Provisions Increasing Taxes on the Oil and Natural Gas Industry

Briefing Paper – 7.13.10

Some in Congress want to increase federal revenue by repealing or modifying several
long-standing, legitimate tax policies affecting the U.S. oil and natural gas industry. At a
time of high unemployment when we are struggling to recover from a recession, these
proposals will threaten U.S. jobs and weaken U.S.-based companies.

Repealing the domestic jobs manufacturing deduction for only oil and gas activities

Congress enacted section 199 of the I.R.C. in 2004 to encourage all U.S. manufacturers
and producers to invest, expand and create jobs in the United States. The oil and natural
gas industry creates high-paying professional and union positions held by geologists,
refinery workers, rig builders and others.

Proposals to repeal section 199 just for oil and natural gas activities could endanger some
of the 2.1 million U.S. oil and natural gas worker jobs and 7.1 million U.S. goods and
services jobs supported by the industry. There is no defensible tax policy basis for treating
oil and natural gas activities differently from any other manufacturing or production activities.

Modifying the provisions that prevent double taxation of US companies ("dual capacity")

The U.S. wins when its businesses can compete in the global marketplace. Our tax rules
have, for almost a century, allowed companies to offset U.S. income tax on foreign earnings
with income taxes paid on those earnings abroad—avoiding a double tax on the company’s
foreign earnings.

Currently, the foreign tax credit enables all U.S. companies to operate and produce goods
and services in other countries without taxing profits twice—once by the host country and
once again by the home country. This allows U.S. companies to have a level playing field
among foreign competitors.

Proposals are being considered to restrict this long-standing principle—and possibly just for
the oil and natural gas industry. U.S.-based oil and natural gas companies would be forced
to pay a double tax on part of their income from their foreign operations—creating a
competitive disadvantage.

These changes would substantially raise the costs and impact operations of U.S.-based
companies. As a direct result, foreign entities – such as national oil companies – would
become competitively advantaged since they would continue to incur only one level of
taxation in almost all cases. An informal look at some large U.S.-based companies shows
that while almost 80 percent of their 2009 net profits are from foreign sources almost 50
percent of their workforce is in the U.S. Many of these U.S. jobs will be at risk if the
companies were to lose market share to foreign competitors.

Eliminating the ability to expense intangible drilling costs

Intangible drilling costs (IDCs) include the labor for setting up drill sites, designing platforms
and drilling the wells—similar to research and development (R&D) costs. The current
treatment of IDCs is directly reflected in oil and natural gas industry jobs, and current law
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 allows independent producers to immediately write off these costs. Integrated oil companies
can recover 70 percent of their intangible drilling costs in the year incurred and the
remainder over 5 years.

IDCs enable U.S. oil and natural gas companies to continue exploring for and producing
domestic resources, which provide significant revenue to federal and state governments—
nearly $13.3 billion for FY09. Proposals are being considered to disallow this treatment and
require these costs to potentially be recovered over the life of the reservoir—as long as a
20-30 year period.

However, the current treatment for IDCs is consistent with the full deductibility of R&D
expenses, currently available to all taxpayers. The uncertainty and risk in drilling wells are
not dissimilar from the uncertainty and risk involved in R&D.

According to the Department of Energy, the U.S. is a very expensive region to drill for oil
and gas. Repealing the deductibility of IDCs will necessarily force U.S. producers to slash
exploration budgets, leading to less domestic production, a loss of U.S. jobs, and increased
imports. None of these results help the U.S. achieve our national goals of jobs, economic
recovery and energy security.

Congress should not overturn these long-standing policies that support U.S. jobs and U.S.
energy security. Possible increases in alternative energy production will not make up for the
U.S. jobs that will be lost if these provisions are repealed.