The Biden administration is promising to raise the tax burden on oil and gas producers by eliminating tax breaks and incentives long used by drillers to bring their products to consumers at affordable prices.
The scenario is also playing out at a lower level in Oklahoma, where the state Supreme Court recently ruled a proposed state question that would ask voters to approve tax hikes on oil and gas production to help fund education can move forward.
The White House would be wise to follow the action in Oklahoma closely before deciding to punish the oil and gas industry in its $2 trillion-plus infrastructure bill. The measure in Oklahoma would ask voters to end discounts on many wells and impose an across-the-board 7% tax on oil and gas production, up from 1%, to fund teacher raises and early childhood education.
Proponents argue that Oklahoma schoolchildren will benefit from more than $250 million in additional public education spending as a result of the reform. But data shows that Oklahomans can expect a large percentage of any additional funding for education will be siphoned off before it reaches its intended target: the classrooms.
In addition, whenever tax collections increase, public education is only one of many tax consumers demanding a slice of the pie. In recent years, total annual state government spending on healthcare in Oklahoma has finally exceeded total annual state government spending for Oklahoma education, according to data from the state’s budget office.
Moreover, there is a risk that the state brings in less oil and gas revenue in the future after the tax hike. If oil and gas companies in Oklahoma find that the economics of drilling become uncompetitive with other parts of the United States, they will chase higher returns in other oil- and gas-producing states, perhaps never to return to Oklahoma.
Those advocating for a major tax increase on oil and gas drilling in Oklahoma are making two dangerous assumptions. First, they assume that energy producers will submit themselves to the higher tax rate, even though capital is more mobile in the 21st century than ever before. Second, they apparently assume that all additional tax collections that might come in due to a rate increase would be directed straight to Oklahoma schoolrooms.
This is wildly dismissive of past experience in U.S. politics. Indeed, the same advocates of the oil and gas tax measure also insist that Oklahoma needs significantly higher funds for Medicaid, corrections, mental health services, pay raises for state government employees, water infrastructure, and much more.
And while a tax increase to 7% may not sound Draconian, for smaller oil and gas companies, it can be ruinous. An intense drive for capital efficiency and improved returns has overtaken the U.S. oil and gas industry. The days of easy, cheap capital are gone for U.S. producers, who now must show that they can deliver strong financial returns in addition to production growth to investors and lenders. That means that even the slightest hike in taxes can have extremely harmful effects, particularly for Oklahoma’s smaller, independent producers and service providers.
In fact, the measure is expected to increase the cost of drilling in Oklahoma by 10%, some experts say. When in an intense battle for capital, a 10% hike in costs is material. And it would inevitably result in job cuts as companies try to offset the impact of higher taxes on their bottom lines by slashing personnel expenses.
Roughly one-quarter of all jobs in Oklahoma are tied to the energy industry, either directly or indirectly. These jobs, which are high-paying positions with salaries higher than those in the low-carbon sector, took a beating during last year’s COVID-19 energy price collapse. But they are returning as U.S. producers add rigs to the fleet, and they will be critical to Oklahoma’s emergence from a recession. Oklahoma’s rig count has rebounded to 20 today, from a low of nine last year, but a tax hike risks reversing this growth.
The lesson should also be heeded in Washington, where the Biden administration seems flippant about the importance of oil and gas jobs in the U.S. economy.
President Joe Biden’s infrastructure bill has an emphasis on tackling climate change and building up the country’s low-carbon manufacturing capabilities for everything from electric vehicles and batteries to solar panels and wind turbines. But punishing the domestic oil and gas sector, which experts agree will be needed for decades to give the nascent low-carbon industry time to develop, is not smart policy — particularly as the U.S. tries to recover from the devastating economic effects of the coronavirus pandemic.
Federal tax incentives such as the deduction for intangible drilling costs have been critical for U.S. independent producers, which were responsible for the shale boom over the past decade.
U.S. shale production costs are already considered high compared to conventional Mideast or Russian oil output, and moves that hurt America’s competitiveness on the global stage will translate to lower domestic output, greater imports, and higher prices for consumers. That would put its economic recovery in danger.
The U.S. oil and gas industry supports more than 10 million jobs. That’s a reality that merits greater attention in the plan, both in Washington and Oklahoma.
Dan K. Eberhart is a managing partner of Eberhart Capital and the CEO of Canary, one of the largest independent oilfield services companies in the U.S.
