Evaluation of ACESwith HB 110 Proposal

Roger MarksLogsdon & Associates

House FinanceMarch 15, 2011

1

Overview

I. How ACES Operates / Problems it CreatesII. International CompetitivenessIII. Current Evidence of Problems from ACESIV. Proposal to Fix ACES

2

Tax Rate under ACES

• Base rate of 25% of net value (after deducting all costs)

• Progressivity element when net value per barrel exceeds $30/bbl:– (Net value per barrel value - $30) X .004

• If oil market price is $90/bbl:– Net value per barrel is $58/bbl– Progressivity = ($58 - $30) X .004 = 11.2%– Total tax rate = 25% + 11.2 = 36.2%– 36.2% X $58 X 0.875 (non-royalty) = $18.37/bbl– APPLIES TO ENTIRE NET VALUE

3

4

0%

10%

20%

30%

40%

50%

60%

70%

$0 $20 $40 $60 $80 $100 $120 $140

ACE

S Se

v Ta

x Ra

te

Net Value ($/bbl)

ACES Severance Tax Rate

2010 U.S. Tax Rate for Single Taxpayer

• First $8,375 10%• Next $25,625 15%• Next $48,400 25%• Next $89,450 28%• Next $201,800 33%• Anything over $373,650 35%

5

20%25%30%35%40%45%50%55%60%

Tax

Rate

on

the

Firs

t D

olla

r of

Val

ue

Net Value per Barrel ($/bbl)

What Happens to the First Dollar of Value under ACES

6

7

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

$50 $60 $70 $80 $90 $100 $110 $120 $130 $140 $150

Ma

rgin

al

Ta

x R

ate

ANS Market Price ($/bbl)

Marginal Tax Rate under ACES (All State & Federal Taxes & Royalties)How Much Gov't Gets When Price Goes Up $1

8

0%

5%

10%

15%

20%

25%

$40 $60 $80 $100 $120 $140 $160 $180 $200 $220 $240

Prob

abili

ty o

f Cer

tain

Pric

e

Oil Price ($/bbl)

Hypothetical Expected Price Outlook

International Competitiveness

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10

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

U.S. GOM U.K. Alberta Thailand Australia Brazil Norway Alaska -ACES

Mar

gin

al T

ax R

ate

@ $

10

0/b

bl

International Marginal Tax Rates @ $100/bbl Market PriceTax & Royalty Regimes

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Where $100/bbl ($25B) Went in 2008

Government$56/bbl($14B)

State: $11BSev tax: $7B

Feds: $3B

Costs$24/bbl($6B)

Producers$20/bbl($5B)

12

After-Tax Income that Would Have Been Earned in Alaska in 2008 With Rates from Other Tax & Royalty Regimes

($billions)

Gulf of Mexico $10.3U.K. $9.0Alberta $8.2Thailand $8.2Australia $6.9Brazil $6.6Alaska $5.0Norway $4.1

13

ConocoPhillips Financial Performance: Alaska vs. Rest of World ($millions)2008 ($100/bbl) vs. 2009 ($60/bbl)

Alaska Rest of World

Additional pre-tax income 2009 over 2008 $3,673 $14,707

Additional taxes 2009 over 2008* $2,898 $7,163

Additional after-tax income 2009 over 2008 $775 $7,544

Percentage of additional pre-tax income retained after-tax 21% 51%

* Alaska: 80% severance tax / 20% income tax; Rest of World: 10% severance tax / 90% income tax

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OIL SEVERANCE TAX RATES BY STATE

State Rate (% of gross) : State Rate (% of gross) :

Iowa NONE : Illinois 5.00%New York NONE : Colorado 5.00%Pennsylvania NONE : West Virginia 5.00%Ohio 10 cents/bbl : Utah 5.00%California 0.10% : Mississippi 6.00%Indiana 1.00% : Wyoming 6.00%Nebraska 3.00% : Michigan 6.60%New Mexico 3.75% : Oklahoma 7.00%Alabama 4.00% : Florida 8.00%Kansas 4.30% : North Dakota 11.50%Kentucky 4.50% : Louisiana 12.50%South Dakota 4.50% : Montana 12.50%

Texas 4.60% : ALASKA @ $90 market (25 % of gross equivalent)Arkansas 5.00%

The State is Making Lots of Money Now:

What is the Problem?

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16

2

2.2

2.4

2.6

2.8

3

3.2

3.4

2002 2003 2004 2006 2007 2009

Bill

ions

of b

arre

ls

Year of DNR Forecast

A History of DNR Forecasts of Total Production between 2010 and 2020

(billions of barrels)

PPT Passes

ACES Passes

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450,000

500,000

550,000

600,000

650,000

700,000

750,000

800,000

850,000

900,000

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

AN

S Pr

oduc

tion

For

ecas

t (b

bls/

day)

Dept of Natural Resources ANS Production ForecastBefore & After PPT (bbls/day)

May 2006 Forecast (last forecast before PPT) Current Forecast (November 2009)

18

0500

10001500200025003000350040004500

Core Fields w/Satellites*

Pt. Thomson Nikaitchuq NPRA Oooguruk

Mill

ions

of B

arre

lsOil Production Forecast 2010-2050

(Millions of Barrels)

Source: DNR Division of Oil & Gas 2009 Annual Report: p. 29

*Core fields are Prudhoe, Kuparuk, Alpine, Endicott, Milne Pt., Northstar

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-100

0

100

200

300

400

500

600

700

800

900

Prod

ucti

on L

osse

s (m

illio

ns o

f ba

rrel

s)Total Forecasted Production Losses 2010-2020

between 2006 and 2009 Forecasts(millions of barrels)

Investment: The Big Picture

• Production requires capital investment• At the corporate level Alaska competes for

capital with other jurisdictions– Capital is finite– Capital is fluid– Capital will go to where it gets the best deal

20

Resource Potential

• 2007 Department of Energy report: 10 billion barrels of additional economically recoverable oil on the North Slope in current core producing area.*

• DNR’s current production forecast is for 5 billion barrels between now and 2050.

* Department of Energy, National Energy Technology Laboratory, “Alaska North Slope Oil & Gas: A Promising Future or an Area of Decline?,” August 2007, pp. 2 - 152-153.

21

22

02468

101214161820

2005 2006 2007 2008 2009 2010

Num

ber o

f Exp

lora

tory

Wel

ls D

rille

d

North Slope Exploratory Wells Drilled: 2005-2010

Context of Spending

• Core fields down*• Non-core fields up* (Nikaitchuq and Pt.

Thomson)– A small share of potential reserves

• No other new fields on the horizon• Gold-plating

* Department of Revenue “Oil and Gas Production Tax Status Report to the Legislature,” January 18, 2011, p. 8.

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24

GOLD-PLATING Spending more because someone else is picking up the tab

Spend $1Before in Capital

ANS Market Price $90.00 $90.00 Less: Transportation Cost $6.00 $6.00 Capital Cost $13.00 $14.00 Operating Cost $13.00 $13.00 Net value $58.00 $57.00

Severance Tax Severance Tax Rate 36.20% 35.80% Credit $2.60 $2.80 Severance Tax $15.77 $15.06

Pre-income tax income $42.23 $41.94 Combined state/federal income tax (41%) $17.31 $17.20 After-income tax income $24.91 $24.75

Reduction in income $0.17

Bottom Line: Spent $1 but reduced income by only 17 cents The purchase only cost 17 cents after-tax The other 83 cents picked up by the state/feds in reduced taxes

25

0%10%20%30%40%50%60%70%80%90%

100%

$50 $60 $70 $80 $90 $100 $110 $120 $130 $140 $150Pct

. of

Cap

ex

Pai

d b

y P

rod

uce

rs A

fte

r-Ta

x

ANS Market Price ($/bbl)

Gold-Plating: Percentage of Capital Cost Paid by Producers After-Tax under ACES

(with 20% capital credit)

Implications of Gold-Plating

• Gold-plating is not efficient spending (spending to produce barrels)

• Gold-plating happens because of high marginal tax rates at high prices under ACES

• Gold-plating may explain a lot of spending without the commensurate increase in production

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Fixing ACES

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Fair Share:Economic Aspect

• Maximizing benefit to people– Long-term benefit– Linked to maximizing long-term production– Production maximized by continual investment

• In designing a tax need to be mindful of how Alaska stacks up internationally

• What is “fair” is what you can get in a competitive environment

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29

$0

$10

$20

$30

$40

$50

$60

$50 $60 $70 $80 $90 $100 $110 $120 $130 $140 $150Pe

r B

arre

l Cre

dit

/Se

vera

nce

Tax

ANS U.S. West Coast Price ($/bbl)

Cash Flow Impact: Credits vs. ACES Severance Tax

per/bbl credits per/bbl sev tax

Proposal for Fix:Bracketed Tax Structure

• The problem is not progressivity – but the progressivity structure

• Changing the progressivity structure– HB 110:– Bracketed progressivity structure

• Values within structure

30

Proposed Bracket Structure: HB 110 (Existing Units)*

Based on Net Value p/bbl**

• $0/bbl - $30.00/bbl 25.0%• Next $12.50/bbl ($30.00 - $42.50/bbl) 27.5% • Next $12.50/bbl ($42.50 - $55.00/bbl) 32.5%• Next $12.50/bbl ($55.00 - $67.50/bbl) 37.5%• Next $12.50/bbl ($67.50 - $80.00/bbl) 42.5%• Next $12.50/bbl ($80.00 - $92.50/bbl) 47.5%• Anything over $92.50/bbl 50.0%

* For other fields outside existing units the tax rates are 10 percentage points less** These net values are approximately $30 less than market values (the ANS West Coast price).

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32

0%

10%

20%

30%

40%

50%

60%

$0 $20 $40 $60 $80 $100 $120 $140

Seve

ranc

e Ta

x Ra

te

Net Value

Comparison of Effective Severance Tax Rates(Before Credits)

ACES HB 110 - Existing Units HB 110 - Other Fields

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

$50 $60 $70 $80 $90 $100 $110 $120 $130 $140 $150

Mar

gina

l Tax

Rat

e

ANS Market Price ($/bbl)

Marginal Tax Rates(All state & federal taxes and royalties)

ACES HB 110 - Existing Units HB 110 - Other Fields

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

U.S. GOM U.K. Alberta Thailand Australia Brazil Alaska - HB 110 - Other

Fields

Alaska - HB 110 -

Existing Units

Norway Alaska -ACES

Mar

gina

l Ta

x Ra

te @

$10

0/bb

lInternational Marginal Tax Rates @ $100/bbl Market Price

Tax & Royalty Regimes

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

$50 $60 $70 $80 $90 $100 $110 $120 $130 $140 $150

Pct.

of C

apex

Pai

d by

Pro

duce

rs A

fter

-Tax

ANS Market Price ($/bbl)

Gold-Plating: HB 110 (Existing Units) vs. ACES(Pct. of Capex Paid by Producers After-Tax)

HB 110 - 20% Credit HB 110 - 40% Credit ACES

Revenue Losses from Proposal?

• Initial revenue losses likely• DOR’s production forecast does not consider

availability of capital– Very plausible that status quo production forecast is

too high • Very plausible that with lower taxes there will be

greater investment and production – Very plausible that production forecast under HB 110

is too low• Cannot compare revenues between taxes using

the same number of barrels

36