The Sun Goes Down and the Wind Stops A' Blowin'. But America's Oil and Gas Keeps On A' Flowin'!

In a rhetoric-filled campaign speech on March 29, President Obama sought to pit one American against another when he told members of Congress that they could “stand with big oil companies, or they can stand with the American people.”

Oil & Gas 360® says: “Come on, Man!  Can’t we find a way to work (stand) together?”

On January 26, 2012, the Obama administration announced that it will hold the consolidated Central Gulf of Mexico Lease Sale 216/222 in New Orleans on June 20, 2012. The sale will include all available unleased areas in the Central Planning Area offshore Louisiana, Mississippi and Alabama. The lease sale will cover approximately 38 million acres in the Gulf.

In the news release, Interior Secretary Ken Salazar said: “Expanding offshore oil and gas production is a key component of our comprehensive energy strategy to grow America’s energy economy, and will help us continue to reduce our dependence on foreign oil and create jobs here at home,” and “The President has made it clear that developing our domestic oil and gas resources is a significant part of this administration’s efforts to grow our economy and create jobs. This lease sale is part of our commitment to safe and responsible development of the Outer Continental Shelf.”

In the news release, the BOEM points out that it “…recently increased the minimum bid for deepwater to $100 per acre, up from only $37.50, to ensure that taxpayers receive fair market value for offshore resources and to provide leaseholders with additional impetus to invest in leases that they are more likely to develop. Rigorous analysis of the last 15 years of lease sales in the Gulf of Mexico showed that deepwater leases that received high bids of less than $100 per acre, adjusted for energy prices at time of each sale, experienced virtually no exploration and development drilling.”

On December 14, 2011, nearly 20 months after the explosion on Mississippi Canyon Block 252, the Macondo prospect, the BOEM received $712MM in bids for 191 tracts on Central Gulf of Mexico leases. The BOEM estimates that the sale could result in production of about 222 million to 423 million barrels of oil and 1.49 trillion to 2.65 trillion cubic feet of natural gas.

Our question for the President is simply: “When do you think that wind and solar could ever meet a meaningful proportion of the world’s energy needs?”  Wouldn’t the Prius look cute with a windmill strapped on the hood? But we’re thinking owners of the Ford F-350 would prefer to not be snickered at while at the construction site. We know these are rhetorical points because oil and natural gas are essential to our economy and the very fabric of our technology-oriented lives. We also recognize that facts aren’t necessarily popular in election years, but a review of the data reveals some important insights into America’s energy policy discussion.  Bill Gates made a point in the Wall Street Journal on March 26, 2012, that he believes nuclear “in terms of overall safety record, is better than other energy.” Really Bill? Spoken like someone who is trying to make some money on a project. Gates said: “By 2022, if everything goes perfectly, our demo reactor will be in place.” Uh Bill? Yucca Mountain has been ruled out as a nuclear waste site. We wonder if you’ll allow the Federal government to build that nuclear dump site next to your place in Medina, Washington?

Oil wasn’t always as expensive as it has been over the past year and natural gas price fundamentals are weak. For example, in 1986 crude oil prices dropped to $10 a barrel and they dropped below $10 per barrel in 1998 and even as recent as 2008, we saw prices dip below $40. Yesterday, natural gas cash prices at Opal traded at $1.86 per MMBtu.

Price doesn’t tell us everything. In a free market economy, well mostly free, producers have to earn a profit to encourage them to meet our energy needs. Using EnerCom’s 117-company E&P database, the industry invested an average of $44.85 per BOE to drill and produce one BOE of crude oil in 2011. The cash margin generated by the industry in 2012 was $25.99 per BOE. Based on a percentage of after-tax net income (net income divided by net sales), exploration and production companies in EnerCom’s E&P database generated 1.3% net income margin. Apple’s net income margin was 23.9% for the year ended September 30, 2011. The Majors’ (Exxon Mobil, Royal Dutch Shell, BP, Chevron and Conoco Phillips) net income margin was 7.9%. The rest of the industries represented in the Dow Jones 30 Industrials (excluding XOM and CVX) had net income margins of 11.5%, or 45.6% higher than Big Oil. Come on, Man!

A barrel of West Texas Intermediate crude oil sold for $102.78 a barrel (42 gallons) yesterday, or $0.02 per ounce. A 20-ounce latte costs $0.23 per ounce, or $1,236.48 per barrel. We have not heard a peep from President Obama that Big Coffee should stop benefiting from “tax giveaways.” Starbucks (NYSE: SBUX) generated a 10.6% net income margin for the year ended October 2011. That’s 34% better than Big Oil.

We recall with clarity that as the financial markets and the world economy was melting down in late 2008 through the end of 2010, not a single dollar was given to Big Oil as bailouts were freely granted to banks and the auto industry. Neither of those sectors would likely exist if it wasn’t for affordable energy. When the near-month futures price for WTI fell 77% to $33.87 per barrel on December 19, 2008 from $145.29 per barrel on July 3, 2008 we can’t recall any oil executive asking for a bailout, incentive, tax break, favor or special treatment to keep their people working.

We also recall that in 1980 the Carter Administration enacted the Crude Oil Windfall Profit Tax Act. The Reagan administration repealed the Act in 1988, once it became clear to Congress that a tax on domestic producers would actually increase the marginal cost of finding, developing and producing domestic resources, which made developing American resources uncompetitive with foreign sources, increasing the need to import crude oil. The very policy that was designed to strengthen energy security did, in fact, quite the opposite. American crude oil production has been on the decline since the mid ’70s.

Starting in 2006, a quiet renaissance was going on in the oil patch. George Mitchell and friends were experimenting with horizontal drilling and multi-stage fracture completion technology in tight natural gas shales. The original shale play, the Barnett Shale, proved that the technology worked. The industry being what it is, filled with entrepreneurial and enterprising people, learned to improve the techniques pioneered by Mitchell and then applied them to the huge Bakken Oil Shale in the Williston Basin (Would you like to “Saudi-Size” your order, please?).

The industry flocked to the play and has been a primary source of a rising tide of American crude oil production. In 2010, we saw the first significant uptick in crude oil production in the U.S. in more than 25 years. For decades, Americans of all political sensibilities seemed to agree that it would be a good thing for America to supply more of its own energy needs. Energy producers are enthusiastically committed to producing more crude oil in the U.S. for Americans and our oilmen (and women) should be congratulated as heroes, not the target of another punishing tax initiative that will only make gasoline more expensive for all of us. We believe there are times the president is on the same team as the rest of America when it comes to making America great – but Come on, Man.

We’re not screaming “Drill, Baby, Drill!” But are we really to believe that Big Oil is evil?  This ain’t J.R. Ewing. It’s time the current administration and the rest of America recognizes just how important Big Oil and independents are to America’s future.
The industry pays taxes, a lot in fact. The American Petroleum Institute (www.api.org) estimates that the industry pays America $86 million every day in the form of taxes, fees, rents and royalties. Here are some of the details on just how much cash the industry supplies the American public in the form of taxes, non-income and excise taxes, and rents, royalties and fees:

Income Taxes

• $1 Trillion – Total income taxes paid or incurred by major energy producers from 1980 through 2009.1
• $376 Billion – Total income taxes paid or incurred for the five years from 2005 to 2009 with over $110 billion paid to U.S. taxing authorities.1
• $35.7 Billion – Income taxes paid or incurred in 2009 alone by major energy producers1
• 41.1 percent – U.S. oil and gas industry’s 2010 income tax expenses as a share of net income.
• 26.5 percent – All non-oil and gas S&P Industrials income tax expenses for 2010.

Non-Income and Excise Taxes

• $362 Billion – Excise taxes paid on petroleum products to U.S. taxing authorities by the oil and natural gas industry from 2005-20092.
• $68 Billion – Other non-income taxes paid to U.S taxing authorities from 2005-2009, not including excise taxes collected and remitted on petroleum products3.

Rents, Royalties, and Fees

• $30 Billion – Land use fees paid to the U.S. government between 2008 and 2010, over $5 billion more than the 2009 budgeted discretionary spending for the Department of Energy4.
• $187 Billion – From 1982 through 2010, the United States government collected rent, royalty, and bonus payments from the oil and gas industry totaling more than $187 billion, with almost $96 billion having been received or accrued since 20015.

President Obama is not an accountant, but he and other opponents of this vital industry characterize Big Oil tax incentives as “giveaways.” “With record profits and rising production, I’m not worried about the big oil companies,” Obama said. “I think it’s time they got by without more help from taxpayers who are having a tough enough time paying their bills and filling up their tanks.” “And,” he added, “I think it’s curious that some of the folks in Congress who are the first to belittle investments in new sources of energy are the ones fighting the hardest to keep these giveaways for big oil companies.”

What are these giveaways? America’s oil and natural gas industry supports 9.2 million jobs throughout the economy and represents 7.5 percent of America’s GDP. We noted earlier that the industry pays $86MM each day to the American public in the form of taxes, fees, rents and royalties. And, without those tax incentives for drilling, as we’ve learned from past initiatives (or have we?), energy becomes more expensive and encourages imports. But giveaways? Come on, Man!

According to the API, “Since its inception, the US tax code has allowed corporate tax payers the ability to recover costs and to be taxed only on net income. These cost recovery mechanisms, also known in policy circles as “tax expenditures”, should in no way be confused with “subsidies”, i.e., direct government spending. The U.S. Tax Code has eight categories that are pertinent to the industry. The API provided a summary of each tax category:

Intangible Drilling Costs (IDCs)

• The IDC deduction is a mechanism that allows for the accelerated deduction of drilling costs, such as labor costs, associated with exploration activities (approx 60-80% of the cost of the well).
• Exploration and production companies can claim a deduction equal to 100% of these costs in the year spent. Integrated companies – “Big Oil” – can only deduct 70% with the remainder recovered over 5 years.
• This is a deduction, not a credit or government spending outlay and is no different than the policy behind and treatment of R&D costs vis-à-vis the R&D deduction available for other industries.

Foreign Tax Credit – Dual Capacity Rules

• The dual capacity regulations are not and never have been considered a tax expenditure or “subsidy” by the government.
• They represent additional rules placed on oil and gas companies to prove that the credit used to offset payments to foreign countries are indeed income tax payments and nothing else.
• Repeal of the rules generates revenue solely because it would impose double taxation on US based companies.

Domestic Manufacturer’s Deduction – Section 199

• A deduction (not a credit) equal to 9% of income earned from manufacturing, producing, growing or extracting in the United States, is available to every single taxpayer who qualifies in the U.S.
• The oil and gas industry, and only the oil and gas industry, is limited to a 6% deduction.

Percentage Depletion

• The percentage depletion deduction is a cost recovery method that allows taxpayers to recover their lease investment in a mineral interest through a percentage of gross income from a well.
• This is available to all extractive industries (gold, iron, clay, etc.) in the US and is in no way unique to the oil and gas industry.
• In fact, this depletion method is limited for the oil and gas industry. It is not available to companies that produce oil as well as refine and market it – i.e. “Big Oil”.

LIFO Repeal

• Taxpayers that hold an inventory are required by law to track inventory costs – it is simply an accounting method and nothing else.
• Repealing LIFO deems a sale of inventory to occur, and generating a significant tax gain. Therefore, there is an assumed tax bill without any corresponding cash gain being generated.

Expensing of Tertiary Injectants

• Tertiary injectants refers to items injected into older reservoirs to help continue production.
• The cost of the injectants are expensed similar to materials and supplies because they are generally used up in the production process.
• Without this provision, it is unclear how such operating costs would be recovered. This could easily increase the costs of operating these older fields.

Geological and Geophysical Costs

• G&G costs are the expenses associated with exploring for oil and gas.
• Currently, independent producers are allowed to recover domestic G&G costs over two years, and the proposal would increase that period to seven.
• ”Big Oil” is not impacted, as the largest integrated oil companies already recover the costs over seven years.

EOR and Marginal Well Credits

• These tax credits are designed to support continued domestic oil production when oil prices are so low that it may otherwise be un-economical. The credits phase out when the price of oil is above a certain amount.
• These credits have not been applicable for taxpayers in the oil and gas industry for years, and in order to be even the least bit useful, the price of a barrel of oil must be at $42 (EOR credit) or $27 (marginal well).

Let’s summarize:

• Big Oil, in the Administration’s eyes, represents the five largest oil companies, i.e., the majors. Those five companies are: Exxon Mobil (NYSE: XOM, U.S. domiciled), Royal Dutch Shell (NYSE: RDS.B, Netherlands), BP (NYSE: BP, United Kingdom), Chevron (NYSE: CVX, U.S. domiciled) and Conoco Phillips (NYSE: COP, U.S. domiciled). As majors, these companies also refine and deliver gasoline. But they are not the largest refiner.  San Antonio-based Valero (NYSE: VLO) is the world’s largest refiner.
• The Administration is worried about gasoline prices. We saw $3.75 per gallon at the Shell station this morning in Denver. Let’s compare the cost of a gallon of regular unleaded in the U.S. to other countries, (all figures in U.S.$):
• Canada: $5.56/gallon
• France: $8.29/gallon
• China: $4.54/gallon
• India: $5.03/gallon
• Japan: $6.62/gallon
• Brazil: $5.98/gallon
• Taxes? The industry pays $86 million per day to the American public.
• Tax giveaways? Recall the net income margins for Big Oil and the 117 companies in EnerCom’s E&P database generated net income margins far less than the rest of the industries in the DJIA 30.
• Solyndra and Keystone XL Pipeline. The President said these were not his programs per se. We don’t care much for the political rhetoric. The English novelist Charles Edward Montague said: “There is no limit to what a man can do so long as he does not care a straw who gets the credit for it.” (1922,Disenchantment) President Truman and John Wooden later popularized the point. We agree. Don’t like the tax system? Change it and make it better. Wood Mackenzie noted in August 2010, that for the period of 2011 to 2025, an increase in the access to resources generates $150 billion in additional government revenue compared to a decrease of net revenues of $128 billion when taxes are increased.

The business of business is what keeps America what America is – strong, resilient, resourceful, and independent. Drill ahead.
In closing, we believe Dwight Yoakum said it best in the song “Let’s Work Together”:

“Well together we stand, divided we fall.
Come on now people let’s all get on the ball and work together.
Come on, come on, let’s work together. Hey now people.

When things go wrong, as they sometime will
When the road that you travel all seems up hill
Let’s all work together…”

http://www.youtube.com/watch?v=fSVWWwaq-Gc