Capital Infusion: Policy Spotlight: Changes in Tax Incentives/Preferences Impacting Oil & Gas Industry
In April of this year, the Obama Administration released the 2014 Fiscal Budget for the federal government which sets forth estimated expenditures of $3.78 trillion, estimated revenues of $3.03 trillion and a budget shortfall of nearly $775 million. The Obama Administration has set forth two major goals: the doubling of domestic energy productivity by 2030, and the cutting of net oil imports by 50 percent by 2020. In order to achieve these goals, the Administration is focused on supporting cost-competitiveness and the deployment of renewable power, electric vehicles, advanced biofuels, innovative manufacturing processes, and energy efficiency in buildings. Balanced against a number of significant spending increases and tax incentives for the clean/renewable energy industry totaling nearly $30 billion over the next 10 years is the elimination of a number of tax incentives and subsidies for the fossil fuel industry totaling nearly $4 billion in 2014 and more than $40 billion over the next 10 years.
The proposed budget will impact the oil and gas industry in particular by repealing or otherwise modifying a number of federal income tax incentives and preferences including the following:
- The repeal of expensing of intangible drilling and development costs
- The repeal of percentage depletion for oil and natural gas wells
- The repeal of the domestic manufacturing deduction for oil and natural gas companies
- An increase in the geological and geophysical amortization period for independent producers to seven years
- The repeal of the exception to passive loss limitations for working interests in oil and natural gas properties
- The repeal of the enhanced oil recovery credit
- The repeal of the credit for oil and gas produced from marginal wells
- The repeal of the deduction available for tertiary injectants
In addition to eliminating the enumerated tax subsidies and preferences above, the proposed budget pledges $2 billion of federal oil and gas royalties over 10 years to a new Energy Security Trust, which would fund research of alternative energy sources. It also proposes to increase the Oil Spill Liability Trust Fund financing rate by 1 percent and to reinstate Superfund taxation – expected to cost the energy industry as a whole more than $21 billion over the next 10 years. Oil and gas producers and refiners would be further affected by additional restrictions on the use of the foreign tax credit by U.S. multinationals and the repeal of last-in, first-out (LIFO) methods of accounting for inventory. These changes could cost the oil and gas industry nearly $81 billion over the next 10 years.
The Administration’s budget proposal also has the coal industry squarely in its sights. The proposed budget will impact the coal industry as well by repealing or otherwise modifying a number of federal income tax incentives and preferences including the following:
- The repeal of expensing of exploration and development costs
- The repeal of percentage depletion for hard mineral fossil fuels
- The repeal of capital gains treatment for royalties
- The repeal of the domestic manufacturing deduction for coal and other hard mineral fossil fuels (repeal)
The 2014 budget proposals summarized above, which are aimed at the fossil fuels industry, are similar to the Obama Administration’s proposals for the 2011, 2012 and 2013 budget years. While many continue to believe that such proposals were (and will continue to be) “dead on arrival” due to deep inter- and intra- party disagreement over spending cuts and the debt ceiling, Congressional action on any number of these tax incentives could occur outside of the passage of a fiscal 2014 budget (which most speculate will not happen), which could have a significant impact on the oil and gas industry. That said, as Congress returns to work, the world will be watching as they focus on short-term stop gap measures, including a temporary funding bill, spending caps and a debt ceiling increase to get the country past several key deadlines this fall.
 Intangible Drilling and Development Costs (IDCs) typically represent a majority of the cost of an oil or gas well and include current charges for wages, fuel, repairs, transportation, etc. that are incident to and necessary for the drilling of wells or the preparation of wells for the production of oil or gas. The election to deduct these drilling costs currently, rather than amortizing them over the life of the well, allows these costs to be treated like most other operating costs of other businesses. Delaying the timing of these deductions by eliminating IDC expensing would significantly impact the cash flows and rates of returns associated with wells.