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Tax breaks for new oil fields could lower revenue forever

Lisa Demer

JUNEAU -- Deep within a proposed overhaul of Alaska's oil tax regime, an element intended to trigger new oil production is being debated as either a smart new tool or a ticking time bomb.

The general idea of tax breaks for new oil production has broad support among lawmakers and Parnell administration officials who see them as a way to halt a steep decline in the volume of oil moving from the North Slope down the trans-Alaska pipeline.

Democrats opposed to a major across-the-board tax cut also include tax breaks for new fields in their plan.

But the details of how big and broad the tax break should be, and whether the benefit should eventually expire, are a source of fierce contention. The financial hit to the treasury is unknown -- because the new production is unknown -- and some worry it could be huge.

The proposed new tax mechanism in Senate Bill 21 is called gross revenue exclusion. It is complex but the bottom line is this: Oil producers could get a tax break of more than 40 percent for new fields compared with what they would pay on production from existing fields.

Under the version of the tax rewrite that cleared the Senate Resources Committee Feb. 27, the tax break would apply to new fields, new areas of big, legacy fields like Prudhoe Bay and Kuparuk, and even newly added acreage within already approved production areas. And it would last forever.

The Senate is taking the lead on oil tax legislation. The Senate Finance Committee now is bearing down on it with twice-a-day hearings expected to extend into mid-March.

The tax benefit for new oil production is "a fairly big piece," said Sen. Kevin Meyer, R-Anchorage and co-chairman of the Senate Finance Committee. "It's a fairly generous tax break, but they only get it if they produce new oil or put more oil in the pipeline, which is what we want."

But that could have long-term implications on state finances, noted Sen. Anna Fairclough, R-Eagle River. "Eventually all oil would be new oil coming through the pipe and everything would qualify," Fairclough said Friday at a Finance Committee hearing.

Fairclough wants legislators to consider a time limit for the tax break. She also serves on the Resources Committee, which issued a memorandum along with the bill suggesting that the Finance Committee evaluate a limit.

The big, legacy fields such as Prudhoe could have decades more production, so everything won't qualify for the tax break any time in the near future, said Joe Balash, deputy natural resources commissioner.

The tax rewrite is significantly altered from what Gov. Sean Parnell introduced in January at the start of the legislative session.

The measure would cost the state an estimated $350 million to $1 billion a year through 2019, without factoring in new revenue from new production and with several unknown elements, including the cost of the new tax break, according to an analysis by the state Department of Revenue.

State officials say the hit would be less if more barrels of oil are produced, and the state could come out ahead within just a few years.

The department estimated maybe $50 million a year would be lost from the tax break but acknowledges that figure is low. Under the Senate version, for instance, the long-delayed Exxon Mobil development at Point Thomson would qualify for a break. While that is primarily a rich natural gas field, it also holds hundreds of millions of barrels of oil.

 

NEW LURES FOR OIL

The latest version of the bill includes a 35 percent flat tax on oil production profits, up from 25 percent proposed by Parnell. The state would abandon the central feature of the current tax structure, which is progressively higher taxes at higher oil prices, an element that Democrats in both the House and Senate want to keep in some form.

Tax credits for capital spending by oil companies that cost the state hundreds of millions a year would be wiped out.

Instead, the state would dangle two new enticements: a $5 credit on every barrel of oil produced, and the tax break for new production. The Resource Committee proposed excluding 30 percent of new oil production from the state tax, compared to 20 percent offered up by Parnell.

On Friday, Barry Pulliam, managing director of Econ One Research, which the Parnell administration has hired as an oil tax consultant, told the Finance Committee that the new tax break is better than traditional tax credits, because it is tied to production, not oil company spending.

Fairclough said she wanted to see examples comparing the two. She said she wasn't convinced the new mechanism would really encourage challenging projects, like developing fields with thick, viscous oil that is difficult to bring to the surface, that otherwise wouldn't happen.

Didn't the consultant's analysis show that with the new tax break in place, Alaska was more lucrative for investment from a tax standpoint than North Dakota? Sen. Click Bishop, R-Fairbanks, asked at the Finance Committee meeting.

Yes, Pulliam said.

"So I don't have to listen about North Dakota anymore?" Bishop asked.

Well, North Dakota is still full of opportunity, Pulliam answered, indicating that taxes were only one factor in that boom. Last year, North Dakota passed Alaska in oil production.

 

A BIG TAX BREAK

Here's how the break would work. Start with a barrel of oil valued at $100. Deduct the costs of producing and transporting the oil, which varies by producer but could be $30 or so. For oil from existing fields, the flat 35 percent tax would be charged on the remaining $70. That's a $24.50 tax on $100 worth of oil.

But for new oil, 30 percent of the value would be exempt, or excluded, from the tax. So the 35 percent flat tax would be assessed not on $70, but on $40. That's a $14 tax on that same $100 worth of oil.

"That's a big cut," Sen. Hollis French of Anchorage, the only Democrat on the Resources Committee, said in an interview Friday. "The idea is still sound, but what you are seeing is it applied to more and more oil."

Too many fields may benefit, and excluding 30 percent of the value from the tax appears too generous, he said. Democrats have proposed lower rates.

Plus, the state natural resources commissioner will face the extra challenge of determining whether oil companies are really tapping new sources of oil. If a pool of oil is like a cup, are they sticking more straws into the same cup, or are they finding new, untapped cups nearby?

"How do you double-check their work?" French asked.

Balash, with the Natural Resources Department, said in an interview that the burden must be on oil companies to prove up. If the measure passes, they will have to submit seismic studies and reports on field pressure showing how the fluids flow underground over time, he said.

The oil tax rewrite has enormous importance. Government in Alaska depends on oil revenue for schools and roads, public safety and health care -- just about every public service. Production of oil from the North Slope has dropped from a peak of two million barrels a day in 1988 to under 600,000 barrels a day last year.

High oil prices have masked some of the decline, but the loss in revenue from lower production still has been remarkable, Balash said. In the 2008 budget year, with oil averaging $96.51 a barrel, the state collected $6.8 billion in taxes on oil profits. This budget year, with oil averaging above $108 a barrel, the state expects to bring in $4.4 billion.

 

Reach Lisa Demer at ldemer@adn.com or 952-3965.

 

 


By LISA DEMER
ldemer@adn.com