Thoughts on Alaska Oil & Gas

Two speeches this week.  The first is Thursday morning (Jan. 12, 2012), as part of the Alaska Support Industry Alliance bi-weekly breakfast series.  The topic is “Judge Gleason’s TAPS Decision:   What does it Really Mean?”  The details are here.  The second is Friday (Jan. 13, 2012) as part of a panel before a luncheon meeting of the Alaska World Affairs Council.  The topic is “Can Alaska Learn from Norway’s Oil & Gas Success?”  The details for that presentation are here.

Senator Wagoner’s presentation is heavy on proposals to expand existing “tax credits” for additional exploration.  That raises questions for three reasons.

First, the revenues to provide the “tax credits” come in the first place from imposing higher taxes on production from existing fields.  The net result is to depress the ongoing development of new horizons in the existing fields.  That is troubling because those horizons contain known oil and gas (e.g., heavy and viscous) resources and are the most certain source for increasing production in the coming years.  In light of the current production decline, it seems appropriate to question whether it makes sense to continue to expand policies which impose penalties on developing known resources in order to fund what essentially are “Hail Mary’s” in new areas.

Second, the “credits” may not be the best use of state funds.  Essentially, they result in the state irrevocably paying up to 40% of the costs of drilling exploration wells, but without the state receiving any equity in return.  As a consequence, the only potential revenue the state ultimately may realize from its “investment” is the royalty and production tax which someday may be earned from any production which may result, if any.  It seems useful to question whether a potentially better use of the same funds going forward would be for the state to invest them as an owner — the approach successfully taken by Norway.

Third, at best, the credits only buy exploration drilling, they do not buy production.  The reason is that once the producer completes the upfront investment necessary to bring on the field and is ready to go into full production, the marginal production will be taxed at the same, high rates as currently apply to — and are depressing additional investment in — the existing fields.  Knowing that, the producer will stop short of making the investments necessary to develop the field for production.

As a result, all that the state’s existing (and proposed) credits are attracting now largely is the oil & gas equivalent of start up software companies — small producers hoping to identify a product (field) with some potential in hopes that once they do, a larger player will either buy them out or, at a minimum, make a significant payment for an ownership share.  At this point, it does not seem that the credit program has attracted larger producers with the financial capability to develop any significant resources they may find.  That, frankly, helps explain why the state’s December 2011 lease sale was less than a full success.  It seems useful to question whether that is an outcome worth expanding.

My suggestion — the Legislature should ask itself hard questions before it continues to expand a program that, to this point at least, seems to be doing more to depress, than expand, production.