changing alaska's oil and gas production taxes: issues and consequences matthew berman...

Changing Alaska's Oil and Gas Production Taxes: Issues and Consequences

Matthew BermanProfessor of Economics

Institute of Social and Economic Research

University of Alaska Anchorage

Presentation to

International Association for Energy Economics

Alaska Chapter

April 20, 2006

Institute of Social and Economic ResearchInstitute of Social and Economic Research

Why does Alaska need to change its tax system?

• Alaska’s effective production tax rate has declined by nearly 50 percent since 1993 and continues to decline.

• Oil companies expect the legislature to change taxes, and want to see what the changes are before committing to a gas pipeline financing agreement with the state.

• Current tax structure unsuited to today’s conditions.

• Governor Murkowski’s proposal: Profit-based Production Tax (PPT)


Three big questions about oil and gas taxes

1. How much is the government take?

2. How does the fiscal regime share risk?

3. What is the nature of the relationship between government and industry?

There is no such thing as a perfect tax.

Every alternative involves tradeoffs.


How much is the government take?

State’s roles: as resource owner, the state collects lease revenues such as royalties; as sovereign, the state has powers of taxation.

Fiscal regime: the overall structure of revenue sources from lease payments and taxes.


Alaska’s take from the oil industry has been declining

Real Alaska State Petroleum Revenues, 1959-2005Source: Alaska DOR Tax Division

0

1000

2000

3000

4000

5000

6000

7000

8000

1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

Fiscal year

Mil

lio

n 2

005

Do

llar

s

State production taxes Other state taxes Royalty and net profit shares

Reserves tax and settlements Bonus and Rental payments

Most state revenues historically have come from royalties and production (severance) taxes.


Alaska’s take has averaged between 30 and 40 percent of wellhead value in most years. But it has been

declining recently.

Alaska State Petroleum Revenues as a Percentage of Wellhead Value

0%

10%

20%

30%

40%

50%

60%

70%

1961 1966 1971 1976 1981 1986 1991 1996 2001

Recurring revenues, including amortized settlements

Total, including amortized bonus and rental payments

Non-recurring revenues, such as lease bonuses and legal settlements, have raised significant revenues.


The proposed PPT would increase the take at high oil prices and reduce it at low prices.

At real world oil prices below $20, the state would lose money. This occurred nearly 30 percent of the time during the past 45 years, including two years out of the past ten.

Average Effective Tax Rates at Different Oil PricesWith Different Tax Percentages, 2006 Production Rates

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

$15 $25 $35 $45 $55 $65

ANS west-coast oil price

Per

cen

t o

f w

ellh

ead

pro

du

ctio

n v

alu

e

Governor's billHouse Resources Committee SubstituteSenate Resources Commitee SubstituteFY05 effective production tax rate (oil and gas, with ELF)FY93 effective production tax rate (oil and gas, with ELF)


Comparing Alaska to other states

Average Effective Oil and Gas Severance Tax Rates

0% 2% 4% 6% 8% 10% 12% 14% 16%

California

Colorado

Kansas

Wyoming

Texas

Alaska, 2005

Oklahoma

New Mexico

Louisiana

Alaska, 1993

Montana

Average of oil and gas, weighted by wellhead valueSource: Alaska: Alaska Dept. of Revenue, Tax Division, Revenue Sources Book , Fall 2005, and unpublished data from the Division. Montana: Montana Department of Revenue, Tax Reform Committee Memo, March 2004; other states: US DOE Energy Information Administration (EIA), State Energy Severance Taxes, 1985-1993, http://www.eia.doe.gov/emeu/sevtax/ accessed March 15, 2006. New Mexico includes severance taxes assessed by local governments. Analysis provided by Pete Larsen.

Alaska has a reputation as a high tax state. That used to be the case, but is no longer true.


Tradeoff: Higher government take increases likelihood of adverse effects on business

decisions

But ... not all taxes are equal. Some ways of taking revenue have bigger effects than others.


International comparison of selected petroleum fiscal regimes, ranked by attractiveness to industry

Fiscal regimegovernment take

rankingoverall competitiveness

rankingUS Gulf of Mexico 1 1UK 4 2Alberta-Oil Sands 2 3Nigeria 3 4Angola 7 (tie) 5PPT-20 7 (tie) 6Azerbaijan 5 7PPT-25 9 8Alaska Current 6 9Norway 11 10Russia-Sakhalin 10 11Note: Fiscal regimes are ranked from most attractive to industry (#1) toleast attractive (#11). The overall competitiveness ranking is based onthree financial performance measures in additional to governmenttake.Source: Derived from analysis presented in Pedro van Meurs, Proposalfor a Profit Based Production Tax for Alaska, February 14, 2006, pages107-118.

PPT would improve Alaska’s international competitiveness ranking compared to the current tax system without reducing government take.


How does the fiscal regime share risk?

Tradeoff: achieving more equitable sharing of risk between government and industry increases the complexity of revenue measures.

Progressivity: the degree to which revenue increases as a proportion of income as income rises.


Relative progressivity of different lease payments and taxes

Progressivity class Explanation Lease terms TaxesHighly regressive Revenue unrelated

or negatively relatedto production

Bonus bids, rentalpayments, workcommitments

Property tax, reservestax

Moderatelyregressive

Based onproduction, ignoringprice or cost

Fixed dollar perbarrel royalty

Apportioned incometax, fixed dollar perbarrel tax

Somewhatregressive

Based on grossproduction value,ignoring costi

Fixed percentagead valorem royalty

Fixed rate ad valoremseverance tax

Neutral Fixed percentage ofnet income

Fixed net profitshare

Fixed rate producerprofits tax

Progressive Percentage of netincome rises asincome rises

Variable rate netprofit share

Variable rate producerprofits tax, producerprofits tax withinvestment credit

i Royalty rates and production tax rates that vary with oil and gs prices may be regressive orprogressive, depending on whether the variation in costs (which are not taken into account)matters more or less to investment returns than does the variation in prices.


Alaska has relied mainly on regressive revenues

When oil prices rise, the state take as a percentage of wellhead revenue actually falls.

Alaska State Government Take by Progressivity of Revenue Source

0%

10%

20%

30%

40%

50%

60%

70%

1961 1966 1971 1976 1981 1986 1991 1996 2001

Per

cen

t o

f w

ellh

ead

val

ue

$-

$5

$10

$15

$20

$25

$30

$35

$40

2005

do

llar

s p

er b

arre

l

Neutral and progressive Somewhat regressive Moderately regressive

Highly regressive Real wellhead oil price


Distribution of revenue from oil sales: PPT vs. current state severance tax, at lower oil prices


Status quo, $20 oil

Transportation (pipelines and

tankers)25%

Royalty9%

Bonus and rental

payments (amortized)

8%

Production cost25%

Production taxes5%

Other state taxes4%

Exploration and

development costs18%

Federal income tax

3%

Producer profit5%

Total state take: 25%

PPT (20%), $20 oil


tankers)25%

Royalty9%

Bonus and rental


8%

Production cost25%

Exploration and

development costs18%

Producer profit7%

Production taxes1%

Other state taxes4%

Federal income tax

4%


Distribution of revenue from oil sales: PPT vs. Current state severance tax, at higher oil prices


Status quo, $50 oil

Royalty11%

Bonus and rental


3%

Federal income tax

17%

Producer profit33%

Exploration and

development costs7%

Production cost10%

Other state taxes3%

Production taxes6%


tankers)10%


PPT (20%), $50 oil

Royalty11%

Bonus and rental


3%

Exploration and

development costs7%

Production taxes11%

Other state taxes3%

Federal income tax

16%

Producer profit29%

Production cost10%


tankers)10%


Examples of expected cash flows and investment returns under the current and proposed tax systems

After-tax cost($millions)

Expected netpresent value($millions)

Expected rateof return

Expected staterevenues($millions)

Exploration investment*

Current tax ($40) ($6.1) 8.8% $162

20% PPT ($30) $4.8 11.2% $160

Heavy oil development investment**

Current tax ($624) ($6.3) 9.5% $109

20% PPT ($462) $23.6 12.2% $109

Investment to prolong field life

Current tax ($6.5) $4.8 - -

20% PPT ($3.9) $4.3 - -


The PPT with investment tax credit defers revenues as it redistributes investment risks

Example Industry Cash Flow Comparison$40 million exploration cost with 15 percent chance of finding 150 million barrels of oil

(35)

(30)

(25)

(20)

(15)

(10)

(5)

-

5

10

15

20

1 5 9 13 17 21 25

Project year

Exp

ecte

d c

ash

flo

w (

$ m

illi

on

s)

Expected after-tax cash flow, current tax Expected after-tax cash flow, 20% PPT

Assumes $20 million bonus payment in year 1, $1 million/yr rental payments until production starts in year 9, 1/8 royalty share, $30 real wellhead price, $4 million /bbl development cost, $4 million operating cost per initial barrel produced.

Example State Cash Flow Comparison$40 million exploration cost with 15 percent chance of finding 150 million barrels of oil

-15

-10

-5

0

5

10

15

20

1 5 9 13 17 21 25

Project year

Exp

ecte

d c

ash

flo

w (

$ m

illi

on

s)

Expected state revenues, current tax Expected state revenues, 20% PPT

Assumes $20 million bonus payment in year 1, $1 million/yr rental payments until production starts in year 9, 1/8 royalty share, $30 real wellhead price, $4 million /bbl development cost, $4 million operating cost per initial barrel produced.


What is the nature of the relationship between government and industry?

Tradeoff: closer relations permit more flexibility in adapting the fiscal regime to changing conditions, but at a cost to transparency in government.

Administrative distance: the degree to which industry and government participate in setting the terms of the fiscal regime.


Administrative distance of industry-government relations

Distance of relationship Lease terms TaxesHigh Competitive lease auctions,

state sets lease terms andbid method

State sets tax regimeunilaterally

Medium Solicitation of competitivedevelopment proposals

Industry participates indrafting proposals for taxchanges, legislature mayamend before ratification

Low Negotiated developmentand revenue terms,government participation asequity investor

Negotiated settlements oftax disputes


Major changes in Alaska’s oil and gas fiscal regime since

1973 -- moving toward less

administrative distance

Year Authority Brief description Administrativedistance

Statetake

Progressivity

1973 AS43.56 Enact propertytax

High Increase Highlyregressive

1975 AS43.58 Reserves tax(temporary)

High Exceeds100%

Highlyregressive

1977 AS43.55 Severance taxwith ELF

High Largeincrease

Reduceregressivity

1978 AS 43.21 Separateaccountingincome tax

High Largeincrease

Increaseprogressivity

1979 AS38.05 Expanded leasebidding options

High Neutral Options toincrease used inmajor lease sale

1981 AS 43.55;AS 43.20;repeal AS43.21

Change incometax andseverance tax

High Decrease Regressive

1989 AS 43.55 Change in ELF High Increase Regressive1990 AS 38.05 Royalty reduction

optionDecrease Decrease Reduce

regressivity1994 AS 43.55 Make hazardous

release taxpermanent

High Increase Regressive

1994 AS 38.05 Explorationlicensing, credit

Decrease Decrease Progressive

1986-2000

Attorneygeneral

Settlement ofmajor tax androyalty disputes

Low Unknown Highlyregressive

1996 Ch. 139SLA

1996Northstar leaserenegotiation

Low Neutral Change fromprogressive toregressive

1998 AS 43.82 Stranded GasDevelopment Act

Decrease Decrease Neutral

2003 AS 55.025 Exploration taxcredit expanded

Decrease Decrease Progressive

2005 Administrative

Aggregation ofsmall field ELF

High Increase Neutral

2006 Proposed Producer ProfitsTax

Moderate Neutral Change fromregressive toprogressive

2006 Proposed State investmentin natural gaspipeline

Low Unknown Progressive


Effects of a standard deduction

Tax-free oil production per company

-

5

10

15

20

25

30

$20 $30 $40 $50 $60

Wellhead oil price

Th

ou

san

d b

arre

ls p

er

day

With $73 million standard deduction

With $10 million standard deduction

The governor’s bill would give each company tax-free oil production.


Effects of a standard deduction ... (continued)

The graph shows the effects of the governor’s bill. Different versions have different effects, but would still tax different companies at different rates.

Effective PPT tax rate as a percent of gross wellhead value: 20 percent tax rate, $30 wellhead price, and 2005 production levels of various firms

-2.6%

-2.6%

-2.6%

-2.6%

3.6%

4.9%

10.0%

10.4%

10.5%

-4% -2% 0% 2% 4% 6% 8% 10% 12%

XTO Energy

Marathon

Forest Oil

Chevron

Unocal

Anadarko

EXXON-Mobil

BP Exploration

Conoco-Phillips


Combined effects of deductions and credits

Different versions have different effects, but each may cost the state as much revenue as would a 5 percent reduction in the base tax rate.

Estimated Marginal and Average Effective Tax Rates With a 20% Tax rate, 20% investment credit, $73 million standard deduction, 2006

production levels

-15%

-10%

-5%

0%

5%

10%

15%

20%

$15 $25 $35 $45 $55 $65

ANS west-coast oil price

Per

cen

t o

f w

ellh

ead

pro

du

ctio

n

valu

e

PPT nominal marginal tax rate on taxable productionPPT average effective tax rate, with standard deduction and tax creditsFY05 effective production tax rate (oil and gas, with ELF)FY93 effective production tax rate (oil and gas, with ELF)


Unresolved questions as the legislature debates and modifies the administration’s proposed PPT

1. Should the tax contain a large standard deduction? Should we move from taxing oil from different fields at different rates to taxing different companies at different rates?

2. Should different regions of different types of oil be taxed differently? Cook Inlet oil? Heavy oil?

3. Should natural gas be included in the PPT? If so, should it have a different tax rate?

4. Should a transitional deduction be included?

5. Should the tax include a progressive rate structure, and increase at high oil prices?

6. Is the PPT too complicated? Will we just bring on endless litigation?


Recommendations

1. The PPT is an improvement over the current production tax.

• The state could easily raise its percentage take to the level of the early 1990s by simply changing the Economic Limit in the ELF formula from its current level of 300 barrels per day per well to a more realistic level of 100 barrels per day.

• But by changing to a tax on net income instead of gross revenues, the state would better share risk with oil companies and cause fewer adverse effects per dollar of revenue collected.

• Alaskans should anticipate disputes and litigation if the PPT is implemented. But the state has weathered these before.


Recommendations ... (continued)

2. Don’t expect too much.

• The PPT should not be viewed as an opportunity to increase the state’s take from its oil and gas. Oil prices are more likely to fall from their current levels than rise. In the long run, the state take from the PPT may be no more, and possibly less, than it is now.

• Alaska’s experience with a major oil tax overhaul in 1981 suggests that it is impossible to know exactly how much revenue will change when the basis for taxation shifts.

• The PPT will not solve the long-term problem of the fiscal gap caused by declining oil production. No oil tax can.


Recommendations ... (continued)

3. Keep it simple!

• Switching to a tax on net income automatically adjusts for differing ability to pay among different investments.

• The more complicated the bill becomes, with attempts to treat different income and operations differently, the more opportunities for disputes and litigation.

• Beware of unintended consequences of special provisions, which, once enacted, become very difficult to remove.

• The gas pipeline contract, not a broad tax bill, is the place to special provisions related to North Slope gas development.

It is better to keep tax rates low and the tax base large.


changing alaska's oil and gas production taxes: issues and consequences matthew berman...

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