Former tax division director weighs in on Prudhoe Bay oil tax case

Prudhoe Bay at night on Jan. 28, 2013.
Prudhoe Bay at night on Jan. 28, 2013. (Creative Commons photo by jweston_40)

Last week, Alaska’s Supreme Court issued an opinion on a Prudhoe Bay tax law case that has been open for 10 years.

Alaska’s Energy Desk reporter Rashah McChesney sat down with the former Department of Revenue tax division head Dan Dickinson.

Dickinson’s decision to change the way the oil and gas division interpreted its production tax calculations led to a challenge and ultimately a lawsuit between state and Chevron, ConocoPhillips, ExxonMobil and Forest Oil.

Interview transcript:

McChesney: We’re here today to talk about an ELF. But not the kind of ELF you typically hear about this time of year. This ELF is an economic limit factor. And it was a key part of the way the state calculated production tax rates in the Prudhoe Bay oil field from the 1970s to the mid-2000s. The Department of Revenue’s interpretation of that ELF led to the Prudhoe Bay producers’ lawsuit that went all the way up to the Supreme Court.

Dickinson: So it was, really, it was a procedural question of how we came to that decision, and how we adopted it.

McChesney: The foundation of this lawsuit was that the Department of Revenue had two different tax rates in Prudhoe Bay. You had these big fields that were taxed at one rate and then these smaller, satellite fields that were still technically in Prudhoe Bay, but they were taxed at another rate because, in theory, those fields required the same kind of infrastructure to operate but had fewer economies of scale. So the state taxed them at a lower rate to keep them profitable?

Dickinson: What the state did is, it created a formula — a very complex formula. And what the effect of that formula was, is it made the taxes on very large fields higher and the taxes on smaller fields, very much lower. Size became very important.

McChesney: The state formula ended up kind of incentivizing the development of these smaller, satellite fields that were taxed at a lower rate. Do you remember the difference in tax rate? I’m recalling something like 15% on the larger fields and 0.5% on the smaller fields.

Dickinson: That’s on average. But yes, the smaller fields could very easily be driven to zero and some of them were slightly above zero.

McChesney: So, producers and field operators started prioritizing oil that came from these satellite fields over oil that came from the big ones. But, it wasn’t just so that they could pay that lower rate. It was also because newer wells tended to produce more oil and less of the gas and water and sand that comes out of older wells.

But, no matter which field the oil was coming from — old or new– the producers were the same. Companies were developing new, satellite fields and asking for them to be taxed separately from the old, larger fields. What were the discussions at the Department of Revenue at the time?

Dickinson: The focus on the tax has always been…there’s a tension between two aspects of it. One of it is the state obviously wants to get the money from the tax. On the other hand, they clearly recognize that a poor tax regime will inhibit the kind of growth and the investment that it wants.

McChesney: At some point, the Department of Revenue decides to change the way it’s interpreting the tax law and informs the companies that it’s going to combine most of those smaller satellite fields into the larger fields for calculating production taxes.

Dickinson: The effect of that would have been the tax on Prudhoe Bay, on the main field, would have gone down just a hair. But the tax on all the other remaining fields would have gone up considerably. It would have increased taxes by more than $100 million a year. I know that.

McChesney: Okay, so the Department of Revenue issues this decision and it’s estimated to increase taxes by $100 million a year. But then the next year, the legislature decides to toss out the ELF system and put something else in place, and then it decides to do it retroactively. So there’s like a four or five month period there where they were taxed under one system and then it switches to a new system. All told, this new interpretation of the ELF was in place for about a year, year and a half?

Dickinson: Yes.

McChesney: So the oil companies pay that $100 million dollars in production taxes. Then they sue. It has taken a decade for them to exhaust their legal remedies. Now, the state isn’t on the hook for paying the money back. So, what’s your takeaway from this whole process and the final resolution of the lawsuit?

Dickinson: It would be nice if the statutes were nice and clear, the legislature set out exactly what they wanted and said it in such a way that it actually made sense when you actually had to deal with tax. That’s just not what happens in the real world. People sitting in Juneau come up with a very conceptual idea and, you know, applying it to actual returns and companies is a difficult task. I think it generally gives a clearer line as to when the department can act when it can’t.

McChesney: The supreme court issued its final ruling on Dec. 16.

Rashah McChesney

Daily News Editor

I help the newsroom establish daily news priorities and do hands-on editing to ensure a steady stream of breaking and enterprise news for a local and regional audience.

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