As the current legislative session heads into the home stretch and the electoral season approaches, Alaskans increasingly hear the slogan "It's our oil (and gas)" as justification for various proposals and positions.
While the slogan makes for good rhetoric, it is important Alaskans keep in mind that, although it's our oil and gas, it's the oil companies' money that discovers, develops, produces and markets, and -- hopefully -- will continue to explore for new resources. Without their investment, our oil would still be in the ground, and according to Scott Goldsmith of UAA's Institute for Social and Economic Research, Alaska would look a lot like Maine, with high state income and sales taxes, no dividend, and a very small local economy.
Theoretically, the development of Alaska's resources could have been handled differently. When oil was discovered in the Norwegian sector of the North Sea, for example, the government established and funded a state owned corporation (Statoil) that put the country's money in the ground alongside private industry. While the effort required significant capital and exposed the government to substantial financial risk, the net result today is that Norway has an entity capable of taking the lead in exploring new areas if private industry is hesitant to do so. Some other countries follow the same model with varying degrees of success.
Since statehood, however, Alaska consistently has chosen a different path. For a number of reasons -- not the least of which are lack of capital and a limited appetite for undertaking financial risk with state funds -- Alaska has chosen to follow the same approach used by the federal government and most private U.S. landowners by contracting with the private sector for the development of state-owned lands.
As the landowner, Alaska leases its oil and gas resources to private oil companies for a contractually agreed term. In turn, the companies agree to shoulder all of the investments necessary to explore for, develop and produce the resources under contractually agreed provisions.
Most importantly, as compensation for Alaska's interests, Alaska and the oil companies have agreed that Alaska will receive a lease bonus and the revenues realized from the sale of a contractually established percent of the production.
Historically, this arrangement has proven to be extremely beneficial to Alaskans. The $900 million in lease bonuses paid by the oil companies in 1969 for the core Prudhoe Bay tracts is largely credited with finally putting Alaska's government -- which had been on shaky ground since statehood -- on a firm footing. Revenues received from subsequent production have enabled Alaskans to finance extensive state and local government projects and operations without any significant individual or corporate tax burden.
There is an even greater degree, though, to which Alaskans have benefitted from creating a stable economic climate supportive of private oil and gas investments: Alaska has oil and gas development, while others in the Arctic do not.
According to a recent U.S. Department of Energy study on "Arctic Oil & Natural Gas Potential," there are 17 identified large oil and gas fields located in the North American portion of the Arctic. Despite the fact that most were discovered in the 1970s and 1980s, to date only three of the 17 have been developed -- all in Alaska.
Why such limited development? Why Alaska?
According to the DOE, in North America "oil and natural gas field development is governed by market-based economics, with fields only being developed if and when they are expected to generate sufficient profits." The costs and risks of developing Arctic projects are significant: Onshore Alaska North Slope projects cost from one and a half to two times more than similar oil and natural gas projects undertaken in Texas. Other factors, such as long lead times, limited logistics support, severe weather and other harsh environmental conditions create even greater economic risk and burden.
"The bottom line for Arctic oil and natural gas potential is that high costs, high risks, and lengthy lead-times can all serve to deter their development in preference to the development of less challenging oil and natural gas resources elsewhere in the world," the DOE study concludes.
In light of these challenges, Alaska's contractually-based investment climate has been critical in distinguishing Alaska's resources from the other Arctic projects. Historically, the oil companies felt comfortable investing in Alaska because, while other factors remained unpredictable, their financial obligations to the state remained fixed.
Alaska's investment climate has changed dramatically in the last four years, though. Applying the catch phrase of requiring the oil companies to pay "Alaska's Clear and Equitable Share" of oil revenues, since 2006 Alaska has twice unilaterally increased the percent of revenues that the oil companies are required to pay for the production of "our" oil.
On some level, this action can be viewed as a breach of trust, if not a breach of contract. Alaska and the oil companies already negotiated Alaska's "fair share" of revenues at the time that the two parties entered into the underlying oil and gas leases. Alaska received significant upfront lease bonuses based, in large part, on the understanding that later revenue streams would be shared in accordance with the agreements.
Through ACES, though, Alaska has started using its taxing power one-sidedly to rewrite its fundamental agreements with the oil companies -- and to take a second bite at the "fairness" apple -- without even bothering to reach agreement with those making the investments.
It's the same as your local bank agreeing to loan you money at a contractually agreed-upon rate, then later convincing the Legislature to pass a law permitting the bank unilaterally to raise the rate higher. The bank's rationale would be that it was "our" money in the first place and all that they want now is their "fair share" of the greater return you are earning. Never mind the contract.
This approach clouds Alaska's future.
As the DOE report additionally concludes, "The high cost of doing business in the Arctic suggests that only the world's largest oil companies, most likely as partners in joint venture projects, have the financial, technical, and managerial strength to accomplish the costly, long-lead-time projects dictated by Arctic conditions."
ACES has, and continues to, undermine the economic climate that previously has attracted those types of enterprises to Alaska. If "the world's largest oil companies" stop investing in Alaska, as they have in other parts of the world in similar situations, significant new Alaska oil and gas exploration and development will come to a halt, and Alaska's future projects will fare no better than other Arctic projects.
Governor Parnell and others in the Legislature think a quick fix to the problem is creating tax "credits" for new investment. They are wrong.
First, Governor Parnell and his allies propose funding the tax credits by maintaining high taxes on production. In other words, once the new investment results in new production, the production is taxed at the current ACES rates. No producer is going to make new investments knowing that, once the investment pays off in production, the producer will again pay the higher rates.
Second, at their core, the tax credits are merely an attempt to limit producer choice. A producer has to invest in Alaska continually in order to receive the benefits of the credit. No producer of the size necessary to invest in Arctic ventures is going to forego the future opportunity to change its investment patterns if financial returns become better elsewhere.
There are no shortcuts or quick fixes. To be successful, Alaska must compete heads-up with the remainder of the world. Alaska cannot be successful by seeking to "trap" investment in the state.
To continue to attract new investment in its resources, Alaska must return to the policies that successfully developed the state's wealth in the first place -- the policies Alaska followed under Governors Egan, Hickel, Hammond and others up to the beginning of the Palin administration. Alaska needs to remember that, while "it's our oil," it's "their" investment that develops it, and return to policies that attract that investment to Alaska's Arctic environment.
Brad Keithley co-heads Perkins Coie, LLP's global oil and gas practice from the law firm's Anchorage office.
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