The Fastest Way to Stop Oil and Gas Drilling, Part 2

For the sake of perspective, in the first installment of this two-part article we took a look at British Chancellor of the Exchequer George Osborne's still new (2011) program of increased taxes directed at oil and gas companies operating in the North Sea. Amazingly, the chancellor's tax hike took a 52% year-over-year chunk out of the area's second-quarter drilling activity.

Now it's time to bring our analysis closer to home and consider how President Obama's avowed efforts to create more new jobs -- and thereby reduce our sky-high unemployment rate -- while also raising revenues for our progressively depleted federal coffers stand to affect our own all-important oil and gas industry. Let me assure Fools, however, that our look at domestic energy tax possibilities is based on economic considerations rather than any sort of political sides-taking.

The big picture
From a proverbial 30,000-foot perspective, let's enlist the aid of Wood Mackenzie, a firm with locations across the globe that's regarded to be among the world's top energy consultants. According to the firm, passage of the president's proposed new taxes on oil and gas producers -- and, by definition, their oilfield services helpers -- would lop off about 700,000 barrels a day of oil-equivalent production at a cost of some 170,000 industry jobs. Those results clearly would be anything but beneficial to our overleveraged, teetering economy.

The lost jobs would be extracted from across the spectrum of companies producing traditional oil and gas domestically, from ExxonMobil (NYS: XOM) and Chevron (NYS: CVX) among the members of Big Oil. Also affected would be the likes of AnadarkoPetroleum (NYS: APC) , generally regarded as the largest of the independent producers and an operator in both the unconventional domestic plays and a variety of international locations. The heightened domestic taxes would also take its toll on Chesapeake (NYS: CHK) , the Oklahoma City-based independent producer that has played a major role in opening and developing such unconventional plays as the Barnett Shale of North Texas, the Haynesville Shale of Texas and Louisiana, and the Marcellus Shale, which subsumes much of the Northeastern U.S.

An Obama sampler
Looking at the specifics of the proposed tax increases, the first thing I notice is that they don't really stem from new taxes at all, but from repeals or removals of existing deductions under which the companies have operated and calculated their economics for some time. And while there are eight such deduction removals, rather than turn this article into a comprehensive course in energy taxes, I'll simply provide a sample of the key proposals in the Obama administration's approach to heightened taxation for the sector:

  • Perhaps the most important of the proposals is the removal of what's called the Section 199 allowable deduction of 3% of the net income obtained through the primary production of oil, natural gas, or products created primarily from the use of those hydrocarbons in a manufacturing process. Note that this rule doesn't affect manufacturing companies across the board. Rather, it singles out energy companies for obvious discrimination.

  • Deductions of intangible drilling costs would also be repealed. These costs -- which include labor, fluids, and costs associated with rig time -- are immediately deductible because they present no salvage value, regardless of whether the well in question uncovers oil or gas.

  • The Marginal Well Production credit would also be repealed. This credit is limited to smaller producers and to periods when crude prices are low. According to the Department of Energy, removing this credit would cost 140,000 barrels of oil and the loss of about $10.5 million each day.

  • Similarly, the Enhanced Oil Recovery Credit would also be removed. Like the Marginal Well Credit, this credit kicks in only when oil prices are at low levels and is meant to maintain production during those periods. The Independent Petroleum Association of America has pointed out that the EOR credit has benefited the nation during times when low prices would make production of expensive oil uneconomical. Further -- and amazingly -- there would be no gain to the U.S. government from a repeal of this credit.

The Foolish bottom line
As indicated, these proposed deduction repeals are only samples of the range of treatment the administration is seeking. It's important to recognize that, in addition to the oil and gas producers named above, those damaged by the deleterious approach aimed solely at the operators and their shareholders also include the oilfield services contingent -- including Halliburton (NYS: HAL) and Baker Hughes (NYS: BHI) -- along with companies, such as Dow Chemical (NYS: DOW) , the bulk of whose raw materials emanate from oil and gas.

Further, implementing higher tax proposals specifically for oil and gas producers would clearly result in a negative -- perhaps brutal -- effect on every American who stands to benefit from an increase in our nation's energy security. That -- it would seem -- would include you, me, and the candlestick maker. For that reason, I'd suggest that Fools keep track of emerging, energy-related news, while also watching the industry's participants, from ExxonMobil on down. The ideal way to accomplish the latter is to add the companies of your choice to your version of the Fool's My Watchlist.

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At the time thisarticle was published Motley Fool newsletter services have recommended buying shares of Chevron and Chesapeake. Try any of our Foolish newsletter services free for 30 days.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Fool contributor David Lee Smith doesn't own shares in any of the companies named above. The Motley Fool has a disclosure policy.

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