Producers may have dodged a bullet on the windfall profits tax (see Daily GPI, Dec. 3), but majors and independents still are concerned that Congress may revise or strip away existing tax benefits for oil and natural gas to offset revenue losses and narrow the budget deficit.

“There’s a lot of ways to skin this cat,” said Rayola Dougher, senior economic adviser for the American Petroleum Institute (API), which represents major oil and gas producers. “There are all sorts of ways [other than the windfall profits tax] that they could go after” producers.

Both major and independent producers are concerned that Democrats may revise current tax policy for intangible drilling and development costs (IDC). Independents also are worried about potential changes to percentage depletion benefits in the 111th Congress.

“These provisions — mainstays to providing capital to develop and maintain American oil and natural gas production — have long been targets of liberal tax reformers,” the Independent Petroleum Association of America (IPAA) said in its “Washington Report” Tuesday.

The erroneous belief that all producers are Big Oil and an increasing emphasis on pay-as-you-go rules to offset revenue losses “can drive very bad policy decisions, pitting one energy source against another when we need it all,” said Lee Fuller, IPAA’s vice president of government relations.

Existing tax policy allows producers to deduct IDC in the year that the costs are incurred. However, Fuller said he’s now concerned that this may be changed, requiring producers to deduct costs over a longer period of time (possibly five years). This would mean that producers wouldn’t get their capital back quickly, and drilling activity would slow.

“The IDC helps keep domestic projects economically competitive with overseas projects,” said Mark Kibbe, API’s director of federal relations and tax expert. Without the tax treatment for IDC, which has been in effect since 1918, U.S. oil and gas production would be severely hampered, he noted. “Congress has a choice.”

Oil and gas tax benefits are always vulnerable “when there’s a budget deficit and Congress is looking for pay-fors…revenue offsets,” Kibbe said. He said it’s “possible” that Congress also may reduce or fully repeal the Section 199 manufacturing deduction, which lawmakers froze at 6% for the oil and gas industry. The deduction is 9% for all other industries. It allows producers to deduct 6% of their U.S.-derived income each year.

He further said a proposal by Sen. Jeff Bingaman (D-NM) to impose a 13% severance tax on Gulf of Mexico production “could very well” resurface in Congress next year. With the severance tax, Bingaman is seeking to recoup some of the lost revenue from the faulty deepwater leases that were issued by the Interior Department in 1998 and 1999.

The IPAA’s Fuller fears that percentage depletion, which has been denied to integrated producers since the mid-1970s, may be stripped from independents. The percentage depletion benefit for independents already has a number of restrictions on it — it’s available for only the first 1,000 b/d; is capped at 15% (used to be 27.5%) of the income per well; and is capped at 65% of the net income of the company, among other limits.

He believes that if Democrats offer a broad tax reduction, they may go looking to peel from the oil and gas industry existing tax incentives to pay for the broader tax cut.

The favorable tax benefits help independent producers attract investment capital, Fuller said. “We’re concerned that that’s not understood by Congress very well.” Far-left politicians believe that the favorable tax treatment only benefits Big Oil, he noted, adding that they fail to realize that increased gas production is critical to reducing greenhouse gas emissions.

In response to these possible threats, IPAA has initiated an analysis of the role that the tax policies play in developing domestic energy. The analysis will be done by PricewaterhouseCoopers experts who have worked with federal revenue estimating and tax policy and with the energy industry. The results are due out in February, according to Fuller.

“We hope to position ourselves to educate Congress and the administration” about the impact that tax changes would have on the industry’s ability to find and produce natural gas, he said.

Fuller noted that Sen. Charles Schumer (D-NY) introduced legislation this year to repeal the IDC and percentage depletion tax benefits. “I wouldn’t be surprised” if Schumer or others, such as members of tax-writing committees who are critical of oil and gas, introduced similar bills next year, Fuller said.

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