The proposal outlined Wednesday is a long way from the finish line and could change significantly in the coming months. One major question is whether Trump and the U.S. Congress balance lower tax rates by reducing other incentives, like a deduction for drilling expenses that may save companies $35 billion over the next decade, according to a report Thursday by analysts at Bloomberg Intelligence.
That could be a bad exchange for independent exploration and production companies — the small and midsize drillers who focus on U.S. shale fields. With oil prices slumping in recent years, they’ve tended to pay less in corporate taxes but plow more of their money back into drilling expenses, said BI analyst Rob Barnett, a co-author of the report.
“Be careful what you wish for, folks,” the analysts wrote. “Lowering tax rates could cause the federal deficit to balloon unless special interest tax breaks, including those used by E&Ps, are eliminated.”
U.S. energy producers paid the second highest effective tax rate of any business sector in 2014, at 37 percent of income, according to BI research. Trump’s proposal to slash the federal corporate rate from 35 percent to 15 percent would have saved $13 billion that year for a group of 56 oil and natural-gas companies tracked by Bloomberg.
Yet losing other tax incentives could be a bad trade-off for some, the analysts said. Corporate tax payments are volatile, fluctuating with company earnings; by contrast, the savings from deducting intangible drilling costs and other tax breaks are more stable.
“Re-investing through predictable and stable cash flow is crucial to confidently replenishing a depleting resource,” the analysts wrote. “The certainty of deducting drilling costs, which are rising due to inflation, drives new well investment.”
The deduction could be replaced by another change that Republicans have discussed, allowing companies to immediately write off capital investments, said tax attorney Stephen D. Marcus, who works with energy explorers. But so far, the write-off has been proposed only for manufacturers, said Marcus, a partner in Dallas with Baker Botts LLP.
There’s also been talk of eliminating the deduction for corporate interest payments. That would force a sea change for oil and gas drillers who’ve relied on borrowed money for decades to help pay bills and boost profits, Marcus said.
“It may well be that if I can no longer deduct the interest, it’s not worth leveraging up and therefore the rewards are not as great and some of the risks are not worth taking.”
While interest for existing debt could be grandfathered in, “until there’s someone in the administration or Congress actually saying that, people have a bit of anxiety,” he said.