Changes in alternative minimum tax (AMT) rules contained in U.S. energy legislation could make more capital available for drilling, predicts John Swords, head of the national energy tax practice of Coopers & Lybrand.
"Several classes of investors, including additional institutional investors, may begin looking favorably at the domestic drilling industry if the pending changes in AMT are passed into law," Swords said.
He works in the Dallas office of the international accounting firm.
Congressional conference committee members are trying to reconcile House and Senate versions of omnibus energy legislation.
INDEPENDENTS' ROLE
"As currently written," Swords said, "the new law would clearly reduce the income tax liability for certain classes of investors in domestic drilling, particularly smaller independents. Since these people historically have devoted virtually all available capital to drilling, it follows that the investor group most likely to put more money into domestic drilling is the independent operator.
"Independents used to put 108% of their oil and gas income back into the ground. But AMT ended that."
Under current law, intangible drilling costs (IDCs) become a tax preference to the extent that "excess IDCS" exceed 65% of a taxpayer's annual net income from oil and gas, Swords explained.
Excess IDC is the amount of IDC deducted for regular tax purposes in excess of the amount that would have been deducted had the IDC been capitalized and deducted equally over 120 months, beginning with the month in which production from the property began.
Oil and gas producers operating as a corporation also face the adjusted current earnings (ACES) AMT calculation under current law.
If an oil and gas corporation's ACEs exceed taxable income, the AMT requires 75% of the excess to be included in the calculation of its alternative minimum taxable income (AMTI).
"This calculation will not disappear under the new legislation, so it remains as part of the overall accounting burden," Swords said.
NOW IT WORKS
An example of the workings of the AMT and its proposed revision, Swords calculated the 1991 AMT that would be due from a hypothetical independent oil producer who has $100,000 in interest and dividend income, $400,000 in gross oil and gas income, $350,000 in lease operating expenses, and $50,000 in other itemized deductions.
This independent, who does no drilling for the year, would face $5,583 in regular taxes on his interest and dividend income less his itemized expenses. However, because of his $50,000 in oil and gas income (the gross oil and gas income less expenses), his total tax bill would increase to $11,217, or an additional $5,634, because of AMT based on percentage depletion as a preference item. A preference item is one on which he must pay taxes.
If the same independent invested $100,000 in drilling a well in 1991, but it did not produce until the next year, his taxes for the year would go from $11,217 to $15,600, an increase of $4,384, because he would have incurred IDCS, another AMT preference item.
"Obviously," Swords said, "under current laws a producer has to pay more taxes for the privilege of drilling a well. This is one of the reasons drilling in the U.S. has declined."
Under the proposed energy bill, however, the producer who had $50,000 in oil and gas income and who drilled a well would no longer be required to pay AMT on percentage depletion and IE)CS, meaning he would no longer have to pay the $5,583 plus $4,384 for a total of $10,018 in AMT required under the old law. This money could then be freed for more drilling if the producer desired, Swords said.
"If this legislation is passed and signed into law, the drilling decision for the independent producer will once again be based mainly on economics of the proposed drillsite and less so on the undue tax burden imposed on drilling expenditures," Swords said.
SECTION 29 CREDITS
Unfortunately, any positive effect of the new energy bill on the U.S. rig count will be mitigated by the end of Section 29 gas tax credits, Swords warned.
"I wish I could say the energy bill will increase the U.S. rig count, but with the Section 29 credit about to expire, I'm not sure," Swords said. "Currently, the Section 29 credit will no longer be available for wells drilled after Dec. 31, 1992.
Estimates indicate that 20-30% percent of U.S. active rigs are working on Section 29 credit properties, Swords said.
"While the Independent Petroleum Association of America estimates passage of the energy bill should increase overall rig count about 20%, the best I can say is that the reduction in domestic operating rigs won't be so severe. But then, I could be pleasantly surprised...
"If an extension of the Section 29 credit is considered, I would favor only a permanent extension. Only a permanent extension would assist in high cost, alternative areas while not artificially accelerating drilling activity required to obtain the credit into a short period of time. This might also alleviate some of the industry's concerns about artificially increasing supply through subsidies."
OTHER FACTORS
Swords pointed out that the new AMT rules, if passed, would not eliminate special accounting work.
"Unfortunately," he said, "both versions of the energy bill contain an overall limiting provision that will require continued complexity and limit its overall effectiveness. Under the new legislation, taxpayers must still calculate AMTI as before. Then they cannot reduce the AMTI below 40% of what it would have been. So there's been no reduction in the accounting load required to calculate AMT."
Swords also predicted a slight increase in the amount of drilling funds that can be raised.
He said, "Due to the working interest exception to passive loss rules, we should see a slight increase in drilling capital raised by the retail sector.
Overall, Swords termed the bill "a step in the right direction." But he does not foresee passage of the bill as a complete resurrection of U.S. oil and gas exploration and development.
Copyright 1992 Oil & Gas Journal. All Rights Reserved.
