You have undoubtedly heard about the renaissance that is just starting on Alaska’s North Slope. It’s a very exciting time with good news breaking every week.
All that excitement may tempt you to think that the North Slope oil cavalry is on the way to help us win our budget battle. I’m sorry to say, it won’t.
Bottom Line Up Front
While all the good news is great for the economy, we shouldn’t get too excited about its implications on the State budget. In fact, we should expect to see a decline in State revenues over the next few years.
Around 2024, we will finally start to see some money flowing in. But, those revenues will just get us back to where we are today.
Sorry, but the cavalry is not riding in to save us from our budget woes. Those reinforcements will help us to keep the battle going, but they won’t turn the tide toward victory.
A majority of the new oil that will be flowing down TAPS will come from Federal lands. So, we won’t see an increase in State royalty payments.
Pikka will help, replacing the royalties lost to natural decline on other State leases. But, we aren’t going to see a huge increase in royalty payments.
We will also see some extra money flowing into the NPR-A impact fund. And extra contributions to the Permanent Fund will spin-off more earnings to pay our PFD and generate some slightly higher POMV calculations. But, the general fund is still going to need some help.
With the exception of Liberty, all the new production will be taxable. However, it is going to take some time before we really see the benefits.
For the next few years, the write-down of development costs will push us into a minimum tax environment and will cut corporate income taxes.
Once production starts flowing, we will see an increase in taxes. But, those increases will only get us back to where we are today.
The major reason this will occur is inflation increases on the costs of transportation and operations, while oil prices are not expected to increase at the same rate. The result is a pinching out of value and a reduction in taxable revenues – even as production rises.
You may notice I did not make an effort to conduct a formal treatment of property taxes. The reason is that I expect the life extension benefits on TAPS, combined with inflation on the asset value, to roughly offset depreciation. So, I didn’t see the benefit to adding the complexity into the model.
The new facilities will be taxable, but those property taxes will mostly be collected by the North Slope Borough.
You might be interested in a little more detail about cash flows from the major projects that are underway. Here is a very brief overview of how they will contribute to the State treasury.
The State’s land ownership includes the submerged lands up to 3 miles off the coastline. Everything beyond 3 miles, up to the edge of the Outer Continental Shelf (OCS) is Federal waters.
The Liberty oil pool is 5 miles offshore. This means that the oil production that will occur is beyond the taxing jurisdiction of Alaska. State production tax, property tax, and corporate income tax will not apply.
That also means that the development and operating costs are not deductible and that tax credits/reduction aren’t earned from this field.
The oil itself belongs to the Federal government. That means that the production will occur under Federal leases and all royalties will flow to the Federal government.
OCS Land Act
However, there is a royalty sharing agreement the Federal government has with the Coastal States. 43 US Code § 1337 8(g) provides for 27 percent of the revenues collected within 3 miles of the State’s boundary (which extends 3 miles from the coast, meaning that this law applies when oil production occurs between 3 and 6 miles from the coastline) to be transferred to the State.
All of the leases at Liberty are 12.5% leases. Since Alaska gets 27% of those royalties, it works out to 3.375% of the total gross revenues.
In other words, while the State doesn’t have ownership rights to any of the oil at Liberty, DNR will get a check every month from the Federal government.
Let’s say there are 120 million barrels of oil that get produced over the life of the field. If oil prices are $60 a barrel and it costs $10 per barrel for shipping, the gross value at the point of production is $6 billion.
Hilcorp and BP must write a check for 12.5% of that to the Federal government, which totals $750 million ($375 million each). The Federal government turns around and transfers 27% of that money to DNR, which totals $202.5 million.
Of course, we don’t get all that money at once. But, we are talking about something like $200 million of revenue to the State spread over the life of the Liberty project.
There are two important things to remember about Willow. First, the Federal government owns the oil. Second, ConocoPhillips is a 100% leaseholder.
The first point is important because of the implication on royalties. Seeing as the Federal government owns the oil, they will receive the royalty. However, one-half of those collections are given to the State of Alaska. These funds are deposited into the NPR-A impact mitigation fund, which is emptied each year.
But, there is a catch. By Federal law, priority use of this money must be given to a “subdivision of the state most directly or severely impacted by development” in the NPR-A. And, the funding must be used for the “planning, construction, maintenance, and operation of essential public facilities, or other necessary provisions of public service.”
That’s a very loose requirement. But, there is a state statute that tightens it up a bit.
NPR-A Impact Mitigation Fund
AS 37.05.530 outlines the administration of the program. That law ensures priority is given to municipalities most affected by oil and gas development in the NPR-A, for projects that reduce that impact.
If there are more applications than funding, 3 AAC 15.060 describes the ranking criteria that is used. If there are not applications to use the available funds for the year, excess funds are treated according to AS 37.05.530(g).
That statute also requires that if more than 74.5% of the available funds are distributed, 98% of the remaining balance be transferred to the Permanent Fund and the rest to the Public-School Trust Fund.
If less than 74.5% of the available funds are distributed, the Permanent Fund and PSTF get their share first and any excess can be used as general funds (which are all “necessary provisions of public service”).
Basically, what this means is that either the capital budget will increase to use these “designated” funds, or the funds will be treated like any other royalty payments received by the State. That’s really up to the legislature.
Deductible Development Costs
The second point is important because we have a net tax system in Alaska. That means that the costs of development are deducted from revenues when taxes are calculated. Because ConocoPhillips has more revenues in Alaska than any other leaseholder, they have enough revenues to deduct these development costs as they are incurred.
The result will be a reduction in tax collections for the next few years, relative to not developing these NPR-A projects, followed by a bigger increase in collections once production begins.
The Pikka Unit is located mostly on State lands (with a handful of ASRC leases sprinkled in). All of these leases have a 16.67% royalty provision.
The leaseholders are a consortium of new entrants to Alaska. None of them are currently producing oil in the State.
Since these leaseholders don’t have any other revenues to reduce, they will carry these expenses forward and write-down their first several billion dollars of revenues.
What this means is that the State can expect to receive only the minimum production tax from the Pikka owners for several years.
There is a lot to be excited about. But, increased oil production will not solve our budget problems. While we should include the additional revenues in our budget projections, we should not assume the cavalry is on the way to fight our battles for us.
Here is the base projection of total UGF oil revenues for the next 10 years:
|FY||UGF Oil Revenues|
Of course, there are many things that create uncertainty (mostly oil prices). So, here is the range of potential outcomes.
Note that there is a chance things will be just fine. However, it would come in the form of higher oil prices, not new production.