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Producers Brace for Early House Action on Tax Breaks, Faulty Leases

The Democratic-controlled House, when it convenes Thursday, is expected to hit the ground running with several measures that have oil and natural gas producers, particularly independents, worried.

"It's going to be a challenging year," said Lee Fuller, vice president of government relations for the Independent Petroleum Association of America (IPAA), which represents independent producers.

He believes one of the "most probable" issues on the Democrats' plate is the revision or repeal of producer tax breaks that were included in the Energy Policy Act of 2005 (EPAct). Fuller is concerned that the House may tinker with an EPAct provision that established a 24-month amortization for the expensing of geological and geophysical costs primarily for independent producers. Congress, in a separate tax package in 2005, created a five-year amortization period for the geological and geophysical expenses of the top integrated energy companies.

The House "could come back and revisit that provision [in the 2005 tax package] or do something more broadly" that could affect the 24-month amortization period for independents, Fuller said.

The top majors, including Shell, BP and ExxonMobil, told Congress last year that they didn't need the tax incentives, but an IPAA spokesman noted "our members really rely on that financial kickback to make the initial investment in exploration and production potentially profitable."

Democrats also plan to tackle the issue of the missing price thresholds in the deepwater Gulf of Mexico oil and natural gas leases that were issued by the Interior Department in 1998 and 1999. The absence of the price thresholds, which trigger the payment of royalties when market prices exceed certain levels, is costing the federal government billions of dollars in lost revenues, according to the Government Accountability Office.

One option being considered is the creation of a conservation fee that would be collected from the holders of the 1998-1999 royalty-free leases when the market price for oil and gas rises above a certain level, Fuller said. The conservation fee would be on par with whatever a producer should be paying in royalties under the 1998-1999 leases, he noted.

A second option calls for the House to pass a proposal, sponsored by Reps. Edward Markey (D-MA) and Maurice Hinchey (D-NY), to bar the holders of the 1998-1999 leases from bidding on future government leases if they refuse to renegotiate their existing contracts with Interior's Minerals Management Service (MMS). Fuller said the House may consider either or both proposals in the first 100 hours of the 110th Congress.

The problem with the 1998-1999 offshore leases issued by MMS was that they failed to include price ceilings. The lease price ceilings cut off royalty relief to producers when oil and gas prices reach a certain level. Without this cut-off point in the 1998-1999 leases, producers who negotiated leases in those two years have escaped paying royalties on production up to a specific volume limit. The price caps that trigger royalties were included in leases that were issued in 1996, 1997 and 2000, but were inadvertently omitted in the 1998-1999 leases due to a mistake on the part of the MMS. Congress has put pressure on producers to renegotiate these leases with the MMS, but only a handful have done so to date.

House Democrats also may seek to repeal a tax deduction in the "American Jobs Creation Act of 2004" for companies engaged in manufacturing, including oil and natural gas producers, Fuller said. Another "dynamic" that could affect IPAA members is a change in the federal pay-as-you-go process, which would require future tax reductions to be offset by tax increases elsewhere.

He believes the proposed measures have a good chance of clearing the House. "I would anticipate whatever they put on the table in the House in the first 100 hours will pass the House," Fuller told NGI. But the Senate will be a bit more slow to act, more deliberative. For instance, he noted that issue of the faulty 1998-1999 offshore leases captured some attention in the Senate last year, and "it clearly will have attention in the Senate [in the year ahead], but exactly how they will approach it is unknown."

Fuller doesn't expect greater access to the Outer Continental Shelf (OCS) to be immediately considered in the new Congress. "I don't know that anything will be identified there quickly," he said. But there could be some activity later. Natural gas prices, in particular, and energy security "may put greater pressure on Congress" to reconsider elements of the broader House OCS bill, which was jettisoned in the final days of the 109th Congress in favor of a more limited Senate version that provided access to the Lease Sale 181 area in the eastern Gulf. The Senate bill was ultimately passed by Congress and signed into law by President Bush (see Daily GPI, Dec. 21, 2006). The House bill would have lifted the moratorium on drilling off the Pacific and East Coasts.

Congressional action on broadening access to the OCS this year "will be driven a lot by what happens to oil and gas prices over the next six months," Fuller said.

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