Oil & Gas Tax ReformBy Mary Lynne Dahl
April 29, 2019
I do not make a habit of offering my opinions publicly. I am neither Republican nor Democrat. I try my best to judge impartially, on a non-partisan basis. I have spent the last 35 years of my professional life giving financial advice as objectively as humanly possible. With these things in mind, I have decided that I must comment on one aspect of the debate over the fiscal situation Alaska finds herself in and the prospects for solutions to the problems.
I am not going to address the debate about whether or not to solve the financial problems of the state via budget cutting or increased income. That is another subject. My comments in this letter are directed solely to one issue of concern that has not been discussed enough and which, I believe, is critically important to solving our budget crisis. The subject is complex, so I will try here to keep it fairly straightforward, in an effort to make it understandable at all levels and representative of the most important points for citizens to consider.
That issue is the oil and gas tax system in Alaska. The Alaska system is based on a hybrid methodology of collecting taxes on a combination of mostly net tax basis and some gross tax basis. Unlike Alaska, all other state oil tax systems are gross systems.
The Trans Alaska Pipeline System (TAPS) is owned by 3 big oil companies doing business in Alaska. They are Conoco Phillips, Exxon and British Petroleum (BP). As the TAPS owners, they charge tariffs on the oil they send down the pipeline. The tariffs are intended to fund the dismantling and removal of the pipeline if/when the oil runs out and the complete restoration of the land back to the original condition it was in before the pipeline was built. The oil companies agreed to be legally obligated to this plan, which is called “Dismantle, Remove and Restore” (DR&R). DR&R tariffs were the methodology designed to insure that there will be enough money on hand to accomplish this legal obligation of the oil companies.
In the beginning of the oil days, when the pipeline was built, Governor Jay Hammond envisioned a gross tax system that he described as 1/3 – 1/3 – 1/3. One third of revenue was to go to the state, one-third to the oil companies and one-third to the federal government. It was based on gross revenue of the oil companies. Today, if Alaska was using this system, our 1/3 share of approximately 518,000 bpd - barrels per day - per 2018 production figures) would be about $3.78 billion for a one-year total amount, assuming a price of $60 per barrel. However, the actual revenue received by the state was about $2.4 billion, $1.3 billion less than it would have been under Governor Hammond’s method. Why is this?
The reason for this shortfall is that our system today is calculated primarily on a net revenue basis, not a gross revenue basis. It is extremely complicated and nearly impossible to verify as accurate. It is so complicated that the state cannot determine the tax due, with the result being that actual oil company costs and profits are unknown. In addition, much of the audits done remain confidential and audits are 5 years behind schedule. In effect, needed financial information is being withheld from the state as a result.
The oil companies are allowed to deduct a variety of production costs, in order to arrive at a net profit dollar amount upon which the tariff tax is calculated, but they are not required to disclose publicly how they arrive at that net profit amount. As a result, Alaska has the highest costs in the nation to operate the tariff system we use to produce revenue for the state.
At this point, you may be saying “So what?” The oil companies are important; they represent the biggest corporations in our state and provide thousands of jobs to Alaskans. You are right, and that makes them valuable players in the economy of Alaska. They provide a lot of well-paid jobs to Alaskans, especially on the North Slope oil fields. However, the state is in partnership with these oil companies, and the product they sell for profit is ours, so our partnership, like any business contract, should be transparent and fair. Alaska should not be getting underpaid for the resource that has made enormous profits for the big oil companies. It is not fair for the state to do without our fair share in order for the TAPS oil companies to enjoy more than their fair share of the profits from our oil.
The oil companies have collected and earned $4.5 billion in tariffs, according to oil and gas expert estimates. The estimate of what it would cost to cover the DR&R obligation at the end of oil production has been stated as being approximately $2.5 billion. The oil companies who own TAPS have charged and retained the excess $2 billion.
The TAPS owners have threaten to stop producing oil in Alaska if they do not get the financial incentives and benefits of the current oil tax system. I do not believe them. The cost to them to dismantle, remove and restore is too great to risk paying. I am not alone in my conviction that the TAPS owners will not leave Alaska. Experts in the oil and gas industry agree with me that the oil companies will not leave the state of Alaska if tax reform of our tax/tariff system is changed to become fair for Alaska and less profitable for the oil companies. The reason that the oil companies will not leave Alaska is because their legal obligation of restoring the land back to pristine conditions would likely be extremely costly, an expense they do not want to have, but also because the TAPS oil companies do not want to lose the $4.5 billion in tariffs that they have accumulated. That $4.5 billion will grow in value with investment earnings. It is simply too much to pay to put the land back to its original condition and too much money to walk away from.
In spite of the threats from the TAPS oil companies, many smaller, independent oil companies would love to drill in Alaska but find it difficult to compete. However, there is too much oil in Alaska to stop drilling and pumping it. The University of Alaska Institute of Social & Economics Research said in their 2011 report that the Alaska OCS is estimated to be the largest untapped oil & gas basin the world. Prudhoe Bay is the largest conventional oil field in North America. That’s too much resource to walk away from. Even with tax reform and less profits to big oil, it is still highly profitable under all expert projections. On top of that, big oil is sitting on billions of dollars in tariffs already collected, which they can use for any purpose they desire, because they are not required to keep tariffs money in a trust or escrow fund account, they do not report on their contributions to it or the current value of it, their audits are confidential and 5 years behind schedule and they make more money in Alaska than in any other state or country. The threats to leave this very sweet spot are just threats. In reality they cannot afford to leave, but they can afford to pay Alaska her fair share, like Governor Hammond originally designed.
You might ask how we got to this point where the state is essentially giving her resource to the TAPS owners. It’s complicated, but boils down to greed on the part of a few big oil companies. Legislators were not sophisticated enough to see the dangers of changing from Governor Hammond’s tax system to the ones we have switched to and now have. Alaska had so much money coming in from oil that no one cared about the details of taxes on that oil. Former oil lobbyists and executives moved into the state and got elected to the senate and legislature, influencing legislation that favors the big 3 oil companies in particular.
Today Alaska is receiving less for our petroleum resources than at any other time in the history of the state. All other states’ oil tax systems are gross tax systems and oil resource owners in other countries that have net tax systems more like Alaska’s system collect 70%-80% of the net revenue, but Alaska receives only 27%-35% of the net revenue, on average (Source: Alaska Legislative Natural Resource Committee testimony of 2/3/17). The Alaska constitution requires a duty of the legislature to provide for the maximum benefit of the people of Alaska. The current oil tax system fails to meet this constitutional standard and needs to be changed. Alaska’s savings account should not be spent to compensate oil companies or pay for the deficits created by wasteful government spending. The state has spent down all of our savings and does not even have enough income to pay the tax credits we owe the TAPS owners, those same oil companies who are selling our resource at the highest profit returns in the nation. No other state or nation does this.
The bottom line: If Alaska received her fair share of the oil wealth being given to big oil, we would not have a deficit and we would not need to be having this debate over other sources of revenue like income taxes and PFD income-sharing. We would not be looking at draconian cuts to the budget, on the backs of our next generation, seniors, health care system and marine highway system. It is time for Alaska’s elected Senators and Representatives to muster the courage to do the right thing, work on a non-partisan basis and revert back to the original plan envisioned by Governor Hammond, to right this wrong and insure that Alaska and her citizens get a fair share of the resource that has made big oil rich.
Mary Lynne Dahl
About: Mary Lynne is a Certified Financial Planner®, long time financial advisor and co-owner of Otter Creek Partners, a fee-only, independent registered investment advisor firm headquartered in Ketchikan. She writes the MONEY MATTERS column for Sitnews and is a published author of MONEY MATTERS FOR WOMEN, Zondervan Press. She lives in Ketchikan with her husband Jim Dahl, also a co-owner of Otter Creek Partners and their 2 boxer dogs, Sunny and Lizzi.
Received April 29, 2019 - Published April 29, 2019
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