Subsidy Cut Wasn’t a Rig-Killer

This week Wyoming’s congressional delegation cheered the demise of a bill that would have cut some tax breaks to the top five oil companies, a measure estimated to bring in $21 billion in revenue over the next 10 years.

In a speech on the Senate floor on Tuesday, Sen. John Barrasso (R-Wyoming) said, “Their (Democrats’) solution for high gas prices is a tax increase. Since when did raising taxes lower the price of gasoline? Since when does raising taxes on one thing ever lower the price of that thing?”

Dustin Bleizeffer

He went on to say: “The only way Americans can take the President’s call for more energy production seriously is if he and the Democratic Leadership abandon their fixation on raising taxes on producing American energy. That’s the first step in helping relieve pain at the pump.”

The bill aimed at cutting oil subsidies died in the Senate this week, and on Thursday morning Sen. Barrasso held a fund-raising breakfast with the oil lobby, a group that has given Barrasso more than $182,000 from 1995 to 2010, according to influenceexplorer.com, a program of the non-profit Sunlight Foundation.

That Barrasso works closely with the oil and gas industry is a good thing. The mining and production of coal, oil and natural gas contributes an estimated $3 billion in revenue to Wyoming annually — 60 percent to 65 percent of all Wyoming revenue.

However, Barrasso’s rhetoric this week doesn’t match a sober analysis of oil and gas fundamentals when it comes to taxes. Getting the most you can for a finite product like oil is just good business sense — and the trait is not exclusive to the GOP. So why the big push-back on trimming subsidies to an industry that seems to be thriving on American oil and gas?

According to one estimate, by Maura Allaire and Stephen Brown, the type of oil subsidies-cut envisioned by Democrats may result in the average U.S. consumer paying an extra $2.17 per year for gasoline — not per gallon. That’s an extra $2.17 more for all of the petroleum the consumer uses in a year.

The reasons that subsidies have little sway on production and prices are mostly global. Oil is a global commodity. Aside from major interruptions, the price of oil moves mostly on world economics and politics — a point which Barrasso acknowledged in his same Senate floor speech this week: “Unrest in the Middle East and a weak dollar is driving oil prices even higher.”

Continuing the current tax subsidies isn’t a strategy to overcome a weak dollar and political unrest in Northern Africa and the Middle East.

Sen. John Barrasso

Here in the U.S., companies responsible for the majority of domestic oil production (about 9.6 million barrels per day, or 11 percent of world production) base their drilling and production plans more on the price-per-barrel and price-per-mcf (thousand cubic feet) of gas than on tax rates. And tax rates do vary from state-to-state.

A 2008 analysis by Headwaters Economics — a Montana-based non-profit whose supporters include the U.S. Bureau of Land Management and the Montana Legislature — found that states with lower tax rates didn’t necessarily attract more rigs or produce more gas. Instead, drilling and production was based more on commodity prices and where quality resources are located.

“When you have (commodity natural gas) prices that swing on the magnitude of $2 per mcf to $14 and now $4, and the price of oil swings from $70 per barrel to $120, a marginal tax rate (difference) of 1 to 2 percent here and there isn’t going to change much,” Headwaters Economics policy analyst Mark Haggerty told WyoFile.

Headwaters Economics conducted a state-by-state comparative analysis of the effective tax rate, which is a simple formula of taking the total amount of tax revenue collected divided by the value of the oil and gas resource developed. The analysis revealed a wide range of “effective” tax rates on the industry from state-to-state — from about 6 percent in Colorado to 16 percent in Wyoming.

Yet it was Wyoming that led the Rockies’ natural gas expansion during the past decade, more than doubling Rockies production and export capacity from 2000 to 2010.

“If taxes really mattered, and states were in competition with each other for drilling, then taxes would equalize,” said Haggerty.

In addition to having world-class oil and gas resources, Wyoming now also has ample pipeline export capacity to major markets both east and west of the state. That recently-upgraded infrastructure makes Wyoming an attractive place to produce natural gas because companies don’t have to take discounted prices to compete for space in the pipeline.

If there’s any evidence of this long-term bet on Wyoming gas production, it’s the industry’s own proposals totaling more than 21,000 new wells throughout Wyoming.

Haggerty said Headwaters Economics’ recent report “Fossil Fuel Extraction and Western Economies,” supports work done by former University of Wyoming economist Shelby Gerking for the state of Wyoming in 2000. “The Gerking” study revealed that modest severance tax fluctuations have little or no effect on production or jobs in the extraction industry, meaning that the revenue foregone through a 2 percent severance tax break, for example, doesn’t result in a net payback in terms of enticing additional drilling and production.

“Based on what we know about state taxes and their ability to influence production, there’s not a lot there,” said Haggerty. “By extension, we’re assuming that federal taxes behave the same way, perhaps with even less (influence).”

Casper oilman Steve Degenfelder, senior vice-president of exploration for Double Eagle Petroleum, countered that drilling rigs rushed out of the Rockies to drill new shale gas and shale oil plays in Texas, Louisiana, Pennsylvania and North Dakota in recent years.

“They’re a lot easier to get drilling permits and their taxes are lower,” Degenfelder told WyoFile.

But the transient nature of drilling is nothing new, and often it represents the industry’s wish to establish new production fields. Wyoming’s biggest players that participated in the new shale oil and shale gas plays didn’t give up their leases in Wyoming, which is a sign they intend to continue to produce here for the long-term. And when rigs left Wyoming for shale gas plays elsewhere in 2008-09, the wells they had drilled here flourished and pushed production to the state’s highest rates.

Degenfelder suggested that some tax subsidies, such as a value depletion allowance and a break on intangible drilling costs, would hurt small- to mid-sized producers more than the majors, and those producers actually make up a large portion of domestic oil production.

However, Degenfelder also agreed that factors other than taxes can have a major influence on drilling and pricing.

“During the Bush administration, commodity prices went down because everyone had a positive view of oil and gas drilling and leasing,” said Degenfelder. “I’m glad (about) Obama’s recent comment about encouraging more drilling. It is very positive because what is going to drive down commodity prices and gasoline prices is a positive attitude by the administration.”

Just as Barrasso said of President Obama’s promise to boost domestic oil and gas drilling, “talk is cheap.” The biggest gasoline savings consumers can find is through conservation. Don’t worry, if you cut back on the volume of gasoline you use, the refining and chemical industries will find other uses for that U.S.-produced petroleum.

— Contact Dustin Bleizeffer at (307) 577-6069 or dustin@wyofile.com.

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Published on May 19, 2011

{ 2 comments }

Dustin Bleizeffer May 25, 2011 at 5:02 pm

Mr. Degenfelder mentioned the ability to write off some drilling expenses as important to exploration efforts. And it’s true that the expense to drill is a huge upfront cost without a guaranteed pay-off. However, the original intent of the tax credit may not fit today’s reality, according to some economists. It’s tempting to assert that, today, exploration for oil reserves is more a matter of tweaking the technology, and less a matter of turning over stones and drilling in areas overlooked. But I’m sure others can argue otherwise.

Regardless, I came across a report that speaks to this matter — the 2010 study, “State Tax Policy and Oil Production; The Role of the Severance Tax and Credits for Drilling Expenses,” by Ujjayant Chakravorty, Shelby Gerking, and Andrew Leach. Regarding this tax credit, the authors write:

“Simulations based on the U.S. experience demonstrate that the credit for drilling expenses does turn out to increase drilling as intended. However, if the credit is applied in the United States, particularly in areas where a great deal of drilling has already occurred, its contribution to identifying new reserves may be rather limited. In other words, much of the continental United States has been extensively explored, so the chances of large oil dis- coveries probably are small. Simulations of the model show that the drilling expense credit does not generate enough incremental severance tax revenue to pay for itself.”

— Dustin Bleizeffer, WyoFile editor-in-chief

Bob LeResche May 24, 2011 at 7:53 am

Excellent analysis. Of course Willie Sutton said it in fewer words when asked why he robbed banks: “Because that’s where the money is.” It’s pretty pitiful that our junior senator spouts such BS in order to increase his personal $182,000 take at such a huge cost to the nation.

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