Oklahoma Finance Secretary Preston Doerflinger sparked controversy throughout the state oil patch earlier this summer when he suggested legislators consider changing a tax break for horizontal drilling.
“My only position in bringing this to everyone's attention — and particularly to the policymakers — is that it is my responsibility and the responsibility of my office to make them aware of revenue risks,” Doerflinger told The Oklahoman on Thursday. “This is one where I felt like it was time for everyone to have an honest dialogue, understanding that something had to give. I'm thankful that we've been engaged in a very productive conversation with industry folks on how to collaborate on addressing this issue.”
At issue is the gross production tax energy companies pay on oil and natural gas produced in Oklahoma through horizontal drilling. The state historically has assessed a 7 percent tax on most production.
But in 2010, the legislature created a temporary incentive designed to stimulate horizontal drilling by cutting the tax to 1 percent for the first 48 months of production from horizontal wells.
Out of 174 rigs drilling for oil and natural gas in Oklahoma, 161 were involved in horizontal drilling, according to the most recent numbers from Baker Hughes.
“What I have tried to suggest is that the industry stakeholders and policymakers and the governor's office work together to come up with what makes the most sense,” Doerflinger said. “I think 7 percent is still competitive when you look at a state like North Dakota that has an 11.5 percent tax. But we're not saying it should necessarily move back to 7 percent.”
The current tax credit is set to expire in 2015, at which time the tax rate would return to 7 percent.
“Probably more important to the industry is certainty,” Doerflinger said. “It is difficult for the industry to decide in what direction they're going without certainty as to what this will look like. I hope we can come up with something that provides certainty. My desire is to find that sooner rather than later.”
Continental Resources CEO Harold Hamm credited the lower tax rate for fueling the rapid drilling growth in Oklahoma over the past few years and said it is essential to the state that the growth continues.
“We don't want to go from a boom to a bust,” he said. “How we handle that and get to a more permanent situation on the severance tax going forward is something that needs to be done carefully. It worked. It worked tremendously well. It has been a great benefit for the state. A lot of production will be coming on tax rolls as a result of having this incentive in place.”
While the tax break may have been beneficial, Oklahoma Policy Institute Director David Blatt said its time has passed.
“We see these credits for horizontal drilling as having become entirely unnecessary and unaffordable,” he said. “Whatever importance they may have had at some point in incentivizing production that was new and experimental and expensive, it's no longer the case when you have 90 percent of production in the state being done horizontally. You're not encouraging something that private companies can't do on their own. You're just providing a large giveaway that is not encouraging drilling.”
Berry Mullennix, CEO at Tulsa-based Panther Energy, credited the tax program for helping his company grow to more than 90 employees, up from 18 a few years ago.
“I would argue the tax incentive is a direct reason we have so much horizontal drilling in the state today,” Mullennix said. “The companies used the credit to help discover this massive wealth in oil and natural gas.”
While horizontal drilling has become an industry standard practice, the process is still extremely expensive and risky, especially for smaller operators, said Mike McDonald, president and co-owner of Oklahoma City-based Triad Energy.
“When you run into problems, you can spend half a million dollars to fix it. You have $600,000 worth of downhole equipment in the well,” he said. “If you get that stuck, you can't retrieve it, and you have to pay for that equipment.”
A higher tax rate could make some wells uneconomical and could lead to less drilling, McDonald said.
“The less capital we have, the fewer wells we can drill. We've pretty much been drilling most of our available cash flow,” he said.
Blatt, however, said it is not the state's role to make unprofitable operations profitable.
“If they can't be profitable without a tax giveaway, there are other problems,” he said. “We generally don't use tax policy to continue to subsidize permanently what the private sector should be able to do on its own.”
Not all in the energy industry support the lower tax rates.
Stacy Schusterman, CEO at Tulsa-based Samson Energy, said the tax rate should return closer to 7 percent, boosting revenue to other state programs.
“We have a 25 percent college graduation rate while the national average is 33 percent,” she said. “We need to invest in our human capital and invest in our economy overall, which will help the oil and gas companies by having a more highly trained workforce.”
Mullennix, however, said that returning to a higher tax rate could lead to less drilling, fewer jobs and a reduction in other tax collections.
“We would drill fewer wells,” he said. “I don't know how many, but we would drill fewer.”
While she could not speak to individual companies, Schusterman said overall drilling likely would not be reduced if the full tax were reinstated.
“I believe that at a higher gross production tax than 1 percent, they will still continue to drill and hire people,” she said. “When paying more in taxes, they will have less cash flow, but I still believe their cash flow will be sufficient because the reserves are at such a quality that the wells will be profitable.”