The People of America's Oil and Natural Gas Indusry

Study: Higher Taxes Lower Energy Production

Jane Van Ryan

Jane Van Ryan
Posted August 17, 2010

Risk is an integral part of exploring for oil and natural gas. There's no guarantee that drillers will find commercially viable amounts of energy. Yet before they begin, they must invest large sums of money to lease the land, get the needed permits, procure the rig, hire workers, and assemble all of the necessary equipment. Sometimes they find energy; other times they drill a dry hole.

How these costs are treated for tax purposes directly impacts the economics of a project. Though a substantial portion of the costs are recovered over a long period of time, exploration and production companies do get a tax deduction for the labor associated with drilling to defray some of the upfront risk and economic cost.

Additionally, they are eligible for a deduction under Section 199 of the Tax Code-a provision aimed at encouraging job creation and retention by US industry and available for all US manufacturers and producers--for their ongoing production activities. Both of these deductions have been available to the oil and natural gas industry since their enactment.

But now the administration and some members of Congress want to prohibit the industry from using these deductions. The impact on U.S. oil and natural gas supplies could be quite serious.

A new study produced by Wood Mackenzie and commissioned by API shows that the loss of these two deductions could have a particularly onerous impact on domestic natural gas production. When combined with today's low natural gas prices, Wood Mackenzie estimates a total of 300,000 to 600,000 barrels of oil equivalent per day(boe/d) would be at risk in 2011. In 2017, the tax changes could put more than 10 percent of U.S. total production capacity in jeopardy.

API President and CEO Jack Gerard says the tax changes also could cost thousands of jobs. "Advocates of higher taxes should understand who would really be hurt," Jack adds.

The Energy Information Administration (EIA) projects that oil and natural gas will comprise more than half of U.S. energy supplies in 2035. The United States can either purchase this energy abroad, which adds to the trade deficit and reduces U.S. energy security, or produce it here where energy development creates jobs, generates government revenue, and provides U.S. energy supplies to American consumers.

The choice is clear. Prohibiting the oil and natural gas industry from taking these deductions is a bad idea.