Unprofitable Wells Now a Big Tax Break

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A pumpjack on a well near Norman.

A pumpjack on a well near Norman.

It’s become one of the state’s biggest tax breaks almost overnight.

The Oklahoma Tax Commission estimates the state will pay out $158 million in rebates next year to operators of “economically at-risk” wells that are no longer profitable at current oil and gas prices.

Two years ago, before prices plunged, those rebates totaled just $11 million.

The intent of the tax breaks is to cushion the blow of low prices on well operators and extend production from wells that otherwise might be shut down, either temporarily or permanently.

According to state officials and oil industry advocates, scores of well operators across the state are expected to take advantage of the at-risk rebate. In many cases the state will wind up refunding most of the gross production taxes that operators paid during the previous year, officials said.

A bill introduced this year would have suspended the break for two years to reduce the state budget squeeze, but it failed to advance past a legislative deadline. Still, industry officials say the issue might be raised again before the session ends.

Bristow oilman Don Darragh, who operates a handful of aging “stripper,” or marginally producing, wells in Okmulgee County, said shutdowns already are occurring. He said he had halted production of two wells because of low prices and cut production on others to two days per week. Strippers are wells that produce 10 or fewer barrels of oil per day.

On March 26, the pumpjack went out on Darragh’s best well, the Lyons No. 4. Darragh said the repairs would cost about $1,000. But he said he probably would wait for prices to improve before doing the work.

“Right now, with the price like it is, I’m not in a big hurry to go fix it,” he said.

Darragh said he has never applied for the state’s at-risk tax rebate but plans to have his accountant determine whether he would qualify this year.

During the current fiscal year, the at-risk rebate reduced the amount of money available to finance state government by an estimated $41 million. The cost is expected to nearly quadruple to $158 million next year, contributing to the state’s $1.3 billion budget shortfall. The expected rebates already have been incorporated into official revenue estimates presented to lawmakers.

“This is by far the biggest impact that the price of oil has had,” said Tax Commission Executive Director Tony Mastin. “Because of the price decline we’re getting less gross revenue, and also because of the price decline this rebate has come into effect. So it’s kind of a double hit.”

Created in 2005, the at-risk tax rebate has exploded in cost because of the decline in oil and gas prices since late 2014.

Two years ago, Oklahoma crude oil was selling at the wellhead for about $100 a barrel and natural gas between $3 and $5 per thousand cubic feet (MCF). This year, oil prices have fallen below $40 a barrel and gas typically sells for less than $2 per MCF.

Under Oklahoma’s complicated severance tax rules, traditional vertical wells are taxed at 7 percent. Horizontal wells drilled before July 1, 2015, are taxed at 1 percent for four years and 7 percent thereafter. Under a new rate formula enacted two years ago, all wells drilled after July 1, 2015, are taxed at 2 percent for three years, then jump to 7 percent after that.

The economically at-risk rebate refunds 6/7ths of oil and gas production taxes collected on any 7-percent well that generates less revenue in a year than the combined cost of royalty payouts, operating costs, overhead expenses and production taxes. In effect, it reduces the tax rate from 7 percent to 1 percent, retroactively.

To qualify for the rebate, operators must file an application on a lease-by-lease basis.

About half of the state’s crude oil production now comes from horizontal wells drilled before mid-2015 and taxed at 1 percent. But about 40 percent of production still comes from older vertical wells taxed at 7 percent.

“There are wells in Oklahoma that are 100 years old that are still producing crude oil,” said Cody Bannister, vice president of the 2,500-member Oklahoma Independent Petroleum Association.

“The majority of Oklahoma’s oil and natural gas producers are small mom-and-pop companies,” Bannister said. “They don’t drill a lot of wells. They manage some historic properties. Those are the people that this helps most of all.”

Bannister said his group was prepared to make the case to Oklahoma lawmakers that the at-risk rebate is doing what it was designed to do: keep stripper wells operating during a period of low prices.

The proposed two-year suspension of the rebate was included in a bill introduced by Senate Finance Committee Chairman Mike Mazzei, R-Tulsa. Even though it failed to advance, oil industry advocates said the idea might be revived in final budget negotiations.

“When you’re in a $1.3 billion budget shortfall, anything and everything’s going to be on the table,” said Chad Warmington, president of the Oklahoma Oil and Gas Association. “So yeah, we’re keeping an eye on it.”

Bristow well operator Darragh said the economics of stripper well production sometimes boil down to a few dollars per day.

Darragh’s old wells typically produce about one barrel of oil per day, he said. The Sunoco refinery in Tulsa is currently paying about $34 a barrel. The 7-percent gross production tax takes about $2.40 of that, and his payment to royalty owners is about $6.40 per barrel. Darragh pays his pumper a fixed rate of $5 per well per day. His liability insurance costs about $1.70 a day per well, and the electricity used to run his pump jack about $4 per day.

Those fixed costs don’t leave much to cover maintenance and repairs and provide much of a profit he said.

“I produce cheaper than anybody. Nobody can come close to me. But I’d like to have $50 or $60 oil,” Darragh said.

“Probably at $45, I’ll put a new pump in.”