Advice for Mr. Obama On Energy

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WASHINGTON--With Japan's nuclear disaster and Senate Majority Leader Harry Reid blocking the disposal of spent nuclear fuel in Nevada's Yucca Mountain, prospects for approving more U.S. nuclear power plants are dimming. But what about oil and natural gas?

With crude oil over $100 a barrel and gasoline prices surging in some U.S. regions towards $4 a gallon, America's options include:

(1) Getting more American oil out of the ground;
(2) Tapping our 727-million barrel Strategic Petroleum Reserve;
(3) Discouraging production of oil and gas in America; and
(4) Using less energy.

Today a subcommittee of the House Energy and Commerce Committee holds hearings on some of these issues.

With higher prices, we're already choosing Option 4.

So far President Obama has, to his credit, avoided Option 2, tapping the SPR. That's wise, because dipping into the reserve would have little or no effect on gasoline prices and would weaken the country's ability to cope with a shortage if supplies of foreign oil were pinched.

Further to his credit, Mr. Obama declared on March 11, "First, we need to continue to boost domestic production of oil and gas." That seems to point to Option 1.

Unfortunately, however, Mr. Obama has proposed tax increases that would discourage domestic production just when he states that it is imperative to expand it. He says he wants Option 1, but he is choosing Option 3.

The taxes in Mr. Obama's 2012 budget would make domestic oil relatively less profitable, and tend to raise the country's already high fraction of imports of crude and product. Such taxes would result in the substitution of foreign oil for domestic, and curtail well-paying jobs in domestic exploration for and production of oil.

Mr. Obama's budget raises $3.6 billion in 2012 and $46 billion over the next decade from direct tax increases on oil and gas, more than on any other industry. Plus, a disproportionate share of tax increases on overseas income and higher Superfund levies would hit oil hard, raising another $21 billion, for a total of about $67 billion over ten years.

His proposals include $18.3 billion over ten years from repealing the domestic manufacturing deduction for oil and natural gas companies. Currently manufacturers can take a deduction from taxes of 9% on their income from domestic production. Oil companies have a lower deduction of 6%.

Under Mr. Obama's proposal, the deduction for oil and gas companies would be eliminated completely, so oil companies would be the only domestic manufacturers not to qualify. Singling out one industry makes no sense. If domestic manufacturing is not worthy of a deduction, why not repeal it for all industries?

Mr. Obama wants to raise $12.4 billion over ten years from repealing expensing of intangible drilling costs. Intangible drilling costs are those that do not have a salvage value, such as those for labor and well preparation, in contrast with drills and rigs, which are written off over the life of the equipment.

Currently, independent oil companies can expense 100% of intangible drilling costs, and larger integrated oil companies can expense 70%. Under the proposal, intangible costs would be depreciated over the life of the well, adding to costs of production. Yet in most other industries, such as scientific research, nonsalvageable costs of creating assets can be expensed.

Mr. Obama would raise $11 billion over 10 years from getting rid of percentage depletion for oil and natural gas wells, a provision that affects smaller wells which pump up to 1,000 barrels per day.

He would effectively raise taxes on U.S. producers by curtailing credits for taxes paid to foreign governments on production abroad. One international tax provision, raising $10.8 billion over 10 years, would limit credits against American taxes for taxes paid to foreign governments, increasing effective tax rates of oil companies.

Such tax increases would shrink the profitability of American companies vis a vis foreign ones. Foreign companies might win out in bidding wars for all phases of U.S. petroleum development because their tax burdens would be lower.

In contrast, Mr. Obama wants to invest in "clean energy technology," far more expensive than oil and gas, raising households' energy costs and effectively shrinking their income.

Testifying in today's hearing is Lucian Pugliaresi, president of the Energy Policy Research Foundation, a non-profit research organization. His testimony points to the importance not only of supply and demand for setting energy prices, but also to expectations about future events, such as world demand, availability of supplies, and government policies.

He states, "In many cases, the immediate loss in output from any number of unexpected events has much less effect on the world market than the resulting shift in expectations about the ability to expand output over the next 5-10 years."

That's why an aggressive U.S. oil and gas development program would signal to buyers and sellers that America is serious about bringing supplies to market. It would open up a resource base to American innovation and result in lower prices.

American oil and natural gas reserves keep expanding as new exploration occurs and new recovery technologies are devised. Just in the last several years, oil has been found in North Dakota, and huge deposits of natural gas have been discovered from Texas to Louisiana to Pennsylvania and New York. Natural gas prices have fallen below any prior expectations.

With uncertainty in Japan, the Middle East, and Africa, Mr. Obama should be praised for refusing to tap the SPR and for calling for higher domestic oil and gas production. A few changes in his tax proposals would help him achieve his goal.

Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter: @FurchtgottRoth.   

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