It’s Folly to Ignore Tax Impact on Drilling in Oklahoma (The Oklahoman)

By The Oklahoman Editorial Board

THE left-leaning Oklahoma Policy Institute would have us believe all that’s needed to provide huge increases in school funding is a tax increase on energy producers. But the assumptions built into the institute’s estimates are untethered from economic reality.

Previously, the state levied a 1 percent gross production tax on horizontal wells for the first four years of operation. Subsequently, the rate rose to 7 percent, the same rate levied on other types of wells. During the 2014 legislative session, lawmakers voted to revise that tax structure. All wells are now taxed at 2 percent for the first three years of production; the rate increases to 7 percent thereafter.

OK Policy was among those arguing for a 7 percent tax on all wells from day one of production. Recently, the group released an analysis claiming the state has effectively lost $516.7 million in tax collections this year by forgoing a 7 percent rate. The analysis suggests Oklahoma government’s fiscal challenges would be eliminated if only lawmakers taxed Oklahoma energy companies more aggressively.

“If it weren’t for revenue lost to the tax break for horizontal drilling, Oklahoma could have restored all of the cuts to education since 2008 and still have more than $200 million left to spare — enough to avoid painful cuts to Medicaid and community health centers, fully fund court-ordered child welfare reforms, and meet other serious needs for our state and citizens,” the OK Policy analysis declares.

If that sounds too good to be true, there’s a reason: It is.

As Chad Warmington, president of the Oklahoma Oil and Gas Association, ably noted, OK Policy “conveniently makes the assumption that if Oklahoma raised the gross production tax rate by 600 percent, as they would like to see happen, that it would have no negative effect on the drilling activity in the state. That is a hugely flawed assumption …”

Higher taxes mean lower profits — or even no profits. Tax rates can make the difference between a profitable well and an unprofitable one, and therefore can make the difference between drilling or not.

For a real-world look at how such financial considerations impact drilling decisions, look no further than the effect of plummeting oil prices on drilling activity. According to a survey by the Federal Reserve Bank of Kansas City, about half of energy sector firms in the local region plan to reduce spending by 20 percent in response to recent low crude oil prices; a quarter of energy companies anticipate significant employment reductions as well.

Rather than costing the state money, there’s some indication the 2 percent rate has actually facilitated drilling (and associated state tax revenue) that might not occur otherwise. During last year’s debate, tax hike proponents argued that North Dakota had far higher gross production tax rates. Yet James Roller, vice president of legislative affairs for the Oklahoma Independent Petroleum Association, notes that the number of drilling rigs in Oklahoma has declined just 6 percent since oil prices have tumbled; North Dakota rigs have declined 17 percent. Oklahoma’s lower gross production tax rate undoubtedly plays a role in that trend.

It not only makes no sense, but also is highly misleading, to act as though oil prices may change drilling decisions but a tax-generated higher cost of oil production would not.

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