2-21-13 Reforming Alaska's Predatory Production Tax

Our friends at Arctic Power have asked our readers to take the time to sign a petition supporting the opening of ANWR’s Coastal Plain to Congressionally authorized oil and gas exploration. We agree! We also suggest that any American citizen or lawmaker who does not sign this petition cannot be serious about improving Alaska North Slope energy production. – dh

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Should Alaska Reform Its Predatory Production Tax and Improve Its Investment Climate? Duh?

Dave Harbour

Yesterday was part two (i.e. video archive coming tomorrow) of an Alaska State Senate Resources Committee hearing that began on Monday (i.e. video archive) and the overwhelming number of witnesses supported oil tax reform. Witnesses cited example after example of the State’s declining economy due to falling oil investments that could sustain a vibrant economy, were Alaska’s tax policies competitive with other oil investment areas.

The bill attracting the widespread testimony had been earlier introduced by Governor Sean Parnell (NGP Photo), SB 21. SB 21 is designed to improve Alaska’s investment climate and oil production by reforming the petroleum production tax (i.e. severance tax). We offered testimony (reprinted below) designed to provide lawmakers with a brief historical perspective of Alaska’s oil tax regime.

Most agreed that the Trans Alaska Pipeline System (TAPS), which once transported over 2 million barrels of oil per day was now on a path leading to extinction. This is because the 800 mile long, 48" pipeline is nearly 3/4 empty, averaging a little over 500,000 barrels/day but declining at an annual rate of about 7%. While Alaska once provided the country with 20% of its domestically produced oil and was the top producing state, it now delivers less than 10% of domestic production and is being left in the dust by competing producers: North Dakota, Texas, California … with Oklahoma and other states coming on stronger and stronger.

Alaska is in a particularly precarious position because — unlike other producing states — its governmental revenue sources are limited and undiversified. Some tax revenue flows into the State’s coffers from tourism, commercial fishing, mining, and timber–and from permitting and other regulatory fees. However, those sources are insignificant when compared with the 90% of Alaska’s operating budget nourished by oil taxes and royalties. Since Alaska is both among the highest cost oil producing areas and the highest taxing jurisdictions, it will continue to see investment flee to friendlier venues until it improves the investment climate. One witness said Alaska was like an unattractive date, wondering why no one wanted to dance with her.

As we said in our testimony, Alaska once had a stable investment climate that led to widespread prosperity for two decades. Then, two governors, during the last decade, began to tinker with a more complex net profit system for extracting severance taxes, moving away from the simpler, 15% gross tax on production, offset for declining productivity of older fields. With that big barn door opened, legislators piled on, increasing the net profit production tax rate and adding a predatory, progressivity feature that significantly removed investment incentive.

Steve Pratt (NGP Photo) of Consumer Energy Alliance – Alaska provided testimony on Monday that pretty well summarized the general message in support of tax reform as did citizens representing chambers of commerce, some labor unions (i.e. though some labor witnesses oppose tax reform), small business owners representing the 40 thousand employees that directly support the oil industry, and others.

Yesterday, oil industry experts testified. BP described the little known problems in administering, calculating and auditing Alaska’s complex production tax regime. ConocoPhillips emphasized the importance of treating all oil investments equally, in such a way that government did not pick with its tax policies, winners and losers. It said, and the other companies agreed, that the Prudhoe Bay and Kuparuk legacy fields could provide the greatest production increases if treated fairly. ExxonMobil assured lawmakers that incremental improvement in tax policy would positively affect incremental investment decisions.

One witness who identified himself as the Chief of Staff of a former governor advocated that lawmakers, "bring in the CEOs" of the top three producers to "negotiate" a tax rate with them. We are astounded at the absurdity of that suggestion. While CEOs have voluntarily come to the state in the past to personally interact with governors and even to negotiate individual issues, no CEO is in a position to ‘negotiate’ what his company will ‘do for Alaska’ in return for tax reform. This is because CEOs work at the pleasure of Boards of Directors representing shareholders. From time to time, their policies will changes based on changing conditions. It would be foolhardy and a blow to the free enterprise system if government officials begin thinking that they can ‘bring in CEOs’ to ‘negotiate’ quid pro quos in return for tax action. As ExxonMobil testified, government will set tax policy and investors will react to that policy. To suggest otherwise is to further isolate Alaska from investors and make the investment climate even more opaque. Using this line of logic, one is left wondering why this supposedly astute, former chief of staff didn’t urge the legislature to guarantee certain benefits to the oil industry when it retroactively enacted today’s predatory production tax.

On a related note, one legislator asked if the tax ‘take’ should be a certain percentage of total production revenue. In 1981, lawmakers and industry did agree on a general split, made easier by the large volume of production and the relatively smaller demand by the state for cash. Rather than an inflexible, formulary percent, today’s lawmakers could simply remember this: the higher the costs (i.e. including taxes) the lower the investment. Today’s strategy is probably best served by calculating a tax burden that makes Alaska competitive with other oil producing jurisdictions.

In the past, legislators have had nearly endless discussions with consultants about, "taxing to the tipping point". That concept is fraught with danger. Having government discuss how it can tax you almost to death without actually killing you is not an incentive for you to invest in that government. Even if the idea weren’t bad on the face of it, implementing a ‘tipping point’ would be impossible, for different producers have differing producing real estate properties with different cost structures with different organizations and varying investment policies.

Alaska’s oil tax policies have demonstrably resulted in declining production that threatens the viability of Alaska’s economy. That policy, was put into place retroactively and made investors prey to a predatory government.

Alaskans now appear to be increasingly concerned about falling production. There seems to be a growing consensus that the state should reform its oil tax structure to attract more investment. To this consensus, we say, "duh". The handwriting has been on the wall for many years and now that economic catastrophe is fully within view, action may be imminent. Since a changed investment climate will take years to result in investment flows, we can only urge lawmakers to make changes quickly.

There are two more things that can be done.

First, Alaska tax policy affects production on Alaska lands. The majority of real estate surrounding Prudhoe Bay (i.e. ANWR, OCS, NPR-A, etc.) is under federal control. Legislators and citizens need to also be supporting Governor Parnell’s efforts to fight overreaching, arbitrary and capricious federal efforts to slow or stop energy developments in the state. We need to be testifying at federal hearings and signing petitions such as the ANWR link noted above.

Second, just as we encourage Alaska to design tax policy that is competitive with other oil producing areas, so do we urge lawmakers to focus equal attention on government spending. Just as the Fraser Institute provides statistical evidence of Alaska’s oil investment competitiveness, so should the Legislature acquire statistics on Alaska’s status as a magnet, welfare state. By acquiring statistics reflecting Alaska’s tax policy and its spend policy status among other states, the State can most effectively pass onto its next generation a government that attracts prosperity by living, sustainably, within its means.

Testimony

Senate Resources Committee – Tax Reform

February 20, 2013

Dave Harbour, Publisher

Northern Gas Pipelines

Twenty years of tax and investment climate stability began in Alaska with a press conference on March 18, 1981, along with associated legislation. I would ask you to enter this video link of the press conference to your record in this proceeding: https://vimeo.com/10293150.

This new era of tax and investment climate stability followed about a decade of annual tax increases as Alaskans struggled to define the ‘fair share’ of oil and gas revenues that would have them achieving their constitutional mandate to maximize natural resource benefits.

The press conference featured: Governor Jay Hammond, Senator Jay Kerttula (Senate President), Senator Don Bennett, Senator Ed Dankworth, Representative Jim Duncan (House Speaker), Representative Hugh Malone, Representative Sam Cotton and Representative Tony Vaska.

Together they announced that with bi partisan legislation (i.e. which they jointly supported) they had achieved for Alaska a "fair share" of oil revenues: 30%. In fairness, we should note that the general sentiment seemed to be that Alaska’s share should not be ‘less than 30%’. Citizens should also understand that while this group of officials made a decision and established a tax policy, such action does not automatically bind future legislatures to adopt or maintain the same policy. A student of government would also appreciate that while government policies may be changed, the degree that they remain stable or unpredictable affects the reliability of the investment climate and the resulting inflow of investment.

The first ten years of Y2K resulted in a very large, retroactive industry production tax (i.e. severance tax) increase, contentious debates among taxpayers and tax authorities, a return to tax instability and lack of clarity for investors who were considering gas pipelines and other projects. By 2013, Alaska’s undiversified operating budget has become 90% dependent on oil revenue. Therefore, the fact that the Trans Alaska Pipeline System (TAPS) is nearly 3/4 empty and becoming further depleted at a rate of about 7% annually has put the social and economic future of our state in significant jeopardy. (Detroit has become fiscally insolvent and has lost over half its population, as reported this week. Part of its problem is an unfunded pension liability exceeding $6 billion; Alaska’s unfunded pension liability, with a population similar to Detroit’s, is over twice that of Detroit.)

Compounding Alaska’s Post-Y2K anti-investment message was a ‘natural gas reserves tax’ voters’ initiative sponsored by several Alaska lawmakers. The initiative failed in 2008, but its sponsors vowed to support it in upcoming election cycles.

Last year, legislators began talking of new, anti-industry legislation that would convert the State’s oil and gas income tax from an ‘apportionment formula’ to a ‘separate accounting’ income tax. The 1981 press conference documented in the video, memorializes the Legislature’s and Governor’s successful effort to repeal a "separate accounting" income tax experiment that resulted in a lawsuit the government felt it would lose. While changing from "separate accounting" back to "apportionment", among other things, the Legislature increased the severance tax from 12.25% to 15%, including an economic limit factor to encourage production from depleting fields. Such stability led to much more oil production than the proven reserves (i.e. 9.6 billion barrels) upon which the original field development and Trans Alaska Pipeline System investments were based.

Alaska production is now dropping quickly as production blooms in competitive oil and gas regions. At the time of the 1981 press conference, Alaska was America’s leading oil producing state, transporting about 2 million barrels per day through TAPS. The 49th State was providing the United States with about 20% of all domestic oil production. Now, Alaska provides less than half of domestic oil production and has fallen from its position as top domestic producer to ‘also-ran’ status behind North Dakota, Texas and possibly even California.

Thus, as Alaska had by 2008 become among the most costly places to engage in the oil and gas business, it had also become one of the most risky venues for new investment based on its uncertain initiative process and its unreliable–if not hostile–tax and regulatory policies.

Much of the anti-investment climate atmosphere here flows from a highly disciplined cadre of environmental activists. Some, but not all, labor unions oppose tax reform and seem to be more interested in short term, tax-revenue-supported, Davis-Bacon capital projects than in the State’s long-term, economic sustainability.

Many private sector citizens and organizations have confronted this challenge but with the Obama Administration also executing a withering array of regulatory and lease sale policies and attacks, hope for free enterprise nourishment from Federal land activity in and around Alaska is also uncertain.

If asked what course of action to follow, in view of my observations over the last several decades, I would suggest that the Legislature and Governor:

1. Take appropriate steps to make Alaska a more competitive oil producing state and investment destination, by

2. Clarifying, simplifying and stabilizing Alaska’s tax structure.

3. I further recommend that decision makers: recognize and appreciate Alaska’s competitive liabilities, including: remoteness to the markets, high logistical costs, high labor costs, climactic and volcanic risk, added cost of pipeline and tanker transportation, etc., and

4. Recognize the strengths of competitors, almost all of whom have lower labor costs, great resource potential, are closer to markets (i.e. and, are mostly located near transportation hubs or at tidewater), operate in friendlier climates (i.e. many of which are tropical), have experienced and less expensive labor forces, have shorter logistical chains, and

5. That they carefully evaluate competing oil and gas jurisdictions using various tools, including statistical surveys performed by organizations like the Fraser Institute, and

6. That they agree on an oil and gas taxing regime that puts Alaska, statistically, in the low median range

[1] of our competitors — in the eyes of investors — and

7. That they seek a way to offer guaranteed tax regime stability for one to two decades, perhaps by boldly creating a constitutional amendment permitting the Legislature more flexibility when trying to develop Alaska’s resources in a world full of aggressive competitors.

[1] “Low median” placement is intended to compensate for the non-statistical liabilities noted under 3. above.