Big Oil's Tax Subsidies Aren't What You Think They Are

A recent study by Tax Payers For Common Sense claiming that big oil companies fail to pay their fair share in taxes has vaulted the issue of big oil tax breaks and subsidies once more into the public consciousness. This article takes a look at these tax breaks to see if big oil is unfairly taking advantage of U.S. taxpayers and what, if anything, should be done about it.

Aug 23, 2014 at 10:00AM

Tax Payers for Common Sense recently released a report arguing that big oil companies are woefully underpaying their fair share of taxes, paying just 11.7% despite pre-tax profits of $133.3 billion between 2009 and 2013. 

The study outlined specific tax breaks such as deductions for intangible drilling costs as reasons that big oil wasn't paying the 35% corporate rate the law dictates. 

Intangible drilling costs, along with percentage depletion, are some of the most popular tax deductions that politicians and members of the media like to point to when they speak of "big oil subsidies." An often quoted number is $7 billion in annual subsidies, and in his 2013 fiscal year budget request, President Obama targeted eight tax provisions for elimination that were said to cost tax payers $3.85 billion per year. However, as unpopular as it may be to defend big oil, it is time to make something very clear -- big oil subsidies aren't what most people think they are, and those tax breaks that do exist immensely benefit the nation as a whole. 

No special favors 
In 2013, while testifying before Congress, Harold Hamm, Chairman and CEO of Continental Resources, put it very plainly: "Now my recollection of what a subsidy means is when you are given money to do something. I guess when I drilled 17 dry holes in a row, I missed that pay window. No one sent me a check." 

Mr. Hamm's point is an important one to keep in mind because when most people think of "big oil subsidies" they probably imagine companies like ExxonMobil receiving unfair advantages other industries don't, and that is the reason for their large profits. In fact the oil industry's average profit margin is just 5.2%, far lower than other industries such as telecommunications (7.7%) and technology (17.1%). 

Meanwhile, far from singling out big oil for favorable treatment, oftentimes the tax code excludes them from receiving the same tax treatment as other heavy industries. For example, all natural resource extraction companies are allowed to deduct the depletion of their resources from their taxes. This has been in the tax code since 1913. In 1926, this was made applicable to oil and gas, but in 1975, it was severely constrained to only very small independent oil and gas producers -- those producing under 1,000 barrels per day. 

Another example of this is the Manufacturer's Tax Deduction signed into law in 2004 to encourage the creation of American jobs. In 2008, this was decreased for the oil and gas industry by a third. No other industry received this negative treatment. 

What about industry-specific tax breaks? 
There are a few tax deductions that apply to oil and gas companies alone -- for example, the Marginal Well and Enhanced Oil Recovery credits. However, these laws are immensely beneficial to not just our economy but the environment as well

The Enhanced Oil Recovery credit is capped at a 15% deduction from the cost of augmenting a standard well. The tax credit is phased out as oil prices increase, but in the meantime, it encourages tertiary oil recovery, which is accomplished via CO2 injection into oil wells. This serves two purposes: It increases oil production from wells previously thought depleted, and it traps CO2, the leading greenhouse gas, underground.

This is known as carbon capture and sequestration, and Judi Greenwald, Deputy Director of the Department of Energy's Climate, Environment, and Energy Efficiency Office, has endorsed it, stating: "By using captured man-made carbon dioxide, we can increase domestic oil production, promote economic development, create jobs, reduce carbon emissions, and drive innovation."

How these tax breaks benefit you
Let's consider the Enhanced Oil Recovery tax credit for a moment and see why it benefits not just the oil industry, but the entire globe. Using standard pumping techniques, only about 20% of oil is recovered from a well. That extra oil not only helps stabilize prices, but it creates large amounts of good-paying jobs and reduces dependence on the ultra-volatile Middle East. 

Job creation and economic prosperity
Oil Disruptions

Judging by the way oil and gasoline prices have been declining for weeks, you'd never guess that chaos in the Middle East and sanctions against Iran have left 4% of the world's oil supplies out of the market. Sanctions against Russia threaten to increase that number, which could potentially trigger a larger oil shock.

US Retail Gasoline Prices Chart

US Retail Gasoline Prices data by YCharts.

Yet, oil prices are at 13-month lows, and Goldman Sachs is predicting oil prices will remain stable over the next 12 months thanks to continued growth from U.S. shale oil production. 

North Dakotatexas Oil Production

Source: EIA

Meanwhile, a recent study by IHS states that $890 billion in investment into the U.S. energy boom through 2026 could generate $75 billion in annual income. This is from the 1.7 million jobs that analyst firm McKinsey expects to be created by 2020 alone. For example, in North Dakota, the over the road (OTR) truck driver can make $72,000-$90,000 per year. 

IHS estimates that the coming energy investment boom could increase America's GDP growth rate by 0.75% per year and result in $27 billion annually in greater tax revenue. That additional tax revenue is far more than the $7 billion in annual tax incentives that politicians often get worked up over. 

Bottom line 
Oil subsidies don't exist in the sense that many Americans perceive them. What do exist are tax incentives enjoyed by every other natural resource industry, and the results of these incentives have been improved economic growth, lower unemployment, more stable energy prices, and increased geopolitical security. 

An energy tax "loophole" for investors
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.


Adam Galas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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