Study: Delaying IDC Recovery to Result in US Production, Job Loss

Study: Delaying IDC Recovery to Result in US Production, Job Loss

Delaying the oil and gas industry’s ability to quickly recover intangible drilling costs (IDC) would lead to significant losses in oil and gas production and jobs, and negatively affect the economics of many key oil and gas plays, according to a recent report commissioned by the American Petroleum Institute (API).

Delaying IDC deductions would have a “significant and immediate effect” on U.S. oil and gas production, resulting in a production loss in 2023 of 3.8 million barrels of oil equivalent per day from U.S. oil and gas fields, according to Wood Mackenzie, which conducted the study on API’s behalf.

Both liquids and gas production would be impacted if IDC deductibility timing is altered. By delaying IDC recovery, Wood Mackenzie estimates that, by 2023, total cumulative production of 8.9 billion barrels of oil equivalent would be lost.

“The oil and gas industry has been a bright spot for the United States, benefiting both consumers and manufacturers nationwide,” said Stephen Comstock, director of tax and accounting policy at API, in a conference call Thursday.

However, exploration and production is expensive, requiring significant financial investment before a return can be seen.

IDCs allow oil and gas companies to recover non-salvageable expenses for oil and gas drilling quickly, treating them similar to operating costs. Allowing a quick recovery of IDCs improves cash flow for oil and gas companies, allowing them to reinvest in drilling, “creating more jobs, helping to grow the economy and generating more revenue for the U.S. government without raising taxes,” Comstock noted. 

Oil and gas companies can currently recover non-salvageable expenses quickly, treating them similar to operating costs.  However, lawmakers and the Obama administration have sought to repeal IDCs, which have existed for oil and gas since the early 20th century, while keeping similar measures for other industries, Comstock said.

IDCs meet the criteria outlined in legislation proposed by Senate Finance Committee Chairman Max Baucus (D-Mont.) and Ranking Member Orrin Hatch (R-Utah) that would eliminate all tax provisions except those that grow the economy, keep the tax code fair and promote U.S. policy objectives, Comstock noted, adding that the oil and gas industry shouldn’t be singled out when companies in other industries can recover costs quickly.

While the proposed tax reform has been in the works for the past three years, Comstock said that API has fielded a lot of questions from the industry regarding IDCs, which prompted the study.

In the study, Wood Mackenzie looked at how delaying the oil and gas industry’s ability to recover IDCs would impact energy supply, job and economic growth at the regional and national levels for the 2014-2023 time period.

Wood Mackenzie modeled for the study two cases to infer the impact of delaying IDCs deductibility, including one with no change to IDCs treatment for tax purposes, and the other with IDC deduction delayed starting Jan. 1, 2014. The second case assumes that IDCs will no longer be fully deductible when they are incurred, and will instead be depreciated on a straight-line basis over the expected average life of a U.S. lease.

According to the study, 190,000 jobs could be lost in the first year after the tax deduction for IDCs is repealed, said Comstock. Wood Mackenzie estimated that employment losses resulting from changes in the current IDC deduction timing would reach 233,000 by 2019. By 2023, the number of jobs lost could reach over 260,000 due to declining activity levels forecast to result from delaying IDC deductions. 

Over 90 percent of the jobs lost would be related to a slowdown in U.S. onshore activity, and future deepwater Gulf exploration could be curtailed as well. All seven areas looked at by Wood Mackenzie for the report would be hit with job losses, including the U.S. Gulf Coast, Midcontinent, Northeast, Permian, Rockies, Gulf of Mexico and West Coast.

While direct oil and gas industry jobs lost would likely peak at more than 75,000 by 2023, for every direct job lost, another 2.5 indirect and induced jobs would be lost as well. Nearly 200,000 jobs would be lost in the overall U.S. economy in 2023, Wood Mackenzie said.

U.S. industry investment would also decline by $407 billion over the 2014-2023 timeframe, or a yearly average of over $40 billion.

“Given the high level of unemployment and budgetary stress facing the nation, the findings of this study should be of interest to policy makers as they move forward to craft solutions to these problems,” Wood Mackenzie noted.

Federal tax increases would be more than offset by reductions in federal, state and private royalties and other state taxes lost as a result of delaying IDC recovery, Wood Mackenzie noted.

Regions that will be particularly hard hit by IDC delay include the Northeast, Midcontinent and Rockies, with each region possibly losing around 20 percent of their future growth production if IDC deductions are delayed, Wood Mackenzie said.

IDCs include charges for wages, fuels, repairs, hauling and other non-salvageable expenses incident to and required for drilling wells or preparing wells for production. IDCs usually represent 60 to 90 percent of a well’s cost, depending on the well type and costs associated with the specific intangible services.

The tax treatment of IDCs does not reduce the actual tax liability over a project’s life, but allows the liability to spread across the life of a project.  While Wood Mackenzie tends to see a higher percent of intangible cots in offshore wells, the percentage of intangibles in onshore wells rise after drilling is completed and hydraulic fracturing begins. Completion costs, including fracturing, can be the largest single intangible cost, greater than the cumulative day rate.

The delay of IDC recovery will mean that many projects will no longer meet the criteria for investment as many U.S. plays and fields will become marginalized if IDC deductions are delayed.

“Rates of return are directly influenced by the timing of cash outflows and inflows related to the project,” Wood Mackenzie noted. “Therefore, any significant delay of the timing of the tax deductibility of drilling costs will reduce the discounted cash flow and rate of return values such project will generate.”

As a result of a delay in IDC recovery, 8,100 fewer wells would be drilled in the United States in 2019 and 9,800 fewer wells in 2023. Delaying the deductibility of IDCs will cause at least 300 rigs to be laid down in 2014; that number would rise to over 400 rigs by 2018 and nearly 500 by 2023. The delay of IDC recovery on cash flow could be severe enough for a number of companies that they could not afford to invest in future drilling and development.

If current U.S. policy regarding IDCs remains, Wood Mackenzie estimates U.S. domestic production will rise from 22.4 million barrels of oil equivalent per day (MMboepd) in 2013 to 26.8 MMboepd in 2023, a 20 percent increase over the 10-year period. Significant production growth is anticipated in the Rockies, Northeast, Gulf Coast and Gulf of Mexico regions thanks to unconventional oil plays, consolidation of shale gas plays, frontier activity and emerging Gulf of Mexico deepwater plays.

“The U.S. oil and gas regime is viewed as being stable and attractive when compared to most other countries,” Wood Mackenzie noted. “Fiscal stability allows companies to plan and make sound investment decisions. Delaying the deductibility of IDCs would create instability in the U.S. fiscal regime, and lower its relative competitiveness compared to other oil and gas regions.”



WHAT DO YOU THINK?


Generated by readers, the comments included herein do not reflect the views and opinions of Rigzone. All comments are subject to editorial review. Off-topic, inappropriate or insulting comments will be removed.

Gib Brown  |  July 11, 2013
For something which has been a part of the tax code for nearly 100 years, what makes this administration think they know more than those who have come before them. EVERY industry, including community organizers, have intangible manufacturing costs which are paid for with pretax dollars.


Most Popular Articles