The Alaska Oil and Gas Production Tax has been changed multiple times, particularly over the last 12 years. And each change in the statutes brings additional changes—and complications—to the regulations that the Alaska Department of Revenue (DOR) issues to implement the tax. Even the last few years are telling, with overhauls of the tax structure in 2013, 2016 and again in 2017, and debate about several production tax bills this legislative session. This uncertainty dramatically impacts the oil and gas industry in Alaska and investment in the state.

The oil and gas production tax structure is a critical consideration for oil and gas explorers and producers in Alaska due to its impact on project economics. It has been and will likely continue to be an area of uncertainty, and the Department of Revenue has finalized one set of regulations to implement House Bill 111, which passed last year, and has published a second set of draft regulations that govern carried-forward annual production tax losses that can be accrued starting in 2018.

Alaska's oil and gas production tax regime is found at AS 43.55.011-AS 43.55.900. The production tax structure, including production tax rates, tax limitations, credits and other incentives varies depending on the area of the state that is the focus of the exploration, development or production activity.

Unlike other states that levy a severance tax on the gross value at the “wellhead,” Alaska's production tax is levied on the net revenues of oil and gas production from leases or properties in the state, except for the federal and state royalty share and oil and gas used in drilling or production operations, or for repressuring. At a high level, the calculation starts with destination value, generally the higher of the sales price or a calculated prevailing value. The costs of pipeline and marine transportation are subtracted from the destination value to obtain the gross value at the point of production—the wellhead value.

Upstream operating and capital costs are subtracted from the gross value at the point of production to reach net revenue, known as production tax value. Allowable upstream costs are essentially the ordinary and necessary and direct costs of exploration, development, or production upstream of the point of production (generally the first point that oil and gas are accurately metered and in a condition of pipeline quality), plus an overhead allowance of 4.5% of those costs.

Production tax value is then multiplied by the tax rate and the result is reduced by credits. At a high level, the calculation can be shown as follows: Production Tax Liability = [(Value at point of production—Upstream Expenditures) * Tax Rate]—Credits.

Production tax credits have been vital to oil and gas exploration and development in Alaska and certain credits for costs of upstream capital and operating expenditures have spurred investment in the state over the last decade. Explorers and small producers could apply to the state for purchase of credit certificates, and the ability to receive these rebates was a powerful driver of investment in Alaska for drilling wells and shooting seismic, and for production facilities and pipelines. Unfortunately, the program's success made it a target. With the drop in oil prices, the portion of Alaska's petroleum revenue available to pay for government dropped tremendously, creating roughly $3 billion annual deficits. The Walker administration (Alaska's Gov. Bill Walker) and certain factions of the legislature focused on the rebate program and introduced legislation to end it.

House Bill 111 was aimed primarily at ending the system of rebatable credits in Alaska, which will now be available only for expenditures incurred before July 2017. The legislature also repealed the annual loss credit for all areas of the state and created the carried-forward loss to be applied against taxes in later years. This legislation and the Department of Revenue's proposed regulations add new complexity to an already complex system.

The drop in state revenues also impacted appropriations to the oil and gas tax credit fund, which had historically paid all outstanding applications for production tax credit rebates. Gov. Walker used his veto power to reduce the appropriations in 2015 and 2016, and the legislature appropriated a relatively minimal amount in 2017. Based on information provided by the Department of Revenue, as of Jan.1, 2018, the total amount of tax credits for which purchase was requested is $807 million. The department has forecasted that a total of $821 million in tax credits will ultimately be purchased, which assumes that $125 million will be transferred to producers for use against production taxes. The governor has introduced legislation to allow the state to issue bonds to purchase outstanding credits at a discount. At the time this article is being written, that legislation has passed the House of Representatives and is on its way to the Senate for consideration.

Jonathan E. Iversen, a partner at Stoel Rives, is an Alaska-based tax attorney who provides tax planning and tax structuring advice and represents clients in tax audits and appeals.His practice emphasizes state and local taxation. Iversen has extensive experience counseling clients on state and local tax audits and appeals, incentives, and financing associated with Alaska's oil and gas production tax credits.