• Energy Tax Facts
  • 16 Aug 13

Midland Reporter Telegram: O&G operator discusses how eliminating deductions would impact domestic energy production and the economy

Oil and natural gas producers opposing efforts to change tax treatments enjoyed by the industry are directing legislators’ attention to a new study on what repealing the Intangible Drilling Costs deduction would cost.

The study, commissioned by the American Petroleum Institute, said eliminating that one tax deduction would cost the country 190,000 jobs and reduce domestic oil and gas drilling investment by more than $400 billion over a 10-year period.

That deduction alone is a driving force in attracting investment to the industry, said David Neal, tax and consulting partner at Whitley Penn in Fort Worth and himself a small oil and gas operator.

“The reason is well costs are so capital intensive, without offsetting them immediately, wells would cost 20 to 25 percent more,” he explained. “Large integrated companies and even large independents have ways to finance drilling projects — they may be reduced, but not eliminated. For smaller operators, it doesn’t reduce the capital, it makes the capital not there.”

Since small operators use their own funds to drill wells, they’d likely cancel drilling plans, he said, citing himself as an example.

Little of the equipment put down a wellbore, beyond some tubing and rods, is salvageable, he said, comparing IDCs to research and development investment.

Another concern is efforts to repeal the percentage depletion deduction and the passive loss deduction.

Percentage depletion, Neal pointed out, is available only to independent operators and up to 1,000 barrels a day. Like IDC, he said small operators would see the most impact.

“The IRS disallows a lot of deductions if you don’t have the funds to produce reserve reports to support the deduction,” he said.

It would also impact royalty owners and land owners because operators would have no reason to lease land if they don’t plan to drill wells.

Eliminating passive loss would hurt small operators’ efforts to attract outside investors, he said.

The Intangible Drilling Cost deduction was written into the tax code in 1913 and percentage depletion in 1926, he said. “They have an established history and are there for a reason.”

These deductions, he pointed out, don’t result in operators receiving funds from the government. “With IDCS for example, it all comes back around, it all evens up,” he said.

While regulators and legislators say they are trying to eliminate “corporate welfare” for major oil companies, Neal stressed that the impact of altering or eliminating these tax treatments would be felt mostly by small oil and gas operators like himself.

It would also impact the nation’s economy, he said.

Noting that most of the nation’s wells are being drilled by small independents who produce 12 percent of the nation’s natural gas and that 19 percent of the nation’s crude oil comes from wells producing 15 barrels of oil or less a day, Neal said removing those tax deductions would suddenly eliminate any incentive to operate such marginal wells.

“You would eliminate a massive amount of domestic production and a massive number of jobs,” he said, adding that those jobs extend beyond drilling rigs to include chemical services, pumpers, equipment manufacturers and operators. Job creation being driven by the shale oil activity would slow, he said.

“Another result is that this has been helping the economy as a whole by us not sending dollars overseas,” he said.

With more than 35 years experience working with oil and gas clients with accounting, drilling and exploration taxation and estate and trust taxation, he said he has a unique perspective from that side of the issue. But his work as a small operator also gives him a unique perspective, he said.

“The point I’m making is that this isn’t against ‘Big Oil’ or even medium-sized companies. This would hurt small independent operators and drillers who need capital from outside sources, who need IDC and percentage depletion deductions,” he said.

While he thinks the Obama administration is seeking broad-based tax reform, which could be a worthy goal, “this should not be a part of that effort. You really have to look at the impact on jobs and on the national economy. This is one area where they need to tread lightly.”

Even if those deductions are eliminated, he cautioned, “the government won’t get any more money.”