The Friday Alaska Landmine column: The Legislature badly needs to fix production taxes before we continue to “drill, baby, drill.”

This week, we examine the potential consequences of "drill, baby, drill" on state finances. In the absence of repairing the state's badly broken oil tax code, it's not what some think.

In the wake of President Trump’s emphasis on opening additional federal lands in Alaska for oil and gas exploration and drilling, we have increasingly seen and heard some in the state, including some state legislators, repeat the mantra of “drill, baby, drill.”

But before Alaska producers continue to “drill, baby, drill,” legislators badly need to fix Alaska’s broken oil tax regime. Otherwise, legislators will find that the result of “drill, baby, drill” is that Alaska continues to fall further and further down an already deep fiscal sinkhole.

The reason is how various components of Alaska’s production tax system work.

As we explained in a previous column, while Alaska North Slope (ANS) oil production levels are projected to rise in the Department of Revenue’s (DOR) most recent revenue forecast (Spring 2025 Forecast) over the next 10 years by over 40%, from 461 thousand barrels per day (kpd) in Fiscal Year (FY) 2024, to 663.5 kpd by FY34, production taxes on that production are projected to drop precipitously over the same period by over 55% from $970 million in FY24 to $430 million in FY34.

Some attribute the decline to the growing share of production coming from federal lands over the period. But that’s not true. Alaska’s state production tax applies equally to federal and state lands.

Others attribute the steep decline to a drop in oil prices, but that plays a minor role. The following chart tracks projected oil prices over the same 10-year period included in DOR’s forecast, compared to projected royalties and production taxes expressed as a percentage of gross oil revenues.

The impact of the moderate decline in oil prices is evident in its effect on royalties, which are directly tied to oil price levels. While both the oil price and the share of royalties as a percent of gross revenues decline in the early years of the period, they stabilize after that and begin to rise in the latter part of the period.

Production taxes don’t. Instead, they decline at a significantly steeper rate than oil prices and continue to fall throughout most of the period. While they rise slightly toward the end, production taxes still end the period at a level significantly less than half of where they started. Something besides oil prices is affecting production tax revenues.

The answer largely lies in the interaction among three provisions of the production tax code. The first relates to the level of oil field expenditures - both operating and capital - being made by producers. The basis for Alaska’s production tax is a company’s net profits from oil production. Net profits are the difference between revenues and expenditures. All other things being equal, as expenditures rise, net profits - and thus, production taxes - fall.

The following chart analyzes the level of expenditures and their percentage of gross oil revenues for the past and projected 10-year periods, as reflected in the DOR’s Fall 2024 Revenue Sources Book (Fall 2024 RSB). The Fall 2024 RSB is the latest publication to include such detailed data.

While there have been occasional spikes in the past decade, there has not been as sustained a period of high expenditures compared to revenues as is projected for the upcoming decade. Higher expenditures as a percent of revenues contribute to lower production taxes.

The second reason for the projected decline in production taxes over the next decade is the impact of what is referred to as the “GVR” or Gross Value Reduction provision of the production tax code. As explained in the Fall 2024 RSB:

The gross value reduction (GVR) allows a company to exclude 20% or 30% of the gross value for that production from the tax calculation. Qualifying production includes areas surrounding a currently producing area that may not be otherwise commercial to develop, as well as certain new oil pools. Oil that qualifies for this GVR receives a flat $5 Per-Taxable-Barrel Credit rather than the sliding scale credit available for most other North Slope production. As a further incentive, this $5 Per-Taxable-Barrel Credit can be applied to reduce tax liability below the minimum tax floor, assuming that the producer does not seek to apply any sliding scale credit. The GVR is only available for the first seven years of production and ends early if ANS prices exceed $70 per barrel for any three years.

By reducing the gross value—or revenues—from production, the provision reduces net profits subject to tax, thereby lowering production tax levels in a manner similar to the net effect of increased expenditures.

The following chart compares the level of expenditures as a percent of ANS gross revenues over the forecast period to the amount of production qualifying for GVR.

The results are clear. Just as the level of expenditures starts to come off its multi-year high - potentially reducing their impact on production taxes - the volumes qualifying for GVR grow significantly, increasing their impact on reducing production taxes.

The impact is also clear. As the first chart in this column indicates, the level of production taxes received by the state continues to plummet over the period during which the GVR volumes grow.

The third reason for the projected decline in production taxes over the next decade is the impact of the per-barrel tax credits that many have talked about since the passage of SB 21 in 2013. Again, according to the Fall 2024 RSB, the per-barrel credit follows a sliding scale, which is progressively reduced from $8 per barrel to $0 as wellhead value increases from $80 per barrel to $150 per barrel. At the projected wellhead price levels included in DOR’s Spring 2025 Forecast, which average less than $60/bbl over the next decade and never exceed $63/bbl, the credit remains at its maximum throughout the period.

While they are projected to fall in the near term, the per-barrel oil credits continue to play a significant role in reducing revenues from the state’s production tax. The following chart tracks the impact of the credits from FY2015 through the end of the projection period used in the Spring 2025 Forecast, both in absolute dollars and as a percentage of the production tax revenues that the state would receive absent the credits (production tax before credits).

The change is dramatic over the projection period. While the per-barrel credits are projected to average only 58% of production tax before credits for the 5-year period from FY2025 through FY2029, the level increases to 74% for the subsequent 5-year period, from FY2030 through FY2035. Put another way, just as the impact of the decline in expenditures starts pushing net profits, and thus, potential production tax levels up, the level of per-barrel credits rises to push production tax levels even further down.

The impact of any of the three provisions standing alone would be significant. As demonstrated by the plunge in production taxes over the period, the cumulative impact of all three operating concurrently is huge.

Some have asserted that the significant decline in production tax levels projected for the coming decade is an anomaly and will reverse as the impact of high expenditure levels diminishes. But that’s far from certain.

Under current law, producers can carry forward both certain tax credits and annual losses. According to the DOR’s Spring 2025 Forecast, “carried-forward tax credits are any remaining credits for previous calendar years that were eligible for carry-forward but were not eligible or requested for state purchase, primarily for net operating losses under AS 43.55.023(b). Carried-forward annual losses could be earned for certain activity after January 1, 2018, and the tax value is estimated by multiplying the amount of carried-forward annual losses by the statutory 35% tax rate.” Carried-forward credits can be applied to future tax liabilities.

As the following chart demonstrates, the balance of those carried-forward credits is projected to build substantially over the coming decade. While the balance begins to decline after FY2030, the reductions are at a relatively slow pace. The balance at the end of the period ($2.304 billion) is still more than five and a quarter times greater than the level of production taxes actually collected for the same year ($429 million). The impact on production taxes from those carried-forward credits alone will remain significant throughout the remainder of the 2030s.

And that only accounts for the expenditures projected by DOR at the time of its preparation of the Spring 2025 Forecast. Additional drilling announced since that date, such as ConocoPhillips' recent announcement of further drilling in NPRA, or other responses to the Trump Administration’s ‘drill, baby, drill” initiatives, are not reflected in the numbers. Assuming they are made by a current taxpayer - such as those being made by Conoco - or result in future production - such as expansions made by Santos and Repsol in the Pikka field - they will only add to deductions and credits available to offset future production tax obligations.

In the past, production taxes have comprised a significant share of Alaska’s revenue stream, and, particularly with rising production levels, they have the potential not only to continue doing so but also to increase their level of contribution in the future. Among other things, realizing this potential could significantly reduce the deficits the state is currently running, which are creating heavy dependence on personal taxes that hit middle- and lower-income Alaska families hardest.

However, to realize that potential, legislators must urgently address Alaska’s broken oil tax regime. Otherwise, legislators will find that the result of “drill, baby, drill” is that Alaska not only continues to fall further and further into its already deep near-term fiscal sinkhole, but that the sinkhole persists well into the future as accumulated and ongoing deductions and credits continue to significantly reduce production tax obligations.