So you thought $4.00 was a lot for a gallon of gas??

Just wait.

Just wait a little while.

It’s axiomatic for conservatives, and other people with common sense, that if you want less of an activity, you tax it. If you want more, reduce the tax. Governor Jindal said that recently, but I’m sure he wasn’t the first.

The oil and gas industry is tax advantaged. Historically, the government saw a benefit in encouraging drilling; tax breaks are one way to cushion the manifold risks an operator incurs. Exploration and production firms factor tax benefits into their economics when they judge whether or not to drill. You may not agree with the rationale behind certain “tax preference items” that encourage drilling and production, but the current tax law status quo equates to a given level of activity.

Democratic tax proposals and policy changes, announced today in President Obama’s FY2010 Budget, will definitely reduce drilling activity. I’ll even go so far as to say they’re designed to curtail activity. [See p.79 and pp.122-3 for the damage.]

I’ll try to explain why it matters. And it’s not necessarily the reason you expect.

The Dems have resurrected some old ideas for taxes and fees, and thought up some new ones. The big ticket items I’ve seen so far:

  • A new excise tax to take back royalty relief the government (mistakenly?) gave certain deepwater producers to encourage deepwater technology back in the ’90s.
  • Repeal expensing of intangible drilling costs.
  • Increase rental payments on non-producing leases [the topic, btw, of one of my RS 2.0 blogs, lovingly entitled “On the Utter Stupidity of Drill It or Lose It”.]
  • Repeal percentage depletion.
  • (I don’t even know what this vague language means):”Increasing the return from oil and gas production on Federal lands through administrative actions, such as reforming royalties and adjusting rates.”
  • As I said, we may disagree whether the industry “deserves” favorable tax treatment, but it would be asinine to think that by “reforming” tax policy you’re going to enhance domestic energy security. This is a measure to punish oil and gas, but you my friends are going to share the pain.

    Why? It’s all in the rig counts. Rigs drill new wells, and active rig activity means higher total deliverability: more oil and gas on the market. Baker Hughes has the most authoritative rig count statistics, and rig utilization is dropping like a stone, down to 1300 active rigs this past week, a decline of 471 rigs since a year ago. (Canada is down to 401 rigs, 246 less than a year ago.)

    What most people don’t realize is that some 80% of the domestic rig fleet is searching for natural gas. Because of prices, rig activity is way down in both sectors. But, especially for natural gas, it is important to maintain high activity.

    At current rig utilization rates, we’re probably treading water with gas deliverability. But these tax proposals will absolutely kill any desire on the part of drillers to make new wells. You, the consumer will feel the pain, if not this coming winter, then the next. There will be a shortage of natural gas.

    The real irony is that natural gas is perhaps the greenest fuel we have. And we have plentiful domestic resources, and world-leading technology to go get it. But we’ve got to be able to drill wells…

    Oil and gas companies have felt the double whammy of prices (down 75% in 8 months) and the stock market meltdown. The typical small oil and gas company’s share are down 75% from 52 week highs – many are trading for pennies on the dollar. This is clearly not the time to make independent oil and gas companies a political whipping boy.

    Owning an oil and gas company is not a license to print money. It is a highly risky, highly competitive business that, contrary to popular opinion, has few barriers to entry. Just like any other business, capital flies to an easy return. New companies start up all the time. But then others go out of business, victims of price fluctuations, or bad geologists, or bad luck, or bad decisions. Or bad tax policy.