Oil industry tax deductions may face fiscal cliff woes soon, analyst warns

The tax package that passed on Tuesday evening and included credits for a range of areas of renewable energy did not include another widely discussed area of possible tax revenue – removing some of the tax deductions that oil and gas companies have enjoyed.

There are a range of tax deductions available to oil and gas companies, including intangible drilling costs, which include costs and the percentage depletion deductions.

Some analysts are predicting that tax reformers in Washington may target the highest-revenue generating deduction, the intangible drilling cost deduction, for inclusion in future legislation.

“The ability to expense intangible drilling costs survived the year-end fiscal cliff bill passed on Jan 1st,” wrote Tudor Pickering in a Thursday research note. “However, President Obama campaigned on removing “subsidies” for oil companies and with spending cuts/debt ceiling decisions deferred for only two months, (and) we believe IDC repeal is still on the table.”

Under the intangible drilling cost rule, exploration and production companies can expense about 60 percent of all costs for actual expenses other than drilling equipment, such as survey work, wages and supplies. While the calculation of this tax benefit sounds complicated, its value to the industry is huge – about $14 billion over the next ten years, said Allen Littman, a partner with Baker Hostetler who specializes in tax policy.

Littman is less convinced that the intangible drilling cost deduction will be on the slate in the near term, or other oil and gas deductions in the tax code, which are valued at $13 billion for the next ten years, bring the grand total of potential government revenue from their eradication at $27 billion.

Littman instead anticipates that its removal would only come as part of a broader corporate tax reform that could also remove the renewable energy credits that were extended through the fiscal cliff tax legislation.

“Removal of these tax preferences would probably come together in a tax reform package that would focus on dropping these special industry benefits in exchange for a lowering of the overall corporate business tax rate,” Littman said. “That is the tax reform model from the 1986 tax reform. That is what people are talking about trying to do again.”

President Obama’s vocal support during his campaign for removing the deductions for the oil and gas industry has led analysts to believe that the deductions may be a future target.

“This has been the president’s position all along, that the oil and gas industry is getting all these benefits, and they don’t need them, because they are doing so well,” Littman said.

If there is a repeal of these deductions, an unresolved question is how the repeal will be structured, Tudor Pickering said. Different options include a 2013 versus a 2014 timing of the repeal, whether it would be phased in and whether small companies would be excluded, Tudor Pickering said.

But that is not to say that any of these concessions will come without a fight from industry.

“In the tax reform discussion to come, there will be winners and losers,” Littman said. “The losers could be the fossil fuel industry, the wind industry. The losers are not going to let go of easily – it will be a big fight.”