Monday, April 17, 2006

Gazprom: The Sleeping Giant Waits

The other day, former Alaska Governor Wally Hickel wrote a commentary to the changes made both politically and economically in Russia.

Governor Hickel was a visonary in some respects and but I have to take issue with his feelings on Russia. Russia is in a transformation, but it is a transformation that is empowering Russia to where its state owned energy company Gazprom is a sleeping giant.

I read with interest the desire of the Russians wanting to know more about Alaska and I found it of some interest that Governor Hickel explained the Alaska Constitution and the Alaska Statehood Compact.

Our system, I explained to a standing-room only audience, is built on the unique Alaska Statehood Compact that combines the fundamentals of democracy with common ownership of state lands and resources. The terms require that subsurface resources forever remain in the hands of state government, and our constitution mandates that those resources be used "for the maximum benefit of its people."

The question on why would Russia be so interested in Alaska has to be asked. Is it because Alaska was a colony at one time? Could be. The common Russian may be interested. But the Governor was not among a standing room only crowd of the common Russian.

Businessmen and government officials where there. Interestingly, today, I received an e-mail that had this article from the Petroleum News attached.

April 2006

Vol. 11, No. 16

Week of April 16, 2006

State of Alaska, the world is watching

The author In this guest editorial Dave Harbour expands upon a brief opinion piece he recently prepared for the Anchorage Daily News. Harbour is a founder of Arctic Power, former chairman of the Anchorage Chamber of Commerce, the American Bald Eagle Foundation and the Alaska Council on Economic Education. He is the former public affairs director of the Arctic Gas consortium and a former government relations director for Atlantic Richfield Co. He has no financial ties to the oil industry and asked that Petroleum News stress he has written this piece as a private citizen of Alaska and not as a state employee.

The world watches Alaska and knows us through beautiful tourism and wild salmon television commercials. The world also watches as our Congressional delegation seeks ANWR approval. Citizens keep a wary eye on us as their natural gas prices rise, wondering how they will fare when our famous gas pipeline is built. They have also heard about Alaska’s bridges, NPR-A and PFD.

And now, the world is coming to sense a relationship between taxes and the proposed natural gas pipeline from Alaska’s North Slope.

In mid-February, when the Murkowski Administration submitted its proposed Production Profit Tax (PPT) legislation with reluctant industry support, Financial Post Columnist Peter Foster in Canada wrote, “…when resource prices go up, governments are inclined to cry ‘windfall’ and raise taxes, which happened to be part of the deal that Alaska and the companies signed this week.”

On March 18, Morningstar reported, “Major oil companies operating in Alaska and state administrators took issue Saturday with a proposed tax they said concentrates on short-term revenues for the state at the expense of long-term investment in the oil patch.”

U.S. Sen. Ted Stevens, R-Alaska, has reminded us in recent weeks to be mindful that the world watches us as we create Alaska’s 21st Century investment climate with the oil tax overhaul now in progress.

Tax summaryIn the 1970s, legislators sought a “fair share” of oil wealth by levying annual tax increases on the oil industry, but the term was rhetorical and never accurately defined. A large oil and gas income tax change in 1978 triggered stronger than usual industry criticisms of discrimination, double taxation and negative investment climate.

Then, as the issue simmered amid industry lawsuits, on March 17, 1981, Gov. Jay Hammond and legislative leaders read a joint statement and answered journalists’ questions. Their landmark legislation established rules that, in retrospect, created Alaska tax stability for a generation, lasting until now. All agreed on that day 25 years ago, that Alaska had defined a “fair share” tax policy. Hammond called the gathering “unprecedented,” probably referring to the new tax policy consensus as well as the unified non-partisan grouping that included Senators Jay Kerttula, Don Bennett, Ed Dankworth and Representatives Jim Duncan, Sam Cotton, Hugh Malone and Tony Vaska.

Hammond noted that the new plan provided a 30 percent share of oil and gas revenue to the state, 34 percent to the producing companies and 36 percent to the federal government. The plan removed flaws in the oil income tax. It increased the severance tax from 12.25 percent to 15 percent and modified the economic limit factor to encourage less productive fields to continue producing jobs, royalties and income and property tax payments. Meantime, the state has adopted some ELF changes and many believe more changes are needed today.

A generation later In February, the Administration proposed a new definition of “fair share” to the Legislature in HB 488 and SB 305. According to handouts, the change from a severance tax to a higher production profit tax, the PPT, should contribute to a 35 percent petroleum resource share for the state through taxes and royalties, 5 percent more than the 1981 definition of “fair share.” In 1981, the governor, both legislative bodies and industry players adopted their generation’s “fair share” definition. In 2006, the Administration and industry have, at least reluctantly, agreed on a “fair share” definition that significantly increases taxes even at a time when Alaska production is fast diminishing.

Why should industry have agreed to the more costly and complex PPT concept? Oil companies presumably consider the increase acceptable if it extends tax stability and a positive investment climate for another generation. That stability and investment climate could then, we are told, lay a foundation for massive gas pipeline investments and additional oil and gas exploration and development.

Legislative leaders have worked hard analyzing the Administration-industry concept, but they haven’t yet agreed. Many want even higher industry taxes. In the next few weeks, consensus must emerge. Without consensus, as occurred that day 25 years ago, the investment climate could deteriorate causing delays in various capital-intensive projects such as the gas pipeline.
As our leaders struggle, position and bargain among themselves, here are some principles to ponder:

• Gordian Knot Principle. Citizens of 3rd Century B.C. Macedonia struggled over the meaning of the complex Turkish knot King Midas had attached to an ox wagon. The lore grew until an oracle foretold that he who could solve the knot’s puzzle would rule all of Asia. But how could a knot be untied when all of its ends were ingeniously buried within the knot itself? Alexander the Great decided that the way to expose the ends and solve the puzzle was less important than accomplishing the mission. With a sword’s blow, he cut the knot, exposing the ends and solving the puzzle; as the oracles predicted, Alexander came to rule the known world. Today’s leaders struggle over a puzzle of tax solutions with economic advisors giving confusing if not conflicting advice … in an election year! Like Alexander and like our 1981 leaders, today’s generation of leaders could cut through the puzzle of endless rhetoric with a sword of non-partisan consensus by accepting the Administration’s PPT proposal unchanged. The principles below justify such decisiveness.

• Fair Share Principle. With the Administration’s proposed PPT tax replacing the severance tax, Alaska could get about a 35 percent resource share, 5 percent more than the 1981 “fair share” definition. That’s about $1 billion above this year’s $1.4 billion windfall surplus, $0.5 billion above the 1981 formula. Oil industry taxes and royalties now provide close to 90 percent of Alaska’s unrestricted general fund revenues. Other industries pay a much smaller share of state revenue. With repeal of the personal income tax in 1981, citizens began paying no share of state tax revenue … much less any “fair share.” Before adding to the Administration’s PPT increase, high tax advocates should explain why more than a 35 percent share is “fair”; how it improves, without damaging, our investment climate.

• Maximum Benefit Principle. Some leaders promote taxing companies to a “break point,” using our constitution as justification. Article 8 Section 2 says, “The legislature shall provide for the utilization … of all natural resources … for the maximum benefit of its people.” High tax advocates say we should squeeze more drops of tax from the oil turnip than the PPT extracts. Some demand dramatically higher taxes, fearful of “leaving money on the table.” But the Constitution didn’t restrict “maximum benefit” to dollar benefits, nor did it selfishly restrict benefits to our generation of “people.” Leaders should unselfishly aim for a long-term, sustainable tax structure that creates, as in 1981, an investment climate providing for “… the maximum benefit of,” this and future generations.

• Investment Climate Principle. Good investment climates involve certainty. Even if a tax structure is outrageously high, with certainty investors can at least decide whether or not “to play.” Conversely, changing the rules after investments are made produces uncertainty and poorer investment climates. I’ve always thought that from the day an oil or mining or timber lease was signed, the tax structure on that date should apply for the life of the project. No elected leader has yet proposed that much certainty. But in today’s tax dialogue, perhaps we can at least agree that there is no such thing as a “break point,” as some politicians and consultants have termed it. If tax law established a “break point” taxpayers would have incentive to invest and profit below that point. Tax rates don’t produce black and white, “break point” results. Investment happens by degree: the more something costs the less a prudent person will invest in it. In other words, a state’s investment climate becomes less attractive by degree as taxes and other costs rise. Dramatically increasing tax costs today will result in less future investment benefiting our children than if the tax costs were lower. Our leaders shouldn’t be looking for a “break point” to meet their Constitutional mandate, but for a reasonable investment climate balance benefiting the current and future generations.

• The “We don’t care how they do it outside,” principle. Alaskans love such bumper-sticker slogans. Yet, elected officials are spending large sums on consultants to advise Alaska how other jurisdictions tax their companies. While Alaskans should prize expertise, in the same breath we could hope our leaders really do want to approach tax policies more positively than their counterparts in Libya, Russia, Iran and Venezuela. It is at our peril that we would think our Arctic conditions, remoteness to markets and free enterprise traditions are comparable to oil production in areas that are sometimes tropical, almost always cheaper to explore and develop and often located at tidewater.

• The “Law of Unintended Consequences” principle: Progressivism. The Administration and Legislature may be trying to do the right thing. The trick is always to make sure that in our zeal to do the right thing we don’t produce an unintended consequence that undermines good intention. We’ve now seen the Administration offer a tax package with industry’s reluctant agreement that produces significantly greater revenue for Alaska than was defined as a “fair share” 25 years ago by leaders who were just as dedicated. Some leaders are working to increase the proposed PPT tax rate and add a “progressive” factor to that rate as oil prices rise. Progressive tax proponents should more fully appreciate that the high risk of failure endemic to the oil business requires an equally high hope for profitability in the good times. More tax burden applied on high prices will affect calculations, participation and excitement surrounding lease sales and board meetings when investment decisions are made.

• The “Windfall” principle. Some tax advocates claim, “Those taxpayers received a windfall,” usually an irrelevant observation in a free market, capitalist nation. Alaska’s fall 2002 Revenue Forecast projected that with oil in the $22-$25 range the state would have a $1 billion annual deficit by 2005. Others predicted draconian cuts in government services by now. Instead, we have a surplus. What happened? Oil companies enjoyed high oil prices and so did Alaska which gets tax and royalty percentages of value. It’s more than a little a bit hypocritical and “third world” that that in an effort to justify higher “progressive” taxes, anyone should stick a “windfall” label on taxpayers to rationalize increasing government’s “windfall.” “Windfalls” aren’t necessarily evil; a free market phenomenon, they balance bad times and support reinvestment. It would be disingenuous for government to point a finger at oil company taxpayers saying, “You got a windfall and we should increase your tax rate, so we can increase our surplus, produced by our own windfall.” It’s classic, “Heads I win, tails you lose.”

Were our leaders to adopt these common sense principles, tax stability for a new generation could evolve from the Administration’s proposal. After all, the proposal exceeds the 1981 “fair share” definition by about $0.5 billion annually. It promises increased investor interest in Alaskan exploration, production and gas pipeline construction. Insisting on more than the 35 percent share maximizes income for today’s people at the next generation’s expense, jeopardizes gas pipeline progress, dampens interest in other Alaska investments and does not pass to another generation the stable investment climate legacy our 1981 generation of leaders gifted to us.

Yes, we would do well to sense the eyes of the world upon us and heed Senator Stevens’ advice. What we do will be well reported and well understood by Lower 48 decision makers and world oil industry investors. They will react accordingly, attracted to our wisdom or repelled by our greed.

The headlines say it all. State of Alaska, the world is watching. And Gazprom is waiting as our legislature listens to their paid consultant Daniel Johnston, talk about raising taxes and how it did not have an impact on new production in the U.K.

In an earlier post, I pointed out Mr. Johnston's comments were in error and that production in the U.K. has fallen off dramatically and it can be linked to high taxes. Just recently, some interesting events have taken place in the U.K.

The headlines......................................................................................

Paper Reveals U.K. Feared Gazprom Buy

British Trade and Industry Minister Alan Johnson had eight meetings this year on how to block a potential takeover of British utility Centrica, the country's biggest gas supplier, by Gazprom, the Financial Times said on Monday.

The newspaper report, citing government officials and information gained under the Freedom of Information Act, said Johnson, along with other ministers, was briefed in February on the legal changes required to allow them to block a rumored bid by Gazprom for Centrica.

Another headline.....................................................................................

Gazprom delivers its first LNG to the UK

LOS ANGELES, Apr. 17 -- Russia's state-owned OAO Gazprom has delivered its first shipment of LNG to the UK—140,000 cu m purchased from Gaz de France and delivered to BP PLC.

It was the largest LNG shipment to reach the UK's Isle of Grain terminal in north Kent, which has the capacity to receive and process up to 3.3 million tonnes/year of LNG.

A joint venture of BP and Algeria's state-run Sonatrach has been formed to market LNG from the Isle of Grain terminal, which is expected to provide 5% of the UK's supply needs.

Governor Hickel talked about Vladimir Putin and the reforms he has implemented. Mr. Putin is a very savvy man and has the popularity of the older Russians and evokes a sense of Russian pride in the youth of Russia.

This popularity gives him the ability to throw his political might around. He has used his political might against the Ukraine, he has used it against the Baltics, mainly against Latvia and he has used it against Belarus as a reminder to the citizens there that he holds the might.

Putin has used his political might through Gazprom.

Interestingly, the ADN ran a commentary from a gentleman in the lower 48 and he spoke about Gazprom and used proof that Gazprom was inefficent by stating Gazprom was raising its rates in Belarus.

Well, Gazprom didn't. It was a threat and Gazprom is not raising its rates.

How is Gazprom going to play out in the world market? Gazprom is a sleeping gaint that will be operating in an environment where private companies will be investing in a politcal machine.

Putin is very intelligent and he has set up Gazprom in a manner that 51 percent of the ownership will be controlled by the government and that the private companies that buy in will ride on the coatails of the profits made on the political manuevering done through Gazprom.

Russia is now decreasing taxes so that new investment is made into Russia and Gazprom.

Alaska is looking at increasing taxes.

What will the effect be on Alaska and this nation? As I said before, Gazprom has begun shipping LNG to the East Coast. Gazprom has contracted with Mitsibushi on sending LNG from the Sahkalin fields to a West Coast terminal off California.

I have listened to talk radio and heard the arguments about Venezuela having cheap gas as well as Libya and it a reason to raise taxes.

First, labor in these countries is dirt cheap and secondly, we subsidize those cheap prices at the pump in countries like Venezuela, by paying for the imported oil from those nations and the taxes attached.

Russia has raised their rates to about $2.10 a gallon. Russia is getting leaner and is not subsidizing its national outlets like it did before.

As you begin to read more and more about American companies investing in Russia and Russia exporting more oil and gas into the U.S., the sleeping giant, Gazprom will have taken hold in a market that Alaska should be dominating in.

It's too bad that politicians do not see the big picture.

In the end, the folly may be reversed and Alaska will be a picturesque land with memories that are short lived and find themselves memorialized in bumper sticker slogans.

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