TAX POLICY

Baucus proposes axing key oil and gas tax breaks

Oil and natural gas companies would lose some of their most lucrative tax breaks under a reform proposal unveiled yesterday.

Proposals to eliminate the industry's incentives in the tax code are nothing new from congressional Democrats, but Senate Finance Committee Chairman Max Baucus' inclusion of them in a draft of his broader tax reform proposal heightens the risk they could be swept away as part of a tax code overhaul lawmakers in both parties have said they want to enact next year. The Montana Democrat -- a critic of some environmental regulations and proponent of the Keystone XL pipeline -- is no one's idea of Public Enemy No. 1 to the oil industry on Capitol Hill.

Oil industry groups were quick to argue yesterday that the proposed bill would increase their costs, cause workers to be laid off and reduce the amount of oil and gas produced in the United States. Environmentalists and administration supporters welcomed what they saw as a positive first step to reining in incentives they have long said should be eliminated for an industry that is among the most lucrative in the country.

The draft proposal to reform part of the corporate tax code would eliminate oil and gas drillers' ability to deduct their "intangible" costs in the year they were incurred -- instead requiring those costs be deducted gradually over five years. The same holds true for deductions available on oil "tertiary injectants," "geological and geophysical expenses," and similar costs incurred in energy development. Baucus' discussion draft also eliminates the so-called percentage depletion rules oil companies use to account for production declines over the life of a well.

Many of the energy-related provisions in yesterday's draft -- which included broader proposals on "cost recovery" and accounting rules applied to all businesses -- were drawn from the "Close Big Oil Loopholes Act," introduced by Sen. Robert Menendez (D-N.J.) and other Democrats in the last two sessions of Congress.

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In addition, the Baucus draft proposes eliminating "last in first out" (LIFO) accounting, which is used in a variety of industries but is especially prized by the oil and gas industry. It allows firms to assume the last unit of inventory they added -- a barrel of oil purchased at a refinery, for example -- was the first sold and lowers the taxable value of existing inventory.

A spokesman for the American Petroleum Institute, the industry's leading lobby group, said its members "appreciate" Baucus' effort but warned against some of the changes he proposed.

"Changes to cost recovery and repeal of legitimate accounting methods like LIFO could unintentionally hit the brakes on America's energy and manufacturing renaissance," API spokesman Brian Straessle said in an email. "People's jobs are at stake, so lawmakers had better get the details of tax reform right."

Baucus yesterday said his staff is working on another draft that would feature additional energy-specific proposals that he hoped would be released before the end of this year. In response to early complaints from industry allies, he stressed that there is a long way to go before tax reform will be implemented.

"This is all very, very preliminary. There are many steps down this road," Baucus told E&E Daily. "It's a draft, not a bill."

The Finance Committee is accepting comments through Jan. 17 on the cost recovery proposal and two other tax reform drafts Baucus released this week.

Industry officials said they were still reviewing the plan's details yesterday, but their initial impression was that eliminating the intangible drilling costs (IDC) deduction and other incentives would be detrimental.

"The effect on each company could be a little bit different, but generally speaking this would be a huge penalty to the independent oil and gas exploration and production business," said Bruce Thompson, president of the American Exploration and Production Council, in an interview yesterday.

At a tax forum earlier this week, Thompson said the 32 independent drilling companies his organization represents spend about 130 percent of their cash flow each year, meaning the IDC deduction is vital to staying active. Without the IDC, he predicted his companies would drill 4,000 fewer wells per year, he said at the forum. But yesterday he was unable to estimate the precise effect of taking the deduction over five years instead of one.

The fate of the IDC has been a key concern for investors in the oil and gas business since at least 2009, when President Obama included IDC elimination in his first budget proposal, said Jim Lucier, who leads the energy and environment practice at Capital Alpha Partners.

"It's a pretty significant deal because oil and gas companies are very capital intensive; it's a very lumpy sort of business," he said in an interview. "You've got to keep continually recycling those dollars to maintain drilling activity."

The draft did not address all tax benefits enjoyed by oil and gas companies. For example, it did not mention the so-called Section 199 deduction oil and gas firms receive because they are classified as manufacturing companies, although the committee's request for comments specifically solicited input on that break as well as tax credits to promote clean energy. Also unmentioned in the draft was the status of master limited partnerships, which are especially popular among pipeline operators.

Environmentalists welcomed the hit to an industry whose largest players have already made tens of billions of dollars in profits this year.

"Chairman Baucus has put forward a thoughtful proposal. ... Ending century-old giveaways to the polluting fossil fuel industry is the right course," said Franz Matzner, associate director of government affairs at the Natural Resources Defense Council. He added that more effort is needed this year to ensure existing incentives for clean energy, such as the production tax credit, do not expire as broader tax reform discussions proceed.

The Finance Committee did not release estimates for how much revenue the draft would raise because its details are subject to change.

But the Center for American Progress, a liberal think tank with ties to the Obama administration, analyzed some of the oil and gas proposals as they were presented in earlier iterations. For example, according to a 2011 CAP article, repealing LIFO could raise up to $22.5 billion over a decade and eliminating IDC would raise $12.5 billion over the same period.

Separately yesterday, Sen. Bernie Sanders (I-Vt.) reintroduced an even more sweeping bill to eliminate a broad swath of tax incentives and other breaks for fossil energy companies. It is similar to legislation he offered last year with Rep. Keith Ellison (D-Minn.), also a co-sponsor this year (E&ENews PM, May 10, 2012).

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