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In a recent editorial, Senator Kevin Meyer touted the importance of the recently constructed and to be constructed energy projects around Alaska. He stated that there are 66 projects in the pre-construction phase and 58 projects under construction or completed. That’s 124 projects supported by legislators from around the state, 124 projects where legislators brought home the bacon, 124 projects that helped legislators get reelected. Regarding those projects, Senator Meyer suggests that it is “important to monitor the state’s investment. The legislature must remain vigilant, as granting money without strong oversight, review or audit can sometimes be more harmful than investing none at all.”
The problem is that the legislature failed to use the same vigilance, review and analysis when approving the projects. Projects were placed on the Legislature’s renewal energy project wish list with little or no analysis of the future viability of those projects. Most were merely ideas without any analysis of the long term viability of the project after it gets built. Most were not even required to submit a business plan that could show the long-term economic viability of the project.
The result will be that most of the approved projects will fail from an economic standpoint no matter how much vigilance the legislature puts forth. You can’t make a poor project successful merely by auditing it to death. You will, at least, be able to record your own failure in approving the project in the first place. The old adage “fail to plan and plan to fail” will once again raise its ugly head.
As with any appropriation, there is some value in the approved projects. Some projects actually put forth viable business plans and would have been approved on their own merit if the legislature had done the analysis they should have done before approving the projects. The projects will probably succeed because they can prove, at least on paper, that they will be successful and economically viable in the long-term if built. For those projects, I congratulate them for their diligence, their preparation, their analysis, and their willingness to do what it takes to ensure the successful viability of their project. For the rest of the projects that were approved without the proper preparation, without the proper analysis, without a business plan, good luck. Perhaps another old saying “by the luck of the draw” will be your story. Perhaps you will be successful inspite of your own poor efforts.
And to the legislators that approved the 124 projects without the proper analysis, if you approve any more renewable energy projects, at least make sure they have submitted a viable business plan. Even an optimistic business plan, which it inevitably will be, is better than none at all.
My prediction is that 10 percent of the approved projects will clearly succeed, 50 percent will fail, and 40 percent will be hoping for “the luck of the draw.”
Sunday, October 9, 2011
Thursday, September 22, 2011
Loan Guarantees and Pipeline Economics
In a recent letter to Governor Parnell, Alaska Senator Mark Begich stated that it would be difficult for Alaska’s congressional delegation to get an increase in the federal loan guarantees anytime soon; so, Senator Begich proposed that the state should consider loan guarantees for the remainder of the debt that the federal government would not cover – in the realm of $9 billion in loan guarantees. The problem with his proposal is that it requires a substantial amount of legislative energy, time, and effort and does nothing substantial to change the economics of the gas pipeline.
Loan guarantees tend to reduce the cost of debt and consequently reduce the tariff. This is good, but it reduces the cost of debt only by a small margin making only a minor change to the tariff.
The loan guarantees are important to the pipeline builders, but they do little to create incentives for the shippers. The risk to the shippers is substantially unchanged. The State of Alaska needs to look for solutions that reduce the risk to the shippers and solutions that make a substantial reduction to the tariff and thus increase the economics of the pipeline.
I have two recommendations regarding how to change the economics of a large diameter pipeline: one for the Alaska portion of the pipeline and one for the Canada portion of the pipeline.
Alaska Portion of the Pipeline
Regarding the Alaska portion of the pipeline, I recommend the State of Alaska fund the equity portion of the pipeline, take a debt rate of return, and not start receiving payment on its investment until the original debt is paid off. This funding mechanism could take the form of a financial interest or an ownership interest. That could be determined by discussing the proposal with companies that might want to participate in the ownership of the pipeline.
The benefit of this proposal is that it would change the economics of the pipeline and reduce the tariff more than any other single proposal that has been put forth so far. Combined with other risk reduction actions, it may be sufficient to move the gas pipeline forward.
The cost of this proposal would probably be up to $10 billion for a success scenario but less than $2 billion to see if it would be likely to succeed. The risk capital would be invested to develop a proposal and hold an open season. If the open season was successful, then the project could move forward to a FERC certificate. It is possible that up $3 billion would have to be expended to get to a project sanction decision, but this capital would only be expended after a successful open season and signed precedent agreements from the shippers.
One hundred percent of equity contribution should be invested in the Alaska portion of the pipeline only. That way Alaska gets the full benefit of the investment, and the tariff on the Alaska portion of the pipeline sees the greatest impact, thus providing cheaper gas for Alaskans.
If Alaska decides to make such a commitment to the pipeline, Alaska should approach the federal government to see what they can do to support Alaska’s commitment. The two things Alaska should ask for are 1) Alaska’s fair share of the revenue from federal offshore development, and 2) Alaska should ask for the chance to explore in ANWR.
Regarding AGIA and TransCanada, Alaska should get TransCanada to either agree that the current AGIA plan is uneconomic or get TransCanada to waive their rights to damages under AGIA in exchange for the opportunity to participate in the Canadian portion of the pipeline. I am fairly certain that TransCanada would not want to own a piece of the Alaskan portion of the pipeline under to above plan. I am also not worried about TransCanada threatening to sue under AGIA. It is clear that the present plan is uneconomic; so, there will be no liability under AGIA if TransCanada does not agree to waive their rights.
In addition, contrary to AGIA’s capital contribution, Alaska would get a return on its capital investment and future generations would receive the benefit. Consider the investment a savings account for the future when Alaska may need the return.
Canada Portion of the Pipeline
TransCanada has proposed a 70/30 debt equity ratio (with some modifications). They propose to invest 30% of the cost of the pipeline in equity. The equity rate of return on the pipeline will probably be greater than 12%. The cost of the debt, on the other hand is closer to 5% depending on who the borrower is and their credit rating. Clearly it is better to have more of the pipeline funded by debt and less by equity because the return on the equity is more than twice as expensive to the pipeline as the debt.
Alaska should try to get TransCanada to agree to an 80/20 debt equity ratio. This will lower the tariff by a certain amount and save the State of Alaska and the shippers over the life of the pipeline billions of dollars. In the alternative Alaska should argue to the Canadian government for an 80/20 debt equity ratio. Alaska should also argue for a return on equity of 12% or less on the Canadian portion of the pipeline. Once again this would lower the tariff and make the pipeline more economic. These two terms are not unreasonable. Both were given serious consideration during the initial pipeline negotiations with the producer group.
As a reminder, gas pipeline economics is a major element of achieving a successful gas pipeline, but there are many more elements that must be addressed to move the project forward.
The issues that need to be addressed are:
1) Fair oil and gas taxes
2) Long term fiscal plan
3) Short term annual capital and operating budgets
4) The permanent fund, its present and future use
5) Gas pipeline economics (discussed in this article)
6) Exploration and filling TAPS and the Gas Pipeline
7) Fiscal certainty/stable oil and gas tax environment
8) Point Thomson (hopefully this will be resolved soon by the State of Alaska and the Point Thomson owners)
Loan guarantees tend to reduce the cost of debt and consequently reduce the tariff. This is good, but it reduces the cost of debt only by a small margin making only a minor change to the tariff.
The loan guarantees are important to the pipeline builders, but they do little to create incentives for the shippers. The risk to the shippers is substantially unchanged. The State of Alaska needs to look for solutions that reduce the risk to the shippers and solutions that make a substantial reduction to the tariff and thus increase the economics of the pipeline.
I have two recommendations regarding how to change the economics of a large diameter pipeline: one for the Alaska portion of the pipeline and one for the Canada portion of the pipeline.
Alaska Portion of the Pipeline
Regarding the Alaska portion of the pipeline, I recommend the State of Alaska fund the equity portion of the pipeline, take a debt rate of return, and not start receiving payment on its investment until the original debt is paid off. This funding mechanism could take the form of a financial interest or an ownership interest. That could be determined by discussing the proposal with companies that might want to participate in the ownership of the pipeline.
The benefit of this proposal is that it would change the economics of the pipeline and reduce the tariff more than any other single proposal that has been put forth so far. Combined with other risk reduction actions, it may be sufficient to move the gas pipeline forward.
The cost of this proposal would probably be up to $10 billion for a success scenario but less than $2 billion to see if it would be likely to succeed. The risk capital would be invested to develop a proposal and hold an open season. If the open season was successful, then the project could move forward to a FERC certificate. It is possible that up $3 billion would have to be expended to get to a project sanction decision, but this capital would only be expended after a successful open season and signed precedent agreements from the shippers.
One hundred percent of equity contribution should be invested in the Alaska portion of the pipeline only. That way Alaska gets the full benefit of the investment, and the tariff on the Alaska portion of the pipeline sees the greatest impact, thus providing cheaper gas for Alaskans.
If Alaska decides to make such a commitment to the pipeline, Alaska should approach the federal government to see what they can do to support Alaska’s commitment. The two things Alaska should ask for are 1) Alaska’s fair share of the revenue from federal offshore development, and 2) Alaska should ask for the chance to explore in ANWR.
Regarding AGIA and TransCanada, Alaska should get TransCanada to either agree that the current AGIA plan is uneconomic or get TransCanada to waive their rights to damages under AGIA in exchange for the opportunity to participate in the Canadian portion of the pipeline. I am fairly certain that TransCanada would not want to own a piece of the Alaskan portion of the pipeline under to above plan. I am also not worried about TransCanada threatening to sue under AGIA. It is clear that the present plan is uneconomic; so, there will be no liability under AGIA if TransCanada does not agree to waive their rights.
In addition, contrary to AGIA’s capital contribution, Alaska would get a return on its capital investment and future generations would receive the benefit. Consider the investment a savings account for the future when Alaska may need the return.
Canada Portion of the Pipeline
TransCanada has proposed a 70/30 debt equity ratio (with some modifications). They propose to invest 30% of the cost of the pipeline in equity. The equity rate of return on the pipeline will probably be greater than 12%. The cost of the debt, on the other hand is closer to 5% depending on who the borrower is and their credit rating. Clearly it is better to have more of the pipeline funded by debt and less by equity because the return on the equity is more than twice as expensive to the pipeline as the debt.
Alaska should try to get TransCanada to agree to an 80/20 debt equity ratio. This will lower the tariff by a certain amount and save the State of Alaska and the shippers over the life of the pipeline billions of dollars. In the alternative Alaska should argue to the Canadian government for an 80/20 debt equity ratio. Alaska should also argue for a return on equity of 12% or less on the Canadian portion of the pipeline. Once again this would lower the tariff and make the pipeline more economic. These two terms are not unreasonable. Both were given serious consideration during the initial pipeline negotiations with the producer group.
As a reminder, gas pipeline economics is a major element of achieving a successful gas pipeline, but there are many more elements that must be addressed to move the project forward.
The issues that need to be addressed are:
1) Fair oil and gas taxes
2) Long term fiscal plan
3) Short term annual capital and operating budgets
4) The permanent fund, its present and future use
5) Gas pipeline economics (discussed in this article)
6) Exploration and filling TAPS and the Gas Pipeline
7) Fiscal certainty/stable oil and gas tax environment
8) Point Thomson (hopefully this will be resolved soon by the State of Alaska and the Point Thomson owners)
In summary if Alaskans really want an Alaskan Gas Pipeline, they need commit their resources to its success. They need to be disciplined fiscally. They need to lead instead of follow. They need to take charge of their future. The result is they will be better off by pursuing such a direction. If the pipeline is a success because of their efforts, they will reap the benefits. If the pipeline is not a success then they will be prepared for the new world they will find.
Tuesday, September 20, 2011
A Comprehensive Plan - What is Necessary
In May of this year Bud Fackrell, Denali Pipeline Project President announced that “Denali is ending its efforts (to continue the pipeline project) because of a lack of customer support.” This was not a surprising outcome. The pipeline project, without a more comprehensive strategy, will not proceed ahead. The price of gas in the lower-48, current oil and gas taxes and the uncertainty of those taxes in the future, and the lack of a long term plan to finance state government, all contribute to decisions by the shippers of the gas not to commit their gas to a pipeline.
Some will say that TransCanada’s Alaska Pipeline Project is still moving forward, but the only reason it is still moving forward is because the State of Alaska is financing 90% of the costs from the open season until the filing for the FERC certificate. TransCanada’s project will flounder as well once the FERC does not award a certificate due to the lack of shippers for the gas. Gas pipelines aren’t awarded certificates and pipelines don’t get built if they do not have gas to ship.
What is necessary for any gas pipeline to proceed is a comprehensive plan that changes the playing field, a plan that assures a reasonable tax, a plan that provides a modicum of certainty that the tax will not change every time the state needs additional revenue to balance its budget, a plan that shows the industry the state can manage its short-term capital and operating budgets in a way that shows restraint/discipline/understanding of their impact on the long term, a plan that includes a long-term fiscal plan that is not dependent on the oil and gas industry to balance its budget. What the state needs is a plan that changes the economics of the gas pipeline. It is time for a more comprehensive approach to Alaska’s future.
Some have advocated the state should build a large diameter gas pipeline through Canada. Some believe LNG will save Alaska through a large diameter line to Valdez. Some believe a large gas pipeline project will never get built and that Alaska should focus on a smaller diameter in-state gas pipeline. Some tout “Alaska’s gas for Alaskans” like it is some creed or motto that will automatically make whatever project they are supporting economic. The problem with all of these ideas is that without a more comprehensive picture, none of them will be economic, and none of them will ever get built.
There are at least eight issues that must be addressed in a comprehensive manner in order to move Alaska forward in bringing Alaska’s gas to market. Every proposal to bring Alaska’s gas to market should be required address all eight issues.
1) Fair oil and gas taxes
2) Long term fiscal plan
3) Short term annual capital and operating budgets
4) The permanent fund, its present and future use
5) Gas pipeline economics
6) Exploration and filling TAPS and the Gas Pipeline
7) Fiscal certainty/stable oil and gas tax environment
8) Point Thomson (hopefully this will be resolved soon by the State of Alaska and the Point Thomson owners)
Over the next several weeks I will propose alternatives that will address all eight issues. I have written previously about most of them, but I have a few additional ideas I would like to place on the table in advance of the October 18th Alaska Gas Pipeline Forum.
Some will say that TransCanada’s Alaska Pipeline Project is still moving forward, but the only reason it is still moving forward is because the State of Alaska is financing 90% of the costs from the open season until the filing for the FERC certificate. TransCanada’s project will flounder as well once the FERC does not award a certificate due to the lack of shippers for the gas. Gas pipelines aren’t awarded certificates and pipelines don’t get built if they do not have gas to ship.
What is necessary for any gas pipeline to proceed is a comprehensive plan that changes the playing field, a plan that assures a reasonable tax, a plan that provides a modicum of certainty that the tax will not change every time the state needs additional revenue to balance its budget, a plan that shows the industry the state can manage its short-term capital and operating budgets in a way that shows restraint/discipline/understanding of their impact on the long term, a plan that includes a long-term fiscal plan that is not dependent on the oil and gas industry to balance its budget. What the state needs is a plan that changes the economics of the gas pipeline. It is time for a more comprehensive approach to Alaska’s future.
Some have advocated the state should build a large diameter gas pipeline through Canada. Some believe LNG will save Alaska through a large diameter line to Valdez. Some believe a large gas pipeline project will never get built and that Alaska should focus on a smaller diameter in-state gas pipeline. Some tout “Alaska’s gas for Alaskans” like it is some creed or motto that will automatically make whatever project they are supporting economic. The problem with all of these ideas is that without a more comprehensive picture, none of them will be economic, and none of them will ever get built.
There are at least eight issues that must be addressed in a comprehensive manner in order to move Alaska forward in bringing Alaska’s gas to market. Every proposal to bring Alaska’s gas to market should be required address all eight issues.
1) Fair oil and gas taxes
2) Long term fiscal plan
3) Short term annual capital and operating budgets
4) The permanent fund, its present and future use
5) Gas pipeline economics
6) Exploration and filling TAPS and the Gas Pipeline
7) Fiscal certainty/stable oil and gas tax environment
8) Point Thomson (hopefully this will be resolved soon by the State of Alaska and the Point Thomson owners)
Over the next several weeks I will propose alternatives that will address all eight issues. I have written previously about most of them, but I have a few additional ideas I would like to place on the table in advance of the October 18th Alaska Gas Pipeline Forum.
Friday, March 25, 2011
Alaskan Advocate - Where to From Here?
Over the last year I have maintained a this blog as a commitment to Alaskans to provide them with a view that may be different than what they are hearing from the industry or government. My goal was to comment primarily on Alaska energy issues. The focus of the blog has been on oil and gas taxes, short and long-term fiscal responsibility, and gas pipeline issues. Because of personal obligations I may not be able to contine to comment on Alaskan issues, but I will attempt at least one additional article that will propose a more comprehensive plan on how to move the State of Alaska forward. It will include a discussion of a short and long-term fiscal plan, fiscal certainty, oil and gas taxes, a large diameter gas pipeline, in-state gas needs and Point Thomson. Some of the proposal will not be as specific as I would like because detailed information is lacking; other proposals will be quite specific. Regardless, I will recommend sufficient direction in each area to enable the state to move forward.
I am also not arrogant enough to assume my recommendations will be followed just because I made them. But I hope the article will at least move the debate forward in each of the areas I discuss.
Below is a list of the articles I have written over the last year. My next article will incorporate much of what I have already written below.
12/30/2009 - The Sovereign’s Responsibility
12/30/2009 - Fiscal Certainty and a Fair Gas Tax
12/30/2009 - Fiscal Certainty and a Stable Tax Environment
01/02/2010 - Timing of the Legislative Debate
01/02/2010 - Restructure Alaska’s Revenue System
01/05/2010 - Bob Swenson – Instate Gas Czar
01/06/2010 - PFD – To Enshrine or Not To Enshrine
01/13/2010 - Point Thomson – Where to From Here?
01/19/2010 - Do Oil Taxes Need Revision
01/27/2010 - Two Important Pipeline Variables
02/20/2010 - DNR Point Thomson Study Evaluated by Feds
02/21/2010 - Resource Potential of the Alaska North Slope
02/23/2010 - Geology is King
03/13/2010 - Which Pipeline Project is Best
03/14/2010 - Boring
03/21/2010 - In-State Gas Line
04/05/2010 - The Point Thomson Unit – The Next Step in the Process
04/28/2010 – A System Failure and An Idea
05/03/2010 – The Red Pen Challenge Update
05/27/2010 – Evaluation of Exploration in the Arctic OCS
06/14/2010 – BP Gulf Oil Spill Response Plan Review
07/30/2010 – Alaska Gasline Port Authority Proposal to Purchase Fairbanks Natural Gas LLC
09/06/2010 – Energy Issues in the Alaska Gubernatorial Race
09/08/2010 – Own a Piece of the Pipe – Part 1
09/09/2010 – Own a Piece of the Pipe – Part 2
09/11/2010 - Alaska Gasline Inducement Act (AGIA)
09/15/2010 - Analysis of the Twenty “Must Haves” of AGIA
09/16/2010 - Berkowitz Oil Revenue Proposal
09/21/2010 - Berkowitz Revenue Proposal Analysis
09/23/2010 - Political Posturing
09/26/2010 - State Ownership of the Pipeline
10/07/2010 - Clarification of the MidAmerican Deal
10/15/2010 - Natural Gas Pipeline Options
10/17/2010 - Equal Time for Parnell
10/19/2010 - Security Guards Need Education on Private Rights
10/26/2010 - Repost – Resource Potential of the Alaska North Slope
10/27/2010 - NPRA Oil and Gas Reserves History
11/01/2010 – Consider the Candidate
11/02/2010 – Legislative Agenda Proposal
11/15/2010 – Roadmap to a Fair Tax
01/26/2010 – The Real Cost of the Governor’s Proposed Oil Tax Change
02/10/2010 – An Either/Or World
03/14/2010 – The Specious Argument
03/17/2010 – Just the FACTS
03/24/2010 – Who to believe? Does it matter?
I am also not arrogant enough to assume my recommendations will be followed just because I made them. But I hope the article will at least move the debate forward in each of the areas I discuss.
Below is a list of the articles I have written over the last year. My next article will incorporate much of what I have already written below.
12/30/2009 - The Sovereign’s Responsibility
12/30/2009 - Fiscal Certainty and a Fair Gas Tax
12/30/2009 - Fiscal Certainty and a Stable Tax Environment
01/02/2010 - Timing of the Legislative Debate
01/02/2010 - Restructure Alaska’s Revenue System
01/05/2010 - Bob Swenson – Instate Gas Czar
01/06/2010 - PFD – To Enshrine or Not To Enshrine
01/13/2010 - Point Thomson – Where to From Here?
01/19/2010 - Do Oil Taxes Need Revision
01/27/2010 - Two Important Pipeline Variables
02/20/2010 - DNR Point Thomson Study Evaluated by Feds
02/21/2010 - Resource Potential of the Alaska North Slope
02/23/2010 - Geology is King
03/13/2010 - Which Pipeline Project is Best
03/14/2010 - Boring
03/21/2010 - In-State Gas Line
04/05/2010 - The Point Thomson Unit – The Next Step in the Process
04/28/2010 – A System Failure and An Idea
05/03/2010 – The Red Pen Challenge Update
05/27/2010 – Evaluation of Exploration in the Arctic OCS
06/14/2010 – BP Gulf Oil Spill Response Plan Review
07/30/2010 – Alaska Gasline Port Authority Proposal to Purchase Fairbanks Natural Gas LLC
09/06/2010 – Energy Issues in the Alaska Gubernatorial Race
09/08/2010 – Own a Piece of the Pipe – Part 1
09/09/2010 – Own a Piece of the Pipe – Part 2
09/11/2010 - Alaska Gasline Inducement Act (AGIA)
09/15/2010 - Analysis of the Twenty “Must Haves” of AGIA
09/16/2010 - Berkowitz Oil Revenue Proposal
09/21/2010 - Berkowitz Revenue Proposal Analysis
09/23/2010 - Political Posturing
09/26/2010 - State Ownership of the Pipeline
10/07/2010 - Clarification of the MidAmerican Deal
10/15/2010 - Natural Gas Pipeline Options
10/17/2010 - Equal Time for Parnell
10/19/2010 - Security Guards Need Education on Private Rights
10/26/2010 - Repost – Resource Potential of the Alaska North Slope
10/27/2010 - NPRA Oil and Gas Reserves History
11/01/2010 – Consider the Candidate
11/02/2010 – Legislative Agenda Proposal
11/15/2010 – Roadmap to a Fair Tax
01/26/2010 – The Real Cost of the Governor’s Proposed Oil Tax Change
02/10/2010 – An Either/Or World
03/14/2010 – The Specious Argument
03/17/2010 – Just the FACTS
03/24/2010 – Who to believe? Does it matter?
Thursday, March 24, 2011
Who to believe? Does it matter?
The Alaska State Legislature is currently engaged in a debate regarding changing ACES, the production tax on oil and gas, in hopes of encouraging new investment on the north slope and ultimately additional production to fill the TransAlaska Pipeline System (TAPS).
Many have entered into the debate regarding the tax. Some have argued that a change to the tax will increase jobs that have been lost due to the current production tax, known as Alaska’s Clear and Equitable Share (ACES); others have argued that the current tax system is working because jobs have increased on the north slope.
Some have argued that a change in the tax will multiply the revenue to the state many times over the cost of the change; others have argued that the tax change will cost the state billions of dollars over the next decade.
Some have argued that exploration drilling on the north slope has become almost nonexistent because of ACES. Others have argued that there were more wells drilled in 2010 than 2009. In fact the number of wells drilled in 2010 was the highest number of wells drilled since 2005.
Some have argued that the pipeline will be shut down if we don’t change the tax, but no one is arguing if we stay the present course that oil production will increase and the pipeline will once again be full.
Who to believe? Does it matter?
All who enter the debate seem to believe they need to justify their position based on either a positive or negative impact from the current production tax, ACES. But all are focused on the wrong question. It does not matter what has happened in the past, even what the actual impact of ACES has been. This is especially important since they will never agree on the results of that impact anyway.
What is clear is that production is falling on the north slope, and everyone agrees with this fact. What is also clear is that everyone would like to see production increase. The real question is how to go about encouraging industry decision-making so that more is invested on the north slope in hopes of increasing production to the benefit of both the industry and the state.
Where might the potential reserves be found and how many reserves can we expect or hope for?
Infield drilling and satellite fields - Small increases to production that will help stem the decline of production if produced, up to a few billion barrels here.
Heavy and viscous oil - Over 20 billion barrels of oil in place. If the technology could be conquered and the economics could be enhanced, perhaps several billion barrels of this heavy oil could be produced.
Exploration - Exploration could bring in several hundred thousand barrels of oil, so even though the amounts may be smaller, exploration should be encouraged.
NPRA - The State of Alaska receives half the bonus and royalty revenue from NPRA plus the state receives a production tax on all oil produced in NPRA. The federal government believes there are still hundreds of millions of barrels of oil to be found in NPRA. Even though this is not a large amount, it should be encouraged.
Federal OCS - Even though the state gets no revenue from the majority of offshore development, offshore production would provide jobs to Alaskans, increase the life of the pipeline, and perhaps someday the state could share in the OCS revenue if Congress changes the current law. Even though OCS development should be encouraged, it does not enter into the debate over changing the state's oil and gas tax.
What is the potential value of those reserves?
This is the estimation of the “golden egg” if the reserves can be found and produced. This estimation is the easiest to determine. Plug in the potential reserves from above, plug in a range of prices and the current tax and the potential value (or range of values) of those reserves can be determined. Any change in the tax can be compared against this range of values. Any change in the tax should be justified against the potential for the state to benefit through production of these additional potential reserves.
What are the options for encouraging industry to pursue those reserves?
The debate is not an either/or debate. It is not “reduce the tax on all production or don’t reduce the tax.” The decisions the legislature needs to make are more complex than that. There are several options or combination of options the legislature could pursue.
Credits - Credits gives the state one of the most measurable benefits of any alternative. One of the concerns is ensuring the state receives something in return for any reduction or benefit it provides to the industry. With a credit the state is guaranteed that the industry must invest in Alaska before it can apply for the benefit. Credits are a good option, but they may not supply sufficient benefit to entice the industry to produce all the reserves Alaska would like to see produced.
Focused reduction in tax - A tax that is focused on the reserves the legislature would like for the industry to pursue, i.e., additional reserves that could be produced through infield drilling, heavy and viscous oil additions, and exploration success.
Broad reduction in tax – this option is overinclusive, giving additional reduction in tax to reserves that would have been developed without the reduction, and it will be difficult to determine if the broad reduction was necessary or if a more strategic alternative would have worked just as well. But the legislature may determine it is the best means to obtain the results they are after.
Summary
The debate in the legislature often turns on looking backwards and using, or misusing, that data to justify a particular position the individual is advocating. The legislature should avoid getting into that debate. The key to moving forward is to recognize the current status of production on the north slope (decreasing production), what the state wants to happen (increased production), and where the potential production can come from (NPRA, infield drilling, heavy and viscous oil, and exploration) and most importantly how the state believes it can achieve its desired goal while obtaining the maximum return to the state for the benefit conveyed.
Many have entered into the debate regarding the tax. Some have argued that a change to the tax will increase jobs that have been lost due to the current production tax, known as Alaska’s Clear and Equitable Share (ACES); others have argued that the current tax system is working because jobs have increased on the north slope.
Some have argued that a change in the tax will multiply the revenue to the state many times over the cost of the change; others have argued that the tax change will cost the state billions of dollars over the next decade.
Some have argued that exploration drilling on the north slope has become almost nonexistent because of ACES. Others have argued that there were more wells drilled in 2010 than 2009. In fact the number of wells drilled in 2010 was the highest number of wells drilled since 2005.
Some have argued that the pipeline will be shut down if we don’t change the tax, but no one is arguing if we stay the present course that oil production will increase and the pipeline will once again be full.
Who to believe? Does it matter?
All who enter the debate seem to believe they need to justify their position based on either a positive or negative impact from the current production tax, ACES. But all are focused on the wrong question. It does not matter what has happened in the past, even what the actual impact of ACES has been. This is especially important since they will never agree on the results of that impact anyway.
What is clear is that production is falling on the north slope, and everyone agrees with this fact. What is also clear is that everyone would like to see production increase. The real question is how to go about encouraging industry decision-making so that more is invested on the north slope in hopes of increasing production to the benefit of both the industry and the state.
Where might the potential reserves be found and how many reserves can we expect or hope for?
Infield drilling and satellite fields - Small increases to production that will help stem the decline of production if produced, up to a few billion barrels here.
Heavy and viscous oil - Over 20 billion barrels of oil in place. If the technology could be conquered and the economics could be enhanced, perhaps several billion barrels of this heavy oil could be produced.
Exploration - Exploration could bring in several hundred thousand barrels of oil, so even though the amounts may be smaller, exploration should be encouraged.
NPRA - The State of Alaska receives half the bonus and royalty revenue from NPRA plus the state receives a production tax on all oil produced in NPRA. The federal government believes there are still hundreds of millions of barrels of oil to be found in NPRA. Even though this is not a large amount, it should be encouraged.
Federal OCS - Even though the state gets no revenue from the majority of offshore development, offshore production would provide jobs to Alaskans, increase the life of the pipeline, and perhaps someday the state could share in the OCS revenue if Congress changes the current law. Even though OCS development should be encouraged, it does not enter into the debate over changing the state's oil and gas tax.
What is the potential value of those reserves?
This is the estimation of the “golden egg” if the reserves can be found and produced. This estimation is the easiest to determine. Plug in the potential reserves from above, plug in a range of prices and the current tax and the potential value (or range of values) of those reserves can be determined. Any change in the tax can be compared against this range of values. Any change in the tax should be justified against the potential for the state to benefit through production of these additional potential reserves.
What are the options for encouraging industry to pursue those reserves?
The debate is not an either/or debate. It is not “reduce the tax on all production or don’t reduce the tax.” The decisions the legislature needs to make are more complex than that. There are several options or combination of options the legislature could pursue.
Credits - Credits gives the state one of the most measurable benefits of any alternative. One of the concerns is ensuring the state receives something in return for any reduction or benefit it provides to the industry. With a credit the state is guaranteed that the industry must invest in Alaska before it can apply for the benefit. Credits are a good option, but they may not supply sufficient benefit to entice the industry to produce all the reserves Alaska would like to see produced.
Focused reduction in tax - A tax that is focused on the reserves the legislature would like for the industry to pursue, i.e., additional reserves that could be produced through infield drilling, heavy and viscous oil additions, and exploration success.
Broad reduction in tax – this option is overinclusive, giving additional reduction in tax to reserves that would have been developed without the reduction, and it will be difficult to determine if the broad reduction was necessary or if a more strategic alternative would have worked just as well. But the legislature may determine it is the best means to obtain the results they are after.
Summary
The debate in the legislature often turns on looking backwards and using, or misusing, that data to justify a particular position the individual is advocating. The legislature should avoid getting into that debate. The key to moving forward is to recognize the current status of production on the north slope (decreasing production), what the state wants to happen (increased production), and where the potential production can come from (NPRA, infield drilling, heavy and viscous oil, and exploration) and most importantly how the state believes it can achieve its desired goal while obtaining the maximum return to the state for the benefit conveyed.
Thursday, March 17, 2011
Just the FACTS
Recently, in an editorial in the Anchorage Daily News, Representative Mike Hawker recognized how important the decision regarding changing the oil tax is to the future of Alaska. He expressed the concern that all Alaskans feel, that oil production on the North Slope is declining. He also noted that the difference between what the Department of Natural Resources predicted a few years ago for 2011 production and current expectations is 200,000 barrels per day. He went on to state, “Between the two forecasts, 600 million total barrels have been lost for the years 2010 to 2020”, a stark statement of what is in Alaska’s future. He concluded his editorial by recommending a change to the progressivity tax and stated that “These changes will result in real improvements to Alaska’s economic prospects if we stick to the FACTS - - that is, a Fair and Competitive Tax System. Just the Facts.”
Representative Hawker’s advice is important to remember. We should all strive to understand all the facts regarding the oil tax issue before jumping to any conclusions. For example, let’s take a look at the facts Representative Hawker uses in his editorial. He states,
“Just three years ago, DNR predicted 816,000 barrels per day production in 2011. Now the expectation is only 616,000. That is 200,000 barrels a day less. Between the two forecasts, 600 million total barrels have been lost for the years 2010 to 2020.”
He goes on to say,“The facts are clear. Exploration has all but ceased and production has been lost as a result of ACES.”
According to the facts Representative Hawker has provided in his article the reader should come to the conclusion that a change to ACES is necessary because ACES caused the production decline in the last three years. But nothing could be farther from the truth. Let's take a look at the real facts.
First, DNR is not the state agency that predicts future production. That would be the Department of Revenue, in their annual Revenue Sources Book. The Crude Oil Production – Forecast can be found in Appendix C-2b of each year’s Revenue Sources Book. The following list is the Department of Revenue production forecast for the year 2011 for north slope oil from the years 2004 through 2010.
Fall 2004 forecast 975,000 bbls/day
Fall 2005 forecast 853,000 bbls/day
difference from 2004 – 122,000 bbls/day
Fall 2006 forecast 782,000 bbls/day
difference from 2005 – 71,000 bbls/day
Fall 2007 forecast 676,000 bbls/day
difference from 2006 – 106,000 bbls/day
Fall 2008 forecast 644,000 bbls/day
difference from 2007 – 32,000 bbls/day
Fall 2009 forecast 623,000 bbls/day
difference from 2008 – 21,000 bbls/day
Fall 2010 forecast 616,000 bbls/day
difference from 2009 – 7,000 bbls/day
So what does the above tell us. First that three years ago the revenue forecast predicted 676,000 bbls/day, not the 816,000 bbls that Rep. Hawker stated. The resulting difference would be 60,000 bbls/day instead of the 200,000 bbls/day the representative stated.
The reason the representative had to go back so many years is because in recent years the change in the production forecast has not been significant. To find a substantial difference between predictions the representative would have had to go back to the Fall 2006 forecast. Between the Fall 2006 forecast and the Fall 2007 forecast the state lost 106,000 bbls/day. Perhaps that can be attributed to the change in the tax from PPT to ACES.
The best place to look for the answer would be in the Fall 2007 Revenue Sources Book. There the Department of Revenue states at pp. 46-47:
“To account for unforeseen production interruptions slopewide, as well as anticipated scheduled interruptions attributed to renewal projects, we have increased our estimates of downtime at the Greater Prudhoe Bay Area, the Greater Kuparuk Area, Milne Point Unit and Endicott for the next 6-8 years, depending on the field. The impact of this deferred production is significant in the near term, ranging from 30,000 – 70,000 barrels of oil per day slopewide. This is in addition to the rate impacts attributed to reevaluating the scope and timing of projects under development and under evaluation.”
So even the significant change that occurred in the 2011 production projection from 2006 to 2007 had nothing to do with taxes. It had to do with attempting to incorporate downtime into future production scenarios.
In addition, if you graph the Revenue Sources Book production projections for each year from 2004 to 2010, what you will find is that the state is generally more optimistic in its production projection than what actually occurs. Production projections are based on what the Department of Revenue consultants can project will probably occur in the future based on what they know about the reservoir, decline curves and industry plans to bring a development online. Production predictions have nothing to do with tax changes.
So as you review the facts relating to impacts from a change in the oil tax, make sure you understand the FACTS, all of the FACTS, and nothing but the FACTS.
Representative Hawker’s advice is important to remember. We should all strive to understand all the facts regarding the oil tax issue before jumping to any conclusions. For example, let’s take a look at the facts Representative Hawker uses in his editorial. He states,
“Just three years ago, DNR predicted 816,000 barrels per day production in 2011. Now the expectation is only 616,000. That is 200,000 barrels a day less. Between the two forecasts, 600 million total barrels have been lost for the years 2010 to 2020.”
He goes on to say,“The facts are clear. Exploration has all but ceased and production has been lost as a result of ACES.”
According to the facts Representative Hawker has provided in his article the reader should come to the conclusion that a change to ACES is necessary because ACES caused the production decline in the last three years. But nothing could be farther from the truth. Let's take a look at the real facts.
First, DNR is not the state agency that predicts future production. That would be the Department of Revenue, in their annual Revenue Sources Book. The Crude Oil Production – Forecast can be found in Appendix C-2b of each year’s Revenue Sources Book. The following list is the Department of Revenue production forecast for the year 2011 for north slope oil from the years 2004 through 2010.
Fall 2004 forecast 975,000 bbls/day
Fall 2005 forecast 853,000 bbls/day
difference from 2004 – 122,000 bbls/day
Fall 2006 forecast 782,000 bbls/day
difference from 2005 – 71,000 bbls/day
Fall 2007 forecast 676,000 bbls/day
difference from 2006 – 106,000 bbls/day
Fall 2008 forecast 644,000 bbls/day
difference from 2007 – 32,000 bbls/day
Fall 2009 forecast 623,000 bbls/day
difference from 2008 – 21,000 bbls/day
Fall 2010 forecast 616,000 bbls/day
difference from 2009 – 7,000 bbls/day
So what does the above tell us. First that three years ago the revenue forecast predicted 676,000 bbls/day, not the 816,000 bbls that Rep. Hawker stated. The resulting difference would be 60,000 bbls/day instead of the 200,000 bbls/day the representative stated.
The reason the representative had to go back so many years is because in recent years the change in the production forecast has not been significant. To find a substantial difference between predictions the representative would have had to go back to the Fall 2006 forecast. Between the Fall 2006 forecast and the Fall 2007 forecast the state lost 106,000 bbls/day. Perhaps that can be attributed to the change in the tax from PPT to ACES.
The best place to look for the answer would be in the Fall 2007 Revenue Sources Book. There the Department of Revenue states at pp. 46-47:
“To account for unforeseen production interruptions slopewide, as well as anticipated scheduled interruptions attributed to renewal projects, we have increased our estimates of downtime at the Greater Prudhoe Bay Area, the Greater Kuparuk Area, Milne Point Unit and Endicott for the next 6-8 years, depending on the field. The impact of this deferred production is significant in the near term, ranging from 30,000 – 70,000 barrels of oil per day slopewide. This is in addition to the rate impacts attributed to reevaluating the scope and timing of projects under development and under evaluation.”
So even the significant change that occurred in the 2011 production projection from 2006 to 2007 had nothing to do with taxes. It had to do with attempting to incorporate downtime into future production scenarios.
In addition, if you graph the Revenue Sources Book production projections for each year from 2004 to 2010, what you will find is that the state is generally more optimistic in its production projection than what actually occurs. Production projections are based on what the Department of Revenue consultants can project will probably occur in the future based on what they know about the reservoir, decline curves and industry plans to bring a development online. Production predictions have nothing to do with tax changes.
So as you review the facts relating to impacts from a change in the oil tax, make sure you understand the FACTS, all of the FACTS, and nothing but the FACTS.
Monday, March 14, 2011
The Specious Argument
I recently finished watching the March 10, 2011 Governor’s Press Availability on Gavel to Gavel where the governor discussed his tax change legislation. He discussed the three areas of focus for the bill, 1) new units (tax reductions for areas not in production now), 2) infield drilling tax credits, and 3) progressivity changes. And he explained that his administration is “focused on creating more production here, more investment here, more jobs here.”
This is all well and good and I commend him for his energy and effort, but I question his response to those who have expressed concerns that his legislation could cost the state billions of dollars. In response to those stated concerns about the cost of the legislation he stated “Let’s talk about that specious argument before we go any further.” His comment was out of character for the governor and without a rational basis for the position taken. In the past the governor has not used such a pejorative comment in referring to those who oppose him. Normally he would merely have responded with his position, supported by facts and analysis without putting the opposition down. So why did he use such a strategy this time?
There are several possible reasons why he attacked the opposition with name calling instead of analysis.
Perhaps because he didn’t remember that it was his own staff who wrote the fiscal note that stated the financial impact of the change to the tax would be in the billions. Perhaps he was not around to listen to his Department of Revenue Commissioner and revenue staff explain that the impact would be in the billions. Perhaps he did not read his consultant’s report and did not listen to his consultant testify that the long term cost of the change could be approximately $20 billion.
Or perhaps he is just uncertain about the position he has taken and doesn’t know how to logically defend it; so he reverted to name calling and putting down the opposition.
Or perhaps he doesn’t understand cost/benefit analysis. In its most basic form cost/benefit analysis is first understanding the short and long term cost of the change as well as you can. Once you fully understand the costs of the change, you must determine what the proposed benefits will be and the chance of those benefits occurring. Then you calculate the difference. The result may be that there will be more jobs for Alaskans or the life of the pipeline will be extended, or the possibility that the state may never recoup the difference in tax it gave up in the legislation. Even with the potential negative impact of not recouping the cost of the change in tax, the state may determine the change is still a reasonable course of action. The state may determine it wants short and long-term jobs and an extended life of the pipeline more than it wants to fill its savings account. This would be an acceptable analysis.
But what is not acceptable is not counting the costs and arguing that those costs are not real, that they are “fantasy,” that concerns regarding the costs are “specious.” The costs are real. They can be determined within in a reasonable range, and they range in the billions of dollars. What is not real, what cannot be determined, and what can only be hoped for are the benefits from such a tax change. Those benefits may occur, but they cannot be calculated because a third party must make an independent decision sometime in the future based on present actions by the legislature. Maybe it will be worth it, but the state should count the cost and understand the risk before making such an important decision.
What the governor should have done is provide the analysis necessary to support his position, provide the analysis necessary for the Alaska public to support his legislation, provide the analysis necessary for the legislature to pass his proposed legislation.
What the governor should have done is provide the legislature with an analysis of possible decline curves.
The governor’s consultant used a 6% decline curve to define what might happen if the legislation was not passed; yet the governor’s Revenue Commissioner presented an estimation of future revenue based on a 3.2% decline curve under the current tax. What does the governor believe to be true? What are the ranges of possible decline and what are the bases for those assumptions?
What the governor should have done is explain to the legislature where the governor believes the new reserves are to be found.
A thorough understanding of reserves potential is essential for the legislature to understand so they can determine if there are sufficient potential reserves to compensate the state for the lost revenue from the change in the tax.
What follows are projections from the United States Geological Survey and the State of Alaska, Department of Natural Resources, Division of Oil and Gas of resource potential of exploration areas of the north slope.
NPRA: consists generally of lands west of the Colville River and north of the Brooks Range.
The National Petrolem Reserve-Alaska is not a good source for future oil revenue. The USGS has recently substantially reduced the reserves of technically recoverable conventional accumulations of oil it believes are located in NPRA to less than a billion barrels of oil, about 10 percent of what it previously projected to be in NPRA (See 2010 Updated Assessment of Undiscovered Oil and Gas Resources of the National Petroleum Reserve Alaska (NPRA) ).
Beaufort Sea: consists of all offshore state lands between Pt. Barrow and the U.S-Canadian border.
The Department of Natural Resources, Division of Oil and Gas has projected: “The petroleum potential in the area is considered moderate to high.” (See the January 2011 Five-year Program of Proposed Oil and Gas Leasing Program Report at page 22).
But concerns about oil spills in the offshore environment, concerns about the oil industry’s ability to clean up oil in broken ice, concerns about bowhead whales, polar bear habitat and two species of endangered seals may make it difficult to explore for or produce oil from offshore in the near-term.
North Slope Areawide Oil and Gas Lease Sale: the area consists of all state-owned lands between the National Petroleum Reserve-Alaska (NPRA) and the Arctic National Wildlife Refuge (ANWR), and from the Beaufort Sea to the north and the Umiat Meridian Baseline to the south (an east/west line drawn just north of Umiat, Alaska).
The Department of Natural Resources, Division of Oil and Gas has projected: “Petroleum Potential in this area is considered low to moderate with the potential generally increasing from south to north.” (See the January 2011 Five-year Program of Proposed Oil and Gas Leasing Program Report at page 27).
North Slope Foothills: the area consists of all state-owned lands between the National Petroleum Reserve-Alaska (NPRA) and the Arctic National Wildlife Refuge (ANWR) south of the Umiat Meridian Baseline and north of the Gates of the Arctic National Park and Preserve.
The North Slope foothills are not a good source future oil potential. The Department of Natural Resourses, Division of Oil and Gas has stated “Petroleum potential in the area is considered relatively high for gas, and relatively low for oil." (See the January 2011 Five-year Program of Proposed Oil and Gas Leasing Program Report at page 30).”
Even though the governor believes that these areas “have not been touched for thousands of years,” they have actually been evaluated and tested geologically. That is why the Division of Oil and Gas can project the potential for oil in this area as relatively low. The legislature should request a map of the north slope depicting all the wells that have been drilled. Then the legislature should ask one of the geologists at the Division of Oil and Gas to explain why they believe the oil potential in this area is low.
Federal OCS: the offshore area in the Chukchi and Beaufort Seas seaward of the state offshore.
Even though the governor referred to Shell’s exploration activities in the Chukchi Sea during his press availability, the governor’s tax legislation does not affect Shell’s offshore projects from an economic standpoint because the tax credits do not apply to the federal offshore and the state has no power to tax the federal offshore.
What the governor should have done is explain to the legislature when the new reserves are projected to be produced.
The state land with the greatest oil potential (high potential) is the state offshore, the most difficult area to permit and develop a field. Bringing production on from the state offshore will take at least 10 years and probably closer to 15 years if it can be done. In fact even permitting and developing a new onshore field (low to moderate potential) will take at least 10 years. Therefore we should not expect or depend on any revenue from new exploration in the short-term and little in the long-term.
What the governor should have done is explain the projected revenue and the timing of that revenue from the reserves he proposes will be found.
Even though we don’t expect much from new exploration, the credits have not cost the state much. But maybe someday, many years from now, any new production to be found will be a net positive from a revenue standpoint (after deducting the cost of the credits). In addition, what can be determined with reasonable certainty is that revenue from new exploration will not begin to balance the cost from the tax change for at least 10 years.
What the governor should have done is explain to the legislature the criteria the governor is using to determine if or when the tax change has failed.
In his Press Availability the governor suggested that the legislature would not sit idly by if the proposed tax change was not having the desired effect. What the governor needs to share with the legislature are his expectations for a successful outcome. What would he consider a success? What would the governor consider a failure? How long is the governor willing to wait to see positive impacts from the tax change?
Finally the governor in a final posture challenged the press to ask the “nay sayers” that say the governor’s proposal is going to cost so much what their plan would be. Well I’m not necessarily a nay sayer, and I am certainly not a legislator, but I do believe the governor and the legislature should count the cost before they make such broad sweeping changes to the oil tax. And as far as proposing a plan, I have written close to 40 articles in this blog proposing what the governor and legislature should do, but if the governor doesn’t understand what I am suggesting he is free to give me a call and I will be glad to help him out.
Additional Note
The governor made one comment regarding the large diameter pipeline that is worth clarifying. In referring to the position of the pipeline companies he stated that “Before we commit to buying pipe, we need fiscal certainty.” That would suggest he believes that TransCanada and Exxon or Denali pipeline company needs fiscal certainty before they can commit to buy pipe. Actually the pipeline company does not need fiscal certainty; the shippers need fiscal certainty and they need it before they are willing to commit their gas to the open season. Fiscal certainty has nothing to do with the pipeline companies buying pipe. Fiscal certainty is being requested by the shippers before they are willing to commit their gas at the open season. That is one of the reasons why the open season process has stalled. I am surprised at this basic misunderstanding of who needs fiscal certainty, when it is needed and the risks associated with moving a pipeline project forward.
This is all well and good and I commend him for his energy and effort, but I question his response to those who have expressed concerns that his legislation could cost the state billions of dollars. In response to those stated concerns about the cost of the legislation he stated “Let’s talk about that specious argument before we go any further.” His comment was out of character for the governor and without a rational basis for the position taken. In the past the governor has not used such a pejorative comment in referring to those who oppose him. Normally he would merely have responded with his position, supported by facts and analysis without putting the opposition down. So why did he use such a strategy this time?
There are several possible reasons why he attacked the opposition with name calling instead of analysis.
Perhaps because he didn’t remember that it was his own staff who wrote the fiscal note that stated the financial impact of the change to the tax would be in the billions. Perhaps he was not around to listen to his Department of Revenue Commissioner and revenue staff explain that the impact would be in the billions. Perhaps he did not read his consultant’s report and did not listen to his consultant testify that the long term cost of the change could be approximately $20 billion.
Or perhaps he is just uncertain about the position he has taken and doesn’t know how to logically defend it; so he reverted to name calling and putting down the opposition.
Or perhaps he doesn’t understand cost/benefit analysis. In its most basic form cost/benefit analysis is first understanding the short and long term cost of the change as well as you can. Once you fully understand the costs of the change, you must determine what the proposed benefits will be and the chance of those benefits occurring. Then you calculate the difference. The result may be that there will be more jobs for Alaskans or the life of the pipeline will be extended, or the possibility that the state may never recoup the difference in tax it gave up in the legislation. Even with the potential negative impact of not recouping the cost of the change in tax, the state may determine the change is still a reasonable course of action. The state may determine it wants short and long-term jobs and an extended life of the pipeline more than it wants to fill its savings account. This would be an acceptable analysis.
But what is not acceptable is not counting the costs and arguing that those costs are not real, that they are “fantasy,” that concerns regarding the costs are “specious.” The costs are real. They can be determined within in a reasonable range, and they range in the billions of dollars. What is not real, what cannot be determined, and what can only be hoped for are the benefits from such a tax change. Those benefits may occur, but they cannot be calculated because a third party must make an independent decision sometime in the future based on present actions by the legislature. Maybe it will be worth it, but the state should count the cost and understand the risk before making such an important decision.
What the governor should have done is provide the analysis necessary to support his position, provide the analysis necessary for the Alaska public to support his legislation, provide the analysis necessary for the legislature to pass his proposed legislation.
What the governor should have done is provide the legislature with an analysis of possible decline curves.
The governor’s consultant used a 6% decline curve to define what might happen if the legislation was not passed; yet the governor’s Revenue Commissioner presented an estimation of future revenue based on a 3.2% decline curve under the current tax. What does the governor believe to be true? What are the ranges of possible decline and what are the bases for those assumptions?
What the governor should have done is explain to the legislature where the governor believes the new reserves are to be found.
A thorough understanding of reserves potential is essential for the legislature to understand so they can determine if there are sufficient potential reserves to compensate the state for the lost revenue from the change in the tax.
What follows are projections from the United States Geological Survey and the State of Alaska, Department of Natural Resources, Division of Oil and Gas of resource potential of exploration areas of the north slope.
NPRA: consists generally of lands west of the Colville River and north of the Brooks Range.
The National Petrolem Reserve-Alaska is not a good source for future oil revenue. The USGS has recently substantially reduced the reserves of technically recoverable conventional accumulations of oil it believes are located in NPRA to less than a billion barrels of oil, about 10 percent of what it previously projected to be in NPRA (See 2010 Updated Assessment of Undiscovered Oil and Gas Resources of the National Petroleum Reserve Alaska (NPRA) ).
Beaufort Sea: consists of all offshore state lands between Pt. Barrow and the U.S-Canadian border.
The Department of Natural Resources, Division of Oil and Gas has projected: “The petroleum potential in the area is considered moderate to high.” (See the January 2011 Five-year Program of Proposed Oil and Gas Leasing Program Report at page 22).
But concerns about oil spills in the offshore environment, concerns about the oil industry’s ability to clean up oil in broken ice, concerns about bowhead whales, polar bear habitat and two species of endangered seals may make it difficult to explore for or produce oil from offshore in the near-term.
North Slope Areawide Oil and Gas Lease Sale: the area consists of all state-owned lands between the National Petroleum Reserve-Alaska (NPRA) and the Arctic National Wildlife Refuge (ANWR), and from the Beaufort Sea to the north and the Umiat Meridian Baseline to the south (an east/west line drawn just north of Umiat, Alaska).
The Department of Natural Resources, Division of Oil and Gas has projected: “Petroleum Potential in this area is considered low to moderate with the potential generally increasing from south to north.” (See the January 2011 Five-year Program of Proposed Oil and Gas Leasing Program Report at page 27).
North Slope Foothills: the area consists of all state-owned lands between the National Petroleum Reserve-Alaska (NPRA) and the Arctic National Wildlife Refuge (ANWR) south of the Umiat Meridian Baseline and north of the Gates of the Arctic National Park and Preserve.
The North Slope foothills are not a good source future oil potential. The Department of Natural Resourses, Division of Oil and Gas has stated “Petroleum potential in the area is considered relatively high for gas, and relatively low for oil." (See the January 2011 Five-year Program of Proposed Oil and Gas Leasing Program Report at page 30).”
Even though the governor believes that these areas “have not been touched for thousands of years,” they have actually been evaluated and tested geologically. That is why the Division of Oil and Gas can project the potential for oil in this area as relatively low. The legislature should request a map of the north slope depicting all the wells that have been drilled. Then the legislature should ask one of the geologists at the Division of Oil and Gas to explain why they believe the oil potential in this area is low.
Federal OCS: the offshore area in the Chukchi and Beaufort Seas seaward of the state offshore.
Even though the governor referred to Shell’s exploration activities in the Chukchi Sea during his press availability, the governor’s tax legislation does not affect Shell’s offshore projects from an economic standpoint because the tax credits do not apply to the federal offshore and the state has no power to tax the federal offshore.
What the governor should have done is explain to the legislature when the new reserves are projected to be produced.
The state land with the greatest oil potential (high potential) is the state offshore, the most difficult area to permit and develop a field. Bringing production on from the state offshore will take at least 10 years and probably closer to 15 years if it can be done. In fact even permitting and developing a new onshore field (low to moderate potential) will take at least 10 years. Therefore we should not expect or depend on any revenue from new exploration in the short-term and little in the long-term.
What the governor should have done is explain the projected revenue and the timing of that revenue from the reserves he proposes will be found.
Even though we don’t expect much from new exploration, the credits have not cost the state much. But maybe someday, many years from now, any new production to be found will be a net positive from a revenue standpoint (after deducting the cost of the credits). In addition, what can be determined with reasonable certainty is that revenue from new exploration will not begin to balance the cost from the tax change for at least 10 years.
What the governor should have done is explain to the legislature the criteria the governor is using to determine if or when the tax change has failed.
In his Press Availability the governor suggested that the legislature would not sit idly by if the proposed tax change was not having the desired effect. What the governor needs to share with the legislature are his expectations for a successful outcome. What would he consider a success? What would the governor consider a failure? How long is the governor willing to wait to see positive impacts from the tax change?
Finally the governor in a final posture challenged the press to ask the “nay sayers” that say the governor’s proposal is going to cost so much what their plan would be. Well I’m not necessarily a nay sayer, and I am certainly not a legislator, but I do believe the governor and the legislature should count the cost before they make such broad sweeping changes to the oil tax. And as far as proposing a plan, I have written close to 40 articles in this blog proposing what the governor and legislature should do, but if the governor doesn’t understand what I am suggesting he is free to give me a call and I will be glad to help him out.
Additional Note
The governor made one comment regarding the large diameter pipeline that is worth clarifying. In referring to the position of the pipeline companies he stated that “Before we commit to buying pipe, we need fiscal certainty.” That would suggest he believes that TransCanada and Exxon or Denali pipeline company needs fiscal certainty before they can commit to buy pipe. Actually the pipeline company does not need fiscal certainty; the shippers need fiscal certainty and they need it before they are willing to commit their gas to the open season. Fiscal certainty has nothing to do with the pipeline companies buying pipe. Fiscal certainty is being requested by the shippers before they are willing to commit their gas at the open season. That is one of the reasons why the open season process has stalled. I am surprised at this basic misunderstanding of who needs fiscal certainty, when it is needed and the risks associated with moving a pipeline project forward.
Thursday, February 10, 2011
An Either/Or World
At times in Alaska’s history individuals saw a vision of what Alaska could be and committed themselves to the success of that vision. The purchase of Alaska from Russia, the discovery of gas in Cook Inlet, Alaska Statehood, the discovery of oil at Prudhoe Bay, the creation of the Permanent Fund; each took vision, each took commitment, each took leadership, each took work, each carried a substantial amount of risk of success, and each resulted in a significant change to Alaska’s future. Each was a decided break with the past. Sometimes in history choices need to be made. Sometimes a specific direction needs to be taken. Sometimes decisions need to be made. If those decisions are not made, opportunities escape. Sometimes life really is an either/or world.
It is time to either develop a strategic plan to develop and produce Alaska’s resources or muddle along and see Alaska’s future dwindle away.
It is time to either choose a direction and develop a plan for an Alaska Gas Pipeline or allow the opportunity to pass Alaska by.
It is time to either address Alaska’s long term fiscal needs or inherit the results of indecision 20 years from now.
If Alaska wants a gasline; if Alaska wants to see continued production; if Alaska wants continued oil and gas exploration and development in its future; if Alaska wants future generations to inherit a strong stable economy, it is time for action.
But merely taking action without evaluating what action should be taken is irresponsible. Those who want do something because it is better than doing nothing at all are misguided. Change must be based on rational analysis. A good strategic plan will analyze the State’s resources and strengths. It will analyze the impediments to success, and it will develop a plan to move forward that hopefully increases the likelihood of success and reduces the likelihood of failure. So what are Alaska’s resources and strengths? What are its weaknesses? And what would a viable strategic plan look like?
Alaska’s strategic resources
1) Prudhoe Bay/Kuparuk – North Slope oil production has provided Alaska with substantial wealth in the past and can continue to be the base upon which Alaska builds its future. The goal regarding Prudhoe should be to create a fiscal environment where the producers have incentive to:
a. Maximize the production from currently discovered reservoirs
b. Encourage exploration for satellite fields close to development
c. Encourage development of heavy and viscous oil
2) Alpine/Colville River/Eastern NPRA Development – Discoveries have been made here but development of additional reserves has been stalled due to permitting delays. The goal for this development region should be to:
a. Work with producers and state and federal agencies to bring these known resources to market and to develop the infrastructure to encourage additional exploration.
b. Northeastern NPRA is one of the few areas onshore North Slope where there is still potential for finding significant oil reserves. Work with the various stakeholders, including the North Slope Borough, the village of Nuiqsut, and the federal and state agencies to develop an environment where cultural values are protected and development can still occur.
3) NPRA in general – encouraging exploration of the rest of NPRA is somewhat a waste of time until and unless the gas pipeline issues are resolved. A recent report by the USGS titled “2010 Updated Assessment of Undiscovered Oil and Gas Resources of the National Petroleum Reserve in Alaska (NPRA) makes it clear that the largest potential for undiscovered oil lies in northeastern NPRA and the largest potential for nonassociated gas resources is in structural plays in southern NPRA. If the gas pipeline issues are resolved, NPRA exploration will once again become viable.
4) OCS Beaufort Sea/Chukchi Sea – OCS development will not add much to the State general fund because the state receives no royalty from OCS development and it does not have the power to tax that development, but oil discoveries from the OCS will extend the life of the TAPS oil pipeline. And if a gas pipeline is built, exploration for gas in the OCS will also increase. The North Slope Borough is currently opposed to all exploratory drilling that cannot be done in the winter from an ice island or from a bottom-founded drillship. They oppose all summer exploration that must be done from a floating drillship because of concerns about oil spills and how those spills might affect the bowhead whale and other marine mammals. The state needs to work with the North Slope Borough to see if there is a way that exploration can move forward in open water without their opposition. If a way cannot be found to resolve the North Slope Borough’s concerns, OCS exploration and development will probably not occur in the near term. And if it does occur, it will happen only after costly and time consuming litigation.
5) Point Thomson – enough has been said about Point Thomson in previous posts. It is time for the State and ExxonMobil to resolve their differences and move ahead with this project.
Alaska’s strengths
1) Alaska has the ability, given the proper leadership, to respond to circumstances and change course quickly. This is one strength that most other states are incapable of. Most other states take years to make minor changes to the direction they have taken, but Alaska is unique in that it can recognize circumstances that require a change in course, and it can respond quickly to take advantage of opportunities that may present themselves.
2) Alaska has funds in reserve. Alaska has its Permanent Fund and billions of dollars in savings. Revenue in reserve always provides options.
Impediments to Success
Alaska currently has no vision regarding an Alaska Gas Pipeline. Some want an instate line, some want a trunk-line to Fairbanks, some want to export the gas to the Pacific Rim, some want to stick with AGIA, others are rooting for large diameter line through Canada but don’t believe in AGIA. What is clear is that a State divided over this issue will not succeed.
Proposed solution
So how do Alaskans wade through all the options to come up with the optimum outcome. The first question to ask is what does Alaska really want? If Alaskans could choose from all the above outcomes, which one would they choose? Which one would have the greatest benefit to the people of Alaska? Actually, the answer is clear. A large diameter pipeline, if it can be built, would have the greatest benefit for the people of Alaska.
Then what about an AGIA line vs a pipeline to tidewater for an LNG project vs a non-AGIA line? These are actually questions that don’t need to be answered today. A line to tidewater vs a line through Canada are commercial questions that the owners of the gas will decide at the open season. They are questions that don’t need to be decided by the legislature.
Well what about an AGIA pipeline vs a non-AGIA gasline? Are the remaining benefits of AGIA worth $500 million?
First, the 20 “must-haves” of AGIA have either been accomplished or created no additional value when the Act was passed. See the previous article on this blog titled “Analysis of the Twenty “Must Haves” of AGIA” posted September 15, 2010. It is clear that the only remaining value of AGIA is the $500 million in exchange for TransCanada continuing to move the project forward through the filing of the FERC certificate.
Some have argued that the data collected and the documentation created, if the state allows it to be used by the new consolidated group of TransCanada, ExxonMobil, ConocoPhillips and BP, may save the project up to a year in getting to a project sanction decision. Others have said it is just wasted money that should not be spent on useless paper. If there is value to the $500 million reimbursement, this is where you would find it.
With all that said, AGIA doesn’t really matter. Currently there are two competing projects. Ultimately there will only be one project and AGIA will be immaterial to the successful outcome of that project. The key question for the state is what can the state do now to increase the likelihood of success of that large diameter gas pipeline project.
Elements of a successful large diameter pipeline strategic plan
This is the area where the need for a strategic plan is greatest. A disjointed, non-directional plan here will result in failure. A strategic plan for success requires leadership. It requires broad support from affected stakeholders. And it requires specific actions to address specific problems and concerns.
1) A fair gas tax – the issue of a gas tax must be addressed. It is interesting that the oil tax has garnered a substantial amount of energy and effort, but discussion of the tax on gas is non-existent. The idea seems to be that the State will wait for the producers to come to them and tell them what is needed. This apparently will come in the form of conditions for committing gas to the pipeline. This thinking is not logical, and the state will eventually find that the information obtained from a failed open season will not result in a specific proposal from the producers. The producers will only reiterate what they have stated in the past – that the state needs to provide them with fiscal certainty/stability and a fair gas tax. It is time for the state to start the discussion regarding a fair gas tax. Do the research. Acquire the information necessary to make a reasoned decision, and pass a fair gas tax.
2) Fiscal Certainty/Stability – the producers say they need fiscal certainty because they are concerned that if the state is running short on revenue to balance its budget, the legislature will change the tax on gas once the gas pipeline is built, thus changing the economics upon which the producers committed to ship their gas.
Fiscal certainty can take many forms. Certainty can be created by contract; it can be created by an amendment to the State Constitution; it can be created by statute, although the producers have said they are not comfortable with certainty created by statute because the legislature in the next legislative session can change the certainty provided for in the last legislative session. Another form of certainty can be created by making sure that the legislature cannot change the tax on gas in order to resolve its short term financial problems. If the gas tax was not available to the general fund, a certain level of fiscal certainty would be provided to the producers. The producers have not taken a position on this form of certainty and whether it would suffice to meet their concerns, but it is one option that should be considered.
3) Risk Sharing – If the state is truly committed to a large diameter pipeline project, it might consider sharing some additional risk in the construction of the project. The two easiest means for sharing risk are 1) participation in the ownership of the pipeline, and 2) committing to ship the state’s royalty gas on the pipeline. Both of these options have been considered by prior administrations, and there is a significant amount of analysis available to the legislature if it would like to pursue either one of these options.
Summary
In summary, a great opportunity lies before the state. The state can either commit the effort and resources necessary to make a large diameter gas pipeline project a success or the state can prepare for the gradual decline of its resource base followed by a dependence on the Permanent Fund to finance governmental services in addition to whatever taxes the people of Alaska agree to pay. It’s an either/or world, and it’s time to choose.
It is time to either develop a strategic plan to develop and produce Alaska’s resources or muddle along and see Alaska’s future dwindle away.
It is time to either choose a direction and develop a plan for an Alaska Gas Pipeline or allow the opportunity to pass Alaska by.
It is time to either address Alaska’s long term fiscal needs or inherit the results of indecision 20 years from now.
If Alaska wants a gasline; if Alaska wants to see continued production; if Alaska wants continued oil and gas exploration and development in its future; if Alaska wants future generations to inherit a strong stable economy, it is time for action.
But merely taking action without evaluating what action should be taken is irresponsible. Those who want do something because it is better than doing nothing at all are misguided. Change must be based on rational analysis. A good strategic plan will analyze the State’s resources and strengths. It will analyze the impediments to success, and it will develop a plan to move forward that hopefully increases the likelihood of success and reduces the likelihood of failure. So what are Alaska’s resources and strengths? What are its weaknesses? And what would a viable strategic plan look like?
Alaska’s strategic resources
1) Prudhoe Bay/Kuparuk – North Slope oil production has provided Alaska with substantial wealth in the past and can continue to be the base upon which Alaska builds its future. The goal regarding Prudhoe should be to create a fiscal environment where the producers have incentive to:
a. Maximize the production from currently discovered reservoirs
b. Encourage exploration for satellite fields close to development
c. Encourage development of heavy and viscous oil
2) Alpine/Colville River/Eastern NPRA Development – Discoveries have been made here but development of additional reserves has been stalled due to permitting delays. The goal for this development region should be to:
a. Work with producers and state and federal agencies to bring these known resources to market and to develop the infrastructure to encourage additional exploration.
b. Northeastern NPRA is one of the few areas onshore North Slope where there is still potential for finding significant oil reserves. Work with the various stakeholders, including the North Slope Borough, the village of Nuiqsut, and the federal and state agencies to develop an environment where cultural values are protected and development can still occur.
3) NPRA in general – encouraging exploration of the rest of NPRA is somewhat a waste of time until and unless the gas pipeline issues are resolved. A recent report by the USGS titled “2010 Updated Assessment of Undiscovered Oil and Gas Resources of the National Petroleum Reserve in Alaska (NPRA) makes it clear that the largest potential for undiscovered oil lies in northeastern NPRA and the largest potential for nonassociated gas resources is in structural plays in southern NPRA. If the gas pipeline issues are resolved, NPRA exploration will once again become viable.
4) OCS Beaufort Sea/Chukchi Sea – OCS development will not add much to the State general fund because the state receives no royalty from OCS development and it does not have the power to tax that development, but oil discoveries from the OCS will extend the life of the TAPS oil pipeline. And if a gas pipeline is built, exploration for gas in the OCS will also increase. The North Slope Borough is currently opposed to all exploratory drilling that cannot be done in the winter from an ice island or from a bottom-founded drillship. They oppose all summer exploration that must be done from a floating drillship because of concerns about oil spills and how those spills might affect the bowhead whale and other marine mammals. The state needs to work with the North Slope Borough to see if there is a way that exploration can move forward in open water without their opposition. If a way cannot be found to resolve the North Slope Borough’s concerns, OCS exploration and development will probably not occur in the near term. And if it does occur, it will happen only after costly and time consuming litigation.
5) Point Thomson – enough has been said about Point Thomson in previous posts. It is time for the State and ExxonMobil to resolve their differences and move ahead with this project.
Alaska’s strengths
1) Alaska has the ability, given the proper leadership, to respond to circumstances and change course quickly. This is one strength that most other states are incapable of. Most other states take years to make minor changes to the direction they have taken, but Alaska is unique in that it can recognize circumstances that require a change in course, and it can respond quickly to take advantage of opportunities that may present themselves.
2) Alaska has funds in reserve. Alaska has its Permanent Fund and billions of dollars in savings. Revenue in reserve always provides options.
Impediments to Success
Alaska currently has no vision regarding an Alaska Gas Pipeline. Some want an instate line, some want a trunk-line to Fairbanks, some want to export the gas to the Pacific Rim, some want to stick with AGIA, others are rooting for large diameter line through Canada but don’t believe in AGIA. What is clear is that a State divided over this issue will not succeed.
Proposed solution
So how do Alaskans wade through all the options to come up with the optimum outcome. The first question to ask is what does Alaska really want? If Alaskans could choose from all the above outcomes, which one would they choose? Which one would have the greatest benefit to the people of Alaska? Actually, the answer is clear. A large diameter pipeline, if it can be built, would have the greatest benefit for the people of Alaska.
Then what about an AGIA line vs a pipeline to tidewater for an LNG project vs a non-AGIA line? These are actually questions that don’t need to be answered today. A line to tidewater vs a line through Canada are commercial questions that the owners of the gas will decide at the open season. They are questions that don’t need to be decided by the legislature.
Well what about an AGIA pipeline vs a non-AGIA gasline? Are the remaining benefits of AGIA worth $500 million?
First, the 20 “must-haves” of AGIA have either been accomplished or created no additional value when the Act was passed. See the previous article on this blog titled “Analysis of the Twenty “Must Haves” of AGIA” posted September 15, 2010. It is clear that the only remaining value of AGIA is the $500 million in exchange for TransCanada continuing to move the project forward through the filing of the FERC certificate.
Some have argued that the data collected and the documentation created, if the state allows it to be used by the new consolidated group of TransCanada, ExxonMobil, ConocoPhillips and BP, may save the project up to a year in getting to a project sanction decision. Others have said it is just wasted money that should not be spent on useless paper. If there is value to the $500 million reimbursement, this is where you would find it.
With all that said, AGIA doesn’t really matter. Currently there are two competing projects. Ultimately there will only be one project and AGIA will be immaterial to the successful outcome of that project. The key question for the state is what can the state do now to increase the likelihood of success of that large diameter gas pipeline project.
Elements of a successful large diameter pipeline strategic plan
This is the area where the need for a strategic plan is greatest. A disjointed, non-directional plan here will result in failure. A strategic plan for success requires leadership. It requires broad support from affected stakeholders. And it requires specific actions to address specific problems and concerns.
1) A fair gas tax – the issue of a gas tax must be addressed. It is interesting that the oil tax has garnered a substantial amount of energy and effort, but discussion of the tax on gas is non-existent. The idea seems to be that the State will wait for the producers to come to them and tell them what is needed. This apparently will come in the form of conditions for committing gas to the pipeline. This thinking is not logical, and the state will eventually find that the information obtained from a failed open season will not result in a specific proposal from the producers. The producers will only reiterate what they have stated in the past – that the state needs to provide them with fiscal certainty/stability and a fair gas tax. It is time for the state to start the discussion regarding a fair gas tax. Do the research. Acquire the information necessary to make a reasoned decision, and pass a fair gas tax.
2) Fiscal Certainty/Stability – the producers say they need fiscal certainty because they are concerned that if the state is running short on revenue to balance its budget, the legislature will change the tax on gas once the gas pipeline is built, thus changing the economics upon which the producers committed to ship their gas.
Fiscal certainty can take many forms. Certainty can be created by contract; it can be created by an amendment to the State Constitution; it can be created by statute, although the producers have said they are not comfortable with certainty created by statute because the legislature in the next legislative session can change the certainty provided for in the last legislative session. Another form of certainty can be created by making sure that the legislature cannot change the tax on gas in order to resolve its short term financial problems. If the gas tax was not available to the general fund, a certain level of fiscal certainty would be provided to the producers. The producers have not taken a position on this form of certainty and whether it would suffice to meet their concerns, but it is one option that should be considered.
3) Risk Sharing – If the state is truly committed to a large diameter pipeline project, it might consider sharing some additional risk in the construction of the project. The two easiest means for sharing risk are 1) participation in the ownership of the pipeline, and 2) committing to ship the state’s royalty gas on the pipeline. Both of these options have been considered by prior administrations, and there is a significant amount of analysis available to the legislature if it would like to pursue either one of these options.
Summary
In summary, a great opportunity lies before the state. The state can either commit the effort and resources necessary to make a large diameter gas pipeline project a success or the state can prepare for the gradual decline of its resource base followed by a dependence on the Permanent Fund to finance governmental services in addition to whatever taxes the people of Alaska agree to pay. It’s an either/or world, and it’s time to choose.
Wednesday, January 26, 2011
THE REAL COST OF THE GOVERNOR’S PROPOSED OIL TAX CHANGE
Recently Governor Parnell addressed the Alaska Legislature in his State of the State address. In that address he mentioned his proposal to lower taxes on oil but did not go into any great detail regarding the proposal. For perspective I have included herein the entire paragraph from the governor’s speech regarding the need to lower oil taxes:
“So the question tonight is, how do we continue growing an even more vigorous and diverse economy? And how do we create that gravitational pull for private-sector investment and job growth? It takes four things: keep taxes low, gain access to our resources, invest in Alaska energy, and strategically expand undeveloped resources. That's why this year I'm asking that we work together to lower taxes on oil, and create more jobs in Alaska. Let's build off the success of last year's tourism head tax reduction that pulled more investment to Alaska. Let's pass legislation to make our oil tax regime more globally competitive. Lower taxes lead to more resource development, and that leads to more jobs for Alaskans.” – Governor Parnell
House Bill 110 was submitted to the legislature at the request of the governor to address his recommended changes to the oil tax. According to the Department of Revenue fiscal note, the tax change could cost the people of Alaska approximately $5 billion over the next five years. But the tax is not just a five year tax. It affects all existing and future producing properties in the State of Alaska for the life of the leases. So why has the impact been projected to cost $5 billion? A quick look at the nature of fiscal notes gives us the answer. The impact of the tax change was projected to be $5 billion merely because of the relatively arbitrary reason that fiscal notes are only required to identify impacts for five years. The real question someone should ask is, “What happens in year six and every year thereafter?” The answer they will find is that this is not a $5 billion tax. It is a tax change that will cost the people of Alaska in excess of $10 billion over the life of the leases.
So what does the governor propose the people of Alaska get for their $10 billion? The answer is more jobs and hopefully more oil and gas exploration and development. But how do we know if this is a good deal?
Alaska jobs makes a good emotional appeal but certainly cannot justify the price tag of $10 billion. The only way to justify a tax change of this magnitude is through exploration and new production. The following examines the value of the proposed tax change to bring about new exploration and production.
Impact of the tax change on exploration and production
To determine the impact of the proposed oil tax change on production and on production from successful exploration it is important to first determine the projected production based on the current tax system. The best source for that information is the recent Department of Revenue, Oil and Gas Production Tax Status Report to the Legislature dated January 18, 2011. On page 10 of that report the department displays a chart showing production from all existing and discovered fields that the department expects will be produced between now and 2030. This is the Department of Revenue’s projection of present and future production based on the current oil tax without the proposed changes.
Impact of the tax change on production
Changes to the tax should see significant increases in production in addition to what has been identified in the chart. The problem is that state land, from the Colville to the Canning Rivers, is a mature province for oil production. We should not expect to see nor project discoveries in this area of anything greater than what we have seen over the last ten years, basically incremental satellite production which will, at best, reduce the production decline curve but should not be expected to increase production substantially over the next 20 years. The state will not capture a lot of incremental value here.
In terms of the legislation, the section that amends Alaska Statutes 43.55.011(e)(1) and (g)(1) reduces the oil tax by over $10 billion over the term of the life of the leases on the currently producing units with the hope that this change will increase exploration and development to sufficiently offset the tax change. The likelihood of this occurring on state lands is almost nonexistent. The only hope of significant additional production on state lands comes from increased production of viscous and heavy oil which will be addressed later in this article.
Changing the tax structure on existing production will only incentivize the producers to increase production in the existing fields which, as I have said above, will not occur to any major extent because of the maturity of the existing fields. In addition a tax change of this magnitude will have a significant impact on the future revenue of the state.
The Department of Revenue on January 25, 2011, made a presentation to the Senate Finance Committee regarding the Fall 2010 Revenue Forecast and a 10 year Revenue/Spending projection. On slide 9 of that presentation the department showed their projection of the potential revenue surplus over the next 10 years based on estimated revenue and spending projections. The tax change as proposed in HB 110 would all but wipe out this projected surplus and by the year 2021 would probably result in a deficit. The legislature should assure itself of the value it expects to receive in exchange for such an extreme change in the future revenue picture of the state.
Impact of the tax change on exploration
Changes to the tax structure on existing production will not incentivize exploration. Only changes to taxes on production discovered through exploration will incentivize exploration and the only place where significant oil exploration can still occur is in NPRA. The OCS still has significant potential for oil exploration, but the state has no power to tax the OCS oil; so I have not included it in this discussion.
The changes to the tax structure to incentivize exploration is a good idea because the geology of the NPRA is not all that impressive. Analysis by the Department of Energy, National Energy Technology Laboratory suggests that we can expect to find a few fields similar in size to Alpine and a number of smaller fields but nothing the size of Prudhoe Bay. And the most prospective area around Teshekpuk Lake near the Barrow Arch is currently off limits because of cultural and environmental concerns. The proposed changes to the tax structure for exploration do not cost the state any revenue from current production. It only provides that if oil companies will explore for oil in Alaska, they will pay less tax on that oil. The tax incentive may not be enough, but it is a step in the right direction.
You cannot incentivize an oil company to explore for oil where they believe none exists, but you can incentivize an oil company to explore for oil where they believe oil might exist, even if their belief is that the chance of finding that oil is low.
If changes are made to the oil tax and additional exploration tax credits are added this year, the state may see renewed interest in exploration for oil in NPRA. In a few years, if there still seems to be a lack of interest in exploring for oil in NPRA, the legislature may need to revisit this area to see if additional incentives are appropriate.
Impact of the tax change on heavy and viscous oil
Production of heavy and viscous oil is technically challenging and costly to produce. The tax change reducing the oil tax on existing producing fields will certainly help, but it may not be enough. Plus the tax is overbroad in its application. The producers do not need a tax reduction to produce most of the current oil that remains in the existing fields, but they may need a tax reduction to produce the viscous and heavy oil. A tax reduction that is targeted to oil that is technically challenging and costly to produce makes a lot more sense than a tax change that provides reductions where none are necessary, especially to the tune of $10 billion. Plus a tax reduction that is targeted to areas where the need has been identified can be much greater than was proposed for the existing fields and the negative impact will be much less. If a change in the tax can incentivize the oil companies to produce the heavy and viscous oil, the potential revenue from this production could be substantial since there are billions of barrels of viscous and heavy oil waiting to be produced.
Summary
Tax changes should be targeted to where there is an identified need to encourage action from the producers. Tax reductions and credits that encourage production of technically challenging and costly oil make sense. Tax reductions that encourage exploration of NPRA make sense. Any other tax reductions that are directed at addressing a specific identified need make sense. Tax reductions where a need cannot be identified is a gift to those who receive the reduction.
“So the question tonight is, how do we continue growing an even more vigorous and diverse economy? And how do we create that gravitational pull for private-sector investment and job growth? It takes four things: keep taxes low, gain access to our resources, invest in Alaska energy, and strategically expand undeveloped resources. That's why this year I'm asking that we work together to lower taxes on oil, and create more jobs in Alaska. Let's build off the success of last year's tourism head tax reduction that pulled more investment to Alaska. Let's pass legislation to make our oil tax regime more globally competitive. Lower taxes lead to more resource development, and that leads to more jobs for Alaskans.” – Governor Parnell
House Bill 110 was submitted to the legislature at the request of the governor to address his recommended changes to the oil tax. According to the Department of Revenue fiscal note, the tax change could cost the people of Alaska approximately $5 billion over the next five years. But the tax is not just a five year tax. It affects all existing and future producing properties in the State of Alaska for the life of the leases. So why has the impact been projected to cost $5 billion? A quick look at the nature of fiscal notes gives us the answer. The impact of the tax change was projected to be $5 billion merely because of the relatively arbitrary reason that fiscal notes are only required to identify impacts for five years. The real question someone should ask is, “What happens in year six and every year thereafter?” The answer they will find is that this is not a $5 billion tax. It is a tax change that will cost the people of Alaska in excess of $10 billion over the life of the leases.
So what does the governor propose the people of Alaska get for their $10 billion? The answer is more jobs and hopefully more oil and gas exploration and development. But how do we know if this is a good deal?
Alaska jobs makes a good emotional appeal but certainly cannot justify the price tag of $10 billion. The only way to justify a tax change of this magnitude is through exploration and new production. The following examines the value of the proposed tax change to bring about new exploration and production.
Impact of the tax change on exploration and production
To determine the impact of the proposed oil tax change on production and on production from successful exploration it is important to first determine the projected production based on the current tax system. The best source for that information is the recent Department of Revenue, Oil and Gas Production Tax Status Report to the Legislature dated January 18, 2011. On page 10 of that report the department displays a chart showing production from all existing and discovered fields that the department expects will be produced between now and 2030. This is the Department of Revenue’s projection of present and future production based on the current oil tax without the proposed changes.
Impact of the tax change on production
Changes to the tax should see significant increases in production in addition to what has been identified in the chart. The problem is that state land, from the Colville to the Canning Rivers, is a mature province for oil production. We should not expect to see nor project discoveries in this area of anything greater than what we have seen over the last ten years, basically incremental satellite production which will, at best, reduce the production decline curve but should not be expected to increase production substantially over the next 20 years. The state will not capture a lot of incremental value here.
In terms of the legislation, the section that amends Alaska Statutes 43.55.011(e)(1) and (g)(1) reduces the oil tax by over $10 billion over the term of the life of the leases on the currently producing units with the hope that this change will increase exploration and development to sufficiently offset the tax change. The likelihood of this occurring on state lands is almost nonexistent. The only hope of significant additional production on state lands comes from increased production of viscous and heavy oil which will be addressed later in this article.
Changing the tax structure on existing production will only incentivize the producers to increase production in the existing fields which, as I have said above, will not occur to any major extent because of the maturity of the existing fields. In addition a tax change of this magnitude will have a significant impact on the future revenue of the state.
The Department of Revenue on January 25, 2011, made a presentation to the Senate Finance Committee regarding the Fall 2010 Revenue Forecast and a 10 year Revenue/Spending projection. On slide 9 of that presentation the department showed their projection of the potential revenue surplus over the next 10 years based on estimated revenue and spending projections. The tax change as proposed in HB 110 would all but wipe out this projected surplus and by the year 2021 would probably result in a deficit. The legislature should assure itself of the value it expects to receive in exchange for such an extreme change in the future revenue picture of the state.
Impact of the tax change on exploration
Changes to the tax structure on existing production will not incentivize exploration. Only changes to taxes on production discovered through exploration will incentivize exploration and the only place where significant oil exploration can still occur is in NPRA. The OCS still has significant potential for oil exploration, but the state has no power to tax the OCS oil; so I have not included it in this discussion.
The changes to the tax structure to incentivize exploration is a good idea because the geology of the NPRA is not all that impressive. Analysis by the Department of Energy, National Energy Technology Laboratory suggests that we can expect to find a few fields similar in size to Alpine and a number of smaller fields but nothing the size of Prudhoe Bay. And the most prospective area around Teshekpuk Lake near the Barrow Arch is currently off limits because of cultural and environmental concerns. The proposed changes to the tax structure for exploration do not cost the state any revenue from current production. It only provides that if oil companies will explore for oil in Alaska, they will pay less tax on that oil. The tax incentive may not be enough, but it is a step in the right direction.
You cannot incentivize an oil company to explore for oil where they believe none exists, but you can incentivize an oil company to explore for oil where they believe oil might exist, even if their belief is that the chance of finding that oil is low.
If changes are made to the oil tax and additional exploration tax credits are added this year, the state may see renewed interest in exploration for oil in NPRA. In a few years, if there still seems to be a lack of interest in exploring for oil in NPRA, the legislature may need to revisit this area to see if additional incentives are appropriate.
Impact of the tax change on heavy and viscous oil
Production of heavy and viscous oil is technically challenging and costly to produce. The tax change reducing the oil tax on existing producing fields will certainly help, but it may not be enough. Plus the tax is overbroad in its application. The producers do not need a tax reduction to produce most of the current oil that remains in the existing fields, but they may need a tax reduction to produce the viscous and heavy oil. A tax reduction that is targeted to oil that is technically challenging and costly to produce makes a lot more sense than a tax change that provides reductions where none are necessary, especially to the tune of $10 billion. Plus a tax reduction that is targeted to areas where the need has been identified can be much greater than was proposed for the existing fields and the negative impact will be much less. If a change in the tax can incentivize the oil companies to produce the heavy and viscous oil, the potential revenue from this production could be substantial since there are billions of barrels of viscous and heavy oil waiting to be produced.
Summary
Tax changes should be targeted to where there is an identified need to encourage action from the producers. Tax reductions and credits that encourage production of technically challenging and costly oil make sense. Tax reductions that encourage exploration of NPRA make sense. Any other tax reductions that are directed at addressing a specific identified need make sense. Tax reductions where a need cannot be identified is a gift to those who receive the reduction.
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