Special Session in Retroscpect

GOVERNMENT TAKE SOARS TO OVER 80%,
PETROLEUM PROFITS TAX UP 400% IN TWO YEARS

Last month the Alaska Legislature completed a 30-day special session resulting in the most comprehensive overhaul of Alaska’s petroleum production tax (PPT) in decades, handing the oil industry an enormous tax increase that could discourage the future investment needed to stem the decline in North Slope production.

The final bill approved by the Legislature last month increases the PPT twice as much as what Governor Sarah Palin initially proposed as ‘Alaska’s fair share.’ When combined with the tax increase in the PPT last year, the oil industry is now faced with a 400 percent increase in production taxes.

Under the new PPT, the total government take, including other taxes and royalty, at current prices will increase to over 80 percent. That means out of every dollar earned in Alaska at current oil prices, industry will keep less than 20 cents of it, even though it invests billions of dollars each year to keep Alaska’s oil flowing to market, doing all the work and taking all the risks.

Initial estimates indicate the latest rewrite of the PPT could result in a staggering $1.5 billion to $2 billion tax hike on the state’s leading revenue-producing industry over the PPT enacted last year, which itself boosted industry taxes by $1 billion in 2006. Last year’s PPT would have collected $2.8 billion annually at $80 per barrel oil. The bill passed by lawmakers last month hikes the tax to $4.4 billion – far more aggressive than the governor’s proposal, which would have boosted taxes by $700 million at $80 oil.

Many Alaska business leaders throughout the private sector, as well as some legislators, are worried the huge tax increases of the past two years will deter vital future investment. The state should be concerned since it estimates more than 50 percent of Alaska’s oil production in ten years will need to come from new oil generated by future investment. Currently, the oil industry accounts for nearly 90 percent of state revenues.

“The Governor and her administration have crafted a bill and pushed it through the Legislature that will either tap the producers for another $1.5 billion without harm, or end up hurting our economy by driving away industry investment,” said House speaker John Harris, who voted in favor of the tax hike, along with a majority of his colleagues. “We will need billions of dollars of investment to keep our production up, so I am hopeful the Governor has not made a serious mistake with this legislation. But we won’t really know for sure for a couple of years.”

Harris was not overstating Alaska’s dependency on industry investment to stem the declining North Slope production curve. In fact, in order for the state to meet its Spring 2007 long-term production forecast, the industry will need to double its current investment of $2 billion to $4 billion a year, or $40 billion over the next ten years.

If the giant tax increases do jeopardize the economics of new projects and make the investment climate in Alaska less attractive relative to other opportunities elsewhere, the current production decline of six percent annually would likely accelerate. Maintaining the current decline would require industry to continue investing at existing levels, but the status quo isn’t very attractive since it would yield approximately 350,000 barrels a day in eight to ten years, half of today’s production and 50 percent of what the state is projecting in its longterm forecast. Moreover, the lower production level would pose serious operational challenges for Alaska’s economic lifeline, the oil pipeline.

If current industry investment in new drilling and enhanced oil recovery programs taper off, the production decline could accelerate to about 16 percent a year, putting production at 130,000 barrels per day by 2016. A moderate investment program that limits the decline to nine percent would still jeopardize pipeline operations.

Following passage of the Governor’s modified bill, reaction from industry was somber. Doug Suttles, President of BP Exploration (Alaska), Inc., said, “I am disappointed with the outcome. We all need to be focused on developing new oil production for future generations of Alaskans, but this legislation does nothing to encourage more investment. I can only hope that once the impact of this legislation is clear, the administration and the Legislature will revisit the issue.”

Contractors in the oil service sector warn there is no way the state can increase taxes on industry by billions of dollars and not experience significant contraction in the oil patch. Some expect cut backs within months, followed by an accelerating production decline over the next year as marginal projects are not pursued because of reduced incentives and higher taxes.

The Senate voted 13-5 for the tax hike while the House passed the measure by a 26-13 margin. Opponents claimed the bill was overreaching. The House succumbed to what many called a “feeding frenzy” that will grow state revenues and state spending at the expense of future investment and production.

Supporters of the legislation, including Governor Palin, a number of Republicans and most Democrats, claimed last year’s overhaul of the PPT was tainted by corruption and didn’t go far enough in its tax rate.

Governor Palin credited lawmakers for “improving” her bill. “All Alaskans should applaud the hard work of our Legislature on this important issue,” said Palin. “The bill strikes a careful balance. It assures a fair share of our oil’s value for Alaska, while encouraging producers to invest in new fields. This legislation creates stability for Alaska and I know it is the right thing for the state.”

The new PPT includes a 25 percent tax on the net value of oil and a steep progressivity schedule that applies a 0.4 percent charge for each dollar the price of oil rises above $52 per barrel. While allowing tax credits to encourage new development and reinvestment in existing infrastructure, it severely restricts capital expense deductions to scheduled maintenance and implements extended audit provisions. The new PPT caps operational costs at 2006 levels for the major fields and limits growth to three percent a year, even though industry costs have climbed 53 percent since 2005. The tax hike is also retroactive to July 1.

At RDC’s annual conference last month, President John Shively warned that the massive tax increase represents a huge risk for Alaska’s private sector economy.

“Taxes do deter investment, and I hope five years from now we don’t look back at 2007 and concede Alaska made a terrible mistake,” said Shively. “If so, it may be too late to turn the ship of state away from its ill-fated course.”