Some thoughts on oil taxes

The most important lesson I’ve learned in my first year in the legislature is this: You do the best you can.

That’s what I’ve done on the new oil production tax bill that passed the legislature today. I don’t think this bill is the best possible law for the people of Alaska. I do think it will be the best possible law that could be passed by this legislature.

The majority of legislators came to Juneau convinced that a net profits tax – one that allows the oil companies to deduct all of their costs before paying their taxes – was the best kind of tax to have. Frank Murkowski sold them that idea last year.

This year, Sarah Palin agreed, and so did a legion of consultants. There was no opportunity for an impartial examination of other options, particularly a tax on the full value of each barrel of oil, a so-called gross tax.

Even if there had been, I suspect that the net tax would have won the battle, because it works so well in computer models. Nobody talks much about the fact the models themselves are based on a set of assumption about how the world works, and the world probably doesn’t work that way.

That’s what I meant when I told people all session that I understand that the net tax looks good on paper, but our tax has to work in the real world.

In the real world, we are engaged in a continuing struggle with the oil companies over who gets how much of the value of a barrel of oil. The history of our 30 years of disputes makes impressive reading – I’m including an abbreviated version below – and it underscores just what gassy nonsense all this rhetoric about partnering is.

Everyone talks about how it’s the companies’ job to make as much money as they can for their shareholders. Nobody talks much about the flip side of that: The money that goes to the companies – for outrageous CEO compensation, glossy PR campaigns and lobbyists’ salaries, as well as dividends to shareholders -- does not go to Alaskans in the form of government goods and services.

In general, we have lost this struggle. Each of the disputes with the oil companies is different, but a fair summary is this: The companies exploit every loophole they can find or create. The state catches them in at least some of these attempts. Our accountants fight with their accountants. Our lawyers fight with their lawyers. And a decade later we settle for anything from 10 cents on the dollar to 60 cents on the dollar. By then, of course, the companies have been using this money and discounting it, meaning that they have already gotten its full value before they have to pay us.

Will the new tax law change this? No. There are parts of it that give the state better weapons for this battle, but it’s still the same battle. Even with the tightest regulations and the most vigilant enforcement, this net profits tax contains plenty of nooks and crannies for the companies to exploit.

That’s why it’s a mistake to focus on the predictions of how much money the new law will bring in. Because the companies will find ways to pay less to the state, just as they always have. And once we’re embarked on the claim-audit-lawsuit-settlement cycle, the state can never catch up. Will the new bill bring more money to the state than the current law? Maybe. Probably. How much more? Nobody knows.

All of this, of course, is an argument for a tax on the gross. A tax on the gross isn’t a cure-all either, but it’s much easier to enforce and it offers the state as much revenue certainty as you can get when you’re selling oil, the value of which goes up and down. But this governor didn’t offer us a tax on the gross and this legislature won’t pass one. So, as I said at the start, you do the best you can.

What we did

Here are some of the highlights of the oil production tax bill:

• Raises the base tax from 22.5 percent to 25 percent of net profits
• Increases the rate at which the tax increases at high prices (called progressivity) from .2 percent per dollar to .4 percent per dollar above $30 net profits
• Caps operating expense deductions in the biggest oil fields for three years
• Allows the state to write regulations to dictate what deductions are allowable
• Gives the state more tools to obtain information about the oil patch
• Disallows deduction of repair costs BP incurred to fix its neglected feeder lines in 2006 and all similar cost deductions in the future

A brief history of ‘partnering’

It seems like the state and the oil industry have been involved in disagreements over tax and royalty payments since the day oil first flowed through the Trans-Alaska Pipeline System (TAPS) in 1977. Disputes over income taxes, production taxes, royalty payments and the TAPS tariff (the cost of transporting oil from the North Slope to Valdez), among other issues, stretched well into the mid-1990s. In many instances, it took almost 20 years for the courts to sort things out. And in almost all cases, the state ended up settling for pennies on the dollars it was owed.

Corporate income tax

In the early 1980s, the state required oil companies to operate under a system known as “separate accounting” which required them to segregate their Alaska profits and report them directly to the state. The companies challenged the system in court, and in 1982, Gov. Jay Hammond, fearing a defeat, decided to change the income reporting method to one which allowed the companies to report their Alaska profit as an estimated percentage of their worldwide income.

The result of the industry friendly income tax reporting change was that, from 1982 to 1983, revenue from the Corporate Petroleum Income Tax declined from $669 million to $236 million. Prior to 1982, the income tax generated significantly higher revenue, afterward, significantly less.

Production (severance) tax

The production tax – also called the “severance” tax – is the price the companies pay in exchange for severing Alaska’s non-renewable mineral resource from the state. Before the adoption of the current net profits tax system in 2006, the state used a gross system referred to as the ELF (short for “Economic Limit Factor.”) Production tax disagreements under the ELF gross system were due primarily to long-running disagreements over the TAPS tariff and the true market value of a barrel of oil. A significant portion of the severance tax disputes dating from the late 1970s and 1980s were finally settled in 1995.

According to the legislature’s research agency, the state claimed $5 billion in unpaid production taxes from 1977 through the early 1990s. The assessed interest and late payment penalties were $6 billion. So, total taxes, interest and penalties were $11 billion. After most of the cases were settled in 1995, only $1 billion in unpaid severance taxes and penalties remained in dispute, and was settled at a later date. Of the $10 billion that was settled, it is estimated that the state received somewhere between 40 and 60 percent of the full value it claimed. So, the state settled a $10 billion claim for somewhere between $4 and $6 billion. Determining the true amounts claimed and settled for is difficult because in most instances the details are confidential.

And just to demonstrate that these disputes with taxpayers aren’t one-time occurrences: In 1993, BP settled a production tax dispute from the 1980s for $613 million. In 2000, they settled again, this time for $416 million over disputed taxes from 1991-96.

Royalties

State of Alaska v. Amerada Hess, et al. was a complaint the state filed against some 15 producers in 1980. It is often referred to simply as the “Amerada Hess” case (Amerada Hess had the misfortune of being the first producer listed in the complaint because the producers’ names were arranged alphabetically.) The state alleged that it had been underpaid for its royalty oil for the barrels it took “in kind.” According to legislative research reports, the amount officially in dispute as of 1989 was $900 million, not counting interest and penalties. Most, if not all, of the cases were settled for less than full amount the state claimed it was underpaid. For example, the state claimed Arco had underpaid by $369 million (penalties included) and settled for $287 million. It claimed that Phillips had shorted the state $21 million (not counting penalties) and received $15 million.

The last of the Amerada Hess payment royalty payment disputes was settled in 1995.

Tariff

The TAPS tariff is the cost of transporting a barrel of oil from the North Slope to Valdez. It is deducted from the gross value of a barrel of oil before production taxes are assessed. Historically, the owners of TAPS and the state have disagreed over the cost of transporting oil from the North Slope through the pipeline to Valdez, with the owners consistently claiming a higher cost and the state claiming a lower cost. Not surprising, since the higher the tariff, the lower the taxes the producers have to pay. And, of course, the producers own the pipeline, they are paying the tariff to themselves.

Earlier this year, an administrative law judge with the Federal Energy Regulatory Commission (FERC), which regulates the TAPS tariff, came to the conclusion that the tariff the TAPS owners (including BP, Conoco and Exxon) are claiming is too high.

Finally, Richard Fineberg, an economic researcher and former advisor to Gov. Steve Cowper, asserts that the TAPS owners may have pocketed as much as $4.5 billion over the life of TAPS at state expense.

Th-th-th-that’s all folks

I’ll be vacationing for a while, trying to regain the tattered shreds of my sanity, trying to finish another mystery novel and trying to get ready for the regular session in January. This e-news will resume its regular appearance then. So if we don’t run into each other between now and then, happy holidays.

Until next time...