Coghill: Oil taxes overly complex

North Pole Republican cites consultants observations on state’s complex oil tax regime, adds any changes cannot come all at once

Steve Quinn

For Petroleum News

Senate Resources Committee Vice Chair John Coghill has been in office, first in the House then in the Senate, for 18 years and debates over oil taxes seem to be the norm even for a tenure as long as his. The North Pole Republican’s committee is fresh off re-writing HB 111, the House’s effort to rework oil tax credits and a portion of the how rates get calculated. Coghill discussed his views of and the historical perspective of the state’s efforts to establish a consistent regime.

Petroleum News: You’ve been in office 18 years. So how do you approach oil tax debates, which have been a part of your term almost each of the last 12 years?

Coghill: The good thing about Alaska is that we have good geography and good geology, both. And the geology has made us a producer of oil pretty significantly. The challenge is we are so far away from market. Everybody knows that. Building a pipeline to haul the oil to market was a national decision. It wasn’t about Alaska; it was a national decision. There was a huge environmental debate. We supplied oil to the United States - up to about 24 percent of the nation’s oil. So, we’ve always been noticed by national groups. But we are probably the place for environmental concerns and have proven ourselves very well to be fair. We have done it as good as we can around the world.

Meanwhile, the big field, Prudhoe Bay and then finally Kuparuk, began to be the only fields being developed because they were the prize. The marginal fields, even Kuparuk back in the ELF days, were getting very low tax rates and very low royalty rates. So we figured we had better re-think our gross-based tax system because it wasn’t incentivizing new production, or even new production. So, we went into the PPT which caused no small stir in Alaska. You went into a net-based system, which meant we were going to go into partnership with the oil companies in many ways. We were going to incentivize production the best we knew how.

Petroleum News: At that time, there were some pretty stark changes going on elsewhere in the world, weren’t there?

Coghill: All of that was happening while national oil companies were coming into their own all over the world. At the time PPT was a hot discussion, remember peak oil was the hot discussion at the same time. We were trying to figure how to get best value and still diversify our fields. Along came a governor who thought we should use credits to do that. Under the ACES plan, we credited what we thought was going to be a diversification. In fact it did, but it incentivized spending rather than production.

So we had to go to how do we reset the agenda to incentivize new oil so that we can get that value. The credits were not bringing the value. They were bringing our part of the spending, but not bringing new oil. Under Gov. Parnell, we went into a production-based, net-based system that has proved to be workable.

Our price environment under ACES was contemplating the high end of $80 (a barrel). Low and behold it went up to $140. We harvested cash like we never did before, but we became painfully aware that we were also the last place in the world that anyone wanted to invest under those conditions. We had to reset our incentives - that is our credits - while still trying to incentivize production. We were figuring the low of $60 to the high of $120. Surprise, surprise we touched off $27 barrel of oil for a week.

Then it stayed in the 30s and 40s then finally back up in the 50s during the whole discussion of how we do those credits. What we found out was we couldn’t afford the cash flow of credits under the circumstances of low oil prices and our floor that turned into a gross tax became the great harvester at the low end but we couldn’t afford the cash outlay to incentivize new production the way we agreed under a medium to high price range.

Petroleum News: So you’re still trying to find a sweet spot?

Coghill: Just like the oil companies laid off thousands of people and changed the investment strategy, Alaska has to follow suit on its investment strategy in the oil fields. Add that to those who feel like oil companies should be paying more in our environment where we are cash strapped to those who say no we just can’t afford to incentivize at the level we have been doing. Here we are in 2017, we are arguing over should we raise taxes, change our tax structure and not pay the cash credits or should we say from now on we can’t afford the cash credits. The Senate is landing on let’s march down so that we don’t pay cash credits to the level we have been doing but we still allow companies to harvest value for the investment.

Our consultants told us there is no place in the world that incentivizes by paying cash. They always incentivize being made whole in investment risk. Those are things we learn in Alaska. The oil companies rightfully can pick on us about changing our tax policy but they only have a modicum of credibility in their complaint because they also have to react to a very volatile market and a world market that changes their business model almost year by year. So they change their business model and because we are agreeing to be involved with them in business, diversification or not, we have to change our business model in a low cash environment.

So I have some sympathies for the oil companies because we have the same pain they have to deal with, but ours is much more public. We have to deal with the press that always goes to the extreme, positive or negative. They have deal with headlines that scare investors, we have to deal with headlines that scare voters. It’s the same world in many ways, but ours is very public and our argument is laid out very openly. Investors they meet without that kind of attention.

I’m sympathetic with them but they are less sympathetic with us. We are the sovereign and we are supposed to be stable. We are a single commodity payday in Alaska with oil being the main payer. We are trying to diversify that by using earnings from the Permanent Fund. If the people own the resource and have to own how it’s distributed, they get to be part of the debate. A lot of people would like it to be a democratic populous, but the reality is you’re in a democratic republic, and you elect representatives to come and try to figure these things out. This happens to be a bicameral Legislature with a governor and a court system. It’s served Alaska well since statehood.

I think a lot of people are getting tired of the debate and would rather throw out the system than answer the debate. I’m a believer in our system. I believe our democratic republic, the system of government we have, is totally appropriate, especially when you see other places that are oil provinces all over the world that have to deal with bombs and tribal warfare. We are actually pretty good. The debate being as contentious as it is, it’s probably not that inordinate.

Petroleum News: Two things were discussed during Senate Resources that some believe were criteria or drivers toward the current version of HB 111 and one was is it less complicated?

Coghill: That goes to the question of our oil tax system and one element is the cash credits and the operating loss carry forward. We decided that we would use the operating loss carry forward and the cashable credits as a way to answer a cash flow problem, not a fundamental tax rewrite. The House wanted to go to a fundamental tax re-write, but they made it more complex. Our consultants told us that we have one of the more, hands down, one of the most complex tax systems in the world. It would be nice to re-write it, but we are not going to do it on extended sessions going into the 120th day. We can answer the question can we afford to invest the level we are investing in a field that brings us so much value. For those we agreed to go into partnership with, it would be wrong for us to pull back so dramatically that we left them with no value of what we’ve drawn them into. So allow them a write off on their taxes and their ability carry your losses forward so when they get to production, it’s probably the right approach.

Petroleum News: Do you think at the end, you’ll have something that is durable at a broader price range, which was a problem you even discussed earlier?

Coghill: Durability is always a goal, but in a dynamic world, it’s a moving target. The answer is yes, I think we have heard from our consultants very clearly: simplify your tax. The trouble is we’ve had people make huge investments under our very complex system. They are being audited as we go four years prior to where we are at right now. The durability means you have to be very methodical about how you change your tax system.

Being methodical as we are and as intense as we are, because there are different philosophies in that tax, people have already made investments based on other structures. We need to honor that as best as we know how while we look for simpler solutions along the way. I don’t know that many of us in the Senate disagree that we could do it simpler. The question is when do you want to start that process. My thinking is we need to go through this low cash flow, and get it as stable as we can, and that means it has to remain fairly complex.

Petroleum News: Earlier you touched upon how historically the state has done a good job environmentally. But recently, there have been various oil and gas leaks. Are you concerned that it’s getting a bit much?

Coghill: There is no doubt that we have an aging infrastructure. I think the underwater part in the Anchorage bowl is well into its 30th year and beyond. On the North Slope, I think everything that can be reported gets reported and that’s probably unique from the rest of the world. I do know this: If we have a problem it is worldwide news. That’s not true in the North Sea. That’s not even true in the Gulf any more. That’s not true in Russia. That’s not true in Indonesia. Ours are made dramatic no matter what the size.

It’s just because that Alaska is that unique place in the world and everybody wants to keep it pristine to the point of being able to produce off of it. Our pipeline has been producing oil for several years and people take that for granted. The feeder lines are probably getting old, too. It takes a lot of work to keep those things up to speed and going. They were sized for 2 million barrels a day and we are having to continually re-adjust for 500,000 barrels a day. Should we experience problems there, probably true. Should we keep working at mitigating them, absolutely. In Alaska, we are so close to zero tolerance anything looks bad.

Petroleum News: Do you think the Legislature can come up with a bill that’s durable under HB 111 and so that you won’t be doing this next year?

Coghill: That’s what we are trying to answer. How do we respond to the cash flow problem? I suppose at this point we’ve laid it out from the Senate Resources perspective. As it gets to Senate Finance committee we will begin to hear from the House and the administration if they think they can deal with this particular issue. I think at that point, you’ll find out what the lingering debate is. If the House is just hard over on changing the tax structure, the discussion is not going away. If they can accept a modified change to our cash investment and leave a very complex system to work for the next couple of years, I’d say we’ve got three or four years of sound durability. I’ve been surprised all along the way that it’s come up every year.

Petroleum News: Has the industry said anything that got your attention during these hearings?

Coghill: With the industry, you have to listen to what they don’t say as much as what they do say. This is where maybe I’m more politically astute. Certainly other people think of this stuff. They are always going to say more taxes impact investment. They are always going to say that. Then it’s a matter of what value do you get out of Alaska that we can share with you that is good against the rest of the world.

That’s why we are often asking, how are we doing compared to the rest of the world? What does it look like? We’ve heard loud and clear we are complex and we are within the range of investment. The industry, not withstanding, have not protested loudly on the cash credit issue. They haven’t said they are for it. What you don’t hear them say is how bad we set it up. They are part of the partnership.

We have a royalty but we also have a production sharing we’ve allowed ourselves to get into and if we are going to be in production sharing, we need to know what they think. I guess I’ve been here long enough to know there are the big majors, the medium size majors, the startup producers and the explorers and they all have very different business models and approaches. You have to hear what they are saying. It became very clear to us that unless we allow some value to stay with our credit system, then those who explore are going to have a hard time in Alaska. I think they have been very clear about that.

Petroleum News: We continually hear the term government take. How do you view it, especially with royalties? Alaska gets them but in other states it’s private landowners who get them so do you factor in royalty with government take?

Coghill: Absolutely. The reason we went to a production-based system was to try to encourage investment in a variety of different ways, to find more oil, to get new producers to compete in a world that had been fairly monopolized by a high-cost environment. I don’t know that as an Alaskan I can be anything more than grateful for those who took the long lead time to make investment - BP, Exxon, Conoco - those guys who are bigger companies.

Then you get the Pioneers (now Caelus) and the Armstrongs of the world, they come up now with great hopes to bust open what looks like will be a productive field. I’d say it’s good in that respect. When we had a lot of money, we thought we could do more. I think we are being market responsive just like an oil company is. To say the state is anything other than responsive to a market that drives our whole economy and to blame us for being responsive would be unwise. Maybe I’m being too defensive.

Let me go back to the royalty. The royalty is the king’s 12 percent right. The production tax is based on a different kind of severance. So not only do we get value for the first percentage of it, but if you’ll produce at a greater level, we will give you a sliding scale benefit. It was meant to incentivize. Like I said earlier on, the reason we went to a production based, net based system was so we could incentivize things. Now did Alaska have the expertise to do that, probably not, but we did have a goal in mind of diversifying that field and getting more production.

So the government take is everything. The royalty is always a big part of it and it’s flexible. But once that oil leaves us, if we have not retained the value, then shame on us. That value belongs to generations of Alaska. We get to deal with it in our generation. I think that is one of the reasons why the Permanent Fund was established. That is for generations. That is public safety. We are going to increase our infrastructure and airports. It’s for investing in our schools. It’s not just for paying cash out of the Permanent Fund. It was for a generational view.

Once the barrel leaves Alaska, that’s it. You never get it back. You better get the value that you can. I think the oil companies struggle with that because we value it very highly and we are always trying to figure out where we fit in the world so that we can get the most value for Alaska while we allow those who invest at the risk level to get the risk-reward payback. I don’t know that we’ve always hit it perfectly, but it’s been a constant discussion.

Remember, I got here in ’99, when we were going through the mergers and acquisitions. ARCO was selling to Conoco. BP was under court order to divest. There was a monopoly that had to change hands simultaneous to national oil companies taking over private companies in their country. When they say we’ve changed our tax system in so many years, they’ve changed their business model more often than we’ve changed our tax system, I can tell you that.