ConocoPhillips Alaska did a great job of getting the first Greater Moose’s Tooth (GMT1) development into production, ahead of schedule and under budget.
But, the oil is coming from non-State land in the NPR-A. So what does this good news mean in terms of dollars flowing into the State coffers?
Production from GMT1
We won’t get the official production numbers from the Lookout oil pool (that’s the pool name of GMT1, although I’ve yet to hear anyone actually call it that) until December. That’s when the AOGCC report for the field will become available.
But, the well reports show that there are 3 wells ready to produce and a few more on the way. I used the Alpine wells to design a composite well for GMT1, which should give us a feel for what production will look like.
When I account for the drill plan, production rates, and recoverable oil ConocoPhillips has publicly stated, and draw up a project schedule for the drill rig, I get this production profile range.
That more or less comports with what I’ve heard Conoco say.
Gross Value at Point of Production
Seeing as we don’t know what oil prices will be, we have to make an assumption. Here, I applied the range of reasonable price assumptions for the next 12 years (basically a random number between $40 and $100 each year, but with a little more complexity).
We also need to subtract the cost of transportation. To move oil from the NPR-A to Los Angeles, it must flow through three pipelines and sail on a marine tanker. The cost of that transportation is about $10 per barrel of oil.
Multiplying the 65 million or so barrels of oil that will be produced between now and the end of FY30, by the range of possible price paths minus transportation, gives us an estimated value of that oil of between $2 and $7.5 billion, depending on what oil prices do.
The average value of the simulations is $4.3 billion.
About a decade ago, ASRC selected the acreage under the Lookout exploration wells as part of the Corporation’s land allotment under ANCSA. Therefore, ASRC is the owner of the oil that is now being produced.
The leases in the GMT unit are all 1/6th royalty leases. That means, ASRC receives 1/6th of the gross value of the production. Those payments are shared with other native corporations, but not with the State treasury.
Although the oil produced at GMT1 is not owned by the State, it is within the State’s borders. Therefore, the State does have taxing authority and Alaska tax laws do apply.
The production tax levied by AS 43.55.011(e) applies to the GMT1 production. That law requires a payment of 35% of the net value of production (the gross value minus allowable costs).
Deduction of Development Costs
The $700 million of capital required to develop the drill site are allowable deductions. If the developer were a small company without other revenues and costs, these deductions would roll forward and reduce the first $700 million of revenues from the tax calculation.
However, ConocoPhillips has a lot of revenues from other Alaska projects. So, these development costs have already reduced those revenues in the years the expenditures were made.
Gross Value Reduction (GVR)
Under AS 43.55.160(f)(2), 20% of the gross value will be counted as a cost of production to reduce the taxable value of the oil.
This will apply to Conoco’s 2018 tax filing, along with the next two years of $70+ oil or the next 6 years (whichever happens first).
Conoco’s tax liability will be reduced by $5 per taxable barrel while it receives the GVR, and then by a sliding scale between $0 and $8 after that (sliding inversely with oil prices).
There is a question before the courts whether or not the $5 credit can be used. For now, I’ll assume that it can, in order to be more conservative with my estimates.
An additional GVR is available for “high royalty” units under AS 43.55.160(g). Eligible fields receive an extra 10% reduction to their taxable value, if the entire unit has leases greater than 12.5%.
The Greater Moose’s Tooth Unit does have all leases of greater than 12.5%. However, I don’t think the unit will qualify for this reduction.
The sticking point comes from the phrase “from the lease as determined under AS 38.05.180(f).”
That statute is the State leasing law administered by DNR. Since these are not State leases, I don’t think the statute will apply.
Expected Production Taxes
All told, my numbers come out to between $135 million and $1.1 billion of production taxes paid to the State (after tax credits), depending mostly on oil prices.
The average production tax payments work out to a total of about $500 million spread over the next 12 years.
The GMT1 drill site is taxable property. But property tax law is complicated. It’s hard to put a number on what is tangible and taxable property.
I’m assuming the taxes will be in the range of $5 to $10 million per year. However, most of those property taxes will go to the North Slope borough.
Landowner Royalty Tax
Royalties are not taxable production under State law. So, when those royalties flow to someone other than the State or Federal government, it triggers AS 43.55.011(i).
Because this oil is produced from ASRC lands, the law applies. That means the State will collect a tax equal to 5% of the payments to ASRC.
I am estimating that this tax will generate about $36 million in payments to the State over the next 12 years.
State Corporate Income Tax
The last State tax is the SCIT. This tax is a little more complicate to calculate due to the depreciation schedules and apportionment factors.
But, I can make a pretty good guess. My numbers suggest we will receive between $50 and $250 million in SCIT, as a direct result of GMT1, spread over the next 12 years.
Federal Corporate Income Tax
ConocoPhillips will also owe Federal CIT on the profits it generates from GMT1. The current tax rate is 21%.
It looks like Conoco will end up paying about $400 million is Federal CIT over the next 12 years.
Total Cash Flows
When you add it all up, here is how it looks like the “pie” will be divided.
And if you want to see a table, here you go:
|$ in Millions||FY19||FY20||Total (FY19-FY30)|
|Production||11,410 (per day)||26,045 (per day)||64,754,870 (bbls.)|
|Cost of Production||$55||$125||$1,553|
|Net Cash Flow to Company||$117||$266||$1,021|
Return on Investment
It looks like Conoco should make about $1 billion in profits from a $700 million investment. That’s a pretty good deal.
Of course, that assumes a pretty decent price of oil. And, the company is bearing all the risk if oil prices collapse again.
They also tied up $700 million of capital that they could have invested elsewhere. So, until they recover those costs, we should consider the time value of that money.
Economists do that by what we call “discounting” future cash flows into the present value equivalent. When I do that, it works out to more like $250 million of profit above the cost of money.
Another way to think about how much profits Conoco will make is by calculating the interest rate they would need to get by lending out that money, in order to earn the same cash flow the project is providing (we call this the “internal rate of return”).
An IRR calculation shows this project has an expected return on investment of 23%.
However, there is a one-in-four chance that they will earn less than a 15% return and a one-in-twenty chance they will not recover their initial investment at all.
In total, the State should collect about $600 million from this project. That’s roughly 15% of the gross value of the oil and a quarter of the “economic rents” (the gross value minus the costs of production).
You might be tempted to ask: “is that a fair distribution of net gains?”
I have a lot of friends who will emphatically answer “NO!”
Some of them will argue we aren’t getting enough; others that we are taking too much.
Consider for a moment that the State does not own this oil. What is a “fair” payment to the State for oil it doesn’t own?
I don’t have an answer for you, but it’s an interesting thing to think about.