May 22, 2014

Bill Giving Permanent Tax Break to Oil and Gas Companies to Take Effect

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Update: Gov. Mary Fallin has signed the bill implementing the new severance tax formula.

The Oklahoma Legislature approved a new formula Thursday for taxing oil and gas production, one that will have little immediate impact on state finances but might cause a long-term reduction in revenue collections.

Under the new formula, which would apply to all wells drilled after June 30, 2015, oil companies will pay a 2 percent tax during the first 36 months of production and 7 percent thereafter.

For the past 43 years, the state’s gross production tax has been fixed at 7 percent for conventional, vertically drilled oil and gas wells. Under a temporary tax break enacted in in 1994 and extended several times, the rate was set at 1 percent for horizontally drilled wells during their first four years of production.

Twenty years ago, horizontal drilling was an exotic and expensive new drilling technique, and oil companies said they needed the tax incentive to help them develop it. Today, about 70 percent of all new wells are drilled horizontally, according to the Oklahoma Corporation Commission.

Lawmakers rushed to enact the new formula in the waning days of the 2014 session after three Oklahoma oil companies warned they might curtail drilling by as much as half if the tax on horizontal wells went back to 7 percent in 2015, as scheduled.

The new formula was approved by both the House and Senate Wednesday afternoon and goes to Gov. Mary Fallin for her expected signature. The House vote was 61-34 and the Senate vote 30-14.

The bill’s Senate author, Sen. Rob Johnson, R-Kingfisher, said the oil industry accounts for a big share of Oklahoma’s economic prosperity and the state couldn’t afford to gamble on a possible drilling downturn if the 7 percent tax rate were restored on horizontal wells.

“We need to do everything in our power to encourage them to continue that activity,” Johnson said. “We need to give them stability, set a tax rate that they can rely on that encourages them to drill in this state.”

The new formula was questioned by Senate Finance Committee Chairman Mike Mazzei, R-Tulsa. Mazzei criticized his colleagues for rushing to enact a new, permanent reduction when little was known about its long-term fiscal impact.

Mazzei noted that the cost to the state of the temporary 1 percent incentive on horizontal wells had escalated from about $2 million a year in 1994 to an estimated $252 million this year.

Mazzei cited findings from a recent Oklahoma Watch report detailing optimistic profit projections by the three big oil companies in their presentations to stock analysts and in documents filed with the Securities and Exchange Commission.

In those presentations, Continental Resources Inc., Chesapeake Energy Corp. and Devon Energy Corp. cited projected returns for some of their Oklahoma oil plays that were higher than those expected from drilling programs in other states.

In some cases, the Oklahoma plays would appear to remain higher even if the 7 percent tax rate were in effect during the initial years of production.

Mazzei contrasted those portrayals with warnings by the three companies’ CEOs that restoration of the 7 percent tax might cause them to scale back their Oklahoma drilling activity by as much as 50 percent.

“The statements that they’re making to Wall Street seem to be quite different,” he said.

The Oklahoma Tax Commission said it expected the new tax formula to have a “revenue neutral” effect during the fiscal year that begins July 1, 2015. That means it would not materially change expected tax collections during its first year on the books.

That reflects the fact that the new formula would apply only to wells drilled after June 30, 2015. It would have no effect on production from existing wells, so its impact would be phased in gradually as new wells were brought on line and older wells petered out.

The Tax Commission said it was not able to estimate the longer-term effect on state tax collections.

Opponents of the permanent tax change said it would deprive the state of hundreds of millions of dollars every year that would have been generated if the horizontal well tax break had been allowed to expire as scheduled.

David Blatt, director of the Oklahoma Policy Institute, called the new formula “a huge, unnecessary subsidy” for drilling that would have happened anyway.

Blatt, whose Tulsa-based research group favored restoration of the 7 percent tax, attributed the new plan to “a few well-connected oil executives and their lobbyists, whose views do not represent the majority of Oklahomans.”

Supporters of the new formulation said it would cause companies to drill more wells in Oklahoma than they would drill otherwise, boosting the state economy and generating more tax revenue over time.

Chad Warmington, president of the Oklahoma Oil & Gas Association, thanked lawmakers for approving a “reasonable and competitive” tax rate for future drilling.

Warmington said the new formula was not only a boon to the industry, “it’s a victory for thousands of small businesses and communities across the state that depend upon energy production for their economic vitality.

Warren Vieth can be reached at wvieth@oklahomawatch.org