• Energy Tax Facts
  • 10 Dec 13

Big Sky Business Journal: IPAA’s Barry Russell Helps Explain Intangible Drilling Costs

Dave Galt, Executive Director for the Montana Petroleum Association, explains, “These aren’t ‘subsidies’. IDCs are part of a century-old accounting standard that encourages investment to provide foundation capital that makes production possible for small, independent companies especially.”

This year marks the 100th birthday of a tax treatment that allows companies to attract capital and recoup investments in oil and gas exploration and production, similar to R&D deductions for every other industry in the marketplace.

Intangible Drilling Costs, or IDCs, are an accelerated deduction that applies to 60-80% of the costs an operator incurs on the development a well. Those costs include surveying, site preparation, repairs, and labor costs; everything put into the ground, and not relating to benefits reaped from the ground. Generally, IDCs do not include items which are part of the acquisition price of an interest in the property. IDCs apply to producers, royalty owners, and all parties with a working interest in the tract or parcel of land under lease, who invest in the development of a well.

Typically, for income tax purposes, costs that yield benefits over time are not capitalized and recovered in the year they are incurred, but over periods when revenue is generated; in the petroleum industry, the revenue generation period occurs when a well produces oil or natural gas. IDCs are treated differently because not all wells drilled produce a return, and in some cases, drilling yields only a “dry hole.”

Investors’ ability to either expense or capitalize IDCs makes formation capital available for new exploration and production. Drilling is always a gamble, even with the best available information from geologists and geophysicists. The treatment of IDCs incentivizes continued investments in an otherwise risky business.

If an election to expense IDCs is made, the taxpayer deducts the amount of the IDCs as an expense in the taxable year the cost is paid or incurred. If IDCs are not expensed, but are capitalized, they may be recovered through depletion or depreciation, as appropriate. The election to deduct IDCs applies only to those IDCs associated with American properties.

E&P companies can claim up to 100% of costs spent during the year, but integrated companies are only allowed to deduct 70% of IDCs initially, with the remainder covered over the subsequent 5 years. This treatment favors smaller companies, those who rely largely on outside investments, more so than larger companies. Independent producers drill 90 percent of American natural gas and oil wells, and the top 50 companies reinvest 150% of their cash flow back into American projects.

IDCs are not a tax credit, a public expenditure, or government spending outlay.

Barry Russell, president of the Independent Petroleum Association of America, said the current tax code encourages key investment in new energy production.

“Congress should know that the tax policies that govern independent producers are not credits, subsidies or handouts. These provisions and deductions, which are available to nearly every American industry, enable continued investment in U.S. energy exploration and production. Independent energy producers — companies with an average of 12 employees, which drill nearly 95 percent of the nation’s oil and gas wells — are at the heart of America’s great energy revival. The current provisions in the tax code that promote continued American energy production are key to the success of these small operators.”

To eliminate a company’s ability to deduct expenses that are a part of their necessary start-up costs, is to put the brakes on economic recovery through energy expansion, and to increase taxes, decrease federal revenue, thwart investments, reduce payments to royalty owners, and kill jobs.

A Wood Mackenzie study released this summer showed that removal of the tax standard for IDCs would result in the loss of 190,000 jobs in the first year alone, and 250,000 jobs over the next decade. The same report also projected a reduction in industry spending of $407 billion dollars between now and 2023.

The cost of extracting oil and gas to produce energy is significant; millions of dollars on a single well alone. And without a tax structure that allows for companies, especially small, independent companies, to recover a portion of the costs involved in the process, the economic recovery fueled by the energy sector would be negatively impacted.

“Higher taxes on energy mean higher prices on everything,” said Dave Galt.