Croft Gasline Update #4

Note: I and my staff will be sending these gasline updates on various aspects of the contract over the next few weeks, to give Alaskans more information about this important topic. Please feel free to forward this to other people who you think would be interested -Eric

PPT Net Profits Tax:
Promised Revenues May Be A Mirage

Flawed Premise of the PPT

As the first special session winds down, we're on the verge of a final vote on SB 2001, the resurrected PPT oil tax bill that died at the end of the regular session. Through constant repetition, the Administration and its partners in Big Oil have convinced many people that the PPT concept will increase our tax revenues by upwards of a billion dollars a year. There are at least four major problems with those projections:

1. The comparison is unfair. The existing tax rate is artificially low because of problems with a formula written 17 years ago. The taxes go down based on how long a field has been producing, and the rate is dropping fast every year.
2. The numbers are wrong. From talking to our own experts, the actual revenue could be up to 50% less than estimated. The deduction and credit provisions are written very loosely, and money spent all over the world could be credited against taxes owed to the people of Alaska.
3. The PPT system, if it works at all, only works at high prices. If oil goes back under $30 or $35 / barrel, we would be facing much lower revenues than we have now.
4. If the gasline actually moves forward under the proposed contract, the tax system is designed so that much of the gas field development costs will be credited against oil taxes, years before any gas is flowing. This will have a huge negative impact on our revenues during the construction years.
   

#1: The Broken ELF

Don't listen to any comparison of how much more money the PPT will make versus the existing system. The existing system is broken and should have been fixed years ago.

Our oil production or "severance" tax, for the most part, is remarkably simple. Oil companies are taxed 15% of the wellhead value, times the "Economic Limit Factor," or ELF. The ELF is a multiplier between zero and one, which reduces the tax rate from that base 15% on each individual oil field. It is the multiplier that is broken, not the tax itself.

The multiplier, which was worked out by the legislature in the last hours of the 1989 session, is a complicated formula that considers the number of wells, the number of barrels, the number of years a field has been operating, and several other variables. Because many of the fields have been in operation for years, they pay at a lower and lower rate. Most of our fields, including Kuparuk, pay close to a zero percent rate, and Prudhoe Bay itself pays about 12%. The net result is that our oil fields are paying an average 6% severance tax, based on the gross value. That number is projected to decline to barely 4% ten years from now.

Thoughtful observers have been aware of this for years. In fact, my colleagues Rep. Les Gara and Sen. Hollis French have been saying it loud and clear for three years, proposing bills that would fix it, but nobody was listening. This year, the Governor admitted the ELF was broken, and then rolled out his PPT tax, waving a billion dollars of alleged new money a year in front of the legislature. The tax should have been fixed three billion dollars ago.

#2: A Tax on the Gross is the Better Way

When writer Winston Groom sold the screenplay rights to his novel Forrest Gump, he was promised a share of the profits. However, due to creative use of overhead and shared costs, this huge blockbuster officially showed a net loss, and Groom received nothing. The entertainment business is full of stories like this, about the misled artist who signed a contract for a percentage of the net, and ended up with nothing. With the right accounting, the most successful project can appear to run at a loss.

The big oil companies operate all over the world. They have the best and most creative accountants money can buy. Their most senior officers are often tax lawyers. They are expert at exploiting every clause, every nuance of the tax law. For this and other reasons, it is in the state's interest that the tax system be as simple and transparent as possible.

Instead, the PPT bill contains extremely broad language about what is deductible. It specifically says that an activity "need not be located on, near, or within the premises of the lease" property in order to be a deductible cost. We could be paying for computer modelers in Houston and golf outings in Scotland, and can do nothing about it. There is no requirement for separate accounting, where an oil companies' Alaska operations keep their own set of books. Our ability to audit is extremely limited. We will be gamed, and gamed badly by this tax.

#3: Double Dipping, Credits Carried Forward, and How We Could End Up Owing Them Money

A dollar spent on a construction project on the North Slope is deductible from taxable income. Twenty cents of that same dollar is creditable against taxes owed. A dollar spent five years ago will also get the 20-cent credit, retroactively.

All of the governor's financial models assume about $15 per barrel in costs to get oil to market. That's the cost to build up a field, drill the oil, ship it through the pipeline and tanker it to the west coast. If costs go beyond $15- and they will- the whole revenue projection falls apart.

According to the models, the PPT tax scheme would earn less than our current broken ELF if oil goes below about $30 a barrel. If the models are wrong, and the PPT brings in only 2/3 of the predicted amount, the "crossover" point is closer to $50 a barrel. The actual taxes owed could easily go below zero. We would owe them money.

But, the oil companies have prepared for this. One provision of the bill is that taxes can't go below zero. Instead, a negative tax bill can be carried forward as a credit to the next year. And the next year. In a couple of years of low oil prices, the companies can build up a backlog of credits that they will be able to use indefinitely, they never expire. So even when prices go up again, it could take years before we start collecting taxes again.

The House of Representatives added a provision to protect against this, putting in a "floor" or "alternative minimum" tax based on 4% of the gross value. The oil companies are protesting this vehemently, and it may not survive into the final version. But think about it- they tell us they are prepared to pay a 20% net profits tax, which they say will result in revenues between 5% and 12% of the gross value, depending on the price of oil. But they are fighting hard against the state ensuring we get at least 4% no matter what. Something seems a little fishy here.

#4: Unanticipated Consequences: The "Gas Revenue Exclusion"

Late in the regular session, a version of the PPT came out of the Senate Finance Committee that added new language, saying the tax would be collected on the oil, and "one third of the gas." This tipped the administration's hand that the gasline contract would have a severance tax rate significantly lower than the 20% being offered for oil. Sure enough, the contract came out with a 7.25% tax rate on gas profits, or about 1/3 the proposed tax rate for oil.

In the PPT tax system, the expenses and credits are intermixed between oil and gas. All of the gas-related expenses would be credited at 20%, but taxes would only be paid on one third of the actual gas. Large gas development expenditures could not only wipe out all gas taxes, they would actually cut into oil taxes.

The legislature is given "fiscal notes" that calculate the economic impact of any bill. The fiscal notes for the PPT bills only look forward for five years. They anticipate no gas field construction in that time period, and flatly do not consider the negative impacts of the "gas revenue exclusion" which one former state official estimated at up to $20 billion.

Net Profits Taxes And the World

Some of the same consultants who have been pushing the administration's plan are international "experts" who work all over the world. Their presumptions carry from country to country, but basically amount to one idea: low taxes and capital credits encourage investment and increase tax revenues. It is Reagan-era supply side orthodoxy that simply does not work.

In Bolivia, we've all read the headlines about how the government is nationalizing their gas fields. Let me be clear, I disagree with that action. But, it is important to understand that Bolivia put in a "PPT" style tax system a few years back on the recommendation of some of the same experts, as well as under pressure from the World Bank and the International Monetary Fund. Bolivia signed a contract for an 18% PPT, and revenues have not been close to what was promised despite record gas prices. So the people were upset, and elected someone who promised to increase their share.

Conclusion

The PPT is a bad idea. Since it will likely happen anyway, I am working to make it the best I can, but I'm still against it. But even worse is the governor's "contract to nowhere" gasline deal. That would lock in this flawed tax system for 30 or more years, taking away the power of future legislatures to fix the problems. That is something we simply can't let happen.