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Picture for Alaska oil revenues goes from bad to worse as oil prices drop

  • Author: Dermot Cole
    | Opinion
  • Updated: September 28, 2016
  • Published November 27, 2014

We don't know if oil prices near $70 or lower are a short-term phenomenon or a sign of things to come. The OPEC nations met Thursday in Vienna to plot strategy, deciding to keep their production quotas the same.

Oil prices dropped sharply again on world markets. As Reuters reported, "The wealthy Gulf states have made clear they are ready to ride out the weak prices that have hurt the likes of Venezuela and Iran -- OPEC members which face big budget pressures, but cannot afford to make cuts themselves."

Alaska faces bigger pressures in the wake of the Thanksgiving Day meeting, as state tax revenue is so closely tied to price that the money flowing into the treasury could shrink to levels unimagined just a few months ago.

If prices stay down, it's conceivable that some new oil development projects would pay nothing in production taxes. And the tax on most of the oil in the pipeline would be at rock bottom.

As the administration of Gov.-elect Bill Walker begins to take shape, the state's immediate financial position has deteriorated because of an oil price slide engineered by Saudi Arabia, an increase in Lower 48 production, declining consumption overseas and other factors.

Since the day of the primary election in August, when voters rejected a measure to repeal Senate Bill 21 -- an oil-tax overhaul passed at the end of the 2013 legislative session -- the international upheaval in the world oil market has knocked down the price by nearly $30 a barrel.

An Alaska oil price in the $70 to $80 range means exceptionally low revenue for the state and a tax rate lower than it was a decade ago under the old Economic Limit Factor system.

The production tax on the giant Prudhoe Bay and Kuparuk oil fields has hit the minimum 4 percent gross tax floor provided for in SB 21 as an insurance policy, according to various sources. That was the provision included to guarantee at least some revenue from oil production taxes.

The gross tax in 2005, under the much-derided ELF system that prompted complaints that it shortchanged the state, stood at about 7 percent. In 2013, when SB 21 was under review, Democrats attempted to insert a higher minimum tax, 15 percent, but it remained at 4 percent, which is below the tax level in many other states.

A steep revenue decline at lower prices would have also happened under the previous tax regime, Alaska's Clear and Equitable Share, only worse, because the minimum tax under that system could be reduced below 4 percent by credits.

The big difference between ACES and the new tax regime, SB 21, is that under ACES the state would collect billions more at higher prices -- say $120 and above. ACES was a bet that the state would take in enough money during times of high oil prices to withstand periodic downturns.

It was that feature of the highly progressive tax that led to the accumulation of billions of dollars in surplus funds in 2008-2012, money that the state is now drawing upon to balance the budget.

The opponents of ACES said the progressive tax stripped too much profit from the oil companies during those high-price years and Gov. Sean Parnell led the successful charge to reduce the tax at high prices.

SB 21 eliminated the rising tax rate that saw oil companies pay more to the state when oil prices were high. The bill also set a firm 4 percent minimum tax that applies to most of the oil in the pipeline today.

At $105 per barrel, the state would collect about $1.7 billion in taxes under SB 21. At $85 per barrel, the state would collect about $475 million, the 4 percent minimum, according to a recent analysis by the Department of Revenue.

One of the key aspects to the SB 21 plan is an unusual credit system that gives a maximum credit to the companies at low prices. The oil companies collect a credit from the state of $8 per barrel when oil is below $80. The state pays out less in credits as oil prices go up, dropping to zero at $150.

If today's prices last, that credit will cost the state about $1.3 billion a year, according to Sitka Sen. Bert Stedman, an accountant who is among the most knowledgeable legislators on oil-tax matters.

Net profits system

Since 2006, Alaska has had a net profits tax system for oil, unlike all of the other major oil-producing states, where a tax on gross proceeds is the norm. The theory advanced by the administrations of Govs. Frank Murkowski and Sarah Palin was that the state would accept the risk that at times there would be low oil prices and low oil taxes, in exchange for collecting higher oil taxes when the price per barrel climbed. Under the ACES plan approved in 2007, that was particularly dramatic at prices of $120 and above.

Since then, production has dropped by almost 300,000 barrels per day, which means the cost of developing oil is spread over a smaller number of barrels, amplifying the downward pressure on tax income when prices are low. The billions being spent by ExxonMobil at Point Thomson are a key factor in the increase in deductible costs.

SB 21 was mainly about reducing the state's cut when oil prices were high so that Alaska oil production would be more profitable for the oil companies.

Focused on higher prices

There had been little debate in state government in recent years about the tax consequences of lower oil prices, but the discussion has picked up over the past couple of months as prices have continued to fall.

Consultants for the Parnell administration and the Legislature touched sparingly on these prospects in 2013 before approving SB 21. This year, legislators did all they could to avoid the taxing topic.

One notable exception took place on April 9, when the Senate Resources Committee spent an hour on a bill by Stedman that it had no intention of approving or analyzing.

Stedman warned that the 4 percent gross floor in the SB 21 tax system was too low and the "state's exposure increases as oil prices drop."

In calling for reversing what he dubbed a "going-out-of-business sale," Stedman said falling prices would create long-term instability because of flaws in the SB 21 system that called for greater credits at falling prices.

He predicts that during the tough budget times ahead, lawmakers will be pressured to demonstrate why the state should give $1.3 billion in credits to the industry just because prices are low.

"That's going to be a tough one to explain," he said.

He proposed raising the minimum tax above 4 percent to a higher level that would be determined by further review. But there was no further review.

Triple-digit debate

At that time, oil prices remained comfortably above $100, in a price range similar to the one a year earlier during the deliberation of SB 21, when the focus was primarily on what would happen with the price of oil in the triple digits. Had oil been at $80 or below during those months, the consequences of low oil prices would likely have been at the forefront of the discussion.

But legislators, the governor's office and their consultants focused mainly on what would happen if oil prices dipped a little, stayed the same or increased. They acted as if $100 to $110 oil had become a reliable range.

The potential impact of a 30 percent drop prompted some speculation that state revenue would be lower under either ACES or SB 21 because they are net profits systems, but that was deemed an extreme "what if" scenario, with SB 21 providing better insurance against a steep decline, proponents said.

'Negative tax rate' situation

One of the key discussions about the tax implications of low oil prices took place on March 25, 2013 before the House Resources Committee.

Parnell administration consultant Barry Pulliam said that a provision to provide an extra incentive to new oil developments could create a "negative tax" at "very low prices," as the state would end up paying out more than it collected over the long term.

This discussion centered on a part of the new oil tax law included as an extra incentive to develop new areas. Before calculating the tax due, the companies would take 20 percent of the gross value out of the equation. At current prices, the gross value reduction means about a $14 per barrel cut in the value before the tax is calculated.

This incentive does not apply to oil production from Prudhoe Bay or Kuparuk, but to areas that are not producing oil yet -- such as Point Thomson -- and some that are, like the Nikaitchuq oil field, which began production in 2011, and the Oooguruk oil field, which began production in 2008.

Pulliam said that for the new-oil category, with a price of about $70 per barrel, the companies would collect more -- thanks mainly to upfront credits -- than they would pay in taxes over the life of the field.

"For a new development, if prices didn't go above $70 a barrel, it could be a negative situation for the state," Pulliam said.

He said that by including the value of royalty oil -- the oil owned by the state, usually a one-eighth share -- the total take would not be negative, "but the tax take would be negative."

Balancing act

Homer Rep. Paul Seaton raised the matter of balance at that hearing, saying ACES was constructed on the idea that years of high oil prices "would give quite a bit of revenue that would balance that off and we could take that liability on the low end."

"Here it looks like we're moving the low end out so we have a liability, but we're not getting the relative counterbalance on the high end, so that the state has anything to put in the bank to be able to absorb those losses," he said.

He asked the consultant how a bill in which state income on new oil turns negative at $70 a barrel makes the state more secure.

"The way that this makes the state more secure is that you would be more apt to get the development of those additional barrels with the rates that have been proposed," Pulliam said.

But then Pulliam said that if prices go below $70, "it's going to be hard to get a lot of development, period."

"That's a pretty challenging price range for development on the North Slope," he said.

"We can look at those prices, but we're just not going to get a lot of activity at those levels."

Seaton asked what those prices would mean for long-term liability for the state, a question to which no one offered an answer.

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