Funding Cook Inlet: Legislature debates bonding for oil and gas tax credits

Sometime between 2014 and 2015, Alaska state employees distributed a handout at oil and gas trade shows featuring a cartoon moose holding up a stack of dollar bills.

“For the entire lifecycle of the project, the State of Alaska is there for you,” the handout read. “We do not just talk big, we follow through big — with cash!”

The moose’s offering represents the set of incentives the state government was then giving to oil and gas companies. Text beneath advertised specifics: companies could trade some tax credits for capital spending, seismic exploration, and drilling for cash, and a combination of credits might cover up to 65 percent of a project’s total cost.

As of fiscal year 2018, Alaska has paid a total $3.6 billion to 75 oil and gas companies that earned cashable credits under that incentive program, or to others who acquired credit certificates from companies that sold them.

Alaska offered cashable tax credits from 2007 to 2016, and for most of that time had the funds to reimburse all the credits that holders cashed in each year. But as falling oil revenue brought multibillion budget deficits, the state appropriated credit payments at statutory minimums between $77 million and $72 million. This deferred a total of $630 million from the payments since 2015 , and has left the state a $806 million debt to about 40 credit-holders, said Alaska Department of Revenue Commissioner Sheldon Fisher. $311 million of this debt is for non-North Slope production, mostly in Cook Inlet.

Fisher used the cartoon moose to represent the $806 million obligation in the slideshow he presented to the Alaska Senate Resources Committee on February 21, where he argued for his department’s proposal to pay it off with a bond sale.

Incentives for gas

Alaska has offered tax credits to oil and gas companies since 2003, but the first that could be transferred between holders and exchanged for cash from the state came in 2006. In 2010, the scope of cashable credits increased dramatically in response to a crisis: extraction of natural gas from Cook Inlet — which fuels most of the heat and electricity used on the Kenai Peninsula, Anchorage, and the Matanuska-Susitna Valley — was declining after the major oil companies that had developed inlet fields in the 1960s moved to more profitable investments on the North Slope. The resulting shortages threatened power and heat outages during the winter months of the late 2000s.

Unlike the previous North Slope-targeted tax credits, which were meant to incentivize new production to generate new state revenue from taxes and royalties, the hefty credits created by 2010’s Cook Inlet Recovery Act were an economic stimulus aimed at “preservation of a livable lifestyle in South Central Alaska,” Department of Revenue’s Tax Division Director Ken Alper told Senate Resources.

Because Cook Inlet companies were taxed much less than those on the North Slope, Alper said the 2010 credits were made with an awareness that “there was never going to be any substantial revenue from oil and gas production in Cook Inlet.”

Instead, these credits — which returned up to 40 percent of certain exploration costs and 100 percent of the cost for the first company to use a jack-up rig to drill a new Cook Inlet exploration well (work not done there in almost twenty years) — were aimed at making exploration and drilling feasible for the newer, smaller companies moving into the region.

Such companies frequently operate at a loss in the first years of a project and their initial production is likely too low to be taxable. To make the new tax credits valuable, legislators made them cashable, or salable to larger companies that did have tax obligations to reduce. For Cook Inlet credit recipients, this was overwhelmingly how the program was used. A January 2016 Alaska Department of Revenue analysis found that between fiscal years 2007 and 2014 non-North Slope producers (the majority in Cook Inlet) used credits to cancel a total of $101 million in tax liability while cashing credits worth $504 million.

During the years when full payment on credits was a given, Fisher said the companies used future credit cash as promised repayment for bank loans through which they may be able to get money on a more favorable schedule.

“Many of the companies, I think most of the companies, engaged in that kind of a transaction,” Fisher said. “Everything’s going well until the financial crisis hit and oil prices collapsed and we felt like we didn’t have enough money… The result of that is these companies ended up going into default because they had an obligation to the banks and they can’t make that obligation because they were expecting the state to make a payment to them.”

Fisher said the opportunity to cure these defaults and resume borrowing would motivate credit-holders to take the slightly lower payouts the state may offer under the new bond arrangement.

Victory against gas shortages

Of the 75 companies that have participated in the tax credit program, Alper said that 16 are now producing oil and gas. Fisher, taking a long view, said it’s too soon to judge the success or failure of the incentives. He told Senate Resources that Department of Revenue forecasted future extraction equivalent to 300 million barrels of oil incentivized by the credits.

“Someone can be critical of the program and argue that the state did not get value. I think that remains to be seen,” Fisher said in a later interview. “In the coming years we’ll have a better sense of how much production was generated. There’s some fairly large fields, and if they actually produce in the way we think they will, the program will probably work. If they don’t, then we’ll say it was a foolish investment the state made.”

In Cook Inlet, Alper said, “all of the current oil and gas production has benefited from the credits, there’s no question about it.” The names of past credit-receiving companies are confidential under Alaska’s tax laws, as is the amount each company received (though with the end of credits in 2016, the state has made a yearly report of subsequent payouts). However, at least three Cook Inlet oil and gas companies went bankrupt during the era when most were consuming tax credits.

The Australia-based Bucaneer Energy drilled into the Kenai Loop gas field from a well pad near the Kenai WalMart in 2011, and brought in the jack-up rig Endeavor for off-shore exploration in 2012. Buccaneer’s May 2014 bankruptcy left behind over $2.1 million of debt in Alaska. In October 2015 Cook Inlet Energy’s parent company Miller Resources was forced into involuntary bankruptcy by creditors Baker Hughes and Schlumberger, and two executives of Cook Inlet Energy’s parent company, Miller Energy Resources, were charged by the U.S Securities and Exchange Commission with inflating the value of its Alaska properties by $4 million, settling ultimately for $5 million. By late 2016, Cook Inlet Energy had reformed under new ownership as Glacier Oil and Gas.

Aurora Gas, operator of nineteen wells in Cook Inlet, was forced into bankruptcy by creditors in 2016, leaving behind three non-productive hydrocarbon wells on the west side of Cook Inlet that it can’t afford to plug. Since 2015, Aurora Gas has been solely owned by German investor Kay Rieck, who is also chairman of Deutsche Oel & Gas, which owns Furie, another Cook Inlet gas extractor.

Other companies that arrived in Cook Inlet during the tax credit era explored, but ultimately didn’t reach production before leaving the region or the state.

The Houston, Texas-based Apache Corporation began exploring north of Nikiski in 2010, but left Alaska in March 2016. In September of that year it announced that it had discovered an estimated 75 trillion cubic feet of natural gas and 3 billion barrels of oil in its Alpine High field in Texas’ Permian Basin.

NordAq Energy began onshore gas explorations in Cook Inlet shortly after its incorporation in 2009, drilling exploration wells north of Nikiski in 2011 and on the west side of Cook Inlet around 2013. The Alaska Oil and Gas conservation commission would later fine NordAq $100,000 for leaving the west-side well unplugged after its leases were terminated in 2015 and 2016. NordAq now holds interest in Beaufort Sea leases, but none in Cook Inlet. In early 2017, the Alaska Dispatch News reported that NordAq share-holders sued the company’s founder and its former CEO for allegedly embezzling $6.5 million, some of which was allegedly spent on financing a London musical.

Alper acknowledged to Senate Resources that some of the $3.6 billion spent in tax credits “frankly has gone to companies that aren’t in production, aren’t yet in production, and may never be in production.” Nonetheless, he said that, in part because of the credits, “we’ve solved the south-central gas supply.” The Department of Revenue estimated credits given outside the North Slope have incentivized the extraction of energy equivalent to 89 million barrels of oil — most of that Cook Inlet gas. For comparison, the annual gas consumption of south-central Alaska is equivalent in energy to 15 million barrels of oil, Alper said.

“We sort of declared victory in our war on the gas supply shortage,” Alper said. “We no longer need to provide that benefit.”

Cook Inlet’s largest oil and gas operator, the privately-owned, Houston, Texas-based Hilcorp, isn’t presently eligible to exchange tax credits for cash, according to 2017 Senate testimony by its Senior Vice President David Wilkins. That option was available to companies that produce less than 50,000 barrels a day.

Smaller Cook Inlet companies unbuffered by operations elsewhere (Hilcorp also pumps hydrocarbons in Texas and Louisiana) remain more reliant on tax credits. Among those that followed the call of the cartoon money-moose to Cook Inlet, Furie Operating Alaska and the Fort Worth, Texas-based BlueCrest Energy are two companies with producing wells and plans to drill more. Representatives of both companies have said their operations in Cook Inlet would not be possible without cashable tax credits.

BlueCrest CEO Benjamin Johnson told House Finance Committee members in April 4, 2016 that tax credits had convinced BlueCrest’s founders — a group of former major oil company executives — to come to Alaska despite the fact that “exploration, development and operating costs in the state are at least three hundred percent of any other major hydrocarbon basin in the U.S.”

Testifying against the end of the credits in 2016 — shortly before BlueCrest had produced its first barrel of oil from a converted exploration well ConocoPhillips had drilled in 2001 — Johnson elaborated on BlueCrest’s financial reliance: to become self-sustaining, the company needed to invest an additional $525 million, of which $121 million was budgeted from tax credits BlueCrest expected to receive from its spending in 2015 and 2016, and $24 million from credits it had already received. Other state support would also contribute: a $30 million loan from the state-owned finance company Alaska Industrial Development and Export Authority funded the company’s rig and its transportation from Houston, Texas. Private investors had contributed $200 million, and $150 million had come from a development loan, Johnson said.

When the state funded credit payments at the minimum that year, BlueCrest was able to cash $2.34 million worth of its credits. 2017’s credit payments gave it $6.36 million — not enough to fund the five wells it planned to drill that year, according to Johnson, who announced in August 2017 that BlueCrest would be on a temporary hiatus, after having drilled two wells. In 2018, BlueCrest plans to drill at least one.

As for Furie, its ownership company Cornucopia Oil and Gas cashed $39.85 million in credits in 2016, over half the $72.61 million appropriated for payments that year. In 2017, Cornucopia was the third-highest tax credit recipient with $16.25 million — behind North Slope companies  Repsol (recipient of $17.83 million) and Caelus (recipient of $16.88 million).

Furie is presently in default of its lease from the Alaska Department of Natural Resources on the 83,394-acre offshore Kitchen Lights Unit, Cook Inlet’s largest lease area, for failing to drill two wells it originally committed to in 2015. In correspondence with DNR, Furie representatives have blamed the failure on the shrunken payments of state tax credits.

Bonding the debt

Alaska Governor Bill Walker first announced the plan to pay off tax credit debt with bonds (now passing through the Alaska legislature as Senate Bill 176) with his budget proposal in December 2017. Fisher and other administration officials have since promoted its potential economic stimulus effects.

“The people of Alaska win because we view this as a major infusion into the economy, and it’ll put people back to work,” Fisher said. “And it’s all done with a mechanism that doesn’t cost Alaskans anything because companies are choosing to take a discount that pays for the finance.”

The discount Fisher referred to is a reduction of the $806 million debt which he believes credit-holders are likely to accept in order to get pay-outs quicker. He said these reductions — 10 percent under one option of the plan, or less under others — are less than the interest rate companies are likely to get on borrowed capital from elsewhere. Companies would be able to lower their discount rate for agreeing to re-invest an equivalent amount in-state over the next two years. Companies with credits for spending on seismic exploration could also lower the discount by agreeing to shorten the 10-year confidentiality period on the data gathered in that exploration.

On the other side of the deal, the money that the reduction leaves in the state’s hands should be enough to pay the interest rates on the new bonds, which Fisher estimated would be around 5 percent. Ideally, it would pay off the state’s obligation without extra cost — “almost free money,” he called it at the Feb. 21 Senate Resources committee hearing.

Also speaking at that meeting, Senator Natasha Von Imhof (R-Anchorage) said that the fact that companies had already committed much of their credit payments to paying bank debt made her skeptical of the plan’s economic stimulus effect. Fisher said he believes that once companies renew their credit standing by repaying the debts to which credit payments are pledged, they would spend their future borrowing in Alaska.

Fisher estimated that he and his staff have talked about about the bond plan with about 60 to 70 percent of the remaining credit-holders, and said he has “not heard anyone yet say they’re not interested.”

“That’s not to say everyone has said they are interested,” Fisher said. “… Most of the people I’ve talked to are quite enthusiastic, or at least supportive.”

Reach Ben Boettger at b.boettger@peninsulaclarion.com

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