Roadmap to a Fair Tax

First, a fair tax on oil and gas will not result from “negotiations” with the producers even though it may be a good idea to meet with them to discuss and hear their concerns with the present fiscal system prior to and during any proposed changes to the current tax system.

Generally the producers will oppose what they don't agree with and aggressively oppose what they really don't agree with. The question is how to get the producers engaged in a way that creates productive exchange. The answer is you open up a public dialogue about oil and gas taxes. In that discussion they will explain what they don't like but not help you draw a line on what would be acceptable to them. Their goal will be to continue to put downward pressure on the system and to achieve the lowest tax they can achieve. That position does not allow them to support any tax changes even if the changes would be better than they are now. Their answer will be "that is not good enough." They will also not commit to additional exploration or additional investment based on a tax change.

With that in mind what is required is to get as analysis through models you can trust and try to develop a fair tax. During that analysis you will need to filter the comments made by the producers and figure out if what you are doing is fair based on their negative input. Here is how I would go about the analysis. First, separate analysis should occur for oil and for gas. The pipeline tariff on gas and the substantial volumes of gas that need to be transported to make a reasonable profit makes gas economics substantially different than oil economics.

A fair tax on gas includes an understanding of the possible range of tariffs for a gas pipeline. But the actual cost of the pipeline is not the critical element. The gas tax, like the oil tax should be fair at a range of prices from a marginal net value to a value of gas that is “wildly economic” as some used to say.

Once you distinguish the differences in economics between gas and oil, then break down the discussion between the different economic types of production and exploration, i.e., major know oil fields like Prudhoe and Kuparuk, extension exploration that extends the limits of the fields or that finds puddles near infrastructure, heavy oil production in those fields, known fields like Point Thomson which are large and have economic potential under the right circumstances, smaller marginal fields, exploration on state lands, exploration in NPRA, exploration offshore - state lands and fed lands. On offshore prospects distinguish prospects that can be explored from onshore and from bottom-founded rigs from exploration that must be conducted in the summertime from floating structures. Distinguish the Chukchi from the Beaufort. Recognize that we get no revenue from the Chukchi or Beaufort OCS but we should continue to pursue it (exploration and revenue). Next a comparative economic analysis should be done with other oil and gas provinces to determine the competitiveness of Alaska exploration and development from those in other provinces. Once you understand the relative economics of each of the above variables you can then begin to discuss deductions and credits vs reduction in tax.

Regarding progressivity - I still like some form of progressivity, but we need to remember that progressivity was based on a contractor spreadsheet that modeled Prudhoe Bay development, the most economic of all oil and gas development in Alaska. We knew at the time that there was a possibility that the tax might be too high. The bellwether areas for negative impact due to the tax would be heavy oil and exploration. We now have enough data to begin to see the impacts of the tax on exploration and heavy oil production. BUT we must always remember GEOLOGY IS KING. If the prospects aren't there, the producers won't explore no matter how low the tax. What we can't determine is if the producers aren't exploring because they think the taxes are too high or because the prospects are poor.

What we do know is that there is plenty of heavy oil and the producers aren't pursuing it aggressively. So there is a strong likelihood that economics are affecting the producers' desire to develop heavy oil on the North Slope. A discussion regarding the economics of heavy oil would be a productive discussion for the governor and the legislature to have with the producers.

If the legislature conducts the above analysis, it will have sufficient basis and understanding to make good decisions regarding one of the most important issues facing the state this year.

Legislative Agenda Proposal

Responsible Annual Budgeting, Budget Surplus, Budget Transition Period, Long-term Fiscal Plan, Permanent Fund, Nonrenewable Resources, Reserves Potential, Fiscal Stability, Fiscal Certainty, Fair Oil Tax, Fair Gas Tax, Alaska Large Diameter Gas Pipeline, Alternatives to a Large Diameter Gas Pipeline, Cook Inlet Gas Requirements, Interior Alaska Gas Requirements, Southeast Energy Requirements, Rural Energy Requirements, Alaska’s Gas for Alaskans, Point Thomson, what do all the items in the above list have in common? They, along with many other issues, must be considered in the context of each other to arrive at a comprehensive strategy to move the State of Alaska forward in the coming years.

A stable long-term fiscal strategy that does not require short-term changes to oil and gas taxes to balance the budget goes a long way to create the fiscal stability the oil and gas industry requires to invest in Alaska.

A fair tax on oil and gas that is fair at low prices and high prices, that is fair for marginal prospects robust prospects, that is fair for remote prospects as well as close-in prospects creates an investment climate that encourages explorers to test Alaska waters.

An annual budget that shows fiscal restraint and forethought about the future encourages business to invest because they are not concerned that they will be the ones called upon to supply the funds necessary to balance the budget now or in the future.

Examining those actions the state can take to encourage a large diameter gas pipeline may result in identifying certain steps that actually helps the pipeline move forward.

Getting existing development back on track encourages a business climate where industry can once again believe in fair treatment in the regulatory process.

Understanding the difference between meeting Alaska’s energy needs with “Alaska’s Gas” and meeting Alaska’s energy needs with the most economic energy alternative, for the short-term and the long-term is essential prior to making major funding decisions regarding energy projects.

Understanding and encouraging exploration to capture Alaska’s reserves potential while basing budgets on known resources is essential to sound decision-making.

Understanding that the Permanent Fund must play some part in the future of Alaska, more than just paying Permanent Fund dividends, is essential in developing a viable long-term financial plan.

The State’s obligation is to create a fiscal environment whereby business is secure and willing to take the investment risk necessary to succeed. It’s time to create that fiscal environment.

The above list is long and many complex issues are included, but it is one that can be accomplished. It’s time to get started. It is time to establish a plan. It’s time to lead. My hope is that the governor and the newly elected legislature are up to the task.

Consider the Candidate

My son made an interesting comment to me this morning after watching a few minutes of TV. He said, “I wish they would outlaw negative campaigning so that we could understand the views of the candidates.” His comment is important to remember. When we vote tomorrow, we should try to ignore all the negative campaigning that has occurred and try to remember what we know about the candidate.

 Are they people of integrity; are they people we can trust?

Are they respected by their contemporaries? Will others respect and listen to them if they are elected?

What about their positions; have they held them a long time? Can they express them in a way that will influence others to agree with them? Will they make a difference if they are elected; is the difference they are going to make one that we want?

Consider what you know about the candidate as you go to the polls tomorrow, not merely what others have said about them. Vote for someone you think might do the best job, not against someone based on what others have said about them.

NPRA Oil and Gas Reserves History

It might be helpful to understand the current USGS NPRA oil potential predictions in context. Below are some historical projections made by the USGS.

1.9 BBO      USGS 1976

2.1 BBO      USGS 1980

1.48 BBO    December 31, 2000 (EIA, 2001)

9.3 BBO      USGS 2002 NPRA Only

10.6 BBO    USGS 2002 NPRA Entire Area

10.4 BBO    June 30, 2005 (Bird, et al 2005 and AOGCC, 2005)

0.896 BBO  2010 Updated USGS Assessment of the NPRA

What is apparent from the above is that the current 2010 projections are only slightly less than the projections in 2000. The big change came in 2002 when the USGS increased the potential reserves almost 10 fold. The question one might want to ask is what happened between 2000 and 2002 to allow the USGS to increase reserves of the entire NPRA to such a great extent. The assumptions the USGS made in 2002 turned out to be wrong. They have now scaled back to the projections they made in 2000.

The USGS continues to be optimistic on gas. Below are the historical projections made by the USGS on gas. Please note the substantial change in reserves potential predicted in 2002.

6.3 tcf      USGS 1976

8.5 tcf      USGS 1980

59.7 tcf    USGS 2002 NPRA Only

61.4 tcf    USGS 2002 NPRA Entire Area

52.8 tcf    USGS 2010 NPRA

The USGS may be right about the potential for gas reserves in NPRA because there has been very little exploration for gas in the basin, but we will not find out if they are correct about their projections unless there is a major gas pipeline from the north slope to market the gas. No exploration company will explore for gas without the reasonable likelihood of getting that gas to market.

Repost - Resource Potential of the Alaska North Slope

The USGS recently published a 2010 Updated Assessment of Undiscovered Oil and gas Resources of the National Petroleum Reserve in Alaska (NPRA). The report can be found at http://pubs.usgs.gov/fs/2010/3102/pdf/FS10-3102.pdf


In that report the USGS downgraded the oil resource potential of NPRA from 10.560 billion barrels of oil to 0.896 billion barrels of oil. The new total is only about 10 percent of the total oil estimated in their 2002 assessment.  They also slightly downgraded the gas potential of NPRA from 61.352 trillion cubic feet of gas to 52.839 trillion cubic feet of gas.

Earlier this year I wrote an article regarding the resource potential of Alaska’s North Slope. I am reposting it here. What I attempted to show in that article and is apparent from the recent USGS revision is that “optimistic assumptions” about Alaska’s resource potential are exactly that – optimistic assumptions. Present budgets and future budget projections should not be based on the hope that large discoveries of oil and gas will be made in Alaska in the future.

In my next article I will discuss Alaska’s long term outlook in light of the USGS revised projections. I will also discuss some potential options Alaska should consider based on a range of outcomes that may occur in order to protect itself into the future.

Repost - Resource Potential of the Alaska North Slope

The Department of Energy, National Energy Technology Laboratory published a report titled “Alaska North Slope Oil and Gas A Promising Future or an Area in Decline in August 2007. The NETL recently published an Addendum to the Report. The report has often been quoted and used as a basis for projections of future oil and gas potential of Alaska’s North Slope.

The report is helpful in evaluating the prospectivity of certain areas of the North Slope as compared with other areas. For example, onshore state lands between the Colville and the Canning rivers and State Beaufort Sea, (basically all state lands on the North Slope) represent only ten percent (10%) of the future economically recoverable oil potential on the North Slope. Ninety percent (90%) of all future economically recoverable oil potential will be discovered on lands not owned by the state: twenty-one percent (21%) will be discovered in NPRA where the state will receive a production tax but no royalty; forty-seven percent (47%) will be discovered on the federal OCS lands where the state receives no royalty or production tax; and twenty-two percent (22%) will be discovered in ANWR where it is unknown what the state’s revenue percentage will be.

The state fares slightly better in the future economically recoverable gas potential. State onshore lands between the Colville and the Canning rivers and State Beaufort Sea represents almost twenty-five percent (25%) of all future economically recoverable gas potential on the North Slope. Seventy-five percent (75%) of all future economically recoverable gas potential will be discovered on lands not owned by the state: Twenty-two percent (22%) will be discovered in NPRA where the state will receive a production tax but no royalty; fifty-one percent (51%) will be discovered on federal OCS lands where the state receives no royalty or production tax; and a small percentage of gas may be found in ANWR where it is unknown what the state’s revenue percentage will be.

While the relative prospectivity of each area may be important to understand, the reality of what may be found in each area will be quite different. The NETL has modeled the potential for each area, not what they project will be discovered in each area. Figure 3-55 on page 3-107 of the report illustrates the production forecast for oil if the NETL’s “optimistic assumptions” (their term) are accurate. What the chart shows is current production will remain relatively flat for the next 10 years followed by a substantial increase in production until production peaks in 2042 at 3,000,000 barrels per day. This would mean the current oil pipeline would be at peak capacity and the state would have built a second pipeline to accommodate the additional production. This is based on NETL’s projection of the discovery of 35 to 36 billion barrels of oil. Obviously there is a very low chance of this occurring.

Figure 3-56 on page 3-108 of the report illustrates the production forecast for gas if NETL's "optimistic assumptions" are accurate. These optimistic assumptions of the discovery of 137 tcf of gas would have the state producing 11 bcf of gas per day by 2032 which would require all expansions by compression of the proposed 4.5 bcf per day gas pipline and then looping of that line. This too is a virtual pipe dream.

Many believe that the 137 tcf referred to in the NETL report will be discovered and produced over the next 50 years. In fact, they believe the potential is much greater. The only way to ground that belief in reality is to examine what they must also believe about the oil potential that was referred to in the same report. If they believe the 137 tcf will be produced, then they must also believe the 35-36 billion barrels of oil will be produced and that the existing TAPS pipeline will once again be at full capacity and an additional oil pipeline will be build to transport the surplus oil that has been discovered. The absurdity of such a position becomes apparent once it is understood in context.


Hopefully the above perspective will bring a bit of reality and understanding to the discussion of the oil and gas potential on the North Slope. The state should be an advocate for the oil and gas potential on the North Slope, but it should base its economic and business decisions on a more realistic analysis of North Slope potential. It is one thing to dream about winning the lottery, it is another thing to base your current business decisions on that assumption.

The August 2007 Report is located at http://www.netl.doe.gov/technologies/oil-gas/publications/EPreports/ANSFullReportFinalAugust2007.pdf



The April 2009 Addendum Report is located at http://www.netl.doe.gov/technologies/oil-gas/publications/AEO/ANS_Potential.pdf



If the above reference doesn’t work, the April 2009 Addendum Report can be accessed from the following page. http://www.netl.doe.gov/technologies/oil-gas/AEO/main.html