In a recent editorial, The Oklahoman newspaper accused critics of Oklahoma’s huge tax breaks for the oil and gas industry of ignoring reality. They wrote that the claim that oil and gas companies pay far less taxes in Oklahoma than in other states is “false upon inspection.” They go on to claim that removing the tax break would push investment out of Oklahoma. However, to justify their argument, The Oklahoman makes deeply flawed assumptions about Oklahoma’s taxes and the role of those taxes in decisions about drilling. Here are the facts.
Fact: Big oil and gas companies pay extremely low taxes in Oklahoma
On the first claim, all independent estimates (1, 2) show that Oklahoma taxes oil and gas at a rate far below any of our peer producing states. Oklahoma’s low taxes on oil and gas drilling are magnified by the state imposing no ad valorem taxes (also known as property taxes) on oil and gas reserves that are still in the ground. This is a policy choice that encourages conservation — drillers will only be taxed on the value of their oil and gas when it comes out of the ground.
Other states charge property taxes on proven oil and gas reserves in addition to gross production taxes, while Oklahoma specifically designates its Gross Production Tax (GPT) as in lieu of the property tax on oil and gas. Therefore the taxes need to be combined to make an apples to apples comparison. The industry uses the percentage of gross revenue paid under both of these taxes when projecting the tax cost on an existing or proposed well.
When these taxes are combined, the honest comparison of taxes in Oklahoma and peer oil and gas producing states looks like the chart below. Oklahoma’s 3.2 percent effective tax rate on drilling is less than half what the industry pays in North Dakota and Texas (8.3 percent) and less than one-fourth what they pay in Wyoming (13.4 percent):
That’s according to a study performed by Covenant Consulting Group for the state of Idaho. Another study by Headwaters Economics used a somewhat different methodology but found similar results. Headwaters commented, “Oklahoma collects the lowest effective tax rate, but this incentive has failed to prevent producers from doing business in higher-tax states such as Texas, North Dakota, and Wyoming.”
The primary benefit of Oklahoma’s extremely low taxes on the industry goes almost entirely to a few large public companies — and their mostly out-of-state shareholders — that are drilling nearly all of the new wells in Oklahoma. These companies also pay little to no corporate income tax to the state because tax law allows them to deduct from their income in the year of drilling almost all of the cost of the well. Oklahoma taxpayers, teachers, and any other residents who provide or use a state service (in other words, all of us) are left paying the cost of these generous subsidies.
Fact: Restoring the historic tax rate on oil and gas drilling would have little or no effect on drilling activity in Oklahoma
The Oklahoman editorial board and other defenders of Oklahoma’s very low oil and gas taxes argue that asking the industry to pay more would discourage drilling to such an extent that it would damage Oklahoma’s overall economy. The economic facts show this claim to be ludicrous. Restoring the gross production tax back to its traditional 7 percent rate would be barely a blip in the industry’s calculations on where and when to drill.
Currently Oklahoma charges just 2 percent in gross production taxes for the first three years of a well’s production. These years account for about half of all the value that a well produces in its lifetime. Ending this subsidy and going to a 7 percent tax rate immediately would increase the effective tax rates on each well by about 2.5 to 3.8 percentage points.
A change of this size is dwarfed by routine fluctuations in the three major factors that influence drilling decisions: reserves, product prices, and costs. Each of these can vary by 50 percent from month to month or year to year, more than 10 times the effect of increasing the GPT. For example, here’s the price of a barrel of crude oil at the Cushing storage facility over the past few years, before and after the about 3 percent cost that would result from restoring Oklahoma’s GPT:
It defies credibility to argue that going from the blue line to the red line would be the deciding factor on whether to drill, when fluctuations in the value of oil have an order of magnitude larger effect on return on investment. Last Friday alone, the price of WTI crude oil increased by 2.0 percent — enough to almost completely erase the loss of profits from paying a higher gross production tax.
A similar dynamic exists for other factors related to drilling decisions. Restoring the 7 percent GPT would be like a projected 500,000 barrel well producing 485,000 barrels instead, or like a $150,000 cost overrun on the drilling of a $5 million well — well below the normal random variation of cost projections used by the industry. The idea that an oil and gas industry which routinely deals with much larger cost fluctuations and uncertainties could not handle a 3 percentage point increase in costs should be insulting to those in the industry.
Even as the increased GPT will be a minor consideration for the oil and gas industry, it would on the other side be a major boost for the Oklahoma state budget and core services — especially since it would unlock the grand bargain that enables Oklahoma to fix the immediate budget emergency, put the whole budget on more sustainable footing for years to come, and invest in desperately needed priorities like a raise for teachers and state employees. Even if the GPT increase did affect decisions on a marginal well here and there, the benefits of a lasting fix to the state budget would dwarf that cost.
The evidence is clear: lawmakers are committing economic malpractice by refusing to increase the gross production tax. Their refusal makes Oklahoma less prosperous and less competitive. The deceptive rhetoric used by The Oklahoman editorial board to justify this malpractice does a disservice to their readers. And the willingness of lawmakers to go along with it does a disservice to their constituents.