EX-4.5



 




Exhibit
4.5




			
	bp
	 	






	 	 	 
	Maureen L. Johnson
	 	 
	BPXA Senior Vice President

	 	BP Exploration (Alaska) Inc.
	Greater Prudhoe Bay

	 	900 E. Benson Boulevard
	 

	 	Anchorage, Alaska 99508
	 
	 	 
	 

	 	Tel: (907) 564 5671
	 

	 	Fax: (907) 564 5000
	 

	 	Email: johnsml@bp.com






VIA OVERNIGHT MAIL &

AS A SCANNED ATTACHMENT TO E-MAIL




October 11, 2006




Ms. Ming J. Ryan, Vice President

The Bank of New York

101 Barclay Street

New York, NY 10286




     Re: BP Prudhoe Bay Royalty Trust



Dear Ms. Ryan:



This is to confirm the consensus principles that have been developed with The Bank of
New York (“Bank”), as Trustee of the BP Prudhoe Bay Royalty Trust (“Trust”), for
applying the Alaska oil and gas production tax (“New Tax”), as amended by chapter 2,
Third Special Session Laws of Alaska 2006 (“Act”), in the context of the Overriding
Royalty Conveyance (“Conveyance”) and the overriding royalty interest (“ORRI”)
thereunder that is owned by the Trust. These principles would resolve the two major
issues presented by the Act: one, how the amount of New Tax chargeable against the
ORRI will be determined under the Conveyance; and two, the extent, if any, to which the
retroactivity of the New Tax under the Act is to be recognized for purposes of the
Conveyance.



We understand the consensus principles to be the following:





	 	1.	 	Calculation of the amount of New Tax chargeable against
the ORRI. The amount
of New Tax chargeable against the Trust’s ORRI under the Conveyance will be
determined as follows:






	 	a)	 	The taxable value per barrel equals the WTI Price determined under
Section 4.3 of the conveyance,1 minus the Chargeable Costs under
Section 4.4 as adjusted by the Cost Adjustment Factor under Section 4.5.







 




			
	1	 	All references herein to a “Section” with a capital “S” refer to the corresponding section of the Conveyance unless otherwise specifically noted.




 









 










Ms. Ming J. Ryan, Vice President

The Bank of New York

October 11, 2006

Page 2





	 	b)	 	The tax rate for the “progressivity” portion of the
New Tax under section 011(g),
enacted by § 5 of the Act, in chapter 55 of Title
43 of the Alaska Statutes2 equals 0.25 percentage points times the amount by which
the simple average for each calendar month of the daily taxable values per barrel
under “a)” above exceeds $40 per barrel. If that average taxable value per barrel is
$40 or less, the “progressivity” rate is zero. The $40 figure is not subject to
adjustment over time.
	 
	 	c)	 	The amount of New Tax chargeable against the ORRI equals the taxable value per
barrel under “a)” above times the Royalty Production as defined in Article One of the
Conveyance, times a rate equal to the sum of 22.5% plus the “progressivity” rate
determined under “b)” above.






	 	2.	 	Retroactivity of the New Tax. The tax chargeable against the ORRI under Section
4.6 for Prudhoe Bay oil produced during the period from April 1 to August
19, 2006, inclusive, is the amount of Old Tax as calculated under Section 4.6 for that
production. For Prudhoe Bay oil produced on August 20, 2006 and thereafter, the tax
chargeable against the ORRI under Section 4.6 is the amount of New Tax determined as
prescribed in “1.” above for that production. The “progressivity”
rate under the New Tax for August 2006 will be calculated under “1.b)” above using the
average of the daily WTI Prices under Section 4.3 of the Conveyance for August 20 — 31, 2006, inclusive.3




BP Exploration (Alaska) Inc. (“BPXA”), as Grantor of the Trust, agrees to these
principles, not only because they represent the best interpretation of the Conveyance in light of
the Act, but also because they offer the most reasonable and fair resolution of the issues for all
interested parties, including the holders of beneficial Units in the Trust. These principles also
preserve the historical nature and perception of those Units by investors on the New York Stock
Exchange and in other markets where the Units may be bought and sold.



Assuming the Bank agrees to and approves the consensus principles set out above, we believe it is
important, for those who will be implementing the terms of this agreement in the future, that BPXA
explain and document within this letter why we (and, we believe, the Bank as well) view this
agreement as the optimal outcome.



With respect to the computation of the amount of New Tax chargeable against the ORRI under
Section 4.6 of the Conveyance, we believe the agreement reflects the best of the identified
alternatives available for each of the significant aspects of this major issue. Significant among
those aspects are the following:






 




			
	2	 	Cited as “AS 43.55.011(g)”.
	 
	3	 	Governor Frank Murkowski signed the Act into law on August 19, 2006. Pursuant to
AS 01.10.070(c), the Act took effect August 20, the day after the governor signed it.




 









 











Ms. Ming J. Ryan, Vice President

The Bank of New York

October 11, 2006

Page 3





	 	A.	 	Determination of the taxable value under the New Tax for purposes of the Conveyance






The actual taxable value under the New Tax is calculated by starting with the spot price
for Alaska North Slope crude oil (“ANS”) delivered on the U.S. West Coast, and subtracting
from that spot price the actual costs of transportation to the West Coast from the “point of
production” at the field.4 From this “field value” are then subtracted the capital and
operating expenditures incurred in the course of operating, developing and producing the
field, and the result is the taxable “production tax value” (“PTV”).5




None of these tax values and tax-deductible costs appears in the Conveyance. Even for the
prior version (“Old Tax”) of Alaska’s oil and gas production tax — which was based on
the same value of oil at its “point of production” 6 — the Conveyance did not
calculate the amount of Old Tax chargeable against the ORRI on the basis of the ANS
spot prices and actual transportation costs being used to calculate the amount of the real
tax. Instead, Section 4.6 called for the use of the WTI Price under Section 4.3 and the use of
flat $4.50/barrel (adjusted by the Cost Adjustment Factor under Section 4.5) as proxies for the
actual ANS West Coast spot prices and transportation costs under the Old Tax. This
allowed the chargeable Old Tax to be a function of WTI Price the same as the ORRI itself (see
“C.” below at pp. 6-7).




Since taxable value under the New Tax is simply the taxable value at the
“point of production” under the Old Tax minus field
expenditures, it is reasonable7 to
continue to use the methodology under Section 4.6 to find the value at the “point of production” for the New Tax that was used for the Old Tax. This leaves the question of what to use
as the deductible field expenditures in computing the chargeable New Tax under the Conveyance.





 




			
	4	 	The “point of production” for ANS is the custody transfer meters from the
field facilities into the facilities of the oil pipeline serving the field from which the oil
is produced. See AS 43.55.900(27)(A), enacted in § 33 of the Act.
	 
	5	 	See AS 43.55.160(a) (defining “production tax value) and AS 43.55.165
— 43.55.170 (defining deductible field expenditures), both enacted by
§ 25 of the Act.
	 
	6	 	See section 900(a)(6)(A) of chapter 55 in Title 15 of the Alaska
Administrative Code (Register 165, April 2003) (defining “point of production” for oil).
This regulation is cited as 15 AAC 55.900(a)(6)(A).
	 
	7	 	It seems the Conveyance requires the Section 4.6 methodology to continue to be used
for the New Tax. Section 4.6 says in part, “In the case of taxes based upon well
head or field value, WTI Price less the product of $4.50 times the Cost Adjustment Factor
shall be deemed to be the wellhead or field value.” The New Tax uses the same value at the
“point of production” as the Old Tax, and thus the WTI Price minus $4.50 (adjusted) “shall be
deemed to be” that value. It is unlikely that the New Tax is not “based upon” that “field value” simply because field expenditures are
deducted from it: those deductions mean the New Tax is not levied directly upon that “field
value”, but it seems a stretch to say that the effect of those deductions means the New Tax is
not “based upon” — in the sense of being derived from — that same
“field value”.




 









 










Ms. Ming J. Ryan, Vice President

The Bank of New York

October 11, 2006

Page 4





Two alternatives readily present themselves. One is to use the same field
expenditures that BPXA will report for Prudhoe Bay under the New Tax. There are several
drawbacks to this. For one thing, the field expenditures to be reported each month are
estimates based on what the total deductible expenditures will be for the entire calendar year.
Before the year ends it is impossible to know what the actual total expenditures will come to.
The New Tax calls for a final reconciliation, by March 31 of the following year,
of each month’s estimated deductible expenditures to the actual total expenditures for the
year.8 This estimation and reconciliation process will mean one or more restatements of the
lease expenditures deducted in calculating the New Tax chargeable against the ORRI. Owners of
beneficial Units in the Trust will have to be provided explanations of the changes each time
such a restatement is made. In addition, in the course of these estimates and subsequent
adjustments some Units will change hands, either to the advantage of the seller and
disadvantage of the buyer, or vice versa, depending on whether the adjustments increase or
decrease the amount of New Tax chargeable against the ORRI. Although Sections 3.2
and 3.3 address over- and under-payments of ORRI, they do so as an issue between the Trust
and Grantor in order to keep them whole in light of the time-value of money, rather than
addressing the issue of disparities between holders of Units in the Trust at different times
relative to the times when adjustments are made for over- or under-payments. 9




Moreover, basing the chargeable New Tax on field expenditures actually deducted would
introduce a new parameter into the calculation of the ORRI payments to the Trust
and distributed to the beneficial Unit owners — the budget decisions of the
working-interest owners in the Prudhoe Bay field. Unlike WTI spot prices, which Trust Unit
owners can estimate for themselves, the Prudhoe Bay budget is something that the
working-interest owners determine annually on the basis of the opportunities and economic
conditions prevailing at that time, and even if they could be reliably predicted in advance,
those budgets are not public information in any event. Thus, using actual field expenditures
would introduce an element into the ORRI-payment equation that Trust Unit holders would
generally know almost nothing about. But that new parameter would affect the Unit holders in
two ways: changing the taxable





 




			
	8	 	See AS 43.55.030, as amended by §§ 19 and 20 of the Act.
	 
	9	 	When over- and under-payments are rare, as they have been historically in the
operation of the Conveyance, such disparities among Trust Unit holders may be ignored as too
infrequent to be a material concern for investors in the Trust Units. But if over- and
under-payments are to become frequent, if not regular, occurrences — as they would
if actual field expenditures reported for tax purposes were used to calculate the New Tax
chargeable against the ORRI — then the disparities will become endemic, if not
systemic, and should be addressed. But resolving them would not be easy. Either recent buyers
of Trust Units would end up paying for the recoupment of overpaid ORRI when the estimated
field expenditures turn out to have been too high and the resulting chargeable New Tax
too low, or the overpaid ORRI would have to be recovered from the former Unit owners who
shared in that payment. Either way, potential investors in Trust Units could object. The
consensus principles avoid these difficulties by minimizing the potential for over- or
under-payments to occur.




 









 










Ms. Ming J. Ryan, Vice President

The Bank of New York

October 11, 2006

Page 5





value upon which the New Tax is based, and changing the rate of “progressivity” if that
taxable value is greater than $40/barrel.




The alternative to using the actual field expenditures would be to use a proxy or
surrogate for the actual expenditures, most preferably something already in the Conveyance. As
it turns out, there is such a potential proxy. For all but the years 1989  —  1991,
the figures for annual Chargeable Costs per barrel appearing in the table in Section 4.4 are
greater than the $4.50/barrel being used as a proxy for transportation costs in determining the
“field value” under Section 4.6. Logically, to the extent the tabulated Chargeable Costs for a
year are greater than $4.50/barrel, that excess cannot be for any costs between the “point of
production” and the West Coast since the $4.50 allowance already covers those costs. Thus, the
only thing remaining that the Chargeable Cost in excess of $4.50 might be for is costs incurred
upstream of the “point of production” — that is, costs incurred in the operation of
the field.




This idea that part of the annual Chargeable Costs figures set out in Section 4.4 could be
for upstream costs is supported by the fact that Section 4.4(a) — (c) provides for
reductions to the tabulated Chargeable Cost figures if certain additions to Proved Reserves
fail to be made by their respective deadlines. Obviously, to add to Proved Reserves as
contemplated in Section 4.4 would (and did) require the new investment of considerable sums of
money as well as increased costs for operating those new investments. The “excess” Chargeable
Costs figures beyond $4.50 could well be seen as a recognition of and response to those
significant new investments and expenses.




For 2006 the Chargeable Costs figure tabulated in Section 4.4 is $12.50, which after
adjustment by the Cost Adjustment Factor for the Third Quarter is
$19.63/barrel. Our current
estimate of the 2006 operating and capital expenditures for Prudhoe Bay Unit operations, of
which the initial participating areas are the largest part, and for transportation of Prudhoe
Bay oil is $16 — $17 per barrel. Thus, using the adjusted Chargeable Costs for this
year would result in less New Tax being charged against the ORRI than using our actual
transportation and field-operation costs.




It must be acknowledged that the adjusted Chargeable Costs in the future may not always be
greater than the actual field expenditures that BPXA would be deducting in computing its actual
New Tax for the Prudhoe Bay field. In fact, we believe there is a significant possibility that
in some years the adjusted Chargeable Costs would be less than BPXA’s actual Prudhoe Bay field
expenditures, and in that event, the amount of New Tax chargeable against the ORRI under the
present agreement would be greater than the actual New Tax being paid, and hence the ORRI
payment would be less than it would have been using the actual field costs incurred. Whether
this would happen, and if so, when or how often it might happen, would depend on future
circumstances at that time10 that cannot be predicted now.





 




			
	10	 	Such circumstances might include (without being limited to) estimated
capital and operating costs of particular new projects; expectations about then-future oil and gas price trends;
whether and when the commercial development of natural gas on the North Slope might occur and
its associated transportation






 










 





Ms. Ming J. Ryan, Vice President

The Bank of New York

October 11, 2006

Page 6





	 	B.	 	Determining the “progressivity” rate in the New Tax






“Progressivity” is a function of the extent to which the taxable PTV value of oil is
greater than $40/barrel. The discussion just concluded above about determining the PTV value
for calculating the amount of New Tax to be charged against the ORRI also applies here. The
certainty in determining the taxable value that is gained by using adjusted Chargeable Costs as
a proxy for actual transportation costs and field expenditures is matched by a similar
certainty with respect to the “progressivity” rate. In other words, while the actual costs will
be subject to the annual reconciliation by March 31 of the following year, the amount of the
Chargeable Costs will be known at the time the ORRI payments are made to the Trust, and there
will be nothing further for them to be reconciled to.




The use of a monthly average of WTI Prices to calculate a monthly “progressivity” rate,
instead of calculating and applying a daily “progressivity” rate, is how that rate is required
to be calculated under AS 43.55.011(g). The use of such a monthly “progressivity” rate,
instead of a daily rate, to compute the daily ORRI amount net of chargeable New Tax is not
inconsistent with Section 4.1.




“Progressivity” is a function of the extent to which the taxable PTV value of oil is
greater than $40/barrel. The discussion contained in paragraph “A.” above about determining
the PTV value for calculating the amount of New Tax to be charged against the ORRI also
applies here. The certainty in determining the taxable value that is gained by using adjusted
Chargeable Costs as a proxy for actual transportation costs and field expenditures is matched
by a similar certainty with respect to the “progressivity” rate. In other words,
while the actual costs will be subject to the annual reconciliation by March 31 of
the following year, the amount of the Chargeable Costs will be known at the time the ORRI
payments are made to the Trust, and there will be nothing further for them to be reconciled
to.




	 	C.	 	Preserving the perceived nature of the Trust Units in the market






We believe that since the Trust Units were first publicly offered, they have been
perceived by many in the market as a means for them to make an investment reflecting their
expectations about oil price trends. This is because the only variables affecting the amount
of the ORRI payments to the Trust have been the spot price for WTI and one’s expectations
about the rate of inflation in the future as reflected in the Cost Adjustment Factor. All the
other factors in the calculation are fixed under the Conveyance, and it has been possible to
compute what the ORRI payment as far into the future as one might want, just on the basis of
one’s assumptions about WTI prices


 




infrastructure to market be built; technical and
economic success in developing and applying new technology, and using existing technology in
new ways, to produce viscous crude oil; and the willingness of other working-interest owners
of the Prudhoe Bay field to commit to such investments and expenditures.





 









 








Ms. Ming J. Ryan, Vice President

The Bank of New York

October 11, 2006

Page 7





and inflation. 11




This perception of the Trust Units will be maintained under the agreement. As before,
the factors affecting the amount of future ORRI payments are future WTI prices, future
inflation, and the volume of oil production subject to the ORRI. 11




	 	D.	 	Certainty






The agreement avoids uncertainties about the amount of ORRI payments under the New Tax. The
WTI prices and adjusted Chargeable Costs will be definitively known under this agreement before the
ORRI payments are made to the Trust. Apart from error, there will be no occasion or necessity to
recompute any of the variable parameters affecting the calculation of the ORRI payments. This will
be very different from the actual administration of the New Tax itself.




In addition to the foregoing considerations about how the New Tax is to be applied
for purposes of the Conveyance, the other major issue regarding the enactment of the New Tax is its
retroactivity under the Act, which makes the New Tax applicable to oil and gas
production beginning April 1, 2006. In this regard we acknowledge, as representatives of
the Bank have pointed out, that Section 4.1 provides in pertinent part:


The
Royalty Interest entitles Grantee to receive ... for each calendar
quarter ... the sum of the product for each day in such quarter of (1) the Royalty Production
and (2) the Per Barrel Royalty .... [Emphasis added]





We agree that this calls for a daily calculation of a “product” that is, in effect, a
calculation under the Conveyance of the contractual amount of the ORRI payment obligation arising
for each respective day during a given calendar quarter.




With respect to the retroactivity of the New Tax, therefore, the amount of tax chargeable
against the ORRI was determined contractually under Section 4.6 on the basis of the Alaska tax law
in effect in real time on each day beginning April 1st of this year. Thus, when the Act came into
effect on August 20th and thereupon became retroactive to
April 1st, the contractual amounts of
“daily” chargeable tax under Section 4.6 had already been determined for the days prior to August
20, and those determinations had been made on the basis of the Old Tax. The Act does not purport to
alter the contractual obligations arising under the Conveyance prior to August 20 when the Act came
into effect, and even if it did, it could not alter them under the Impairment of Contracts clauses
of the United





 




			
	11	 	Until the third quarter of 2006, the volume of oil being produced had
never varied as a factor in the computation of the ORRI payment. For the first time it
will be a factor affecting the amount of the payment that is about to be made for the Third
Quarter of 2006. As a result, anyone computing the amount of the ORRI payment in the future will
need to make an explicit assumption about the volume of production subject
to the ORRI.




 









 








Ms. Ming J. Ryan, Vice President

The Bank of New York

October 11, 2006

Page 8



States and
Alaska constitutions. 12



We concur with the view expressed by the Bank’s representatives that the foregoing analysis
regarding the Act’s retroactivity in the context of the Conveyance represents the best
interpretation of the Conveyance and the most defensible position on this issue of retroactivity.



Accordingly, when the New Tax did become applicable and chargeable against the ORRI beginning
August 20th, the most appropriate and fairest way to apply the “progressivity” portion of the New
Tax is to treat the period of August 20 — 31, when the New Tax was applicable, as a
“month” for purposes of determining the “progressivity” rate. If the chargeable tax for
the days in August before the 20th was indeed contractually determined in real
time each day under the Old Tax, then when the New Tax becomes applicable on the 20th,
those prior days in August do not exist for purposes of the calculating the amount of New Tax
chargeable against the ORRI, and the effect is the same as if Prudhoe Bay were first coming into
production on that date. It would be inconsistent to include those prior August days for purposes
of computing the “progressivity” rate for the portion of August when the New Tax is chargeable.



I am signing and mailing to you two counterpart originals of this letter. If the
statement of our understanding of the consensus principles, appearing on pp. 1-2 of this letter,
does indeed accurately state the Bank’s understanding of and agreement with them, please have a
duly authorized officer of the Bank execute the “AGREEMENT AND APPROVAL” appearing below on behalf
of the Bank in each counterpart, and then kindly send one fully executed counterpart original back
to me for BPXA’s records. The other will be for the Bank’s records. As an interim confirmation
pending my receipt of the original counterpart, I would ask you to email a scanned copy
of it to Mark Dennehy, who has been in direct contact with you previously regarding this matter.



BPXA believes the understanding and agreement to the consensus principles as outlined in this
letter is a fair and reasonable resolution to the issues raised by applying the New Tax in the
context of the Conveyance. However, it is recognized there may be issues outside the matters
contained in this letter affecting the Trust Unit holders’ and BPXA’s interests. This letter and
the understanding of and agreement to the consensus principles between the Bank, as Trustee, and
BPXA, are not intended to waive any other rights, obligations or remedies available to them under
law or the BP Prudhoe Bay Trust. Further, in the event of future amendments or changes to Alaska’s
oil and gas production tax laws, or should the understanding of and agreement to the consensus
principles on pp. 1-2 be invalidated by operation of law or by a court of competent
jurisdiction, BPXA and






 




			
	12	 	Article I, section 10, clause 1, United States
Constitution; Article I, section 15, Alaska State Constitution.




 









 










Ms. Ming J. Ryan, Vice President

The Bank of New York

October 11, 2006

Page 9



the Bank, as Trustee, expressly agree to reserve all rights, powers and remedies, they may
have available to them under law or the BP Prudhoe Bay Royalty Trust.



On behalf of BPXA, I should like to take this opportunity to express our thanks and
appreciation to the Bank and its representatives for the attention and constructive cooperation
shown in seeking and achieving a resolution to these issues that is reasonable and fair from all
perspectives for those concerned.




	 	 	 	 	 
	 	Very truly yours,

BP Exploration (Alaska) Inc.

 	 
	 	

 	 
	 	Maureen L. Johnson 	 
	 	BPXA Senior Vice President

Greater Prudhoe Bay 	 
	 


AGREEMENT AND APPROVAL I, the undersigned, certify that I am an officer
of The Bank of New York (“Bank”) duly authorized to execute this AGREEMENT AND APPROVAL, and in
such capacity, I hereby acknowledge that the consensus principles have been accurately and fully
set forth on pages 1 - 2 of the foregoing letter, and do agree to and approve those
principles on behalf of the Bank, as Trustee of the BP Prudhoe Bay Royalty Trust.




	 	 	 	 	 
	 	
The Bank of New York


Trustee of the BP Prudhoe Bay Royalty Trust

 	 
	 	By 	
 	 
	 	Name 	 MING J. RYAN
	 	Title 	 VICE PRESIDENT
	 	Date 	10/13/06