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'Simple' Alaska oil tax reform out the window with ambiguous tax break language

Dermot Cole
COMMENTARY: The major North Slope oil companies and the oil-dependent state are likely to face years of debate over definitions as the new tax cut law adds to the ambiguity and complexity about what constitutes "new oil."

FAIRBANKS -- Comments about the simplicity of Alaska oil taxes seem to be straight out of the Forrest Gump School of Economics.

“It’s simple: Under my proposal, new production gets you tax relief,” Gov. Sean Parnell said early this year.

“It’s simple: Companies are treated fairly, and in order to get tax relief from the state, companies must put more oil into the pipeline,” Parnell said a month after passage of the bill.

Time and again, the governor said simplicity was one of his guiding principles: “Tax reform must be simple, so that it restores balance to the system.”

As a simple person, I like to see complex matters explained in a way that I can understand them. But the truth is that dealing with some of the world’s largest corporations is never simple. Regulations released by the state Department of Revenue to help determine which barrels of North Slope oil qualify for an extra tax break stand as the latest case in point.

In August, legislative Democrats said the extra tax break would be worth $7 per barrel more to the companies, on top of the tax break for existing production contained in SB 21. At today’s oil price, near $100, the extra tax break would be about $5 per barrel, according to one estimate.

Over time, a greater and greater percentage of North Slope oil will be subject to the extra tax break. But the new regulations contain an important loophole that allows oil from existing production areas to qualify for the extra tax break under certain conditions. Companies would get the lower rate if the oil can be developed more “efficiently” from facilities beyond the boundaries of an existing area.

There is no definition of “efficiently” in the regulations, but the oil companies have efficiency experts. They will find reasons why oil from existing production areas can be developed more efficiently from outside the boundaries.

For every well in a new spot that can efficiently tap into 1,000 barrels a day draining from a production area, the companies could gain something like $1.5 million each year in additional profit at current prices.

On Aug. 16, the revenue department published an overview of its proposed regulations, which was before the “efficient” provision was added.

The department said the Legislature was emphatic that the extra tax reduction would only go to oil developed outside an existing production area. It wanted to prevent the companies from moving oil underground into a lower-tax area.

“The Legislature’s concern in this regard was presumably due, in part, to the fact that when acreage is added to an existing participating area, it typically includes an additional portion of the same reservoir from which the producer is already producing oil and gas,” the department said.

The overview said the draft “regulation allows for the possibility of a de minimus degree of drainage, defined as no more than one-tenth of one percent of the oil or gas produced from wells drilled in the added acreage.”

But the final regulations just released to the public do not contain the one-tenth of one percent limit contained in the draft rules.

What the regulations say is this: To get the bigger tax break, the companies have to show that their plans “have not been designed to cause drainage by expansion area wells of oil or gas from the pre-expansion area that could be more efficiently produced by wells with a producing interval in the pre-expansion area.” 

I’ve asked the revenue department why the “de minimus” language was removed from the regulations and why the phrase about “more efficiently produced” was inserted.  In both instances, the choices add ambiguity and complexity to the drainage question, which is not in the state’s best interest.

On Aug. 26, a detailed critique of the proposed regulations by legislative Democrats raised warnings about the language in the law dealing with the scope of the extra tax break.

“It leaves key items undefined and leaves regulators and other executive employees too much latitude for making policy determinations. Defining what is ‘new’ oil from old fields with no clear criteria in statute and hundreds of millions of dollars in revenue at stake is an impossible task and in many ways a fool’s errand the Legislature has forced on state regulators,” they said.

Alaska voters will likely decide next August on whether the tax cut will be repealed.

One of the issues to be examined over the next nine months is whether the Legislature failed to clarify the scope of the extra tax break. Right now we simply don’t know what we’re going to get.

The views expressed here are the writer's own and are not necessarily endorsed by Alaska Dispatch, which welcomes a broad range of viewpoints. Dermot Cole can be reached at dermot@alaskadispatch.com. Follow him on Twitter at @DermotMCole.