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Governor Proposes New Oil Tax Plan

Posted on: Monday, 20 March 2006, 03:03 CST

By Bradner, Tim

Gov. Frank Murkowski will submit his proposal for a new net profits oil production tax to the Legislature "within days" and will ask lawmakers to consider it separately from a natural gas pipeline contract, sources within the state administration say.

Murkowski is still negotiating with North Slope producers on a gas contract, but he wants lawmakers to deal with the oil tax question as soon as possible.

The proposed new tax would replace the state's existing oil and gas production tax, which has become ineffective in the high price range of current oil prices, according to Pedro van Meurs, the state's lead consultant in the gas pipeline negotiations.

In a presentation to state legislaturs in Juneau Jan. 18, van Meurs laid out some details on the new tax proposal and the rationale in supporting it.

Alaska Department of Revenue economists for years have complained that the state's current tax structure is "regressive" in that it earns less at higher price levels than a "progressive" tax like a net-profits tax. On the flip side, when prices are low under the current tax system the companies' profits decline sharply while state revenues remain at higher levels.

Switching tax systems now represents a calculated gamble that high oil prices will remain. Revenue officials have argued that a progressive tax system would help the state attract more investment.

Van Meurs told legislators the current tax law contains an incentive formula, called the Economic Limit Factor, that lowers the tax rate for smaller oil fields. When the ELF formula was created in the 1970s and modified in the 1980s it was intended to help economically marginal oil projects that might not otherwise be developed.

In those days, oil prices were in the range of $10 to $15 per barrel and the ELF formula worked as intended. But with oil prices at much higher levels the formula doesn't capture the revenues is should, van Meurs told a combined meeting of the House and Senate Resources Committees. "There is a huge amount of money slipping through your hands," van Meurs said.

The current ELF formula allows the giant Kuparuk River field on the North Slope, the second largest oil field in North America, to pay almost no state production tax, although state royalties and property taxes are paid.

"It's ridiculous to have a world-class oil field paying almost no production tax," van Meurs said.

Because more of the North Slope production is coming from small fields, in 10 years the only field on the slope paying production tax will be the large Prudhoe Bay field. All other fields will pay zero tax, van Meurs said. The current tax formula uses daily well production rates as a kind of proxy for profitability, and that can create distortions, like encouraging companies to drill more wells than what is needed as a way to lower tax rates, he said.

In contrast, virtually every other major oil-producing region uses a net-profits approach to taxation or some form of production- sharing so that revenues go up as prices climb and profits increase, van Meurs said. If oil prices decline, revenues to the state also decline, he told the legislators.

Some details on the new net-profits tax were still being worked out when van Meurs gave his presentation, but basically the tax would be based on a producing companies "net profit" in the oil field. Net profit would be calculated by subtracting tanker and pipeline transportation costs from market sales prices, as is done now with die severance tax and state royalty, to determine the value of oil in the oil field.

Capital and operating costs would then be subtracted from the gross value figure. These deductions are not allowed under the current severance tax.

A new concept in the tax proposal is an investmerit tax credit feature that will allow producers that invest in new exploration or development to credit expenses and pay less tax, van Meurs said. Companies that do not make new investments will pay higher taxes, he told the legislators.

Companies would also be able to sell the investment tax credits, so that a new explorer that doesn't have production can sell the "expenses" to a company that does have production. This would be a big new incentive in attracting exploration, van Meurs said.

The state now allows limited exploration tax credits but the new proposal would expand the concept.

Some legislators expressed concerns that if the state shifts to a tax that earns more at higher prices but less at lower prices the state could be vulnerable if oil prices fall. Sen. Fred Dyson, R- Eagle River, asked where the "cutoff" point is, the price at which the current tax system would bring the state more than the proposed new tax.

Van Meurs said those calculations, as well as final details like the rate of tax, were still being worked out and would be provided when the tax proposal is introduced.

Copyright Morris Communications Jan 29, 2006

Source: Alaska Journal of Commerce

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