Amortization of All Geological and Geophysical Expenditures Over 2 Years

Section 1344 of the CEB would change the amortization of geological and geophysical (G&G) expenditures incurred in connection with the exploration and development of domestic oil and gas resources. Currently, unsuccessful G&G costs are deductible when the project is abandoned and successful G&G costs are amortized. The CEB proposal allows a 2-year amortization of G&G costs for both successful and unsuccessful projects.

The change in tax provision would result in lower tax liability and thus increased cash flow from operations. This increase in cash flow could be directed toward drilling activity as well as investing and financial activities, e.g., mergers and acquisitions, reductions in long-term debt, purchase of treasury stock, etc.

The JCT estimates that the G&G tax provision would result in a $190-to-$450-million annual decline in tax revenues (or an increase in industry cash flow) for the total industry for years 2005 through 2013. Relative to U.S. oil and gas production revenue, oil and gas producer revenue from the G&G tax provision is expected to be tiny. Even in 1998, when U.S. oil prices sank to $10.87 a barrel, U.S. oil and gas revenue was more than 150 times the highest JCT estimate of the tax revenue loss from the G&G tax provision. The tax provision is expected to have a negligible impact on oil and gas production because the annual cash flow from U.S. oil and gas production for major companies reporting to the EIA Financial Reporting System (FRS),¹⁴ which comprise just a part of the industry, has been in the $17-to-$49-billion range over the 6 years from 1997 to 2002 (Table 6). If the JCT analysis is correct, year-to-year cash flow fluctuations (driven by oil and gas prices) can be at least 35 times larger than the tax value of the provision and, consequently, the provision is unlikely to appreciably sway drilling decisions. Also note that the increase in cash flow as provided by the JCT represents less than a 3-percent increase in FRS companies’ cash flow from U.S. oil and gas production, assuming that the JCT analysis is correct. Since the FRS companies produce slightly less than half of U.S. oil and gas, the overall impact of the proposed tax change on the industry cash flow would be even less. The proposed tax change may improve individual company balance sheets, but on an industry level the impact on oil and gas production would be very small.

Table 6

Notes and Sources