1. Oil and Gas Properties Drilling Rigs Pipelines General Business Assets
LAA Rebuttal Hearing Comments LTC Rules and Regulations Tax Year 2017 Chapters 3, 9, 11, 13, and 25
Hearing Date:
August 10, 2016
Oil and Gas Properties
Drilling Rigs
Pipelines
General Business Assets

2. OPENING REMARKS

3. PROPERTY TAX AND LOCAL AUTONOMY Lincoln Institute of Land Policy
Excerpts from
PROPERTY TAX AND LOCAL AUTONOMY
Lincoln Institute of Land Policy

4. The property tax is the most efficient and effective means for raising revenue to fund local government services. No other sources of revenue can ensure local government autonomy. And such autonomy has been a critical factor in American government since the beginning of the republic.

5. It remains the most sensible way of financing local services, including elementary and secondary education (until recent years a decidedly local government function). Yet the political pressures on the property tax proceed unabated.

6. Understanding the consequences of a diminished property tax system is critical to setting state and local policy in the twenty-first century.

7. If, in fact, the property tax continues to play a reduced role, local governments will be forced to rely even more heavily on state political institutions. If that happens, the overall system will likely be less efficient and less politically responsive.

8. CHAPTER 9 Oil and Gas Properties

9. Issue #1: The oil and gas business is cyclical.
Volatile swings in annual revenue and expense are normal and expected, although the direction is often unpredictable.
LTC’s adoptions for RCN since tax year 2008 began falling way behind actual rise in cost after CY2004.
A 45% reduction for RCN is not warranted primarily because the LTC’s tables 907.A-1, 2, and 3 are still substantially below cost per API JAS data.

10. Percent that LTC’s RCN Tables are Below Actual

11. API Data is Perfect for LTC Use
Please see LAA Supporting Documentation, “UNDERSTANDING THE JAS DATA” (page 5, 3rd paragraph).
The portions of the API JAS report used by LAA covers more than 90% of all wells drilled.
Over 46k wells were drilled in U.S. in 2014.
Less than 4000 wells were not reported to API.
Over 42k wells were reported to API.
API uses estimated cost data only in their Executive Summary which LAA does not use.

12. Issue #2: Property tax is not an income tax, regardless of valuation approach.
LOGA’s “percent of gross revenue” metric is unworkable and inappropriate, changing the basis of tax from value (“ad valorem”) to income.
Income (either gross or net) swings more than value. Oil and gas investors look at more than one year’s income by itself.
The percent varies over the years because of normal production profiles (fairly predictable) and price swings (notoriously unpredictable).

13. Flaws in LOGA’s Exhibit 5 (Examples of Louisiana Horizontal Well Assessments)
Examples given represent marginal end of production for given depth interval and horizontal status.
Gross revenue projections fail to consider or include any secondary production stream (condensate for gas wells, casinghead gas for oil wells).
The analysis should have covered entire life cycle of well to support LOGA’s assertion the LTC shouldn’t adopt 100% of RCN.

14. LAA’s 2017 Proposal
Shape of curve represents “grand bargain” underlying Louisiana’s tax methodology.
Typical beginning production levels for region and depth.

15. Example calculation for new Caddo Parish well (horizontal well with extended lateral)
Louisiana

16. Example calculation for new Caddo Parish well (horizontal well with extended lateral)
Texas

17. Comparison between states is fraught with peril.
Difficult and highly complex because each state employs a different combination of taxes with different tax bases and different tax rates.
Corporate income (or franchise) tax
Severance (production) tax
Property tax
Sales tax
These taxes often interact with each other, by legislative design.
Various deductions, exemptions, credits based on age, production level, and price

18. Texas: Property tax is reserve-based and uses an income approach for the subject mineral interest.
Discounted cashflow based on forecasts of production, price, and expense.
The value of leasehold equipment is de minimis, by design.
A property’s ad valorem tax burden as a percent of gross revenue is not a direct appraisal consideration, although it’s often estimated to be ~5% (many royalty owners withhold one month’s paycheck, or ~8.3% of annual income, as a “rule of thumb”).

19. Arkansas: Bifurcated methodology, oil vs
Arkansas: Bifurcated methodology, oil vs. gas, for valuation of mineral interests using heavily modified income approaches.
Assessed value is equal to less than one year’s net income.
No additional valuation of leasehold equipment.

20. Kansas: Property tax is reserve-based and uses a very unique income approach focused on a detailed and prescribed “payout” methodology for the subject mineral interest.
Much like Texas, the value of leasehold equipment is de minimis, by design.
The resulting property tax burden as a percent of gross revenue is not a direct appraisal consideration.
A 100% exemption applies to oil wells producing at very marginal levels (3-5 bbls per day, depending on depth), or any wells not capable of producing in economic quantities.
A 40% reduction applies to any portion of the prescribed January 1 value attributable to wells that are less than 6 months old.
A 30% assessment ratio applies to this whole category (25% if production is very marginal).

21. Conclusion:
There is no meaningful way to equate or correlate Louisiana’s property tax rules in Chapter 9 with methodologies used in other states.
Different property being appraised
Cost Approach vs. Income Approach (differences in how EO is handled)
Other considerations such as targeted exemptions, credits against other types of taxes, etc.

22. End of LAA Rebuttal for Chapter 9

23. CHAPTER 11 Drilling Rigs and Related Equipment

24. Issue #1: Offshore Rigs (Tables 1103.B and 1103.C)
The market for overwater jack-up rigs and semi-submersible rigs is not as fluid as for onshore rigs.
Very long lead-times for bringing fields online
Extremely large investments required
Barriers to entry quite high (competitive pressures to lower day rates are not as prevalent as for onshore drilling and completion activities)
Values are more stable and can be reliably trended with M&S “Petroleum” industry data.

25. End of LAA Rebuttal for Chapter 11

26. CHAPTER 13 Pipelines

27. Issue #1: Resulting Curve Fit of RCN Cost Data from OGJ
OGJ data used by LAA represents pipelines constructed in Louisiana, whereas MVS data recommended by PTP covers 20 states.
PTP proposal will change the curve fit and result in increases in RCN for all smaller- diameter pipelines.

28. Curve-Fitting Basics y-axis x-axis
Some points end up above the curve, some below.
Small RCN
Large RCN
y-axis
$/mile cost increases with increasing diameter size.
Small Diameter
Large Diameter
x-axis

30. Issue #2: Outliers in the OGJ Database?
For 42” diameter size, the OGJ database is evenly split with some pipelines’ cost “below the norm” and some above.
PTP focuses only on the “high” data points. A uniform level of scrutiny must be exerted on all data points before deciding to delete individual points.
Every data point can potentially be deemed as not fitting the norm – because “nothing fits the norm.”
PTP’s attack similar to “equity-based” challenges of appraisals where the highs in the database are continually thrown out as non-representative of the subject property. But every time the high point is removed, some remaining point becomes the NEW high, so then it can or should be removed too. And so on, and so on…

31. Issue #3: Depreciable Life
Current Rules promulgate use of Marshall & Swift’s “Life Expectancy Guidelines” and “Depreciation – Fixtures and Equipment” tables.
Vast majority of lives shown in M&S table are from IRS federal income tax tables.
 Modified and accelerated depreciation highly inappropriate for FMV calculations.
Per Marshall & Swift instructions, depreciation considerations should be based on property’s effective age, which can be either newer or older than actual age.

32. Summary of Depreciable Life Estimates:
Indicator
Life (yrs)
Recent Accounting
35.0
P&A Clients (Tx)
32.2
Marshall & Swift
34.5
Average
33.9

33. Issue #4: Throughput Formula Is Not A “Cure-All” for Measuring EO
Assessors have difficult if not impossible task of verifying both input parameters in the formula: Throughput and Capacity of the pipeline.
Formula equates the level of use with profitability  Not always true!
Rules do not prohibit the use of a throughput (“inutility”) formula by an assessor.

34. Income Shortfall Method Economic Obsolescence
Of Measuring
Economic Obsolescence

35. Economic Munificence (Obsolescence) Calculations
Projected AFIT NOI from Plant in Service (excludes CWIP)
$34,880,000
RCNLD Plus Oil Inventory and M&S, Less CWIP
$326,159,449
Indicated Rate of Return
10.69%
Avg Rate of Return, Prev 5 Years (AFIT and RCN Basis)
9.85%
Avg Rate of Return, Prev 3 Years (AFIT and RCN Basis)
8.95%
Avg Rate of Return, Prev 5 Years Excluding Min & Max
10.87%
Median Rate of Return, Prev 5 Years (AFIT and RCN Basis)
9.92%
Projected Typical Rate of Return
10.50%
Required Rate of Return from Cap Rate Study
11.75%
ROR “Shortfall” (projected vs. required)
-1.25%
Munificence (+), or Obsolescence (-)
-10.64% =
Say

38. End of LAA Rebuttal for Chapter 13

39. CHAPTER 25 General Business Assets

40. Issue #1: More Delay Needed?
Salt dome cavern property being used for brining purposes is largely indistinguishable from similar property being used for storage purposes.
There are many brine wells and caverns in Louisiana (more than half?) already being assessed under Chapter 25 provisions.
Potential non-uniformity issue results with appraisal of only some salt dome cavern property under Chapter 9 provisions.
LAA has met with LCA several times this year.

41. Issue #2: Solution Mining (Brine) Wells are Not Oil, Gas, or Service Wells
Chapter 9 is entirely wrong chapter for appraisal of salt dome brine wells.
RCN tables are built with API costs for oil and gas wells. No injection wells of any kind are included in these costs.
Brine wells are typically constructed with much larger diameters of casing strings and therefore have much higher RCN.
Solution mining wells are NOT service wells as contemplated by Chapter 9.

42. Issue #3: LTC’s Previous Rulings
The Jefferson Island case (Iberia Parish) was exclusively about salt dome hydrocarbon storage caverns and associated injection wells. No appraisal of solution mining wells was under LTC consideration.
The LTC’s ruling did not speak to the merits of any party’s appraisal, but instead chose to dismiss the P&A appraisal on a technicality (cleared up later by legislation that clarified the legitimacy of P&A’s involvement).

43. In the PBGS v. Duplechain case (St
In the PBGS v. Duplechain case (St. Landry Parish), the LTC ruled that the service wells (not the cavern wells) should be appraised using Chapter 9.
The service wells in question disposed offsite the brine caused by the leaching process.
St. Landry did not appeal the LTC’s ruling concerning the service wells.
Leaching a cavern for eventual storage purposes is exactly the same process as solution (brine) mining, just accelerated. A salt dome cavern is still the result, which might or might not have any value.

44. End of LAA Rebuttal for Chapter 25