Economics of the Producers and Economics of the Pipeline

 I sit here thinking about the decisions before the legislature.  The legislature will make many decisions this year and in coming years regarding the gas pipeline, capital budgets, operating budgets, long-term fiscal plans, and the many needs of the people of Alaska that must be balanced against the ability to pay for those needs. All of the decisions, taken together results in a path forward. As Alaskans look back on those decisions, they will see where the legislature made good decisions and bad decisions. We can only hope that the good decisions will be of great benefit and result in lasting value and the bad decisions will be short-lived and not result in any great damage to the state.

Regarding the pipeline, there are at least two paths the legislature could take. One would be to spend much of its effort changing the economics of the pipeline and the second is to change the economics of the producer. The legislature has chosen the path that would change the economics of the producer although it could still do some things that would change the economics of the pipeline as well.

Changing the economics of the producer

This path primarily focuses on what the state can give up in order to get the producers to move forward with the project. The ultimate decision remains with the producers regardless of what the state gives up in the process.

I use the term project to refer to the pipeline because that is how the producers look at it. I understand that there will be several smaller decisions/contracts regarding gas treatment plants, pipeline participation, etc., but the producers will look at each of these in relation to how they can maximize their individual profits on the whole. Each negotiation will result in winners and losers. The negotiations will not be about all of the parties participating in a bigger pie even though the pie will certainly be bigger. The negotiations, at each stage, will be about reducing risk and costs and maximizing value to each producer from their individual perspective.

The path the legislature has chosen will course through many decisions. The bill before the legislature is not the first decision, and it is not the last the legislature will have to make. The decisions made in the current legislation will refine the path. Luckily, so far the legislation does not contain any major long term commitments, it merely sets direction.

What the legislature doesn’t understand is that unless it works to change the economics of the pipeline, it has done little to move the project forward. Any commitment regarding oil, for example, does little to change the economics of the pipeline.

Things that will change the economics of the pipeline are reducing the costs of infrastructure to the pipeline, maintaining infrastructure during the construction of the pipeline, understanding debt/equity ratios, making sure that the interest earned on equity and the interest on debt are as low as possible, making sure that Alaskans only pay for distance based tariffs for their gas (make sure you understand what the producers mean when they agree to distance based tariffs. It may be different that what you think), making sure that the tax on gas is fair to the state and to the producers, understanding where risk shifts to the state so that the decisions you make regarding that risk will be intentional, no surprises, making decisions to support a particular issue regarding the pipeline because you understand the consequences and agree they are acceptable, not because they are politically correct in an election year.

The most important thing to remember is that this path requires the legislature to depend on the producers to move the project forward. If the producers feel, at any stage along the way, that the economics are not sufficient to move the project forward, they will return to the state, not with hat in hand asking for more, but with a club demanding more; and the state will be at a disadvantage of not knowing if the producers really need whatever they are demanding to move the pipeline forward or if they are merely taking advantage of the situation. The state will be in a position of acquiescing to the producers demands or reaping the wrath of their constituents for killing the pipeline. The producers will certainly have their contractors and supporters writing letters and testifying to the need for whatever the producers request. I am not accusing the producers of being bad. I just understand what they will do when given the leverage to extract additional concessions along the way. It will become clear that what you thought was the deal today will not be the deal two years from now or even months from now when another decision-making milestone is reached. You have released control of decision-making to the producers and you will reap the outcome.

Economics of the pipeline

The legislature can have a substantial impact on the economics of the pipeline, but it is a more difficult path than the one chosen. It requires more research and understanding. It requires a different kind of risk-taking. The difference between changing the economics of the pipeline and changing the economics of the producers is partially the difference between taking the risk with current dollars (changing the economics of the pipeline) which the legislature could be held accountable for on the failure leg, and taking the risk with future dollars (changing the economics of the producers) which the legislature will probably not be held accountable for if history is a indicator of reality.

There are many ways to impact the economics of the pipeline. I would recommend the legislature understand these as best they can before they proceed forward with agreeing to anything with the producers.

Paying for the cost of infrastructure and not placing that burden on the pipeline will have an incremental impact on tariff. The legislature needs to understand how much before they agree to those costs. Some have said that the producers have not asked the state to pay for the costs of infrastructure. My answer is wait. It's in the legislation and it will be in the proposal when the administration returns to the legislature in the next phase. Interestingly, the administration should have been focused on improving infrastructure for the last several years in anticipation of moving the pipeline forward and the state should continue to do so in the future. I am not against the state paying for infrastructure, or at least a portion of infrastructure. I just want to make sure the state understands the value of that payment and captures the accompanying value for the state.

The legislature needs to understand the impact of equity and debt on the pipeline. The debt/equity ratio will have a substantial impact on the tariff. The pipeline owners (especially TransCanada since that is where they will capture their value) will want to argue for a high proportion and large return on equity. The producers will join TransCanada in asking for a large return on equity. This is a way for them to balance their risk. They will also argue that, if the State participates as an owner, it will join the other owners in reaping the benefit of that return on equity. This is a two-edged sword and it cuts both ways. I believe that a lower return on equity and a lower proportion of equity serves the state in the long run, and it certainly serves explorers and those not fortunate enough to own a piece of the pipeline.

Regarding debt/equity ratio, the state should argue for the smallest equity and the largest debt that financing will allow while not significantly impacting the cost of debt. The interest on equity and the interest on debt are substantially different and the legislature should understand those before it agrees to anything in this area. Interest on equity is often more than twice as much as interest on debt; so every dollar of equity allowed impacts the cost of the tariff substantially more than a dollar of debt.

One of the ways to impact the tariff has to do with the timing of paying back the equity. If payment on the equity was delayed until most or all of the debt was paid back, the tariff would substantially benefit, and it would also reduce the cost of the debt which would have an additional impact on the tariff. Of course, the only party that would agree to such a deal would be the state. But the state may want to consider such a decision since this decision would have a substantial impact on the tariff and a corresponding impact on the economics of the pipeline.

The financing of the pipeline and the various elements of the project needs to be understood thoroughly. Many of the options that would impact financing have not even been considered. The producers will suggest that this will be dealt with in the contract negotiations, but some of the possible alternatives will be taken off the table if the state does not evaluate its options now. State ownership, how much of the pipeline the state should own, and how it should manage its ownership are decisions to be made sooner rather than later.

There are many more issues that should be addressed, but the above issues are some of the most important.

Some would ask why they should consider anything I write, especially since I have been out of the state for several years. A good question. The answer is that I worked in the oil and gas industry for over 20 years and participated in several failed attempts to move a pipeline project forward. I also represented the state in pipeline contract negotiations with the producers during the Murkowski administration. I watched the producers negotiate with the state and with each other. I observed their areas of agreement and their differences. There were two points that became clear through the negotiations: 1) each producer attempted to reduce individual risk and maximize individual value. Interestingly what each producer valued was different and led to more conflict between the producers than conflict with the state, and 2) the producers were in alignment in attempting to shift as much of the risk and cost as possible to the state and obtain as much value through reduced taxes and other fees as they could.

The state has many decisions to make regarding the pipeline. My hope is that you don’t make any commitments without fully understanding the value and impact of those commitments and that you make commitments for the shortest timeframe possible so that bad decisions don’t linger for that many years. My hope is that there will be many more good decisions than bad.

 

An analysis of SB138

The Alaska Legislature is currently considering SB138 at the request of the governor. The substance of the bill cannot be reviewed without understanding the context in which it was submitted. The proposed legislation was submitted based on a commitment the governor made to the producers when the governor, through the Departments of Natural Resources and Revenue and the Alaska Gasline Development Corporation signed the Heads of Agreement (HOA) dated January 14, 2014. SB 138 is the result of the governor’s commitment, and most of the provisions of the legislation come directly from that commitment.

 Article 4.4 of the Heads of Agreement (HOA) states that “A decision by the Alaska LNG Parties to advance the Alaska LNG Project to FEED is subject to, among other things:

a. Enabling Legislation and other laws and regulations of the State to advance the Alaska LNG Project, including necessary fiscal and commercial terms as set forth in this HOA;”

Article 7.3 of the Heads of Agreement (HOA) requires the administration “to the extent permitted by law” to “include and support the provisions of Articles 5 through 12, inclusive, in any future legislation or contractual arrangements.”

 The question the legislature should be asking is what did the governor commit to in the HOA? How does that affect the governor’s ability to seriously consider any changes the legislature may propose? What are the actual impacts to the state of the proposed legislation? And what commitments are reasonable for the state to make to encourage the development of a major gas pipeline project? This final question is the most important, and the legislature should come to its own conclusions regarding what the state is willing to do to encourage a large diameter gas pipeline.

 

The fact that the governor signed a document in January to support certain terms does not change the decisions the legislature should make. A decision not to follow what the producers requested in the HOA is not a decision against the pipeline even though that is exactly what the producers will argue. The legislature has a responsibility to review the terms of the proposed legislation and make sure the interests of the state are protected. There will be a bias toward giving the producers whatever they want in order to be seen as supporting the gas pipeline. The legislature must understand this bias and guard against making decisions that are not supported by sound reasoning and economic justification.

The producers are generally going to attempt to change the economics of the pipeline and shift risk to the state through several means:

1)      Reducing/protecting the tax on oil.
2)      Reducing/protecting the tax on gas.
3)      Providing “fiscal certainty” on the benefits gained for the longest number of years.
4)      Getting the state to pay for as much of the cost of the pipeline as possible.
5)      Shifting as much of the risk of the pipeline to the state as possible.
6)      Having the state be an owner of the pipeline so that the producers can have the state pay for any loss of fiscal certainty or risk through the state’s revenue stream.
7)      Alignment of the parties

 Reducing/protecting the tax on oil.

The producers are well aware of the initiative process that would repeal the current tax and revert back to the prior tax. The producers will use the agreement to move forward on the gas pipeline as leverage during the vote to argue that a vote for repeal is a vote against the pipeline. Interestingly the oil tax does not have a major impact on gas pipeline economics. The pipeline economics models upon which the producers depend will attribute no more than a 5% change in economics based on the fiscal certainty on oil. The producers will argue that they must have fiscal certainty on oil or the gas pipeline cannot move forward. Their argument is that the legislature may change the tax on oil if they don’t like the deal they are receiving on gas. There is always a risk that the tax structure will change if the industry is obtaining a disproportionate value from the oil and gas resources in Alaska. That is exactly what happened to the Economic Limit Factor. When the state finally figured out that Kuparuk would pay little or no severance tax while the producers were receiving billions in revenue, it was time to change the tax. Likewise, the state should be cautious when agreeing to protect the current or a proposed tax on oil and gas for more than 15 to 20 years. My guess is that the producers will request 35 years. The state cannot project more than about 10 years into the future when it comes to taxes, and the economics of oil and gas could change substantially in that time. The longer the term of fiscal certainty, the greater the risk to the state that it made a bad decision. 

Reducing/protecting the tax on gas.

The proposed legislation sets the tax on gas with little or no analysis of what the state would receive under the current law or what the state would receive if current law is repealed by a vote of the people. When the value of what the state is giving up in the legislation is not well considered, there is a significant chance that the state is giving up more revenue than it should, especially when the proposed tax rate probably came from the producers as did much of SB 138. There has been very little review and analysis of one of the most significant terms of the legislation. There should be extensive fiscal notes and presentations of the probable revenue impacts from a proposed tax on gas.

 
Providing “fiscal certainty” on the benefits gained for the longest number of years.

This issue has been discussed above, but the key is the legislature should only provide fiscal certainty, if at all, for a limited term. Twenty years is more than enough for the producers to obtain the benefit of their bargain to commit their gas to the pipeline.

Getting the state to pay for as much of the cost of the pipeline as possible.

 
The building of infrastructure is an important aspect of the overall economics of a large-diameter gas pipeline. If infrastructure (roads and bridges, etc.) is built and maintained properly throughout the project, the result could be substantial cost savings or a higher likelihood that there will not be cost overruns due to infrastructure failure. The issue will be how to allocate the cost of infrastructure between the parties. There are suggestions in the proposed legislation and in the Heads of Agreement that the producers will attempt to shift as much of the burden of paying for the cost of infrastructure onto the State of Alaska as possible.
 
Section 31.25.005(5) states that the state corporation to the fullest extent possible should “advance an Alaska liquefied natural gas project by developing infrastructure and providing related services.”
 
Article 10 of the HOA refers to additional State Support for the Alaska LNG Project. Article 10c references “appropriations and permitting for the construction of necessary in-state infrastructure (e.g. roads and bridges) including drafting, introducing and supporting legislation.”

The cost of infrastructure improvements and maintenance required to build the pipeline could be around one to two billion dollars. As much of the cost of infrastructure as possible should be shifted to the federal government. If the state decides to pay a part of the infrastructure costs from the general fund, it should make sure it receives value for that investment.

 Shifting as much of the risk of the pipeline to the state as possible and Alignment of the parties

 
You will hear a lot of talk about alignment of the parties. Much of the alignment will be the producers, in the contractual agreement with the state, shifting risk and costs from the producers to the state. Specifically the producers will require the state to accept the risk of any legislative changes to either the oil or gas tax. This will be similar to a “poison pill.” If the legislature or any local government finds a way to extract additional revenue from the producers, the state will be required to pay the difference in revenue from the state’s portion of the pipeline revenue.
 
Another area where the producers will attempt to limit risk and liability for the pipeline is through the creation of subsidiaries. The producers will propose shell corporations that will protect the parent corporations from any liability and risk associated with the pipeline. The state should require a parent guarantee if the state decides to participate with the producers in the pipeline project. The state should not be the only deep pocket in the room. I assume the producers will argue that the state could also create a shell corporation. The difference is that the producers can allow the pipeline to go belly up and only lose what was invested in the shell corporation (still a significant value), but the state will be stuck with a similar loss as the producers plus the state will be stuck with the result of the failure even if it has created a shell to protect it from liability.

There are other areas where the producers have shifted the cost of the pipeline to the state. One example is workforce training. The producers added a credit for workforce training to the legislation. Because there is already a cap on the total credit allowed, the producers will merely shift what it normally contributes to the university and other organizations currently identified in the credit to training on the pipeline, effectively transferring to the state the cost of pipeline workforce development with a concurrent loss of revenue to the university and other educational institutions. The fiscal note on this issue is similar to a ostrich burying its head in the sand. The fiscal note argues that it cannot determine the revenue impact to the state because it cannot predict the decisions of the producers in advance.

 Summary

 It will be argued that the legislation as proposed does not commit the State of Alaska to anything. The proposed contract that will be presented to the legislature in the future is where the legislature will get an opportunity to examine the terms of the deal. Actually what the legislature is agreeing to in SB 138 is the sideboards of the agreement, and it is clear that the proposed contract, when it is submitted to the legislature, will ask for incrementally more from the state. The legislature needs to understand and be clear about what it is agreeing to in the proposed legislation. This is not legislation to support the Alaska Gas Pipeline. This is legislation that will set the terms of the deal between the producers and the state for a future gas pipeline and the accompanying revenue from that endeavor. Proceed with caution.

Arguments Falling on Deaf Ears

This evening I listened to the House Finance Committee debate amendments to SB21, the Oil and Gas Production Tax. I heard Joe Balash, Deputy Commissioner for the Department of Natural Resources state, ”We are taking less in order to get more.” This is a variation of the Reagan Tax cut philosophy. Reduce taxes and grow the economy. Since it worked for President Reagan, why wouldn’t it work for the State of Alaska. Cutting taxes to grow the economy works when you have a potentially expanding pie. The U.S. economy wasn’t a limited resource, and the U.S. economy grew and generated more wealth for individuals and businesses and additional revenue for the U.S. government.

Alaska oil production potential, on the other hand, is a limited resource. State lands on Alaska's North Slope between the Colville and Canning Rivers is a mature region as it relates to oil potential. There is only a minor potential to expand production. You might consider it a marginally expanding pie. The state can encourage new production, but it will only affect production on the margin. In other words, at best, the oil industry will only produce marginally more oil based on a change in the tax. If the Alaska legislature reduces the tax substantially, there is simply not enough oil on state lands to make up the difference. The numbers just don’t work.

I also heard that lower taxes will result in higher bids at lease sales on state lands. There is a failure of logic in this assumption as well. Lower bids at lease sales on state lands are not because of the tax structure, either high taxes or low taxes. Lower bids at state lease sales are because there are no longer any potentially large hydrocarbon structures that might hold significant new reserves on state lands. All the major oil structures on state lands on the Alaska North Slope have already been drilled and explored. The geologic potential on state lands is limited. Any geologist, whether from DNR or the industry, will tell you there are no more “elephants” on state lands on Alaska’s North Slope.

So how will this reality play out at the next lease sale? If the legislature passes a reduction in tax, the lease sale will occur and the bids per acre will continue to remain small, and the higher bids per acre that the administration suggested would occur if the tax is reduced, will not materialize.

Lease bids per acre will not increase substantially at the next lease sale or any sale thereafter if the legislature decreases the tax, but you will not find the administration acknowledging their error or apologizing for their mistake. In fact they will conveniently ignore that they suggested substantially more revenue at the new lease sales based on the reduction in tax. Their failure in logic is they don’t understand that lease sale bids are based on geology, not taxes. They don’t understand that you can’t make up for a substantial revenue shift from the state to the industry based on the potential of new production in an already mature region. They don't understand the financial implications of a significant revenue shift from the State of Alaska to the oil industry. They don't understand that there is not enough oil to make up for the revenue shift. They merely provide scenarios of the new production that is required to make their proposal work. I have already written about the standard upon which the proposal will be reviewed. I wish the numbers were there to make their proposal work, but the numbers simply don't pencil out.

 

It may be appropriate to modify the tax. It may be appropriate to create a better balance between the industry and the state so far as sharing revenue at low and high oil prices, but the argument that the state can transfer a significant amount of revenue from the state to the industry and make it up in revenue from increased production just simply doesn't pencil out.

As I listened to the discussion at the House Finance Committee, I wished the parties could put down their political affiliations. I wished for an engaged discussion of the finances of proposal. I wished for an evaluation of the likelihood of success of the proposal. I also wish that this article would stimulate additional discussion and evaluation of the proposal, but I am afraid my efforts at encouraging debate will fall on deaf ears.

Bummer for good decision-making. Bummer for the people of Alaska.

 

 

Hall of Fame or Hall of Shame

The Alaska legislature is considering a revision of the oil and gas tax structure in the State of Alaska. There are several estimates of the impact of the change, and not all agree; but it is clear that the proposed change will transfer billions of dollars from the State General Fund to the pockets of the oil and gas industry in the coming years.

How do the legislators know if they are making the right decision?

How will their decision be evaluated in the future?

When will the chickens come home to roost? (sooner than you think!)

Those legislators that vote for the change in oil and gas taxes will either be elevated to the Hall of Fame if they are correct or the Hall of Shame if they are wrong. What is clear is that their vote will certainly be remembered. The next question is how do we know if they should be elevated to the hall of fame or relegated to the hall of shame?

In the article that follows I propose a standard upon which they should be reviewed and I share my concerns with the process and the information that has formed the basis of their proposed legislative change.

The Standard of Review.

Each fall the Department of Revenue produces the Fall Revenue Sources Book for that year. The section of the Book that is the most important for purposes of our discussion is the production projection section. Read pp. 40-45 of the Fall 2012 Revenue Sources Book starting at 4. Crude Oil Production. I recommend legislators read this section because it will be the standard upon which they will be evaluated.

The Revenue Sources Book projects a High Case, a Low Case, and a Risk Adjusted Case. The Risk Adjusted Case is the Department of Revenue’s projection of production in the future based on the current tax structure. (See Figure 4-12, at p. 44).

If future production is equal to or less than the Risk Adjusted Case then the reduction in tax and the transfer of billions of dollars in revenue from the General Fund to the oil and gas industry will be a failure, and the governor and the legislators that voted for the tax should be held accountable.

If future production is greater than the high case projection, then the reduction in tax will be deemed a glowing success and the governor and the legislators who voted for the reduction in tax should be voted into the Hall of Fame because they have made a great decision on behalf of the State of Alaska.

If future production is greater that the Risk Adjusted Case and less than the High Case then the result is uncertain. It will depend on how close production is to the Risk Adjusted Case or the High Case. In this world those in favor of the tax and those against the tax will both have justification to argue for their positions.

Some have argued that all the industry has to do is make sure the decline curve is less than 6% in order to show success, but this is not the case. The Risk Adjusted Case in the near term is a much lower decline curve than that. The Risk Adjusted Case has an Alaska North Slope production decline as follows:

Year    Production      Prod Decline   Percent Decline

2013    552.8

2014    538.4               14.4                 2.6%

2015    518.6               19.8                 3.7%

2016    499.7               18.9                 3.6%

2017    476.1               23.6                 4.7%

2018    442.9               33.2                 7.0%
 

If the industry doesn’t beat the Risk Adjusted Case over the next few years, then the reduction in tax will have been an unfortunate decision.

For a more detailed analysis of the Department of Revenue Forecast see C-2b Crude Oil Production – Forecast at p. 105 of the Fall 2012 Revenue Sources Book.

For those of you that believe the decision cannot be reviewed in the short term because it takes 6-10 years for an exploration project to come on line, you have been misinformed. Production impact can be seen in a much shorter timeframe.

We are talking about increasing production between the Colville and the Canning Rivers, in essence in or near existing fields. Production in or near existing fields can be brought on-line in as few as 2 years. If you need authority for this position, you need only look at the development of Meltwater and Tarn. I was the permitting director on Tarn and I know how long it took. The impact on the Department of Revenue Forecast can be impacted as soon as the wells are on the books to drill, and certainly by the time they are completed. Clearly before the next election cycle there will be sufficient information to begin to see if the reduction in tax has been a success or failure.

Concerns with process and information

The governor has proposed that new additional production will more than exceed the revenue given up in the reduction in tax. But where will that production come from, and is there sufficient production (beyond what is already projected in the Risk Adjusted Case) to account for the increase.

Once again I refer you to the Fall 2012 Revenue Sources Book at page 45. The Department makes reference to the 2007 U.S. Department of Energy Report. The Report projects the Mean Technically Recoverable Oil for the Alaska North Slope State lands (Colville-Canning Area) to be  4.5 billion barrels of oil or only 11.7% of the Mean Technically Recoverable Oil on the North Slope. If you add NPRA to that number, you increase the percent to 14.1 percent. That means that over 85% of the Mean Technically Recoverable Oil on the North Slope is not affected by the change in tax because 85% of the Mean Technically Recoverable Oil is on federal lands and cannot be taxed by the State of Alaska. Some would point out that 27.2% of that oil is projected to be in ANWR. This is true, but that would mean that 58.6% of the oil would still come from the federal offshore that cannot be taxed by the State of Alaska, and no change in the tax will impact industry decision-making in those areas.

Another interesting fact, if you add up all the production the Department of Revenue projects to be produced between 2013 and 2022 you come up with 4.5 billion barrels. The Department of Revenue is projecting that industry will produce all of the Mean Technically Recoverable Oil based on the current tax regime. Clearly the legislature has a lot of questions to ask before it is ready to pass a change in the oil and gas tax.

Next, I am concerned that the governor is withholding information from the legislature and the Alaska public. If the governor has asked for and received reports from other consultants, whether favorable or unfavorable to his position, he is obligated to release them to the public. If the information is adverse to the governor’s position, the governor is subject to being accused of abusing his position and manipulating the data upon which the legislature is making its decision. First it is a breach of ethics and second it is probably illegal. The Alaska Public Records Act, by letter and intent, requires to governor to provide the reports timely, in this instance, before any vote on the subject of oil and gas taxes is made. The entire legislature should demand nothing less. This is not a political issue. It is the responsibility of the sovereign to make sure a thorough and complete review and analysis is done by the legislature prior to making decision of such magnitude. If the governor is withholding reports he has received, he is violating his responsibility to the people of the State of Alaska. If he does not have the integrity to uphold his responsibility to the people, the legislature should do so for him. The legislature should stall the vote until they have all the pertinent information upon which to base their decision. They should then review the reports proceed ahead with the legislation as they see fit.

 

In conclusion, I am surprised that the administration has not put forth more factual/statistical data to back up their proposal. The governor cannot merely make projections based on the numbers he hopes will occur. He must analyze the possibility that his projections might occur. I have reviewed his projections and I cannot back them up with data.

The legislature should not pass such a significant piece of legislation without understanding the reasonable possibility of its success. Merely "going with the party" because they are prodevelopment is not sufficient in this case. The result could cost the state billions of dollars and could cost the proponents their next election.

 

Technology or Tax, Week 7 in Review

In the governor’s Week 7 Oil Tax Message, the governor posts a chart of Oil Production Trends in four areas: Alberta, Texas, North Dakota, and Alaska. Alberta, Texas, and North Dakota show increases in production. Alaska shows a decline. The implication is clear. Alaska is not competitive because of its oil tax structure. This article will examine that premise.

Alberta

Alberta’s production chart shows progressively increasing production since 2001.  In order for the governor’s premise to hold true, Alberta’s tax structure should show consistency since 2001 and certainly should not show any substantial increases in tax during that time. The problem with the premise is that Alberta passed a New Royalty Framework in October 2007 that became effective January 1, 2009 during the time that Alberta saw a constant and substantial increase in production. Alberta’s government analysts projected that royalties would increase approximately $1.4 billion in 2010 based on the change. In essence the opposite conclusion from the governor’s premise could be suggested. But the real answer is not the increase or the decrease in taxes. It is in the Alberta Oil Sands and the technology to produce oil from the sands.

Texas

The chart representing Texas oil production shows substantial increases in production starting in 2010. For the governor’s premise to be validated, Texas would have had to change its tax structure prior to 2010 leading to the increases in production. Once again taxes had nothing to do with the increases in production. Dr. Mark J. Perry, professor of Economics at the University of Michigan explained it best when he stated, “The exponential increases in Texas crude oil over the last two years have been largely the result of the dramatic increases in oil being produced in the state’s 400-mile long Eagle Ford shale formation in south central Texas, which was only recently discovered in 2008. Eagle Ford crude production has more than doubled over the last year, from 120,532 barrels per day in July 2011 to more than 310,000 barrels per day in July of this year, according to a recent Reuters report, and now accounts for about 16% of the state’s monthly oil output. Advanced drilling technologies like hydraulic fracturing and horizontal drilling have also contributed to an almost doubling of the Lone Star State’s oil production over the last three years.”

Once again the change in oil production was a result of advanced drilling technologies, not taxes.

North Dakota

The North Dakota chart shows a substantial increase in production starting in 2006. The governor’s premise would suggest a possible change in oil taxes prior to 2006 created the North Dakota boom. But the tax structure did not change. The culprit was the Bakken Formation which now produces 91% of North Dakota’s oil production. Horizontal drilling and hydraulic fracturing is the reason for the change, not taxes.

Alaska

Much has been written about the decline in oil production in Alaska. But the bottom line is that we have changed the tax structure several times and regardless of the tax structure, the developed fields in Alaska have followed a standard decline curve as they should. The region of state lands between the Colville and the Canning Rivers is a mature region so far as oil is concerned. We can expect that the decline curve will not change substantially based on any tax change.

The bottom line is that most increases in production anywhere in the world is based on new reservoir discoveries or changes in technology. I could not find a single region where substantial increases production was the result of anything other than successful exploration of a new area or advances in technology.

The governor's premise that the tax structure is the reason for the increase in production in other regions and reason for the decline in production in Alaska is not substantiated by the facts.