News Column

What Is 'New Oil' in Alaska?

August 23, 2013

Lisa Demer

alask north slope
Alaska North Slope oil rig (file photo)

State revenue officials struggling to implement Alaska's new oil tax law are getting complaints from the industry that their proposed new rules are both bewildering and too demanding.

While the overall effective date was Monday, the big oil tax changes, including a flat tax on oil profits, become law on Jan. 1. As the Parnell administration tries to craft rules to implement the controversial law, Democrats who fought it all along are launching fresh attacks on it.

The oil companies want the broadest possible definition of "new oil" because new production will be entitled to the biggest tax breaks. That is intended as an incentive for the companies to invest and produce oil that wouldn't have been produced otherwise.

The Parnell administration insists it's not going to give the tax breaks freely and proposes that in some cases the flow of oil be metered from individual wells to prove that new oil is being produced. But industry officials are protesting, saying such metering is impractical.

Democrats in the Legislature warn that too loose a standard could allow vast volumes of oil that was going to be produced anyway to escape the oil profits tax, the state's main source of revenue.

For instance, in a document published Oct. 16 to explain its proposed new rules, the Department of Revenue says if water is injected into a newly installed well in a new area -- a common process to force out trapped crude oil -- and that water pushes through a reservoir and sweeps oil into existing, already producing wells, that counts as new oil.

"I understand that language. I know what they are trying to do. But in reality, it's a fool's errand," said Rep. Beth Kerttula, a Juneau Democrat who serves as House minority leader and who previously worked as a state oil and gas tax lawyer. She said she was outraged by the proposed rules.

"You will never be able to break those hydrocarbons apart. You will never be able to tell what's old versus new."

Democrats are especially upset because the Republican-controlled Legislature agreed to apply the extra tax break to certain new production from Alaska's aging but still highly profitable giant oil fields, including Prudhoe Bay and Kuparuk. Those fields accounted for about 90 percent of North Slope production last year.

It could all be treated as new oil before too long, Kerttula said.

"Couldn't be further from the truth," answered Bruce Tangeman, the state's deputy revenue commissioner. If accurate measurement ends up being impossible, the companies won't get the sought-after tax break for new production, he said.

"The whole point was for the state to set a high bar, a high standard and then have industry, the experts, the producers, the people who do this for a living, come to us and say, we can measure it this way with the technology we have," Tangeman said.

The department is asking industry how to measure new oil. Metering at every well is just one option. But the industry won't get to write the rules, Tangeman said.

TAX BREAK FOR NEW OIL

Even the tax break's name is hard: It's called the "gross value reduction," formerly known as the "gross revenue exclusion."

Gov. Sean Parnell and Republicans in the Legislature pushed through Senate Bill 21, the new tax system. They argued that lower tax rates and new financial incentives were necessary to stem a decades-long slide in North Slope oil production. Alaska's oil profits tax generates the bulk of state revenue, which pays for such things as teachers and troopers, road repairs and health care, state parks and universities.

The new law imposes a flat, 35 percent tax on profits and eliminates the Palin-era tax system of progressively higher tax rates as oil prices rise. It gives oil companies new tax credits of up to $8 a barrel, depending on the market price of oil.

For oil that ends up classified as "new" North Slope production, the tax law also sets aside at least 20 percent of the oil's gross value and exempts it from the profits tax. That's another $7 or more in tax savings per barrel of oil, according to an analysis by state House Democrats. At certain oil fields, for which the state already claims a royalty, or ownership interest, topping the standard 12.5 percent, 30 percent of the oil's value can be set aside for a tax break. That amounts to $11 in savings per barrel.

In all, the changes are predicted to cost the state $700 million to nearly $1 billion a year. The extra break for new oil production is expected to be a small portion of that, maybe $25 million to $75 million, though state officials admit they don't really know how much.

One sticking point in the Department of Revenue's proposed rules concerns how to define new production in the giant old fields. The extra tax break also applies to new pockets of oil in existing fields and to new oil fields. That would include Linc Energy's untapped Umiat prospect, Tangeman, the revenue official, said.

Democrats say two fields already producing oil, Pioneer Natural Resources' Oooguruk field and Italian oil producer Eni's Nikaitchuq field, count as new because they were created after the law's cutoff date of Jan. 1, 2003.

BP, the Prudhoe Bay operator, said it doesn't see the tax break applying there, spokeswoman Dawn Patience said. BP plans to add drilling rigs in 2015 and 2016, mainly for work in Prudhoe Bay, but new oil produced as a result won't qualify for the extra tax break, she said.

'ENORMOUSLY DAUNTING'

At a public hearing last week on the proposed new regulations, the only testimony came from two oil industry representatives. The state will accept written public comments through Monday.

The state should expect oil companies to demonstrate compliance "rather than setting forth an enormously daunting burden of proof that we have to overcome," Marie Evans, ConocoPhillips' tax counsel, told the Department of Revenue, according to a transcript of the Aug. 13 proceeding. ConocoPhillips operates the Kuparuk River field.

The proposed rules are hard even for experts to decipher, Evans said.

"The one thing I can say is right now when I read these regulations, and I have had significant help from different departments within ConocoPhillips, oftentimes I'm answering, 'I don't know what that means,' " she said.

She suggested the department use "normal oil field practices. Some of the standards in here are aspirational, but they're impractical."

For instance, the proposed rule says that no more than one-tenth of 1 percent of the new oil being measured could flow from an existing oil field into a new area. "I don't think there's anything other than a U.S. track and field course that is measured within one-tenth of 1 percent," Evans said.

The state has proposed that one method of measuring new oil would be to continuously measure the flow on each new well through a "multi-phase flow meter" that would, theoretically, calculate how much oil is in the mixture of oil, natural gas and water drawn up from oil reservoirs.

But the type of meter required to continuously measure oil at individual wells, before processing, can cost up to $750,000 and the accuracy varies depending on the precise mix of components, Evans told the Revenue Department. The mixture of oil, gas and water may all be stirred together as it comes out of the reservoir and can take days or even weeks to separate, according to the state's oil and gas director, Bill Barron.

"There's no -- we're just not set up to do this," Evans said.

Currently, individual wells on the same pad are tested at least monthly in a system overseen by the Alaska Oil and Gas Conservation Commission to estimate how much oil comes from each well, Barron told legislators in March.

The oil, gas and water are separated, a meter measures the flow of just oil, and then the components are mixed back together and piped from a pad's wells to a central processing facility, he explained in an interview. The flow information is used for tax and royalty purposes, and to help manage the reservoir, he said. The system is shared among all the wells on a pad.

The oil is measured again, more precisely, after being separated in the central processing facility, according to Conoco.

Tom Williams, BP's tax counsel, testified as chairman of the Alaska Oil and Gas Association's tax committee, the industry group that represents most producers, refiners and other key players. His comments were brief, but he said the association has concerns about the metering issue and how to determine what oil will qualify for the extra tax break.

'LAZY LAW'

Tangeman said his agency expects to have new regulations in place this year. He said the new law contains other incentives for oil companies even if they decide the extra tax break for new oil production is too complex or too expensive. There's the new flat tax, the elimination of tax rates that escalate as oil prices rise, and the sliding-scale, per-barrel credit, he said.

The producers are "going to fight for every inch they can," he said.

The department's nine-page rule explainer issued last week may only add to the muddle. A footnote discusses how oil and gas subjected to "multiphase flow metering" and then commingled with similarly subjected oil and gas could be "mechanically separated according to custody-transfer standards. In this situation, the total amounts metered according to custody-transfer standards are allocated back, proportionally to the respective amounts metered by multiphase flow metering."

The oil tax law, which the Parnell administration calls the More Alaska Production Act, is the subject of an effort to repeal it by public vote on the August 2014 ballot.

This week, state Sen. Bill Wielechowski highlighted his first "reason of the week" to support the repeal. Even when Alaska's oil taxes were so low that 15 of 19 North Slope fields paid no production tax, production declined, the Democrat from Anchorage said.

But oil prices were low then, too, Tangeman said.

By 2000, Wielechowski said, oil prices were rising, taxes were low, and production was still down.

The state's new oil tax measure is what Kerttula said her father, former longtime Sen. Jay Kerttula, a Democrat, used to call "lazy law," meaning the Legislature "dumped it on the regulators."

"The Revenue Department is trying its hardest but I don't know how they are going to ever resolve a geology question on the reservoirs and the hydrocarbons."

Reach Lisa Demer at ldemer@adn.com or 257-4390.

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(c)2013 the Anchorage Daily News (Anchorage, Alaska)

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Source: Copyright Anchorage Daily News (AK) 2013