Tax proposal would deal big blows to Big Oil

WASHINGTON — Rep. Dave Camp’s plan to overhaul the nation’s tax code would deal major blows to independent refiners and the nation’s biggest oil and gas companies, blocking them from taking some long-cherished deductions and forcing them to use an accounting method that would hike their tax bills when crude prices climb.

But independent oil and gas producers as well as midstream pipeline companies dodged big hits in the Michigan Republican’s long-awaited proposal. The draft bill would preserve “master limited partnerships” that have helped finance energy infrastructure and leave intact a provision allowing immediate deductions of intangible drilling costs such as repairs and hauling supplies.

“You’re basically getting a tax proposal . . . that in effect ratifies and recognizes the importance of independent upstream oil and gas producers to the U.S. and the needs we have to finance energy infrastructure,” said James Lucier, who leads the energy and environmental practice at Capital Alpha Partners.

With congressional leaders distancing themselves from Camp’s draft bill on Wednesday, the plan is not expected to advance this year, but it may provide a template for broader tax negotiations in 2015. It also represents the first big move by House Republicans on the issue, following a separate tax proposal offered by former Sen. Max Baucus, D-Mont. last November.

The wide-ranging plan aims to simplify the nation’s tax code while lowering the top income and corporate tax rates.

Oil industry response

Jack Gerard, president of the American Petroleum Institute, said Camp’s proposal could jeopardize “an energy and manufacturing renaissance (that) has supported our economy through tough times.”

For refiners and integrated oil companies, a major concern is Baucus’ and Camp’s proposals to end the last-in-first-out accounting technique that allows inventories to be valued at the most recent price paid when calculating net profit and taxable revenue. Companies that use the LIFO accounting trick — instead of a more international accepted first-in-first-out method — can effectively record higher costs and slash their taxable revenue if the prices for their reserves have gone up.

Using LIFO has meant lower net profits — and, as a result, lower tax bills — for oil companies whose stockpiles of crude have climbed in price over the past decade.

Camp’s proposal also would end an oil and gas industry exception allowing them more latitude to deduct passive losses. And unlike Baucus’ approach, Camp’s draft would phase out the 10-year-old Sec. 199 domestic manufacturing deduction for all industries.

Maintaining some benefits

But Camp would do nothing to change dual capacity taxpayer rules that allow companies to deduct what they pay foreign governments in royalties for oil produced overseas.

For independent companies focusing on exploration and production, the biggest win may be Camp’s decision to spare the intangible drilling costs deduction.

“This longstanding tax deduction provides producers with the ability to reinvest 150 percent of their cash flow into new U.S. production,” said Barry Russell, CEO of the Independent Petroleum Association of America. “Retaining this provision will enhance the American production that is now being recognized as driving much broader investment in U.S. manufacturing.”

Independent producers would not emerge unscathed, as Camp’s plan would prevent royalty holders and landowners from claiming a percentage depletion for the amount of oil and natural gas extracted from their property. The percentage depletion deduction helps improve the economics of operating marginal wells, which IPAA said generates 20 percent of American oil and more than 12 percent of U.S. natural gas.

Lucier stressed that the intangible drilling cost deduction is essential for non-integrated oil and gas companies pouring money into drilling new wells. “A lot of these independent companies have (capital expenditure) budgets that are bigger than their earnings,” he said, “and they’ve got to be able to recycle that money very quickly every year.”

President Barack Obama repeatedly has proposed doing away with the deduction. Baucus’ tax plan would have allowed the expenses to be deducted over five years.

Investors have been especially concerned about Camp’s plans for the intangible drilling cost deduction and the master limited partnerships that are popular with investors.

Master limited partnerships can issue publicly traded ownership shares as public corporations do. But they’re treated like partnerships that don’t pay corporate taxes, with income and tax liability distributed to investors instead.