Sweet deal for oil producers (Tulsa World)

In crisis, there is opportunity.   It’s a cliche, because it’s true. 

 

Relatively recent state history provides a great example – 2010’s state budget crisis turned into a jackpot for the oil and gas industry in Oklahoma. 

 

2010 was, by any fair assessment, a year of crisis for the state budget. 

 

When lawmakers gathered that year, they had $1.3 billion less to spend in fiscal year 2011 than they had the year before. Based on projected tax revenue alone, the state would have to eliminate one of every five dollars it spent to break even. 

 

The state had money in savings and federal stimulus money to make up for some of that deficit, but the sense of urgency was everywhere at the state Capitol. 

 

Let’s flip to the end of that story: When legislators left for the year, the state budget was balanced. 

 

State agency budgets had been cut severely. (You’ll recall the complaints from educators and agency directors about the results.)  Federal stimulus money and the state “rainy day” fund helped out, although state leaders pointed out that neither fund could be counted on for funding in the future. 

 

And, not as closely noted, a new tax deal was struck with the petroleum industry, with sweet long-term implications for their horizontally drilled wells. 

 

I won’t try to explain to you the nature of horizontally drilled wells, except for a few facts. They were once experimental (although now they are relatively common), and they are very expensive. As a result, they were long ago singled out in the 1990s for tax credits to make them a more attractive gamble. 

 

In short, state policymakers in the 90s decided they wanted more people drilling horizontally to try to get at some of the state’s harder to reach oil and gas reserves, so it gave them tax reasons to do it.  And it worked, or at least the number of horizontal wells rose, although the price of natural gas realistically had more to do with that than tax policy. 

 

As horizontal drilling increased, those tax credits – a rebate of nearly 86 percent of the state severance tax for the first several years of production – became a larger and larger drag on state tax revenue. More and more wells were paying less and less in taxes. 

 

That was the opportunity of the crisis of 2010. 

 

The state turned to the big petroleum companies looking for help. The result was legislation that suspended the state’s payments of those horizontal tax credits for two years. The drilling companies would accrue their unpaid credits, and the state would pay them back over three years, starting July 1, 2012. 

 

As a result, the state would end up with $85 million more to spend on schools, roads and public safety in fiscal year 2011 than it would have had otherwise. 

 

But when the rebate moratorium ended, there also would be a new deal on how horizontal well taxes were collected. Instead of rebating the taxes after verifying that the wells qualified for the credits, the petroleum industry would be able to take the credits out of the amount they paid to the state in the first place, essentially knocking the top potential severance tax on horizontal wells from 7 percent to 1 percent. 

 

The same deal also removed a 48-month limit on when those credits could be claimed and struck a limit on credits tied to the cost of the project.  The state got some temporary relief on bills, and the industry got a lot in return. 

 

How much will it end up costing the state?  A bunch. 

 

I’m indebted to Oklahoma Policy Institute Executive Director David Blatt for his research into the issue. His papers show that the total of the IOUs to the petroleum industry during the moratorium was $297 million (nearly double the estimated amount at the time the measure was passed). 

 

The state has started honoring those chits. In November, the state paid out $14.6 million.  At the same time, the amount of money coming in from the oil fields is off sharply because prices are currently low (which triggers a lower severance tax rate) and because the oil and gas companies get to take their credit out of the front end, instead of having it rebated after verification. 

 

Perhaps most important for future state revenue is the removal of the time limit on credits and the cap linked to the project costs. 

 

Blatt estimates that if total production remains steady at current levels and horizontal drilling reaches 50 percent of total production, the state could soon be giving up $400 million a year in potential revenue to horizontal drilling credits. 

 

So, one of the casualties of the budget crisis of 2010 was the gross production tax. Once a robust source of state revenue, the tax has essentially disappeared and isn’t likely to return anytime soon.