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Alaska can't afford current oil tax credits but should think twice before raising taxes

  • Author: Tim Bradner
  • Updated: June 25, 2016
  • Published March 9, 2016

Legislators in Juneau are working to revamp the state's horribly complex, and costly, tax credit incentive program for new oil and gas exploration and development.

It's a tough task and I don't envy them. The Resources Committee in the state House has been holding meetings for weeks on this, with afternoon and often evening sessions. Those people must have steel in their butts and caffeine in their veins. I couldn't sit still that long – or stay awake – so let's give those people credit for working hard to absorb and understand all this.

In a nutshell, here's the issue: The current incentive program has actually worked – new oil has been discovered and developed – but it has become complex, unwieldy and expensive. Change is needed.

What has riled up the industry, however, is that imbedded in the bill are tax increases on the companies, which they feel are unfair given huge losses, at the current oil price, they are now taking on their Slope production.

Basically, it costs $52 a barrel to produce the oil and get it to market. With a $30-per-barrel price, that's a loss of $22 a barrel. This is uncharted territory for Alaska.

Whether lawmakers will approve the increases is a gut policy call, and a pretty simple question, but simplifying the overall incentives is a daunting prospect.

Some history: The idea of giving a tax break to companies developing new oil, particularly small fields facing tough economics, goes back to the 1970s with the Economic Limit Factor, or ELF. This was a formula in the tax law that required an advanced degree in mathematics to comprehend.

About that same time, a separate, small program was developed to grant limited tax credits purely for exploration, for drilling and seismic work.

As usually happens in the tax code, things like ELF become obsolete. Over the years the ELF had clearly become unworkable, to the point that, had it continued, the second largest oil field in North America, the Kuparuk River field on the Slope, would pay no production tax.

It was finally jettisoned in 2006 by Gov. Frank Murkowski when the state switched over to a net profits oil tax in lieu of the former system, a tax on gross revenues.

Murkowski's other idea, however, was for a capital investment tax credit that would give industry a break on taxes if companies reinvest their earnings in the state to develop new oil.

Like all these things, it seemed like a good idea at the time. Fast-forward to 2010 and 2011, and the provision had become very costly.

Gov. Sean Parnell and the Legislature finally repealed it, at least partly, in the 2013 oil tax change in Senate Bill 21.

Had they not done this it would have cost the treasury a billion dollars the following year. Senate Bill 21 also ended several exploration incentives, which actually terminate this year.

Thus, process to ramp down the incentive program has actually been underway for some time and is continuing this year in House Bill 247.

Those capital investment credits were dropped only for the North Slope but were continued in Cook Inlet. They are now one of the main forces driving up the cost of the incentives to $700 million last year until Gov. Bill Walker vetoed $200 million of it.

They have also helped create some bizarre effects of the incentive program, such as a situations in which Cook Inlet oil producers pay no state production tax but some can still get a cash refund from the state for investments.

To be fair, those companies still pay a state royalty and other taxes, like the state corporate income tax and state property tax on oil facilities.

Getting rid of the last vestige of the capital investment tax credit program is one of the main purposes for the tax bill now in the Legislature.

A lot of other things happened to other parts of the program. Over time a tweak was added here, a tweak there. The exploration tax credit was broadened beyond drilling and seismic expenses to include credits for net losses (mainly for small explorers), special tax breaks for very small producers, and a provision unique in the world where the state allowed companies, again mainly small explorers, to cash out their tax credits.

Explorers could drill one winter season, turn in the tax credit certificates and get a check from the state, which they typically used to pay for a second season of drilling.

Sounds like corporate welfare? Some may look at it that way but the program overall actually worked. It achieved the state's goal of getting more wells drilled and diversifying the industry with medium and small independent companies, which are much more aggressive than the big majors.

Things got complicated, however, with several kinds of credit programs, some of which could be stacked one atop another. Just as with ELF, the system had become complex, expensive and ultimately unaffordable for the state in a world of $30-per-barrel oil.

The goal now is to somehow simplify the program, lower its cost and make easier for the public and the Legislature to understand.

What's in the current bill is not just ending some credits but putting limits on others.

However, legislators should take care to preserve parts of that work, such as the "frontier" incentives for exploring big, underexplored basins of Interior and Northwest Alaska, where risks are high and industry has been loath to drill.

This seems like a logical place to put incentives to work.

Also, lawmakers don't want to hurt companies, particularly smaller ones, that have made discoveries and are now developing their finds, or preparing to.

The state is not legally required to pay these credits, but there is a kind of moral obligation, as noted by Gov. Walker when he vetoed the $200 million last year but promised to eventually pay it for companies that had taken risks and done work.

Just ending the program would be a real black eye for us.

The gut call for legislators, however, is that tax increase. With drill rigs being laid down and oil workers being laid off, is it really the time to do that?

Another tough decision to be made.

Tim Bradner is co-editor of Alaska Inc. Magazine and co-publisher of Alaska Legislative Digest.

The views expressed here are the writer's own and are not necessarily endorsed by Alaska Dispatch News, which welcomes a broad range of viewpoints. To submit a piece for consideration, email commentary@alaskadispatch.com. Send submissions shorter than 200 words to letters@alaskadispatch.com or click here to submit via any Web browser.

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