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Governor's oil tax cut plan must be passed for the good of Alaska

Posted: March 30, 2011 - 8:03pm

I am a Juneau resident who spent 23 years in the oil industry. I read last Sunday’s Juneau Empire article regarding oil industry expert Mr. Rick Harper’s address to the Legislature. He made several statements that need to be challenged.

1. Mr. Harper says that tax rates play a small part in project economics. He says the industry makes decisions primarily on resource prospects, development costs and other factors. I say, when a company allocates a portion of its exploration budget to a prospective oil and gas play, it has already calculated the chances of finding hydrocarbons and the likely amounts. It has also projected forward the development cost, the expenses to be incurred in producing and transporting the hydrocarbon to market, the taxes due on that production and calculated a return. Only if the return meets or exceeds the company’s cost of capital will funds be allocated. With rates ranging to 78%, taxes are an enormously important part of that calculation.

Additionally, it is not always necessary to discover new oil fields in order to increase production. More oil can be coaxed out of existing fields with enhanced oil recovery methods (EOR). When considering an EOR investment, a company definitely makes estimates of the increased production and projects forward its after-tax cash flow. Tax rates are crucial in determining the expected return.

I would like to provide an example of the importance taxes play in companies’ investment decisions. Production in the UK sector of the North Sea ramped up steadily from the basin’s early days in 1975 to a peak of about 2.4 million barrels per day (mmbpd) in 1985. It then started to decline, dropping down substantially below 2 mmbpd for the years 1989 to 1993. In 1993, the UK Government reacted to the declining production by reducing the Petroleum Revenue Tax for existing fields from a rate of 85% to 50%. UK North Sea production increased over the next nine years to nearly 3 mmbpd (mostly from existing fields). This increase was achieved, in my opinion, with investment resulting from the tax reduction and certainly not from high oil prices. Prices at the time were generally low, e.g., under $12/bbl in 1998.

In Alaska’s case, it is difficult to determine how much potential our legacy fields possess because the information is largely proprietary. However, according to our Department of Revenue (DOR), Alaska’s North Slope is underdeveloped. We also know there is substantial potential for further discoveries. According to the US Geological Survey, there are 4 billion barrels of recoverable conventional oil yet to be found (without counting NPRA and ANWR). This is a very significant amount that is not going to be found if the stunning decline in exploration wells drilled in our state is not reversed.

Exploration in Alaska is riskier than in many other places because there is no current outlet for our natural gas. Anywhere else, if a company’s exploration efforts result in natural gas finds, they have hit pay dirt. In Alaska, it means they have struck out. We are therefore at a disadvantage and need to compensate for it somehow.

My question is: how can Alaska attract investment in exploration and EOR? Let’s learn from the UK’s 1993 example by making sure our tax structure is competitive.

2. The Empire also quotes Mr. Harper as saying ACES is already competitive. I dispute that statement: (i) by pointing to third party studies that show the opposite (e.g., the Independent Petroleum Association of America’s report on International Petroleum Taxation available at ippa.org); and (ii) with my own calculations comparing Alaska with Louisiana (which, after Alaska, has the highest severance tax of any state in the US), the UK and Norway.

The table accompanying this article shows how much a company would keep from one more barrel of production, assuming oil is at the current $100/bbl. Expenses are assumed to be the same in each location as Alaska’s DOR estimates for North Slope production for 2012, namely: $26.00 in production expenses and $6.39 in transportation expenses. Alaska’s tax rate is capped at 50% as per Governor Parnell’s proposal.

As the table points out, due to taxes, Alaska is a substantially less profitable place than the UK, Louisiana or any other US state, even after Governor Parnell’s proposed reduction. Only Norway is less profitable – but that comparison is not entirely valid for the following two reasons: (i) Norway has a 67% ownership interest in a company named Statoil, which has a large presence in the Norwegian sector of the North Sea; and (ii) the Norwegian government will invest directly in projects to make up for the lack of private company investment. Therefore, it does not matter to Norway whether their revenue comes from taxes or from direct equity stakes in projects or from their investment in Statoil. Alaska, needless to say, has no state oil company and does not invest directly alongside private sector companies.

I hope I have made a case for the importance that oil production taxes play in determining investment. Naturally, I conclude that there is little choice but to adopt Governor Parnell’s plan.

• Meyer is a Juneau resident.

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