THE TIPPING POINT

SPECIAL SESSION: HIGHER OIL TAXES COULD HAVE LASTING NEGATIVE IMPACT ON ALASKA’S ECONOMY

By Chuck Logsdon

Alaska is at a crucial decision point with respect to its economic future. Total oil production flowing through the TransAlaska Pipeline System has plummeted by over 65%, falling from a peak output of 2.1 million barrels per day in 1989 to current levels of less than 700,000 barrels per day.

Every Alaskan should be worried about their economic lifeline being twothirds empty. What do most people think when their own fuel gauge indicates there is only onethird left in their tank? Don’t they consider investing in a full tank at the next station? That’s what Alaska needs to focus its attention on now, putting more oil in the pipeline. But that will be easier said than done.

Over the last 11 years, the oil production decline rate has averaged 6% per year. Without the billions of dollars invested by industry over that same period of time, the decline would have been even more severe. This investment was to develop new stand alone fields like Alpine, satellite fields, and new investment in increasing the recovery from existing fields like Prudhoe and Kuparuk. The importance of further development in Alaska’s legacy fields was illustrated recently by BP’s Doug Suttles in a recent presentation. In those remarks he pointed out that the new investment BP made in existing fields last year added more than 70,000 barrels per day of new production. A separate field producing oil at this level would be the fourth largest in Alaska.

Production forecasts by the Alaska Department of Revenue (DOR) suggest that the future decline in production will become even more pronounced without further investment in oil fields that are not yet developed or have not been fully developed. In fact, DOR is forecasting that “by FY 2010, onequarter of our projected oil production will come from projects requiring significant new investment” and in 10 years, approximately 50% of the oil will need to come from “new oil.”

ANOTHER TAX HIKE LOOMS FOR ALASKA’S OIL INDUSTRY

THIRD IN THREE YEARS: ALASKA’S FISCAL STABILITY FOR NEW INVESTMENT RANKS LOW

The list of undeveloped projects includes areas that have significant economic, technological and logistical challenges, such as the offshore Liberty field and fields in the National Petroleum ReserveAlaska (NPRA). The DOR production forecasts also include fields that have not been fully developed, like the enormous heavy oil deposits overlying the legacy fields in the Prudhoe Bay and Kuparuk production units.

It is projected that there are 20 billion barrels of heavy, viscous oil on the North Slope. It will not be easy to get this oil out of the ground as it is in shallow deposits close to the permafrost zone. Making this oil flow out of the source rocks is like sucking up cold honey with a straw. The industry has made great strides in developing the technology and production techniques that will lower the cost of tapping this abundant resource, but it will still require a huge commitment of capital to fully develop the resource.

At the same time, large outlays of investment will also be needed just to keep the oil production decline at Alaska’s largest oil fields at Prudhoe Bay and Kuparuk from accelerating.

Where will this capital come from? It will come from oil industry profits. This can take the form of either current cash or debt to be paid from future profits. The greater the likelihood of significant profit, the more likely these investments will be made.

The Palin Administration estimates the suggested modifications to PPT would significantly raise taxes by over $700 million. This is a significant increase and creates two disincentives to investment. First, higher taxes reduce profits and the pool of capital available to industry for investment in future production. Second, higher taxes make Alaska relatively less competitive with other petroleum areas in the world.

The proposed changes to the PPT raise tax rates at all levels of profit and even raise taxes when no profit is made at all in the case of the legacy fields. According to the DOR’s own analysis, their recommended adjustments to PPT do not improve the economics of any sample project, a fact acknowledged during the state’s October 2 press conference when DOR Commissioner Pat Galvin stated, “Frankly, we have not said that ACES improves the investment climate. Clearly, there is going to be a larger state share and that isn’t going to make the economics of projects better.”

This tax increase is designed solely to raise more revenue, and is coming at a time of budget surpluses, with no apparent plan for addressing the issue of the state’s longterm reliance on oil production to support the economy. The state continues to rely almost exclusively on oil taxes and royalties to pay for discretionary, operating and capital expenditures, averaging 8590%. The state spending of oilderived revenues, along with oil industry operating and investment expenditures and federal spending are the linchpins of the Alaskan economy as we currently know it, and will continue to be until we obtain revenues from a gas pipeline, which is at least a decade away.

The proposed tax increase would be the third significant increase in oil taxes since 2005. By adopting additional, higher oil taxes, Alaska risks being labeled as a fiscally unstable region, thus reducing its ability to compete for industry capital. Alaska already has the highest government take in North

merica and a higher than average government take compared to the world’s other oil producing regions. In fact, according to the Wood Mackenzie Study of June 2007, Alaska ranks 99th out of 103 in fiscal stability. We have the dubious honor of being ranked just above Russia, Bolivia, Argentina, and Venezuela. This additional tax would not improve Alaska’s ranking.

The most often mentioned reason for increasing the oil tax is that revenues have fallen short of “projections” originally made for PPT. Frankly, there is no “guru” who can divine the future and as a result, projections are educated guesses. The reality is that both oil prices and production costs used in the FY 2006 fiscal note accompanying the PPT legislation have changed substantially from original estimates. Although increased costs reduced industry potential profit, PPT still brought in $1 billion more in state revenue in FY 2007.

The PPT is a workable component of Alaska’s oil fiscal system. It strikes a good balance between higher revenues to the state when industry profits are higher while at the same time providing needed incentives to encourage oil industry investment and reinvestment in Alaska’s oil patch.

Remember, the goal is to get more oil in the pipeline. The current PPT is the better system to keep Alaska competitive and attract the essential investment necessary to achieve that goal.

Chuck Logsdon was the former chief petroleum economist for Alaska and has more than 25 years experience in petroleum economics, working for six different governors.