A landmark year for the oil and gas industry

The last 12 months in Washington, D.C., have been incredibly positive for the U.S. oil and gas industry. Most of the good news has been courtesy of the pro-business Trump administration. What follows is an examination of the major policy aspects affecting the industry, and how things may unfold during 2018.

U.S. AS AN ENERGY EXPORTER

The U.S. has emerged as a major energy exporter—ending a half century of “energy import dependence.” This has profound long-term energy, economic and political implications.

During 2017, the U.S. became a significant oil exporter, shipping more crude overseas than six of 14 OPEC members. Photo: Philly Shipyard, Inc.

The U.S. crude oil exports ban ended in December 2015, and in 2017, U.S. oil exports increased dramatically. In the first half of the year, exports averaged about 750,000 bopd, and in third-quarter 2017, exports reached a peak of 2.13 MMbopd. Indeed, U.S. exports averaged 1.5 MMbopd in the fourth quarter, which makes the U.S. a significant player in the global oil market. At that volume, the U.S. is shipping more oil than six of the 14 OPEC members. With U.S. shale output surging, EIA forecasts that total U.S. oil output will average 10.59 MMbopd in 2018, an all-time high. Refiners from South Korea, India and Poland are beginning to purchase American crude, replacing Middle Eastern oil imports. 

Exports will likely remain high, since more crude export terminals are scheduled to come online in 2018 and 2019. The Louisiana Offshore Oil Port is upgrading to handle VLCCs, which will expand port capacity and lower export costs. That upgrade is scheduled to be completed in early 2018. 

Even more remarkably, for the first time in 60 years, U.S. natural gas exports exceed imports. This change is a significant milestone—the latest in America’s transformation into the world’s largest oil and gas producer, long-awaited by policymakers, who anticipate that it will create jobs and expand U.S. influence. 

The EIA forecasts that the U.S. will continue to export more natural gas than it imports throughout 2018 and beyond. The U.S. status as a net exporter will continue because of growing U.S. gas exports to Mexico, declining pipeline imports from Canada, and increasing LNG exports. 

The U.S. is the world’s largest gas producer, having surpassed Russia in 2009. Data show that U.S. gas production increased from 55 Bcfd in 2008 to 72.5 Bcfd in 2016. About 95% of this is consumed domestically. However, abundant gas resources and large production increases are creating export opportunities. 

The EIA expects LNG exports to increase, as U.S. liquefaction capacity continues to expand, when five new projects under construction—Cove Point, Cameron, Elba Island, Freeport, and Corpus Christi—come online. This will increase total U.S. liquefaction capacity from 1.4 Bcfgd in 2016 to 9.5 Bcfgd by 2019. By 2020, the U.S. will have the third-largest LNG export capacity in the world after Australia and Qatar, and U.S. LNG exports are forecast to reach 4.6 Bcfd
by 2019.

The U.S. becoming a major gas exporter is something that “experts” would have deemed impossible, a decade ago. 

AN ENERGY-FRIENDLY TAX BILL

In December 2017, President Trump signed the most significant tax restructuring since 1986, and the bill has favorable implications for the upstream industry. Companies will save billions of dollars from reduced corporate income tax rates and revised tax of capital expenditures. The major provisions benefiting the industry are discussed below:

In December 2017, President Donald J. Trump spearheaded the effort to pass an energy-friendly tax bill. The eventual passage by both houses of Congress resulted in the most significant tax restructuring since 1986. Photo: The White House.

Corporate tax rates were reduced from 35% to 21%. The rate reduction will benefit all corporations, but energy companies, which have high tax burdens, will benefit the most. The energy sector’s median tax rate for the past 11 years was 36.8%, far above the 30% average tax rate for all S&P 500 companies. The corporate tax reduction will add at least $1 billion to the profits of the U.S. E&P firms and could add 5% to the earnings per share of companies such as ExxonMobil and Chevron. All energy companies will gain, but refiners will benefit the most, because they have enjoyed positive pre-tax income in recent years.

Capital expenditures can now be deducted in the year of their occurrence, whereas previously they could not. This will reduce taxes for oil and gas companies while encouraging more capital spending. It is significant, because energy is the most capital-intensive sector. Each year, industry companies invest billions of dollars in new projects. For example, ExxonMobil had $22 billion of capital expenditures in 2017, and Chevron announced a 2018 capital and exploration budget of $18.3 billion. 

The expensing of intangible drilling costs was retained, and this was the key issue for upstream independents, who produce most U.S. oil and gas. The industry worked intensely to educate Congress, and those efforts paid off.

The percentage depletion allowance also was retained. This is another tax treatment that is especially important to small independents and royalty owners. The allowance recognizes the unique nature of U.S. extraction industries, and can only be claimed by small independent producers and royalty owners whose daily production is less than 1,000 bopd. These firms produce about 20% of U.S. crude oil and 12% of U.S. natural gas. 

A new provision allows the expensing of the full cost of new investments in certain plant and equipment for the next five years. This will benefit many firms in the upstream, midstream and downstream O&G sectors. 

The corporate alternative minimum tax (AMT) was repealed. This mainly penalized marginally profitable corporations, and is a positive development for rapidly expanding midstream companies and many upstream producers. Retaining the corporate AMT would have made it difficult for operators to reduce effective corporate tax rates below 21%. 

The White House has been ground zero for generating efforts to reduce or remove burdensome regulations through actions taken by federal departments and agencies, much to the benefit of the oil and gas industry. Photo: The White House.

The “carried interest” provision was retained for private equity funds. This will help to preserve the oil and gas industry’s access to a critical source of capital that has funded many projects. 

A one-time lower rate for repatriation of overseas profits was established. International companies that have held profits overseas can repatriate these at a one-time rate of 15.5%. This will inject new capital into the U.S., since estimates of the profits held overseas by U.S. companies exceed $2.5 trillion.

Taxes on pass-through business income were reduced. This implies major tax savings for companies structured as partnerships—including MLPs—and reduced tax liability for JVs.

NEGATIVE TAX BILL ITEMS

While, overall, the tax bill is advantageous to the oil and gas sector, it did contain several provisions that were not favorable. These are discussed below. 

The carryback of net operating losses was eliminated, and this is potentially the most costly aspect of the bill to the industry. Costs incurred in one year will not be able to offset 100% of taxable income in the next year. For industry companies, this will require careful planning with respect to intangible drilling cost deductions versus capitalization over longer horizons. 

The tax bill of December 2017 has opened up very selective portions of the ANWR to potential exploration. Map: Senate Republican Policy Committee.

Limitations were imposed on interest deductibility. The bill capped deduction of interest expense to interest income plus 30% of adjusted taxable income—computed without regard to deductions allowable for depreciation, amortization or depletion. This could be troublesome to the highly leveraged E&P sector.

The bill repealed the Section 199 domestic production deduction available for qualified production activities in the U.S. Oil and gas companies that previously claimed this deduction will no longer be able to reduce their taxes.

A base erosion anti-abuse tax (BEAT) was enacted. Functioning like a global minimum tax, industry companies owned by foreign entities, or with significant foreign operations, may be forced to pay the BEAT instead of the base rate, less credits and deductions.

In a major win for the industry, and a bitter defeat for environmentalists, the tax bill opened portions of the Arctic National Wildlife Refuge (ANWR) to oil exploration. For decades, development advocates failed to win congressional approval for a stand-alone measure aimed at drilling in the ANWR. However, opening the ANWR was included as part of the tax bill. 

Environmentalists had fought off numerous attempts over five decades to allow drilling there, and ANWR has long motivated and generated funding for “greens.” Democrats and environmentalists struggled throughout the ANWR debate to promote opposition to drilling, but failed. Environmental groups stated that they had not given up and that they will attempt to block development through litigation and public pressure.  

A DEREGULATION TSUNAMI 

During 2016, candidate Trump campaigned to reduce energy regulations, and in 2017 the Trump administration’s deregulatory agenda was relentless. Former President Obama enlarged the administrative state by creating vast new layers of regulations, pertaining to oil and gas development, environmental reviews, power plant emissions, etc. During 2017, the Trump administration moved aggressively to reduce the energy industry’s regulatory burdens, including many affecting oil and gas development. The major rules that have been overturned are discussed below. 

EPA canceled a requirement for operators to report methane emissions. In March 2017, Republican officials from 11 states wrote to EPA Administrator Scott Pruitt, contending the rule added costs and paperwork for producing companies. EPA subsequently revoked the rule. 

The Trump administration also approved the Keystone XL pipeline. Industry groups opposed the Obama administration blocking the pipeline, arguing that the project would create jobs and support energy independence. After the pipeline company reapplied for a permit, the Trump administration approved it. 

Barring any court challenges by environmentalists, the Trump administration cleared the way for construction of the Keystone XL pipeline, when a presidential permit was signed in March 2017. Operator TransCanada Corporation confirmed in January 2018 that it has secured 500,000 bopd of firm, 20-year commitments, positioning the project to proceed. Photo: TransCanda Corporation.

In addition, the administration approved the Dakota Access pipeline. The industry criticized the Obama administration for delaying construction after protests led by the Standing Rock Sioux Tribe and environmental activists. President Trump ordered an expedited review of the pipeline, and the Army Corps of Engineers approved it. Crude oil began flowing on June 1, 2017, but a federal judge subsequently ordered a new environmental review.  

Meanwhile, the Justice Department prohibited funding of third-party projects through federal lawsuit settlements (“sue and settle”), including environmental programs. Companies settling lawsuits with the federal government have often been forced to pay for third-party projects. The Justice Department has now prohibited such payments, which analysts have termed “slush funds.”  

The Trump administration repealed a ban on offshore drilling in the Atlantic and Arctic oceans. The industry opposed the Obama administration’s use of the Outer Continental Shelf Lands Act to permanently ban offshore drilling along parts of the Atlantic coast and much of the ocean around Alaska. President Trump repealed the policy in an April Executive Order (EO) and instructed Interior Secretary Zinke to review locations available for drilling. 

Secretary of the Interior Ryan Zinke has been instrumental in lifting or amending some of the most burdensome regulations. Photo: The White House.

Officials also approved the use of seismic air guns for exploration in the Atlantic. The Obama administration had denied such permits. In addition, administrators repealed an Obama-era rule regulating royalties for oil and gas. The industry opposed 2016 Interior Department regulations pertaining to royalties paid to the government for oil and gas extracted from federal or tribal lands. In August 2017, the administration rescinded those regulations. 

The Trump administration withdrew guidance requiring federal agencies to include greenhouse gas (GHG) emissions in environmental reviews. The guidelines advised federal agencies to account for possible climate effects in environmental impact reviews, which had slowed permitting. President Trump also relaxed the environmental review process for federal infrastructure projects. The industry contended that the permit-issuing process for new infrastructure projects was costly and cumbersome. In an August 2017 EO, Mr. Trump announced a policy to streamline the process for pipelines, power lines, and other federal projects. 

Meanwhile, the President announced the end of payments to the UN Green Climate Fund. Former President Obama had pledged $3 billion, $1 billion of which Congress has already paid. In a related move, President Trump revoked a directive for federal agencies to mitigate the environmental impacts of projects. A March 2017 EO revoked an Obama-era memorandum that instructed federal agencies to “avoid and then minimize” the impacts of development on water, wildlife, land and other natural resources.  

The Trump administration directed federal agencies to stop using an Obama-era calculation of the “social cost of carbon.” In a March 2017 EO, the President directed agencies to cease using this Obama-era calculation that allowed regulators to monetize the costs of carbon emissions and to instead use standard cost-benefit analysis. President Trump also disbanded the SCC working group. 

Last, but not least, Congress revoked an update to the BLM public land use planning process. Many oil and gas industry groups had opposed the updated planning rule for public lands.  

ADDITIONAL DEREGULATION 

In addition to the items already mentioned, various regulatory rollbacks are still in process, as discussed below. 

Administrator Scott Pruitt is leading EPA efforts to review the agency’s rulemaking from the last several years, to make it more oil-and-gas-friendly. Photo: EPA.

EPA’s proposes to repeal the Clean Power Plan, which was the Obama administration’s signature climate policy, limiting CO₂ emissions from existing power plants. President Trump issued a March 2017 EO instructing EPA to re-evaluate the plan, which is tied up in court and has not yet taken effect. 

In another environmentally related move, President Trump announced the administration’s intent to withdraw the U.S. from the Paris climate agreement. Under that pact, the U.S. had pledged to reduce GHG emissions 26% to 28% below 2005 levels by 2025. The administration formally notified the UN, but it cannot complete the process until 2020. 

Meanwhile, the EPA is rescinding a rule pertaining to tributaries and wetlands under the Clean Water Act (CWA). The industry opposed an Obama-era clarification of the CWA that extended protections over small waterways. EPA and the Department of Transportation also re-opened a review of vehicle fuel-efficiency standards for model years 2021 through 2025. Automakers said it would be difficult and costly to meet fuel economy goals set by the Obama administration.  

The National Oceanic and Atmospheric Administration is reviewing 12 marine protected areas. As part of his April EO aimed at expanding offshore drilling, President Trump requested a review of national marine sanctuaries and monuments designated or expanded within the past decade.  

The Interior Department, led by Secretary Ryan Zinke, is reviewing greater sage grouse habitat protections. Industry leaders termed the Obama administration’s plan for protecting the bird “deeply flawed” and welcomed the Interior Department review, which will reassess restrictions on energy production. And Interior subsidiary, Bureau of Land Management (BLM) is rescinding water pollution regulations for fracing on federal and Indian lands. Energy companies petitioned BLM to rescind the 2015 rule, which was never enforced amid legal challenges. 

Trump ordered a review of regulations on drilling in national parks, where mineral rights are privately owned. His March 2017 EO required a review of Obama-era updates to a 50-year-old rule regulating oil and gas drilling in national parks with shared ownership. Most national parks are owned by the government, and drilling in them is banned. However, in some parks, the government owns the surface rights but not the mineral rights. 

The Trump administration is reviewing safety regulations on offshore drilling. Industry trade groups had written to the administration, raising concerns over oil rig safety regulations implemented after the 2010 Deepwater Horizon accident. The administration is also reviewing a rule regulating offshore exploration by vessels in the Arctic. The rule, a response to the 2013 Kulluk accident in the Gulf of Alaska, increased oversight of floating vessels and other mobile offshore drilling units.  

On the emissions front, EPA is reviewing a rule limiting methane emissions at new drilling sites. The industry had petitioned EPA to reconsider limiting methane emissions and other pollutants from new and modified oil and gas wells. A federal appeals court ruled that EPA must enforce the Obama-era regulation while it re-writes the rule. Finally, BLM proposed delay of a rule limiting methane emissions on public lands. BLM suspended enforcement of the regulation, but in October 2017, a federal court ruled that the delay was unlawful and ordered immediate enforcement. 

About the Authors

Dr. Roger Bezdek

Contributing Editor

Dr. Roger Bezdek is an internationally recognized energy analyst and president of MISI, in Washington, D.C. He has over 30 years’ experience in the energy, utility and environmental areas, serving in industry, academia and government. He has served as senior adviser in the U.S. Treasury Department, U.S. energy delegate to the EU and NATO, and as consultant to the White House, the U.N., government agencies, and numerous corporations and organizations. He has written eight books, has published over 300 articles in professional journals, and his work has been featured in the Wall Street Journal, the Washington Post, New York Times, Time, Business Week, Science, Nature, World Oil, and other print and digital media.