At low prices, North Slope production taxes could drop to zero

As oil continues to hover around $40 a barrel, Alaska is confronting a new reality: if prices stay this low, the state’s major North Slope producers might owe no production taxes at all in coming years.

With the state struggling to close a $4 billion budget deficit, that’s not an appealing prospect. And many lawmakers say they never understood how the tax system would work at very low prices. But industry says this was always part of the deal.

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In its simplest form, Alaska’s current tax regime on the North Slope is a 35 percent net profits tax — meaning, the state takes 35 percent of the profit a company earns on any given barrel of oil. In calculating profits, companies can deduct the cost of producing and transporting that barrel. And companies can use a range of credits to reduce that tax.

To protect the state, there’s also a tax floor — to make sure Alaska gets some revenue at lower prices.

At that point, the the state takes a flat four percent of the gross value of a barrel of oil. Companies can deduct the cost of transportation, but not production.

That tax floor, or minimum tax, goes into effect when oil prices hit around $70 per barrel — meaning it’s been in effect for most of the last two years.

“That four percent tax is our tax,” said Ken Alper, who directs the state tax division. “We are in a minimum tax environment now for the foreseeable future.”

But prices for North Slope crude aren’t just below $70 per barrel — they’re now below $40 per barrel. And at prices that low, the floor breaks.

That’s because at very low prices, even the big producers, like ConocoPhillips, BP and ExxonMobil, start to lose money in Alaska. The companies can then earn credits that allow them to dip below the floor – taking their taxes all the way down to, essentially, zero.

“If prices continue where they are, below $40 a barrel, in 2016, it’s likely that all three of the major producers will be in an operating loss circumstance. They’ll be losing money,” Alper said. “Then, beginning in 2017, they could use their credits to offset the floor and pay zero.”

That’s zero in production taxes. And to be clear, the production tax isn’t the only revenue the state gets from the oil industry. Alaska still expects to take in about a billion dollars a year, mostly in royalties.

But in recent years, the production tax has been the major source of state revenue, bringing in a recent high of $6 billion in 2012.

The Department of Revenue now forecasts it could drop below $16 million by 2018.

Many lawmakers say they didn’t see this coming.

“I don’t believe that we really talked a lot about what happens at low prices,” said House Speaker Mike Chenault, R-Nikiski. “Because I don’t believe anyone thought that we would be at $30 a barrel oil.”

Gov. Bill Walker has proposed what he calls “hardening” the floor. His plan would make it impossible for companies to dip below the four percent minimum tax. (Walker also wants to raise the floor, to a five percent minimum.)

The House Resources committee, the first to consider the bill, stripped out those provisions.

Kara Moriarty, president of the Alaska Oil and Gas Association, said the ability to take production taxes down to zero was always part of the deal.

“We don’t see that as a loophole. We understood that would be allowed,” she said. “I just don’t think people thought that prices would ever get that low. And if they did, we’d all be in a world of hurt….and guess what? We are all in a world of hurt.”

Moriarty points out that in order to dip below the minimum floor, companies have to be operating at a loss in Alaska.

“We are not generating enough revenue every day to pay our daily bills,” she said. “Because the price of oil is not covering the cost to transport or to produce a barrel of oil on the North Slope.”

Hardening the floor could also hit smaller, newer companies that have yet to turn a profit in Alaska.

Sen. Bert Stedman, R-Sitka, has been critical of the current tax system, known as Senate Bill 21 or the More Alaska Production Act (MAPA), since it was first approved in 2013. He said the issue is larger than minimum tax or no minimum tax: the issue is the credits.

“If we’re in the $40 price range for the next 12 to 18 months, we’re going to cripple the treasury for five, six years,” he said.

That’s because whether or not the state hardens the floor, the credits don’t go away – they’re carried forward into future years. If companies take major losses at low oil prices, they can use that to reduce their taxes for years to come.

Stedman said that for all its faults, the previous tax system, called ACES — or Alaska’s Clear and Equitable Share — allowed the state to make up that money if oil bounced back, imposing much higher taxes at high prices. That’s no longer true.

“This downside exposure we have today is extremely dangerous,” Stedman said. “We can’t afford $35 and $40 per barrel oil. Because we can’t recoup it on the upside to repair it.”

Stedman said he hoped lawmakers could work with industry to avoid what he called a coming “calamity.”

The House Finance committee is currently hearing the oil tax credit bill, House Bill 247. The Senate Resources committee will begin discussing the House bill, along with Senate Bill 130, this weekend.