For years, decades really, some political factions in Washington have urged Congress to change the tax code by eliminating what they consider certain unnecessary deductions given to the oil and gas industry. One of these proposed changes is abolition of the Intangible Drilling Costs deduction. Senator Max Baucus of Montana, chairman of the Senate Finance Committee, has stated that his committee will consider the need for the IDC deduction as it looks at tax reform and updating the federal tax code.
The IDC deduction is a way for oil and gas producers to write off some of the expenses incurred at the wellsite when drilling a well. Examples would be costs for preparing the drill site, grading and digging mud pits, and transportation cost for the drilling rig and certain other equipment. These are costs that could not be recovered and would provide no value to the operator if the drilling is unsuccessful. The IRS currently permits operators to recover a portion of these costs quickly, allowing them to reinvest the funds in continued drilling operations.
Although some might consider this a special "perk" for the petroleum industry, the costs are analogous to research and development costs that are fully deductible for other industries, said David Neal of Whitley Penn, a tax consulting and accounting firm based in Fort Worth.
Writing in the November 2013 issue of OGFJ, Neal went on to say that the standard for deducting IDCs is not applied uniformly across the oil and gas industry. Independent producers are allowed to deduct IDS as incurred. However, larger integrated companies can only deduct 70% of their intangible drilling costs.
Neal, who has represented clients in the petroleum industry for more than 35 years, said the IDC deduction is not new. "It was written into the tax code in 1913," he added. "[This provision] has an established history and is there for a reason. It encourages individual investment in the oil and gas industry and influences the competitiveness of small independent producers."
Barry Russell, president and CEO of the Independent Petroleum Association of America, is concerned that the IDC deduction might be eliminated by Congress in a misguided effort at tax reform.
"There are many problems with the nation's tax code, but when it comes to America's oil and natural gas industry, the current tax code, refined over the past 100 years, is an example of public policy that actually works," said Russell in a statement dated Nov. 21. "Current tax rules and laws ensure that our industry pays its fair share in taxes, which is now one of the most heavily taxed industries in the country. The current tax code also encourages investment, resulting in massive new US energy supplies and millions of jobs."
Russell added that a study released by Wood Mackenzie found that repealing the IDC deduction would have a drastic impact on the American economy, including 190,000 jobs lost within the next year and 233,000 by 2018. The study also found that repealing the IDC deduction would force US oil and gas producers to cut back their production by 15% to 20% annually, reducing industry spending by $407 billion between 2014 and 2023.
It has also been estimated that eliminating the IDC deduction would increase the cost of capital by 20% for the industry. The effect of abolishing the deduction would hit hardest the small independent producers who drill an overwhelming majority of the nation's oil and gas wells. They drill most of their wells in the US due to their limited access to capital.
Whitley Penn's Neal noted that the current tax provisions support an oil and gas industry that is a significant piece of our national economy. He cited an American Petroleum Institute study that found the oil and gas industry's total employment impact to the US economy in 2011 accounted for 9.8 million jobs, or nearly 6% of total US employment.
"These provisions help to stimulate production for small independent producers, which directly contributes to US employment, US energy security, and keeping US dollars at home," said Neal. "Congress's business tax reform initiatives threaten these laws, the health of the US oil and gas industry, and the national economy as a whole."
The IPAA's Russell commented, "Congress should know that the tax policies that govern independent producers are not credits, subsidies, or handouts. These provisions and deductions, which are available to nearly every American industry, enable continued investment in US energy exploration and production. Independent energy producers – companies with an average of just 12 employees, which drill nearly 95% of the nation's oil and gas wells – are at the heart of America's great energy revival. The current provisions in the tax code that promote continued American energy production are key to the success of these small operators."
The IPAA says it will be submitting extensive comments to Chairman Baucus on this issue. I encourage anyone who has a stake in the petroleum industry to do so as well.
