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When you work public policy issues for the oil and natural gas industry—as I have done for the last 20-plus years—you often feel like Alice going through the Looking Glass, although you eventually get used to the constant streams of misinformation and demagoguery that emit from industry opponents. But it’s been difficult to shrug off these tactics from the other side, over the last four years, in the debate focusing on tax treatments specific to the industry in the U.S. tax code.
One reason why you can’t just shrug it all off is that the “opposition” in this debate includes U.S. President Barack Obama. President Obama started this debate when, upon assuming office in January 2009, he ordered his staff to scour the tax code for any provision that mentioned the industry. Shortly thereafter, he began advocating the repeal of all such provisions—inaccurately labeling them as “subsidies”—a drumbeat of misinformation that he has maintained ever since.
The truth of the matter is that the industry does not receive any “subsidies” from the federal government. There is nothing abnormal or outside of the mainstream of historical tax policy in any of the treatments available to producers.
Tax treatment origins. While the opposition points fingers at familiar boogeymen, like former Vice President Dick Cheney, as somehow being the evil genius behind the industry’s tax provisions, the truth is that none of them originated in the George W. Bush Administration; most have been on the books for decades. One of the two most common subjects for demagoguery, the Intangible Drilling Cost (IDC) deduction, is celebrating its 100th anniversary, dating back to the original tax code that was passed in 1913, subsequent to ratification of Amendment 16 to the U.S. Constitution. The other target, Percentage Depletion, has been in the tax code since 1926.
Far from being “subsidies” for “big oil” as the President likes to call them, neither of these treatments provides any substantial benefit to major integrated oil companies. In fact, Percentage Depletion has not even been available to the majors since 1975, when it was repealed for companies falling under that designation in the tax code. So, its repeal would only affect independent producers and royalty owners.
The deductibility of IDCs—which basically amount to what other industries call their cost of goods sold—was severely restricted to the majors in 1986 and again in 1992, and now provides virtually no benefits to “big oil” at all. Again, royalty owners and independent producers would bear the brunt of a repeal of this provision.
More recent items. Another great example of the mischaracterization of these tax treatments is the Manufacturer’s Tax Deduction, also known as Section 199. This provision was enacted by Congress in 2004 as a means of encouraging manufacturers to relocate overseas jobs to the U.S. It is in no way specific to, or limited to, oil and gas. In fact, the industry’s ability to take advantage of this provision has already been singled out for limitation. In 2008, Congress reduced the industry’s deduction under this provision to two-thirds of what other manufacturing industries are allowed to deduct.
The tax code contains a couple of credits related to the oil and gas industry—the Enhanced Oil Recovery (EOR) Tax Credit, and the Marginal Well Tax Credit. Far from being “subsidies” to “big oil,” these credits are used almost exclusively by small-to-mid-size independents, who tend to become the operators of marginal fields, as they age and are divested by larger companies. The EOR credit was implemented in 1990, and the Marginal Well Credit was signed into law by President Clinton in 1994.
We always hear a lot of talk from analysts and policymakers about the need to enact a national “energy policy.” I always view such chatter with a jaundiced eye, because the main thing that the federal government is capable of doing with “energy policy” is to mess things up. Such efforts invariably degenerate into exercises, where politicians try to pick winners and losers, and thus distort the marketplace.
Tax policy is energy policy. The federal government does have an “energy policy”—it’s called the Tax Code. The treatments related to the industry were put there to encourage specific behaviors, and they have worked quite well over the years.
The credits mentioned above were put in place after the industry and government realized that many oil fields were being abandoned prematurely, denying consumers billions of barrels of recoverable oil. Those credits have been very instrumental in allowing small producers to squeeze those last barrels out of depleted fields.
Congress realized early on that capital formation was the single most critical aspect of producing the oil that has driven our economy for the last 120 years. Drilling was, and remains, a risky, capital-intensive endeavor, and many companies re-invest every dollar of profit they make to drill more wells. Percentage Depletion and deductibility of IDCs were tools that the government put in place to encourage the formation of that critical capital. For a full century now, those two treatments have served their purpose quite well.
On top of all of the opposition’s demagoguery, these tax treatments also face possible repeal as a part of “tax simplification” efforts being contemplated in Congress. In going through this exercise, Congress and the administration would do well to remember that the industry is unique, and that these tax treatments have played a big role in enabling our nation’s shale revolution. In the tax code, one size definitely does not fit all. 
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