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The truth about America’s oil & gas companies — Part II

By Brian Johnson

The United States oil and natural gas industry does not receive taxpayersubsidized payments.

Given the recent publicity surrounding this issue, this statement may come as a surprise, yet it is 100 percent true. Also true is that the industry pays more than $86 million to the government every single day and has an effective income tax rate of 41 percent. Why then have so many readily bought the notion that the taxpayers are supporting this highly profitable industry?

A fundamental pillar of the U.S. income tax system is that businesses are taxed only on net income. This means that there needs to be some practical method for businesses to recover costs. There are many tax code provisions that allow companies to recover their costs, but tax deductions and cost recovery mechanisms should in no way be confused with subsidies.

For example, many inaccurately classify the ability to recover costs associated with drilling a well as some sort of unique subsidy for the industry. When companies drill, they incur intangible drilling costs, such as site preparation, labor, engineering and design. These “intangible” costs associated with drilling a well usually represent 60-80 percent of the cost of the well. Independent producers can deduct 100 percent of these costs in the year they occur while larger, non-independent companies can deduct 70 percent of the costs in year one and amortize the remainder over five years.

This is the same treatment afforded many different types of taxpayers. Small businesses can expense 100 percent of certain equipment costs and mining companies can deduct mine development costs. Further, research and development (R&D) costs incurred by industries such as biotech, pharmaceutical and software firms can be immediately expensed.

As is the case with research and development, oil and gas development is no sure thing. Despite great advances in technology, drilling a well is the only means to determine the actual presence of hydrocarbons in reservoir rock or sand. And when companies drill, they often rely on new and innovative methods. While these methods have led to the recovery of domestic reserves few thought possible a decade ago, they remain, essentially risky ventures.

Deductions allowed for the U.S. oil and natural gas industry are often more restrictive when compared with other industries. For example, in 2004, Congress enacted the Section 199 Domestic Manufacturers Deduction to spur job creation and retention for all businesses that grow, extract, produce and manufacture goods in the United States. Contrary to assertions, this is not a deduction unique to oil and natural gas manufacturing. It applies to all qualifying industries, from newspapers to home builders, electric companies to movie studios and — logically — oil and gas companies.

For most U.S. manufacturers, the deduction is 9 percent of their domestic net income. However, recent legislation has already penalized U.S. oil and natural gas companies by freezing their deduction at 6 percent.

It is misleading to say this deduction is a subsidy for one industry but a legitimate business deduction for other industries receiving the full amount. Those who argue that oil and natural gas companies are not entitled to the same tax considerations available to other industries ignore the substantial revenue generated by the oil and gas industry for federal and state governments. Every single day, U.S. oil and gas companies pay more than $80 million to the federal government in the form of rents, royalties, lease payments and income tax payments. This goes above and beyond motor fuel excise taxes or state income, property and severance taxes. And they ignore the fact that, since 2000, the industry has invested almost $1.7 trillion right here at home in U.S. capital projects to advance all forms of energy, including alternatives, while reducing the industry’s environmental footprint.

Making the false claim that the industry gets subsidies in order to tax it more has made little impression on voters. As indicated by a recent poll, 62 percent of more than 10,000 voters surveyed oppose efforts to increase taxes on the industry. Perhaps these voters understand something very basic that some politicians and pundits don’t: with some oil and natural gas companies bearing an effective tax rate of more than 40 percent and a real need to develop domestic reserves, policies to impose almost $90 billion in additional taxes do not make any sense.

Original Article

The truth about America’s oil & gas companies — Part I

By Brian Johnson

In a recent interview, Sen. Bernard Sanders (I-VT) alleged that while America’s oil and natural gas companies make “huge profits,” they “pay nothing in taxes.” Nothing could be further from the truth.

A recent 60 Minutes segment and other commentary have examined how U.S. industries use the tax code to export jobs and hold profits overseas. They point to the low effective income tax rates incurred by these companies as proof. While some industries may engage in this behavior, America’s oil and natural gas industry is not one of them.

Make no mistake, U.S. oil and gas companies are large, complex organizations — they have to be in order to succeed in global energy markets, where their competition can be state-controlled energy companies. Their earnings are matched by their significant investments.

Their earnings, however, are in line with those of other major U.S. manufacturing industries, as measured against their sales. The latest available data for 2010 earnings shows the oil and natural gas industry earned 5.7 cents for every dollar of sales. This is below the earnings of all U.S. manufacturing, which earned an average of 8.5 cents for every dollar of sales. Many would not expect an industry as large as the U.S. oil and natural gas industry, which supports 9.2 million U.S. jobs and contributes to 7.5 percent of gross domestic product (GDP), to have lower earnings per dollar of sales than the average manufacturing industry, but that’s the reality.

Further, U.S. oil and natural gas companies pay considerably more in taxes than the average manufacturing company. According to data found in the Standard & Poor’s Compustat North American Database, the industry’s 2009 net income tax expenses — essentially their effective marginal income tax rate — averaged 41 percent, compared to 26 percent for the S&P Industrial companies. The Energy Information Administration (EIA) concludes that, as an additional part of their tax obligation, the major energy-producing companies paid or incurred over $280 billion of income tax expenses between 2006 and 2008.

The U.S. oil and natural gas industry also pays the federal government significant rents, royalties and lease payments for production access — totaling more than $100 billion since 2000. In fact, U.S. oil and natural gas companies pay more than $86 million to the federal government in both income taxes and production fees every single day. In addition, since 2000, the industry has invested almost $1.7 trillion in U.S. capital projects to advance all forms of energy, including alternatives, while reducing the industry’s environmental footprint.

Oil and natural gas companies must constantly find new opportunities to produce more oil and natural gas. Given administration policies limiting new domestic opportunities, these resource-driven companies are forced to explore abroad. However, unlike other industries that may look to open factories in low-tax countries, oil and natural gas companies must invest where the resources are. For example, while it would be great to produce in Ireland and enjoy a 12 percent corporate income tax rate, Ireland holds very small oil or gas reserves. Resource-rich countries understand this and often impose higher income taxes on oil and gas operations.

Despite their international presence, U.S. oil and natural gas companies still directly employ millions of U.S. workers, invest heavily in the United States and pay valuable dividends. Therefore, substantial foreign earnings are constantly returned to this country and put back into the economy. This revenue flow is dependent upon the United States recognizing that, because the income has already been taxed abroad, it should not be taxed again upon repatriation. However, the administration and some in Congress have proposed raising taxes on U.S. companies’ foreign earnings, further undermining U.S. competitiveness abroad and potentially limiting the availability of future reserves.

U.S. oil and natural gas operations are intricate and complex, but the facts are simple: America’s oil and natural gas industry supports 9.2 million jobs throughout the economy and 7.5 percent of our GDP. Its companies provide higher-than-average wages — approximately $98,000 a year for an upstream job — and help ensure our nation’s energy security. In the process, they generate tax revenues from operations and sales of products that contribute billions every year to federal, state and local governments.

Contrary to what some political pundits may say, major energy producers are paying their fair share.

Brian Johnson is the senior tax advisor for the American Petroleum Institute — a trade association representing over 470 oil and natural gas companies. Visit www.api.org for more information. This is the first of a two-part series.

Original Article

Obama has been telling energy fables

By Lawrence J. McQuillan

President Obama just released his new energy plan. After a bruising battle over “cap and trade” last year, Obama has set his sights on another target — oil and natural gas companies. Vilifying “big oil” might be good politics, but it’s bad policy. If we’re going to get serious about energy solutions, we first need to separate the facts from the fables.

Fable: Oil and gas companies aren’t paying their fair share of taxes.

U.S. oil and natural gas companies pay considerably more of their profits in taxes than other industries such as technology and financial services. In fact, the industry pays an effective corporate income tax rate that is 70 percent higher than roughly three in 10 S&P industrial companies.

As for those billion-dollar subsidies oil and gas companies supposedly enjoy, they don’t exist. The industry gets tax deductions, as any business does, but they are far less generous than those enjoyed by others in the energy sector. While oil and gas receive slightly more than 1 percent of government energy R&D funding, renewables receive 22 times as much funding.

Fable: Oil and gas industry profits are “excessive”.

Many lawmakers have long pushed to increase taxes on oil and gas companies.

After all, these companies are, in President Obama’s words, “doing just fine.” Why not spread the wealth?

The trouble is, oil and gas companies aren’t as flush as lawmakers make it seem. Like other commodity businesses, oil and gas profits are cyclical, making them prone to booms and busts. According to PricewaterhouseCoopers, in all but four years from 1987 through 2006, oil and gas companies actually earned a lower return on their capital investment than other industries.

This is a key measure of comparative economic performance.

The costs of finding and producing oil and natural gas are always steep.

With much of the world’s conventional oil and natural gas reserves already developed, companies are turning to increasingly expensive non-conventional and offshore projects to meet the nation’s energy demands. Whereas land-based drilling is relatively cheap-as low as $20 per barrel-production costs for offshore oil can run between $60-$70 per barrel. Oil sands are even higher.

Fable: Taxing oil and gas companies will reduce the national debt.

Senate Majority Leader Harry Reid (D-NV) and Congressional Democrats recently proposed cutting tax breaks for oil and gas companies to help pay down the national debt.

Besides the fact that oil and gas companies are already paying their fair share of taxes, there is another problem with this argument, namely, the oil and gas industry is a cash cow for government already. According to data from the U.S. Energy Information Administration (EIA), between 1981 and 2008, U.S. governments collected more in taxes from the oil industry than the industry earned in profits for shareholders. Raising taxes on the industry even more will only discourage investment, reduce exploration and production, and eliminate jobs.

Fable: Raising taxes on oil and gas companies will bring us closer to a “clean” energy future.

Oil and gas companies pour billions into alternatives to conventional energy. In fact, University of Texas researchers found that from 2000 to 2008, the oil and gas industry invested more in alternative energies than the federal government and all other U.S. industry combined.

For all the presidential finger pointing, the oil and gas industry is not the problem. Oil and gas are necessary parts of our current energy supply and, along with renewables, will play a critical role in securing America’s energy future. If President Obama wants his new energy plan to succeed, he’ll abandon energy fables and start dealing with realities.

Lawrence J. McQuillan, Ph.D., is director of Business and Economic Studies at the Pacific Research Institute. Contact him at LMcQuillan@pacificresearch.org.

( Original Article )

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