The House Resources Committee explored Friday the impacts of provisions in a new oil tax bill. The bill is expected to have a positive fiscal impact for the State.
The House majority introduced HB 111 on February 8 as part of a long-term deficit reduction plan.
“HB 111 is one component of a fiscal solution that will ensure Alaska has a balanced, sustainable budget for years to come,” House Resources Co-chairs Geran Tarr (D-Anchorage) and Andy Josephson (D-Anchorage) said in a sponsor statement.
According to the Department of Revenue (DOR), HB 111 will net $45 million more in oil taxes in Fiscal Year 2018. That rises to $75 million the following year, mostly due to an increase in the minimum tax from four percent to five percent.
“This is the major change on the revenue side,” Tax Division Director Ken Alper said Friday of the minimum tax increase.
A bill provision reduces net operating losses (NOLs) companies can claim from 35 percent to 15 percent. Another prevents companies on the North Slope from taking those NOL credits in cash.
Those two sections will save an additional $60 million in FY 2019.
“That is a very substantial change,” Alper testified in the House Resources hearing. “The largest expected demand for credits in the future is going to be these NOLs.”
Alper noted that the base tax rate of the current regime is 35 percent, but the effective production tax rate does not rise to reach 35 percent until oil hits $160 per barrel, something it is not expected to do in the foreseeable future.
“No one’s paying an effective tax rate of 35 percent,” Alper said, suggesting an NOL reduction is a reasonable move.
That would close the FY 2019 deficit at current spending levels, if DOR’s forecast of $1.3 billion in oil revenue is realized.
In a presentation, Alper showed that at current oil prices, HB 111 would increase by two percent the amount of oil profits that go to the State and municipalities. The 58-percent share is in line with the the State’s share over the last ten years, Alper said.
Producers’ percentage of the profits would correspondingly decrease from 29 percent to 27 percent.
HB 111 would also protect the State in ways that don’t appear in the fiscal note because that note reflects forecast oil price.
At oil prices below $30 per barrel, the Gross Value at the Point of Production (GVPP) — the market price less transportation costs — can drop below zero.
Alper highlighted Point Thomson, an ExxonMobil project that is currently pumping about 5,000 barrels a day of diesel-like natural gas condensate down an expensive 22-mile pipeline.
Transportation costs for Point Thomson oil are about $30 per barrel.
At an oil price of $28 — a price the State saw in January and February of 2016 — Point Thomson would lose $3 million per year at current production levels. Without the protections in HB 111, the State would then be responsible for $1 million in NOLs as ExxonMobil applies those losses to tax liability from other fields.
House Minority Members Wary of Oil Tax Change or Income Tax
“Does the governor support this?” Rep. Chris Birch (R-Anchorage) asked Alper.
Alper said that Gov. Bill Walker does not comment on legislation before it has been approved by the legislature, but added, “The governor did propose probably half of the sections of this bill himself a year ago.”
Alper noted that the State’s first oil tax regime, called the Economic Limit Factor (ELF), had steep declines in production tax from 1998 to 2006, partly because satellite fields were taxed at a lower rate than Prudhoe Bay.
If the average tax rate from the mid-1990s had held, the State would have realized $3 billion more in production tax revenue, said Alper.
The State won a lawsuit in December stemming from Gov. Frank Murkowski’s 2006 change to ELF, taxing satellite fields at the higher rate. The suit saved the State about $500 million, plus interest.
What is the take-home lesson from this, asked Josephson. Is it that the legislature was indifferent to the decline, or that life was good enough despite the decline?
ELF was an extremely complex system built on assumptions, responded Alper. When assumptions underperform, a tax system should be revisited.
“My big takeaway from this message is that we should really beware of complexity,” said Rep. Justin Parish (D-Juneau). “We should recognize that our industry partners are sophisticated actors — often more sophisticated than we ourselves — and will do what’s best for their shareholders, even when that looks like gaming the system to someone who set up the system.”
“There is another byproduct out there that is happening when [oil companies] invest in the state of Alaska. Not only are they creating jobs, but there are sales that are going on internally that we reap benefits from in the economy, not just the profits or the losses or the NOL or all that other stuff,” countered Rep. George Rauscher (R-Sutton).
“They are a very large part of the economy,” agreed Alper.
In a press conference Thursday, Rauscher and other House minority members expressed concern about the impact an oil tax change could have on the economy. But they were more opposed to the House majority’s income tax plan.
“I’m really not that hot on an income tax. I don’t think that’s going to be the answer,” said Rauscher. “I think before we start to get Alaskans to pitch in through an income tax, we have to make sure to provide the right-sized government for them.”
“If nobody’s working, there’s nothing to tax,” Rep. Gary Knopp (R-Soldotna) said simply.
Rep. Chuck Kopp (R-Anchorage) commended House Finance Chair Paul Seaton (R-Homer) for introducing a fiscal plan.
“Do we all agree on every point of that plan? No,” said Kopp. “Do we all know that there’s going to have to be some compromise to get to a balanced approach? Yes.”
But, Kopp added, “An income tax injects a permanent revenue stream into our source of income that will not go away, even when, financially, things change. One of the things that my colleagues and I are always concerned about is government grows to spend the amount of money that comes to it. We just want to be very careful that the income tax is Alaska’s last tax, the very last thing we should be asking people to do if all else fails.”
In Tough Fiscal Times, Cash Credits Eliminated
The Walker Administration and the House majority argue that changing the tax credit system will actually stabilize the economy by providing certainty to the industry.
Under the current tax regime, the State’s share of GVPP has averaged 30 percent since 2014.
However, tax credits have effectively reduced that share to 27 percent.
“The credits have a larger impact at lower prices,” Alper explained Friday. “The credits themselves, even when they are stable over time, are a larger portion of the underlying revenue and therefore have a larger impact or change to the State’s effective revenue.”
The State’s cash credit liability in FY 2018 is $900 million. Last year, Walker vetoed $430 million of the credits down to the statutory formula of $30 million, building up the liability.
That was the second time Walker vetoed the credits, which the legislature has historically appropriated without any limit.
In FY 2016, Walker vetoed an appropriation estimated at $700 million to a maximum $500 million. $498 million in credits were eventually paid, just below the cap.
“Everyone that needed to get paid or needed to earn their certificate received it and was paid within that fiscal year,” said Alper.
“The coverage, I think, in the media and scuttlebutt… in the legislature generally was that in FY ’16 there was great turmoil both on Wall Street [and] to purchasers of the certificates,” Josephson said. “I mean, I remember that profoundly, that there was this belief that everything had sort of been upended and there was chaos.”
“With the governor’s veto, what he vetoed more than the dollars was the concept of open-ended repurchase of credits,” Alper responded. “I think that change was dramatic, considering it had been open-ended for about eight years before that, and there was some reaction in the financial sector. Knowing that a new paradigm had been set — those who were then borrowing money and then doing work knew that it could be the same or worse in years to come.”
“Industry was probably correct in recognizing that this was a sea change, but not necessarily correct that it was an immediate change in the availability of cash,” Alper concluded.
HB 111 eliminates cash credits for companies on the North Slope, and along with them, the expectation that they can receive unlimited amounts of money from the State every year.
Instead, smaller companies will have to sell their credits to other companies or use the credits against future tax liability.
Alper recommended that House Resources change a separate provision in the bill that leaves the interest rate on delinquent oil and gas production taxes at three percent.
“We are, one way or another, going to be spending Permanent Fund earnings — or at least, it’s likely we will — to help fund the operations of government. If you’re using the Permanent Fund as a source of revenue, that’s a dollar that’s not sitting in the Permanent Fund earning our invested return,” Alper explained. “So it seems to me the State’s interest rate on unpaid taxes should at least roughly parallel the expected average earnings of our primary savings account and investment account, the Permanent Fund, which is in the neighborhood of seven percent.”
Protecting the State in a Low-Price Environment
HB 111 increases the minimum production tax to five percent, a revenue increase of about $58 million at current oil prices.
Oil is trading near the forecast of $54. Without a minimum tax, there would be no production tax until oil hits $70 per barrel. That price is not expected until FY 2022.
The bill would also prevent certain credits from dropping a company’s tax rate below the minimum, or “piercing the floor.”
Small producer credits, NOLs, and a Gross Value Reduction (GVR) credit available for projects in the first seven years of production all currently pierce the floor and could lower the tax rate to zero.
“We recently did some analysis that was published that says that, given the average normal field and current costs, the Gross Value Reduction-eligible oil tends to pay zero tax up until an oil price of about $69 per barrel. We’re well below that [price] now,” Alper said. “So it’s generally true that any so-called ‘new oil’ is not paying production tax in current environment.”
“Hardening the floor” is a policy consideration, Alper told House Resources. For example, should a company like Chevron, which is considered a small producer in Alaska because it produces less than 50,000 barrels a day, be allowed to pay less than the minimum tax?
A working group chaired by Sen. Cathy Giessel (R-Anchorage) recommended that the legislature harden the floor, but Giessel’s Senate Resources Committee later backed down when it saw that large producers could carry forward their losses at extremely low prices, building up a $1 billion liability.
Those credits could eventually be used when oil prices recover and companies again generate a tax liability, reducing State revenue for years afterward.
“I think there was some anxiety in the legislature when debating hardening the floor last year when we saw how big it could get,” Alper said of the carry-forward NOLs.
The State is not forecasting an extended period of low price within the next ten years that will result in large losses for major producers.
However, there is still the chance for volatility within a given year. As an example, Alper said oil prices could spike for a couple months in the event of a war that disrupts oil supply.
In 2014, oil prices crashed, causing companies to bump against the minimum tax toward the end of the year. Companies earned tax credits in those later months that they applied to months earlier in the year when prices were high and they had a tax liability.
“The net result was we, in the Spring of 2015, facing a fiscal crisis, wrote refund checks of $112 million to our major producers to cover the difference between the monthly estimated tax and the true-up based on the migration of this credit within the calendar year,” Alper told House Resources.
HB 111 would prevent this “credit migration” phenomenon in volatile years.
The bill also reduces the maximum per-barrel credit from $8 to $5. The per-barrel credit drops as oil prices climb above $110.
“It’s a tax increase at a particular range of moderate prices that tends to diminish at higher and lower prices,” Alper said of the per-barrel credit provision.
According to the fiscal note, HB 111 protects the State the most if prices drop to between $20 and $40 per barrel. At the forecast price, the bill has a moderate impact that grows over time with expected price increases.
The next House Resources hearing on HB 111 is scheduled for Monday. Members of the oil and gas industry will testify Wednesday and Friday.