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Friday, May 25, 2012

It's summertime, and the taxation is easy


What could be more stimulating that a pre-Memorial Day weekend blog on taxation of the oil and gas industry?


Probably anything.  

But my friend Jan Jarrett’s blog post today on energy subsidies moved me to – forgive the pun – drill into the subject a little deeper. Here – mercifully, in brief - is what I found.

The Congressional Research Service helpfully describes the generous federal tax subsidies to oil and gas production in a straightforward way. The subsidies include:

  • Intangible Drilling and Development Costs (IDC) – drillers can deduct from taxable income 100 percent of any cost incurred that has no salvage value and is necessary for the drilling of wells or the preparation of wells for production.  That includes, for example, surveying, ground clearing, and draining; wages, repairs, supplies, drilling mud, chemicals, and cement; and the cost of fracking a well. Intangible expenditures of drilling are usually about 65 to 80% of the cost of a well.
  • Percentage Depletion –in the tax code since 1926, percentage depletion is the practice of deducting from an oil company’s gross income a percentage value, currently 15 percent, of the total value of the oil deposit that was extracted in the tax year.
  • Geological and Geophysical (G&G) Amortization – G&G costs are written off over seven years.
  • Marginal Well Tax Credit – Enacted in 2004 to create a safety net for marginal wells during periods of low prices; it has not been necessary, for obvious reasons.
  • Enhanced Oil Recovery (EOR) Tax Credit – a 15% credit – a direct reduction of tax liability - on costs of using oil production using technologies that increase oil production from older wells.
  • Manufacturing Tax Deduction –enacted in 2004 to encourage the development of American jobs, the gas industry can write off six percent of payroll costs subject to a cap.
  • Passive Loss Exception for Working Interests in Oil and Gas Properties – I won’t even attempt to describe it.


These federal tax provisions were estimated in 2009 to be worth $30 billion annually to the industry.

But wait, as the TV infomercial pitchman says, there’s more.

  • Tangible Drilling Cost Tax Deduction - The costs of equipment are considered Tangible Drilling Costs and are 100 percent tax deductible.
  • Lease Costs - Lease costs (purchase of leases, minerals, etc.), sales expenses, legal expenses, administrative accounting, and lease operating costs are also 100% tax deductible.
  • Tertiary injection expenses, including the injectant cost, are also 100% tax deductible.


So much for that brief tour of Federal tax subsidies. What about state-level taxation in Pennsylvania?  Natural gas drillers in Pennsylvania pay very little in state and local taxes, despite industry claims to the contrary.  And 2012’s Act 13 imposed an effective tax rate of about 1.5% - one of the lowest rates in the nation - among many egregious flaws.

The industry, of course, insists that these subsidies are necessary to support investment and produce domestic energy.  Why a fraction of such subsidies for renewable energy are not necessary - or downright un-American, as is frequently argued - is less clear.   

3 comments:

  1. Mr. Quigley,

    The PBPC study you show seems to conveniently omit many of the avenues by which the industry is paying their taxes, and only looks at the early years of the play. The millions of gallons of fuel that is burned are all taxed. The injection of billions of dollars of investment in lease payments and royalties into the economy goes around and around, and is taxed each time it changes hands. The tens of thousands of jobs created generate payroll taxes, and the majority of the wages paid stay in Pennsylvania and circulate, creating sales taxes. The industry has contributed well in excess of a billion dollars of taxes to the state through traditional revenues, not counting the massive impact fee.

    The gas industry is not a panacea for Pennsylvania's budget shortfalls. Earlier today, you posted on Twitter about how coal to gas switching is going down as the price of gas recovers. Act 13 is adding significant expense to the drilling process. EPA air regulations will add cost. The impact fee adds cost. Chapter 78 added significant costs. The new water treatment procedures add costs. If you want to yank the long standing IDC write offs on top of all of this, the price of gas will go up significantly. Is that really what we want? More coal? More foreign oil? Because that's the road you're leading us down. Let's reward those who choose to take their money and invest it in clean, American energy, instead of demonizing them.

    Have a great holiday weekend Mr. Quigley.

    Michael S. Knapp
    President
    Knapp Acquisitions & Production

    ReplyDelete
  2. Mike,

    Thank you for reading and commenting. No one can responsibly deny a realistic economic multiplier effect for the gas industry or any other industry, for that matter. But the gas drilling companies don't pay most of the taxes you mention. Others do.

    As studies by groups like NRDC have shown, the industry can well afford the cost of additional regulations.

    Pointing out the facts is hardly demonizing. I didn't say and am not suggesting that the gas industry is the solution to PA's budget problems. What I am suggesting is that we need to acknowledge and realistically assess the subsidies we provide to ALL energy sources, and adjust those policies if necessary.

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  3. I'm not familiar with the NRDC study you are referencing, but I can tell you with complete certainty from personal experience that these current prices are barely sustainable (if at all) for most companies. Most are looking for a $4-$6 range. If companies can't so much as break even at $2.50, then soon the drills will stop, production will drop, the price will rise, and king coal will prevail.

    I'm not an economist, but I suspect if you aggregate the tangible and intangible costs to the taxpayer from a coal based power generation system you're going to be seeing a number with a lot of zeros.

    You will not hear me whine about the increased regulatory costs. They are necessary, and the industry must find a way to deal with them. But removing the tax incentives you list above to spur investment into natural gas (and they are incentives, NOT subsidies, a not insignificant difference) will create a cost that will ultimately be passed on to the consumer. A cost that can be measured in both dollars, and environmental damage.

    ReplyDelete