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When most people think of a stable and durable tax environment, they think the producers are asking for a lock on gas taxes for a substantial number of years. Some have suggested 35 years as a reasonable timeframe. But there are alternatives that haven’t been considered that can provide the producers with just as much stability without a contractual lock on the gas tax they are requesting.
In order to understand the effectiveness of an alternative to the producers’ proposed contractual lock, the producers’ issues of concern needs to be identified and understood. Why do the producers believe the Alaska tax structure is not stable or durable?
The producers are concerned that, even if the tax is fair, the legislature may ultimately decide to increase the tax to balance the State budget during hard economic times, especially after the producers have committed billions of dollars to an Alaska Gas Pipeline. This is part of the reason why the producers say that there is no fiscal stability in the State tax structure, and they are correct. The producers have seen this “pressure to increase taxes” occur every time there is pressure on the State to find additional tax revenue to balance its budget. If this concern were addressed effectively, then the concern about legislative freedom to change the tax would not be as important.
There are two aspects of producer concern: first the legislature’s willingness to change the law whenever it serves the interests of a majority of the legislature to do so, and second the legislature’s need to find additional tax revenue to balance the state budget when times are tough.
Regarding the first issue, the legislature is generally reticent to take on controversial issues unless it is absolutely necessary. Gas taxes is one of those issues. Unless the oil and gas industry is receiving a strongly disproportionate share of the revenue, e.g., oil taxes under the economic limit factor (ELF), the legislature will not take up the tax issue during the legislative session. If the legislature does an effective job when it revises the current gas tax and creates a fair tax, then it will not be necessary to take up the issue for purposes of a fair allocation of revenue between the State and the producers. The first part of the tax stability issue will have been resolved. So long as there is a fair allocation of revenue between the State and the producers the political incentive to change the tax is gone.
The next problem the producers have with our current system is that the State’s budget is based on projected annual revenue in the general fund. Oil taxes are placed directly into the general fund for legislative appropriation. If the state is having difficulty balancing its budget, the industry believes that increased oil and gas taxes will be the first place the legislature looks to balance the budget. Personal income taxes and any other taxes that burden the Alaska public come only after taxing the oil and gas industry. Historically fiscal restraint and increased taxes on the oil and gas industry have allowed the state to balance its budget without burdening the rest of Alaska with additional taxes. Serving as the backstop for the legislature to balance its budget is not a business friendly environment in which to operate for the oil and gas industry.
So long as the state’s budget is based on oil and gas revenue in the general fund the state will not have a predictable and durable tax structure. So long as the State can increase oil and gas taxes to balance its budget, the state will not be a stable fiscal environment in which to do business. What the State needs to do is to alter the way funds are received and spent. A method needs to be devised whereby an increase in oil and gas taxes does not “fix” the state’s current budget problem. If new taxes could not be used to balance the state’s budget; then there would be less incentive to raise taxes on the oil and gas industry.
If the legislature were to be able to change its tax structure to create a fair tax and change the budget process to address the stability concern prior to the Alaska Gas Pipeline open season, then the legislature will have effectively addressed the producers’ desires for a stable and durable fiscal regime.
Wednesday, December 30, 2009
Fiscal Certainty and a Fair Gas Tax
When the producers say fiscal certainty, it means different things to different people. To some it means lowering taxes. To others it means locking in certain taxes for a long period of time. But the real question is what does it mean to the producers. The producers have stated on several occasions that they require something more than is currently on the books to provide them with the certainty necessary to participate in the open season of the Alaska Gas Pipeline project. They have asked for durable and predictable financial terms. They have asked for a predictable fiscal regime. They are concerned about managing the risks of a sovereign that can change tax laws any time the majority of legislators believes it is necessary and appropriate to do so. Durable and predictable financial terms? Fiscal regime? What do the producers really want? What do they really need?
The common belief is that the producers are asking for tax concessions when they use indistinct terms like fiscal regime and financial terms. They may certainly want tax concessions, but that is not what they really need to move the project forward. There are two issues that need to be addressed in order to encourage the producers to participate in a binding open season: fair gas taxes and a stable fiscal environment.
First, fair gas taxes. The goal of any tax should be create a tax structure that shares value fairly between the sovereign and the taxpayer. When profits are high, the state should receive a greater share of the wealth. When profits are low, the tax payer should be allowed to pay less. The goal of a fair gas tax should be to create a tax that is fair at all gas price ranges and for a broad range of pipeline costs.
If the tax is not seen as fair by either the taxpayer or the sovereign, it is not stable. There is a higher likelihood of the tax changing than if the tax was seen as fair or at least acceptable by both sides. If the taxpayer sees the tax as unfair, then the taxpayer, if it has the option to do so, will spend its development dollars in other jurisdictions, and the sovereign will lose the value of the taxpayer’s participation in the State. There will be fewer jobs and less tax revenue.
If the tax is seen as unfair by the sovereign, the people or the governing body, then there will be pressure on the legislature to change the tax. The greater the disparity in fairness, the greater the pressure to change the tax. The oil tax under the economic limit factor (ELF) is a good example of this occurring. The problem encountered in the ELF was that a portion of the production was not tied to the price of oil, and it led to an inequitable result. Ultimately the oil tax was revised under the new Production Profit Tax (PPT) and the problem discrepancy was resolved.
The oil tax that was passed included a progressivity element that allowed the state to have a lower share of the profits at low oil prices and higher share of the profits at high oil prices. The tax was primarily focused on the reserves at Prudhoe Bay. It was hoped that the tax would not negatively impact heavy oil development or exploration in the state. If it was determined that the tax was affecting the future development of oil in the state then the tax could be changed based on that new information.
Some say that the state went too far when it passed the PPT, especially as it relates to exploration and heavy oil. If that is the case, the legislature can reexamine that portion of the tax and determine if adjustments to the tax need to be made. Part of the reason not to lock in a tax for a fixed number of years is so that the legislature can modify the tax as the need arises. But some would argue that having the ability to change the tax is the very risk the producers are concerned about. If the tax is fair to both the taxpayer and to the sovereign, then there will not be the political will to change the tax, and it will be stable. If the tax is not fair, either to the taxpayer or to the sovereign, then there will be pressure to change the tax, and the tax will need to change to take care of the disparity. That is a risk that should be acceptable to the taxpayer and to the sovereign. The state needs to continue to have the right to adopt a taxing structure that responds to the ever changing economic environment of oil and gas development in the state.
There is a similar problem with the current gas tax as there was in the ELF oil tax. The problem with the gas tax is that the tax is based on a fixed value ratio between oil and gas. When gas prices are low and oil prices are high, as they are now, the industry gets an extra tax break that wasn’t intended in the original legislation. Such a fairness disparity will make the tax unstable in the future if not fixed, and ultimately there will be pressure to change the tax to fix the disparity. This issue should be resolved before the open season because there is at least some chance that gas shippers will bid at the open season and have the right to the current gas tax fixed by statute for at least 10 years after first production. The first ten years of production may be the most productive years of the field. It may also be the years where the greatest impact is seen from the flaw in the current gas tax that allows for an unintentional credit from gas production to those who are also producing and selling oil.
The state needs to take the same approach to developing a fair gas tax as it did with the oil tax. It needs to begin with a review of the economics of gas development in Alaska, taking into account the existing reserves already found at Prudhoe Bay and Point Thomson and the risk and cost of exploring for gas in the most remote regions of our state. It needs to make sure there is a fair allocation of revenue between the producers and the state for all costs and gas price structures.
This review needs to happen now. If the legislature were able to pass a new gas tax prior to the first binding open season, then the producers could calculate the cost of development of their reserves and be prepared to participate effectively in the open season process. To delay this debate will only lead to more debate later if there is a failed open season. Some will say the industry was merely using the failed open season as an excuse for not participating in a project they wanted to fail anyway. Others will blame the administration for being so adversarial to the industry that they would rather see the project fail than the see the industry economically benefit from the project moving forward. They see the Administration as more interested in hurting the industry than in helping the State.
The industry will blame the state for not addressing the fiscal certainty issues. The state and public will blame the industry for wanting to kill the project. Finger pointing and assigning blame for a failed open season will not be helpful in moving a gas pipeline project forward. The state needs to take the issue off the table by addressing it during this next legislative session.
The common belief is that the producers are asking for tax concessions when they use indistinct terms like fiscal regime and financial terms. They may certainly want tax concessions, but that is not what they really need to move the project forward. There are two issues that need to be addressed in order to encourage the producers to participate in a binding open season: fair gas taxes and a stable fiscal environment.
First, fair gas taxes. The goal of any tax should be create a tax structure that shares value fairly between the sovereign and the taxpayer. When profits are high, the state should receive a greater share of the wealth. When profits are low, the tax payer should be allowed to pay less. The goal of a fair gas tax should be to create a tax that is fair at all gas price ranges and for a broad range of pipeline costs.
If the tax is not seen as fair by either the taxpayer or the sovereign, it is not stable. There is a higher likelihood of the tax changing than if the tax was seen as fair or at least acceptable by both sides. If the taxpayer sees the tax as unfair, then the taxpayer, if it has the option to do so, will spend its development dollars in other jurisdictions, and the sovereign will lose the value of the taxpayer’s participation in the State. There will be fewer jobs and less tax revenue.
If the tax is seen as unfair by the sovereign, the people or the governing body, then there will be pressure on the legislature to change the tax. The greater the disparity in fairness, the greater the pressure to change the tax. The oil tax under the economic limit factor (ELF) is a good example of this occurring. The problem encountered in the ELF was that a portion of the production was not tied to the price of oil, and it led to an inequitable result. Ultimately the oil tax was revised under the new Production Profit Tax (PPT) and the problem discrepancy was resolved.
The oil tax that was passed included a progressivity element that allowed the state to have a lower share of the profits at low oil prices and higher share of the profits at high oil prices. The tax was primarily focused on the reserves at Prudhoe Bay. It was hoped that the tax would not negatively impact heavy oil development or exploration in the state. If it was determined that the tax was affecting the future development of oil in the state then the tax could be changed based on that new information.
Some say that the state went too far when it passed the PPT, especially as it relates to exploration and heavy oil. If that is the case, the legislature can reexamine that portion of the tax and determine if adjustments to the tax need to be made. Part of the reason not to lock in a tax for a fixed number of years is so that the legislature can modify the tax as the need arises. But some would argue that having the ability to change the tax is the very risk the producers are concerned about. If the tax is fair to both the taxpayer and to the sovereign, then there will not be the political will to change the tax, and it will be stable. If the tax is not fair, either to the taxpayer or to the sovereign, then there will be pressure to change the tax, and the tax will need to change to take care of the disparity. That is a risk that should be acceptable to the taxpayer and to the sovereign. The state needs to continue to have the right to adopt a taxing structure that responds to the ever changing economic environment of oil and gas development in the state.
There is a similar problem with the current gas tax as there was in the ELF oil tax. The problem with the gas tax is that the tax is based on a fixed value ratio between oil and gas. When gas prices are low and oil prices are high, as they are now, the industry gets an extra tax break that wasn’t intended in the original legislation. Such a fairness disparity will make the tax unstable in the future if not fixed, and ultimately there will be pressure to change the tax to fix the disparity. This issue should be resolved before the open season because there is at least some chance that gas shippers will bid at the open season and have the right to the current gas tax fixed by statute for at least 10 years after first production. The first ten years of production may be the most productive years of the field. It may also be the years where the greatest impact is seen from the flaw in the current gas tax that allows for an unintentional credit from gas production to those who are also producing and selling oil.
The state needs to take the same approach to developing a fair gas tax as it did with the oil tax. It needs to begin with a review of the economics of gas development in Alaska, taking into account the existing reserves already found at Prudhoe Bay and Point Thomson and the risk and cost of exploring for gas in the most remote regions of our state. It needs to make sure there is a fair allocation of revenue between the producers and the state for all costs and gas price structures.
This review needs to happen now. If the legislature were able to pass a new gas tax prior to the first binding open season, then the producers could calculate the cost of development of their reserves and be prepared to participate effectively in the open season process. To delay this debate will only lead to more debate later if there is a failed open season. Some will say the industry was merely using the failed open season as an excuse for not participating in a project they wanted to fail anyway. Others will blame the administration for being so adversarial to the industry that they would rather see the project fail than the see the industry economically benefit from the project moving forward. They see the Administration as more interested in hurting the industry than in helping the State.
The industry will blame the state for not addressing the fiscal certainty issues. The state and public will blame the industry for wanting to kill the project. Finger pointing and assigning blame for a failed open season will not be helpful in moving a gas pipeline project forward. The state needs to take the issue off the table by addressing it during this next legislative session.
The Sovereign's Responsibility
Much has been said about the State of Alaska's responsibility to get a pipeline project moving. Alaska's governors (present and past), legislators, candidates, and advocates for various alternatives have all weighed in on the issue. Most of the comments and positions have centered on when and how to negotiate with the producers and how that will affect the upcoming elections in 2010. The most popular position seems to be waiting to negotiate with the pruducers until after the open season when the State will know more about the cost of the pipeline and the conditions under which the producers will ship gas. This might seem like a logical position at first blush, but not all seemingly logical positions are right. The State does have a responsibility toward the pipeline and toward the producers, but negotiations is not a part of that responsibility.
The State has a right to negotiate contracts when granted that right by law. The Stranded Gas Development Act (SGDA) granted the State the right to negotiate a contract with anyone interested in building a gas pipeline. Included in the SGDA was the right to negotiate taxes and other incentives in order to encourage the building of the Alaska Gas Pipeline. This course of action resulted in a contract with the producers that was ultimately rejected by the people of Alaska.
Another form of contract negotiations is through the competitive bid process. The Alaska Gasline Inducement Act (AGIA) utilized this process when it granted TransCanada a license under the conditions stated in the statute. Once the license was awarded, it became a binding contract on the State. The State agreed to provide TransCanada with a State matching contribution of up to $500 million in support of their project and a commitment not to extend preferential tax treatment or state money to competing projects. In exchange TransCanada agreed to the conditions under which the license was granted, including certain timelines and commitments regarding expansion of the pipeline. TransCanada is currently pursuing building a pipeline under that license. The license does not provide for the State to negotiate with the producers in order to make the TransCanada project successful.
There are no other methods of negotiations provided for in statute except those found in the SGDA and AGIA. If the producers require certainty or changes to the tax structure beyond that which is currently granted in the law in order to make the Alaska Gas Pipeline project economic, then they have the right just like every other resident of the State of Alaska to take their petitions to the legislature. If they can convince a majority of the legislators in an open public process of their recommendations, the legislature will change the laws and address those concerns. If they cannot, the producers will move forward or not move forward with the project based on the laws as they now stand. When determining if a law needs to be changed, the sovereign does not negotiate with anyone, no matter how strong, rich or powerful they may be. If someone wants to convince the governor of their requests, the governor may submit proposed legislation to the legislature for their consideration, but it is the legislature's responsibility to determine if the requests are justified.
The State has a right to negotiate contracts when granted that right by law. The Stranded Gas Development Act (SGDA) granted the State the right to negotiate a contract with anyone interested in building a gas pipeline. Included in the SGDA was the right to negotiate taxes and other incentives in order to encourage the building of the Alaska Gas Pipeline. This course of action resulted in a contract with the producers that was ultimately rejected by the people of Alaska.
Another form of contract negotiations is through the competitive bid process. The Alaska Gasline Inducement Act (AGIA) utilized this process when it granted TransCanada a license under the conditions stated in the statute. Once the license was awarded, it became a binding contract on the State. The State agreed to provide TransCanada with a State matching contribution of up to $500 million in support of their project and a commitment not to extend preferential tax treatment or state money to competing projects. In exchange TransCanada agreed to the conditions under which the license was granted, including certain timelines and commitments regarding expansion of the pipeline. TransCanada is currently pursuing building a pipeline under that license. The license does not provide for the State to negotiate with the producers in order to make the TransCanada project successful.
There are no other methods of negotiations provided for in statute except those found in the SGDA and AGIA. If the producers require certainty or changes to the tax structure beyond that which is currently granted in the law in order to make the Alaska Gas Pipeline project economic, then they have the right just like every other resident of the State of Alaska to take their petitions to the legislature. If they can convince a majority of the legislators in an open public process of their recommendations, the legislature will change the laws and address those concerns. If they cannot, the producers will move forward or not move forward with the project based on the laws as they now stand. When determining if a law needs to be changed, the sovereign does not negotiate with anyone, no matter how strong, rich or powerful they may be. If someone wants to convince the governor of their requests, the governor may submit proposed legislation to the legislature for their consideration, but it is the legislature's responsibility to determine if the requests are justified.
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