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Friday, September 16, 2011

President Obama's Energy Tax Hikes

President Barack Obama has been consistent and relentless in his efforts to increase taxes on oil and natural gas firms. Indeed, even when offering a plan that he says will help the economy and employment, Mr. Obama is still pushing higher taxes on domestic energy producers.

It does not take a graduate degree in economics to figure out, however, that increased taxes are never good for the economy or for jobs. It also should be pretty clear that if you raise taxes on energy firms, those companies will have fewer resources available for investment in energy exploration, development and production. That, in turn, translates into reduced job creation among those energy businesses.

The President has proposed eight different tax increases on oil and gas firms in the legislation he sent to Congress:

Sec. 431. Repeal of Deduction for Intangible Drilling and Development Costs in the Case of Oil and Gas Wells. The elimination of this tax measure would raise the costs of domestic drilling and development, and reduce research, innovation and technological advancements.

Sec. 432. Repeal of Deduction for Tertiary Injectants. The use of tertiary injectants extends the life of older oil fields, and such a tax change would push many of these older fields in the U.S. closer to closing up.

Sec. 433. Repeal of Percentage Depletion for Oil And Gas Wells. The Independent Petroleum Association America explains and provides some powerful information related to this proposal:

"Despite ... limitations, percentage depletion remains an important factor in the economics of American oil and natural gas production. Most independent producers do not exceed the 1000 barrel per day limitation. Yet, these producers are a significant component of America's oil production. For example, they are the predominant operators of America's marginal wells. Over 85 percent of America's oil wells are marginal wells - producing less than 15 barrels per day. Yet, these wells produce about 20 percent of American oil production. About 75 percent of American natural gas wells are marginal wells, producing approximately 12 percent of American natural gas. Marginal wells are unique to the United States; other countries shut down these small operations. Once shut down, they will never be opened again - it is too costly. Even keeping them operating is expensive - they must be periodically reworked, their produced water (around 9 of every 10 barrels produced) must be disposed properly, the electricity costs to run their pumps must be paid. The revenues retained by percentage depletion are essential to meet these costs."

The IPAA concludes: "Loss of percentage depletion would adversely affect American oil and natural gas production."

Sec. 434. Section 199 Deduction Not Allowed With Respect to Oil, Natural Gas, or Primary Products Thereof. When passed in 2004, the 199 deduction was implemented to reduce the costs of investment in domestic manufacturing, effectively reducing the corporate income tax rate from the stated 35% rate to 32%. The Obama tax increase would restrain investment in domestic energy production by reducing the returns on such activity.

Sec. 435. Repeal Oil and Gas Working Interest Exception to Passive Activity Rules. When the President laid this idea out earlier this year, an analysis by Cadwalader explained: "Under the proposal, the passive activity loss rules would apply to prevent passive holders of oil or gas properties from using losses generated by these properties to offset gains from non-passive activities until the holders dispose of their interests in the oil or gas properties." The effect of this measure, again, would be to reduce the incentives for investing in oil and gas development.

Sec. 436. Uniform Seven-Year Amortization for Geological and Geophysical Expenditures. API explains the situation with G&G expenditures:

"Oil and natural gas exploration includes costs for geologists, surveys and certain drilling activities. These costs are referred to in the oil and gas industry as G&G (geological and geophysical) expenses. The function of G&G activities is to locate and identify properties with the potential to produce commercial quantities of oil and natural gas. Before Congress simplified the law in 2005, G&G costs associated with producing wells were allowed as tax deductions only after production began and over a longer period of time. In 2005, Congress allowed all G&G costs to be deducted over two years."

Quite simply, extending the period for deducting G&G expenses raise the costs of exploration.

Sec. 437. Repeal Enhanced Oil Recovery Credit. This credit is only available when oil prices are low to ensure that production can continue. The IPAA points out: "The EOR tax credit has served the country well by encouraging the development of expensive oil reserves when prices would make them uneconomic. It can continue to do so as a safety net against low prices in the future."

Sec. 438. Repeal Marginal Well Production Credit. This credit also is only available when prices are low. The IPAA reports:

"A principal recommendation of the National Petroleum Council's Marginal Wells report was the creation of a countercyclical marginal well tax credit.1 The Dept. of Energy has evaluated the benefits of a tax credit and believes that it could prevent the loss of 140,000 barrels per day of production if fully employed during times of low oil prices like those of 1998 and 1999. This countercyclical credit established a safety net of support for these critical wells. Eighty-five percent of all American oil wells are marginal wells, but they provide 20 percent of American oil production. Seventy-four percent of all American natural gas wells are marginal wells, providing 12 percent of American natural gas production."

Of course, one can debate such tax measures from a tax code efficiency and complexity standpoint, but the answer certainly is not to just reduce or wipe them out so the government can grab more resources from energy production to waste on political escapades. Instead, tax reform should focus on rationalizing deductions and credits, making expensing a permanent option for all capital expenditures for all businesses, and slashing income tax rates. But that's not really in the Obama mix right now.

Instead, the President has been relentless in his pursuit of increased oil and gas taxes for political reasons - seeing a political benefit from bashing and punishing so-called "Big Oil." His proposals certainly have nothing to do with economic common sense.

President Obama talks about reviving the U.S. economy, but his energy tax agenda tells a different story. It is policy that will restrain domestic energy production, economic growth and job creation.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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