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Producer Tax Proposals Absent from Congressional Budget Blueprints

The nearly $3.5 trillion budget resolutions passed by the House and Senate last Thursday had some moderately good news for producers -- they did not include the $32.6 billion tax hike on oil and natural that President Obama proposed for fiscal year 2010, at least not at this stage of the budget process (see NGI, March 2).

The tax hike proposals were stripped out of both budget resolutions by the House and Senate budget committees, according to spokesmen for Rep. Gene Green (D-TX) and Sen. Mary Landrieu (D-LA), who voted for the budget blueprints only after the language on the oil and gas tax increase was struck.

But the situation could change as the House and Senate "are leaving the door open for discussion" of the proposed oil and gas tax hike during conference or later on, said Green spokeswoman Brenda Arredondo. The House-Senate are expected to begin conference on their budget resolutions when they return from a two-week recess on April 20.

"We fought to remove oil and gas taxes that were a direct assault on domestic drilling [and] contentious climate change legislation...These initiatives were bad policy and should not be fast-tracked through the Senate. They could have hurt the businesses that drive our state's economy," said Landrieu, who worked with Senate Budget Chairman Kent Conrad (D-ND) to carve out the oil and gas taxes.

The budget resolution cleared the Senate by a vote of 55-43, while the House voted 233-196 in favor of the Democratic budget proposal.

"They [budget resolutions] don't have presumptions about any oil and gas taxes, and no reconciliation instructions" on how to finance the president's energy priorities, said Lee Fuller, vice president of government relations for the Independent Petroleum Association of America, which represents independent producers. These are good signs for producers, he noted.

"But we're still a target certainly and will continue to work aggressively to explain [to lawmakers] the impact" that such taxes would have on independent producers, Fuller said (see NGI, March 30).

Even if the proposed $32.6 billion tax hike on oil and gas does materialize later, Raymond James & Associates energy analysts don't believe that it will be all that paralyzing. Of course "the industry would rather not see higher oil and gas taxes. But in the grand scheme of things, it's not a catastrophe," assuming the intangible drilling costs (IDC) are left untouched, Raymond James analysts said in an energy "Stat of the Week" last Monday.

The proposed tax hike of $32.6 billion, or $3.3 billion annually over 10 years, would equate to only 1% of the projected annual revenue of $327 billion for the oil and gas industry as a whole for that period, according to Raymond James. This assumes the "worst-case scenario" that every single one of Obama's 10 producer tax proposals will be enacted, which it believes is unlikely. The annual revenue of $327 billion is based on Raymond James' assumptions of 65 Bcf/d for gas production and 7.5 million b/d for oil production, and projected 2010 prices of $6/Mcf for gas and $65/bbl for oil.

"We are not arguing that every company will 'lose out' by 1% -- clearly there will be differences from company to company. For example, operators whose drilling budgets are especially sizable relative to their revenue, which includes many aggressively growing E&P [exploration and production] small-caps, would be disproportionately affected by the repeal of IDC expensing," Raymond James said.

"About half of the [president's 10 tax] provisions are almost certain to pass [in Congress], in our view, either because they are immaterial [four repeals are expected to raise little or no revenue] or politically popular [excise tax on Gulf of Mexico production]...Two of these provisions are not expected to raise any revenue in the next decade. This is presumably because the commodity prices in the OMB's [Office of Management and Budget] forecast -- which have not been detailed -- are higher than prices at which these tax breaks are activated," Raymond James said.

"The most controversial aspect of the proposed [budget] plan -- abolishing the favorable tax treatment of intangible drilling costs -- appears to be the least likely to be enacted [by Congress]. And while high taxes are never much fun, the irony is that on the margin, they could actually lead to higher gas (and, to a lesser extent, oil) prices by reducing domestic drilling activity," the analysts said.

Raymond James estimates that the odds of Congress repealing IDCs is only 30%. "We think it's likely that some Democrats from oil/gas producing states, such as Louisiana's...Landrieu, will be inclined to support the industry on this point. For one thing, higher taxes on 'Big Oil' are often popular among the general public, but there is rarely the same voter sentiment aimed against independents," the analysts said.

Repealing IDCs would be "inherently harmful for E&P companies, and from our discussions with operators this is generally the most objectionable thing they see in the bill," Raymond James noted, adding that E&P budgets could be be cut by as much as 25-30% if this were to pass.

The proposed higher taxes, which would not kick in until 2011, are "not at all" a done deal for producers, according to Raymond James. "It is entirely possible that some of these [tax] provisions could be amended or tossed out altogether (which we see as likely in at least one instance), but by the same token, new ones could be introduced. Democrats are obviously in control of both the White House and Congress. But as with any budget, the process will still be long (months, not weeks) and unpredictable.

"As [the Prussian statesman Otto Eduard Leopold von] Bismarck once said, making laws is like making sausages: Even if the final product tastes good, it's best not to watch how it's made. Truer words have never been spoken."

As for other Obama tax measures, Raymond James believes that a repeal of the percentage depletion for oil and gas has less than a 50% chance of being enacted. "This would abolish a tax deduction (the allowable percentage is 15% of gross income, subject to other limits) that is only available to independents...The tax deduction is most relevant in places like the Permian Basin that have primarily mature wells...It is likely that the Treasury would lose tax revenue with this policy (can somebody please give these guys a calculator?)," the analysts said.

Likewise, Raymond James believes that Obama's proposed increase of geological and geophysical amortization period for E&Ps to seven years has only a 50% chance of being enacted. It sees the proposed repeal of the Section 29 manufacturing tax deduction for oil and gas producers, which the Obama administration projects would raise $13.3 billion over 10 years, as having a higher chance of being passed -- 70%.

Raymond James gives the proposed excise tax on Gulf of Mexico production a 90% chance of being enacted. "But it's really a non-event for most Gulf of Mexico producers...because it will only affect companies that do not already pay the normal royalties rate in the Gulf on certain specific acreage," it said.

"The intent of [the] provision is to rescind a 'loophole' (although the industry may disagree with this term) included in certain 1998-1999 lease contracts due to a bureaucratic snafu at the Department of Interior."

While all of the attention has been focused on the Obama administration's proposed $32.6 billion tax hike on producers, the American Petroleum Institute (API) believes that the tax burden on producers could be more than double this, if all of the tax proposals are enacted by Congress.

The proposed $32.6 billion tax increase includes only those initiatives aimed solely at producers, said API spokeswoman Cathy Landry. But there are several other tax hike proposals -- such as reinstatement of the Superfund tax, repeal of last-in-first-out (LIFO) accounting and reform of the international tax policy -- that are directed at all companies and could add to producers' tax load, she noted.

These three tax proposals, which were included in the president's budget blueprint for fiscal year (FY) 2010, "are targeted at all industries, but some of them will disproportionately affect oil and gas," Landry said.

The proposed reinstatement of the Superfund tax would result in the collection of $17.2 billion, a large chunk of which would be paid by oil and gas, she said. Repeal of LIFO accounting would net $61 billion and would have a huge impact on refineries. And reform of the international tax policy, which would affect all companies, would result in an additional $210 billion for the federal government, she noted.

The API's "best guesstimate" is that the total impact of Obama's tax proposals on the oil and gas industry could be more than $80 billion over a 10-year period, Landry said, adding that this is a "conservative estimate." She also quickly added that the figure did not include the projected costs associated with a cap-and-trade system to limit carbon emissions.

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