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Oil executives quizzed on tax breaks

Industry saves $4.4b a year

By Jonathan Fahey
Associated Press / May 13, 2011

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NEW YORK — Motorists are paying nearly $4 for a gallon of gasoline as the oil industry reaps pretax profits that could hit $200 billion this year.

This makes another big number hard to take: $4.4 billion. That’s how much the industry saves every year through special tax breaks intended to promote domestic drilling.

President Obama is increasing pressure on Congress to eliminate these tax breaks — including one that is nearly a century old — at a time of record budget deficits. Obama and congressional Democrats say eliminating the tax breaks will also lower gas prices by making alternative energy sources more competitive.

Oil industry advocates, a group that includes many Republicans in Congress, argue just the opposite. They say oil companies reinvest tax breaks into exploration and production, generating more tax dollars and increasing the supply of oil. They say eliminating tax breaks will raise the cost of doing business and lead to higher gas prices.

Executives from the five biggest oil companies were asked about these tax breaks at a Senate finance committee meeting yesterday. Democrats accused the oil companies of not paying their share to help the country emerge from economic hard times. Republicans derided the hearing as a dog-and-pony show staged to score political points.

The industry executives said eliminating the tax breaks would reduce investment in the United States. Exxon Mobil chief executive Rex Tillerson said the proposal “would discourage future investment in energy projects in the United States and therefore undercut job creation and economic growth.’’ He said it would do nothing to reduce gas prices.

The 41 oil and gas companies that break out their federal taxes said they paid Uncle Sam $5.7 billion in 2010, according to data compiled by Compustat. That’s more than any other industry. Exxon alone paid $1.3 billion. (The company’s total tax bill was $21.5 billion, but most of that was paid to foreign governments and states.)

But at a time when motorists are fuming about gas prices, Obama and Democrats see a huge political opportunity.

The price of oil is so high that removing these tax breaks would probably have little to no effect on domestic oil production. There are other factors that make the United States a highly attractive place to drill: It is politically stable, it has good roads and pipelines, and it is the world’s biggest energy consumer. And the industry would remain profitable even though eliminating the tax breaks would increase its US tax bill by nearly 70 percent.

The tax breaks that Obama wants to eliminate will cost the Treasury $44 billion over the next decade. A Senate proposal targets many of the same rules, but would eliminate them only for the five biggest oil companies: ExxonMobil, Chevron, BP, Royal Dutch Shell, and ConocoPhillips.

A look at the main tax breaks:

■ The biggest is called the Domestic Manufacturing Deduction. It is a 2004 tax change meant to encourage companies to manufacture in the United States.

It allows companies of almost any type to deduct from their taxable income up to 9 percent of profits from domestic manufacturing. Under the rule, oil and gas companies were classified as manufacturers, but their deduction was capped at 6 percent.

This provision alone is expected to save the industry $18.2 billion over the next 10 years.

The industry feels singled out. “It can’t be good for some and not for others or it is just a punishment,’’ says Stephen Comstock, tax policy manager at the American Petroleum Institute.

■ Another subsidy, established in 1913 to encourage domestic drilling, allows oil companies to deduct more quickly the intangible costs of preparing a site for drilling.

To accountants, intangible costs are costs for things that have no salvage value when the well runs dry, including clearing land and pouring concrete. Ordinarily, a business would have to deduct these costs over the life of the drilling site. Instead, small, independent drillers are allowed to deduct all of these expenses in the first year; major companies like ExxonMobil can deduct 70 percent in the first year. The break is worth $12.5 billion over the next 10 years.

Comstock compares the write off to other companies’ ability to write off research and development costs. Other tax specialists say this is a subsidy.

■ A rule dating from 1926 that establishes how oil companies can depreciate the value of their wells allows drillers to deduct 15 percent of the well’s revenue from its taxable income per year. This is instead of a more traditional depreciation scheme in which the cost of the well is depreciated over the well’s life.

The tax break was created in part to simplify accounting, so companies wouldn’t have to guess how long an oil or gas field would produce in order to calculate how to depreciate it. It can be a boon: The total of the deductions over the life of the well can sometimes be bigger than what the company spent on the well.

This provision was eliminated for major oil companies in 1975, but it continues for independent producers. The break is worth $11 billion over 10 years.

■ Royalties that companies pay foreign governments for the oil they extract are not deductible from US taxes. But often the industry is allowed to claim royalties as foreign taxes, which are deductible. Obama and Senate Democrats call this a loophole. Obama doesn’t include this in his proposal, but Whitney Stanco, an analyst at MF Global, said removing this benefit could cost the industry $8.5 billion over 10 years.