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Delaying recovery of federal tax deductions covering oil and natural gas drilling expenses could cost companies billions of dollars, kill thousands of jobs and threaten production, according to newly released results of an industry study. “What it means is less drilling, less discoveries, less employment and more imported oil,” said David Neal, a tax and consulting partner with Whitley Penn LLP in Fort Worth.
Fearing such potential repercussions, the American Petroleum Institute commissioned the study on how delaying recovery of intangible drilling costs could affect energy companies. Currently, energy firms quickly recover those expenses – what companies spend to develop oil or gas wells such as site preparation and labor – but a proposal to delay reimbursement has some companies worried. They depend on prompt recovery of those drilling costs, which represent billions of dollars spent on U.S. drilling operations each year.
Seeming to validate those worries are results of the study conducted by Wood Mackenzie, a consulting firm. By 2019, 233,000 jobs would be lost as a result of delaying the deduction, the study found. And by 2023, more than 3.8 million barrels of oil equivalent per day would be lost from U.S. oil and gas fields while U.S. industry investment would drop by $407 billion between 2014 and 2023, an annual average exceeding more than $40 billion, according to the study. Delaying the deduction would negatively impact job growth, the study said, as companies restrict spending, leading to less drilling activity. The Permian Basin could be especially hard hit, with the West Texas-southeastern New Mexico shale play losing 216 million barrels of oil equivalent per day from the 2.9 billion barrels expected to be produced in 2023, according to the study. “The greatest impact would be in central and West Texas, from Abilene to west to the Permian Basin,” said Neal, reasoning that the stretch represents a hefty chunk of the state’s drilling activity.
But delayed cost recovery is just one issue. Another potential impact of proposed tax reform threatens percentage depletion deductions for smaller independent producers and individual investors. That’s drawn concern from industry groups such as the Independent Petroleum Association of America, determined to protect the oil and gas industry’s “working interest” exclusion from categorization as passive income for tax purposes. Depletion, a form of depreciation for mineral resources, allows deductions from taxable income to reflect less reserve production over a period of time, according to energytaxfacts.com. Percentage depletion is calculated by applying a 15-percent reduction to the taxable gross income of the property supporting a productive well.
“It’s going to hit the small producers bigger than the big guys,” said Neal, who has spent 35 years representing oil and gas industry clients with accounting and consulting services. That’s because percentage depletion is limited to the first 1,000 barrels of daily oil production. Chesapeake Energy Corp., Quicksilver Energy Corp. and other industry heavyweights produce much more than that amount, so they do not qualify for that deduction. “So it’s going to hit the smaller producers bigger than the big guys,” said Neal, pointing out that the nation’s smallest wells comprise a major part of U.S. oil and natural gas production. In fact, those wells produce less than 15 barrels of oil per day but collectively represent nearly 19 percent of domestic oil production and less than 90,000 cubic feet per day. Those with smaller operations look to percentage depletion to recover some costs required to keep those wells operating. Though both measures have not been enacted, Neal is not optimistic. “I think it will reach fruition. I think it really is in the context of major tax reform.”