A surprising loophole in Alaska's oil tax law allows companies losing money in certain circumstances to cover more than 100 percent of their losses with a state cash rebate.

While this appears to have happened only once or twice so far and the amounts are kept secret under state law, it turns out a company can lose $1 and collect more than $1 from the state under particular combinations of price and cost on so-called "new oil" that qualifies for favorable tax treatment, according to testimony before the House Resources Committee.

Closing this loophole is one of several provisions in a bill proposed by Gov. Bill Walker to trim state cash outlays by $400 million on tax credits and raise oil taxes by $100 million, a response to the state's fiscal crisis. Companies would still be able to claim a net operating loss credit, but the system would no longer artificially inflate the loss and the size of the state refund.

Three points come to mind. First, this was an unintended consequence of Senate Bill 21, a complicated law with many moving parts and provisions. Second, the companies using this benefit are following the law as written. Third, a correction is in order to limit the credit to 35 percent of net losses.

The law requires secrecy and the only details released to the public about how this has worked are in a statement by Caelus, a privately held company funded by Apollo Global Management. Caelus is spending about $300 million in oil exploration and development on the North Slope, with 70 employees and 400 contract workers. It expects to produce a little more than four million barrels of oil this year, Vice President Pat Foley told the committee.

Foley said removing the inflated credit that grows out of the "gross value reduction" would reduce the worth of the Caelus business by 13 percent at these low oil prices. What he did not say is that without a big increase in oil prices, few projects on the North Slope will have strong economics, with or without state subsidies.

Foley sees the inflated credit as a part of the oil tax law, not as a loophole.

"So right now I can take GVR (gross value reduction) and I can use that to actually increase my net operating loss. There are those who will say that was an unintended consequence. They'll say that was not the intention and they'd like to correct that. I can say we have reviewed the current law. We make business decisions based on the current law. All of our modeling assumes that GVR can be used to take our net operating loss lower. And if that is eliminated, the value of my business is eroded by 13 percent," he said. "So if I'm worth a dollar today, if that element of House Bill 247 is passed, I'm worth 87 cents."

Janak Mayer, a consultant for the Legislature going back to the period when Senate Bill 21 was under consideration, said he was "shocked and surprised" when he first heard about the inflated credit, which he didn't realize could take place. But he said that once he checked the models, he found that the series of calculations called for in SB 21 provide for the inflated credit in specific situations.

Mayer, chairman and chief technologist of Enalytica, a consulting firm with a $400,000 contract with the Legislative Budget and Audit Committee, said any company assessing the economics of an oil project does it based on the law, "not necessarily on the basis of legislative intent."

Homer Rep. Paul Seaton said that since the consultants hired by the Parnell administration and the Legislature during the SB 21 debate did not notice this quirk and because no oil company testified about it, it would be natural for the industry to expect that the state will want to modify the law.

"I don't think they would be surprised if we came back and assessed the system that we thought we were passing at the time," Seaton said.

Anchorage Rep. Mike Hawker, chairman of the Legislative Budget and Audit Committee, said the law "very, very clearly states" that the credit is available, but he acknowledged a "problematic value translation."

"No matter what we have written, does not both we and industry have a reasonable expectation that they will comply with the law as it's written?" Hawker asked Mayer during a resources meeting.

"Absolutely," Mayer said.

"Any way we look at it, even if we think we're fixing something, a mistake we made, from the standpoint of the people that we're asking to rely on our statute, isn't it still a tax increase?" Hawker asked.

"Absolutely it is, without question," Mayer said.

It would be more accurate to call it a reduction in state credits, not a tax increase.

The oil industry "has made investment decisions based on the system as it is, not as it might have been in an ideal world," Mayer said.

We don't live in an ideal world, but given the fiscal crisis facing Alaska, it absolutely makes sense to fix the loophole on net operating loss credits.