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Alaska Oil Tax Policy

Ships passing in the night?

Map showing North Slope Units by State of Alaska (yellow), federal government (green), and state and federal (orange).

Map showing North Slope Units by State of Alaska (yellow), federal government (green), and state and federal (orange).

MAP: State of Alaska, DNR, DOG

click here for high resolution map

Any opinions expressed herein are the author’s own.

 

Alaska’s approach to oil and gas taxes has taken a number of twists and turns over the last several years. The latest twist may largely be the result of ships passing in the night.

 

Background

Shortly following her election in 2006, Gov. Sarah Palin proposed a set of changes to the then-existing tax structure. She termed the package “Alaska’s Clear and Equitable Share,” or “ACES.”ACES changed a previous package of modifications which had been enacted in 2006.

Although he supported ACES at the time it was passed, late in his campaign for his own term in 2010 Gov. Parnell began generally to talk about what he then termed as the need for “tweaks” in ACES. Following his election, Parnell proposed a set of changes, which was introduced in the Alaska House of Representatives and subsequently referred to as “HB 110.”

After some modifications, the House passed the governor’s proposal in March 2011 by a vote of 22-16. The bill then went to the Senate.

The Senate held hearings in various committees on the governor’s proposal for the remainder of the 2011 legislative session and again most of the 2012 legislative session.

Ultimately, during the very final days of the 2012 legislative session, the Senate passed its response to the governor’s proposal as an amendment to HB 276, a bill that started out for a different purpose. The Senate’s response took a different approach to the governor’s original proposal and focused mostly on so-called “new fields,” areas outside the existing so-called “legacy” fields such as Prudhoe, Kuparuk, Alpine, Milne Point and Endicott.

The Senate bill provided for potentially significant reductions in taxes assessed on oil produced from the “new fields” — so-called “new oil” — and made limited modifications to the tax structure governing the legacy fields.

Citing the lack of time remaining in the regular session to consider the Senate’s changes, the House did not take up the Senate’s rewrite of the governor’s proposal, but while in committee the House leadership expressed concern with the bill’s limited focus.

Immediately following the end of the 2012 regular session, Parnell called a special session to deal with three issues, one of which was oil tax reform. Echoing the House leadership’s concerns about the limited scope of the Senate’s proposal, the Governor started the special session by offering a new bill, SB 3001 (HB 3001 in the House).

Seeking to build on the approach taken by the Senate, the governor’s revised version adopted much of what the Senate had included in its legislation for new fields, but extended it also to the legacy fields.

The special session soon imploded after initial committee hearings in the Senate showed a lack of support—even among traditional allies—for the Governor’s revised proposal.

Throughout, the governor argued that tax reform was necessary in order to encourage investment in the development of additional oil. The Senate floor debate and subsequent passage of HB 276 indicated most—and perhaps all—senators ultimately agreed with the governor’s position to some degree.

The reaction to SB 3001, however, demonstrated sharp differences over the need for extending tax reform to the legacy fields. Throughout the regular session and into the special session, legislators opposing the Governor’s proposals repeatedly expressed the view that oil from the legacy fields does not require additional incentives to be profitable.

Those differences ultimately came to a head during the special session, and likely now will live on into the coming fall election campaign.

 

The Confusion

In a very real sense, dividing the North Slope oil world into “new fields” and “legacy fields” is a false debate. To its advocates, the purpose of the approach is to provide incentives for the development of new, previously undeveloped oil, while maintaining the existing tax structure in place for previously developed oil.

The theory is that incentives are required to encourage the substantial investments required to develop and produce new oil, while the ongoing investment requirements to maintain the production of previously developed oil are relatively minor and are justified sufficiently by the margins produced under the existing tax structure.

The real world problem with this approach on the North Slope is that there are substantial amounts of new undeveloped oil remaining in the so-called legacy fields.

This is for a simple reason. In Alaska, oil and gas “units”—the mechanism through which the state administers its oil and gas leases for a number of purposes—are defined by surface geographic boundaries. So, most maps of the North Slope oil patch which depict the various fields are showing the surface boundary of the oil and gas leases that form the unit. From that perspective, the oil appears to be located in continuous, deep pools lying underneath the surface of the leased lands.

In fact, the oil is not arranged in such a neat manner. Viewed horizontally, there are several entirely different—and unconnected—producing intervals of oil located at different depths within the units, laid down at different geologic times and with vastly different characteristics.

Some intervals, such as the Ivishak, which extends across the bottom of the Prudhoe Bay field, contain light oil, are relatively easy to produce through conventional means and have been the source of most of the oil produced from the Prudhoe Bay Unit over the years.

Other intervals, however, such as the West Sak/Schrader Bluff, contain more viscous (thicker) oil and, because of the technological challenges that must be overcome and investment which must be made to achieve large scale production, are still near the starting line in terms of development. The closest interval to the surface, the Ugnu, holds significant potential, but because of the even greater technological challenges it presents, has not advanced yet significantly beyond the “science experiment” stage.As a result, even within the existing North Slope units, there are both existing fields, such as those producing from the Ivishak and Kuparuk, and new fields, such as those targeting the more challenging and costly West Sak/Schrader Bluff.

The potential of these new fields located within the legacy units is impressive. A recent presentation estimates potential oil in place within the West Sak/Schrader Bluff interval at roughly 12 billion barrels, and from the Ugnu at roughly 12 - 18 billion barrels.

To put this in perspective, the similar number for the Prudhoe Bay field—mostly from the Ivishak—is 25 billion barrels. In short, in combination the relatively undeveloped zones within the geographical boundaries of the existing North Slope units—the new fields within the legacy units—hold at least as much oil—and may hold more—than the original Prudhoe Bay field itself.

Despite this significant potential, HB 276, the version of oil tax reform that passed the Senate late in the regular session and supposedly targeted new fields, made no provision for the new oil potential located with the existing units. Instead, HB 276 effectively adopted as its definition of a legacy field any field included within the boundary of an existing oil and gas unit.

Because the West Sak/Schrader Bluff, Ugnu and other undeveloped intervals are located largely within the geographic boundaries of the existing North Slope units, they were excluded from the incentives contained in HB 276.

One of the reasons given by the governor for the extension of those incentives also to the legacy fields in SB 3001, introduced by him at the start of the special session, was to provide similar incentives also to the development of new fields in the existing units.

The governor’s bill was similarly imprecise, however. It provided the same incentives both to old and new fields located in the existing units, and provided a reduced set of incentives within the existing units. As a result, even the governor’s revised approach continued to discriminate against new fields located within the existing units.

 

Ships Passing in the Night

So, as of the end of the special session, the Senate was on record as favoring incentives for the development of oil from new fields, but without addressing new fields located within existing units. The governor similarly was on record as favoring incentives for the development of oil from new fields, including new fields located within existing units, but at a lower level for those than for new fields located outside of existing units.

The potential prize to the state from zeroing in both sides’ focus on the area located between the two ships—providing equal incentives for the development of new fields located inside of the existing units—is substantial. The estimates of 24 to 30 billion barrels of oil in place contained in the West Sak/Schrader Bluff and Ugnu intervals dwarfs almost all of the estimates for oil in place in the remainder of the North Slope.

Moreover, while substantial investment both in technology and equipment will be required to realize the potential, because the resource lies within the reach of the existing North Slope footprint, it likely can be brought on line more quickly than other potential sources.

To be sure, this approach only addresses part of the problem.

As the North Slope producers repeatedly have demonstrated, increasing amounts of oil can be recovered even from old fields through continued investment in new technology and techniques. For example, the original estimated recovery factor from the Prudhoe Bay field was 40 percent of the original oil in place (roughly 10 billion barrels). Over time, the recovery factor subsequently has been increased above 50 percent through the investment in and development of new recovery techniques and technology.

That represents, even in an old field, the addition of an incremental 2.5 billion barrels of oil.

With continued investment, some now estimate the recovery factor ultimately could exceed 60 percent, adding another 2.5-plus billion barrels of production. Reaching this potential may well require additional targeted changes to the oil tax code, even with respect to old fields.

In the meantime, however, focusing on improving the economics for the development of new fields, a goal that all sides appear to agree on—although in different ways—is worth the effort. Sometimes, stepping back from a battle and identifying the areas where both sides are near agreement—despite themselves—reveals new ideas for moving forward. This is one of those times.

 

Brad Keithley is a Partner and Co-Head of the Oil & Gas Practice at Perkins Coie, LLP. He maintains offices in both Anchorage and Washington, D.C., and is the publisher of the blog “Thoughts on Alaska Oil & Gas” (http://bgkeithley.com).

 

This article originally appeared in the July 2012 print edition of Alaska Business Monthly magazine.

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