IDC Policy Change Not Anticipated in Year-End Fiscal Cliff Negotiations

While intangible drilling costs (IDCs) could be reduced or phased down starting in 2014, FBR Capital Markets & Co. analysts do not expect a policy change in the end-of-2012 fiscal cliff negotiations.

The discussion of whether IDCs is generally not expected to enter the fiscal cliff debate due to opposition by Republicans in the U.S. House of Representatives and lukewarm approach to raising revenues, according to a Dec. 12 FBR research note.

President Obama has repeatedly called for eliminating over $43 billion in oil industry tax incentives over the next decade. The focus on IDC expensing has grown following news reports highlighting the relatively low federal tax paid by some exploration and production companies and the reduced risk of drilling dry holes in the shale.

The issue has gotten little traction in Congress. But the current fiscal shortfall is forcing policymakers to make tough decisions on raising revenue and cutting prized spending programs.

"In this environment of scarcity, even the sacred cows may no longer be off limits," FBR analysts noted. "However, we believe that IDC expensing serves an important policy goal for Democrats in encouraging domestic production and energy independence."

Instead, House Republicans have deferred discussion of changing oil industry taxes to a comprehensive corporate tax reform effort at lowering rates and eliminating deductions targeted for 2013.

"If Congress passes corporate tax reform in 2013, we would expect adjustments to oil industry axes, potentially including intangible drilling costs, Section 199, percentage depletion, and geological and geophysical amortization, among others," FBR analysts noted.

According to FBR's analysis, a change in expensing from 100 percent of IDCs to 70 percent of 50 percent has a clear cut impact on returns, net present value (NPV) and cash flows. In the 70 percent expensing ratio, the Hayneville core experiences the greatest NPV impact at 33 percent, followed by the Bakken at 11 percent and Fayetteville at 11 percent. The liquids-rich Marcellus and Eagle Ford condensate are the least affected of the five sample plays at six percent each.

FBR used a natural gas price of $4.50/Mcf and $80/bbl crude oil price for its base case.

An independent E&P company currently is allowed to expense 100 percent of IDCs in year one. IDCs are typically 75 percent of total cost to drill a new well.

Energy industry groups and some Republican lawmakers have criticized Obama's plan to eliminate tax incentives, saying the move will snuff out the U.S. shale play's transformation of the U.S. economy and its energy future.

Karen Boman has more than 10 years of experience covering the upstream oil and gas sector. Email Karen at kboman@rigzone.com

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