Obama's Plan to Punish Big Oil Will Backfire

Buried within President Obama's 2009 budget proposal are nine provisions intended to eliminate $31.5 billion of "oil and gas company preferences" over the next decade. Most are repeals of existing tax breaks, while a new excise tax on Gulf of Mexico production is thrown in for good measure.

These budget measures are a pretty clear shot at Big Oil, which remains a political target despite the sudden shrinkage of those wicked windfall profits. I'm afraid, however, that our country's independent energy producers will disproportionately bear the brunt of these proposed changes, which could lead to less domestic production.

Give me a break
Consider the repeal of the manufacturing tax deduction. This deduction is straightforward enough: produce stuff domestically, score a tax break. If you take this benefit away from globally diversified ExxonMobil (NYSE: XOM  ) , maybe it drills a few more wells in Thailand or Turkey instead of Texas. No biggie.

Strip a domestic producer like Southwestern Energy of these savings, though, and the money to pay the higher taxes will predictably come right out of the capital budget. The impact gets multiplied as it translates to reduced demand for the services of Dawson Geophysical (Nasdaq: DWSN  ) , Nabors Industries (NYSE: NBR  ) , and the rest of the oil patch's service providers.

Maybe politicians aren't paying attention to what's happening in the oil patch these days, but we energy-focused Fools are following the company implosions, collapsing rig count, and asset fire sales with great concern. This is a heck of a time to put the brakes on productive activity in the energy sector.

A more tangible example
Let me flesh out this next example a bit more. Another line item in the Obama budget proposes the repeal of intangible drilling cost (IDC) expensing. Sounds boring, I know, but the numbers here (crunched by research associate Lisa Fancy of Ross Smith Energy Group) should grab your attention.

When it comes to drilling and completing a well, IDCs represent anywhere from 60% to 90% of the total cost. Basically, the more complex the job, the higher the proportion represented by IDCs like site surveys and fracture jobs. Integrated oil companies are already required to capitalize a portion of these costs, so once again independents are the ones getting hit hardest here.

Wait a tick. Isn't capitalization versus expensing just an accounting choice, leading to non-cash discrepancies between firms such as Devon Energy (NYSE: DVN  ) and Anadarko Petroleum? Not when we're talking about tax reporting. Take away the ability to expense IDCs, and you accelerate the payment of cash taxes.

Capitalization, on the other hand, doesn't usher in an increase in taxes, but rather a shuffle. Still, the temporal shift is enough to seriously ding the net present value of a drilling operation. In a hypothetical case in which an E&P spends the same amount year after year, Fancy calculates a 13% hit to the firm's net asset value (NAV). Of course, given the depleting nature of oil and gas assets, spending usually rises each year (when the economy's not paralyzed, at least). In the case of a 10% annual bump in capital expenditures, the hypothetical hit to NAV rises to 20%.

The most costly and complex natural gas wells being drilled onshore today are in the Haynesville shale play in Louisiana and east Texas. Consequently, single-well economics in the Haynesville appear hardest hit by a loss of IDC expensing, perhaps to the tune of 18% of net present value. This would be pretty bad news for folks such as Petrohawk Energy (NYSE: HK  ) , though I suspect that particular outfit would keep plowing ahead in any case.

Drilling our domestic producers
I see the same problem recurring across these various oil-industry tax proposals. Global firms such as ConocoPhillips (NYSE: COP  ) get encouraged to shift business abroad, while small fries lacking the scale to move activity outside of the country simply do less drilling. In both cases, we see less domestic energy production (not to mention fewer jobs). I don't see how this helps us "reduce dependence on foreign oil," a stated goal of the budget.

Through these line items, we are effectively kicking our independent producers while they're down. And they produce 82% of U.S. natural gas!

As the head of StatoilHydro (NYSE: STO  ) recently pointed out in a letter to shareholders, "despite the best of intentions, it is a fundamental energy reality that the world is decades away from a low-carbon society." These measures, which we can expect to drive up the marginal cost of natural gas, promise to make the ensuing decades just that much more uncomfortable as we continue to rely on fossil fuels for the majority of our energy needs.

Dawson Geophysical is a Motley Fool Hidden Gems recommendation; StatoilHydro is an Income Investor pick. Drill into any of our premium stock newsletters free for 30 days.

Fool contributor Toby Shute doesn't have a position in any company mentioned. The Motley Fool has a dependable disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 25, 2009, at 5:10 PM, jclawsonPHN wrote:

    Brezette have you ever used anything solar powered? I have, and they sucked. There is absolutely no consistency with them, they are unreliable. I am all for alternative energy, but we need something act as a bridge between fossil fuels and whatever is consistent and reliable in the future.

  • Report this Comment On March 25, 2009, at 5:25 PM, Melaschasm wrote:

    Obama's domestic oil tax is just going to shift more energy production, and high energy industries out of the USA.

    That is one reason why my only energy investments are in companies outside of the USA.

  • Report this Comment On March 25, 2009, at 5:56 PM, farmnut1985 wrote:

    Unfortunately oil is currently and will be our main source of energy for probably at least another ten years and realistically, probably at least twenty. We have a long way to go to come up with replacement energy sources of which most will come from the agricultural sector in the form of biorenewables. Wind and solar will play a part in the electrical grid but the sun doesn't always shine and the wind doesn't always blow (except in Washington, lots of hot air to go around there) meaning that power plants are going to have to run on something. Hammering fossil fuels is just going to continue to cripple the economy.

    Another problem is oil is a limited resource and by taxing it, they will just cut production to increase the price to offset the tax cost. I don't like big oil, but they are smart and they will get their cut either way.

  • Report this Comment On March 25, 2009, at 6:13 PM, LesMar wrote:

    Higher energy prices simply translate to a lower standard of living for years to come.

  • Report this Comment On March 26, 2009, at 1:55 PM, beatnik11 wrote:

    It drives me crazy when folks speak of taking away tax breaks as if they are tax hikes. Nobody is actually raising the taxes, they are just getting rid of the preferential treatment that many oil companies got very used to. Slowly we will ween ourselves off this very dirty source of energy and into cleaner sources, but there will still be a growing global demand for oil in teh near future and unless you are living in a fantasy land, you will realize that its a finite resource that is deminishing. In the short term it will feel like a kick, but the oil industry in the USA is not going to shrivel up and die because of it and in the future the demand and price will pick up and things will be just peachy again. It seems like the internet is the favorite place for chicken littles to proclaim that the sky is falling every day

  • Report this Comment On March 26, 2009, at 2:21 PM, latechdawg wrote:

    Natural gas is incredibly clean; problem is, liberals don't want it because it's still carbon-based. It all stems to idiots like Al Gore running around screaming "global warming"--which has been proven to be false anyway. The next 4 years will have nothing to do with anything except AGENDAS!

  • Report this Comment On March 26, 2009, at 5:37 PM, mpendragon wrote:

    Increasing domestic production won't help us reduce cost over the long term when we consume 25% of the world's fossil fuel and have 3% of the world's reserves.

    The best long term strategy is to develop alternative energy sources, embrace smart grid technology, promote energy saving choices when it comes time to replace old appliances, get over our issues with nuclear power, and become accustomed to expensive energy. In the meantime I say we consume the fossil fuel reserves of any nation willing to sell them to us while keeping ours in the ground for as long as possible. When it becomes more scarce we'll be in a position to consume it more efficiently than we can now and more efficiently than other nations will be able to then.

  • Report this Comment On March 26, 2009, at 8:19 PM, sabertoothtiger wrote:

    So the oil and gas industry have been propped up for 100+ years, and now their taxpayer-funded goodies are being phased out. HOORAY!

  • Report this Comment On March 26, 2009, at 9:02 PM, moerequity wrote:

    Brettze- you sound like someone who lets their car run in the driveway; set the A/C to 60 degrees; drives and SUV and then talks like you are green.

    relax

  • Report this Comment On March 26, 2009, at 9:34 PM, sevenofseven wrote:

    Get a life Brettze.

  • Report this Comment On March 27, 2009, at 10:59 AM, biotech4ever wrote:

    In 10 years we'll all be shaking our fists in anger at Big Solar!

  • Report this Comment On March 27, 2009, at 11:07 AM, TexasLonghorns wrote:

    As the head of StatoilHydro (NYSE: STO) recently pointed out in a letter to shareholders, "despite the best of intentions, it is a fundamental energy reality that the world is decades away from a low-carbon society."

    Think Obama, The Golden One knows diddly squat about how you keep this country running until there is an alternative? I don't think so....just TAX it into oblivion and we will all be sitting in the White House in the winter to stay warm.

    People get your heads out of your ....! These green freaks don't want to face REALITY, which is we are ten years out from getting anywhere near off hydrocarbons.

  • Report this Comment On March 27, 2009, at 12:56 PM, farmnut1985 wrote:

    Well said texas, I work in the biofuels research area, every effort of research is being made to reach the goal of getting off of fossil fuels, but the reality of it all is that it takes time. Also a note on the nuclear power, there is actually only enough nuclear fuel stock available to power the worlds electrical grid for about 30 years if we all switched to nuclear making it a temporary solution as well.

    On another note they are removing tax breaks on drilling costs, that is a business operating cost, every other business gets to write that off of their taxes. So by repealing that, you essentially are raising their taxes! And who is going to pay for that? Not the oil company, you and I. Just like his cap and trade on carbon emmisions idea, is probably a good idea in the future but now is not the opportune time.

  • Report this Comment On March 27, 2009, at 12:59 PM, carbonates wrote:

    Toby, I couldn't agree more. The proposals are not directed fairly at the ENTIRE oil industry, but instead will have a very negative effect on the DOMESTIC oil industry. This in turn will likely lead to LOWER tax revenues. The largest beneficiary of this change will be companies like Saudi Aramco (owned by Saudi Arabia).

    Few people stop to realize that 12-25% of the GROSS income of domestic oil and gas production is paid to owners of US real estate (which can be the government) in the form of royalties. When this goes away, that is billions of dollars of income that US landowners never receive. Last summer, lease bonus payments in the Barnett Shale of Texas reached $30,000 per acre for landowners, and currently they would be lucky to receive anything. This in turn helps depress real estate values, leading to more defaults on mortgages. In addition to royalties most states collect 5% or more of the GROSS income from oil and gas wells as severance tax. When you stop drilling in the US you lose this important source of income for local schools, local fire departments, and local governments. Some of the most vocal opposition in California's recent attempt to change severance taxes with Prop 87 were local tax districts who stood to lose revenue as a result of decreased oil and gas production.

    Additionally, 17% of domestic production of oil and gas comes from stripper wells, which are those wells that produce less than 10 barrels of oil a day. Most of these wells will be uneconomic under Obama's tax plan and the US stands to lose 10-17% of US production almost immediately as a result of these changes.

    And to answer all the comments about how we don't need oil: have you looked at the computer you are using? It couldn't be built without oil. Your keyboard is made from oil. Your flat screen monitors are made from oil. Your shampoo you used this morning was made from oil. The laundry detergent you wash your clothes with was made from oil. The carpet you are walking on was made from oil, your tennis shoes were made from oil. So, if you want to live in a canvas tent waterproofed with goat fat, heated with a wood fire, and wear skins for clothes and never bathe, and maybe drive a solar powered car with no tires or paint or lubrication, you can go right ahead and do without oil. There is almost nothing in today's life that does not depend on oil and natural gas for part of its raw materials.

    One more comment: This tax proposal will not only push the large majors to do more drilling outside of the US, it is pushing experienced oil-finders like myself to look for work outside of the United States. When I leave, I will escape all of my state taxes (10%) and most of my Federal income taxes (about 38%), so that will be just one more effect that will reduce the tax income from this change. When you factor in the losses of jobs (there is likely to be 15-20% loss of high paying jobs in the energy sector) this is really not going to help with jobs or taxes. To add insult to injury, the jobs being created in the "green sector" pay only about 50% of the pay level of most oil field jobs.

  • Report this Comment On March 27, 2009, at 1:00 PM, stan8331 wrote:

    Removal of these tax breaks would be pretty rough on small and mid-size producers, as things stand right now. However, I think it's a virtual certainty that oil and gas prices will be rising significantly in the fairly near term. If prices double or more from where they are now - a very likely possibility - the impact of the lost subsidies will be far less severe.

    I don't want to see any draconian measures against oil and gas producers - I own a fair amount of their stock. I would definitely prefer to see natural gas production treated more favorably than oil - it is the only suitable bridge fuel available to get us to a renewable future.

    Overall, it does make sense to begin shifting tax preferences away from fossil fuels and toward renewables. If we continue to tiptoe around the problem of global warming, massive human misery and unprecedented economic disruption will be the unhappy result.

  • Report this Comment On March 27, 2009, at 1:17 PM, carbonates wrote:

    "Increasing domestic production won't help us reduce cost over the long term when we consume 25% of the world's fossil fuel and have 3% of the world's reserves"

    mpendragon, your statistics might be correct, but could not be much more misleading. You really should study your facts.

    While the US consumes 25% of the world's fossil fuel, we also produce 28% of the world's gross domestic product, and the two figures are correlative. When GDP goes down, so does oil consumption. Yes, we may have something like 3% of the world's reserves of OIL, but we have about the 2nd or 3rd largest reserves of NATURAL GAS (even the wildly out of date CIA Factbook ranks the US as 6th). As for coal, which is included in your 25% statistic, the US ranks as 2nd in world coal production, and is probably 2nd or 3rd in total reserves.

    The US still produces 5.4 MILLION barrels of oil per day, and imports 8.9 MILLION bbls, so we still produce 38% of our oil domestically. There is no reason (except politics) that we could not improve that to about 50% and maintain that level for a decade or two, which would vastly improve our balance of trade, strengthen the dollar, increase tax revenues, create jobs and generally improve the US economy.

  • Report this Comment On March 27, 2009, at 2:52 PM, mpendragon wrote:

    We are still consuming beyond a sustainable level and rapidly mortgaging our future by misusing our domestic energy reserves is not a virtue.

  • Report this Comment On March 28, 2009, at 10:45 PM, AuntMinnie001 wrote:

    mpendragon,

    You must be pretty young. That same prophecy has been put forth for decades and has yet to come to pass.

  • Report this Comment On March 29, 2009, at 3:03 AM, Letitallhangout wrote:

    I have an Idea... lets figure out someway to harness Brettze's energy and we could all go green... :)

  • Report this Comment On March 30, 2009, at 2:09 PM, mpendragon wrote:

    AuntMinnie001

    Consuming more of a limited resource almost every year without serious consequences is unrealistic.

    The idea that the good times can last forever when reason doesn't support it is the kind of thinking that leads to things like the internet bubble and the real estate bubble and the debt situation in the US. The rules don't stop applying when there is a short term advantage in ignoring them.

  • Report this Comment On March 30, 2009, at 4:42 PM, statsguy wrote:

    Why do we care so much where our petrol/gas comes from when we sure don't seem to care where our cars, clothes and even food gets created. Yes, gas is more important to our economy than artichokes, but boy would religious conservatives be pissed if we suddenly stopped importing Chinese clothes, leading to widespread nudity!

    But seriously folks- creating special tax breaks for certain industries is bad policy. It makes the tax code more complicated and guarantees jobs for lots of high paid (and arguably unproductive for our country) lobbyists, lawyers and accountants. Let's stick to a fixed set of rules for tax credits and deductions and stick to them. The tax code is already too complex. Getting rid of tax credits is simply good policy.

  • Report this Comment On March 30, 2009, at 4:53 PM, MyDonkey wrote:

    We need a solar grand plan like the one detailed at SCI AM:

    http://www.sciam.com/article.cfm?id=a-solar-grand-plan

    The sooner we get the ball rolling, the better off we'll all be.

  • Report this Comment On March 30, 2009, at 6:26 PM, dgoogins100 wrote:

    This is all well and good, but those that are in favor of going green need to remember that there is a cost in all of this. In Texas we deregulated electricity. You can buy "normal" electricity for 11 cents per kwh or "green" electricity for 18 cents per kwh. The real jobs in this country are not service jobs, they are manufacturing jobs, and by my reckoning, paying 63 percent more for power just causes that much manufacturing to move to China. And besides that, Senator Feinstein who helped kill the oil and gas business in California, now doesn't want the solar and wind projects to be built in the desert and is trying to convert it all to a national monument. Our country is being run by a bunch of inept idiots and we brought it on ourselves by electing them. Taking down the domestic energy industry is like putting a gun to the head of our economy.Yes we can! Kill the economy! Yes we can! Bury our grandkids in debt! Yes we can! Turn our country from a place when anyone can succeed to a place where everyone can be paid to fail or not even try at all. Good job Obamatrons! The USA's heartbeat is starting to falter... just pile on enough of those socialistic stones and we can kill it for sure!!!

  • Report this Comment On March 30, 2009, at 9:51 PM, farmnut1985 wrote:

    statsguy , they aren't tax breaks specifically for the oil industry, they are simply the regular business expense write off. Works the same for every business and farms which are also businesses where we write off our expenses so we are taxed on our net income which is equivalent to you being taxed on a paycheck. A business owners paycheck is their net. Rumors are they want to limit how much we can write off for farm as they want to limit to a percentage of the farm or businesses gross income. Bad deal especially for high input cost high output businesses.

  • Report this Comment On March 31, 2009, at 9:23 AM, Xciteddon wrote:

    Obama specifically stated he was going to reduce our dependence on foreign oil. He just put us at the whim of the big oil producing countries in the middle east! April Fools everybody, "Obama's big joke. He just raised the cost of gas, heating oil, anything plastic, etc for everyone. Companies are in business to make money.They will pass these costs on to you and me. We are the Fools guys...Is he trying to help us or destroy us?

  • Report this Comment On April 03, 2009, at 1:15 AM, oaklandraiders wrote:

    The oil price will continue to rise because inventories will soon be falling in response to OPEC. OPEC controls the price because of supply and demand. They shut down a lot of U.S. production already because they undersupplied to make marginal projects appear profitable. Now they are undersupplying again to get the Middle East economy to grow faster than anywhere. The United States needs cheap oil to grow, but their only choice is a good price for shale gas. Not near enough will be supplied at the current low price.

  • Report this Comment On May 13, 2009, at 1:07 AM, oldetoad wrote:

    Its a good feeling to read some free press that explains why pending legislation would have dire unentended consequences. Carbonates (~post 15)

    does a great job expanding on this.

    I recall when The House first voted on Hank P's TARP

    bailout, and after something like 90% negative e-mail response from an aroused public, they voted it down.

    (Yes the supporters rallied an e-mail campaign the next week and so it passed.)

    What we need is to come to grips with is, that we the people need to speak out, like we did on TARP

    and keep it up every day until BO and the entire Congress are at least exposed to this point of view, if not called on the carpet over their logic. We the people need to become a much bigger voice.

  • Report this Comment On June 11, 2009, at 12:29 AM, oilworker33 wrote:

    I have worked in the oilfield 33 years and make a good living at it but if Obama takes tax brakes away from independent oil and gas opeartors They will not be drilling any new wells and we will be dependent on foreign oil. And Carbonates is right they will be a lot more jobs lost.

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