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Lawmaker says extra tax break in SB 21 would give zero value to oil

Dermot Cole

FAIRBANKS -- When Parnell administration officials described the economic consequences of SB 21 for legislators and the public before its approval, they did not say that under certain conditions the state would be better off with no production tax at all than the incentives the law includes for "new oil," Anchorage Rep. Les Gara contends.

Gara says that, had the "net present value" calculations for the gross value reduction been known a year ago, the Legislature would not have approved SB 21. A referendum to reject the tax cut is on the ballot next week.

“I have never once heard another legislator during the SB 21 debate say that we would get a negative long-term or near-zero, longterm value of any oil after 2003,” he said.

The Parnell administration rejects Gara's argument, saying that when oil royalties, corporate income taxes and property taxes are included, the overall net present value would be positive, even with the lower tax rate. They also say that the threat of going into the red was higher under ACES, a claim that Gara disputes.

The GVR tax break does not apply to the major so-called legacy fields that produce most of the oil in the pipeline, including Prudhoe Bay and Kuparuk, but to undeveloped areas -- with some exceptions.

Gara said he learned about the potential for meager or nonexistent state tax income from so-called “new oil” projects through a slide in the presentation on SB 21 released in May by retired University of Alaska Anchorage Professor Scott Goldsmith.

Goldsmith considered a hypothetical case in which $4 billion in new spending occurs from 2015-2019, creating new production peaking at 50,000 barrels per day from a new area, defined in SB 21 as being outside the long-established development sites.

Goldsmith included a chart showing that oil production that qualifies for the GVR under SB 21 produces a revenue stream of tax dollars that has a net present value to the state of near zero or dips into negative numbers when all of the yearly cash flows are accounted for and discounted.

The higher the discount rate -- the percentage used to estimate how much the value of a dollar changes over time— the more negative the result. At a discount rate of more than 1.5 percent, the state would be better off with no production tax at all.

Put another way, the value of the tax deductions starting in the years before production begins and the cost of future credits could exceed the value of the production taxes the state stands to receive in the long run for projects qualifying for the GVR, Gara said.

Just as companies judge the value of an investment in part on how much cash flow they can expect -- applying a discount rate because a dollar in the future is worth less than a dollar in the present -- the state can calculate the economics of a system that combines tax deductions, credits and taxes paid over many years.

“It absolutely should have been presented to the public and the Legislature,” Gara said of this aspect of the law, adding that the Parnell administration experts during the oil tax debate "were like Fred Astaire and Ginger Rogers; they just danced all over the place and never answered questions.”

Goldsmith wrote that the effective tax rate on new investment would be about 23 percent under SB 21 in established areas, dropping to 13 percent in areas qualifying for the GVR. Gara said the Goldsmith report shows the 13 percent rate could be more than wiped out over time because of deductions and future credits. 

"All oil fields in place after 2003 and all future fields pay us a negative or near-zero value for Alaska’s oil under SB 21’s production tax. That’s in the Scott Goldsmith report and that part has been hidden in TV ads for too long," Gara wrote.

Parnell administration officials argue that Gara is wrong and he has misrepresented Goldsmith's analysis. They say he left out the part in which the retired UAA economist said "the total revenue impact of the new investment is not limited to the increase in the production tax."

Goldsmith said that the state would collect royalties -- the portion of the oil the state owns -- and there would be some increase in corporate income taxes and property taxes. That would tilt the balance into positive territory for net present value.

"With the inclusion of these revenues, the net present value of the future revenue stream would be positive," Goldsmith wrote.

There is positive value for the state in "almost any conceivable circumstance," Deputy Revenue Commissioner Mike Pawlowski said in an email. He said the administration talked about the GVR  and the lower tax rate for new fields at multiple legislative hearings. The approach in SB 21 is holistic, he said, because the state is trying to get more oil into the pipeline.

"Greater production that stems decline brings economies of scale throughout the system and costs per barrel decrease," said Pawlowski.

Gara said lawmakers were not told that there could be circumstances under SB 21 in which having no production tax would be better than the rate under the GVR. And he said that the production tax has been and should continue to be a major element that helps fund schools, public safety and other services in Alaska.

Goldsmith concluded that the same $4 billion investment under ACES would also produce a negative net present value at a high discount rate, mainly because of higher tax credits paid before production. With royalties, corporate income tax and property tax included, it would produce about the same amount of revenue for the state as the GVR-eligible investments, he said.

Second review

In a report last week, UAA Professor Matt Berman of the Institute of Social and Economic Research offered more analysis on the GVR tax rate, describing it as "quite low" and saying that over time the rates are likely to keep falling, “possibly to historic low levels.”

Berman said at oil prices predicted for 2013-2015, the GVR  "would provide only a little more revenue per barrel than the old severance tax when it reached its lowest effective rate, about 7 percent per barrel.” Oil prices would have to hit $130 per barrel before the tax would be equal to the severance tax in 1993, Berman said.

Pawlowski said the administration disagrees with the assertion that the GVR tax is too low.

"The rate has to be right so that the companies will have the incentive to engage in the project and produce oil and generate a profit that can be taxed. The rate has to be right so that the state can generate revenue optimally over the long term," he said.

In reviewing the minutes and the audio of House Finance Committee hearings on April 6-7, 2013, the administration said the cost of the GVR would be about $25 million for this fiscal year and that it would apply to a small percentage of the oil in the pipeline for years to come.

Pawlowski said the risk under ACES was that the combination of low oil prices, high spending and high tax credits could have produced large projects with a negative net present value. There was no comparable review about how projects under the GVR could be negative.

In an interview, Gara said the proof the GVR is too low is that the state could lose money on a net present value basis with the system.

Point Thomson qualifies

The state revenue sources book says oil eligible for the extra tax break will be from “areas surrounding a currently producing area that may not be commercial to develop, as well as new oil pools that have not been discovered or developed.”

But it also applies to two oil fields that are already producing oil and to Point Thomson.

Gara said the commercial argument should not apply with Point Thomson, the oil and gas field east of Prudhoe Bay that has been a point of contention between the state and ExxonMobil for many years.

The state ended that fight by reaching a settlement with ExxonMobil before SB 21 became law. The company has to produce 10,000 barrels a day -- a relatively small amount -- or lose acreage by 2015-2016. There are additional work requirements for future years.

Applying the extra tax break to that project makes no sense, Gara says, as the deal was signed with ACES in place.

In testimony before the Legislature in 2013, Joe Balash, now the commissioner of the Department of Natural Resources, and Pawlowski said the additional tax break would also apply to the Nikaitchuq oil field, which began production in 2011, and the Oooguruk oil field, which began production in 2008.

In April 2013, Gara asked at a hearing why the state would give incentives for production that was already happening. Balash said the state wanted to be fair to the companies and they deserved the lower tax rate.

“The decisions to move forward with the investments were made in the context of a big swirl over the state’s fiscal policy and taxation,” Balash said.

Nikaitchuq was sanctioned in 2008 after the enactment of ACES and after the state reduced its royalty take in 2007 to make the project more economic.