On the line?

February 10,2012: The political volleys over oil tax reform have revealed one consistent pattern; critics who can muster the strength to return shots always seems to hit them wide.

Such has been the takeaway of my back and forth with many anti oil tax reformers including the latest, a retired University of Alaska professor who maintains the state's tax regime is just fine.

Last week I posted a blog that addressed two of the more common arguments that supporters of high oil taxes tout: Alaska's current taxes are competitive and marginal tax rates are not important to the discussion of investments. Both of these are false.

The first issue about Alaska's competitiveness came from a standard diagram used by tax reform critics in attempts to show Alaska ranks in the middle. The tax opponent in this case, retired University of Alaska Professor Neil Davis, had stated unequivocally that Alaska's tax regime is fair.

"To reiterate just for emphasis: The real, factual, data-based Total Government Take for Alaska under ACES has been 56 to 69 percent, near the worldwide average, and less to far less than in at least twenty other major oil provinces shown on the diagram."

But when called on the fact that the chart was clearly not an accurate comparison of Alaska's tax ranking, Davis attempted to walk back his claims after advertising his chart as "real" and "factual."

"It’s difficult to determine exactly what the total government take is for North Slope oil operations, in part because of oil company secrecy and in part because Alaska’s Department of Revenue seems unable to process the information it has in order to know how much money we are contributing in tax credits."

So now Davis has gone from stating the data is "real" and "factual" to saying "it's difficult to determine." 

But in fact, it's not difficult to determine.

A recent study by former State oil economist Roger Marks compared Alaska to twenty three jurisdictions that could be considered Alaska's peers. These oil producing regions share Alaska's operating environment, costs, distance from markets and the same production and reserve qualities.

Marks' study revealed that under ACES, at $120 barrel oil, Alaska's effective tax rate (all taxes, royalties divided by pre tax net income) is the fifth highest only behind, Russia, Norway, Indonesia and Oman.

Fifth highest is not in the middle of twenty three similar jurisdictions.

Davis goes on to try and explain that Alaska is an investment partner with the oil companies. "Evidently that sharing of risk is having a positive influence on the increasing interest by petroleum companies in exploratory drilling in the state and a factor in the current high petroleum industry employment in Alaska."

Again, this volley is clearly outside the line and is yet another half truth conjured up by tax reform critics.

Yes for the millionth time, new explorers are surging on the North Slope. But that's because the state is essentially paying for them to explore with the generous tax credits in ACES.

However, those same small companies who are busy poking holes in the ground looking for oil & gas have all stated that in order for them to produce any discovery they make, oil production taxes will have to be lowered.

One of these small independent explorers testified during the ACES bum rush that the comparison that lawmakers (and Davis) were using to compare the tax environment was not accurate for the small players.

Testifying in front of the legislature, Ken Thompson of Brooks Range Petroleum stated, "most of the individual people and company investors specifically in AVCG, LLC, do not consider international regimes as areas to consider as competition for our investment dollars with Alaska. Rather, the main competition for most AVCG Owners’ cash is in other states in the U.S."

He went on to point out that under ACES the "high tax rate and the added progressivity tax will start immediately along with royalties, corporate taxes, property tax and other charges rather than allowing for recovery of capital and a contractual rate-of-return."

And it's not just Thompson who has expressed concerns about the high tax take. In fact every prominent independent explorer from Great Bear and Repsol to UltraStar Exploration has voiced serious concerns about the high rate of taxation strangling oil production.

In addition, Jim Weeks who is the managing partner of UltraStar stated in a letter to lawmakers that even with the explosion on the North Slope, small companies would not be able to meaningfully increase the oil flow through the pipeline.

"We simply don't have the balance sheet or the leasehold," Weeks wrote. Adding, the major producers would have to be drawn back into the investment mix to make any appreciable strides in boosting production. They "need to participate, but are not because of the tax structure of ACES."

So again, even the much vaunted explorers have told lawmakers exactly what everyone else in the industry is saying; the current tax structure is too high.

The second part of Davis' response regarding the record employment is also a much repeated half truth. 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 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.

Finally, joining the ranks of such luminaries as State Senator Hollis French (D-Anchorage) and Bill Wielechowski (D-Anchorage), Davis offers up a closing argument against tax reform that makes the case for tax reform.

He attempts to rebut the significance marginal tax rates are having on the investment climate on the North Slope. "It measures only how profit sharing varies as prices rise and fall. And as many American homeowners have discovered, prices do both rise and fall," Davis responded.

He's dead right, which is why he's dead wrong.

The marginal tax rate does show how profit sharing varies as prices rise and fall.

Under ACES, it shows that when oil is over $100 per barrel, the state is taking two dollars to every one for the producers. Under ACES, it shows Alaska's progressivity rate is higher than any other OECD country and ranks sixth overall only behind Venezuela, Algeria, Uzbekistan, Azerbaijan and Kazakhstan.  

You see, it's not just that marginal tax rates tell a story as Davis points out, it's what kind of story the marginal tax rates are telling. And ACES is telling us that production will continue to decline as marginal tax rates continue to squeeze profit margins, capping investment upside.

Davis is also right when he points out that American homeowners have discovered that prices rise and fall. However, I don't know anyone who buys a house with the anticipation that their equity will be capped by higher government taxes.

To put this another way; if you had the choice of investing between two homes in the same neighborhood, one would allow you to retain most of the equity for every dollar your home increased in value, or one that eventually capped what you could retain because more would go to pay taxes...which house would you buy?

In the words of the great John McEnroe, "You cannot be serious!"