A Reaction While “The Concerned” Awaits a Reply …

Created by the Alaska Dispatch, “The Concerned” is, to quote the person who channels it, “a fictional, collective persona (based loosely on the Alaskan Zeitgeist) which petitions various people and institutions on behalf of itself. Think Star Trek’s ‘The Borg,’ then add a sense of absurdist humor. The Concerned’s oil and gas petitions, in particular, are based on the idea that Alaska’s simultaneous dependence on and mistrust of the oil industry is a paradox, as are the opposing corporate and government mandates in regard to the resource.”

In that vein, The Concerned recently wrote to the Alaska Oil & Gas Association, suggesting that the state’s oil industry provide “exploration certainty,” in exchange for “fiscal certainty.”  The following is a reaction to give The Concerned something to read, while it stands by the mailbox waiting on a reply.


Dear Concerned:

Your letter of March 18th raises an interesting question.  While I certainly am not the intended recipient – and can only speak for myself on these issues – I thought I would throw in two cents while you stand at the mailbox waiting for the real response.

Your letter suggests that, in exchange for “fiscal certainty” related to the state’s take of oil and gas revenues (presumably, at a level reflecting the pre-ACES levels), the oil companies in Alaska provide “exploration certainty.”

There are several challenges with “exploration certainty,” but one of the most significant is that, in the current environment, it leaves the companies at risk if, after giving “fiscal certainty” a try for awhile, the state again changes its mind, once the additional exploration investment has been made, and reverts to higher taxes the next time oil prices rise.

Frankly, that is how we have found ourselves in the current situation.  In the late 1990’s and early 2000’s, the companies made significant investments in order to identify and develop new fields, and extend the life of Prudhoe and the other North Slope oil fields.  Those were made in reliance on the “fiscally certain” terms of the original leases that the companies entered into with the state, which clearly set out the share of revenues the state would receive as compensation for the production of oil from state lands (largely, an upfront lease bonus and one-eighth of the revenues).

In 2006 and 2007, as those investments were achieving increased production – and positioned to produce returns the companies’ shareholders (including, the Permanent Fund) expect during periods of high oil prices – the state unilaterally revised the previous deal, significantly increasing “Alaska’s share” of the revenues, and, through the progressivity provisions, essentially confiscating the distinctive returns their shareholders expected (and received from other oil companies not similarly invested in Alaska).

As a result, as this debate continues to unfold, the old adage of “fool me once, shame on you; fool me twice, shame on me” keeps coming to mind.  Going forward, the companies are unlikely to make exploration commitments of the type suggested in your letter, even if the current rates are returned to more moderate levels, as long as the state reserves the right unilaterally again to reverse course and reinstitute higher rates once the additional investment has been made.

Put another way, promises by the state of fiscal certainty “until we change our mind” likely will not be sufficient to elicit long-term exploration commitments.  Because exploration investments made today are based on the expectation of returns that extend significant periods into the future, to be effective “fiscal certainty” will need to be guaranteed to extend over a similar period.  In the absence of firm, long-term commitments from the state, we should anticipate that industry investments made in Alaska will similarly continue to be short term.

In other regions, these types of issues largely are resolved by negotiations and long-term contracts.  Frankly, up until ACES, my guess is that the companies thought, more or less, they were in a similar environment in Alaska – with the terms being set by the oil and gas leases agreed at the outset between the companies and the state.  ACES undermined that expectation.

In areas where these issues are not resolved by contract (Venezuela comes to mind), private industry investment levels are much lower and subject to being reduced at any time.  While short term fixes to ACES (by eliminating or severely reducing the progressivity rate) likely would increase levels of short term investments, long term commitments of the type your letter suggests require a similar long term commitment by the state.

Interestingly, although certainly not alone, even Ethan Berkowitz – not known as a close friend of the industry – recognizes the importance of this tradeoff.  In a Compass piece published in the Anchorage Daily News on February 12, 2010, Berkowitz said “[d]oing what we have been doing – relying on a net profit tax – is, at best, standing still and does not adequately advance Alaska’s competitiveness.”  The preferred course, he said, is to pursue “contractual, negotiated [resolutions] between the state and the leaseholder, which insulates rates from legislative changes.”

In short, if the state is willing to make long term commitments based on binding contractual agreements, the answer to your ultimate question – “how about it” – may start moving toward “yes.”

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