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State has model in royalty relief process to attract more oil investment

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Posted: Monday, April 4, 2011 2:34 pm

As part of the debate over cutting oil taxes in Alaska, the governor and Legislature should consider extending or adapting processes already in place to change state fiscal terms to make specific projects more attractive for oil companies.

This would require a higher level of research and analysis than that put forward to date by the state Department of Revenue and a more flexible approach by the state. The Legislature has the option of seeking this review, however, and it could make a variety of projects more attractive for investment.

The state has a procedure under which companies can apply for reductions in the amount of oil royalties paid to the state to make projects viable. This has been rarely used by oil companies, but it is one of several underutilized tools with the potential to improve the economics of the industry.

The royalty is the state ownership share of the oil, which is 12.5 percent of the total in many cases.

In 2008, the state found that a reduction in royalties was warranted for the Nikaitchuq project on the North Slope because the project would not be economically feasible without better fiscal terms. The reduction was determined to be in the best interests of the state and the company seeking the reduction, Eni Petroleum.

The royalty reduction from 12.5 percent to 5 percent applies if the price of oil dips below $42.64 a barrel, on an inflation-adjusted basis, over the next 25 years.

Nikaitchuq is on a shallow offshore drilling pad in the Beaufort Sea about three miles north of Oliktok Point. The Italian oil company began production this year and said it expects the field will produce for 30 years at a maximum of 28,000 barrels per day, though it is far from that rate at the moment.

Before deciding to lower the royalty rate, the Department of Natural Resources analyzed the economics of the project in detail, keeping certain information confidential, as provided for under state law to protect the developer's internal operations.

The system is  "is designed to replicate the kind of analytical framework used by industry for making prudent oil and gas investment decisions under uncertain conditions involving significant capital outlays and lengthy project life cycles." 

A similar analytical framework could be put to broader use by the state on production taxes to protect the interests of Alaskans while taking steps to expand oil production. With a system like that, the state could better evaluate the effects of proposed changes to the fiscal structure.

"The prudent investor standard is maintained throughout the project evaluation process. Under this standard, ADNR incorporates a collection of project performance benchmarks that are consistent with industry norms," the 2008 report on the Nikaitchuq royalty reduction said. 

"To obtain royalty relief the applicant must show by clear and convincing evidence that  without royalty modification the project is not economically feasible.  Nikaitchuq is an offshore, heavy oil prospect with relatively high expected exploration and development costs and low expected production possibilities.  The final analysis of Nikaitchuq project development conducted by ADNR pursuant to the Eni royalty modification application suggests that, under reasonable assumptions about future oil prices and without some form of royalty relief, this project would not be sanctioned for funding and development," the state said.



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