Texas Tea

Thanks to Swede for pointing me towards this op-ed in the Billings Gazette, Obama’s Oil Tax Changes Would Cripple Industry, by Tom Hauptman of Billings. Tom is a natural gas producer/explorer who has had much success. He writes about some special tax breaks given people in the oil business. But first,

As a young man growing up in the big city of Billings, my “summer camp” consisted of working for my uncle Stewart at his ranch in the Flint Creek Valley of Western Montana. We worked long hours in the hay fields either picking rocks or driving buck rakes. In those days, loosely stacked hay was the standard. Round bales had never been heard of, and “idiot cubes” were to be avoided at all cost! He made two promises to me, long hours and low pay, and Stewart was always a man of his word.

Conservatives talk like that, I’ve found. They like to think they invented hard work – they imagine that liberals are people who live off their sweat. Honestly, the hardest-working people I’ve ever met are restaurant cooks, followed closely by dish washers, and then the wait staff. Their rewards are paltry compared to Tom’s – heck, they are lucky if their employer provides health insurance. Last I heard, the Montana Restaurant Association was in Helena trying to undercut their pay by making it legal to reduce the minimum wage by any tips they receive. So much for conservatives and hard work. As my rich and surly uncle once told me, “you will never get rich on your own sweat. You make others sweat for you.”

I digress. Let’s get down to business. Tom, like all people who receive special tax breaks, thinks 1) he is entitled to them, and 2) they benefit us more than him. What’s good for him is even better for us.

In the upcoming Fiscal Year 2010 federal budget, the Obama administration is proposing the elimination of the depletion allowance and the further elimination of the expensing of intangible drilling costs for all wells drilled in the U.S. after July of this year. What does this oilfield mumbo jumbo mean? The depletion allowance allows an oil and gas producer to deduct 15 percent of his production income from taxation. The reason for this is simple. As the oil or gas well depletes, the producer must drill more wells or he will soon be out of business. It is exactly the same as depreciation expense for plant and equipment.

We all know depreciation is a real expense. All a rancher has to do is look at that “new” tractor he bought 15 years ago. The green has faded and, some day, he is going to have to knuckle under and buy a new one. Same thing goes for oil and gas wells. They don’t last forever.

That’s not exactly true. Actually, it’s exactly wrong. Suppose, for example, a farmer invests $100 thousand in a combine – he is allowed an expense for depreciation over the useful life of that piece of equipment as it produces revenue for him. When he has “recovered” the entire cost, he can no longer take depreciation expense.

In the oil business, it’s a little different. Tom doesn’t distinguish between “cost depletion”, the equivalent of depreciation of the farmer’s combine, and “percentage depletion”, a tax gift. If farmers were treated like oil men, they would be able to write off their equipment in full when they buy it, and 15% of their revenue forever after. That’s percentage depletion – a permanent and perpetual write off of 15% of all revenue received from oil and wells regardless of cost basis, aka “intangible drilling costs”.

The next item is intangible drilling expense, which is everything that can’t be salvaged from an oil or gas well. That is building the well pad, the cost of drilling the well, the cost of the pipe and the cement used to place the pipe in the ground, the cost of stimulating the well, etc. The majority of these costs are labor. Name one industry that can’t expense the labor costs before determining net income. I can’t think of one!

The ability to write off intangibles for successful wells is another tax gift. Without the IDC writeoff, oil producers would have to recover the cost of a well, it’s “IDC’s”, by cost depletion, a mathematical estimate of the portion of the recoverable reserves produced applied against the cost of drilling. This would be in sync with farmers and their equipment.

And the majority of these costs are not labor – where did that come from? Oil and gas is a capital-intensive business. They drill using rigs costing tens of millions of dollars, and chemicals and muds and technology developed in the last century, the cost of which makes labor a paltry part of the process.

Small producers get special tax treatment (percentage depletion) because they lobbied for it back in the 1980’s. As a matter of public policy, Congress thought it important to encourage domestic oil and gas production by small companies. But don’t confuse this special treatment written into the tax code with normal tax policy that other manufacturers and independent businesses must abide by. It’s a special benefit we gave them.

If this provision passes, the independent oil and gas industry in America is basically over. No one will drill wells with their hard to come by after-tax dollars. The business is just too risky. The mineral rights under Montana’s farms and ranches will become basically worthless. Even if you don’t own any mineral rights, it will hit you in the pocket, too.

Stand back! I think he’ll really do it! This is self-serving, I’m afraid. Tom has done what we all do – he has taken the special treatment given him by Congress, internalized it, and now believes that what is good for him personally should be public policy.

That’s a matter for debate. If we decide that independent producers no longer deserve special tax break, life will go on, wells will be drilled, farmers and ranchers will still farm and ranch, and lucky ones might find they have some Texas Tea underneath. Loss of the IDC writeoff would slow down deductions, but not eliminate them.

It all rests with the U.S. Senate. Call Sens. Max Baucus (800-332-6106) or Jon Tester (406-252-0550) and tell them you support the domestic oil and gas industry and are opposed to these destructive tax law changes. Time is of the essence. Our energy future is in peril.

Lives are at stake.

Let’s be frank here. The United States will always be dependent on oil from other countries. Oil is where you find it, and there isn’t much of it left here. Small producers, taken in total, provide some relief from the need to import, but mostly they are gamblers playing for high stakes, men and women not content to make their money a buck at a time. They want huge rewards, and so entered this very risky business. Most of them minimize their risk by doing infield drilling, expanding on known reserves, and by shying away from wildcatting. The really big risks – the deep-sea drilling and stone-cold wildcatting under arctic tundra, are taken by the Exxons and Shells and BP’s – only they have enough money to justify the risks taken.