Oil and gas tax incentives not needed

By Julia Haggerty and Mark Haggerty, Headwaters Economics, Bozeman
Originally posted as a guest column in The Missoulian
Posted on On Your Left with the permission of the authors

The Obama administration has proposed eliminating several federal tax breaks for the oil and natural gas industry. This raises an important question: Do tax incentives influence oil production? At a time of both record budget deficits and energy industry profits, both Montana and the federal government should look to the experience of other states for answers.

Many states are especially reliant on revenue from oil and natural gas. According the U.S. Census of Governments, severance taxes accounted for 74 percent of all state tax revenue in Alaska, 34 percent in Wyoming, and 9 percent in Louisiana in 2010. This reliance encourages close attention by states to the assessment of the effects of rates and incentives.

It is no accident that Alaska and Wyoming, the states most dependent on revenue from oil and natural gas, also have the highest tax rates on these fossil fuels. Each has learned that tax rates have a very small effect on production. In other words, rates do not change drilling rates or total production.

In the late 1990s, Wyoming's legislature passed a 2 percent tax break on production, hoping to induce more exploration and drilling. At the same time, it funded the University of Wyoming to study how these tax incentives would affect oil production.
Two years later, the Legislature rescinded the tax break. Oil and natural gas prices had begun a decadelong rise and fossil fuel resources were again flowing from Wyoming. High prices eliminated the need for incentives, and the state badly needed revenue.

The University of Wyoming research confirmed what the past two years showed: lower severance taxes could not, to any great extent, induce the industry to drill more; only higher prices could. The study also noted that higher taxes do not reduce production when prices are high.

For example, during the last decade natural gas production in Wyoming grew significantly faster than in Colorado, but Wyoming's effective tax rate was nearly three times higher (16 percent) than was Colorado's (less than 6 percent) in 2008.
Rather than taxes, fossil fuel production responds to opportunities determined by geology, price, and technology. Some industries, like textiles or automakers, can choose where they want to locate and can take their factory with them across state and national borders. The oil and natural gas industry does not have that luxury. Companies must drill where resources exist, and when price and technology support development.

In the Rockies, high natural gas prices in the mid-2000s supported the use of emerging technologies - seismic 3D imaging, horizontal drilling, and multi-stage fracking - to unlock previously unrecoverable resources and a natural gas boom followed. Now that oil prices are high and natural gas prices low, the same technologies are behind booming oil production in North Dakota and eastern Colorado.
As an example of a tax policy that accounts for the key drivers of energy production, Alaska provides incentives for exploration and technology to encourage the full development of resources, while calibrating production taxes to maximize revenue when prices are high. Production taxes begin at 25 percent and increase by 0.4 percent for every dollar the price of a barrel exceeds $30, and can reach as high as 70 percent.

Montana and the federal government should learn from these states. First, eliminating existing tax incentives will not noticeably affect production. Second, with high oil prices providing industry every incentive to drill, the time is right to eliminate these tax breaks, and to revisit oil and natural gas tax policy to learn what works and what does not to create jobs, encourage production, and provide a fair return to the treasury.