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Alaska oil tax debate: Playing ACES high

Aaron Jansen illustration

Tax reform critics are continuing to try and bluff their fellow Alaskans into believing the state's oil tax regime is competitive. For the sake of Alaska's economic well being, they should start being honest about the cards we're playing. The fact is lawmakers are playing ACES high.

One of the bedrock arguments proffered by critics who oppose reforming oil taxes is that compared to other oil producing regions, Alaska is right in the middle. This is false.

Here is what retired University of Alaska Professor Neil Davis and a member of an anti tax reform group, wrote in defense of the current tax regime.

To reiterate just for emphasis: The real, factual, data-based Total Government Take for Alaska under ACES has been 56 to 69 percent, near the worldwide average, and less to far less than in at least twenty other major oil provinces shown on the diagram.

The diagram Davis is referring to is shown below.

A chart of total government take

While the simplistic view of the data shows Alaska ranks as the twenty-sixth highest-taxing region in the global marketplace, drawing a conclusion based purely on the state's place on the list isn't accurate. What really matters is the color of the box next to the regions who levy higher taxes.

Out of the 25 higher-taxing regions, seventeen of those have production sharing contracts, four have service agreements and only four have a conventional royalty/tax system like Alaska.

In short, an apples-to-apples comparison of similar royalty/tax regimes shows Alaska ranks fifth not twenty-sixth, as the highest-taxing oil region in the world.

In all, 14 of the top 15 taxing regions in the world have either production sharing contracts or service agreements. 

Why these numbers matter is because both production sharing contracts and service agreements offer the oil industry a higher degree of return and risk containment that offset their higher tax rates. 

In countries that offer oil producers production sharing contracts, the company shoulders the financial risk of the initiative and explores, develops and ultimately produces the field as required.

When successful, the company is permitted to use the revenue from produced oil to recover capital and operational expenditures, known as "cost oil." The remaining money is known as "profit oil," and is split between the government and the company, typically at a rate of about 80 percent for the government, 20 percent for the company. 

Production sharing contracts are popular in countries that lack the expertise and finances to develop their resources and wish to attract foreign companies to do so. And while any investment contains risk, the psc allows companies to contain their risk by being assured that if a discovery is found, they will recoup their initial capital investment along with an agreed upon return.

It's only after these expenses are recouped by the producers that the high tax rate kicks into play. However that information is never disclosed when tax reform opponents trot out their comparative tax analysis graph.

Service agreements are similar to a production sharing agreement in the sense that they limit the companies risk and provide an agreed upon return for investments. Again, it's only after the agreed upon return has been realized that the high rate of taxation is levied.

In Nigeria, one of the regions listed as higher than Alaska, exploration and development costs are paid in installments over a period of time and the contractor has no title to the crude oil produced, although they can be allowed the option to accept reimbursement and remuneration in oil. As an incentive for the risk taken, the contractor has the first option to purchase certain fixed quantity of crude oil produced.

Again, it's only after the investment costs have been fully recovered that the high rate of taxation is levied. 

These facts put this comparative tax chart in an entirely different context; an honest one. 

To put this into perspective; we're expecting Alaska's producers to invest billions to increase oil production, under the highest tax structure in North America as well as the fifth-highest in the world.

Another argument critics are using is the debate over marginal tax rates. Again, here is what Neil Davis wrote.

By contrast, the Marginal Tax Rate index tells us nothing other than how Government Take varies with the price of oil. It is not obvious to me what value Marginal Tax Rate has other than for purposes of obscuring reality.

At least the writer admits he has no understanding of a critical component used by oil companies in evaluating investment opportunities.  

If fifty is the new forty, then not knowing is the new knowing when it comes to ACES.

Marginal rates are the ordinary rate of tax charged on the last dollar of income. These rates are heavily relied upon to estimate calculations for investment decisions.  

However, under ACES we're not talking about ordinary marginal tax rates. We're talking about marginal tax rates with a dramatic escalating progressivity factor. 

By the time oil rises over $100 per barrel, the state is taking two dollars to every one for the producers. With the Department of Revenue projecting the price of oil will average $106 per barrel in 2012, the high marginal tax rates have played a huge factor in discouraging North Slope investment.

This is not "obscuring reality," as Davis claims.

It's brutal reality for a private sector company considering making billions in investments.

For example, companies looking to invest in a new piece of infrastructure to stimulate oil production need to accurately be able to model their tax liability. Under ACES, every dollar increase over a $30 per barrel results in an escalating tax burden of .4 percent. Since the progressivity component is not bracketed, and applies to the entire cost of the barrel of oil, higher prices can drive marginal tax rates up to over 80 percent when oil reaches the top end.  

And unlike a progressive tax on income where you pay a higher rate on only the incremental difference between brackets, under ACES the incremental tax burden applies to the entire revenue stream which increases as a greater percentage of revenue as the price of oil rises. The progressivity factor included in ACES takes away the upside and at the end of the day actually caps what companies can earn.

According to a global analysis conducted by PFC Energy, Alaska's progressivity rate is higher than any other OECD country and ranks sixth overall only behind Venezuela, Algeria, Uzbekistan, Azerbaijan and Kazakhstan.  

The end result is if your incremental tax exposure continues to diminish profit margins every time the price of oil rises, you have no certainty. Therefore you have no way to manage your risk profile or conduct proper economic modeling. Thus no reliable cost/benefit analysis, ergo no investment.

So to say that the marginal tax rate discussion is economic hocus pocus, is to admit you really have no concept about how investment decisions are made.

But therein lies the problem with the debate over reforming ACES.

Those who understand the proper context of industry data like comparative tax charts, employment statistics and marginal tax rates, are trying to reason with those who don't.

Meanwhile as oil production declines and investment flees, state senators continue to play ACES high.

Andrew Halcro is the publisher of AndrewHalcro.com, a blog devoted to Alaska issues and politics, where this commentary first appeared. He is president of Halcro Strategies and Avis/Alaska Rent-A-Car, his family business. Halcro served in the Alaska House of Representatives from 1999 to 2003, and he ran for governor in 2006 as an Independent.

The views expressed here are the writer's own and are not necessarily endorsed by Alaska Dispatch. Alaska Dispatch welcomes a broad range of viewpoints. To submit a piece for consideration, e-mail commentary(at)alaskadispatch.com.