Alaska is Unique When it Comes to Oil Ownership and Taxes

Around the globe, there are two basic systems governing the ownership of oil. In the first, resources are owned and controlled by the government. In the second, personal property rights extend all the way down to the core. The difference between the treatment of subsurface mineral ownership has far reaching implications. And, Alaska finds itself in a strange place between the two.

Napoleonic Model

The idea that a government is a separate entity from the people is an extension of the Napoleonic Code. Under this system, individuals can own land, but private landowners do not control the subsurface estate.

Instead, the government is responsible for entering agreements with companies that have the expertise and capacity to develop the resources. Revenues flowing from these contracts are used to support the public.

Perhaps this philosophy is best captured in the Constitution of the Republic of Indonesia, at Article 33, which states:

“The land, the waters and the natural resources within shall be under the powers of the State and shall be used to the greatest benefit of the people”

While Indonesia has moved toward a market economy in recent years, it was built on a socialist economic system. The government still runs over a hundred public corporations, controls the price of certain goods, and views resources as a common good.

Anglo-Saxon Model

The other form of ownership is based on the Anglo-Saxon model of governance. In this system, private property rights reign high. Most capitalist economies subscribe to the Anglo-Saxon model – most notably, the United States.

Almost all Americans have complete ownership of the subsurface estate beneath their lands (unless they sell or lease those rights to others). These individuals are independently responsible for negotiating contracts with companies interested in accessing those subsurface substances.

Any value created by extracting those resources belongs to the land owner and their contractors. In other words, the obligations, risks, and benefits are all owned by the individual. Just like with any other business endeavor, the rest of society has no claim to the money an individual or business earns.

The idea of private property rights is the foundation of a capitalist economic system. It is best illustrated in the US Constitution, within the Fifth Amendment “…nor shall private property be taken for public use without just compensation.”

Two Types of Petroleum Fiscal Systems

This difference in ownership structure gives rise to different ways that oil fields are developed around the world. They can be broken into two corresponding types of fiscal systems:

Production Sharing Agreements

In the Napoleonic Model of resource ownership, the nation-state is the owner. The country typically has a national oil company (NOC) that participates in the development and production of those resources. That NOC creates jobs for domestic workers, generates profits for the government, and manages the development of the resources.

When a nation enters a contract with an international oil company (IOC), it does so to bring in outside help. That outside company brings expertise, equipment, and capital to the country. The employees of the NOC work alongside the foreign experts, gaining knowledge and skills.

In most cases, the IOC and the NOC form a joint venture to develop the resources. A development opportunity is defined, and the government authorizes the project under specific project terms. This agreement can have any number of requirements, but the entire structure is a contract called a production sharing agreement.

Fiscal Certainty

All of the terms and conditions are laid out in advance. The company knows exactly what the financial terms will be – and that they will not change. The company and the government know how much capital each will contribute, what the repayment terms on that capital will be, and how any profits will be shared.

The amount of risk that each party assumes is understood, the NOC participates in that risk, and the IOC determines if engaging in the project is worth the effort. The fiscal terms are well defined and stable. There is a mutual benefit between the IOC and the nation-state, as they approach the project as partners.

The understanding of risk and reward is defined up front and there is no future argument about whether or not that split is “fair.” Because of this fiscal stability, shared risk, direct participation, and defined rewards, the government usually ends up getting a larger share of any profits in this type of arrangement – but also takes more risk.

Concession Agreements

The cost of bringing an oil field into production is millions, or even billions of dollars. And, that money is spent before a drop of oil starts flowing. If the whole effort fails, someone is on the hook.

It is unlikely that an individual land owner can form an oil company to develop their resources on their own. They probably don’t have the experience, equipment, or money to participate in development in a meaningful way. So, it would be strange to see a private landowner enter a joint venture with an oil company.

Instead, that land owner is likely to sign over the whole effort to an oil company that can take that risk. This contract lets the land owner off the hook for providing any money or work to the project.

In exchange for the concession of those mineral rights, the oil company agrees to some form of compensation to the landowner. The most common agreement is an upfront payment (called a bonus), some minimum annual fee (called rent), plus a percentage of the value that is produced (called a royalty).

No Taxing Power

In exchange for temporarily giving up those mineral rights, the land owner takes no risk, gets an upfront payment, and then gets a portion of the proceeds if the project is successful. The company takes all the risk of losing millions of dollars in the project fails. In exchange, they get a majority of the gains if the project is successful.

But, there is no discussion of taxes in a royalty contract. Taxes are levied by the government, whom has no participation in the development of privately owned resources. Instead, oil production is just another business making money within a sovereign’s jurisdiction. It can tax that activity in accordance with its taxing authority.

Why Alaska has Ownership

During the first world war, petroleum and other resources became increasingly important to the US national defense. The federal government decided to control these strategic resources by passing the Mineral Leasing Act of 1920.

The act identified certain resources as having strategic importance to the Nation – specifically coal, oil, natural gas, and some other minerals. Any of these resources under federal land would not transfer to new owners from that point forward. These rights could only be leased by the federal government, but could not be sold.

Alaska was the first state to enter the union after the Mineral Leasing Act passed. That created a complication during the quest for statehood. Alaska wanted a large land grant, but it needed the resources beneath those lands to serve as the catalyst for economic development and financial autonomy.

Congress acquiesced, but placed a condition on that 103 million acre land grant. The Federal government would transfer the subsurface rights to the new state, but maintained that these strategic products must be leased and could never be sold.

Section 6, paragraph (i) of the Alaska Statehood Act says:

    “(i) All grants made or confirmed under this Act shall include mineral deposits. The grants of mineral lands to the State of Alaska under subsections (a) and (b) of this section are made upon the express condition that all sales, grants, deeds, or patents for any of the mineral lands so granted shall be subject to and contain reservation to the State of all of the minerals in the lands so sold, granted, deeded, or patented, together with the right to prospect for, mine, and remove the same. Mineral deposits in such lands shall be subject to lease by the State as the State legislature may direct: Provided, That any lands or minerals hereafter disposed of contrary to the provisions of this section shall be forfeited to the United States by appropriate proceedings instituted by the Attorney General for that purpose in the United States District Court for the District of Alaska.”

– Alaska Statehood Act (emphasis added)

The Unique Circumstances of Alaska’s Ownership

In effect, the Alaska Statehood Act placed a prohibition on private ownership of mineral rights in Alaska – at least on lands granted to the State from the Federal government. In order to comply with this provision, Alaska’s constitution includes a leasing requirement for certain resources. Article 8, Section 12 reads (in part):

“The legislature shall provide for the issuance, types and terms of leases for coal, oil, gas, oil shale, sodium, phosphate, potash, sulfur, pumice, and other minerals as may be prescribed by law.”

However, all other resources continue to follow the Anglo-Saxon model of individual property rights. That is demonstrated in Article 8, Section 11, which states that “Discovery and appropriation shall be the basis for establishing a right in those minerals…”

Alaska’s unique position

This puts Alaska in a unique position. Alaska is a state within the USA, which is very much a follower of the Anglo-Saxon model. As such, Alaska must adhere to the US constitution and live within the system of laws that govern all other states designed with individual mineral rights in mind.

But, those individual ownership rights are prohibited under the MLA, forcing the State of Alaska and the federal government to act as though it followed the Napoleonic model with respect to these resources under public lands.

And so, Alaska is governed by both systems. The Anglo-Saxon model embedded within the US and State Constitutions, and the principles of the Napoleonic Code emblazoned into one part of the State Constitution. As such, Alaska is forbidden from managing its resources in the way that most sovereign owner-states manage theirs.

But, Alaska also has the power of taxation that private property owners don’t usually have. Therefore, we should not be compared to Petrostates that follow a very different set of rules. Rather, we are an American jurisdiction with additional ownership obligations.

Constitutional Mandates

Alaska’s statehood was so dependent on resource development that the topic received an entire Article in our constitution. Article 8 provides 18 sections that guide how the state manages natural resource issues.

One important provision within the state constitution is found in section 2:

“The legislature shall provide for the utilization, development, and conservation of all natural resources belonging to the State, including land and waters, for the maximum benefit of its people.”

Notice that it says maximum benefit, not maximum revenue. Read in conjunction with the three seemingly contradictory directions of “utilization, development, and conservation,” the legislature is required to give some weight to the value of non-monetary benefits.

However, that provision must be read with the Article 8, Section 1 in mind:

“It is the policy of the State to encourage the settlement of its land and the development of its resources by making them available for maximum use consistent with the public interest.”

That provision clearly states that more weight should be applied on the development of our resources than the conservation of them. Together, the direction is clear that we are to promote development and to consider the non-monetary benefits of development as we do. An attempt to maximize revenue collection at the expense of development would border on unconstitutional.

The Role of Taxes

Another thing to note in section 2 is that it uses the phrase “natural resources belonging to the state.” This is an important distinction – as the constitutional mandate to maximize benefits only extends to those resources under state ownership.

There is no directive to attempt to capture the maximum benefit from Federal or privately owned resources. In the context of oil, this provision clearly speaks to the leasing of those resources. Just like the federal government, the leasing of these strategic resources is a separate function of the government. It is meant to control the ownership of those resources, and not to adopt some notion of communal ownership.

Once the resources are under lease, the rents, royalties, and bonus payments are compensation for giving up the property rights to a leaseholder while the lease is in effect. Management of those lands and leases are the responsibility of the government as the owner. And, ensuring that fair compensation from forgoing ownership is received happens by enforcing the terms of the contracts.

From the perspective of the sovereign, an oil producing company is just like any other business. They are creating jobs and economic value by conducting that business in the State/Country. When viewing the profits stemming from that business activity, there should be no consideration of the ownership that was leased away when creating tax law.

While other Petrostates include taxation within their Production Sharing Agreements, that is not allowed in the United States. In fact, it is expressly forbidden in Alaska’s constitution at Article 9, Section 1. And, because taxes extend to all activity in the state, regardless of ownership, the extension of taxation as part of the mandate to maximize benefits from state owned resources is erroneous.

Wrap Up

Alaska is unique in a lot of ways. It’s public oil ownership status makes it unlike any other state in the Union. And, it’s inability to include taxation in its oil contracts makes in unlike any other nation-state with oil ownership.

The constitution prevents us from including taxes in our ownership contracts. Therefore, we cannot provide the fiscal certainty that a production sharing agreement offers.

Instead, we enter royalty contracts with oil companies, just like private landowners in the rest of the country do. That’s how we get value out of our ownership. Taxation is not part of the ownership equation whatsoever.

In fact, using taxes to attempt to get more out of our ownership position could be, in effect, a material change in the fiscal terms of the contract with the leaseholders. And, if the higher tax rate results in less development, it directly conflicts which the statement of policy in our constitution.

Alaska should consider the oil companies doing business in the state as it contemplates the best way to raise the revenue needed to provide the public with the services it requires. But, we should not compare ourselves to countries that use fiscal terms that are not allowed in Alaska. Nor should we compare our fiscal system directly to states that are not structured like us.

Alaska has a unique ownership situation that warrants a more thoughtful conversation about how to handle our resources. The best way forward is to divorce the ownership and sovereign roles of the state from one another. Using taxation to renegotiate the terms we agreed to accept in exchange for giving up our ownership interests is bad faith dealing. Using taxation to manage our financial circumstances is perfectly proper. Let’s not confuse the two.