Although independent oil and natural gas producers would likely disagree, Raymond James & Associates energy analysts don't believe that President Obama's proposal for a $32.6 billion tax hike on producers in his fiscal year 2010 budget 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" 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 Sen. Mary 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."
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