study of the many factors that go into an oil company’s decision on where to invest – whether the North Slope, the Lower 48 or abroad – has shown Alaska is becoming less competitive for attracting new development dollars.
The Fraser Institute’s survey of industry views of various petroleum jurisdictions around the world showed Alaska trailing most Lower 48 energy states as an attractive place to invest capital, with the exception of California and Colorado.
The survey responses have been tallied to rank states, Canadian provinces, and countries by the severity of investment barriers such as high taxes and costly regulatory schemes, among others.
Fred McMahon, Vice President of Research at the Fraser Institute, noted California is considered to have the most unfriendly, anti-business climate in the U.S. and that Alaska ranks almost as poorly when 16 policy factors affecting investment decisions are considered. McMahon spoke about the survey at the Alaska Support Industry Alliance’s Meet Alaska conference in Anchorage January 22.
The survey ranked 143 jurisdictions throughout the world and an all-inclusive composite index provided an overall assessment of each jurisdiction. This process enabled the jurisdictions to be ranked into quintiles, with the first containing those areas most appealing for investment and the fifth listing the least attractive.
Overall, Alaska ranked in the second quintile, a satisfactory rating globally, but well behind most other U.S. states, which McMahon said is Alaska’s main competition for investment dollars. The most attractive states in America for investment were Arkansas, Alabama, Kansas, Mississippi, Nebraska, South Dakota, Texas, Oklahoma and Indiana.
McMahon cautioned that Alaska could be in a similar position as Alberta, which has declined significantly in recent surveys into the third quintile. Oil and gas production has dropped considerably in Alberta since a hike in royalties. The province is now considering reducing government’s take to restore its competitiveness.
“To some extent this shows you what can happen if a jurisdiction comes to rely on oil and gas and thinks that it basically inherited the family mansion and doesn’t have to worry about being competitive anymore,” McMahon said. “I think to some extent that’s what’s been going on here in Alaska.”
With regard to individual factors, Alaska is positioned near the middle of the pack on a global basis when it comes to fiscal terms, but that also means at least 50 percent of other jurisdictions are more appealing for investment. The state, however, ranked low in the category of environmental regulation. Onshore Alaska rated third from the bottom, even well below Norway, which has a reputation of having high environmental standards.
“It isn’t because Norway’s regulations are weak. They aren’t. This is because Alaska’s are uncertain and difficult,” McMahon said.
McMahon said Alaska will need to build certainty and trust within the oil industry, especially with respect to regulation and taxation, if it expects to be successful in attracting the industry investment necessary to offset declining production. He said this doesn’t mean Alaska needs to reduce environmental protection. It suggests establishing a regulatory climate that is predictable and sensible.
Determining tax policy should not be a zero sum game, with both the state and the industry trying to secure as much as possible from a fixed production and revenue pool, said Scott Goldsmith, economist at the Institute of Social and Economic Research at the University of Alaska Anchorage.
“There’s some level of taxation and other fiscal policy that gets us to the sweet spot, that accommodation of production, employment and revenue that maximizes benefit to the state, not just today, but for the foreseeable future,” Goldsmith said. Maximizing benefits to the state requires finding the right balance for fiscal policy, one that encourages future production, which in turn results in higher revenues for Alaska, Goldsmith explained.
Goldsmith urged the state to put more effort into finding that “sweet spot” and suggested an inventory of potential petroleum investments and an analysis of their likely sensitivities to different tax rates.
Larry Archibald, ConocoPhillips’ senior vice president for exploration and business development, said investment on state land in Alaska isn’t competitive with investment opportunities the company has elsewhere. As a result, ConocoPhillips isn’t exploring in Alaska this year, the first time since 1965.
Archibald pointed out industry is unable to drill some of the world’s most technical and expensive wells into challenged reservoirs without adequate fiscal terms. He said existing fields on the North Slope represent the best chance for significant reserve replacement, but warned the state tax on these fields – the highest on the Slope – has contributed to low reserve replacement.
Alaska now has the highest energy taxes in the U.S. since the implementation of Alaska’s Clear and Equitable Share (ACES) in 2007. The multi-billion dollar tax hike increased production taxes by 50 percent from 2007 and 350 percent from 2006, based on an oil price of $80 a barrel. It also includes an aggressive “progressivity” formula that boosts the tax rate as oil prices rise.
At current oil prices, the production tax rate is 40 percent of net revenues, and total government take on a barrel of oil is between 65 and 70 percent, including royalties and all government taxes at the local, state and federal levels.
At higher oil prices, production tax rates can reach 75 percent, and total government take on each additional $1 in price can exceed 90 percent. This virtually eliminates the upside on investments at higher oil prices, giving oil companies little incentive to incur the risks inherent in Alaska development and putting the state at a significant competitive disadvantage with other oil and gas regions where companies can invest and earn more.
With regard to exploration and development on federal lands in Alaska and offshore, Archibald said access and permitting policies are poor, but fiscal terms are adequate, although moving in the wrong direction. The opposite is the case on state land where access and permitting is better, but fiscal terms are poor.
“It’s within the control of the federal and state government to change a lot of those conditions,” he said. “We see more stability in many of the third-world counties we explore in than we’ve seen lately in this state.”
At a recent hearing in Juneau on oil taxes, ConocoPhillips’ Wendy King cited a 17 percent decline in development well drilling and deferral of $2 billion in field projects since 2007. She noted that core drilling activity is not tracking the rise in oil prices and the progressivity factor in ACES is probably a key factor in Alaska’s deteriorating rig count.
King noted that approximately $40 billion in new investment will be required in the next ten years to develop new fields and prevent the current six percent annual decline in North Slope production from accelerating.
At the hearing, Marilyn Crockett, Executive Director of the Alaska Oil and Gas Association, warned “tax rates under ACES are too high and overshoot the optimum point where total state revenues, Alaska jobs and economic growth are maximized” for the remaining life of North Slope fields.
Meanwhile, BP reported in January that its drilled footage is down more than 50 percent since 2007 and is now at the lowest level since 1999, when oil was $17 a barrel. The company cut its Alaska capital budget by 15 percent this year and says its investments in development projects that boosts production and state revenues are down 30 percent in three years.
RDC Executive Director Jason Brune said it is imperative the state have the right tax and royalty policies in place to attract the industry investment necessary for new exploration and development, as well as new production from existing fields. He also pointed out that 38 percent of projected production in 2015 is expected to come from fields that are not yet in production.
“Yet Alaska appears to be heading in the wrong direction, Brune said. “Capital spending by Alaska’s major oil producers has fallen and a disproportionate share of spending has been directed to maintenance projects, which do little to generate new production.” He noted 2010 will bring the number of exploratory and development wells to their lowest levels in a decade on the North Slope, where production is down 80,000 barrels since 2007.
“RDC finds these trends alarming and the lack of investment where it matters most indicates the production decline is likely to accelerate well beyond state projections,” warned Brune.
Apparently, Brune and industry leaders are not alone in their concerns about Alaska’s investment climate. The Anchorage Economic Development Corporation Index Survey revealed that 68 percent of Anchorage businesses believe Alaska’s oil and gas tax environment discourages oil production on the Slope.
“The oil industry is a global business and companies will invest their capital where they get the larger, risk adjusted returns,” Brune said. “The investors are warning us Alaska is not globally competitive. We need to listen to what they are telling us.”
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