Tax torpedoes in the budget proposed by US President Barack Obama have vital significance to the oil and gas industry regardless of their political fate. They indicate how the administration thinks about energy in general and oil and gas in particular. In a word, the administration's thinking on these subjects is unsound.
A new study by the Energy Policy Research Foundation Inc. (EPRINC), Washington, DC, challenges the rationale offered by the Treasury Department for tax changes that would hurt small producers and major companies alike. In fact, EPRINC says, the changes would have costly effects directly opposed to the administration's assertions.
The proposal
As proposed, the budget would hammer small producers by repealing tax preferences that boost cash flow and encourage drilling investment, such as percentage depletion. It would raid larger producers with measures such as a new levy on Gulf of Mexico production and fees on nonproducing federal leases. And it would hit refiners with reinstatement of Superfund taxes, repeal of last-in first-out inventory accounting, and exclusion from the manufacturer's tax deduction ("Sect. 199") available to other US industries. From the administration's year-by-year estimates in budget documents, EPRINC calculates the average cost to the industry of tax code changes in the proposal at $3.263 billion/year.
The Treasury Department says current tax provisions, by generating investment it deems excessive in oil and gas production, is "detrimental to long-term energy security" and "inconsistent with the administration's policy of reducing carbon and encouraging the use of renewable energy sources through a cap-and-trade program (OGJ, June 1, 2009, p. 18)." EPRINC points out that tax changes that lowered production would yield compensating increases in oil imports, a development not usually thought to be a boon to security.
A shift from domestically produced to imported oil also can be expected to raise emissions of greenhouse gases because of the long-haul transportation required by much imported oil, the study says. Compounding that disadvantage would be the extent to which gas production cuts induced by the tax changes limited the displacement of coal by the lighter hydrocarbon in power generation.
Beyond the security and environmental drawbacks, a rise in imports would aggravate US fiscal problems. EPRINC cites a 2006 study by the Oak Ridge National Laboratory estimating the cost of imported oil to the US economy, beyond the market price, at $13.58/bbl in 2004 dollars. In 2009 dollars, the cost is $14.70/bbl. At that level, according to the study, the US would sustain economic losses exceeding expected increases in federal receipts when production declines resulting from the heavier tax load exceeded 160,000 b/d. The estimated economic cost doesn't account for drops in receipts by the Treasury, states, and localities.
A production hit of that size isn't difficult to imagine. EPRINC estimates the tax changes would lower long-term investment by large companies in US exploration and production by 3%. And it points out that 2006 production from US stripper wells, the category most sensitive to cuts in cash flow from existing operations, was 915,000 b/d.
For US refiners, the tax proposals would hurt competitiveness in a market increasingly supplied by imported products, especially gasoline. "Foreign refiners are so entrenched in the domestic gasoline market that they are directly linked in a competitive battle for a share of the US products market in which relatively small shifts in cost advantage can bring about large changes in product flows," EPRINC says.
Real possibilities
Diminished security. Increased emissions of greenhouse gases. Net economic losses. Hampered ability of an important manufacturing industry to compete in its home market. These can't be outcomes the administration had in mind when it proposed its first federal budget. They are very real possibilities, however, which must be taken seriously.
For now, oil and gas elements of the budget proposal seem to have stalled in Congress, which has other distractions, including unwieldy legislation on energy and climate change with its own arsenal of economic bombs. But the thinking that produced the budget proposal remains at work. For oil and gas companies, therefore, the threat endures.
