IRS, FERC LET MORE WELLS RECEIVE SEC. 29 CREDITS

Frank W. Lewis, Terry Grapentine
Petroleum Management System
Del City, Okla.

Two new ways exist for producers in the U.S. to qualify additional production for federal Sec. 29 nonconventional fuel tax credits.

Until now the Federal Energy Regulatory Commission and Internal Revenue Service deadlines had limited eligible production to wells spud or recompleted and filings made under the Natural Gas Policy Act on or before Dec. 31, 1992.

Large numbers of producers in many states filed timely NGPA applications seeking federal and state regulatory approval, and currently most producers believe the deadline to apply for Sec. 29 tax credits to have passed.

FILING EXCEPTIONS

The first exception to the Dec. 31, 1992, deadline was issued by the FERC and covered qualifying zones eligible for the tax credit with spud or recompletion dates prior to Jan. 1, 1993, but without timely NGPA Sec. 107 applications.

For these wells, the FERC recently agreed to accept NGPA applications from state agencies until Apr. 30, 1994.1

Other rules further limit tight formation applications, but state regulatory authorities can accept NGPA applications submitted after 1992 by utilizing the dated permit to drill to establish that the Sec. 107 application was filed on or before Dec. 31, 1992.

The second exception, with potentially the widest application, is IRS Ruling 9354 allowing eligible production from recent behind-the pipe recompletions to qualify for nonconventional fuel tax credits. 2

The new IRS revenue ruling states, "If a well that is drilled after Dec. 31, 1979, and before Jan. 1, 1993, is recompleted after Jan. 1, 1993, to produce fuel that is a qualified fuel under Sec. 29(c) of the Code and if the recompletion does not involve additional drilling to deepen or extend the well, the fuel produced from the recompletion qualifies for the Sec. 29 credit."

The qualifying fuel categories or eligible zones for Sec. 29(c) gas include coalbed methane, Devonian shale and tight formation gas.

Under the ruling, a well drilled in 1982 with a 1993 qualifying recompletion could be eligible for a 1993 tax credit of 51.72/MMBtu for tight formation gas or at least 95.32/MMBtu for coalbed methane or Devonian shale gas. 3

The coalbed methane and Devonian shale rates escalate yearly with inflation, and the fight formation rate does not.

Under existing law, the Sec. 29, nonconventional fuel tax credit terminates on Dec. 31, 2002, so producers could potentially receive the tax credit for as long as 10 more years.

HOW TO REACT

In the absence of FERC approval and specific IRS guidelines, a prudent posture for producers would be to prepare for qualification under IRS Revenue Ruling 93-54 as if FERC approval were still required. Current IRS Sec. 29 audits revolve around FERC qualifications and approval.

The most common limitation to the nonconventional fuel tax credit regards alternative minimum tax; however, AMT has recently been restructured and is less onerous to producers.

Disqualification of tax credits due to AMT in one year does not automatically preclude producers or royalty interests from filing in subsequent years, nor does the ineligibility of one working interest owner due to AMT taint the ability of other working interest owners to utilize the tax credit.

Revenue Ruling 93-46 clarifies that royalty owners are entitled to participate in their pro-rata share of the tax credit from eligible production. 4

Nonconventional fuel tax credits are a major tax benefit. Producers seeking to enhance after tax cash flow for their investors should examine each well's potential for coalbed methane, Devonian shale, or tight formation gas zones.

In some cases, the tax credit can be greater than the net income from the well. The incremental cost of a recompletion generally offers an attractive payback as the recompletion costs are generally significantly less than the value of the tax credit to working interest owners.

The purpose of this article is not to debate the fairness of the nonconventional fuel tax credit but to expand its use.

The credit is intended to enhance domestic gas production. In these difficult times, successful producers will use every legal, cost effective opportunity to increase their after tax profitability.

REFERENCES

Federal Energy Regulatory Commission, Qualifying Tight Formation Gas for Tax Credit, Order 539-A, 57FR 31123, July 14, 1992; Order 539-B, 58FR 19607, Apr. 15, 1993; Order 539-C, 58FR 38528, July 19, 1993.
Internal Revenue Bull., Revenue Ruling 93-54, Bull. No. 1993-27, Aug. 16, 1993, p. 4.
Internal Revenue Service, Nonconventional Source Fuel Credit; Publication of Inflation Adjustment Factor, Nonconventional Source Fuel Credit, and Reference Price for Calendar Year 1992, 58FR 1-302, Apr. 1, 1993.
Internal Revenue Bull., Revenue Ruling 93-46, Bull. No. 1993-25, July 19, 1993, P. 6.