C'mon...

February 17, 2012: My friends at the Alaska Dispatch have run a two part series on what they're calling the "Myths" of the oil tax reform debate. I feel obligated to respond, but then again don't I always?

The six point argument laid out by Dispatch reporters over the last two days, attempts to counter a few of the arguments that supporters have offered in their advocacy of lowering oil taxes to stimulate new production on Alaska's North Slope. And while they raise some interesting points, every one needs a deeper analysis and discussion.

I'll take them one at a time.

1.) Myth: Oil companies are always trustworthy business partners.

Although trust is the cornerstone of many business relations, we are arguably not partners in the true business sense. The State of Alaska is essentially a lessor in a competitive global market with the ability to tax as much as they want.

The mere fact that Alaska has the power of taxation and permitting fails the partner test. There is no partnership when one partner has the ability to raise taxes unilaterally and retroactively without any discussion from the lessee.

In a partnership, one of the players could simply walk away from the relationship. This is not possible on the North Slope where lessees have invested tens of billions in building pipeline infrastructure and cannot simply walk away. In addition, the state cannot walk away either, due to the growing reliance on oil revenue which will pay for .92 cents out of every dollar the state spends in fy12.

In short there is no partnership. Just a uneasy alliance between a lessor and a lessee. 

Other issues regarding trust that were mentioned in the Dispatch article were Amerada Hess, Exxon Valdez and the current court decision over the valuation of the pipeline.

The first thing about the Amerada Hess case is many people simply don't understand the issues at play in the court case.  

The Amerada Hess litigation was  filed in June 1977, within days of the first oil going into the Trans-Alaska Pipeline System, and it  proceeded throughout  the 1970s and 1980s. Final settlement of those issues didn't occur until 1996.   

There were huge issues at stake, the biggest being over royalties. For the first 10 or 15 years, the underlying problem was related to the value of the oil. In the 1970's and 80's, the value of oil was hard to establish due to market dynamics.

According to testimony from Dan Dickinson, who worked for years on the Amerada Hess case for the state, the litigation dragged on for so long because the DOR had a difficult time establishing the value of a barrel of oil. And although a judge ruled the legislature was too friendly with the oil industry, Dickinson stated that both sides had "decent arguments."

This case wasn't about the industry ripping off Alaskans, it was a legitimate dispute over the value of oil at a time when it was difficult to peg. Some believe the industry screwed the state on taxes for years until they got caught, but that is far from the truth. The disagreement over taxes owed occurred immediately, as is evident by the case being filed just days after oil started flowing through TAPS.

In the end the case was settled and the state was awarded billions plus interest. 

The Exxon Valdez, although tragic, was at a time when Alaska was producing almost two million barrels of oil per day. The ensuing law suit that ended up taking over fifteen years to resolve, wasn't about denying fisherman just compensation, it was about a punitive damage award that was one of the biggest in U.S. history at the time.

Again, while the Exxon Valdez was an avoidable environmental disaster, many of the claimants had already been made more than whole.

In one case, a fisherman's tax returns showed that he averaged around $20,000 a year fishing, but the year of the spill he made over $200,000 by renting his boat to the Exxon clean up effort. In another case, a friend of mine who fished crab out of Kodiak said he made enough money off renting his boat that he and his wife retired and bought a bed and breakfast.

This of course in no way excuses Exxon's negligent behavior and the real impacts it had on Alaska's pristine coast line. It simply highlights that many Alaskans profited nicely off the spill and that factored into Exxon's appeal of the punitive damages claim. I can still remember a client who bought a 1989 Ford Probe from my company who then put a specialized license plate frame on her car that read, "I Love My Car...Thanks Exxon."    

With regards to Judge Sharon Gleason's recent decision that the pipeline had a higher valuation than producers argued, this is really no different than any Anchorage homeowner appealing the Municipality's property tax valuation of their home. This is a process where even if homeowners recognize they could sell their homes for far more than the Muni's green card states, they still can appeal the valuation.

In fact, residents filing baseless appeals is one of the reasons former Mayor Mark Begich established a fee for appealing a property tax bill. 

And while Judge Gleason's ruling states the pipeline could last for another fifty years with significantly lower volume, the real issue isn't how much oil the pipeline can live with, it's how much oil Alaskans can live with and still maintain public services without levying any personal states taxes.

And as far as the producers having two sets of valuations, I agree that they should not be telling Wall Street one thing and Alaskan communities another. However the appeal of any tax bill is a part of due process and is a legitimate action in a dispute of the valuation of an asset. In addition, unlike a homeowner who has the flexibility to sell their home if their mortgage or taxes get too high, owners of a 35 year old pipeline cannot.

Finally, if trust is the issue...what about lawmakers raising taxes retroactively? Or trying to shove a $40 billion pipeline down producer's throats under the threat of baseless litigation?

2. Myth: Alaska oil companies are taxed at 80 to 90 percent.

This is absolutely true. What some columnist fail to point out is that the 80 to 90 percent figure applies to the marginal tax rate. When oil is at $120 per barrel, the state is taking 83% of every additional dollar of equity. Yesterday oil closed at $120 per barrel.

In fact, at $120 per barrel, Alaska has the highest effective tax rate of any similar jurisdiction. The existing marginal tax rates have created a barrier for reinvestment for major producers because ACES currently caps the upside of any investment they might make.

And while the state offers tax credits for certain types of investments on the North Slope, the tax credit fails to make up for the long term tax burden producers must pay once they begin producing oil.

Also, the Dispatch article about oil myths used Libya's 93 percent tax rate as an example of a higher taxing jurisdiction.

First Libya is nowhere near a comparative tax environment. Factors such as cost of production, reservoir geology,and the fact that Alaska is an Arctic region make this an apples to oranges comparison.

Second, due to its lack of oil & gas expertise, Libya has attracted outside producers such as BP with generous Production Service Agreements. These agreements allow producers to recover all of their up front costs, as compared to ACES which offers tax credits on only a portion of the company's spend. The problem is with ACES steep progressivity rate which in the long term offsets any tax credits the producers may receive. 

Also, those who criticize the producers big profits aren't really being honest about the source or reasons for those profits.

This past week in the Senate Resources Committee, Conoco-Phillip executives were aggressively questioned by Sen. Bill Wielechowski (D-Anchorage) if 30 percent of the company's profit came from their Alaska operations. The answer was yes...but.

Because 50 percent of Conoco's business is gas, and the price of gas has been severely depressed the last four years, high oil prices have dramatically shifted where the company derives a higher percentage of their profits as compared to the rest of their portfolio.

With regards to Exxon and BP, a good chunk of their profits, almost seventy five percent of Exxon's alone, comes from foreign operations. But you never hear that from critics, even though Alaskans benefit from Exxon's increased stock value because it's the second largest holding of the Alaska Permanent Fund Corporation's stock portfolio.

In addition, lawmakers were warned in November of 2007 during the debate over ACES that the system of taxation they adopted was not only uncompetitive but too complex.

Here is what Exxon's former Alaska Chief Craig Haymes told state senators in 2007 during testimony, "analyzing  the  Administration's tax proposal, we found that virtually all of the  provisions are simply tax rate increases or further increases in complexity."

Here is what International oil & gas expert Pedro van Muers said just a few days ago; ACES is too complex and discourages investment. He stated that he was approached by Repsol, one of the new entrants on the North Slope, because they couldn't understand Alaska's system of taxation. 

Remember what the acronym ACES stood for? Alaska's Clear and Equitable Share. So much for clear and equitable. 

3.) Myth: North Dakota is so much rosier.

While I personally don't care for North Dakota as a comparison to Alaska, all of the experts do. 

Former state oil economist Roger Marks and International oil & gas expert Pedro van Meurs both classify North Dakota as an Arctic environment and have produced charts that show at $120 barrel oil, Alaska's effective tax rate is much higher than North Dakota.

The problem is, as in the Alaska Dispatch article, people are basing Alaska's tax rate on $100 per barrel of oil. After oil passes $100 per barrel, that's when the progressivity factor begins taking a larger chunk of the profits for every dollar of increase. Once again, the price of oil closed at $120 per barrel yesterday.

Like it or not, this is playing into where companies invest.

4.) Myth: Jobs in droves are heading south

I know people who have formally worked on the North Slope and have since moved to North Dakota for better opportunities and a more stable employment environment.

And even though as the Dispatch points out that the North Slope is enjoying record employment, you must stop and look at what kind of employees have contributed to the employment boom; maintenance workers and new explorers.

Companies have testified that a good majority of their investments are going towards maintenance and repair...not production. BP's President stated that only two out of six employees working on the North Slope are engaged in production related duties.

So aside from the new explorers, who have said very clearly that their success in producing oil depends on lawmakers ability to pass meaningful tax reform, and the increased number of employees working on repair and maintenance...the production and employment picture isn't as rosy as critics like to paint.  

Again, while the Dispatch points out that investment is high, they fail to explain that a large chunk of that is being rebated to new explorers. However, even oil consultant van Meurs stated this week that Alaska's tax credits are too generous and don't link to actual production.

Meanwhile, capital investment in production facilities from the major producers have either been down or flat. As one Conoco executive testified this week, the one big project they are working on was approved before ACES was passed.

In addition, BP's former Alaska Chief Doug Suttles stated in 2009 at the beginning of their Liberty project, if their leases had been on state land versus federal, taxes would have been too high to pull the trigger on the investment.

This is what I wrote in July of 2009:

The Liberty field is a development entirely on federal land. The state will get no production taxes and only a small amount of royalty over the life of the project.

The new progressive ACES marginal tax rate does not make investing on state land worthwhile, even with the tax credits. During the ACES debate all the Palin administration focused on was whether investors could make money under ACES. The question they never examined was whether you could make more money somewhere else.

At yesterday's news conference, Doug Suttles, BP Alaska's president, said due to Governor Palin's hefty ACES oil production tax adopted by the legislature last fall, Liberty would not have been developed on state land.

“If this were on state lands, it’s doubtful we’d have been able to move it forward,” Suttles said. “Alaska is a very high-cost environment for the industry."

5.) Myth: The pipeline is running dry.

This is true, just look at the scoreboard. Over the last thirty five years Alaska has gone from producing over two million barrels a day down to less than 600,000.

A few months after ACES was adopted, the Palin administration predicted that in 2011 we would be producing 674,000 barrels of oil per day. The actual production was 600,000 barrels per day. In fact, the Palin administration forecasted that production wouldn't drop to current day levels until 2022.

To add insult to injury, over 50 percent of the production that is being predicted in 2020, will come from investments that have yet to be made.

6.) Myth: Alaska is running out of oil.

False...but.

Most of the remaining oil is going to be much more expensive and difficult to lift from the ground. Even International oil & gas expert van Meurs proposed changing ACES to reflect the challenges associated with the various types of oil that remains to be extracted.

In addition, the big offshore players such as Shell Oil are on federal land which will result in little if any revenue to the state treasury. In fact a good portion of the oil & gas remaining on the North Slope is located on Federal lands.

Now it's time for my myth....

7.) Myth: Sen. Hollis French (D-Anchorage) and Sen. Bill Wielechowski (D-Anchorage) are truly using this debate to understand the facts and improve Alaska's economy.

Yeah...that's true...and I'm starting at shortstop for the Boston Red Sox on opening day. 

This dynamic duo of disingenuousness is beyond comprehension when it comes to cluelessness and paying attention.

Yesterday during a hearing featuring Conoco-Phillips executives, French thanked them while blasting both BP and Exxon. We appreciate you coming before us as others won't, French stated. A few minutes later, committee chair Tom Waggoner corrected French by informing him that both BP and Exxon had agreed to make their presentations later in the month.

But as always, French's knee jerk reaction was to demonize the oil industry even though he had no factual information to back up his rantings. Of course that's never stopped him in the past.

Later in that same hearing, Wielechowski queried Conoco's execs about their rate of return and net present value on the North Slope. However, he had already been told twice before by oil tax experts that using ROR and NPV exclusively was not accurate measure when analyzing a project's profit potential. 

In testimony five years ago during the ACES debate, Wielechowski brought up the same question to oil & gas consultant Dan Dickinson. He was told very clearly that is was false to use ROR and NPV exclusively in looking at project profitability. There are many more factors that go into the equation, Dickinson replied.

Three days ago, Wielechowski brought up the same question to International oil & gas consultant van Meurs. You cannot use simply ROR and NPV as there are many more factors that go into the equation he was told by van Meurs.

Two days later, he asked the Conoco execs the same question. We do not use ROR and NPV exclusively to determine a projects viability, one of the executives responded.

Three different different experts. Three times the same exact question. Three times the same exact answer. Isn't it three strikes and you're out?

But the defining moment came last Tuesday when Wielechowski grilled van Meurs on his suggestion that lawmakers needed to lower current taxes. Your opinion today conflicts with your opinion in 2006, Wielechowski said.

Van Meurs response was one every Alaskan interested in this debate should pay attention to. The world market has become more competitive since 2006 and there are more investment opportunities thus the need to be more competitive, van Meurs replied.

In hindsight since ACES was passed with the strong support of both French and Wielechowski in 2007, looks like they made it just in time to price Alaska out of the world market. 

C'mon.