Palin: Wrong For Alaska, Wrong For America Part 2

{Note from Bradley C. Roberson: This post is part 2 of a guest article from a friend of mine who works in the oil industry. This article is concerned with ACES which is necessary background for the next article on on AGIA.}

ACES – Palin’s Tax on Petroleum Production
Alaska’s efforts to tax, regulate and promote growth of its oil and gas industry are complex and intertwined.  In order to keep this analysis to a manageable length I will provide some necessary background, but cannot go into much of the complexity.
 
Before Palin passed her new tax plan called ACES (for Alaska’s Clear and Equitable Share), Gov. Murkowski, the prior governor enacted the Petroleum Profits Tax (PPT) approximately a year earlier.  The PPT itself was adopted as an increase to Alaska’s predecessor tax regime.  Like most taxes, the PPT had complexities.  It contained incentives that were intended to enhance investment in-state investment and to correct the situation that, compared to international taxing authorities, Alaska had a lower tax-take at high prices and a higher tax-take at lower prices.
 
Two problems quickly arose which lead to the replacement of PPT.  First and probably most important was that the PPT was believed to be tainted because Bill Allen, the CEO of VECO an Alaska-based oil services company, pleaded guilty to bribing members of the Alaska state legislature in exchange for their support of certain tax rates; and second, a revised State Department of Revenue forecast of future revenues showed a surprising drop compared to the revenue stream expected at the time the tax was initially passed.
 
The issue regarding whether the PPT was tainted is part of ongoing ethics investigations in Alaska and has caused the usually skeptical Alaska public to become even more suspicious of “Big Oil.”  Although its practically considered fashionable to bash “Big Oil” (FYI, I work for a major) I point out that no one directly employed by a major has been indicted in the investigation into corruption here in Alaska.
 
The issue of state revenue shortfall was not well understood by Palin’s administration, the Alaska legislature or the general public.  Perhaps because of the public’s mistrust of the oil industry, many people believed that oil companies were “manipulating” their tax calculations.  One of the major factors leading to the lower state revenue was the exceptional high cost inflation that began impacting the industry at that time.  Oil production requires tremendous amounts of steel and its cost increased sharply (perhaps due to demand from China) about that time.  Another major factor was the Renewal effort that is currently ongoing on the North Slope.  The major fields there are 30 years old and its time to replace much of the major infrastructure.  This investment doesn’t necessarily increase the volume of oil produced (it insures that the volume doesn’t fall as fast); therefore costs increase rapidly on a per barrel basis.  The investment credits and depreciation from Renewal reduce the state’s tax take.
 
It also important to understand the deeply held Alaskan view of natural resource (oil) ownership and how this contributed to the state’s taxing policy.  Two general principles under Alaska’s constitution are:  1) natural resources within state lands belong to the people, and the state government is obligated to obtain the maximum value for those resources.  As a result of the first of these principles, many Alaskans fail to properly recognize the point at which legal ownership of produced oil transfers from the state to the producing companies.  As I understand it, in general, the state owns the oil in the ground and the petroleum companies own the oil as it arrives at the surface and is “produced.”  The price paid by the oil companies to the state for transfer of ownership is the royalty, usually around 12.5%.  Any amount paid beyond this is a tax.  And like every other tax, it is fundamentally a transfer to the state of property owned by a private person or company.
 
The phrase “It’s MY oil” is often heard here.  Perhaps unconsciously, perhaps not, it is the concept under which the revenue the state receives from oil companies is considered a return of their property more so than a taking of profits (or property) from “Big Oil.”  This view makes it politically easier to pass tax increases (although given the general feeling toward “Big Oil” it might not be difficult in any case). 
 
The two principles combined have caused a predisposition to create policy that gives greater weight to short-term benefits over longer-term benefits, without properly weighting the two.  In my view, this bias towards getting revenue in the short term at the expense of longer-term benefits is a fundamental flaw in ACES.

Within this environment Palin’s administration purported that ACES would: 1) be as transparent as possible to maximize public confidence and minimize risk of taxpayer manipulation, 2) provide a “fair share” of revenue to the state, 3) create an attractive investment climate for new oil and gas explorers to discover new fields, and for existing producers to re-invest in existing fields, including development of heavier oils and natural gas.

Under ACES, Alaska is protected when oil prices fall or production costs rise but the state retains a greater share of value when oil prices rise, a situation that would be very difficult to negotiate in a commercially based agreement.
 
There are two main consequences to the tax increases: 1) a reduction to investment in the most important sector of Alaska’s economy and 2) an erosion of “Fiscal Certainty” for the oil companies.  “Fiscal Certainty” is a condition such that companies can predict their tax burden (which is ultimately in control of the state) with enough confidence that to justify the risk of making investments.  It is particularly important to large capital projects.  It is NOT synonymous with LOWER taxes – but simply the concept that taxes be predictable.
 
Whether ACES moved Alaska’s petroleum taxes to among the highest in the world is debatable, but what’s not debatable is the more than half a billion dollars of investment planned for Alaska that evaporated as soon as she signed the law.  
 
Almost immediately after Palin passed ACES, ConocoPhillips cancelled a $300 million project to produce ultra low sulfur diesel (ULSD) in a plant near the North Slope.  Based on my knowledge of changes in the capital budgets of the major oil companies in Alaska, I am confident that, in addition to this project, at least $200 million of projects have been cancelled in the since ACES passed.  As it is written ACES will continue to impact investment.  Perhaps more importantly, it put the Alaska at great risk should oil prices fall significantly from the over $100 per barrel level were at today.
 
It’s ironic that the first project impacted by ACES was a diesel plant because today Alaska is facing increasing tight supplies of diesel and has some of the highest diesel prices in the nation – over $5 per gallon.  And, to make matter worse, the need to transport USLD hundreds of miles via diesel-hungry trucks will add to air pollution and erode any environmental benefit that comes from the switch to USLD. 
 
Based on the loss of investment, I calculate that hundreds of high-paying construction and support jobs also fell prey to Palin’s tax plan.  So far, it hasn’t been noticed because, thanks to current high oil prices, Alaska’s economy is red-hot.  But many Alaskans are already seeing signs of softening demand for labor.
 
Palin likes to tout her “energy experience” and tell the American public that she will help make us independent of foreign oil.  While I don’t have a good handle on how ACES has impacted oil production since its passage, or how it will impact future oil production, it is not unreasonable to believe that, if not modified it could result in many billions of oil being left un-produced. 
 
The single major new development ongoing at the North Slope is BP’s Liberty project and is on federal land, where it is not subject to ACES (most of the North Slope is subject to ACES).  This is a project that will require hundreds of billions of dollars of investment and generate hundreds of jobs.  If Liberty had been on state land, and thus subject to ACES, it’s economic would not have justified that it go forward, and the toll from ACES would have been higher.
 
ACES moved through Alaska’s political process on the backs of the Democrats with little Republican support.  The real wind filling the sails that took ACES from idea to law was the environment of corruption and mistrust of oil companies (guilt by association) that came from Bill Allen’s VECO, and the bad taste left in the mouths of most Alaskans from Murkowski, the prior governor, who pushed PPT through the legislature. 
 
As opposed to Palin reaching across the aisle to the Dems, it was more akin to Democrats leaping over the aisle to Palin.  The Republican stood back while the Democrats rushed to “punish” the oil companies rather than set a long-term tax policy that would maximize the economic growth of Alaska.  And when it came time for Palin to inject discipline into the process and recast ACES from a tax that punishes oil companies to a tax that promotes Alaska’s long-term economic interest, Palin was invisible.
 
In summary, in passing ACES Palin showed neither leadership nor wisdom, but rather the politically opportunistic and populist instincts that have been the hallmark of her career.

(David Chacon lives in Anchorage, AK and works for a major petroleum company. He has more than 25 years of experience in the oil and gas industry.)