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Devon's Nichols Says Proposed Tax Hikes Would 'Cripple' Industry

The Obama administration's proposals to repeal tax breaks for oil and natural gas producers in the fiscal 2010 budget "are aimed at crippling our industry," Devon Energy Corp. CEO Larry Nichols told a Senate Finance subcommittee last Thursday.

"These proposals are based on myths rather than facts," he said during a hearing on the Obama tax proposals held by the Senate Energy, Natural Resources and Infrastructure Subcommittee.

Natural gas prices have plunged 75%, while oil prices have fallen 50%, and "now the administration proposes to further weaken an industry that is already suffering," he said. Sen. Jim Bunning of Kentucky, the ranking Republican on the subcommittee, echoed the sentiment, saying that "with America in the midst of a recession now is not the time to impose new taxes on oil and gas."

Nichols noted that an Obama administration document says the current tax system encourages over-production of oil and natural gas, and that this is detrimental to the long-term security of the nation. "That's absurd. I have never heard anyone reading this document think that we had a problem with producing more oil and gas," he said. "It makes absolutely no sense to discourage production from our leading sources -- oil and gas."

Nichols, also chairman of the American Petroleum Institute (API), further told the subcommittee that "increased taxes represent real increases in the cost of doing business" for producers. They will mean fewer jobs, less exploration, fewer wells and higher consumer prices, he said.

"Congress' choice is straightforward: reduce American oil production by 20% and its natural gas production by 12% or retain the current historic tax policies that have encouraged American production," said H.G. "Buddy" Kleemeier, chairman of the Independent Petroleum Association of America and CEO of Oklahoma-based Kaiser-Francis Oil Co.

Stephen Brown, a nonresident fellow with the think tank Resources for the Future, and Alan Krueger, assistant secretary for economic policy at the Treasury Department, agreed that repealing the producer tax breaks would have a "very small" impact on prices and production. Brown noted that the repeal of the tax breaks would account for less than 1% of the projected $3.4 trillion in overall revenues for the domestic industry over the 10-year period.

If the producer tax breaks are repealed, he estimated that consumer prices for natural gas would be pushed up by about 2.4 cents/MMBtu and producer prices would fall by 2.7 cents/MMBtu, for an overall increase in taxation on natural gas of about 5 cents/MMBtu. Brown said the average customer would pay about $1.40 more per year for petroleum products and natural gas over the 10-year period.

The "government should get out of the business of subsidizing oil and gas," said Calvin Johnson, professor of law at the University of Texas School of Law. "No one has yet made a plausible case that a subsidy is needed for oil and gas," he noted.

Nichols estimated that the Obama administration proposals call for more than $80 billion in new taxes for the oil and gas industry over the next 10 years (see NGI, April 6). An estimated $30 billion of the proposed tax hikes would be aimed directly at producers, while several indirect tax hike proposals -- such as reinstatement of the Environmental Protection Agency's Superfund tax, repeal of last-in-first-out accounting and reform of the international tax policy -- would push the tax burden up even further for producers. The additional tax revenue from oil and gas would be earmarked for renewable fuels and other alternative energy sources.

With respect to the tax hikes directly targeting producers, the Obama administration seeks to eliminate the preferential time period treatment for geological and geophysical amortization for independent producers (estimated to cost producers $1.19 billion over 10 years); the deduction for tertiary injectants ($62 million); the expensing of intangible drilling costs ($3.35 billion); the Section 29 manufacturing credit for oil and gas companies ($13.29 billion); and the passive loss exemption for working interests in oil and gas ($49 million); and repeal the percentage depletion for oil and gas ($8.25 billion). The proposed tax hikes would take effect Jan. 1, 2011 (see NGI, May 11).

The fiscal 2010 budget also would increase permitting fees and repeal royalty incentives, as well as impose new inspection fees, a fee on nonproducing leases and an excise tax on offshore production.

"For now, we view the risk of these [tax repeal] proposals being included in final energy legislation and enacted as low. Current energy proposals do not need 'pay-fors' (revenue raisers) and climate legislation could potential raise plenty of revenue without touching existing tax credits for other industries," wrote energy analyst K. Whitney Stanco of Washington Research Group in a "Washington Energy Bulletin" last week.

Also working against the tax repeal proposals is the fact that "the economic consequences of limiting oil and gas development [would] now affect multiple states where vast shale plays have been discovered. Some of those states are represented by moderate Democrat legislators [who] must now also consider the employment and economic benefits of regional resource development when deciding how to vote on energy policy," Stanco said.

The total value-added contribution of the oil and gas industry to the national economy was more than $1 trillion, or 7.5% of the U.S. gross domestic product in 2007, the most recent year for which data was available, according to a report commissioned by API and prepared by PricewaterhouseCoopers (PwC).

"The economic impact of the oil and natural gas industry reaches all 50 states and the District of Columbia," PwC said in the report released last Thursday. The top 15 states, in terms of the total number of jobs directly or indirectly attributable to the oil and gas industry's operations in 2007, were Texas, California, Oklahoma, Louisiana, New York, Pennsylvania, Florida, Illinois, Ohio, Colorado, Michigan, Georgia, North Carolina, Virginia and New Jersey, the report noted.

While the odds may be low for Capitol Hill to roll back the tax breaks for oil and gas this year, "we believe the issue of deepwater royalty relief may gain momentum [in Congress] later this fall if the Supreme Court chooses not to issue a writ of certiorari on the Obama administration's July petition for the court to review a January appeals court decision blocking the government from collecting royalty payments from certain offshore leases," Stanco said.

In July the Department of Justice (DOJ) asked the Supreme Court to overturn an appeals court ruling that has allowed Anadarko Petroleum Corp. to avoid paying royalties allegedly owed over a four-year period on eight oil and natural gas leases in the Gulf of Mexico (see NGI, July 20). In its filing to the Supreme Court, DOJ said if the ruling were to stand, other producers could avoid paying royalties that "will likely cost the United States at least $19 billion in forgone or refunded royalties."

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