Administration’s Ideas on Energy May Collide With Budget Realities

The Reagan Administration’s new ideas for spurring oil and gas exploration and drilling, taken together, could eventually cancel out the sharp drop in U.S. oil production that occurred last year as a result of the collapse of oil prices.

But the Administration’s tax and fiscal options, contained in a report this week on energy security, would cost the U.S. Treasury upwards of $2 billion in lost tax revenues and require tinkering with the tax reform law enacted last year.

Modest though the oil industry views the options advanced by Treasury Secretary John S. Herrington, the White House and congressional aides noted Wednesday that they run counter to both the spirit of tax reform and to the reality of the federal budget crisis.

And despite the tone of alarm sounded by Herrington about the long-term dangers of increased reliance on imported oil, it isn’t yet clear whether Congress is convinced.

“There’s no sense in Congress yet that anything’s going to be done, and there’s a strong prejudice against doing anything that worsens the deficit,” said an aide to Rep. Dan Rostenkowski (D-Ill.), chairman of the House Ways and Means Committee. “There’s not a sense of urgency about it.”

As reported, the study dismisses the idea of a fee on imported oil on grounds that it would do more harm to the economy than good. Instead, the report cautiously favors various tax breaks intended to make it more economically attractive to look for domestic oil and gas.

“These tax incentives carry economic costs, especially in terms of reduced federal revenues. But because they generally leave domestic oil prices unchanged, the tax and financial measures do not have the severely negative macroeconomic and trade costs associated with import fees,” the report said.

The main proposals, which would theoretically boost production by 918,000 barrels of oil per day while cutting tax revenues by $2.2 billion, are:

- Eliminating a rule that now prohibits independent oil companies from using the percentage depletion allowance on oil reserves they buy from the major oil producers. The current allowance lets small producers deduct 15% of gross revenues from their taxable income.

This change could limit the abandonment of low-producing, so-called “stripper” wells by giving independent firms an incentive to buy such wells from larger companies that would otherwise plug them as unprofitable. The closing of stripper wells--those producing fewer than 15 barrels a day--was a major reason that U.S. production fell by 800,000 barrels a day last year.

- Doubling to 100% the amount of gross income that is the basis against which the 15% depletion allowance is figured. This is also aimed at salvaging stripper wells.

- Establishing tax benefits for geological and geophysical costs, enabling a faster recovery of those expenditures. They typically constitute perhaps 5% of the cost of drilling a well. This is intended to encourage the discovery of new oil, as opposed to the production of known reserves.

- A 5% tax credit for all exploration and drilling expenditures.

- Raising the 15% depletion allowance for independent companies to the 27.5% level of the 1970s, and applying the higher 27.5% rate to all production of new oil and gas, not just the first 1,000 barrels per day allowed now. A “sunset” provision would take effect if oil prices rose to a certain level.

The report explores several other ideas, including a flat loan-price guarantee protecting investors in the event oil prices fall. Intended to attract leery investors, such a plan could soar in cost to $15 billion if applied to all domestic oil production.

A reduction in the minimum bids required for federal leases on the Outer Continental Shelf, to $144,000 from $864,000, could boost the number of leases awarded by 40%, the report calculates. “Exploration credits” for remote, high-risk drilling projects could result in drilling that might not otherwise take place, with the potential of major new discoveries.

Another gimmick: a “royalty holiday.” Such a temporary waiver of the 12.5% to 16.67% royalty that oil producers pay the federal government for oil they produce on U.S. lands is equivalent to an oil price increase to the producer of about $3 a barrel. But if applied to all such production, it would cost $2.8 billion next year in lost tax revenues.

The implementation of special tax breaks when the ink is barely dry on the new tax reform law poses major political problems, and oil industry officials say that none of the tax breaks separately would do much to foster exploration and drilling. But several of the measures taken together could have a significant effect.

“On a $200,000 well, the geological costs might be $10,000,” says Mark Greenfield, president of Sopac Energy Corp., an independent Los Angeles-based producer. “If you’re in the 33% tax bracket, you’re talking about a $3,300 tax incentive on your $200,000 well. That’s nice, but it’s not particularly motivational. But these things might become interesting in the aggregate. It could end up making it very attractive to investors.”

Mark Edmunds, tax specialist for the Independent Petroleum Assn. of America, argues that the report shows that production can be encouraged without a major cost to the nation. But he agreed that the debate will be how to pay for it.

“Those measures will increase production by 918,000 barrels a day,” Edmunds says. “That’s a lot of production. How do you fund it? Based on their numbers, you could pay for it with a 2-cents-a-gallon increase in the gasoline tax. This kind of production isn’t going to bring us national security, but it dramatizes that it doesn’t have to be cost-prohibitive.”

Perhaps, but it all sounds heretical to the budget writers.

“Tax reform is a delicately balanced package,” Rostenkowski’s aide says. “You can’t handle one issue like this in isolation, because other people are soon at your door. And we have a real problem with anything that costs money.”

REAGAN’S PLAN TO BOOST PRODUCTION

Cost in tax Gain in oil, gas revenues production Proposal millions of dollars barrels per day Percentage depletion allowance Repeal transfer rule $23.4 55,000 Double the coverage to 100% of oil produced $47.2 58,000 Tax breaks on $260 200,000 geophysical costs Tax credit for exploration $740 325,000 Raise depletion allowance to 27.5% For independent producers $680 280,000 For new oil $460 370,000 Royalty “holiday” $2.8 Unknown Lower bid minimums $10- Unknown $50