Comments by the Alliance to the US Senate Finance CommitteeJune 9, 2021 The US Senate Finance Committee met in Washington in late May to consider Chairman Ron Wyden’s (D-OR) Clean Energy for America Act which, among other things, seeks to change various tax provisions for US independent oil and gas companies, both small and large. Most notably, the bill would fully eliminate the percentage depletion deduction for small independent operators, and would change the deduction for Intangible Drilling Costs (IDCs) from full 100% deduction for those costs in year one, to spreading them out over a five-year period of time. The Alliance made the point to the Committee that eliminating percentage depletion and altering the treatment for intangible drilling costs would cost Texas jobs, reduce industry investment, lower production, reduce tax revenues and economic activity to Texas and its producing regions, and reduce the level of energy independence we worked so hard to achieve. Our comments can be found here on our website. To: The US Senate Committee on Finance Click here to download pdf of written comments. Statement by the Texas Alliance of Energy Producers to the United States Senate Committee on Finance for the record on the hearing, Open Executive Session to Consider an Original Bill Entitled The Clean Energy for America Act, held Wednesday, May 26, 2021 On behalf of our members and our Board of Directors, the Texas Alliance of Energy Producers appreciates the opportunity to comment on the Clean Energy for America Act, and the hearing that took place on Wednesday, May 26. The Texas Alliance of Energy Producers (“the Alliance”) represents about 2,600 member companies and individuals. The Alliance represents primarily the “upstream”, or exploration and production sector of the oil and gas industry in Texas, including operators and producers of crude oil and natural gas, oilfield service companies, and drilling companies. Our direct membership is approximately 2,600; however, we represent thousands more than that in terms of the total employment of our member companies. More broadly, we represent an industry that presently directly employs approximately 160,000 Texans, on the payrolls of oil and gas extraction (operating and producing) companies, oilfield service companies, and drilling companies. That number is climbing as the US and global economies recover from the COVID pandemic of 2020 in which nearly 62,000 upstream jobs were lost in Texas alone between February and September of last year. What this means is that the present 160,000 jobs total is not the ceiling for upstream oil and gas employment in Texas. Thousands more stand to be added as the industry recovers from the deep downturn of last year, perhaps tens of thousands in a sustained period of recovery in which presumably a great many of those 60,000 jobs lost last year may be added back. That means, of course, that the number of jobs potentially at risk from harmful US domestic energy policies is considerably higher than the current upstream employment levels would indicate. Further, those are not the only jobs in Texas dependent on the upstream oil and gas sector. The upstream companies engage in purchases from a second tier of suppliers – pipe, pumping equipment, compressors, office supplies, automobiles, sand, tubing, drilling rigs, transportation services, etc. – and these jobs are at risk as well, along with jobs elsewhere in the economy dependent on wages paid to direct upstream companies and their suppliers of goods and services. A conservative estimate would be to multiply upstream jobs by 2.5 to approximate the number of jobs that may be affected by movements in direct upstream employment. For example, were upstream employment in Texas to increase to, say, 200,000, a very real possibility as industry activity expands in the post-COVID recovery, the total number of jobs connected to oil and gas exploration & production activity would actually be 500,000 or more. The upstream industry in Texas achieved its most recent cyclical peak in December 2018 at which time about 228,000 Texans were on the payrolls of E&P companies. Oil and gas employment declined in 2019 in advance of the COVID decline, losing about 20,000 jobs based on lower oil prices in 2019 compared to 2018, and a corresponding decline in the statewide rig count and other measures of upstream activity in Texas. In October 2018 crude oil prices peaked in the $70/barrel range – just this week, crude oil prices returned to that level. As the industry ramps up to meet rising demand post-COVID, it is at least possible that oil and gas employment in Texas could increase to as high as 220,000 or more in a sustained period of domestic and global economic recovery. With a multiplier of 2.5, petroleum-dependent employment in Texas would then be approximately 550,000 jobs. (As a matter of context, Texas upstream oil and gas employment reached its all-time high of approximately 300,000 in late 2014. Oil and gas employment has declined since then even as production has increased, thanks to the extraordinary efficiencies and productivity gains achieved by oil and gas companies, meaning more can be produced with fewer rigs and fewer employees.) The quantity of these jobs is not the only issue, of course. The quality of upstream oil and gas jobs must be considered as well. Jobs in the oil and gas exploration & production (E&P) sector are routinely the highest, or among the highest wages paid of any industry employment category in Texas, making the loss of those jobs more painful to the Texas economy and its local and regional economies. While there is a concentration of upstream oil and gas jobs in Houston and in Midland-Odessa, oil and gas jobs exist in virtually every corner and region of the state. As such, they provide much of the fabric of local and regional communities and rural economies. Of the 254 counties in Texas, crude oil and/or natural gas is produced in about 85% of them. The economic benefits of an active, vibrant, and expanding oil and gas industry are spread far and wide in Texas; conversely, the economic pain inflicted as a result of a diminished, declining oil and gas industry is deeply felt all throughout the state. Indeed, the story of US and Texas energy production in this century is a remarkable one. Thanks to the development and deployment of horizontal drilling and hydraulic fracturing, US oil and gas operators first cracked open massive new supplies of natural gas, with the Barnett Shale in north Texas as the laboratory, the first shale play (production region) to be exploited on a large-scale basis for the production of hydrocarbons. Following the Great Recession in 2008-2009, these same techniques were used to raise Texas and US crude oil production dramatically, cracking open a brand-new production region called the Eagle Ford Shale in Texas, from which scarcely a barrel of crude oil was produced before 2008. The Eagle Ford was a gamechanger to be sure, helping to raise levels of Texas crude oil production along with the Texas share of total US production, but it was the deployment of these production techniques in the massive Permian Basin that raised the state’s profile in terms of petroleum energy provided to a growing national economy in which energy demand is on the rise. Other US shale plays followed – the Marcellus in the northeast, the Bakken in North Dakota, and others. At the same time, rising Texas and US production spectacularly displaced imports of crude oil into the United States, especially from non-North American sources (Canada has long been a source of significant crude oil imports into the US, helping to provide the US market with the volume and types of oil that it needs to keep US consumers abundantly supplied). The fantastic increases in US production, with Texas leading the way, paved the way for the long-stated goal, once nothing more than a pipe dream, of largely achieving US energy independence, lowering prices to consumers and shielding the US from supply shocks resulting from global geopolitical events in the Middle East and elsewhere. In 2009 and early 2010, Texas crude oil production was approximately 1.1 million barrels per day. Texas crude oil production achieved its all-time peak in March 2020 (before COVID crashed production over the next two months) of over 5.4 million barrels per day, a five-fold increase in production in just 10 years! During that period of time, the Texas share of US total crude oil production more than doubled from about 20% in 2020 to about 42% in early 2020. Total US crude oil production well more than doubled over roughly that same time frame from just over 5 million barrels per day in early 2010 to over 12.8 million barrels per day in late 2019. The combination of US domestically produced crude oil, which has increased dramatically, and imports of crude oil from other countries, which have decreased dramatically, has met the rising demand for energy as the US economy has grown over time. That will continue to be the case as the economy recovers from COVID and enters in a new round of expansion – an expansion that will require growing volumes of energy to meet its needs. Petroleum energy supplies virtually all of the US transportation sector on the ground and in the air. Coal and natural gas provide the majority of fuel for electric power generation in the US, with the natural gas share of that total increasing as coal declines. The demand mix is highly unlikely to change appreciably in the near term. Detrimental energy policies could very easily change the supply mix, however, by reducing domestic energy production, increasing energy imports, and very likely raising prices to consumers significantly at the same time. In other words, the demand for petroleum energy is likely to increase in the future as the economy grows, and that demand will be met by rising imports if US domestic production is stifled as a result of future tax and regulatory policy. Various policy proposals already implemented or under discussion will have that very effect. A moratorium on petroleum energy production from federal lands and waters begins to lower production from those assets which, previous to the implementation of any moratorium, provided well over 20% of US crude oil production and 12% or so of US natural gas production. Putting the Keystone XL pipeline out of commission has the same effect by limiting supplies of crude oil into the US from our most reliable energy trading partner to the north. The change in petroleum production tax policy under consideration in the Senate Finance Committee will have the same effect of restricting Texas and US crude oil and natural gas production, lowering the volume of domestically produced energy to Americans, necessarily once again increasing our dependence on sources of crude oil imports we spent decades hoping to separate ourselves from. We will focus largely on two tax measures that are most likely to affect our member companies, and these are percentage depletion and the tax treatment for Intangible Drilling Costs (IDCs). Percentage Depletion As you know, percentage depletion, a part of the US tax code since 1926, is a form of depreciation unique to extractive mineral interests. Its purpose is to allow for a deduction from taxable income to account for declining production of reserves of those mineral assets over time. It is not unique to oil and gas but applies to a broad range of extractive industries. The proposal in the Clean Energy for America Act to eliminate the deduction is unique to fossil fuel producers, however, meaning the industry appears to have been singled out for a negative change in tax treatment. Not all wells and companies qualify for this deduction, of course. By law, the deduction can only be taken by independent oil and gas producers. It is limited to the first 1,000 barrels of crude oil produced per day by the taxpayer, or to the first 6,000 mcf of natural gas produced per day. Further, it is capped at the net income of a well and limited to 65% of the taxpayer’s net income, meaning there is no “tax credit”, or negative tax that can occur as a result of this deduction. The nature of these restrictions on percentage depletion means that only small independent producers are able to take advantage of this particular deduction. Conversely then, only small independent operators are harmed by its elimination. Depletion and decline are the nature of production from crude oil and natural gas wells, and therefore the wells have a life cycle that hopefully ends with decommissioning and plugging the well. Low volume wells approaching the end of their life cycle are those most likely to be able to take advantage of the percentage depletion deduction. Their operators are typically small independent producers, often family run companies, scattered all across the producing regions of Texas and the US. They employ anywhere from less than 5 to perhaps 40-50 workers, paying higher-than-average wages and providing the livelihood for their households and economic support for their communities. Even though the deduction applies only to low-volume wells and low daily volumes of production, taken together these wells account for 7-8% of total US crude oil and natural gas production. The elimination of the percentage depletion deduction must necessarily lower that volume and share of production as it becomes uneconomic with the increased tax burden. Production from these wells is a significant part of the total US supply mix, and the decline in total Texas and US production volume must and will be made up from some other source to meet current and future US demand. That source will be increased imports into the United States. The elimination of percentage depletion therefore harms ONLY US small independent producers, and disadvantages those producers compared to larger publicly traded independents and major integrated US oil and gas companies, and to foreign suppliers of crude oil into the United States. A study recently completed by the National Stripper Well Association and introduced into the hearing record by Senator Lankford of Oklahoma, estimated the economic impact by various measures of eliminating the percentage depletion deduction. The Alliance was a partner in that effort, and I served on the steering committee for the study. The study was conducted by Energy & Industrial Advisory Partners (EIAP) in Houston, and followed a standardized methodology utilizing US Bureau of Economic Analysis (BEA) published multipliers for upstream oil and gas activity in the US and its producing states for employment, spending, and so on. Not surprisingly, Texas is the hardest hit by the elimination of the percentage depletion deduction. The base year for the study is 2021 and generally looks 15 years into the future. Over the course of the forecast period 2022-2035 over 58,000 jobs are lost economy-wide (direct industry jobs, indirect employment, and induced employment), with over 24,000 of those going by the wayside in 2022, assuming percentage depletion is eliminated in 2021. The Texas well count declines by over 45,000, and production declines by nearly 190,000 barrels per day over that 15-year period of time. Over $6 billion is lost to statewide Gross Domestic Product, and taxes collected by the state as a direct result of these activities would decline by $145 million. Percentage depletion applies to royalty owners as well – those that have an ownership interest in the mineral assets. Tens of thousands of people receive royalty payments which serve to supplement their income, and in Texas royalty payments are projected to decline by about $450 million dollars should percentage depletion be scrapped. In terms of stripper well operators, the percentage depletion deduction makes it not only possible to continue to operate those wells through the course of their entire productive lifetime, generating production, jobs, and other positive economic impacts, it also significantly reduces the number of wells that may ultimately be orphaned or abandoned. Intangible Drilling Costs (IDC) The loss of current Intangible Drilling Cost (IDC) provisions would have a similar effect, of course. Like percentage depletion, only independent oil and gas companies may take advantage of the immediate expensing of intangible drilling costs. However, the IDC provision applies to a much broader range of crude oil and natural gas producers, and the negative implications of altering that provision are much more far-reaching. Independent producers from small to large may expense 100% of intangible drilling costs in the first year; therefore, changing that provision would change the math for oil and gas companies for the worse, and would clearly cost high-paying direct industry jobs as well as jobs elsewhere in the economy, lower the volumes of crude oil and natural gas produced, reduce well counts, and significantly lower the economic and tax contributions of the industry to the state of Texas. The word “intangible” is somewhat misleading – these are hard-dollar expenses incurred in the drilling of a well, and they comprise the majority of the total cost. Employment would take a direct hit – labor costs associated with drilling a well are counted among the intangible drilling costs and the inability to immediately recover those costs would without question reduce the level of investment in exploration and drilling projects, a sizable portion of which goes to the labor costs of those activities. The immediate expensing of IDCs for oil and gas companies is designed to encourage investment and development for the benefit of the consuming public and the economy as a whole. It helps to keep these activities within the confines of the United States rather than encouraging their offshoring. It is not inconsistent with other industries, including the deduction for R&D expenses, for example. And again, as the largest and most active producing state, Texas is again hardest hit by the elimination of current IDC tax provisions. Many have suggested that those who have lost oil and gas jobs as a result of changing or eliminating these provisions will be able to find employment in the new energy economy. The problem is that the new energy economy does not now exist, certainly not in sufficient form to absorb displaced oil and gas workers. A realistic assessment of current employment in renewable energy technologies makes that perfectly plain. Electric power generation from non-fossil fuel sources presently totals just over 5,000 jobs in Texas, and that includes nuclear. There are some manufacturing, construction, and other jobs that will accompany wind and solar projects, but it is abundantly clear that there is no room elsewhere in the present energy economy for the workers that will be displaced from oil and gas jobs as a result of these proposed changes in the tax treatment for US oil and gas companies. Any attempt to suggest otherwise is highly misleading, and the loss of these jobs should not be shrugged off or treated so cavalierly. US oil and gas companies, with Texas leading the way, have accomplished the task once thought impossible – to grow domestically produced petroleum energy dramatically, and establish a long-term, abundant, affordable supply of energy for literally decades to come. In summary, eliminating the percentage depletion deduction for small independent oil and gas operators and changing the treatment for intangible drilling costs will demonstrably cost significant numbers of jobs directly in the industry and elsewhere in the economy, reduce the levels of investment and development activity, and reduce the volumes of domestically produced crude oil and natural gas. That in turn will raise energy costs to US consumers and force the country to turn once again to foreign sources of energy to meet our domestic energy needs. Thank you again for the opportunity to provide these comments.
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