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.