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Windfall Profits Tax Shelved; Other Tax Concerns Linger

President-elect Obama has nixed plans to impose a windfall profits tax on oil and natural gas producers due to the steep slide in energy prices over the past couple of months. But while the incoming administration hath taketh away, Congress may giveth producers additional tax burden in the upcoming year, industry officials in Washington fear.

"Our understanding is that they've decided not to pursue the windfall profits tax," said Lee Fuller, vice president of government relations at the Independent Petroleum Association of America (IPAA), which represents independent producers. "They believe that with prices falling, it's not a logical place for them to pursue revenues." Fuller said he also believes the Obama team has realized that it would be "inconsistent" with its national security policy to impose a tax that could slow investment in oil and gas.

"It's good news for the industry and it's good news for America."

The news that the Obama team reversed direction came last Tuesday when a small business group announced that the transition team had struck all reference to the windfall profits tax on oil and gas from the transition website (www.change.gov). The language regarding the tax was removed on Nov. 8 in an "unceremonious and abrupt manner," but it had just come to the public's attention, according to the American Small Business League (ASBL), which favors a windfall profits tax on oil and gas.

During the presidential campaign Obama proposed using the receipts from the windfall profits tax to give consumers, who at the time were struggling with high gasoline prices, an energy rebate of $500 per individual or $1,000 per married couple.

Producer groups had hoped that Obama would not resurrect the windfall profits tax, recalling that the tax was disastrous when it was last imposed in 1980. It resulted in less domestic production and more foreign imports. Industry sources conceded late in the presidential campaign that a windfall tax was becoming a less attractive option for Obama in light of the steep drop in oil and natural gas prices.

Even Obama adviser Elgie Holstein acknowledged that the windfall profits tax had lost some of its steam. "That was his [Obama's] proposal, but of course oil prices have been declining so that may obviate at least some of the need [for the tax]. It would certainly reduce the extent to which a windfall profits tax would apply," he said in late October following a Natural Gas Roundtable (see NGI, Oct. 20).

But while producers may have dodged a bullet on the windfall profits tax, both majors and independents still are concerned that Congress may revise or strip away existing tax benefits for oil and natural gas to offset revenue losses and narrow the budget deficit.

"There's a lot of ways to skin this cat," said Rayola Dougher, senior economic adviser for the American Petroleum Institute (API), which represents major oil and gas producers. "There are all sorts of ways [other than the windfall profits tax] that they could go after" producers.

Both major and independent producers are concerned that Democrats may revise current tax policy for intangible drilling and development costs (IDC). Independents also are worried about potential changes to percentage depletion benefits in the 111th Congress.

"These provisions -- mainstays to providing capital to develop and maintain American oil and natural gas production -- have long been targets of liberal tax reformers," the IPAA said in its "Washington Report" last Tuesday.

The erroneous belief that all producers are Big Oil and an increasing emphasis in Congress on pay-as-you-go rules to offset revenue losses "can drive very bad policy decisions, pitting one energy source against another when we need it all," said IPAA's Fuller.

Existing tax policy allows producers to deduct IDC in the year that the costs are incurred. However, Fuller said he's now concerned that this may be changed, requiring producers to deduct costs over a longer period of time (possibly five years). This would mean that producers wouldn't get their capital back quickly, and drilling activity would slow.

"The IDC helps keep domestic projects economically competitive with overseas projects," said Mark Kibbe, API's director of federal relations and tax expert. Without the tax treatment for IDC, which has been in effect since 1918, U.S. oil and gas production would be severely hampered, he noted. "Congress has a choice."

Oil and gas tax benefits are always vulnerable "when there's a budget deficit and Congress is looking for pay-fors...revenue offsets," Kibbe said. He said it's "possible" that Congress also may reduce or fully repeal the Section 199 manufacturing deduction, which lawmakers froze at 6% for the oil and gas industry. The deduction is 9% for all other industries. It allows producers to deduct 6% of their U.S.-derived income each year.

He further said a proposal by Sen. Jeff Bingaman (D-NM) to impose a 13% severance tax on Gulf of Mexico production "could very well" resurface in Congress next year. With the severance tax, Bingaman is seeking to recoup some of the lost revenue from the faulty deepwater leases that were issued by the Interior Department in 1998 and 1999.

The IPAA's Fuller fears that percentage depletion, which has been denied to integrated producers since the mid-1970s, may be stripped from independents. The percentage depletion benefit for independents already has a number of restrictions on it -- it's available for only the first 1,000 b/d; is capped at 15% (used to be 27.5%) of the income per well; and is capped at 65% of the net income of the company, among other limits.

He believes that if Democrats offer a broad tax reduction, they may go looking to peel away existing tax incentives from the oil and gas industry to pay for the broader tax cut.

The favorable tax benefits help independent producers attract investment capital, Fuller said. "We're concerned that that's not understood by Congress very well." Far-left politicians believe that the favorable tax treatment only benefits Big Oil, he noted, adding that they fail to realize that increased gas production is critical to reducing greenhouse gas emissions.

In response to these possible threats, IPAA has initiated an analysis of the role that the tax policies play in developing domestic energy. The analysis will be done by PricewaterhouseCoopers experts who have worked with federal revenue estimating and tax policy and with the energy industry. The results are due out in February, according to Fuller.

"We hope to position ourselves to educate Congress and the administration" about the impact that tax changes would have on the industry's ability to find and produce natural gas, he said.

Fuller noted that Sen. Charles Schumer (D-NY) introduced legislation this year to repeal the IDC and percentage depletion tax benefits. "I wouldn't be surprised" if Schumer or others, such as members of tax-writing committees who are critical of oil and gas, introduced similar bills next year, Fuller said.

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