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OIPA comments to U.S. Senate Finance Committee

January 24, 2014
OIPA sent the following comments to the U.S. Senate Committee on Finance in January:

Comments by the Oklahoma Independent Petroleum Association for U.S. Senate Committee on Finance Regarding the November 21, 2013 Cost Recovery and Accounting Rules Discussion Draft

Please accept the following comments in response to the U.S. Senate Committee on Finance’s November 21, 2013, discussion draft on proposed changes to the U.S. Tax Code’s cost recovery and tax accounting rules.

With more than 2,650 members, the Oklahoma Independent Petroleum Association (OIPA) is among the nation’s largest and most active state-based trade associations for independent producers of crude oil and natural gas and the service companies which support them. Unlike integrated major oil companies, OIPA’s independent producers have no refining or retail marketing operations.

OIPA wishes to associate itself with comments submitted by the Independent Petroleum Association of America (IPAA), its state and regional cooperating associations, and like-minded crude oil and natural gas industry groups that find the discussion draft to be fatally flawed.

The draft proposes to repeal the ability of domestic producers to deduct ordinary and necessary business expenses in the year the costs are incurred and repeal percentage depletion. Qualified extraction expenditures including tertiary injectants and geological and geophysical work would be subject to the same 60-month amortization schedule as proposed for intangible drilling costs.

The Senate Finance Committee proposal would destroy jobs, weaken the national economy, reverse gains in U.S. energy independence, increase consumer costs for motor fuels and hundreds of everyday products, increase energy price volatility, undermine the U.S. manufacturing renaissance, and limit U.S. leaders’ foreign policy options.

OIPA urges, in the strongest possible terms, that the Committee reject the proposed changes due to their detrimental impact on the United States of America.

OIPA appreciates the challenges of comprehensive tax reform and understands that in addition to providing an opportunity to eliminate outdated, inequitable, or unworkable policies, tax reform presents a chance to reaffirm policymakers’ commitment to provisions that are succeeding in meeting national goals.

Today’s tax treatment of intangible drilling costs and percentage depletion meets this good public policy test and should be retained as these provisions continue to have a dramatic positive impact on U.S. energy production and the economy. These two provisions are critical to producers’ day-to-day operations.

There are roughly 18,000 independent producers operating in 33 states.  While some are larger and well known, the typical independent producer employs 11 full-time and three part-time employees. He or she has been in business for 26 years on average.

Clearly, the average independent producer is not “Big Oil.”
Yet independent producers drill approximately 95 percent of all U.S. wells and account for 68 percent of total U.S. production – more than 85 percent of U.S. natural gas production and more than 54 percent of domestic oil production.

Just onshore here in America, independents are responsible for:

• over 3 percent of the total U.S. workforce;
• more than 4 million American jobs;
• more than $579 billion in total economic activity;
• 4 percent of U.S. GDP;
Indeed it is difficult to keep pace with the positive news from today’s rapid unconventional crude oil and natural gas revolution. Game-changing advances in America’s ability to harvest its abundant energy resources have made obsolete the supply pronouncements and public policy questions that resonated loudly just a few years ago.

In 2010, independent producers’ employees paid $30.7 billion in income, sales, and excise taxes. Their combined total federal, state, and local taxes, royalties and rents were $69.1 billion. Their ecosystem of direct, indirect and induced jobs generated $131 billion for federal and state coffers.

Every $1 million of upstream capital expenditure by independent producers results in $1.1 million in total taxes, $5.1 million in overall contribution to U.S. GDP, six direct jobs, and 33 total upstream jobs.

These economic multipliers are critical points for the Committee to consider as a recent survey by the American Exploration & Production Council (AXPC) of just the 32 largest independent producers reveals an immediate $18 billion first-year reduction in a combined exploration and production budget of $81 billion.

This loss of access to capital does not translate into an improved U.S. Treasury balance sheet. Contrary to what fossil fuel opponents say, the immediate deduction of intangible drilling costs is not a subsidy. No federal funds are transferred to independent producers. There is no 1:1 ratio. Any short-term improvements to the revenue side of the ledger would be insignificant and quickly swamped by a dramatic decline in economic productivity.

Had the Committee’s plan been in place in 2013, these larger independents would have drilled 4,000 fewer wells last year. Multiply the scale of this hit to drilling budgets across the entire upstream industry and 18,000 independent producers nationwide, throw in the repeal of percentage depletion, and the economic harm that would result from the Committee plan starts to come into focus.

Speaking specifically about Oklahoma, the oil and gas industry is our lifeblood.  Our industry is responsible for one out of every three dollars in gross state product, one out of every five dollars in personal income, and represents one out of every six jobs in our state. Since 2009, our industry has added roughly12,000 jobs with the average compensation in our industry being more than $113,000 per job.

However, U.S. job creation is in no way limited to America’s traditional oil patch. Federal tax policies that encourage producers to take risks in capital intensive exploration projects have spurred new onshore oil and gas investment in local economies from Appalachia and the Rust Belt through the Great Plains and into the West.

If federal policymakers do not undermine its potential, the U.S. energy renaissance will continue to dramatically improve lives and afford state and local governments the ability to improve citizen services as oil and natural gas tax receipts swell public coffers.

IHS predicts that U.S.  jobs attributed specifically to unconventional oil and gas exploration will grow from 2.1 million in 2012 to 3.3 million by 2020 with many of those jobs in industries the general public does not typically associate with the oil and gas business – everything from automobile sales and steel manufacturing to agriculture and retail.

Unconventional activity alone contributed an estimated $74 billion in federal, state and local tax receipts in 2012. By 2020 total government revenue attributed to unconventional oil and gas activity will grow to $125 billion. By 2025, unconventional activity is expected to have generated more than $1.6 trillion in cumulative government revenue since 2012.

When midstream and downstream factors are considered, America’s oil and gas industry supports 9.2 million U.S. jobs and 7.7 percent of the nation’s GDP according to the American Petroleum Institute (API). The industry pays almost $86 million in federal rents, royalties, bonus payments and income tax payments daily and has an effective tax rate of 44.6 percent.

America’s recent economic recession would have been deeper and more painful without independent producers’ commitment to high-skilled workers, good-paying blue-collar jobs, and American energy. The industry continues to lead the nation out of its economic doldrums and provides a foundation upon which other domestic industries from coast to coast are building.

Thanks to technological breakthroughs in horizontal drilling, hydraulic fracturing and appropriate tax treatments that encourage producers to risk private capital to find and produce new resources, America now imports less than 35 percent of its oil, down from 60 percent a few short years ago.

America’s foreign policy and defense leaders are just now beginning to incorporate into plans the strategic importance of the United States becoming the world’s swing energy producer. Energy security is national security.

A recent Harris Interactive poll conducted for the Domestic Energy Producers Alliance (DEPA) shows that 93 percent of Americans believe energy independence is an important policy goal for the United States. Approximately 89 percent of Americans say energy independence will improve national security. We are on the way to achieving this goal.

According to the U.S. Energy Information Administration (EIA), crude oil production increased by 790,000 barrels per day between 2011 and 2012, the largest increase in annual output since the beginning of U.S. commercial crude oil production in 1859. In 2011, U.S. petroleum product exports exceeded imports for the first time in more than 60 years. The domestic clean-burning natural gas supply is now measured in centuries.

Not only does this improvement in energy security provide officials more foreign policy options, but also it creates a dramatic opportunity to restore America’s manufacturing sector as companies seek onshore operations that can benefit from inexpensive domestic energy.

In seven years U.S. natural gas production has increased from 51 billion cubic feet (bcf) per day to 66 bcf per day – a 27 percent increase. As a result, manufacturing companies are now planning to invest hundreds of billions of dollars in U.S. projects with the U.S. chemical industry particularly well-suited for growth.

However, in each of his budgets U.S. President Barack Obama has sought the repeal of tax treatments used by the oil and gas industry. Among his targets are intangible drilling costs and percentage depletion. Despite rhetoric to the contrary by fossil fuel opponents, neither are subsidies. The U.S. Treasury does not write checks to independent producers for intangible drilling costs or percentage depletion.

Intangible drilling costs are ordinary and necessary business expenses for services and items associated with oil and natural gas production that have no salvage value such as labor, fuel, hauling, supplies, seismic work, site preparation, etc. These costs usually represent 60 to 80 percent of the cost of a well. Only independent producers may elect to deduct 100 percent of such costs in the year they occur and only on domestic production.

Despite tremendous technological improvements each well remains a high risk and capital-intensive effort which can easily cost as much as $10 million. The immediate deduction of ordinary and necessary business costs allows producers to quickly reinvest capital in the next drilling project. The average independent producer typically reinvests more than 100 percent of annual cash flow in new drilling projects. That is, he invests all his revenue and raises or borrows additional capital.

Since its inception, the U.S. Tax Code has held that necessary expenses actually paid in carrying on any business should be allowed as deductions. It would be more than highly inappropriate to repeal the ability of independent producers to deduct ordinary and necessary business expenses, it would be economically damaging.

OIPA’s producers report that on average they would drill one-third fewer wells each year were they unable to deduct ordinary and necessary business expenses. This negative impact would ripple through the economy and kill tens of thousands of oil and gas jobs immediately.

A 2010 Wood Mackenzie study put the costs of such a federal policy blunder at 58,800 U.S. jobs lost, 165,000 U.S. jobs at risk by 2020, a domestic production loss of perhaps 600,000 barrel of oil equivalents per day with 5 percent of natural gas production lost in the first year, and the curtailment of at least $130 billion in capital expenditures over 10 years. It would certainly increase consumer prices on fuels, transportation, and many consumer goods.

Such projections are likely conservative given advances in U.S. domestic production since 2010.

Meanwhile, percentage depletion is simply the depreciation of mineral assets as they decline. All mineral resources, except inexhaustible resources such as air, are eligible for percentage depletion. Percentage depletion has been part of the U.S. Tax Code since 1926 after cost depletion of minerals proved unworkable for both the IRS and taxpayers.

Percentage depletion is available only to independent producers and America’s estimated 8.5 million private royalty owners, only on domestic production, and is limited to the first 1,000 barrels per day of production. It is further limited to the net income of a property and 65 percent of a producer’s net income.

Percentage depletion is especially important to marginal well operators as it helps them offset the costs of wells that produce 15 barrel of oil equivalents or less per day. On average, each U.S. marginal well produces 2.3 barrel of oil equivalents per day. Such production numbers sound inconsequential, but are not. These marginal wells are responsible for 17.8 percent of U.S. domestic oil production and 9 percent of U.S. domestic gas production. There are more than 375,000 marginal oil wells and 322,000 marginal gas wells across 29 states producing more than 262 million barrels of oil and 2.1 trillion cubic feet of natural gas annually.

For every $1 million directly generated by marginal well production, more than $2 million in economic activity is generated elsewhere. Each additional $1 million of marginal well production employs 10 direct and indirect workers, with some producers employing as many as 15 workers.

The loss of percentage depletion would be catastrophic for marginal well producers and damaging to the national economy. Once a well is abandoned it is rarely cost-effective to bring it back on-line.

The National Stripper Well Association (NSWA) estimates that the abandonment of all marginal wells would result in an estimated loss of 292,374 jobs and more than $12.5 billion in lost earnings.  The United States is the only nation that produces oil and natural gas in economically significant amounts from marginal wells and they are a key component of U.S. energy security.

Unlike depreciation for a building, which may be completely depreciated yet retain a value and be sold, oil and gas wells only retain an expense once depleted. Wells must be capped and sites must be cleaned up and restored in accordance with regulations. The excess of percentage depletion over cost depletion helps marginal well operators address such costs.

As referenced, percentage depletion also is important to the nation’s private royalty owners. OIPA refers the Committee to public comments by the National Association of Royalty Owners (NARO) and the Royalty Owners & Producers Educational (ROPE) Coalition on this topic.  

OIPA directs the Committee to the extensive histories of these tax treatments as provided by IPAA and API and the comments of the AXPC and DEPA.

OIPA wishes to call the Committee’s attention to a March 2013 Harris Interactive survey of 1,000 registered voters which finds that a majority of Americans believe Congress should not raise energy taxes. The findings include:

• 74 percent of voters agree -- Now is not the time for politicians in Washington to raise energy taxes. They should solve the country's budget issues without hurting consumers and taxpayers.
• 63 percent of voters agree -- Raising taxes only on America's oil and natural gas industry, or just on a handful of companies, as some politicians in Washington have recommended, would be bad tax policy, as well as unfair and discriminatory.
• 69 percent of voters agree -- Increasing energy taxes, like taxes on oil and natural gas companies, hurts everyone because those tax increases could drive up energy costs for consumers.
• 57 percent of voters agree -- Increasing energy taxes, like taxes on oil and natural gas companies, could kill jobs and negatively impact the economy.

Finally, it is important to emphasize that these issues are so important to OIPA’s membership and to the future of the United States that our organization would be “key voting” both committee and floor votes related to such proposals in the U.S. House of Representatives and the U.S. Senate and would work to publicize those key votes extensively to our members who operate nationwide, their employees and investors, and their royalty owner stakeholders in all 50 states.
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