Simply stating that Alaska's tax burden on Oil Companies is undue is a nebulous statement that has no weight if not backed up by numerical evidence other than to alienate oneself from every Democrat within earshot. Everyone can agree that by virtue of their fiduciary responsibility to shareholders, E&P companies have a vested interest in minimizing their tax burden. Therefore it it is a clear conflict of interest for the latter to directly dictate the taxation structure.
The case made in this piece is that Alaska's tax structure is exceedingly heavy and over the past 30 years, been subject to frequent change - particularly in the last decade. The amount of take specified by any particular tax regime is less of an issue than the frequent change in when it comes to encouraging investment. Alaska's North Slope has been called a geologist's dream and an investor's nightmare. This is not the bitter complaints of a brash CEO but rather a accurate reflection of reality.
An Issue Deeper than Prudhoe Bay
Firstly, we must dig back into history - the first governor of Alaska, William A. Egan testified before Congress in 1957 that "..an equitable, though not burdensome tax structure......[Alaskan's] to put their house in order" [as to prep for becoming a state]. Basically Alaska had to promise that they would pay taxes despite their small population and limited economy (pre-oil) in order to become the 49th state in 1959. The federal government had legitimate concerns.
The 1950's saw the Korean war and unfolding of the Cold War and the military aggressively built up bases which powered the Alaskan construction/military industry. However as the hostilities of the Korean war were resolved in 1953 the defense appropriations dropped off and the economic base of Alaska had to return to natural resources. George W. Roger's The Future of Alaska: The Economic Consequences of Statehood is rather austere harsh pronouncement of the issues facing Alaska in 1962. In Roger's words:
"Statehood could be either a major contributing cause of Alaska's future economic growth or of it's bankruptcy.
Though no one likes to pay taxes, no one hated taxes more than the non-Alaskans who provided most of the private capital to develop Alaska, but had no interest in paying for government services they were not going to use. As a result, the outside interests naturally fought diligently to keep taxing authority away from resident Alaskans, who might be more interested in adding or improving government services to better their living conditions. - Blinded by Riches (Cole, 2004), pg. 94.
Economist George Rogers explained in The Future of Alaska that this inordinate reliance on land revenues and mineral royalties “as a means of fiscal solvency” was recognized as a risky gambit.
During the legislative session one member, a mining engineer, questioned the soundness of the revenue estimates and the wisdom of planning state finances on this basis. ‘The administration’s predictions are all optimistic, but are they going to hold up? If they don’t we’re in trouble. If the people want to gamble, that’s okay, but I think we should make it very clear to them the gamble they are taking.’ - Blinded by Riches (Cole, 2004), pg. 123
Alaska would have gone bankrupt in 1959 had oil not been struck on the Southern Peninsula at Swanson River. It's important to note that the majority of Alaska residents have no idea there is/was a producing oil field in Southern Alaska - that's because Swanson river is a small field but ideally located such that it can be loaded on a tanker. It peaked production in 1969 at 40,000 barrels/day. However it's existence provided enough cash for the state of Alaska to keep the lights on from literally day 0 of statehood.
The Balance sheet of Alaskan economic history is simple: one Prudhoe Bay is worth more in real dollars than everything that has been dug out, cut down, caught, or killed in Alaska since the beginning of time. - Terence Cole, UAF Professor of History
So now that we've explained just how dependent upon oil Alaska is, let's talk about the tax structure the State has set-up.
Alaska's Oil Tax Structure
Alaska's Tax Structure Exists in four parts:
- Production Tax (also referred to as "Severance")
- Coorporate Income Tax
- Property Tax
Note that Alaska has no state income tax and any property or sales taxes are levied at a municipal level. Royalties and tax revenue from oil and gas made up 92% of state's revenue in 2013.
Presenting Alaska's tax structure and then preceding to accuse it of being an excess burden on the oil industry is not productive. Because oil companies undisputably should be subject to taxation - as any other corporation is taxed. A good metric of fairness is comparing Alaska's tax structure to the tax structures in other oil producing states.
To illustrate this, I'm going to comparatively break down Alaska's Oil tax structure in comparison to other oil producing states.
Oil Companies pay a 12.5% royalty on each barrel of oil produced. The 12.5% is not an arbitrary percentage - it goes far back to the Anglo-Saxon rule of one eight - it was assumed that the entity/company was set to make a 25% profit on the produced resource and that profit was to be shared evenly with the landowner hence 12.5%. Landowners where generally royal hence the term "royalty".
In the lower-48 higher royalty rates are generally applicable to private land owners who do not receive the additional benefits of leveraging a income tax or severance tax from an oil producer as a state would.
Compared to it's peer group, Alaska is in a fairly average bracket for royalties. Note that all of the oil in Alaska (onshore) is on state land. Federal rates apply if the lease is on federal land.
So far, nothing outrageous.
This tax is a tax upon the act of producing oil and gas and is based upon the market value of the resource. It is imposed under a State's tax structure. In Alaska this means that it applies to the market value of a produced production after all applicable royalties have been paid.
This is were Alaska makes its real money. About 72% of oil and gas revenue is from severance (as of 2013). Following are the main tax structures applicable the last 40+ years.
Tax Structure: Years: Base Production Tax Rate:
Economic Limit Factor (ELF) 1977 - 2005 Oil: 12.25% for 1st 5 years, then 15%
As oil fields age, their economic performance deteriorates and the ELF system was devised as a appropriate form of tax relief to prevent fields from being pre-maturely shut-in. It also incentivizes producers to develop and produce smaller fields with lesser economics while large prolific fields are taxed at a higher rate. ELF is a capital cost estimate that approximates the % of the production value being consumed by the cost of production (which of course rise over time) this calculation produces a ELF factor (typically <1). The effective tax rate was = ELF*Base Tax Rate. The calculation works such as that when the operation of the field is at break-even, the ELF = 0. the production tax is zero. In other words, its a fractional surrogate for deductions. Note that the above rates would be the maximum base tax rates for prolific fields with older more expensive developments qualifiying for ELF adjusted rates.
Aggregated ELF 2005 - 2006 Same, but operators could lump fields together to their advantage.
Petroleum Profits Tax (PPT) 2006 - 2007 22.5%
Alaska's Clear & Equitable Share (ACES) 2007 - 2014 25%
More Alaskan Production Act (MAPA) - SB21 2014 - 2017 35%
Massive Tax Credit Offering + Cuts/Credits
to Small Operators, increased production tax
OIL & GAS PRODUCTION TAX - SB111 2017 - Present ?
Cuts Tax Credits Offered, Increased Tax
How does Alaska's production tax stack against other state's production/severance taxation rates?
- Texas: 7.5%
- California: 9.5%
- Oklahoma: 7%, if the oil prices is > $17/bbl.
- North Dakota, 5% , (previously 6.5%) if the oil is <$90/bbl
By any measure, Alaska's producton tax is far higher than any other state's rate, even California. It's been argued by politicians that the quality of Alaska's oil fields merited these high rates. In my view this doesn't hold water - even if Alaska had boundless beautiful homogenous carbonate fields a la Saudi Arabia, Alaska would still have extremely high operating costs. A task that takes 1 hour in Texas takes 3 hours on the Slope because it is cold, care to argue? Wait till it's -20F and go try starting a diesel and shovel off your roof while your out there, I'll wait. This isn't even to mention the high labor cost in Alaska. Or cost of living. Or cost of transportation.
Even by the lowest tax structure (ELF), Alaska's production tax rate has beat out California, at it's highest by a multiple of 3.6.
The production tax is not just very high it is also very complicated.
Why? Over the years, various legislatures have devised tax credit and deduction schemes to incentivise investment and conveniently sidestepping the political suicide of actually reducing the production tax to an appropriate level. Industry get's nervous when talks about getting rid of these various schemes is discussed. There is no reliable outlook for a reasonable tax code hence companies would like to hold on to what tax advantages they have. This is a double edged sword: (1) it makes the tax structure very complicated, even for companies that can hire the necessary bus full of accountants to understand it, (2) it's negative politically. A number of Alaskan politician's view these schemes as a loophole for industry to short-change Alaska and politically that message carries. Voters understand flat rates not complicated deductions and CAPEX calculations. Plus it plays into the existing stereotype of evil, greedy companies which makes for good campaign ads. Their solution is to punitively raise the base production tax rate.
Let's just talk about how much it ****ing changes. Alaska has made six major tax law changes in 12 years. There's no comparison to any other state. Other states routinely tweak their tax structure, but they do not overhaul it the way Alaska does. This a complex Frankenstein-ian Production Tax system is the result of
- the system being changed every 2 years
- bipolar political fiscal attitudes.
(1) starts a cycle with apocalyptic fear of the Alyeska Pipeline shutting down due to low throughput and what Alaska's finances would look like without out Oil & Gas revenue (read: a giant gaping fiscal hole). The end result of this cycle is tax credits/deductions being handed out like candy on the hopes that production/prices will rebound to their previous highs. The second segment of the cycle is the state approaching the next Fiscal Year and realizing that because of the candy they handed out last year, their revenues are stunted this year. They promptly confiscate the candy and vote for yet another radical re-write of the production tax structure.
(2) The result is of this swing between panic and greed makes for an extremely poor investment environment. Radically shifting the tax structure between generously low rates and a smorgasbord of tax deduction/credits to cold austerity is a poor way of managing Alaska's natural resources.
An example of this bi-polar policy is the creative but very expensive More Alaska Production Act (MAPA) of 2014 (SB21). In a nutshell, MAPA was designed to incentivize oil companies to drill exploration wells to ensure future oil production and pipeline throughput by offering them generous tax credits and the state's cash purchasing of certain tax credit certificates from small independent exploration companies. Yes. Cash. Payments.
MAPA was both a huge success and a huge disaster. Repsol and Armstrong Energy announced a 1.2 billion bbl discovery in March of 2017. In the fall of 2016, Caelus Energy made a world-class 6 billion barrel discovery field in Smith Bay. This was a fantastic exploration success, and one that was not expected*.
However, the price of oil collapsed in the Summer of 2014 and did not recover. By 2015, the state was staring into a budget shortfall abyss and on the hook for cash payments to companies who qualified by virtue of their exploration and production activities. By July, 2017, the legislature ended the cash incentive program.
Many politicians decried give-aways to big oil companies. However Armstrong Energy, has just 45 employees and Caelus Energy has a similarly few employees. Neither of these companies could afford a massive loss. BlueCrest Energy announced in August, 2017 that it will cease exploration drilling in Cook Inlet. They claim that the State owes them nearly $100 million and without it, they can no longer bankroll drilling activities.
Alaskan politicians are accustomed to being able to short-change large companies with no real repercussions. That is not the case with MAPA, Caelus was forced to layoff a quarter of its workforce in 2016. This stunt does not bode well for Alaska's future oil exploration as for the next decade Alaska will have the reputation of state in which companies cannot rely on a fair and consistent business environment.
The MAPA policy was poorly conceived in that it did not consider what the cost to the state would be with oil <$80/bbl. While incentives are a good idea, nobody is really in favor of cash payments from the State to oil companies. Why not just make the tax code reasonable and competitive in the first place?
*Within industry, the driving consensus was that only really big companies like BP, ConocoPhillips and ExxonMobil had the money to drill exploration wells on the North Slope. These companies had spent millions on expensive dry holes over the last 30 years, and owned all of the proprietary subsurface data in existence. Chevron's 1986 KIC-1 well - the only well to be drilled in ANWR (were some Alaskan's believe the actual mammoth oil field is hiding) - remains a secret. Most E&P professional's opinion is blunt, Chevron drilled a dry hole. No oil company discoveries a massive oil field and walks away.
All of this drove the sentiment that if if IOC's weren't out aggressively punching wildcat wells, it was too expensive and the geology didn't support it. John Miller, a longtime BP engineer, in his book The Last Alaskan Barrel: An Arctic Oil Bonanza that Never Was is reflective of this general consensus.
Companies in all states pay a 35% corporate income tax and an additional income tax to the state.
Alaska beats out California (a state, by the way, who had a $26 billion dollar deficit in 2010) in the state coorporate income tax bracket. I was frankly surprised that Alaska (a firmly RED state, beats California, a state rivalling the Blue Man group in Blue-ness, in State Corporate Income Tax.
E&P companies in Alaska pay a 2% on the assessed value on all applicable infrastructure. The assessed value is a sticking point and legal battles over the value of the Alyeska Pipeline is essentially an annual tradition in Juneau. In addition to the saga over assessed value, there is another rich tradition of arguing over what cut of the tax municipalities gain vs. the state. Alaska politics as usual.
There is only one comment to be made concerning the current administration's stance on this issue: Gov. Walker claimed the pipeline would last until 2068 (a total of 91 years in operation). This is a unrealistic stretch no matter the upgrades and maintenance undertaken. Anyone with experience maintaining a vehicle manufactured before 1980 can attest to the impossibility of that statement. Steel doesn't last forever.
In this case, Alaska does not claim the #1 spot - only Texas has a higher tax rate but notably this is due to the large volume of refinery infrastructure in Texas which falls into this tax bracket.
Prior to writing this post, I knew Alaska's taxation on oil and gas was heavy, but frankly surprised how much more in comparison to other oil producing states.
Economic Limiting Factor (ELF)
Comparison of Alaska Oil Taxes (2014)
Alaska's Oil & Gas Taxes (2009)
Alaska's Oil & Gas Production Tax (2011) - ACES