Study: Cutting IDC, Sec. 199 breaks hurts gas more than oil

Aug. 17, 2010
Eliminating federal tax deductions for intangible drilling costs and for US oil and gas production expenses would hurt oil production growth and devastate future US natural gas development, a Wood Mackenzie study commissioned by the American Petroleum Institute concluded.

Nick Snow
OGJ Washington Editor

WASHINGTON, DC, Aug. 17 -- Eliminating federal tax deductions for intangible drilling costs and for US oil and gas production expenses would hurt oil production growth and devastate future US natural gas development, a Wood Mackenzie study commissioned by the American Petroleum Institute concluded.

“The study illustrates a fundamental rule of economics: Tax something more, get less of it,” API Pres. Jack N. Gerard said as the trade association released the study on Aug. 16. “But far more important than the lost production is the loss of thousands of jobs that would follow. Advocates of higher taxes should understand who would really be hurt.”

WoodMac said it used its upstream database of 230 plays and fields with future development potential to test the impact of eliminating IDCs and Section 199 manufacturing tax incentives for domestic producers because these proposals would hit the industry hardest. OGJ has learned that US Sen. Bill Nelson (D-Fla.), for example, has recommended excluding the oil and gas industry from the industrial manufacturing tax exemption to fund the federal government’s $15 billion disease prevention trust fund.

Under the two proposals, WoodMac said 88 of 230 plays or fields in its database would fall below a 15% internal rate of return, with almost 90% of those being gas targets “while oil is shielded by price assumptions greater than $80/bbl.”

The study’s executive summary said, “In the current gas price environment, many of the gas plays are subeconomic before accounting for the tax increase, and these plays become more severely disadvantaged under the additional tax burden.”

Volumes at risk
It estimated that 300,000-600,000 boe/d of production would be put at risk by repealing the two incentives. “Total at risk volumes include 57,000 b/d and 2.9 bcfd in 2011, with as much as 250,000 b/d and 9 bcfd at risk by 2017, representing more than 10% of US productive capacity,” it said, adding that the volumes account for about $10-17 billion/year in direct upstream investments.

Eliminating the two incentives would shift the average break-even points for US oil and gas development from $47/bbl and $5.40/Mcf, respectively, to $52/bbl and $6/Mcf, the study said.

In a scenario where gas prices remain low and both the IDC and Sec. 199 deductions are eliminated, WoodMac said almost all additional US productive potential would disappear, with more than 700 million bbl of oil and 27 tcf of gas production at risk. The full effect of the tax changes probably would not be as dramatic as this worst-case scenario indicates, “but volume impacts would be significant enough to alter pricing fundamentals in the US gas market,” it added.

Gerard said the two tax incentives have increased US oil and gas production, and that other businesses get similar breaks. “Proposals to eliminate them for oil and gas alone would discriminate against an industry that already pays federal income tax at an effective rate more than 70% higher than for the other [Standard & Poor’s] Industrials,” he maintained.

The Sec. 199 federal tax provision was enacted to help US manufacturers create jobs, and the US oil and gas industry has done exactly that in the past decade, Gerard told reporters during an Aug. 17 teleconference about API’s latest public advocacy plans.

“We’re glad to have the tax conversation,” he said, adding, “We think there’s an appropriate role for us to play. We contribute millions of dollars to the American economy and significant contributions to the Treasury. Discriminating against this industry at a time when we contribute so much doesn’t make sense.”

Contact Nick Snow at [email protected].