In his long-awaited $3.77 trillion budget for fiscal year (FY) 2014 unveiled last Wednesday and forwarded to Congress, President Obama again sought to repeal tax breaks for oil and natural gas producers. He also proposed tacking on new fees and increasing oil and gas royalties to fund renewable fuel development, as well as elevating spending for the Commodity Futures Trading Commission (CFTC).
The budget proposes to unwind annually $4 billion oil and gas tax incentives, which have been part of the tax code since the 1920s, said Jeff Eshelman, a spokesman for the Independent Petroleum Association of America (IPAA). He noted that the tax provisions allow oil and gas producers to deduct certain expenses so that they can reinvest in other projects. Repealing the benefits would impact smaller producers the most, he said.
Obama has proposed repealing the oil and gas tax provisions since he took office, but he has been defeated by Republicans at every turn (see NGI, July 4, 2011). However, Eshelman told NGI that he believes the tax benefits could be more vulnerable this time because of the pressure to control the budget. “I think we have to be extremely vigilant to educate Congress on the necessity of the tax provisions.” The oil and gas industry is the one bright spot in the U.S. economy, he added.
The Obama budget specifically targets eight tax benefits for oil and gas producers, including expensing intangible drilling costs (IDC), percentage depletion and the 199 manufacturing deduction, which allows energy firms and other companies to deduct 6% of their qualifying incomes. The administration estimates that the roll-back, which is in the Department of Energy (DOE) proposed budget for FY 2014, would raise $44 billion over the next decade.
IDCs are all the costs involved in drilling a well, including drilling contractors, ground-clearing work, hauling and supplies, and are typically 65-80% of the well cost. Calling IDCs a subsidy is a mischaracterization, since IDCs involve deductions of business expenses, not subsidies, contend producers and producer groups.
And percentage depletion was specifically intended to encourage the participation of small natural gas and oil producers. The deduction has been part of the tax code since 1926 and is only available on the first 1,000 boe/d. By allowing for the recovery of capital investment over time, it is essential to meeting the costs of operating marginal wells, said the groups.
“We believe that the eventual funding bills will not reflect the president’s [budget] proposal,” said the Well Fargo Securities LLC Energy & Utility Team. “An adage on Capitol Hill is that the president proposes, and Congress disposes. That said, some of our Hill contracts previously said that some provisions could be incorporated into a larger overhaul of the tax code. We’ve also been told that the Republicans will not go along with a repeal of the  domestic manufacturing tax credit for only oil and gas.”
IPAA Chair Virginia Lazenby, who is CEO of Nashville-based Bretagne LLC, blasted Obama’s 2014 budget plans.
“Independent oil and natural gas producers currently reinvest 150% of their capital budgets into new energy projects, and by doing so, they keep the economy moving. The tax treatment is crucial to the business decisions of these companies.”
Lazenby said if the president’s budget proposal were enacted, independent producers, which drill 95% of the nation’s wells, could reduce their capital investments by up to 25%, which would result in fewer jobs, less revenue to government treasuries and a step back from achieving energy security.
The IPAA chair also took issue with Obama’s proposal to hike royalties and fees in the Interior Department budget. “The president’s budget…outlines a series of royalty and fee increases, as well as policy changes that will make it harder for independent producers to operate on federal lands,” she said.
“The administration claims to support oil and natural gas development on federal lands, but the proposed list of increased fees, royalties and regulations will only make it more burdensome for small producers to operate on federal lands and waters.”
Since the White House has essentially recycled its budget from last year, the American Petroleum Institute recycled its 2012 statement on the budget. API President Jack Gerard expressed disappointment with the proposed tax increases, especially in light of the president’s apparent endorsement of more domestic oil and natural gas development in his State of the Union address.
The administration also seeks to increase fees on nonproducing leases on federal lands. The budget in addition would hike oil and gas permit processing and other administrative fees, so that industry would share some of the cost of federal permitting and regulatory oversight for these activities. It also would repeal a law that has allowed offshore producers to escape payment of royalties in past years.
In addition, the president’s budget includes $18.6 million for Interior to continue participating with the Environmental Protection Agency and DOE in research efforts on hydraulic fracturing, said Interior Deputy Director David Hayes.
The Interior budget calls on Congress to create a trust fund using $2 billion in royalties from oil and gas production on public lands, to promote the research into advanced vehicles. Another $71 million in funding is proposed for the Interior’s U.S. Geological Survey to study climate change.
Moreover, the budget has offered a proposal to “accelerate [the] conversion to electronic permitting” for oil and gas activities on public lands. “[We want to] take the paper out of our permitting system,” Hayes said.
Overall, the president has proposed $28.4 billion for DOE in FY 2014 and $11.9 billion for Interior. Of the total Interior budget, $771.6 million was earmarked for conventional and renewable energy programs, up by $97.5 million over 2012. This “starts getting the Department of Interior out of the ditch” that the budget sequester plunged the department into, outgoing Interior Secretary Kenneth Salazar said.
On the regulatory side, Obama’s request for a spending increase for the CFTC in FY 2014 is warranted because of the expanded role of the agency in regulating the futures and swaps markets, Chairman Gary Gensler told a House panel Friday. But Commissioner Scott O’Malia argued the agency failed to make a case for a budget hike.
The president’s budget requests an appropriation of $315 million and 12,015 full-time employees for the agency in FY 2014, up from the president’s FY 2013 budget proposal of $308 million and 1,015 employees. The CFTC’s current funding is $207 million prior to sequestration, according to Gensler.
“We recognize that the federal government is operating under a sequester and that budgets for agencies across government require additional scrutiny. Our mission, however, has expanded dramatically. We have a duty to help protect the economy and taxpayers from risks in the financial system,” he said during a hearing of the House appropriations subcommittee on agriculture.
“This is an incredibly strained budget environment. But without sufficient funding for the CFTC, the nation cannot be assured this agency can closely monitor for the protection of customer funds and utilize our enforcement arm to its fullest potential to go after bad actors in the futures and swaps markets.”
In justifying the budget request, Gensler said the futures market, which the agency has traditionally overseen, has grown fivefold. In addition, the CFTC now directly oversees the swaps market, which is eight times bigger and far more complex than the futures markets.
The president’s spending request would provide $44.3 million and 185 employees for the CFTC to conduct more in-depth examinations of the major market participants, such as futures commission merchants, clearinghouses and swap dealers. It sets aside $61.7 million and 174 employees for surveillance, data acquisitions and analytics, up by $18.3 million from the current fiscal year.
The budget also provides a significant increase to $57.7 million for the CFTC’s enforcement activities. Nearly one-third of the overall budget will be earmarked for information technology (internal and external services).
O’Malia said he could not support the budget request for two reasons. “First, I believe the requested funding level of $315 million…is both improbable and unsustainable. Second, this budget fails to provide specifics and makes a broad, unsubstantiated appeal for more resources without the requisite demonstration of either mission priorities or essential deliverables,” he said.
“Expanding our mission to oversee the swaps markets, along with existing oversight of the futures and options markets, is significant” and “cannot be accomplished without modest increases in resources for the Commission,” he said.
“What is questionable, however, is whether the Commission has developed a sufficiently clear plan to achieve this mission, and a sufficiently detailed budget request to reflect such a plan.” He called on Congress to direct the CFTC to “develop such a plan and support our mission by making technology our top budget priority.”
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