The "Oil Battle" in Alaska is Spreading

A political battle is playing out in the Alaskan legislature, the first of what are likely to be a number of such tussles nationwide.

These are going to be increasingly frequent contests pitting current tax structures in oil- and gas-producing states against the rising concern over generating enough domestic drilling to counter events abroad.

As I have mentioned here on several occasions, there are no prospects of curtailing continued reliance on imports – so long as we remain an economy based on crude oil… and so long as we are primarily concerned with keeping prices low.

Still, domestic sources of even higher-priced crude can provide a modest offset to increasing dependence on foreign oil. And that provides the fodder for rising political fights in state legislatures. That and the argument that tax concessions will improve local employment and company expenditures.

Currently, this is centered in Juneau, where a governor's proposal to provide tax breaks to oil producers has renewed some deep divisions…

Oil & Gas Account for 90% of Alaska's Budget Revenue

At issue is Alaska's Clear and Equitable Share (ACES), put into force in 2007. ACES provides for a system of tax receipts that improves with the rise in oil prices. The state receives progressively higher revenues once the price of crude exceeds $30 a barrel. And that was more than $70 ago.

This is decisive in a state like Alaska, where oil and gas production accounts for almost 90% of the state's budget revenues. Under ACES, the state has received a windfall that it has put into budget reserve funds now standing in excess of $10 billion. Not bad for three years of tax collecting.

Unfortunately, Alaska has also been unable to conduct the company audits required to realize the full benefits from ACES.

However, this year Governor Sean Parnell introduced legislation that would reduce production taxes paid to the state on North Slope oil while increasing tax credits producers can claim for exploration and development work. Opponents say it will cost the state at least $2 billion a year, while supporters counter it will prompt greater production, employment and investment.

The battle lines have been drawn for some time along a partisan basis, with Republicans largely in favor of the governor's move and Democrats more united in opposition. That division means the bill finally passed the Republican-dominated lower house on Saturday (April 2) but will meet some stiff resistance in the state senate.

That Parnell called them "do nothing senators" last week probably won't help much.

Yet this legislative fight brings to center stage a difference of approach certain to be a very visible element moving forward. As we travel into some heady times of oil volatility, legislators will need to question how much increasing production actually contributes to the local economy and the state coffers.

Do oil and gas drillers actually require tax incentives to increase domestic production? If so, what general budgetary programs need to be cut to justify the reductions in tax revenues?

Across the country, state and municipal budgets are already facing deficits. That means such cuts are not likely to hit extravagant programs, pork, or (well-known when it comes to Alaska) bridges that lead nowhere. These are already on their way out. The reductions will cost programs of wider impact.

In the political mix of a new-found popular support for cutting taxes and trimming budgets, providing incentives for development and reducing overall corporate tax liability are again on the front burner. But what effect do such approaches actually have? Is there even a likelihood that benefits given to a producer would be realized in the state providing them?

The Debate is Spreading Beyond Alaska

A similar battle is developing in Pennsylvania, where a new governor has pledged no new taxes in a state about to realize a significant rise in Marcellus Shale drilling volume. It also happens to be the only state having significant gas production without a severance tax or its equivalent, while having an expanding statewide budgetary deficit.

This is the recipe for Harrisburg becoming in short order the Juneau of the East. Meanwhile, events in Arkansas and West Virginia are also beginning to move in a similar situation.

Of course, the investor needs to determine how such changes – either to cut or introduce taxes, provide concessions, credits and the like – are going to impact company profitability. There is not a single corporate exec I know who will turn down a change advancing his or her bottom line.

But experience demonstrates that such changes, in the accelerating demand and pricing scenarios already here, usually have a short-term effect upon existing projects. They do not become a causal factor for major new ones. The market, in short, will drive production decisions, not political decisions. After all, major greenfield projects will take decades and legislative priorities change.

Marginal companies may benefit most, those needing such changes to stay afloat. The more stable and larger outfits are already well-positioned in the sector. Of course, the struggling companies are not the investment targets anyway, even if they trade publically.

Which means the ultimate result of such political battles may end up being negative pressures on social spending and state infrastructure programs. These cuts also tend to reduce demand for energy products.

Are we then better off?

Sincerely,

Kent