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Community Perspective

Shale oil, conventional oil and taxes

Normally, the state’s strategy for oil development and petroleum resource maximization is simple: place an appropriate tax on oil profits and watch the money roll in. However, the question is this: What is an appropriate oil tax? That depends on what your overall strategy is.

For example, if you give tax credits or tax reductions on oil in the hope of inducing higher oil production, then you have to understand the characteristics of the different oil resources that you are trying to incentivize; otherwise, the result will be disappointing. That means you have to understand that there is not one oil resource on the North Slope but two completely different resources with two completely different costs, profits and physical characteristics: conventional oil and shale oil. Without understanding the crucial differences between these two oils, the state may be misunderstanding what its oil tax strategy actually is.

The oil industry is quick to point out, and hammer the point ad infinitum, that North Dakota and Texas have had a robust oil production growth rate over the past 10 years even as Alaska’s has languished. The reason often cited is that Alaska has high costs and high taxes. What is not explained carefully is the apples to oranges comparison of conventional oil versus shale oil, a comparison that is crucial in understanding Alaska state oil tax strategy.

North Dakota and Texas have had a “renaissance” of increasing oil production these past 10 years due to the exploitation of shale oil resources. Presumably, then, so too could Alaska. The problem is that Alaska has characteristics that are quite different from North Dakota and Texas, making shale oil difficult to exploit here no matter how low Alaska taxes are. And that makes comparing those shale oil development regions to Alaska illogical.

When you develop shale oil, unlike conventional oil, you pump water, sand and chemicals into the underground geologic structure in order to frack it, i.e. in order to crack the deep shale rock open. Then you pull the water out and suddenly you have oil and, more often than not, a lot of natural gas as well. Therein lies the dilemma.

In Texas, the oil and natural gas that come out are separated and both are sold. This is because Texas has an extensive natural gas pipeline system in place close to most shale resources. The North Slope has no easy way to deal with a sudden huge influx of natural gas other than to flare it, which is to have a giant flame that burns off the natural gas. There is just no pipeline in place to whisk that gas away to markets.

Prudhoe Bay can easily deal with natural gas by reinjecting the gas into the conventional oil trap, which pushes out more oil, but shale oil and shale gas will not work in that manner. There is no easy way to reinject shale gas down into a shale formation to get more oil, and to do so is relatively expensive. One simply has to cap the well if there is no oil, or even if there is only a little oil and a lot of natural gas, then wait for Alaska’s North Slope natural gas development. At this point, though, such development is more expensive by twofold compared to Alaska’s global competitors. The natural gas is therefore stranded and has little value.

North Dakota actually does flare its natural gas as it produces shale oil, although it is trying to reduce that flaring now to conserve resources. What all this means is that it will be hard for Alaska to obtain the kind of shale oil production that other states have had these past 10 years because of a lack of a way to deal with the simultaneous production of natural gas with the oil. And no amount of tax credits will change that. So the tax system has to be set up for conventional oil, not set up for a false hope of obtaining shale oil.

Oil taxes can be structured to help the state’s economy in general. However, if tax credits are used to induce, say, more employment on the North Slope, then care has to be taken to garner real benefits for the state. Oftentimes increasing North Slope employment means that more out-of-state workers fly in to work for two weeks and then take the money and run. While technically the industry increases “Alaska” employment, in reality a lot of that money is leaving the state because Alaska has no income tax. 

Doug Reynolds is a professor of petroleum and energy economics at the University of Alaska Fairbanks. He can be contacted at dbreynolds@alaska.edu.

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