A Call for a 7% Gross Production Tax in Oklahoma

When we carried a story last week about the reaction of Moody’s to an increase in Oklahoma’s gross production tax on oil and gas, one oil producer responded by writing the increase should have been more.

Our headline was “Oil and Gas Groups Didn’t like the Tax Hikes—Moody’s Did.”  But Everett Moran of Moran Oil Enterprises in Seminole had this in response:

“That is not entirely true. The Oklahoma Energy Producers Alliance has actively advocated for a restoration of the historic 7% GPT on all wells, including newly drilled ones. We support that because our industry can afford it and it is the right thing to do for Oklahoma.

THE ARGUMENT IN SUPPORT OF A  7% GPT:

The leadership and controlling members of the state’s two largest oil & gas lobbying organizations want you to believe that restoring the gross production tax to 7% on new wells would drive investment away from Oklahoma into neighboring producing states. They claim that their opponents have no skin in the game, that they are not drilling wells, pay little or no GPT and are not raising new capital. Nothing could be further from the truth. The group formed to advocate in support of the 7% rate, the Oklahoma Energy Producers Association (OEPA) was founded by former leaders of the aforementioned organizations, oil & gas producers and explorers who value the needs of the state at least as much as their own bottom lines.

The claim that drilling is booming in Oklahoma because of the 36 month GPT break for new wells is just plain wrong. The drilling boom in our state is due to the superior quality of the prospects and Oklahoma drillers’ experience drilling and completing horizontal wells. The SCOOP and STACK plays are not tax driven, they are technology and reserve driven. In other words, we drill where the best quality rocks are, not where the tax rates are lowest. Let’s look at this logically:

The current (a/o 4/12/18) price of oil is $66.76, equating to about $64.26 in the field. Had we gone the distance – restoring the GPT rate to 7% (rather than the newly approved 5%) the effective price paid per barrel would be lowered by $3.12/bbl (5% x $64.26) to $61.05. If restoring the GPT rate to 7%, effectively lowering the price by 2%, would “kill drilling” in Oklahoma, how does one explain the ever-increasing rig count that began in mid-2016 when the average field price was only $45/bbl? If these prospects were economic at $45/bbl, why would they become uneconomic at $61/bbl? Furthermore, as you can see in the chart below, there is little or no correlation between price and rig count at these levels: 

 

Here are the estimated economics for SCOOP, according to an IHS analysis: 

and for STACK:

Last year, Marathon Oil’s President and CEO, Lee Tillman, called STACK “one of the best unconventional U.S. plays” and cited it as a part of their strategy to cope with low oil prices. (Karen Bowman, Rigzone, 8/25/16).  Wood Mackenzie, the highly respected energy research group, has [also] cited breakeven prices for SCOOP as low as $40/bbl. (Ibid). We cannot have it both ways. We cannot both tout the superior economics of the SCOOP and STACK plays and, at the same time, assert that these wells would not be drilled if the effective commodity price was $1.29 lower. The evidence clearly refutes that assertion. Furthermore, the hit to the state treasury is significant. Oklahoma produced 128 million barrels of oil in 2014. Wood MacKenzie reckons that Oklahoma oil production could double between 2014 and 2020, suggesting an annual compounded increase of 12%. If correct, almost all of that increase will be taxed at the 2% rate, robbing the state treasury of nearly $1 billion (at $50/bbl).

HOW OKLAHOMA COMPARES TO OTHER PRODUCING STATES

In a November 1st editorial titled “Oil tax arguments often ignore reality,” The Oklahoman argued that advocates for a restoration of the 7% gross production tax (GPT) got it wrong when they asserted that doing so “won’t cause producers to shift any drilling from Oklahoma to other states.” Citing a September 2016 report from the State Chamber of Oklahoma Research Foundation (SCORF), they went on to suggest that critics also get it wrong when they point out that oil and gas companies pay far less in energy taxes than in other states, calling that “false upon inspection,” again citing the SCORF report. The methodology used in the report, however, is deeply flawed.

In its attempt to compare apples to apples, the study neglects other taxes on oil & gas production, considering only GPT. As various states employ a range of tax vehicles and incentives, ignoring all but GPT proves woefully inadequate… of little more use than only considering property tax when comparing state tax burdens on individuals, simply because not all states have a personal income tax. Any meaningful analysis must include all forms of taxation on a particular sector. 

Oklahoma likes to compare itself with Texas, so let’s compare [only] the tax rates levied directly on oil & gas production. Since the lion’s share of new wells in Oklahoma drill for oil, I will focus on oil in this analysis. Production from all newly drilled wells in Oklahoma is now taxed at 2% for the first three years – by which time 60% to 80% of the likely recoverable reserves will have been produced, then at 7% thereafter. This is the only tax levied directly on Oklahoma oil & gas production. Texas has no such incentive and levies a severance tax (another term for GPT) of 4.611% on oil production (and 7.5% on natural gas). Texas also levies ad valorem taxes against oil & gas reserves. The rates can vary widely from county to county so, for this analysis, I picked a county that is experiencing a boom in horizontal drilling and levies neither the highest nor the lowest ad valorem tax rate. Howard County is located in the Permian Basin of West Texas. Big Spring is the county seat. Ad Valorem taxes are levied by the county (.44%), the city of Big Spring (.84232%), Big Spring ISD (1.3995%), and Howard College (.314285%) for a total of 2.68%, bringing the direct tax rate on oil production to 7.29% (Anecdotally, interest owners I have spoken to say they often pay much higher rates). I have not checked the current rig count, but when I was through there last year (when the average field price was $44/bbl compared to $62.46 today), there were rigs running as far as the eye could see.

DO THE RIGHT THING

It is disheartening to witness the moral and ethical decline evident in the leadership of this very important industry. Our industry’s strength and success has always been driven by reasoned analysis and science. Today, we cavalierly reject both out of sheer greed. Our industry used to be a leader in education and environmental responsibility, creating the OERB to clean up abandoned well sites at our own expense (I seriously doubt something like that would even be considered today). We owe our prosperity to the application of science: geology, geophysics…. and technology: petroleum and mechanical engineering, yet we refer to the scientific community as radicals or crackpots or, worse still, suggest that they falsify data in the pursuit of research grants. We vigorously oppose any and all regulations, no matter how sensible. We have, in short, devolved into an organization of self-serving narcissists.

Most of us have been very fortunate. Those of us who have been prudent have not only survived the periodic price shocks, but have emerged leaner and stronger. Shame on us for lobbying to keep a tax break on wells drilled with [what is now] established technology that are highly profitable while the state faces tremendous budgetary shortfalls. Paying a 2% GPT on the majority of the reserves, then paying 7% on what is left is akin to eating a big steak dinner, then throwing the scraps to the dog. Is that how we view our neighbors, our children, our teachers…. like the family dog waiting for leftovers?

Some of my colleagues like to point out that our industry “pay(s) nearly 25% of all taxes paid in the state. No other industry comes close!” Assuming that is correct – and I will have to take their word on that – this should be a point of pride, not consternation. It simply reflects how successful our industry has been, from the explorer down to the service company. After all, GPT makes up a mere 3% of state tax revenue, so the 25% number must necessarily include ALL tax revenues derived from all sectors of the industry.

It is time for us to start acting like the leaders we think we are and do the right thing for Oklahoma and Oklahomans. If we fail to adequately fund [and reform] education in Oklahoma, where will the next generation of geologists, engineers, economists, and managers come from? I, for one, as a 34 year veteran of the oil & gas industry, intend to continue lobbying hard for a return to the 7% GPT rate. It is the right thing to do for now and it is the right thing to do for the future of Oklahoma.

Everett Moran

Moran Oil Enterprises

Seminole OK”