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Alaska asks oil companies to help write rules for oil tax cut

Alex DeMarban
New oil meters: How to measure new oil production? Efforts to simplify measurement of North Slope oil production aren't simple enough, one oil company warns, and they could stymie future production that state coffers are counting on. Whaley, Frank H. photo. AMRC. Wien Collection

Alaska Senate Bill 21 -- the controversial tax break for oil companies doing business in Alaska -- passed the Legislature months ago and was signed into law this summer by Gov. Sean Parnell. But oil producers and the state are still wrangling over details in a little-watched debate with potentially enormous outcomes.

The Department of Revenue has issued draft regulations and asked the industry to offer improvements. So far, the oil industry says the draft rules are extremely difficult to understand and key aspects will be impossible to implement or too costly. Worst of all, the companies say they may not be able to meet the eventual goal of the tax cut -- producing more oil -- if the proposed rules don't change.

Gov. Sean Parnell introduced the law and ballyhooed its passage, saying it met his key guiding principles. One of those principles was simplicity.

So far, the proposed rules are far from simple.

"The one thing I can say is right now when I read these regulations -- and I have had significant help from different departments within ConocoPhillips -- oftentimes I'm answering, 'I don't know what that means,'" said Marie Evans, a tax attorney for Alaska's leading oil producer. "That's not good for the Department of Revenue, and it's not good for ConocoPhillips. 

"It's not going to meet the goals of SB 21 if I'm answering 'I don't know,'" she said at a recent hearing.

Bruce Tangeman, deputy commissioner with the Department of Revenue, defended the new law as much simpler than ACES, the state's current tax regime and one which required more than 70 new rules. 

What is 'new oil'? 

At issue is a key question left unresolved by the powerful Republican majority that powered the bill through Juneau: How to accurately determine and measure new oil?  

It's a critical matter for Alaska, which in recent months has begun dipping into its savings. Senate Bill 21, set to become effective Jan. 1, gives hundreds of millions of dollars a year back to the producers -- primarily BP, ConocoPhillips and Exxon Mobil Corp. 

At the heart of the tax break are incentives for oil produced from new areas after Jan. 1, 2014. The Legislature provided the most generous breaks for "new oil," as it's called under SB 21, because Alaska needs that new oil to increase state income.  

A key incentive for new oil is what the Legislature called the Gross Revenue Exclusion, though the draft rules dub it the Gross Value Reduction. It allows producers to not account a substantial portion of their income for tax purposes. Specifically, the producers would not count between 20 percent and 30 percent of the oil's gross value when produced.

That could be an extremely valuable deduction, hypothetically worth somewhere around $10 million a day if it were applied to all the oil currently produced on state lands, or about 500,000 barrels a day.

In some cases, determining what should qualify as new oil, and therefore qualify for the Gross Value Reduction, is easy. There's no question, for example, that new oil will come from a new, untapped reservoir, such as might happen if Linc Energy one day produces oil from the Umiat prospect, a site far from currently producing fields. 

But the question gets very sticky if that oil comes from a new area in an already-producing reservoir within Prudhoe Bay or Kuparuk, for example, the nation's two largest oil fields. The problem? Oil can migrate between the already producing site and the newly added area, particularly when the reservoir's internal pressure changes. Such changes occur when producers inject substances back into the field. 

When oil comes out of the ground, the state wants to make sure that only the new oil, and not the oil from legacy areas, is getting the Gross Value Reduction.  

Should industry measure its own 'new oil' tax obligations?

The debate was on display at the public hearing called by the agency last week that gave the producers a chance to weigh in on Revenue's draft regulations. State officials said such hearings are typical before any law is passed into regulatory code, and they were not making special exceptions for the oil industry, the state's top industry and its most important taxpayer.

Tangeman, the deputy Revenue commissioner, said during a break that the agency wanted to hear ideas from the producers to improve the draft rules, including on how new oil should be measured. 

"They're the experts, they're oil producers. If they have a better proposed methodology to meter, measure, account for these barrels they hope to qualify for the GRE, then we're hoping to hear those suggestions," Tangeman said. 

"That's the point of this process," he said. "We put out our draft regulations and they can point out where they have issues and make suggestions on clearer, better ways to measure that potential GRE oil." 

"It's not our goal to ram through regulations if they're not going to be effective," he said. 

A big sticking point is that to properly measure new oil, the state is proposing highly accurate meters on wells before the oil and gas from old and new areas is mixed together.

Currently, meters are typically employed later in the process, after the oil and gas from numerous wells has been mixed together, and at the point that the oil is ready for shipping after going through a processing facility, a state official used.

The draft rules propose doing the metering earlier and more often.  

During the hearing, Conoco's Evans centered most of her comments on the Gross Value Reduction. 

The proposed rules require the oil companies to overcome an "enormously daunting burden of proof" before they receive that tax break, she said. 

Some of the state's metering goals are impossible to meet, she said. 

In some cases, they're so costly they could possibly make a project uneconomic, especially if put on every well, she said. For example, some of the meters could cost $750,000 each, and come with added operational and maintenance costs because they need regular recalibration.

Tangeman said the state has proposed a high standard to achieve the best metering accuracy. 

"Our goal was to set a high standard and for them to come in and say they can meter and measure it to our satisfaction," Tangeman said. 

Tom Williams, a senior tax counsel for BP Exploration Alaska, spoke to the committee as a member of the tax committee for the Alaska Oil and Gas Association. 

AOGA, representing top companies in the state's oil industry, is also concerned about the metering requirements and the state's method for deciding what oil qualifies for the Gross Value Reduction. 

The state had proposed metering in the rules because that's a "clear, objective standard" to accurately measure oil, said John Larsen, Revenue's audit master and the man who ran the hearing. 

But the proposed rules left open the possibility that other methods beyond metering could be used, he said. 

Larsen asked the industry attorneys at the hearing to let him know what alternative they would propose. 

Industry: Rules could fail without 'certainty'

AOGA is also concerned about how another credit will be applied, according to testimony submitted by Williams. The legacy oil in Prudhoe and Kuparuk, the nation's two largest oil fields, does not receive the Gross Value Reduction. 

But it does receive a tax credit ranging between $1 and $8 for every barrel produced, depending on the price of oil.  

The industry group is concerned that the state has proposed a method that would take six years, after audits are complete, before the oil companies would know the amount of the credit they're getting. 

But oil producers need to know how much they can expect at the time the oil is being produced, not several years later, Williams said. Even a difference of $1 a barrel could be worth hundreds of thousands of dollars a day to BP, Conoco and Exxon.  

Not letting the oil companies know what amount of credit they can expect up front does not provide the certainty companies need to make investments, said Williams. 

It'd be like the IRS telling a family they can expect a tax break, but only some time in the far-off future with the amount to be eventually specified, too. That's not a promise a family could count on for investing purposes.  

"If the credit is to have its full effect as an incentive to increase oil  production, the producers making the investment to increase that production need to know how much that credit is," said Williams. "They cannot wait up to six years for the Department to audit the transportation costs .... They need to know it when they file." 

"The tax credits stand to fail if the regulations do not provide this certainty," he said. 

Still time to comment 

Late last week, the state released a sort of Cliff Notes versions of the draft rules. The agency is taking comment on them until Monday, Aug. 26, at 4:30 p.m. 

One way to comment is by email to Larsen, the Revenue Department's audit master, via email at john.larsen(at)alaska.gov

Evans and Williams said they will submit additional remarks.   

The state is open to hearing their ideas, said Tangeman after the meeting. 

"Common sense is you put a meter on (a well) and you measure it," he said. "That's the simplest, highest standard there is.  If there's something other than that, I'm looking forward to seeing what they respond with."

Contact Alex DeMarban at alex(at)alaskadispatch.com