Revising Historic Tax Policies for American Oil and Natural Gas Production Will Cost the Country

There’s a lot of talk about “subsidies” and “tax incentives” these days, including with respect to energy, so we thought we’d gather a few pertinent facts to clear up some misunderstandings.

First, we need to sort out some definitional issues.  The word “subsidy” may conjure up images of the government handing out checks or waiving taxes for industries deemed to be of special value or that create jobs.  Many definitions of “subsidy” contain the phrase, “a tax reduction that a government gives a business for a particular purpose, usually to create jobs.” This last part is the crux of the issue.  Market-created jobs, rather than those directly created and supported by the government, are the key benefit of increased activity by independent producers (IHS STUDY “The Economic Contribution of the Onshore Independent Oil, Gas Producers to the U.S. Economy). These jobs are stable, high paying, and often in rural areas of the country that are struggling for opportunity. Efforts to resolve the debt ceiling must also consider the effects those decisions will have on our other impending national crisis, the economy. The independent oil and gas sector is a natural and substantial job creator. To view the industry only as a target for revenue, by way of capital destruction, would be to ignore the critical mass that independents represent in U.S. energy productivity, the national job market, and in the wallet of every American citizen.

Independent producers drill 94 percent of the wells in the U.S., so how Congress treats the tax provisions that impact them, such as intangible drilling costs and percentage depletion, is of paramount importance. These are neither “loopholes” nor “subsidies,” but rather methods very similar to real estate depreciation in accounting for those capital expenditures.

Intangible Drilling and Development Costs (IDC) – IDC tax treatment is a normal business deduction – a form of capital recovery. Expensing IDC has been part of the tax code since 1913. IDCs generally include any cost incurred that has no salvage value but is necessary for the drilling of wells or the preparation of wells. Only independent producers can fully expense IDCs, and only on American production. Eliminating IDC expensing would have the direct result of removing capital that would have been invested in new American production and the jobs that support it – such as the emerging shale gas and shale oil resources throughout the country.

Percentage Depletion – All natural resource minerals, from coal to gold to sand and gravel, are eligible for a percentage depletion income tax deduction. Percentage depletion for natural gas and oil has been in the tax code since 1926. Unlike percentage depletion for other mineral resources, natural gas and oil percentage depletion is highly limited. It is available only for American production, only for independent producers and royalty owners, limited to the first 1,000 barrels per day of production, limited to the net income of a property, and limited to 65 percent of the producer’s net income. Percentage depletion provides capital primarily for smaller independents and thus is particularly important for marginal well operators. Eliminating percentage depletion would remove capital that would have been invested in maintaining and developing American production.   Many royalty owners are farmers, ranchers and retirees who rely on their royalties for essential supplement income.

In IPAA’s assessment, the proposed tax increases from the administration would result in a 25-35 percent reduction in capital expenditures for independent producers who reinvest more than 150 percent of their American cash flow back into new American projects. (See IPAA’s letter to Congressional leaders regarding taxes).

We’ve reviewed federal assessments of energy tax issues by the Congressional Research Service (CRS) and the Energy Information Administration (EIA). These include intangible drilling costs and percentage depletion – unfortunately characterizing them as “tax incentives” or “subsidies”.   Nevertheless, the results are still revealing, considering the dominant role played by fossil fuels in our energy sources. For example, a CRS memo dated May 16, 2011 on “Energy Production by Source and Energy Tax Incentives” concludes that while fossil fuels (including oil, natural gas, and coal) accounted for 78 percent of domestic energy production, they received just 13 percent of energy related “tax incentives” in 2009. Meanwhile, renewables accounted for more than 77 percent of the roughly $20 billion in “tax incentives” that went to energy, but generated less than 11 percent of domestic energy production. Renewables have received additional boosts as part of Federal spending packages enacted under the banner of economic recovery. The following charts illustrate these points.

In an extensive study released by EIA in 2008 (Federal Financial Interventions and Subsidies in Energy Markets 2007), the agency’s analysis shows that oil and gas accounted for less than 13 percent of the “subsidies” for 2007 with the majority going to renewables, coal, nuclear, end-use programs, and other initiatives. The following chart shows EIA’s breakout.

Even more interesting is EIA’s analysis translating these figures into dollars per BTU of energy delivered (see following charts). On this basis, the highest figure by far is for ethanol and biofuels, at $5.72 per million BTU for 2007, with oil and gas coming in at just 3 cents per million BTU. (A gallon of gasoline contains roughly 0.125 million BTU.)

For electricity generation, support was by far the highest for “refined coal” (coal that is upgraded to improve combustion and emissions), solar, and wind, all within the $20 to $30 per megawatt range. (For comparison, this would be a little less than a third of the entire per-megawatt-hour average retail price paid by all users in 2007 of $91.) While oil provides only a small share of U.S. electricity generation, natural gas accounts for 24 percent of generation.


We find that, even with the varied approaches and definitions taken in these studies, tax policies affecting the oil and natural gas industy are rather limited compared to renewables and other sources that currently comprise a much smaller share of the energy mix – both today and projected for many years to come (For example, illustrated out to 2035 in EIA’s Annual Energy Outlook 2011). 

IPAA believes that while we need all forms of energy to compete in the global marketplace, we must keep in mind the job and BTU-destroying impact that a removal of these tax provisions would have, in particular, to the U.S. oil and natural gas industry as well as to the U.S. energy consumer. American oil and natural gas provides for real, meaningful job creation going forward as well as decreased dependence on more expensive imports. Changing tax policies affecting this industry would diminish U.S. investment and U.S. jobs.

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