Alaska’s unusual oil tax credit system poses daunting budget challenge

With less than a month left in the legislative session, one of the biggest questions before Alaska lawmakers is what to do about oil and gas tax credits.

The state’s refundable credit program is unusual – and huge. In recent years, refundable credits have become the third-largest line item in the general fund budget, behind only the Departments of Education and Health and Social Services.

Now, Gov. Bill Walker argues the state can no longer afford those kind of subsidies. But some lawmakers worry about unwinding the system too quickly.

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This year, the State of Alaska expects to pay out $500 million in credits to oil and gas companies. Next year, that number could be even higher: $825 million, according to estimates from the Department of Revenue. (That number includes $200 million the governor vetoed last year, which is still owed to companies.)

Meanwhile, the department estimates the state will take in about $2.1 billion in total petroleum revenue – including all taxes and royalties – during that same period.

That means over the next two years, the state will pay out credits amounting to $1.3 billion — more than half the total revenue it expects from the oil and gas industry.

That is pretty unusual, said Tim Bradner, a longtime energy reporter who writes the Alaska Legislative Digest. Nobody else in the world offers a credit program quite like this, Bradner said.

“It started out as a good idea, but incrementally got more and more complicated to the point that it’s difficult to understand, and difficult to control, and way too expensive,” he said. “Even if we had the money, it’s just way too expensive.”

Gov. Bill Walker agrees. With the state facing a deficit of more than $4 billion, Walker proposed cutting some credits and capping others. So far, lawmakers have preferred much smaller cuts.

But first things first: what are oil and gas tax credits?

The system began as a set of incentives. The state wants existing companies to explore for oil and gas. And it wants new companies to come into Alaska. To encourage that, it instituted a system of credits.

“It was simple in those [early] days,” Bradner said. “The concept was that you could give a company a little bit of a tax break to encourage them to go drill, spend money on exploration that they might not otherwise have spent, and find more oil and gas that way.”

In theory, at least, the state would make more money on the back-end — in taxes and royalties — than it invested on the front end.

But what if a company doesn’t owe any taxes? For a small company that’s never operated in Alaska, and isn’t producing any oil, a different incentive was needed. Lawmakers wanted to bring smaller companies into the state, in the hopes that they would explore more aggressively, potentially pursuing fields that were too small to interest the big North Slope producers.

So in 2007, the state made some credits refundable. This is basically a check the state writes to reimburse a company for doing things the state likes. You drill a well, and the state will pay part — or even most — of the cost.

“For small companies, it worked pretty well,” Bradner said. “You could make the investment, drill your wells, turn in your tax credit certificates to the state, and get a check from the state, and you could use that to finance your next year’s drilling. So it was very attractive for small companies.”

Only smaller companies are eligible for a refundable credit. The big producers — like ConocoPhillips, BP and ExxonMobil — can use credits to reduce their taxes, but they don’t get a refund check.

And that $825 million the state expects to pay next year? That’s just in refundable credits.

The system was designed with high oil prices in mind. “At the time, we had plenty of money,” Bradner said.

And the goal was to take some of what the state was raking in through taxes – mostly from big legacy producers on the North Slope — and reinvest that money in the oil industry, through credits for smaller companies, both on the North Slope and in Cook Inlet.

But now of course, oil revenue has plummeted. Meanwhile, the refundable credits have grown.

“It seems like each year, somebody would have a new idea, and the thing became kind of like a Christmas tree, to the point that it’s very difficult to understand how it all works,” Bradner said.

Companies can also “stack” some credits, to the point that the state might pay more than two thirds of the cost of certain work.

That’s what makes it so unusual, Bradner said

“I think the most unique thing is you can get a check,” he said. “But it’s also the scale of it. And the many different kinds of tax credits that, in some cases, can be layered on top of each other, to the point that 60 to 70 percent of the cost of an exploration well can be covered by these different types of credits.”

Just about anywhere else, Bradner said, if the government is funding 60 or 70 percent of your costs, it would then own part of that well.

So the big questions is – it a good investment? It’s hard to know, Bradner said.

“One of the problems with this kind of thing is you never really know if the companies would have explored and found the oil anyway,” Bradner said. “That’s the unknowable. The companies…argue that the tax credits have helped them. You’ll never really know if that’s the case, but the fact is, you got wells drilled that may or may not have gotten drilled [otherwise].”

Certainly, many smaller companies have come into Alaska, and explorers like Armstrong Drilling on the North Slope, or BlueCrest Energy in Cook Inlet say the credits were a major draw.

But here’s the catch: the state has spent more than $3 billion on refundable credits since 2007. And neither the public nor the legislature actually know where that money has gone.

For instance, at some point in the last nine years, one company, in one year, received more than $200 million dollars, according to testimony before the House Resources committee by state Tax Division director Ken Alper.

That’s a lot of money – more than half of state spending on the University of Alaska. What was it for?

“We can disclose nothing,” Alper said, in an interview.

That’s because most specifics about credits are protected as confidential taxpayer information.

“We’ve had circumstances, for example, where a company will put in the newspaper how much they’re getting in tax credits, and someone will ask a question, and we can’t even confirm that that company has applied for a tax credit in Alaska,” Alper said.

The governor, and Alper, want to change that. They’d like the state to be able to disclose which companies receive credits, how much they get, and roughly what kind of work they use it for.

“We think it’s important,” Alper said. “It is, frankly, difficult to have a conversation in public, whether it’s in the legislature, the press, or at public meetings…without being able to talk about what we’ve actually done in the past.”

But companies worry that the provision, as written, could reveal too much proprietary information. The measure was stripped out of the bill by the House Resources committee.

House Speaker Mike Chenault (R-Nikiski) said he’s not sure there’s a point to more disclosure.

“The state knows who it is, the state knows how much was invested, the state knows all that information,” Chenault said. “And sometimes I just wonder, is that really information that every Alaskan is just dying to know?”

House Resources also scaled back the governor’s cuts. The governor had proposed ending some credits for Cook Inlet immediately, while the committee bill steps down credits over eighteen months.

And while the governor’s bill imposed a cap of $25 million in refundable credits per company per year, House Resources raised the cap to $200 million.

The result? Over the next three years, the governor’s bill would save some $905 million, while the committee’s bill would save about $140 million.

Chenault said he worries about yanking the rug out from under companies that have banked on the credits – and threatening future oil production.

“My concern is, if we pull everything away today, how much, if any, investment is going to happen in the next few years?” he said.

The bill has several more stops in the legislature before reaching the House and Senate floors. At this point, Chenault said, his only prediction is that the bill will change.