Tax hikes on the domestic oil and natural gas industry could put production at significant risk next year and through the coming decade, according to a new study commissioned by the American Petroleum Institute (API) and conducted by Wood Mackenzie. API said it plans to hold a number of citizen rallies in the coming months to promote and protect American energy jobs while also laying out its concerns on energy legislation, which it said could damage the economic recovery.

The study, "Evaluation of Proposed Tax Changes on the US Oil & Gas Industry," targeted changes to the intangible drilling costs (IDC) and the domestic production activities deduction (Section 199) incentives as having the greatest impact on industry. If passed, the break-evens for the average gas and oil development shift from $5.40/Mcf and $47/bbl to $6/Mcf and $52/bbl, respectively, according to the study.

"The study illustrates a fundamental rule of economics: tax something more, get less of it," said API CEO Jack Gerard. "But more important than the lost production is the loss of thousands of jobs that would follow. Advocates of higher taxes should understand who would really be hurt."

Under the proposed revisions to IDC and Section 199 deduction pending in Congress, the study said 88 of the 230 plays/fields considered for this analysis fell below a 15% internal rate of return (IRR) threshold. Higher taxes could reduce domestic oil and gas production next year and cut it by as much as 10% in 2017, the study concluded.

"The incentives have increased U.S. energy production and jobs, and other industries enjoy the same or similar incentives," Gerard continued. "Proposals to eliminate them for oil and gas alone would discriminate against an industry that already pays federal income tax at an effective rate more than 70% higher than the other S&P Industrials."

The study estimates that the adverse impacts of tax increases would be worse for natural gas. Almost 90% of the plays falling below a 15% IRR are gas targets, while oil is shielded by price assumptions greater than $80/bbl. Wood Mackenzie found that the producing regions of the Gulf Coast onshore, Midcontinent and Rocky Mountains are disproportionately affected by the proposed tax changes. Over $12 billion of the total $15 billion of investment at risk in 2011 is directly related to these three onshore regions.

The study found that even the plays that do not fall below the economic threshold yield much lower returns and development could be impacted over the long-term. A typical Marcellus well in Pennsylvania has a typical IRR that drops from 27% to 21% and the prolific Pinedale field of Wyoming has typical returns drop from 29% to 22%, Wood Mackenzie said.

"Total resources not produced could reach as high as 27 Tcf of gas and 700 MMbbl of oil over the next 10 years," the study concludes. "Almost half of the gas plays we consider to have future development potential are at risk under the proposed tax changes. The gas plays that become sub-economic are not only great in number, but represent more than 10% of the gas that will be produced over the next 10 years."

Under the proposed tax changes, Wood Mackenzie estimates a total of 300,000-600,000 boe/d of production additions in 2011 are at risk. Total at-risk volumes include 57,000 b/d and 2.9 Bcf/d in 2011, with as much as 250,000 b/d and 9 Bcf/d at risk by 2017. These volumes account for approximately $10-17 billion in direct upstream investment per annum.

To complete the study Wood Mackenzie utilized its upstream database of 230 play and field files with future development potential to test the impact of proposed tax changes in Alaska, the Lower 48 and the U.S. Gulf of Mexico. Economics for a typical well in each play and full field development was calculated in Wood Mackenzie's Global Economic Model (GEM) to determine what impact the current proposal could have on U.S. production and investment.

Wood Mackenzie did allow that it does not expect the full effect of the tax changes would be realized as 55 of the 88 sub-economic plays already provide a return of less than 15% without the additional tax burden. This reflects current low gas price expectations and suggest that volumes impacted could be less than considered in its analysis, the company said.

In a separate initiative, the API pointed out that the energy industry is of great importance because it currently supports 9.2 million jobs. "More energy equals more jobs, higher incomes and greater economic growth," API said. "We must come together to tell Washington that our livelihoods depend on the oil and natural gas industry and consumers who rely on access to affordable energy will not be overlooked. Throughout September, thousands of Americans will assemble together to call upon the government to re-open the gates of American energy prosperity."

The first rallies are to be held in the Texas cities of Corpus Christi, Beaumont and Houston on Sept. 1; followed by Canton, OH, on Sept. 7; Joliet, IL, and Farmington, NM, on Sept. 8; and Grand Junction, CO, on Sept. 11.

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