The Most Targeted Oil & Gas ‘Subsidies’ Aren’t Subsidies at All

More than 50 lawmakers are pushing for the repeal of oil and natural gas industry “subsidies” as part of the budget reconciliation bill currently being hashed out in Congress. But ironically, the two most notable “subsidies” in their crosshairs – the expensing of intangible drilling costs (IDCs) and the percentage depletion allowance – aren’t subsidies at all.

A subsidy is defined as “a sum of money granted by the government or a public body to assist an industry or business so that the price of a commodity or service may remain low or competitive.” In other words – a direct government handout. IDCs and percentage depletion are in no way, shape or form government handouts. They are actually tax provisions that have been part of the United States tax code for 108 and 95 years, respectively. The U.S. tax code has always allowed the oil and gas industry, along with a vast majority of the manufacturing sector and households, to utilize tax provisions so that they are only taxed on net income.

IDCs and percentage depletion are also anything but “Big Oil” tax breaks. IDC deductions and percentage depletion are used almost exclusively by small, independent producers who produce less 1,000 barrels of oil per day (BOPD). In Illinois, all but four of the state’s 1,500 operators produce less than 1,000 BOPD. The 50-plus lawmakers targeting these tax provisions say they “simply enhance profits of fossil fuel companies” and do “nothing” to create jobs and reduce dependence on foreign oil, but the opposite is true.

Intangible drilling costs are expenses associated with drilling a well that cannot be salvaged, including employee wages, contract labor, fuel and service costs. All told, they account for roughly 85 percent of an oil and gas producers’ total expenses, according to The Petroleum Alliance of Oklahoma. Small oil producers, like almost all businesses, are able to deduct these ordinary business expenses from their gross income so that they are taxed only on their net income. The Petroleum Alliance of Oklahoma estimates the elimination of intangible drilling costs would result in an immediate 25 percent tax hike on oil and gas producers and a similar reduction in drilling activity.

Percentage depletion is very similar to the non-mineral depreciation deduction that all U.S. companies are allowed to utilize. It can only be used by only the smallest oil and gas companies that make less than 1,000 BOPD and wells making less than 15 BOPD. Oil and gas producers should be the last companies denied the ability to depreciate their assets, considering oil reserves are a textbook definition of a depleting asset. Unlike assets such as a building or machinery, which can retain value even when they depreciate to zero value for tax purposes, oil and gas wells not only eventually lose all value as they become exhausted, but incur costs because they have to be plugged and abandoned. Percentage depletion allows small oil companies to plan for plugging and abandoning wells in addition to retaining a portion of their earnings.

The only way for an oil producer to replace depleting resources is to drill new wells. Otherwise, they go out of business – plain and simple. And considering drilling wells is an inherently risky endeavor (only about 60 percent of wells drilled are successful) these tax provisions are fundamentally necessary and appropriate. After all, deducting the cost of doing business is standard practice for all businesses, and oil and gas companies pay every dime of tax revenue they owe. In fact, the American Petroleum Institute notes that the U.S. oil and gas industry paid an effective tax rate of 34 percent between 2013 and 2017, compared to 26.7 percent for the S&P industrials.

Despite the narrative that fossil fuel companies are heavily subsidized, a recent analysis by the non-partisan Energy Information Administration (EIA) found that in Financial Year 2016, oil, natural gas and coal companies received just seven percent of federal energy subsidies despite supplying 78 percent of the country’s energy. On the other hand, the analysis found renewable, nuclear energy and other non-carbon energy industries obtained 93 percent of federal energy fuel subsidies in FY2016 despite generating just 22 percent of the country’s energy.

Much has been said and written about oil and natural gas “subsidies” lately. But often overlooked is the fact the two most talked about “subsidies,” intangible drilling costs and percentage depletion, aren’t subsidies at all. Without them, the small oil producers most prominent in the Illinois Basin would not be able to continue producing the oil, jobs, tax revenue and royalty income our state and country need now more than ever.

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