Saturday, October 2, 2010

Alaska Candidates: Oil is declining, so what do we do?

Tim Bradner Economy

When the debate topic turns to state economic policy in the governor's race, the first thing out of the chute is usually petroleum policy and oil taxes, and what we can do to stimulate this industry, which many fear is declining.
Oil is vital to Alaska. Royalties and oil taxes pay for 90 percent of the state budget, the Department of Revenue says. Overall, the industry supports about a third of Alaska's economy directly and indirectly, according to University of Alaska studies.
However, the trends in this vital industry are headed the wrong way. Production is declining, employment is down and new exploration may hit a record low this year.
Don't think a gas pipeline will bail us out, either. State revenues generated by gas will be very modest compared with oil and a pipeline is 10 years away, if then.
What do our governor candidates say about this? Sean Parnell, the incumbent, talks about expanding targeted tax credits for field work. His major opponent, Ethan Berkowitz, talks about negotiation of special fiscal terms for new fields as a way of inducing development.
Both ideas have merit and both are done in Alaska today on a more modest scale, and with success. But neither packs the punch to really turn this industry around. The big problem, which no major party candidate will talk about, is that Alaska's oil taxes are just too high, period.
Retired state economist Roger Marks has authored a new paper showing that Alaska's marginal oil tax rate, in essence the tax rate on profits from new investment, can exceed 80 percent. Alaska now has the dubious distinction of having one of the heaviest tax rates among major oil producing regions of the world, Marks says.
With production, drilling and jobs declining, is this where we want to be? I want to hear some discussion from candidates that we may have overshot in 2007 when we did major surgery on the state oil tax law and adopted a very aggressive tax formula. Do our politicians have the stomach to admit they possibly made a mistake? The proof of this is in the declining production and drilling. Only Ralph Samuels, a candidate in the Republican governor's primary, had the guts to talk about this.
Some legislators raised this in Juneau earlier this year, State Rep. Craig Johnson among them. Most lawmakers weren't interested in taking the issue on, however.
It's not that political leaders are clueless. In fact, our state has adopted some very innovative incentives with very generous investment tax credits for exploration and special royalty terms for development that have brought new companies here, most recently Apache Oil.
These help, particularly for small independent companies, but the problem is that the high overall tax rate really dampens the economics of major exploration projects, the very high-cost, high-risk ventures aimed at making really big discoveries. These are the kind that can really turn things around.
When exploration managers model their risk/reward balance with a new exploration project, for example in a high-cost, remote area, they seek a balance between the small chance they could make a very profitable find and the high probability of failure. The high state tax on a profitable discovery skews this balance, in that if the company wins its gamble the state takes almost all the gain, as Roger Marks shows. The state's current drilling incentives help ease the risk a bit but not enough to overcome the disadvantage of the high tax rate.
We need more discussion of this. Gov. Parnell says he likes targeted investment tax credits because no credit occurs unless the investment is made. He worries that there is no guarantee investment dollars will follow if a general tax reduction is made. Parnell's challenger, Berkowitz, basically follows a similar safe strategy: Unless a company agrees to invest in a negotiated deal, no fiscal agreement occurs.
Again, nothing is wrong with these tried-and-true strategies but they're too cautious. We need something more daring to turn things around. The Legislature had real guts last session in offering up a radical incentive for new drilling in Cook Inlet, a state offer to pay most of the costs of the first three test wells drilled with a jack-up rig. As a result we now have new companies investing in the Inlet. We need something similar for the North Slope, our largest oil basis, and we should engage the discussion now.