several new projects announced in the last nine months, which now total $6 billion in investment, is not included in the department's production forecast.

We know the change in oil taxes would be a gamble. Let's keep our fingers crossed that everybody wins.

Tim Bradner is an Alaska business writer who lives in Anchorage.

 

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