Energy Tax Hikes, Impacts and the Great White Whale

Mark Green
Posted November 22, 2013

Today we offer three charts – all associated with the latest congressional bid to raise revenue for the federal government by hiking taxes on oil and natural gas companies.

U.S. Sen. Max Baucus has proposed delaying industry’s ability to write off intangible drilling costs (IDCs) and doing away with the “last-in, last-out” accounting method (LIFO) used by a number of energy companies. More on LIFO below. Here are three charts from Wood Mackenzie’s recent study on the impacts of delaying IDC deductions.

This one goes up …

… but an increase in the number of wells not drilled wouldn’t be good for our country’s energy picture. Wood Mackenzie estimates delaying the deductibility of IDCs – including wages, fuel, repairs and other expenses in drilling a well or preparing it for production that can range between 60 and 90 percent of the total cost of a well – could cause a loss of 15 percent to 20 percent of U.S. annual drilling. The study projects that at least 8,000 wells per year would not be drilled from 2018 forward.

A second chart. This one levels off and goes down:

Here we see the impact of delayed IDC deductions on oil and natural gas production (blue) compared to production otherwise (orange). Wood Mackenzie estimates that by 2023 this would result in a loss of 3.8 million barrels of oil equivalent per day from U.S. oil and natural gas fields.

Now the third chart:

This one shows another negative impact of delaying IDC deductions: lost jobs. Wood Mackenzie says these will reach 233,000 by 2019. These are real impacts that could stab at the heart of the U.S. shale energy revolution. Wood Mackenzie:

We tend to see a higher percentage of intangible costs in offshore wells, driven by rig rates for offshore wells which are typically higher than onshore. However, unconventional onshore wells (shale gas and oil) require fracture stimulation once the rig has been removed, thus increasing the percentage of intangibles in these wells. For such wells, completion costs including fracture stimulation can be the largest single intangible cost item …

Like Herman Melville’s classic tale of the quest for "Moby Dick," raising taxes on a productive, job-creating, investing industry – despite compelling evidence of potential economic and energy harm and that much more revenue could be generated for government by fostering more oil and natural gas development – is a narrative some in Washington can’t let go of.

It’s driven by a sidebar mythology that our industry receives cash outlays or “subsidies” from the federal treasury. It does not. Similarly, there are no targeted tax credits currently being used by industry. It does use legitimate tax treatments – like those used by other business sectors. IDC is one of them, much like the research and development deduction enjoyed by other industries.

The LIFO inventory method of accounting has been used for more than 70 years by U.S. taxpayers and is fully regulated by the Internal Revenue Service. Repealing LIFO creates an assumed tax bill without any corresponding cash gain. Taxing inventory, versus taxing income, would require companies to redirect cash or sell assets to cover the tax payment.

America’s oil and natural gas companies supply $85 million a day to the U.S. Treasury in income taxes, rents, royalties and other fees. Our industry pays its fair share and more, with an effective tax rate of more than 44 percent (income tax expenses as a share of net income before taxes) compared to about 25 percent for other S&P Industrials.

The right way to generate more revenue for government from industry is through pro-energy development policies that result in greater oil and natural gas activity. Another Wood Mackenzie study found that increased access to domestic reserves could produce $800 billion in additional cumulative revenue to government by 2030. This is the right path for more oil and natural gas, for job creation and greater energy security.