[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
INCENTIVES FOR DOMESTIC OIL AND GAS PRODUCTION AND STATUS OF THE
INDUSTRY
=======================================================================
HEARING
before the
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
FEBRUARY 25, 1999
__________
Serial 106-17
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
56-935 CC WASHINGTON : 1999
------------------------------------------------------------------------------
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Oversight
AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio WILLIAM J. COYNE, Pennsylvania
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
WES WATKINS, Oklahoma JIM McDERMOTT, Washington
JERRY WELLER, Illinois JOHN LEWIS, Georgia
KENNY HULSHOF, Missouri RICHARD E. NEAL, Massachusetts
J.D. HAYWORTH, Arizona
SCOTT McINNIS, Colorado
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
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unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
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C O N T E N T S
__________
Page
Advisory of February 17, 1999, announcing the hearing............ 2
WITNESSES
U.S. Department of Treasury, Hon. Donald C. Lubick, Assistant
Secretary for Tax Policy....................................... 7
U.S. Department of Energy, Hon. Jay Hakes, Administrator, Energy
Information Administration..................................... 26
______
California Independent Petroleum Association, Don Macpherson, Jr. 52
C.E. Jacobs Company, North Texas Oil & Gas Association, Panhandle
Producers & Royalty Owners Association, Permian Basin Petroleum
Association, West Central Texas Oil & Gas Associations, and
Texas Independent Producers & Royalty Owners Association, Glenn
Picquet........................................................ 74
Chandler & Associates, LLC, and Chandler Company, Mitchell Solich 57
dba Reata Resources, John D. Bell................................ 67
Macpherson Oil Company, Don Macpherson, Jr....................... 52
Merrill Lynch & Co., Constantine D. Fliakos...................... 34
National Association of Royalty Owners, Julia A. Short........... 43
Oklahoma Basic Economy Corporation, S. Michael Cantrell.......... 61
Somerset Oil and Gas Company, Inc., Bill Waller.................. 46
SUBMISSIONS FOR THE RECORD
American Petroleum Institute, statement.......................... 88
Friends of the Earth and U.S. Public Interest Research Group,
statement and attachment....................................... 92
Gas Processors Association, Tulsa, OK, statement................. 94
Interstate Oil and Gas Compact Commission, Oklahoma City, OK:
Hon. Bill Graves, Governor, State of Kansas, statement....... 95
Hon. Edward T. Schafer, Governor, State of North Dakota,
statement.................................................. 97
INCENTIVES FOR DOMESTIC OIL AND GAS PRODUCTION AND STATUS OF THE
INDUSTRY
----------
THURSDAY, FEBRUARY 25, 1999
House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, DC.
The Subcommittee met, pursuant to notice, at 9:05 a.m., in
room 1100, Longworth House Office Building, Hon. Amo Houghton
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON OVERSIGHT
FOR IMMEDIATE RELEASE CONTACT: (202) 225-7601
February 17, 1999
No. OV-2
Houghton Announces Hearing on
Incentives for Domestic Oil and Gas Production
and Status of the Industry
Congressman Amo Houghton (R-NY), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced that the
Subcommittee will hold a hearing on current law incentives for domestic
production of oil and gas, and the status of that industry in light of
current economic conditions. The hearing will take place on Thursday,
February 25, 1999, in the main Committee hearing room, 1100 Longworth
House Office Building, beginning at 9:00 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. Invited
witnesses include officials from the U.S. Department of the Treasury
and the U.S. Department of Energy, economists with insights on the
industry, and independent producers from across the country. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing.
BACKGROUND:
Current tax law provides several incentives for the domestic
production of oil and gas including: (1) expensing of exploration and
development costs, (2) a deduction for excess of percentage over cost
depletion, and (3) a tax credit for enhanced oil recovery costs.
Over the past year, crude oil prices have fallen from about $20 per
barrel to less than $10. According to independent, domestic producers,
the cost for them to produce each barrel has remained constant in the
mid-teens. As a result, producers must consider whether to cap marginal
wells. Because of the difficulties inherent in reopening capped wells
at a later time, many are concerned about the potential for worsening
domestic economic impacts and increasing U.S. dependency on foreign
supplies of oil and gas.
In announcing the hearing, Chairman Houghton stated: ``It appears
that current tax incentives may be ill-suited to stem the current
problems faced by the domestic oil and gas industry, especially small,
independent producers. I am concerned about the hardships they are
facing in light of falling prices over the past year. The time is ripe
to review our laws to ensure that they are adequate to meet the needs
of an important national industry.''
FOCUS OF THE HEARING:
The hearing will focus on how current law affects the domestic
production of oil and gas, the status of the industry in light of
current economic conditions, the long-term ramifications for the
economy and national security, and possible policy options.
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and Means, U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written statements
wish to have their statements distributed to the press and interested
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House Office Building, by close of business the day before the hearing.
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noted above.
Chairman Houghton. Good morning, ladies and gentleman.
Great to have you here at this hearing on domestic oil and gas
production.
It is no secret that domestic oil and gas industries is in
the midst of a severe downturn. Oil prices are down 55 percent
over the last 15 months. It is not clear when they will
rebound.
The good news is that this means lower gas prices at the
pump. The bad news is it also could put small producers in many
regions of the country out of business. One estimate is that
more than 42,000 jobs have already been lost in the United
States, including 12,000 last month alone.
The Members of this Subcommittee will be joining the Trade
Subcommittee this afternoon to discuss the crisis affecting the
steel industry. I am sure everyone has heard about this. The
problems in the domestic oil and gas industry have not garnered
the same media attention, but you don't have to be a three-
story mind to see parallels that will come out in today's
hearings.
We will focus this morning on the state of the industry,
both short and long term, and also on the tax laws which affect
the industry. Many domestic producers are small businesses.
They risk shutting down their companies if the downturn is
severe and prolonged.
The members of the first panel can explain the problems
that these businesses face with statistics and predictions. And
the members of the second panel can help us understand their
problems in real terms.
Now, in the past, Congress has passed tax laws to encourage
the domestic production of oil and gas. But it is now time to
examine whether these laws are adequate to support the U.S.
industry in light of the current circumstances. We will also
examine some possible solutions proposed by Members of this
Subcommittee.
I would like to yield to our Ranking Democrat, Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman.
Today's Subcommittee on Oversight will review issues of
concern to the domestic oil and gas industry. Specifically, the
Subcommittee will review: One, the current tax laws' effects on
domestic oil and gas production; two, the state of the industry
in light of the current economic conditions; three, the long-
term ramifications of a downturn in the industry, on the
economy, and on national security, as well; and, number four,
and possible policy options.
My colleague on the Oversight Subcommittee, Congressman
Watkins, has urged that we conduct oversight review of issues
facing the domestic oil and gas industry, and I support that
effort. Similarly, I appreciate receiving the support of
Oversight Subcommittee Chairman Houghton and the Members of the
Subcommittee for my request to conduct oversight review of
similar issues facing the steel industry and its workers on a
priority and expedited basis today.
As a result, the Subcommittee's official agenda for the
106th Congress highlights the Oversight and Trade
Subcommittees' extensive interest in reviewing the steel
crisis, and a hearing on the steel crisis will be this
afternoon, as we all know.
I would hope that the entire Oversight Subcommittee will
join the Trade Subcommittee Members and participate in this
session here today and this afternoon. I am pleased that the
Department of Treasury is represented here today, and I welcome
Don Lubick as the Assistant Secretary for Tax Policy. I will be
interested in learning whether Treasury believes the Tax Code
needs to be changed to improve the financial health of the
domestic oil and gas industry. I will also be interested to
learn what tax relief the administration would recommend for
the American steel workers who have been laid off as a result
of the recent surge in steel imports. I also look forward to
hearing what our other witnesses have to say about these very
important, national industries.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you, Mr. Coyne.
Would Mr. Watkins like to make an opening statement?
Mr. Watkins. Mr. Chairman, I definitely would and would say
a big thank you to you and Mr. Coyne in working and agreeing to
have these particular hearings. They are very much needed. And
let me say to a lot of our friends, there are a lot of things
on the agenda--it is very difficult getting different topics
their needed hearings, and we are making a lot of people aware
of what is going on out there.
We are in a crisis in the oil patch. As someone said, Mr.
Chairman, ``We are hemorrhaging.'' Mr. Chairman, it is worse
than hemorrhaging. We literally have an artery that has been
cut, and we are gushing, and we are going to lose, if I may
make a point, over 50 percent of our marginal wells will be
gone between now and Independence Day if we don't turn this
thing around, and we will become more dependent on Independence
Day on foreign oil than ever before in the history of our
country.
So, we have a crisis there. I want to say, again, thank you
to the first panel. I look forward to hearing from you and also
a lot of the folks that I know on the second panel. I just want
to say, welcome, and we are glad this day has finally arrived.
Maybe we don't have awareness, but we can create some
solutions.
Thank you.
[The opening statements follow:]
Opening Statement of Wes Watkins, a Representative in Congress from the
State of Oklahoma
Mr. Chairman, first I would like to commend you for holding this
very time sensitive important hearing on the state of the domestic oil
and gas industry. As you are very aware our domestic industry is in
turmoil and we are losing our valuable domestic production because of
the continued low prices.
Adjusted for inflation, world prices are at levels not seen since
1933. This price slide threatens 1.3 million barrels of daily
production--equivalent to the amount of oil the United States imports
from Saudi Arabia daily. Losing our domestic production will increase
the nation's dependency on already record high levels of oil imports.
The domestic oil industry cannot sustain itself if these prices
continue. In January and February 19,000 jobs have been lost in the
industry and since October of 1997 52,300 have been lost according to
the Bureau of Labor Statistics. What we are talking about is not only
the thousands and thousands of jobs that are at stake or the thousands
and thousands of jobs that have all ready been lost, but our National
Security.
The impacts to this situation could become irreversible if Congress
does not take action expeditiously. I have introduced H.R. 53, the
Marginal Well Tax Credit Bill, which is not the sole answer to this
question, but should assist in keeping our marginal wells from being
plugged. In Assistant Secretary Lubick's testimony, he states that my
legislation would not benefit marginal well owners, because they were
not paying taxes. I would like to know where he got this
misinformation, because every independent producer that testified at
the hearing stated that H.R. 53 would help them. I trust the producers
keeps up with the taxes they pay and are aware if these credit are of
benefit to them. H.R. 53 would provide a tax credit up to $3 dollars a
barrel for oil and $.50 per 1000 cubic feet of natural gas when prices
drop to $14 for oil and $1.56 for natural gas. The credit is phased out
when oil hits $17 and gas hits $1.89. It allows the producer to take
the credit on the first 3 barrels of production a day, not to exceed
1095 barrels per year or barrel equivalents. One barrel of oil equals
6,000 cubic feet of natural gas. The credit can be used on regular and
minimum tax, and there is a 10 year carryback provision to be used on
past tax liability, and a 30 year carryover. Mr. Chairman, I understand
that this legislation is not a miracle cure to our ailing domestic
industry, but it will prevent many of our marginal wells from being
plugged.
As the U.S. continues to import over 50 percent of its oil
consumption, we are enjoying a very robust economy, nationally.
However, the oil patch is the one paying the price. Soon the entire
country will be paying the long term price for the U.S. not having
strong energy policy. I assume the only energy policy that the
Department of Energy has come up with is support for Iraqi production
and destruction of the United States domestic production. This is a
death wish for our economy. It is time that the Congress act to rectify
this situation and hold the Administration responsible for its lack of
attention to this crisis. It is time that Congress and this great
Nation we represent, start asking ourselves some very tough questions.
Are we going to continue to let our domestic industry become extinct
and risk our national security? Are we going to continue to turn a
blind eye at this problem and become solely dependent on OPEC? My
answer is no! I am willing to work until this problem is solved, and I
invite my colleagues to join me. Mr Chairman, again I want to thank you
for holding this hearing and look forward to the dialog and state of
the industry it has produced.
Opening Statement of Bill Thomas, a Representative in Congress from the
State of California
Mr. Chairman, I thank you for the chance to share my
concerns about the California oil industry and my constituents
in California's 21st District which includes Kern County, one
of the largest oil producing counties in the U.S. As you know,
the Clinton Administration recently announced tax relief for
the American steel industry because steel producers are
suffering from huge levels of imported steel, resulting in the
recent loss of 10,000 steel jobs. However, the oil industry has
lost jobs nationally in the last year and more are expected.
These workers from a vital U.S. industry have been hit hard by
increases in imports and also need our help.
Earlier this month you heard me ask Secretary of the
Treasury Rubin about this glaring discrepancy in the
Administration's policy. Mr. Rubin vaguely mentioned the need
for a ``dynamic economy'' to ``embrace change.'' In short, this
Administration has paid no attention to America's energy needs
and is doing nothing to help the thousands of people out of
work from that industry. This Congress should not be so short-
sighted. Our ``dynamic economy'' needs energy every bit as much
as steel to keep it running.
Before I address solutions, let me provide some background
on this crisis. California's oil and gas industry provides $10
billion to the California economy. We have been especially hard
hit by the collapse of crude oil prices in recent years. Since
most of California's onshore oil is heavy (i.e., viscous)
compared to other oil on the market, it costs more to produce
and refine and thus sells for less in the marketplace. So, last
month when Texas crude oil sold for a very low $13.50 per
barrel, oil from Kern County sold for $7.00 per barrel. The
result: large scale lay-offs and shutting-in of wells.
Nationally, almost 49,000 wells were idled or shut-in during
the first half of 1998.
There are long-term consequences from allowing this trend
to continue. One can not simply ``turn off the key"of a heavy
crude oil well and wait until prices rise. Such fields require
a huge amount of time and money to heat the field with steam.
For example, four major California fields required over $5
billion in the past 30 years to keep these fields operational.
Closing wells can take them out of production for years; yet,
this is precisely what many oil producers are doing.
Consequently, we risk becoming even more dependent upon
foreign oil imports every year. Since 1990, as U.S. production
sagged by over 4 million barrels per day, world production
increased by 5 million barrels per day due largely to OPEC
countries increases. Those of us who remember being at the
mercy of such foreign producers--the gas lines, the high
heating bills, and the recession resulting in part from
inflated energy costs--should better appreciate the need to
protect our domestic oil supply. Low energy costs are
contributing to our current low inflation and strong economic
environment, but history repeats itself and I fear Congress
will remember the oil shocks of the 1970s too late.
We need stability so low oil prices caused by the Asian
economic slowdown and cheap oil imports do not cost America
resources in the long run and leave us vulnerable to oil shocks
in the future. I encourage the Committee to consider two pieces
of legislation to aid this industry. H.R. 423 is a bill I
introduced to allow a 5-year net operating ``carry-back'' for
losses attributable to operating mineral interest of oil and
gas producers. Oil producers could reduce their taxes by using
net operating losses during the past five years. This is
similar to the relief being offered to the steel industry. H.R.
53 is a bill sponsored by our colleague Wes Watkins to allow a
tax credit of up to $3 per barrel of oil produced from marginal
wells during low price periods. Passage of these bills will be
a good first start in helping oil workers get through these
tough times while also helping ensure domestic energy supplies
for America.
Chairman Houghton. Thank you very much.
Well, I would like to introduce Mr. Lucas of Oklahoma, Mr.
McCrery, and Mr. Stenholm of Texas.
I would like to call the first witness, Hon. Don Lubick,
the Assistant Secretary at the U.S. Department of Treasury.
Thank you very much for being here.
STATEMENT OF HON. DONALD C. LUBICK, ASSISTANT SECRETARY FOR
TAX POLICY, U.S. DEPARTMENT OF TREASURY
Mr. Lubick. Thank you, Mr. Chairman and Members of the
Subcommittee.
I am pleased to be here today to discuss current tax
incentives for the domestic production of oil and gas. We have
long recognized the importance of maintaining a strong,
domestic energy industry, and, to that end, the Internal
Revenue Code includes a variety of measures to stimulate
domestic exploration and production.
The tax incentives contained in present law address the
drop in domestic exploratory drilling that has occurred since
the midfifties, and the continuing loss of production from
mature fields and marginal properties. The current tax
incentives are generally justified on the ground that they
reduce vulnerability to oil supply disruption by stimulating
increased production reserves and exploration.
Oil, of course, is an internationally traded commodity with
its domestic price set by world supply and demand. Domestic
exploration and production activity is effected by the world
price of crude oil. Historically, world oil prices have
fluctuated substantially. From 1970 to the early eighties, we
saw a fivefold increase in real oil prices. World oil prices
became relatively more stable from 1986 through 1997, but
recently, as you have pointed out, they have declined to
historic lows. And last year, about $13.50 at the refiner,
their lowest level in 25 years in real terms.
Despite increasing oil prices in the seventies and early
eighties, domestic oil production declined during that period,
and it has continued its downward trend during the more recent
period of relatively stable, but generally declining, prices.
From the late seventies to the mideighties, oil consumption
in the United States declined, but in the last decade, oil
consumption has risen by 12 percent. The decline in oil
production and the increase in consumption have led to an
increase in oil imports. Net crude oil imports have risen from
approximately 38 percent of consumption in 1988 to 58 percent
in 1998.
The fall in crude oil prices over the past year has focused
attention on the economic condition of the oil and gas industry
and its potential for increasing U.S. dependence on foreign oil
and gas supplies. The concern raised by the Chairman, in
announcing this hearing, is that current tax incentives may be
ill suited or inadequate to address the problems of the
domestic oil and gas industry, particularly in the case of
small, independent producers.
My prepared statement, which I assume will be presented for
the record, outlines in detail those tax incentives for oil and
gas production, but let me refer to them briefly.
Preferential tax treatment is an important source of
assistance provided by the Federal Government to the domestic
oil and gas industry. Incentives for oil and gas production in
the form of tax expenditures are estimated to total $7 billion
for fiscal years 2000 through 2004. Approximately half of these
expenditures, or $3.5 billion, are for the nonconventional
fuels-production credit. The statement states in detail the
terms of that.
The next largest expenditure is $1.9 billion for the
enhanced oil recovery credit. The allowance of percentage
depletion for independent producers and royalty owners,
including increased percentage depletion for marginal wells,
results in a tax expenditure of $1.4 billion.
Oil and gas producers are also allowed to expense their
intangible drilling and development costs, or IDCs. And in the
case of independent producers, a 100-percent deduction is
allowed.
In addition, working interests in oil and gas properties
are largely exempt from the passive-loss limitations, a tax
expenditure of $190 million, and they have largely been
eliminated from the alternative minimum tax.
To give you some idea of the magnitude of tax preferences
for this industry, Mr. Chairman, for the year 1996, when oil
prices were $18.46 per barrel, 75 percent of corporate firms
engaged in oil and gas production paid no Federal corporate
income tax at all. Thus, it appears unlikely that tax
incentives will significantly address the problems of this
industry when the problem is historically low prices.
With that introduction, Mr. Chairman, I would be pleased to
respond to questions that you or other Members have.
[The prepared statement follows:]
Statement of Hon. Donald C. Lubick, Assistant Secretary for Tax Policy,
U.S. Department of Treasury
Mr. Chairman and Members of the Subcommittee:
I am pleased to discuss the current tax incentives for the
domestic production of oil and gas.
The importance of maintaining a strong domestic energy
industry has been long recognized and the Internal Revenue Code
includes a variety of measures to stimulate domestic
exploration and production. The tax incentives contained in
present law address the drop in domestic exploratory drilling
that has occurred since the mid-1950s and the continuing loss
of production from mature fields and marginal properties.
The current tax incentives for oil and gas are intended to
encourage exploration and production. They are generally
justified on the ground that they reduce vulnerability to an
oil supply disruption through increases in production,
reserves, and exploration and production capacity. U.S.
vulnerability to oil supply disruptions also has been reduced
by the growth of oil production outside the Middle East, the
establishment of the Strategic Petroleum Reserve, and measures
that promote energy conservation and alternative energy
sources.
Before I turn to my discussion of the present tax treatment
of oil and gas activities, I would like to provide a brief
overview of this sector.
Overview
Oil is an internationally traded commodity with its
domestic price set by world supply and demand. Domestic
exploration and production activity is affected by the world
price of crude oil. Historically, world oil prices have
fluctuated substantially. From 1970 to the early 1980s, there
was a fivefold increase in real oil prices. World oil prices
were relatively more stable from 1986 through 1997. During that
period, average refiner acquisition prices ranged from $14.76
to $23.25 in real 1992 dollars. In the last year, however, oil
prices declined to about $13.50 at the refiner, their lowest
level in 25 years in real terms, and they are somewhat lower
today.
Despite increasing oil prices in the 1970s and early 1980s,
domestic oil production declined during that period, and has
continued its downward trend during the more recent period of
relatively stable, but generally declining, prices. From the
late 1970s to the mid 1980s oil consumption in the United
States declined, but in the last decade oil consumption has
risen by 12 percent. The decline in oil production and increase
in consumption have led to an increase in oil imports. Net
crude oil imports have risen from approximately 38 percent of
consumption in 1988 to 58 percent in 1998.
The fall in crude oil prices over the past year has focused
attention on the economic condition of the oil and gas industry
and its potential for increasing U.S. dependence on foreign oil
supplies. The concern raised by the Chairman in announcing this
hearing is that current tax incentives may be ill-suited to
address the problems of the domestic oil and gas industry,
particularly in the case of small, independent producers. In
reviewing possible policy options to relieve the hardships
confronting the oil and gas industry as a result of falling oil
prices, the Subcommittee should consider whether additional
Federal tax subsidies for the oil and gas industry can
adequately address this situation or whether other measures
would be more cost effective.
I would now like to discuss the tax incentives for oil and
gas in more detail.
Tax expenditures
Preferential tax treatment is an important source of
assistance provided by the Federal government to the domestic
oil and gas industry. Incentives for oil and gas production in
the form of tax expenditures are estimated to total $7.0
billion for fiscal years 2000 through 2004.\1\ They include the
nonconventional fuels (i.e., oil produced from shale and tar
sands, gas produced from geopressured brine, Devonian shale,
coal seams, tight formations, or biomass, and synthetic fuel
produced from coal) production credit ($3.5 billion), the
enhanced oil recovery credit ($1.9 billion), the allowance of
percentage depletion for independent producers and royalty
owners, including increased percentage depletion for stripper
wells ($1.4 billion), the exception from the passive loss
limitation for working interests in oil and gas properties
($190 million), and the expensing of intangible drilling and
development costs ($40 million). In addition to those tax
expenditures, oil and gas activities have largely been
eliminated from the alternative minimum tax. These provisions
are described in detail below.
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\1\ Analytical Perspectives, Budget of the United States
Government, Fiscal Year 2000. U.S. Government Printing Office,
Washington, DC, 1999, p. 117. These estimates are measured on an
``outlay equivalent'' basis. They show the amount of outlay that would
be required to provide the taxpayer the same after-tax income as would
be received through the tax preference. This outlay equivalent measure
allows a comparison of the cost of the tax expenditure with that of a
direct Federal outlay.
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Present law tax incentives for domestic oil and gas production
A. Percentage Depletion
Certain costs incurred prior to drilling an oil-or gas-producing
property are recovered through the depletion deduction. These include
costs of acquiring the lease or other interest in the property, and
geological and geophysical costs (in advance of actual drilling). Any
taxpayer having an economic interest in a producing property may use
the cost depletion method. Under this method, the basis recovery for a
taxable year is proportional to the exhaustion of the property during
the year. The cost depletion method does not permit cost recovery
deductions that exceed the taxpayer's basis in the property or that are
allowable on an accelerated basis. Thus, the deduction for cost
depletion is not generally viewed as a tax incentive.
Independent producers
Independent producers and royalty owners (as contrasted to
integrated oil companies) \2\ may qualify for percentage
depletion. A qualifying taxpayer determines the depletion
deduction for each oil or gas property under both the
percentage depletion method and the cost depletion method and
deducts the larger of the two amounts. Under the percentage
depletion method, generally 15 percent of the taxpayer's gross
income from an oil-or gas-producing property is allowed as a
deduction in each taxable year. The amount deducted may not
exceed 100 percent of the net income from that property in any
year (the ``net-income limitation).\3\ Additionally, the
percentage depletion deduction for all oil and gas properties
may not exceed 65 percent of the taxpayer's overall taxable
income (determined before such deduction and adjusted for
certain loss carrybacks and trust distributions).\4\
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\2\ An independent producer is any producer who is not a
``retailer'' or ``refiner.'' A retailer is any person who directly, or
through a related person, sells oil or natural gas or any product
derived therefrom (1) through any retail outlet operated by the
taxpayer or related person, or (2) to any person that is obligated to
market or distribute such oil or natural gas (or product derived
therefrom) under the name of the taxpayer or the related person, or
that has the authority to occupy any retail outlet owned by the
taxpayer or a related person. Bulk sales of crude oil and natural gas
to commercial or industrial users, and bulk sales of aviation fuel to
the Department of Defense, are not treated as retail sales for this
purpose. Further, a person is not a retailer within the meaning of this
provision if the combined gross receipts of that person and all related
persons from the retail sale of oil, natural gas, or any product
derived therefrom do not exceed $5 million for the taxable year. A
refiner is any person who directly or through a related person engages
in the refining of crude oil, but only if such person or related person
has a refinery run in excess of 50,000 barrels per day on any day
during the taxable year.
\3\ By contrast, for any other mineral qualifying for the
percentage depletion deduction, the deduction may not exceed 50 percent
of the taxpayer's taxable income from the depletable property.
\4\ Amounts disallowed as a result of this rule may be carried
forward and deducted in subsequent taxable years, subject to the 65-
percent taxable income limitation for those years.
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A taxpayer may claim percentage depletion with respect to
up to 1,000 barrels of average daily production of domestic
crude oil or an equivalent amount of domestic natural gas. For
producers of both oil and natural gas, this limitation applies
on a combined basis. All production owned by businesses under
common control and members of the same family must be
aggregated; each group is then treated as one producer for
application of the 1,000-barrel limitation.
Special rules for marginal wells
Special percentage depletion provisions apply to oil and
gas production from marginal properties. The statutory
percentage depletion rate is increased (from the general rate
of 15 percent) by one percentage point for each whole dollar
that the average price of crude oil (as determined under the
provisions of the nonconventional fuels production credit of
section 29) for the immediately preceding calendar year is less
than $20 per barrel. In no event may the rate of percentage
depletion under this provision exceed 25 percent for any
taxable year. The increased rate applies for the taxpayer's
taxable year which immediately follows a calendar year for
which the average crude oil price falls below the $20 floor. To
illustrate the application of this provision, the average price
of a barrel of crude oil for calendar year 1997 was $17.24;
thus, the percentage depletion rate for production from
marginal wells was increased by two percent (to 17 percent) for
taxable years beginning in 1998. In addition, the 100-percent
net-income limitation has been suspended for marginal wells for
taxable years beginning after December 31, 1997, and before
December 31, 2000.
Marginal production is defined for this purpose as domestic
crude oil or domestic natural gas which is produced during any
taxable year from a property which (1) is a stripper well
property for the calendar year in which the taxable year
begins, or (2) is a property substantially all of the
production from which during such calendar year is heavy oil
(i.e., oil that has a weighted average gravity of 20 degrees
API or less corrected to 60 degrees Fahrenheit). A stripper
well property is any oil or gas property for which daily
average production per producing oil or gas well is not more
that 15 barrel equivalents in the calendar year during which
the taxpayer's taxable year begins.\5\ A property qualifies as
a stripper well property for a calendar year only if the wells
on such property were producing during that period at their
maximum efficient rate of flow.
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\5\ Equivalent barrels is computed as the sum of (1) the number of
barrels of crude oil produced, and (2) the number of cubic feet of
natural gas produced divided by 6,000. If a well produced 10 barrels of
crude oil and 12,000 cubic feet of natural gas, its equivalent barrels
produced would equal 12 (i.e., 10 + (12,000 / 6,000)).
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If a taxpayer's property consists of a partial interest in
one or more oil-or gas-producing wells, the determination of
whether the property is a stripper well property or a heavy oil
property is made with respect to total production from such
wells, including the portion of total production attributable
to ownership interests other than the taxpayer's. If the
property satisfies the requirements of a stripper well
property, then that person receives the benefits of this
provision with respect to its allocable share of the production
from the property for its taxable year that begins during the
calendar year in which the property so qualifies.
The allowance for percentage depletion on production from
marginal oil and gas properties is subject to the 1,000-barrel-
per-day limitation discussed above. Unless a taxpayer elects
otherwise, marginal production is given priority over other
production for purposes of utilization of that limitation.
Effect of provisions
Because percentage depletion, unlike cost depletion, is
computed without regard to the taxpayer's basis in the
depletable property, cumulative depletion deductions may be far
greater than the amount expended by the taxpayer to acquire or
develop the property. The excess of the percentage depletion
deduction over the deduction for cost depletion is generally
viewed as a tax incentive.
B. Intangible Drilling and Development Costs
In general, costs that benefit future periods must be
capitalized and recovered over such periods for income tax
purposes, rather than being expensed in the period the costs
are incurred. In addition, the uniform capitalization rules
require certain direct and indirect costs allocable to property
to be included in inventory or capitalized as part of the basis
of such property. In general, the uniform capitalization rules
apply to real and tangible personal property produced by the
taxpayer or acquired for resale.
Deduction for intangible drilling and development costs
Special rules apply to intangible drilling and development
costs.\6\ Under these special rules, an operator (i.e., a
person who holds a working or operating interest in any tract
or parcel of land either as a fee owner or under a lease or any
other form of contract granting working or operating rights)
who pays or incurs IDCs in the development of an oil or gas
property located in the United States may elect either to
expense or capitalize those costs. The uniform capitalization
rules do not apply to otherwise deductible IDCs.
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\6\ IDCs include all expenditures made by an operator for wages,
fuel, repairs, hauling, supplies, etc., incident to and necessary for
the drilling of wells and the preparation of wells for the production
of oil and gas. In addition, IDCs include the cost to operators of any
drilling or development work (excluding amounts payable only out of
production or gross or net proceeds from production, if the amounts are
depletable income to the recipient, and amounts properly allocable to
the cost of depreciable property) done by contractors under any form of
contract (including a turnkey contract). Such work includes labor,
fuel, repairs, hauling, and supplies which are used in the drilling,
shooting, and cleaning of wells; in such clearing of ground, draining,
road making, surveying, and geological works as are necessary in
preparation for the drilling of wells; and in the construction of such
derricks, tanks, pipelines, and other physical structures as are
necessary for the drilling of wells and the preparation of wells for
the production of oil and gas. Generally, IDCs do not include expenses
for items which have a salvage value (such as pipes and casings) or
items which are part of the acquisition price of an interest in the
property.
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If a taxpayer elects to expense IDCs, the amount of the
IDCs is deductible as an expense in the taxable year the cost
is paid or incurred. Generally, IDCs that a taxpayer elects to
capitalize may be recovered through depletion or depreciation,
as appropriate; or in the case of a nonproductive well (``dry
hole''), the operator may elect to deduct the costs. In the
case of an integrated oil company (i.e., a company that
engages, either directly or though a related enterprise, in
substantial retailing or refining activities) that has elected
to expense IDCs, 30 percent of the IDCs on productive wells
must be capitalized and amortized over a 60-month period.\7\
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\7\ The IRS has ruled that if an integrated oil company ceases to
be an integrated oil company, it may not immediately write off the
unamortized portion of the IDCs capitalized under this rule, but
instead must continue to amortize those IDCs over the 60-month
amortization period.
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A taxpayer that has elected to deduct IDCs may,
nevertheless, elect to capitalize and amortize certain IDCs
over a 60-month period beginning with the month the expenditure
was paid or incurred. This rule applies on an expenditure-by-
expenditure basis; that is, for any particular taxable year, a
taxpayer may deduct some portion of its IDCs and capitalize the
rest under this provision. This allows the taxpayer to reduce
or eliminate IDC adjustments or preferences under the
alternative minimum tax.
The election to deduct IDCs applies only to those IDCs
associated with domestic properties.\8\ For this purpose, the
United States includes certain wells drilled offshore.\9\
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\8\ In the case of IDCs paid or incurred with respect to an oil or
gas well located outside of the United States, the costs, at the
election of the taxpayer, are either (1) included in adjusted basis for
purposes of computing the amount of any deduction allowable for cost
depletion or (2) capitalized and amortized ratably over a 10-year
period beginning with the taxable year such costs were paid or
incurred.
\9\ The term ``United States'' for this purpose includes the seabed
and subsoil of those submerged lands that are adjacent to the
territorial waters of the United States and over which the United
States has exclusive rights, in accordance with international law, with
respect to the exploration and exploitation of natural resources (i.e.,
the Continental Shelf area).
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Effect of provision
Intangible drilling costs are a major portion of the costs
necessary to locate and develop oil and gas reserves. Since the
benefits obtained from these expenditures are of value
throughout the life of the project, these costs would be
capitalized and recovered over the period of production under
generally applicable accounting principles. The acceleration of
the deduction for IDCs is viewed as a tax incentive.
C. Tax Credits--Nonconventional fuels production credit
Taxpayers that produce certain qualifying fuels from
nonconventional sources are eligible for a tax credit (``the
section 29 credit'') equal to $3 per barrel or barrel-of-oil
equivalent.\10\ Fuels qualifying for the credit must be
produced domestically from a well drilled, or a facility
treated as placed in service, before January 1, 1993.\11\ The
section 29 credit generally is available for qualified fuels
sold to unrelated persons before January 1, 2003.\12\
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\10\ A barrel-of-oil equivalent generally means that amount of the
qualifying fuel which has a Btu (British thermal unit) content of 5.8
million.
\11\ A facility that produces gas from biomass or produces liquid,
gaseous, or solid synthetic fuels from coal (including lignite)
generally will be treated as being placed in service before January 1,
1993, if it is placed in service by the taxpayer before July 1, 1998,
pursuant to a written binding contract in effect before January 1,
1997. In the case of a facility that produces coke or coke gas,
however, this provision applies only if the original use of the
facility commences with the taxpayer. Also, the IRS has ruled that
production from certain post-1992 ``recompletions'' of wells that were
originally drilled prior to the expiration date of the credit would
qualify for the section 29 credit.
\12\ If a facility that qualifies for the binding contract rule is
originally placed in service after December 31, 1992, production from
the facility may qualify for the credit if sold to an unrelated person
before January 1, 2008.
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For purposes of the credit, qualified fuels include: (1)
oil produced from shale and tar sands; (2) gas produced from
geopressured brine, Devonian shale, coal seams, a tight
formation, or biomass (i.e., any organic material other than
oil, natural gas, or coal (or any product thereof); and (3)
liquid, gaseous, or solid synthetic fuels produced from coal
(including lignite), including such fuels when used as
feedstocks. The amount of the credit is determined without
regard to any production attributable to a property from which
gas from Devonian shale, coal seams, geopressured brine, or a
tight formation was produced in marketable quantities before
1980.
The amount of the section 29 credit generally is adjusted
by an inflation adjustment factor for the calendar year in
which the sale occurs.\13\ There is no adjustment for inflation
in the case of the credit for sales of natural gas produced
from a tight formation. The credit begins to phase out if the
annual average unregulated wellhead price per barrel of
domestic crude oil exceeds $23.50 multiplied by the inflation
adjustment factor.\14\
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\13\ The inflation adjustment factor for the 1997 taxable year was
2.0331. Therefore, the inflation-adjusted amount of the credit for that
year was $6.10 per barrel or barrel equivalent.
\14\ For 1997, the inflation adjusted threshold for onset of the
phaseout was $47.38 ($23.50 x 2.0331) and the average wellhead price
for that year was 15.98.
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The amount of the section 29 credit allowable with respect
to a project is reduced by any unrecaptured business energy tax
credit or enhanced oil recovery credit claimed with respect to
such project.
As with most other credits, the section 29 credit may not
be used to offset alternative minimum tax liability. Any unused
section 29 credit generally may not be carried back or forward
to another taxable year; however, a taxpayer receives a credit
for prior year minimum tax liability to the extent that a
section 29 credit is disallowed as a result of the operation of
the alternative minimum tax. The credit is limited to what
would have been the regular tax liability but for the
alternative minimum tax.
Effect of provision
This provision provides a significant tax incentive
(currently about $6 per barrel of oil equivalent or $1 per
thousand cubic feet of natural gas, or roughly half the
wellhead price of gas) for production of nonconventional fuels.
Coalbed methane and gas from tight formations currently account
for most of the credit.
Enhanced oil recovery credit
Taxpayers are permitted to claim a general business credit,
which consists of several different components. One component
of the general business credit is the enhanced oil recovery
credit. The general business credit for a taxable year may not
exceed the excess (if any) of the taxpayer's net income over
the greater of (1) the tentative minimum tax, or (2) 25 percent
of so much of the taxpayer's net regular tax liability as
exceeds $25,000. Any unused general business credit generally
may be carried back three taxable years and carried forward 15
taxable years.
The enhanced oil recovery credit for a taxable year is
equal to 15 percent of certain costs attributable to qualified
enhanced oil recovery (``EOR'') projects undertaken by the
taxpayer in the United States during the taxable year. To the
extent that a credit is allowed for such costs, the taxpayer
must reduce the amount otherwise deductible or required to be
capitalized and recovered through depreciation, depletion, or
amortization, as appropriate, with respect to the costs. A
taxpayer may elect not to have the enhanced oil recovery credit
apply for a taxable year.
The amount of the enhanced oil recovery credit is reduced
in a taxable year following a calendar year during which the
annual average unregulated wellhead price per barrel of
domestic crude oil exceeds $28 (adjusted for inflation since
1990).\15\ In such a case, the credit would be reduced ratably
over a $6 phaseout range.
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\15\ The average per-barrel price of crude oil for this purpose is
determined in the same manner as for purposes of the section 29 credit.
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For purposes of the credit, qualified enhanced oil recovery
costs include the following costs which are paid or incurred
with respect to a qualified EOR project: (1) the cost of
tangible property which is an integral part of the project and
with respect to which depreciation or amortization is
allowable; (2) IDCs that the taxpayer may elect to deduct; \16\
and (3) the cost of tertiary injectants with respect to which a
deduction is allowable, whether or not chargeable to capital
account.
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\16\ In the case of an integrated oil company, the credit base
includes those IDCs which the taxpayer is required to capitalize.
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A qualified EOR project means any project that is located
within the United States and involves the application (in
accordance with sound engineering principles) of one or more
qualifying tertiary recovery methods which can reasonably be
expected to result in more than an insignificant increase in
the amount of crude oil which ultimately will be recovered. The
qualifying tertiary recovery methods generally include the
following nine methods: miscible fluid displacement, steam-
drive injection, microemulsion flooding, in situ combustion,
polymer-augmented water flooding, cyclic-steam injection,
alkaline flooding, carbonated water flooding, and immiscible
non-hydrocarbon gas displacement, or any other method approved
by the IRS. In addition, for purposes of the enhanced oil
recovery credit, immiscible non-hydrocarbon gas displacement
generally is considered a qualifying tertiary recovery method,
even if the gas injected is not carbon dioxide.
A project is not considered a qualified EOR project unless
the project's operator submits to the IRS a certification from
a petroleum engineer that the project meets the requirements
set forth in the preceding paragraph.
The enhanced oil recovery credit is effective for taxable
years beginning after December 31, 1990, with respect to costs
paid or incurred in EOR projects begun or significantly
expanded after that date.
Effect of provision
Conventional oil recovery methods do not recover all of a
well's oil. Some of the remaining oil can be extracted by
unconventional methods, but these methods are generally more
costly and uneconomic at current world oil prices. In this
environment, the EOR credit can increase recoverable reserves.
Although recovering oil using EOR methods is more expensive
than recovering it using conventional methods, it may be less
expensive than producing oil from new reservoirs. At present
world oil prices, this credit is fully available.
D. Alternative Minimum Tax
A taxpayer is subject to an alternative minimum tax
(``AMT'') to the extent that its tentative minimum tax exceeds
its regular income tax liability. A corporate taxpayer's
tentative minimum tax generally equals 20 percent of its
alternative minimum taxable income in excess of an exemption
amount. (The marginal AMT rate for a noncorporate taxpayer is
26 or 28 percent, depending on the amount of its alternative
minimum taxable income above an exemption amount.) Alternative
minimum taxable income (``AMTI'') is the taxpayer's taxable
income increased by certain tax preferences and adjusted by
determining the tax treatment of certain items in a manner
which negates the deferral of income resulting from the regular
tax treatment of those items.
AMT treatment of depletion
As a general rule, percentage depletion deductions claimed
in excess of the basis of the depletable property constitute an
item of tax preference in determining the AMT. In addition, the
AMTI of a corporation is increased by an amount equal to 75
percent of the amount by which adjusted current earnings
(``ACE'') of the corporation exceed AMTI (as determined before
this adjustment). In general, ACE means AMTI with additional
adjustments that generally follow the rules presently
applicable to corporations in computing their earnings and
profits. As a general rule a corporation must use the cost
depletion method in computing its ACE adjustment. Thus, the
difference between a corporation's percentage depletion
deduction (if any) claimed for regular tax purposes and its
allowable deduction determined under the cost depletion method
is factored into its overall ACE adjustment.
Excess percentage depletion deductions related to crude oil
and natural gas production are not items of tax preference for
AMT purposes. In addition, corporations that are independent
oil and gas producers and royalty owners may determine
depletion deductions using the percentage depletion method in
computing their ACE adjustments.
AMT treatment of IDCs
The difference between the amount of a taxpayer's IDC
deductions and the amount which would have been currently
deductible had IDCs been capitalized and recovered over a 10-
year period may constitute an item of tax preference for the
AMT to the extent that this amount exceeds 65 percent of the
taxpayer's net income from oil and gas properties for the
taxable year (the ``excess IDC preference''). In addition, for
purposes of computing a corporation's ACE adjustment to the
AMT, IDCs are capitalized and amortized over the 60-month
period beginning with the month in which they are paid or
incurred. The preference does not apply if the taxpayer elects
to capitalize and amortize IDCs over a 60-month period for
regular tax purposes.
IDCs related to oil and gas wells are generally not taken
into account in computing the excess IDC preference of
taxpayers that are not integrated oil companies. This treatment
does not apply, however, to the extent it would reduce the
amount of the taxpayer's AMTI by more than 40 percent of the
amount that the taxpayer's AMTI would have been if those IDCs
had been taken into account.
In addition, for corporations other than integrated oil
companies, there is no ACE adjustment for IDCs with respect to
oil and gas wells. That is, such a taxpayer is permitted to use
its regular tax method of writing off those IDCs for purposes
of computing its adjusted current earnings.
Effect of provisions
Absent these rules, the incentive effect of the special
provisions for oil and gas would be reduced for firms subject
to the AMT. These rules, however, effectively eliminate AMT
concerns for independent producers.
E. Passive Activity Loss and Credit Rules
A taxpayer's deductions from passive trade or business
activities, to the extent they exceed income from all such
passive activities of the taxpayer (exclusive of portfolio
income), generally may not be deducted against other
income.\17\ Thus, for example, an individual taxpayer may not
deduct losses from a passive activity against income from
wages. Losses suspended under this ``passive activity loss''
limitation are carried forward and treated as deductions from
passive activities in the following year, and thus may offset
any income from passive activities generated in that later
year. Undeducted losses from a passive activity may be deducted
in full when the taxpayer disposes of its entire interest in
that activity to an unrelated party in a transaction in which
all realized gain or loss is recognized.
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\17\ This provision applies to individuals, estates, trusts,
personal service corporations, and closely held C corporations.
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An activity generally is treated as passive if the taxpayer
does not materially participate in it. A taxpayer is treated as
materially participating in an activity only if the taxpayer is
involved in the operations of the activity on a basis which is
regular, continuous, and substantial.
A working interest in an oil or gas property generally is
not treated as a passive activity, whether or not the taxpayer
materially participates in the activities related to that
property. This exception from the passive activity rules does
not apply if the taxpayer holds the working interest through an
entity which limits the liability of the taxpayer with respect
to the interest. In addition, if a taxpayer has any loss for
any taxable year from a working interest in an oil or gas
property which is treated pursuant to this working interest
exception as a loss which is not from a passive activity, then
any net income from such property (or any property the basis of
which is determined in whole or in part by reference to the
basis of such property) for any succeeding taxable year is
treated as income of the taxpayer which is not from a passive
activity.
Similar limitations apply to the utilization of tax credits
attributable to passive activities. Thus, for example, the
passive activity rules (and, consequently, the oil and gas
working interest exception to those rules) apply to the
nonconventional fuels production credit and the enhanced oil
recovery credit. However, if a taxpayer has net income from a
working interest in an oil and gas property which is treated as
not arising from a passive activity, then any tax credits
attributable to the interest in that property would be treated
as credits not from a passive activity (and, thus, not subject
to the passive activity credit limitation) to the extent that
the amount of the credits does not exceed the regular tax
liability which is allocable to such net income.
Effect of provision
As a result of this exception from the passive loss
limitations, owners of working interests in oil and gas
properties may use losses from such interests to offset income
from other sources.
F. Tertiary Injectants
Taxpayers are allowed to deduct the cost of qualified
tertiary injectant expenses for the taxable year. Qualified
tertiary injectant expenses are amounts paid or incurred for
any tertiary injectant (other than recoverable hydrocarbon
injectants) which is used as a part of a tertiary recovery
method.
Effect of provision
The provision allowing the deduction for qualified tertiary
injectant expenses resolves a disagreement between taxpayers
(who considered such costs to be IDCs or operating expenses)
and the IRS (which considered such costs to be subject to
capitalization).
Mr. Chairman, this concludes my prepared testimony. I will
be pleased to answer any questions you or other members of the
Subcommittee may have.
Chairman Houghton. Thank you very much, Mr. Secretary.
I am going to pass on my questions and turn it over
immediately to Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman.
Mr. Lubick, does the Treasury Department believe that the
Tax Code needs to be changed to improve the financial health of
the domestic oil and gas industry?
Mr. Lubick. Mr. Coyne, as I have indicated, the Tax Code
already, as far as the independents are concerned, has resulted
from an exemption from taxation of probably more than 75
percent of persons involved.
It seems to us, therefore, that since the dominating
problem of the industry is low prices, we ought to explore
whether there are more effective, more cost-efficient methods
of dealing with the problem of the industry and the people in
the industry. We recognize this has an impact not only on the
producers of oil and gas, but the ripple effect to all the
persons in the community that have established businesses and
whose occupations depend upon the well-being of that industry.
They are in distress. We recognize that the State and the local
governments that are dependent upon revenues that are generally
associated with production are being hard pressed.
It is a very serious problem when the economy generally is
doing very well that here is an area, as we have found in the
case of steel as well, that is seriously at a disadvantage. But
the problems seem to us to be of a magnitude that goes beyond a
ready solution through changes in the tax law when most people,
those who are most adversely affected are not paying taxes, it
seems to us the solution does not lie in additional tax
incentives. This is an industry that probably has larger tax
incentives relative to its size than any other industry in the
country.
Mr. Coyne. Well, to what extent is the Asian financial
crisis responsible or does it have any responsibility for the
lower worldwide demand?
Mr. Lubick. It certainly is a factor that was unexpected.
The weakened demand for petroleum products has been a factor
depressing oil prices.
At the same time, there are other factors affecting demand.
For example, we have had, in the Northern Hemisphere for the
last two winters, unusually warm winters. What has perhaps been
a blessing to people in your community and my community further
North, in terms of lower fuel bills, has been somewhat of a
disaster for oil producers.
At the same time, not only is there a weakened demand, but
on the supply side, since this is a commodity produced
worldwide, there has been excess supply. That combination of
excess supply and weakened demand has been responsible for the
crisis which affects this industry which is a crisis dominated
by weak prices.
Mr. Coyne. Thank you very much.
Chairman Houghton. Mr. Watkins.
Mr. Watkins. Mr. Chairman, I am so thankful for these
hearings. Mr. Coyne and I would like for all of our staff and
others--I cannot believe my ears. I cannot believe my ears. You
say about the conditions and the tax incentives that are out
there today, you have got to explore for more effective ways,
Mr. Lubick.
Your administration, that, by the way is to allow Iraqis to
produce 2.5 million barrels of oil today are 2 million more
than what they did have. Senator Lugar pointed out, a year or
two ago, that in order to protect the Middle East and have that
oil supply, we are paying up to $100 a barrel. That is your
solution to our problem, paying a whole lot more. I cannot
believe how un-American it is, to be very honest with you.
What we have on our hands is, yes, a crisis. But in my ear,
I hear kind of a gleeful attitude. It pains me in my heart to
think this administration is taking that kind of attitude to
where their domestic oil economy that keeps our country going--
yes, we are importing more every day, and we are going to pay
the price one of these years, big time. But the American people
are the ones that are going to end up suffering later on.
Yes, we are hemorrhaging in the oil patch. It is a lack of
policy, a lack of energy policy.
What measures does this administration have? Does it have
any suggestion? Or is this important? Is this important? Is the
domestic oil economy important, Mr. Lubick, do you think at
all?
Mr. Lubick. Mr. Watkins, you have misconstrued me
completely if you think we are gleeful about the situation in
the oil industry. We recognize--and I want to emphasis my
complete agreement with you with the importance of this
industry and our feeling of distress----
Mr. Watkins. All I heard was cold heartedness. I didn't
hear any empathy and saying that we were going to do something
about it.
Mr. Lubick. Well, Mr. Watkins, the question which I have
been addressing is what is the most efficient way to deal with
the problem. I have not in any way denied the problem, nor in
any way indicated that something shouldn't be done to alleviate
the distress, not only by the producers, but by people whose
livelihoods depend upon the producers. There are other pockets
in our economy today that are suffering similarly, I think as
Mr. Coyne is aware of as well.
The question that lies within my field of competence, or
minimal competence, at any event, is the tax system and
efficient way to address the problem. And that, I think, if one
looks at the situation----
Mr. Watkins. If you would yield, Mr. Lubick?
Mr. Lubick. Surely.
Mr. Watkins. I think this Subcommittee would welcome any
suggestions you have that are constructive that would be more
efficient that address this problem if we think a domestic oil
supply is important for this country.
Mr. Lubick. There certainly have been some measures that
have been taken.
The Department of the Interior, for example, has announced
it is allowing stripper oil well producers, producing on public
lands, to suspend their operations for up to 2 years without
losing their leases. There is some relief for them.
The budget has requested $364 million to fund fossil energy
research and development activities at the Department of Energy
to develop technologies, among other objectives, that will
reduce the cost of domestic oil and natural gas production.
There are other proposals to improve the Nation's energy
security.
But I think that this is----
Mr. Watkins. Let me ask another question.
Let me say on a couple of things right there that we are
going to have a lot of funerals out there in oil patching
because most of them will be dead and buried before those come
about.
In 1994, the administration's National Petroleum Council,
concerning margins of wells, reported and recommended a margin
wells tax credit, and we have introduced that in both areas.
And I understand the Energy Secretary has also met with the
Treasury Secretary about this. Could you shed some insight,
some light, on that? How did they feel about the tax credit?
Mr. Lubick. Well, the problem we have with the marginal
well tax credit--we met with Secretary Richardson on this--is
that it won't benefit the most unprofitable firms because they
have no tax liability. Again, as I stated in my opening
statement, over 75 percent of corporations in the oil and gas
extraction industry did not pay any domestic, corporate income
tax.
A more serious problem for the producers is severance
taxers, and I understand that some States are producing some
relief in that area, but, again, the problem that is the cause
of all of this, and I think as everyone recognizes, is the
historically unusual, or record depression of prices. It seems
to us that if one considers the efficiency of a tax credit, it
is not going to go to those producers most in distress.
Mr. Watkins. Mr. Chairman, I will have a second shot,
maybe, to talk? I know we have a special guest and good friend
of yours and the Subcommittee's from Texas here, and he wants
to say something, too, so I will just take my second turn here
in 1 minute.
Mr. Chairman, thank you.
Chairman Houghton. Mr. Stenholm, would you like to----
Mr. Stenholm. Thank you, Mr. Chairman, and I thank the
Members of the Subcommittee for allowing a Member from the
Agriculture Committee to come and be here today.
And I appreciate the opportunity to follow up, Mr.
Secretary, on your comment that we need to look at a more
efficient way to deal with the problem. I agree with your
assessment that the problem is price. I also agree with Mr.
Coyne's comments concerning other industries. The steel
industry has a similar problem, as does the agriculture
industry. And all of us, as policymakers, are struggling, as
you are, Mr. Secretary, with how to we deal with this problem.
And the fundamental question for us to consider here today is,
Should we deal with the oil price crisis? And here, I would
like to hear your answer to this question, because clearly our
country has been benefiting with cheap oil. My constituents
like to pay 82 cents for a gallon of gasoline. My farmers like
to pay 38 cents a gallon. In the short term, low prices are
benefiting the economy.
But we now see some very real storm clouds gathering. We
are about to do some irreparable harm to the infrastructure of
an industry that will not come back if protections are not
created. Allowing other governments to set our prices in this
country is now beginning to pose a national security problem.
We must ask whether we are willing to allow our inaction to
hand control of our economic well-being to other countries.
You are right on the price.
One suggestion I am looking at very seriously, and this
applies to all industries, is whether or not we should
establish a minimum price in the United States. We can examine
whether to do it through the Tax Code, as Mr. Watkins suggests,
or whether to do it through what used to be called an oil-
import fee. I suggest that, this year, we examine an
environmental-equalization fee. When we recognize that other
countries, who are now enjoying the benefits of our markets,
have, I am told, a $4 to $4.50 advantage over our producers in
environmental compliance costs. Because imported oil does not
carry an environmental premium, our producers are at a
disadvantage in the marketplace. Would seeking to level the
playingfield for domestic producers with such a fee be
something that would make economic sense? Is this something the
administration is looking at, has looked at, or would be
interested in looking at? And examining whether or not a floor
price would, in fact, put money into the pockets of the
producers that you say a Tax Code change will not assist. Is
this something that has some merit?
Mr. Lubick. Mr. Stenholm, I think you are dealing with an
area that is obviously not one of my areas of competence or
experience. I was here recently before this Subcommittee when
Chairman Archer admonished some other member of the
administration from my department that you shouldn't be giving
answers in areas where you don't have competence, and he said
to me, ``I like the way you testify because you stick to areas
that you purportedly know something about.'' He may be wrong on
that. But at least he is right that I try not to get beyond my
areas.
I think all of the things you suggest are things that
should be considered. There are obviously problems under trade
agreements as to what you can do, and, again, I come to the
conclusion, along with my colleagues who have tax expertise,
both economic and legal, that the tax route doesn't leave much
wiggle room to do anything in an efficient way, and it is not
that I don't agree with you that this is an important industry
that we need to have in this country, and I think the points
that you make about its plight are perfectly correct, but I
would hope you would consult with my wiser and more experienced
colleagues to discuss some of these other solutions.
Mr. Stenholm. Mr. Secretary, you don't have to worry about
that. I think this is a subject that all of us take seriously,
and, again, Mr. Chairman, the fact that you are holding these
hearings indicates that more and more people outside of the oil
patch are recognizing there is a problem.
I hope as we pursue the solution to the oil crisis, we
recognize the problems of the steel industry, of agriculture
and of other industries caught in crisis. We must examine
whether our policies are in the best interests of the United
States. We need to look at executive branch policies, as well
as legislative branch policies, and we have some work to do
there.
I appreciate your answer, Mr. Lubick. I probably would be
better off sticking back with the Agriculture Committee myself
at this stage, but the oil and gas industry is awfully
important to my district, to my State, and, I believe, to the
Nation. And I really believe that, as you say, if there are
more efficient ways to deal with the oil crisis, I hope that we
will pursue them will all haste before we pay a very dear
price.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you.
Mr. Lucas.
Mr. Lucas. Thank you, Mr. Chairman, and I appreciate the
indulgence of you and the Ranking Member to participate in this
hearing.
I guess I really have one question for the Secretary. Last
year, the administration signed a bill that provided a net
operating loss carryback period for agriculture, a very
meritorious action in an industry that is under stress and
deserves--in this budget, I understand, they proposed the same
or similar type of net operating loss carryback period for the
steel industry.
I suppose my question is this, If the administration signed
a bill that provided this kind of language for one industry
that deserved it and was under duress, has proposed it for
another industry that is also under duress, why do we not see
the same kind of proposal for the oil and gas industry which is
under just as much strain as both agriculture and steel?
Mr. Lubick. Congressman, we think the steel situation was a
somewhat different situation because of the great danger of
dumping, and that is why we recommended, somewhat reluctantly,
this net operating loss carryback provision in the steel area.
Now, the problem in replicating that in other industries is
that it would benefit only those producers or companies that
can use net-operating losses more rapidly if carried back an
extra 3 years. Again, that tends to be firms that only recently
have become unprofitable, or firms that expect to face serious
losses in the near future but are currently or are recently
profitable. It seems to us that the data we have examined--and
we are continuing to try and analyze cases in this industry,
unfortunately we haven't had sufficient time to compile all of
the economic data that we need, but the data for which we have
information indicates that the stock of unused net-operating
loss carryovers is concentrated in corporations without income
in 1996, which was the highest oil price year after 1990. It
seems unlikely that those that are most seriously affected by
the low oil prices are unlikely to be helped in any significant
way by an extension of the carryback period.
Now, just 2 years ago in this Subcommittee, you made a
decision, with our recommendation, that the carryback period be
shortened from 3 years to 2 years. If we start responding in
every situation without regard to whether there is going to be
a serious, significant benefit from it, it seems to me we do
violence to the complexity that we were trying to avoid in the
restructuring act recently by setting up a series of
industries, each receiving its own, separate carryback period.
Again, I think this would help so few firms that it is not
going to provide any significant solution to the problem we are
facing.
Mr. Lucas. But, Mr. Secretary, if we go back to the basic
premise, which I think is appropriate in the steel industry,
that there is predatory dumping going on, that there are
countries out there systematically trying to disrupt and
destroy our steel production industry, a very strong case can
be made that that is going on in the energy exporting business.
There are countries out there moving crude oil in volumes that
they know will destroy the domestic production in this industry
in this country. Thereby, ultimately this enables them to
totally dominate the market here. That is the same basic
premise. And it is a technique that the Federal Government went
after at the turn of the century in a particularly large
national oil company now being practiced against us.
I look forward to the next round, Mr. Chairman.
Chairman Houghton. Thanks.
Mr. Lubick. I am not aware it is a dumping problem. My
understanding, not based on my knowledge, but in talking to the
Department of Energy, is that in most foreign producers, the
world price is far above their costs of the extractions, so
they are not dumping oil below their costs. There are so many
producers in a worldwide competitive market that it is market
forces that are determining the price. But if there is evidence
of that that is brought forward, well, then, I think that we
would have to take another look at it.
Chairman Houghton. Mr. McCrery.
Mr. McCrery. Thank you, Mr. Chairman, and I want to thank
the Chairman of the Oversight Subcommittee for having this
hearing today, particularly for someone coming from New York
which is basically a consuming State. I want to thank you for
having the foresight to call this hearing and to focus
attention on what I think is a real crisis in this country.
Mr. Stenholm talked about this becoming a national security
issue. I agree with him 100 percent. And Mr. Lucas expounded on
that by carrying through the logic of what is happening. If
foreign producers continue to gain market share and eventually
render useless our domestic production capabilities, then we
are at the mercy, from a security standpoint, of foreign
countries. I hope that that is not desirable for this
administration.
I know that you are not responsible for the whole budget,
but do you know of anything in the President's budget that
provides relief for the oil and gas industry?
Mr. Lubick. Well, Mr. McCrery, I already cited the two
things: One, the Interior announcement, and the other the
research for more efficient technologies to lower the costs.
The Department of Energy has recently announced plans to add 28
million barrels to the Strategic Petroleum Reserve. And, again,
has requested $838 million for energy conservation grants to
improve energy efficiency which is a problem, as you cite, of
energy security.
Mr. McCrery. Frankly, we need people to use more energy,
not less. We don't need to be much more efficient, or the price
will go through the floor.
But I appreciate those items in the budget, and while they
are positive, I would submit that they are negligible. It
doesn't do someone much good to shut down for 2 years if they
are not making any money.
And, Mr. Lubick, I have heard you give criticisms of Mr.
Watkins' proposals for marginal wells tax credit and reasons
why you can't apply the net-operating loss provision that you
put in your budget for the steel industry to the oil and gas
industry, and it reminds me of the Titanic. And if you had been
on the deck of the Titanic in charge of the lifeboats, I think
that you might have said, ``Well, gosh, most of the people out
there are dead already, so let's don't throw out the lifeboats,
that is a waste of energy.'' Come on, now. Do you want to wait
until not 75 percent, but 100 percent of independent producers
are out of business? Let's get real here. What we want to do is
try to throw some lifelines out there to help those that are
still in business and have a hope of remaining in business to
get through this. But if we just say, ``Oh well, most of them
aren't making a profit anyway, so let's don't do anything.''
Well, pretty soon none of them will be making a profit, and we
will surrender even more market share to foreign producers.
I would urge you to reconsider your rationale for not
supporting any tax credits or any other tax measures to help
the oil and gas industry. There are a few people out there
still making a profit, although they are getting fewer and
fewer. So, we need to help those folks to try and maintain
their businesses for just a few more months, we hope maybe a
couple of years, until prices recover.
Do you get the analogy there?
Mr. Lubick. I guess I would rather see if I can't steer the
boat to avoid the iceberg rather than toss one lifeboat out.
Mr. McCrery. Well, by the time you do that, Mr. Lubick, you
are going to have so many more people drowning. You are going
to have them freezing to death out in the ice water. You don't
have time to do that. Throw them a lifeboat. It doesn't take
that much effort. And if what you say is true, it won't cost us
that much money.
Mr. Lubick. The basic problem is that the Code has gone
almost as far as it can go, and each marginal tax reduction is,
as you point out, probably--I don't have a revenue estimate on
this, as yet, but it probably is not very high. But that means
it is not going to help very many people, and, generally
speaking, we already had a problem of tax sheltering in this
industry where the benefits were flowing not to the people in
the oil patch, but to others. And it seems to us that, given
absolute recognition to the seriousness of the problem--and I
don't want anyone to think that we don't recognize the
seriousness of the problem and recognize the seriousness of the
distress that it has caused here--it seems to me it is time to
give some thought, perhaps as Mr. Stenholm suggests, to ways
that will address the real problem.
Mr. McCrery. Well, I would appreciate that, too, but we
would also appreciate your reducing or eliminating your
opposition to some of these small, minor things in the Tax Code
that we could do to help.
Chairman Houghton. All right, thanks very much.
Mr. Watkins.
Mr. Watkins. Thank you, Mr. Chairman, for letting me have a
second round.
Mr. Lubick, some things from the bank of knowledge or being
around here--I know that you were here 20 years ago and that
administration--you were a part of advocating the windfall
profit tax when it was going the other way. And I think that it
is a sure place that you can repent a little bit today, and if
you try to work with us and try to plug the hemorrhaging that
is going on out there. You say you are not gleeful and that you
share pain, but I don't know if you have ever been broke or if
you have ever seen people who are going bankrupt, that is going
to be very costly also.
Let me say, concerning some of your suggestion, I made a
couple of notes. We have thousands of small, independent
producers that are not corporations. You said that for
corporate firms, 75 percent would not benefit. There are a lot
of them out there. And let me also say, we are going to hear
from a person, a lady, later on, a royalty owner, a mineral
owner, and there are hundreds of thousands of them that their
several hundreds of dollars of checks have been cut in half or
down to about one-third of what they--so, we are not talking
about the major Exxons and British Petroleums and all of those,
who, by the way, have overrides in a lot of foreign countries
that are receiving revenue from what is happening in other
countries at really the expense of the small, independent
producers. I think it is something we might have to address--we
were talking to about it with Congressman Stenholm and all.
But I want to mention that about the individual tax, a lot
of them out there have--also, under the current tax law, it is
appropriate that you have a tax credit in the secondary and
tertiary methods of recovery, yet the Internal Revenue Service
has refused to apply this in the secondary methods, such as
water flooding, as approved tax credits under the enhanced oil
recovery. Why is that? Can you give me a short answer to that,
because I have a couple of other things.
Mr. Lubick. I am not familiar with the Service's action on
that, Mr. Watkins. I will be glad to look into it and see if I
can't find out what the Service has done.
As far as the enhanced oil recovery credit, the language of
the statute applies to a specified tertiary recovery method.
Mr. Watkins. And, true, it should, but they are not
applying it to water flooding projects out there, and it should
be. It should be allowed there. I just want to ask you, if you
don't mind, to provide us with an answer as to why this is not
done. It should be done. If you can make the decision to make
that, you would.
Mr. Lubick. Let us communicate with you on that.
Mr. Watkins. I would appreciate that.
[The following was subsequently received:]
Section 43 of the Internal Revenue Code (the ``Code'')
provides a 15% credit for certain costs associated with
qualified enhanced oil recovery projects. ``Qualified enhanced
oil recovery projects'' are defined, in part, as projects
involving the application of one or more tertiary recovery
methods defined in section 193(b)(3) of the Code. Section
193(b)(3) defines ``tertiary recovery method'' to include the
methods described in subparagraphs (1) through (9) of section
212.78(c) of the June 1979 energy regulations (as defined by
section 4996(b)(8)(C) as in effect before repeal)--which do not
include waterflooding--as well as immiscible non-hydrocarbon
gas displacement. Treasury Regulation Sec. 1.43-2(e)(3)(i)
specifically provides that waterflooding is not a qualified
recovery method for purposes of the enhanced oil recovery
credit.
When Congress enacted the enhanced oil recovery credit in
1990, it was very specific as to the types of recovery methods
that were intended to qualify for the credit:
Nine tertiary recovery methods were listed in the June 1979
Department of Energy Regulations (section 212.78(c)). The
conferees intend that a project employing one of these listed
methods generally be considered a qualified enhanced oil
recovery project. In addition, for purposes of the enhanced oil
recovery credit, immiscible non-hydrocarbon gas displacement
generally is considered a qualifying tertiary recovery methoda.
The Secretary of the Treasury is granted the authority to
clarify the scope and parameter of the listed tertiary methods
for application of the enhanced oil recovery credit (e.g., the
Secretary may re-examine the use of polymer augmented water
flooding and may distinguish situations in which this method is
appropriately treated as a tertiary recovery method from
situations in which it is not). In addition, the Secretary is
given discretion to add to the list of qualifying methods to
take into account advances in enhanced oil recovery technology.
H.R. Conf. Rep. No. 964, 101st Cong., 2d Sess. 124-25
(1990) (emphasis added).
Waterflooding was and is widely understood in the industry
to be a--in fact the only--secondary recovery method. Tertiary
methods typically are used only after waterflooding already has
occurred. In light of Congress' specificity about which methods
qualified for the credit, its repeated references to tertiary
methods, and its understanding that waterflooding was a
secondary recovery method, it was reasonable to conclude that
Congress did not intend for waterflooding to be eligible for
the credit, and the regulations were drafted accordingly in
1992. If Congress now wishes a different result, a legislative
change is necessary. However, we believe that expansion of the
credit to waterflooding, a commonly employed method of oil
recovery, would be inappropriate.
Mr. Watkins. I saw that the Chairman raised the gavel, and
I don't want him to use it on me, so I think that I better
yield to my Chairman.
Chairman Houghton. I just have one quick question, and I
thank you very much for your time, Mr. Secretary.
Let me just make clear that clearly there are remedies
here. They may not be tax remedies. They may be trade remedies
such as section 201. There may be subsidy remedies.
However, let me understand what you are saying that in
terms of carryback provisions, in terms of completion
allowances, in terms of accelerated depreciation, or what have
you--what you are saying, and from what I understand, correct
me if I am wrong, is that for those people who we are talking
about, the small, independent gas and oil producers, that there
is no significant tax remedy. Is that what you are saying?
Mr. Lubick. I am saying that so far, we haven't identified
on, Mr. Chairman. I think that is correct.
Chairman Houghton. All right.
Mr. McDermott, did you have anything you wanted to ask?
Mr. Lubick. And I emphasize significant and efficient.
Chairman Houghton. To have an impact on the state of the
industry.
Mr. Lubick. Yes, that is exactly right.
Chairman Houghton. Do you have anything?
Mr. McDermott. I would like to ask a question.
Chairman Houghton. Yes, go ahead.
Mr. McDermott. I confess that I don't understand everything
about the free enterprise system. And I don't understand why
oil prices are as low as they are today. Some people say that
this is going to last for some period of time. Is that true?
Please explain to me what is going on. I am buying gas at 99
cents per gallon which is about where it was when I was in high
school----
Mr. Lubick. I bet it is less.
Mr. McDermott. Probably. I remember 20 cents a gallon, so I
figure it is somewhere in there.
What is happening?
Mr. Lubick. Well, I stated earlier, Mr. McDermott, that we
have had a confluence of weakened demand and excessive supply.
Weakened demand, in part, because of Asia, in part because of
weather for a couple of years. And coupled with that, you have
had international production, with which you are doubtless
familiar--the Department of Energy, of course, is in a better
position to prognosticate prices than I am. The next panel will
include a witness from the part of the Department of Energy
that deals with the statistics of prices, and I think that that
question should be addressed to them as well.
But it is my understanding that we are probably at the
bottom of the trough and that the forecast is perhaps for price
increases to commence relatively soon at the rate of about 6
percent per year.
But, again, that is not my bag to predict oil prices.
Mr. McDermott. Well, the reason I ask the question is that
I was in Sicily at Christmas time where gasoline was $4 a
gallon. What is the difference in the way that Italy taxes gas
and the way we tax it?
Mr. Lubick. In where?
Mr. McDermott. Sicily. Italy.
Mr. Lubick. Italy. Well, I lived in France for a couple of
years before coming back here where it was $4 a gallon. But
that is all taxes. The world price is the world price, and they
buy oil at the same prices that we buy oil. They impose very,
very heavy, heavy taxes on gasoline as do most countries in the
world, other than places like Saudi Arabia and the United
States, and so forth.
Mr. McDermott. There is no real reason why we couldn't have
a carpet tax to deal with the deficit or to deal with trying to
get people to change their behavior with respect to global
warming and a few other things?
Mr. Lubick. Well, I think there are at least 218 reasons in
this body, 51 in the other.
Mr. McDermott. But there is no economic reason why we
couldn't?
Mr. Lubick. Well, one could put a tax on most anything, I
guess.
Mr. McDermott. Well, I find this whole business of us
trying to prop up the oil industry when they like the free-
enterprise system on the way up, but when it gets tough, we
have people coming in here saying that we have to save them.
And I am not sure what our responsibility is for doing that.
What do we lose?
Mr. Lubick. You are getting into questions of philosophy. I
think this is getting to be personal now--I think that is maybe
not relevant to anything, but the government does have a
function to aid those of its citizens for whom the market works
harshly. I think that we apply that in a lot of areas, and I
think that this is an industry where people are suffering from
dislocations, and I think the Secretary testified at the
original hearing here that we have to deal in an efficient way
with dislocations caused by these economic changes.
But beyond that, there is a national security element to
maintaining a domestic oil industry. I think you probably
remember when you were at the mercy of OPEC in the
midseventies. It caused a very severe dislocation to our
economy.
Mr. McDermott. Only for a short time. We modified things
and then things got better----
Mr. Lubick. But it was quite painful at the time in many
parts of the country. I think that there is a case that we want
to both protect this industry which has been historically
important to this country and beyond that, the people that are
in a very painful, distressed situation just as we are
concerned with the steel workers, and we have been concerned
with textile workers--I started out here in 1961 when we had
some very severe problems there. I just don't think it has been
our general practice to say, ``Well, let everybody fend for
themselves.'' There are difficulties, and I think there is a
basis for at least, if there are to be dislocations, providing
some help that can't be done----
Mr. McDermott. Is there any difference between oil and
steel policy?
Chairman Houghton. The gentleman's time is pretty close to
up.
Mr. McDermott. Is there any difference between oil and
steel in this regard?
Mr. Lubick. Well, I think that there are, as we indicated,
some differences in the steel situation because we have some
indications that there is significant dumping from abroad, and
I think that question has been raised as to whether that exists
in oil. To my knowledge, I don't believe that it has. There may
be some difference, but I don't know that there is a difference
in the distress felt by the individual steel worker and the
individual oil worker.
Chairman Houghton. OK, well thanks very much, Mr.
McDermott.
Mr. Secretary, as you can see here, we are obviously trying
to get the facts here, but also we are trying to save an
industry, an industry that has permitted us to do things that
no other country in this world, other than the oil-producing
nations, can do. If you can help think through the Tax Code,
along with our other deliberations in terms of trade remedies,
we would certainly appreciate it.
Thanks very much for being with us.
Mr. Lubick. Thank you, Mr. Chairman and Members.
Chairman Houghton. OK, now we are going to have the first
panel. Jay Hakes, Administrator of the Energy Information
Administration, U.S. Department of Energy; and also Constantine
Fliakos, managing director of the fundamental Equity Research,
International Oils, Securities Research Division of Merrill
Lynch.
OK, are you all ready? Mr. Hakes, we would like to have
your testimony.
Thanks very much for being with us.
STATEMENT OF HON. JAY HAKES, ADMINISTRATOR, ENERGY INFORMATION
ADMINISTRATION, U.S. DEPARTMENT OF ENERGY
Mr. Hakes. Mr. Chairman and Members of the Subcommittee, in
the time allotted, I would like to present the views of the
EIA, Energy Information Administration, on how oil prices got
so low, what the major impacts of the decline have been, what
the prospects appear to be in the coming year.
As of EIA's most recent report on Monday, retail prices for
regular gasoline now average about 91 cents a gallon. Figure 1
shows the historical significance of low prices in annual
averages through 1998, but today's prices are even lower than
last year's average. When controlled for inflation, current
gasoline prices are the cheapest in official records and
probably the cheapest ever.
Prices of all petroleum products have fallen as a result of
a 55-percent decline in crude oil prices since December 1996.
The fall in crude oil prices, which can be seen in figure 2 of
my testimony, has been gradual, but the prices have dropped
very substantially and stayed low longer than previous price
collapses in 1986 or in 1993.
The decline in world oil prices has been associated with
the buildup in world oil inventories. Figure 4 in my testimony
shows the stock build for the world's major economies. The
level of world inventories is slowing substantially, a return
to more normal price levels. The EIA is currently projecting
moderate increases in oil prices in 1999, but not back to the
historic range.
The reasons for excess supply and low prices seem
relatively clear. First, the return of Iraq to world oil
markets in January 1997 boosted supplies substantially. Iraqi
petroleum production increased from 0.7 million barrels per day
in the fourth quarter of 1996 to 2.5 million barrels a day in
the fourth quarter of 1998.
Second, other increases of world supply, OPEC and non-OPEC,
had occurred earlier in this period of price decline and
further increased world supplies.
Third, the economic collapse in Asia stopped the rapid
growth in oil demand that many suppliers had hoped would soak
up the increase in supplies. From 1990 to 1997, Asian oil
demand grew by an average of 800,000 barrels per day each year.
But in 1998, demand actually declined by about 70,000 barrels
per day, and it is not expected to reach precrisis growth until
sometime after the year 2000.
Fourth, as was mentioned previously, consecutive mild
winters reduced the need for heating oil in North America and
Europe.
Worldwide imbalances between supply and demand and
depressed prices have had several major impacts. Some can be
seen as positive for the economy, and many as negative. For
instance, inflation has been restrained by low-energy prices. A
large 7.7-percent decline in the energy category of the
consumer price index in 1998 reduced the overall index by 0.7
percent from what it would have been without the energy price
decline. In other words, instead of inflation being about 2.3
percent in 1998, we saw an increase of only 1.6 percent.
Another impact has been a steep drop in U.S. production, as
seen in figure 5. A decline in domestic production seemed to
have finally stopped in 1995 and production remained fairly
flat in 1997. The apparent stabilization was the product of
technology-driven cost reductions, developments in the Gulf of
Mexico, and the relatively higher prices in 1996 and early
1997. But the recent price declines are taking their toll on
production once again. Preliminary EIA data suggests that the
decline in production, like the drop in prices, began in
earnest during the second quarter of last year. By December
1998, production had fallen by about 500,000 barrels per day
lower than it was 1 year earlier, despite an increase in
production in the Gulf of Mexico.
As exploration and development slowed, U.S. onshore areas
see the effects first since U.S. offshore drilling projects are
much longer duration and, therefore, trail off more slowly.
Production shut-ins are more likely onshore as well, since this
area contains more marginal wells with high lifting costs such
as those associated with enhanced oil recovery, heavy oil
production, and smaller volume wells.
Since independent producers account for the majority of the
lower 48 onshore production, they are likely to bear a larger
portion of U.S. production decline than the major oil
companies. Import dependence would rise even with stable
domestic production given the steady rise in U.S. oil
consumption. But the drop in domestic production is pushing
imports even higher.
The oil business is cyclical, and today's low oil prices
are planting the seeds of later price increases. But world oil
stocks and uncertain world demand lead us to believe that the
bounce back will be slower than in previous periods of decline.
That concludes my testimony, Mr. Chairman, and I will be
glad to answer any questions.
[The prepared statement follows:]
Statement of Hon. Jay Hakes, Administrator, Energy Information
Administration, U.S. Department of Energy
Crude Oil Prices
I wish to thank the Committee for the opportunity to
testify today on the state of the petroleum industry, which is
experiencing unusually low crude oil prices. As Administrator
for the Energy Information Administration (EIA), which is an
independent analytical and statistical agency within the
Department of Energy, I have been asked to focus on what is
behind the low prices, and on some of the effects we are
already seeing in the United States--both good and bad.
For example, inflation has benefited from low energy
prices. Declining energy prices, particularly in the oil
sector, have been a significant factor contributing to the low
inflation rate during the past several years. Inflation can be
measured from changes in the Consumer Price Index (CPI), which
is calculated from data representing a wide variety of goods
and services across the nation. As of December 1997, ``Energy''
was calculated to represent approximately 7 percent of the
overall CPI. Energy prices rose less than other prices in 1994
and 1995, reducing the inflation rate by about 0.2 percent. In
1996, when energy prices increased substantially, they boosted
the inflation rate by about 0.2 percent, but when energy prices
began to weaken during 1997, they lowered the rate by 0.2
percent. But a large 7.7 percent decline in the energy category
of the CPI in 1998 reduced the overall index 0.7 percent from
what it would have been without the energy price decline. Thus,
instead of inflation being about 2.3 percent in 1998, we only
saw about a 1.6-percent increase.
Gasoline Prices Lowest Ever (Figure 1)
Today, the cheapest liquid you can buy at a service station
is gasoline. Figure 1 shows that in 1998, consumers enjoyed the
lowest gasoline prices in inflation-adjusted terms since at
least 1942, and possibly the lowest ever. Regular gasoline
prices averaged only $1.03 in 1998, but this obscures the fall
off at the end of the year. In November and December gasoline
prices averaged less than $1.00 per gallon ($0.995 and $0.945
per gallon respectively), and the latest weekly Energy
Information Administration (EIA) data shows them at $0.907.
This is about $1.36 per gallon less than we paid in 1981 in
inflation-adjusted terms, and $0.40 cheaper in nominal terms.
That 30-cent-per gallon gasoline that some people may recall
buying in the 1950's and 60's is equivalent to about $1.50 in
today's dollars. Or put differently, gasoline prices in 1998
were about 35 percent lower than those of the 1950's, adjusted
for inflation.
[GRAPHIC] [TIFF OMITTED] T6935.001
All petroleum products have fallen in price as a result of
a 55-percent decline in crude oil prices since December 1996
(West Texas Intermediate monthly averages). Crude oil is the
raw material from which gasoline is made, and in 1998,
represented about 30 percent of the retail price of gasoline.
Taxes (federal and state) on average represented over 35
percent; although, taxes vary significantly from state to state
and even among localities within states. The remaining one-
third of the price represents refining, marketing, distribution
costs and profit margins. When petroleum product prices move as
much as they have recently, it is primarily due to changes in
crude oil prices.
Low Crude Oil Prices Not Likely to Rebound Soon (Figure 2)
Figure 2 provides a perspective on the recent decline in
crude oil prices relative to other recent declines and
increases. Monthly average crude oil prices fell about 55
percent ($14 per barrel) from about $25 per barrel in late 1996
to just over $11 in December 1998. The West Texas Intermediate
(WTI) crude oil price shown in Figure 2 is not what all
producers receive for their crude oil. Heavier crude oils
normally sell at a discount. EIA data are showing many
transactions for low quality crude oils at less than $6 per
barrel.
[GRAPHIC] [TIFF OMITTED] T6935.002
The decrease in price since 1996 occurred in two steps. The
first $5-6 per barrel drop represented a retreat from unusually
high prices at the end of 1996 before Iraqi crude oil returned
to global markets. By spring 1997, prices settled briefly into
the typical historical trading range of $17-$21 that has
existed since 1986 (excluding the Gulf War). The second $8-9
decline began at the end of 1997 with the drop in demand caused
by the Asian financial crisis, and continued through 1998 as
Iraqi production increased even more after UN Security Council
limits were raised. Annual average refiners' crude oil prices
have not been this low in real terms since 1972, and in nominal
terms since 1978.
The current decrease approaches the size of the drop in
prices experienced in early 1986, but there are differences in
the factors driving the decline. At the end of 1985, Saudi
Arabia was no longer willing to be the major swing producer,
reducing its production to balance worldwide markets as demand
declined in the early 1980's and non-OPEC \1\ production
increased. Saudi Arabia therefore announced a new pricing
regime and increased production. In the four months from
November 1985 through March 1986, prices plunged about 60
percent (over $18 per barrel) from almost $31 to about $12.50.
In contrast, the current $14 per barrel decline occurred over
24 months. In 1986, prices didn't bottom out until July when
they averaged $11.60; however, they rebounded fairly quickly
and settled into a $17-$21 trading range by January 1987. A
quick rebound may not occur in the current situation. EIA
projects WTI oil prices reaching $15/barrel by the end of 1999,
but they may not return to the historical $17-$21 trading range
before 2001. I will explain shortly why the recovery could take
some time.
---------------------------------------------------------------------------
\1\ OECD--Organization for Economic Cooperation and Development
---------------------------------------------------------------------------
The 1986 price drop marked the transition from a world
dominated by long-term contracts and official prices to one
driven by spot and futures trading and of supply (production)
and demand imbalances driving immediate price responses. We now
see crude oil supply and demand moving in cycles like other
commodities--shifting from too little supply to too much
relative to demand, with prices reflecting the changes. Figure
2 shows the shift from a weak price market in 1993, to a
strengthening one through 1996, ending with our current weak-
market cycle.
World Supply/Demand Imbalance Behind Current Low Prices (Figure 3)
This cyclic effect is demonstrated more directly in Figure
3, which shows quarterly world petroleum production (in gray
shading) and world demand (the dotted line). Normally world
petroleum demand is seasonal--being higher than production in
winter when heating needs increase, and lower than production
in summer. As a result, petroleum stocks normally build in
summer and are then drawn down in winter (black areas) when
demand exceeds production, as seen in 1994-1996.
[GRAPHIC] [TIFF OMITTED] T6935.003
As with other commodities, longer-term supply/demand cycles
are overlaid onto this seasonal pattern. When production
exceeds demand for petroleum worldwide for a year or more,
prices weaken. Since early 1997, we see little or no seasonal
stock draws, mostly stock builds, a pattern that is due to both
supply and demand factors. We had a similar pattern in 1993
when the lingering effects of the 1991 world recession and the
collapse of the former Soviet Union's economy, coupled with a
warm winter, kept demand below supply all year. During that
period, crude oil prices also fell, but only about $7 per
barrel. That weak cycle ended when increased demand from a cold
first quarter and renewed economic growth removed the surplus
supply. The current market imbalance is larger than that in
1993, as shown on the next chart.
Stocks Reflect the Supply/Demand Imbalance (Figure 4)
The present oversupply cycle has resulted in an unusually
long interval of building stocks. OECD \2\ country stocks are
now at very high levels, as seen in Figure 4. OECD stocks
generally follow the seasonal patterns just discussed. But this
chart shows very small winter inventory reductions during the
last two years. There are mainly four reasons behind the
oversupply and weak prices:
---------------------------------------------------------------------------
\2\ OECD--Organization for Economic Cooperation and Development
[GRAPHIC] [TIFF OMITTED] T6935.004
the return of Iraq to oil markets in January 1997,
without OPEC or other producers reducing production to make
room for the extra supply (Iraqi petroleum production increased
from 0.7 million barrels per day in the 4th quarter 1996, to
1.3 million in 4th quarter 1997, to 2.5 million barrels per day
in 4th quarter 1998.
----------------------------------------------------------------------------------------------------------------
1996 1997 1998
----------------------------------------------------------------------------------------------------------------
Qrtr 4 Qrtr 1 Qrtr 2 Qrtr 3 Qrtr 4 Qrtr 1 Qrtr 2 Qrtr 3 Qrtr 4
----------------------------------------------------------------------------------------------------------------
0.7 1.1 1.1 1.3 1.3 1.6 2.1 2.5 2.5
----------------------------------------------------------------------------------------------------------------
Source: Energy information Administration, 1996-3rd Quarter 1998, Monthly Energy Review, Table 10.1, 4th
Quarter, EIA estimate.
the economic collapse and reduction in demand from
Asia (From 1990 through 1997, Asian oil demand (including China
and Japan) grew by an average of 800,000 barrels per day each
year, but in 1998, this region's demand actually declined by
about 70,000 barrels per day, and is not expected to reach pre-
crisis growth until sometime after the year 2000.);
two warm winters worldwide in a row; and
non-OPEC supply growth and other OPEC supply
growth on top of Iraq (OPEC petroleum production excluding Iraq
is estimated to have increased by over 0.5 million barrels per
day since 1996, in spite of agreed-upon production cuts, on top
of Iraq's 1.6 million barrel per day increase, while non-OPEC
production increased by 1.1 million barrels per day.).
Until the large stock overhang is eliminated, prices are
not likely to return to the historical $17-$21 trading range.
We may be seeing recent signs of both a more normal seasonal
demand-supply cycle and the beginning of a reduction in the
surplus inventories, but the EIA sees that erosion occurring
slowly and projects that prices may not return to the
historical trading range before 2001. But keep in mind that any
re-balancing of production and demand that removes excess
inventories depends on the four highly uncertain factors just
discussed. EIA's high and low price ranges encompass credible
scenarios that could result in a more rapid return to higher
prices, or an even weaker market.
Low Oil Prices Reduce Production and Increase Imports (Figure 5).
Low oil prices stimulate higher demand growth and a steeper
U.S. production decline. Imports must increase to meet both
higher consumption and the loss of higher cost domestic
production. Figure 5 shows that, following the price drop in
1986, U.S. crude oil production declined about 2.5 million
barrels per day or 28 percent, falling from 8.9 million barrels
per day in 1985 to 6.4 million barrels per day in 1997. Alaskan
production accounted for about 0.5 million barrels per day of
that loss. During this same time, imported crude oil grew 5
million barrels per day (from 3.2 million barrels per day in
1985 to 8.2 in 1997) to replace the lost production and to meet
growing petroleum demand. The decline in domestic production
seemed to have finally stopped in 1995 and remained fairly flat
through 1997. The apparent stabilizing was the result of
technology-driven cost reductions, developments in the Gulf of
Mexico, and relatively higher prices in 1996 and early 1997.
[GRAPHIC] [TIFF OMITTED] T6935.005
But the recent price declines are taking their toll on
production once again. Preliminary EIA data suggest that, while
first quarter production was relatively flat, a steep decline
began in the second quarter. By December 1998, production had
fallen about 500 thousand barrels per day from year-ago levels,
despite an increase in production in the Gulf of Mexico. If
prices recover only slowly as shown in our current base case
forecast, the cumulative loss in production between 1997 and
2001 would be another three-quarters to 1 million barrels per
day, on top of the 2.5-million-barrel decline we have seen
between 1985 and 1997. Under these circumstances, imports would
increase at least another 1 million barrels per day over the 5-
million-barrel-per-day increase that occurred between 1985 and
1997.
We see the industry responding in a number of areas. From
December 1997 through December 1998, operating oil rigs have
fallen 57 percent and gas rigs 24 percent. Exploration and
production expenditures are also falling. According to Salomon
Smith Barney's expenditure survey, total U.S. exploration and
production expenditures planned for 1999 are 21 percent below
1998 expenditures, following a 0.2 percent decline in 1998.
Production exhibits inertia, responding slowly to oil price
changes. Price declines tend to retard exploration and
development plans to a greater extent than current production;
although, marginal wells begin to be shut in as prices decline.
Generally, significant production changes lag large price
changes, which is why aggregate production only began to show
substantial declines in the second half of 1998.
As exploration and development slow, U.S. lower 48 onshore
areas see the effects first, since U.S. offshore and frontier
area drilling projects are of much longer duration and
therefore trail off more slowly. However, low oil prices have
even delayed projects on the Alaskan North Slope that earlier
had been expected to stabilize or increase production there.
Additionally, U.S. onshore (lower 48 onshore) activities
contain more small firms that have fewer resources to continue
operating during a price downturn. Production shut-ins are more
likely in the lower 48 onshore as well, since this area
contains more marginal wells with high lifting costs, such as
those associated with enhanced recovery, heavy oil production,
and small volume wells. Since independent producers account for
the majority of lower 48 onshore production (almost 60 percent
in 1997), they are likely to bear a larger portion of the U.S.
production decline than the major oil companies.
In conclusion, oil prices may not return to the $17-$21
trading range before 2001, but there is much uncertainty in
price forecasts. The factors depressing today's prices are
highly unpredictable. Global demand growth is highly uncertain,
given Asian economic problems and slowing economic activity
elsewhere; future OPEC production behavior is unknown; and the
full impact of today's low prices on non-OPEC production is
also difficult to assess.
Continued low oil prices are good news for consumers and
the general economy. Imports will likely rise with declining
domestic production as the domestic oil industry reduces costs,
increases productivity, or contracts. However, regional
economic impacts, including job losses, business losses, and
reduced severance tax revenues will accompany these production
declines.
This concludes my testimony before the Subcommittee. I
would be glad to answer any questions at this time.
Mr. Watkins [presiding]. Thank you.
The Chairman, Congressman Houghton, went over to cast that
vote and will be returning shortly. So, we will proceed and not
lose any particular time.
I would like to take a personal privilege right fast, if I
could. From the State of Oklahoma, an elected official from the
Corporation Commission, Denise Bodie, used to be the head of
the Independent Petroleum Association of Americas, is in the
audience. And Denise, we are pleased you are hear with us.
All this information, as we look at it--oh, Mr. Fliakos,
would you like to testify at this time?
STATEMENT OF CONSTANTINE D. FLIAKOS, MANAGING DIRECTOR,
FUNDAMENTAL EQUITY RESEARCH, INTERNATIONAL OILS, SECURITIES
RESEARCH DIVISION, MERRILL LYNCH & CO.
Mr. Fliakos. OK. Fine.
I was asked to talk about the causes of the price collapse,
and I don't want to be repetitive. I would just point out that
clearly what we have witnessed for the last several years in
the oil business is a very powerful inventory cycle. Oil is a
commodity. It is susceptible to an inventory cycle. It has been
a pretty powerful one with a lot of extremes.
In 1996, not long ago, inventories were very low, and the
price of oil was over $35 a barrel. And those low levels of
inventories were caused by just-in-time inventory management by
the oil industry. It was caused by the absence of the Iraqi oil
exports. It was caused by a cold winter 2 years ago. Since
then, inventories have recovered to excessive levels because of
the resumption of Iraqi oil, the slowdown in Asia, and two warm
winters. It has been an inventory phenomenon that has caused
the decline in the price of oil.
What I would like to highlight, however, is a very
disconcerting complacency that I see not only in the public, in
the press, but also in the government about the current level
of oil prices. And I say this because I think that in the oil
business, and for that matter, I imagine, in any commodity, we
have to be able to distinguish between price gyrations that are
caused by inventory phenomena, which are temporary, and price
effects that are caused by underlying, secular dynamics which
have a much more lasting influence. I believe the current
complacency is not really justified from a long-term
perspective, and I think that the complacency is, in fact, very
dangerous, not only for our economic well-being in the future,
but also for our national security.
I think that today's situation is dramatically different
than the situation that we had, for example, in the
mideighties, the last time the price of oil collapsed. Back
then, there was a lot of surplus capacity in the world. In
fact, the surplus was nearly 25 percent of the demand. Back
then, the industry was in secular abundance, and the price
collapse was inevitable.
I would point out that following, today, notwithstanding
the inventory glut, there is very little surplus capacity in an
industry which is very susceptible to politically induced
supply interruptions. Even with the cutbacks that OPEC has
implemented, I reckon that the surplus capacity is less than 8
percent of demand, in contrast to the nearly 25-percent surplus
that we had back in the mideighties. This is hardly a
comforting thought in an industry that, as I said before, is so
susceptible to politically induced supply interruptions.
I am convinced that the problem is temporary because the
glut is going to disappear and the demand for oil will begin to
recover--I think with the underlying growth in demand is about
2.5 percent a year once we return to a more normal, economic
environment around the world. We may, in fact, overshoot
because there is likely to be in the meantime a lot of
devastation on the supply side of the equation.
Today's low oil price and the sharply lower capital
spending by the oil industry is going to have a very negative
impact on supplies, and I believe that in the future we are
going to become more and more dependent on OPEC oil, on Middle
Eastern oil, on oil that is politically vulnerable.
In assessing the implications for the future, and in trying
to find solutions to the problem, I think it is important to
keep in mind that there are certain peculiarities and
idiosyncracies in the oil industry. I'll mention two of them.
One peculiarity is the geological fact that most of the
world's oil resources, the low-cost oil resources in
particular, are in politically vulnerable countries. The
economic cost is low, but the political cost is very high. As
we seek an adjustment process, we have to recognize that there
is a divergence between economic costs and political costs in
the oil business.
There is another peculiarity in the oil industry that has
to do with the enormous lead times entailed in developing
projects from the planning process to the implementation and
their ultimate commissioning. It takes a long, long time to
move projects forward.
There is, in other words, a big divergence between the
price of oil in the short term, which is caused by temporary
phenomena, such as weather, and the price in the long run which
should be high enough to ensure that we have adequate supplies
in the future at reasonable prices. We need, therefore, some
adjustment mechanism that will reconcile the discrepancy that
exists between short-term price and long-term price.
And let me point out that the oil industry, like corporate
America in general, is so preoccupied with the near-term
financial performance in response to the demands of the
financial markets that I believe that the pendulum in tilting
against a focus on long-term growth. Therefore, the reaction by
the industry, even those that are financially strong companies
in the industry, is to retrench, to cut down spending, to lower
production, to lower development, and I believe this is going
to have serious, negative implications down the road.
Let me conclude, therefore, by expressing my very strong
feeling that even though today we are enjoying lower prices and
lower oil prices are contributing to the economic well-being of
our Nation and the world, I am afraid that these gains are
being achieved at the expense of a very, very high price that
we may have to pay in the future, unless things improve and
they improve soon.
Thank you very much.
[The prepared statement follows:]
Statement of Constantine D. Fliakos, Managing Director, Fundamental
Equity Research, International Oils, Securities Research Division,
Merill Lynch & Co.
Excessive Inventories Have Been The Cause Of The Oil Price Collapse
Oil, like any other commodity, can exhibit wide inventory swings
influenced by near-term factors including weather, economic conditions,
political developments and miss-judgements by both the oil companies
and governments. We have witnessed a major shift in inventories from
very low levels in 1996 to adequate in 1997 and to excessive levels in
1998. Inventories remain very high today.
The factors that contributed to the low level of inventories in
1996 included just-in-time inventory management by the oil industry;
the absence of Iraqi oil exports; and unusually cold weather during the
winter of 1995/1996.
Following delays throughout 1996, the UN and Iraq finally agreed on
a plan of limited oil sales for humanitarian purposes and oil exports
began in December of 1996. Oil exports from Iraq coincided with a
fairly mild winter throughout the Northern Hemisphere in the winter of
1996/1997. Those factors contributed to the replenishment of
inventories to normal levels at the end of 1997 from very low levels in
the beginning of 1997.
As we headed into 1998, there were clear signs that inventories
would become excessive. And yet OPEC agreed to increase production when
it met in November of 1997 resulting in higher output by Saudi Arabia,
Kuwait and the United Arab Emirates in the beginning of 1998.
In the meantime, the economic slowdown in the Far East and another
unusually mild winter lowered the growth in oil demand substantially in
1998. Iraqi oil exports also expanded in 1998 because of an increase in
the oil-for-food program. All these factors converged to raise
inventories to very high levels in 1998.
The oil price extremes we experienced in the last two and a half
years have been caused by the extreme changes in inventories. Unusually
low inventories in 1996 drove oil prices sharply higher--they reached
more than $26 a barrel in the beginning of 1997. Excessive inventories
caused oil prices to collapse to the low teens in the beginning of
1998--which is where we are today.
The only way the oil price slide could have been reversed within a
relatively short period was to curb oil production. OPEC, in
cooperation with some non-OPEC countries, agreed, in fact, to curtail
production last year and reductions of more than 2.0 million barrels a
day were implemented since the middle of 1998.
The production cuts occurred, however, at a time when market
conditions were deteriorating rapidly. In addition to weakened oil
demand, production and exports rose very substantially in Iraq. The
output restrictions by oil producing countries proved to be inadequate
to reduce excessive inventories.
Complacency Is Unjustified . . . We Should Be Concerned
Despite low oil prices there is considerable complacency
about the outlook. The widespread belief seems to be that oil
supplies will remain abundant, and oil prices will, therefore,
remain weak for a long time.
When oil prices were strong in 1996 and in early 1997, the
inclination was to argue that oil prices would never again fall
to low levels because there was presumably a secular tightness.
Now we are told we are entering a period of secular weakness.
Today's complacency is, in my judgment, unjustified and
dangerous. Unless the current trend is reversed soon, we may be
heading inexorably toward another energy crisis sometime in the
next five years.
The oil situation today is, I believe, quite different than
it was in the mid-1980s--the last time we experienced a major
collapse in oil prices.
Leading up to the price collapse of the mid-1980s, the oil
industry was in a major secular decline. Oil demand was
declining; OPEC's share of total supplies fell sharply; Saudi
Arabia's oil production fell to unsustainably low levels; and
surplus production capacity amounted to nearly 25% of demand
and was clearly excessive. The secular weakness was the main
underlying cause for the 1986 oil price collapse, and the
collapse was unavoidable.
As I indicated earlier, the recent oil price collapse was
caused by excessive inventories rather than by a secular
weakness. The price collapse was, in fact, avoidable.
Despite abundant inventories and very low oil prices, the
underlying conditions in the oil business are much tighter now
than they were in the 1980s--and they are likely to get even
tighter--and should be cause for considerable concern.
Because of growing demand, surplus production capacity
globally has been limited to about 5% of total demand during
most of the 1990s and is now 7-8% of demand despite the
cutbacks that have been implemented by oil producing countries.
This is in contrast to the mid-1980s when surplus capacity, as
I mentioned earlier, amounted to nearly 25% of demand.
Once the economic problems are solved around the world,
global oil demand should begin to grow once again by 2.5% a
year which will be equivalent to about 2.0 million barrels a
day of incremental demand each year.
I expect that supply sources outside of OPEC will be able
to satisfy only a small portion of the projected growth in
demand. In fact, one of the most devastating consequences of
low oil prices will be the very negative impact that they are
likely to have on non-OPEC supplies. Low oil prices has already
led to the shutdown of some high-cost production--and the
shutdown is likely to be permanent. Moreover, sharply low
levels of capital spending will curtail the development of new
supplies as well.
We will have to depend more and more, therefore, on OPEC
supplies in order to satisfy growth demand. But even within
OPEC, capacities may erode because the budgets of producing
countries are strained and not enough money is being spent to
maintain let alone to increase capacities.
The amount of surplus oil capacity is limited and could
become even more limited if oil prices remain low for a while
longer. It is a disquieting phenomenon for a commodity such as
oil that is so susceptible to supply disruptions that can
result from political and social upheaval, as well as
accidents.
Timely Adjustments Are Difficult To Achieve In The Oil Business
Because of the idiosyncrasies of the oil industry, it is
almost impossible to ensure a continuing flow of oil supplies
at reasonable prices by relying exclusively on conventional,
market-related adjustment processes.
An important characteristic of the oil business is the
geological fact that a major portion of the world's low-cost
oil supplies are located in parts of the world that tend to be
politically vulnerable. The ``economic'' cost of those supplies
is indeed low but their ``political'' or ``national security''
cost can be quite high. Any adjustment process must, therefore,
take into account the large discrepancy that can exist between
economic and political costs if resources are to be allocated
optimally from both an economic as well as a political
perspective.
Another important aspect of the oil business is the long
lead-times entailed in the capital investment process--from the
planning of capital prospects to their implementation and their
ultimate commissioning.
Because of the long lead times, supply and demand
adjustments in response to signals given in the marketplace
through the price mechanism are not instantaneous. Adjustments
ultimately do occur, of course, but in the meantime there can
be severe dislocations that may be unacceptable for a commodity
that is so essential for our nation and the world's economic
well being.
Another way to view this dilemma is to point to the
divergence that sometimes exists in the price of oil--as it
does today--from a near-term versus a longer-term perspective.
The near-term price of oil can be depressed, as it is today,
because of the influence of temporary factors. In the longer-
term, the price needs to be high enough to ensure continuing
the availability of supplies at reasonable prices.
The dilemma that stems from a possible divergence between
the price of oil in the short-run and the appropriate price in
the long-run is exacerbated by the changes that have occurred
in the attitudes of the managements of the major oil companies
as they try to be more responsive than they have been in the
past to the near-term demands of the financial markets.
It is fair to say, I believe, that in trying to reconcile
immediate financial performance with longer-term growth
considerations the pendulum has probably tilted in the oil
industry--as is probably the case for ``Corporate America''
generally--in favor of immediate financial performance.
The immediate response to lower oil prices, therefore,
tends to be to retrench, to restructure and to curtail capital
spending in order to protect profits. For some companies, of
course, particularly the smaller ones, retrenchment is a
necessity dictated by cash flow considerations and by the need
to survive financially.
The inevitable consequence of such retrenchment is lower
future growth--and in the oil business, in particular, it means
lower oil supplies in the future.
If oil prices were to recover, the industry will no doubt
accelerate capital spending and will focus on growth once
again. But the adjustment is likely to be slow. And in the
meantime, the consequences for our nation and the world could
be quite severe because we are so dependent on supplies that
are susceptible to politically induced supply interruptions.
Today's low oil prices are no doubt contributing to today's
unprecedented economic prosperity by keeping inflation low.
Unfortunately, however, we may have to pay a high price in the
future for the benefits we are enjoying today.
Chairman Houghton [presiding]. Would you like to ask a
question, Mr. Watkins? Are you going to vote?
Mr. Watkins. Mr. Chairman, in order to indicate the
significance and the problems of this entire problem, I am
going to miss this vote because I am going to be here with you.
And I appreciate you having these hearings, and I appreciate
everyone being here. I am going to stay here and miss that
vote. I would like to ask some questions.
I wanted to try to follow up on--you indicated that we have
about 8 percent surplus, if I understood correctly here. And
that was compared to 25 percent surplus back in 1985. So our
little margin of difference today is by far a whole lot less.
With any interruption around the world, we could be in a very
undesirable spot as far as the Nation goes, but a situation
that could really be a catastrophic problem, to say the least,
for our country. Is that the interpretation I have received? Is
that correct?
Mr. Fliakos. That's very much the point I was trying to
make, and, also, I think we should bear in mind that this
surplus can very easily dissipate if you consider that the
demand for oil under normal circumstances--if the world returns
to normality, if the problems in the Far East are resolved--the
world can grow at 2 million barrels a day every year.
And in the meantime, because of lower oil prices,
capacities which we thought a few years ago were going to rise,
capacities to produce oil may not rise because of lower oil
prices. In this country, capacities are eroding for economic
reasons. But the producing governments within OPEC, because of
budgeting constraints, they are not expanding capacity either.
The 8-percent surplus that I talked about could become even
less down the road, so any politically induced supply
interruption could have a devastating effect.
I am actually amazed that we have forgotten that in the
last 25 years we have had several major supply shocks at times
when capacities were greater. We had the Arab embargo of 1973.
We had the Iranian revolution in 1979. We had the Iran-Iraq war
in 1980 and beyond. We had Iraq's invasion of Kuwait in 1990.
These were supply shocks that caused a sharp rise in oil
prices.
And even today, as we look around the world, we can see the
potential for social upheaval in Nigeria. There are potential
problems in other oil producing countries such as in Indonesia,
and many other trouble spots could surface. We cannot be
complacent.
Mr. Watkins. It seems like the administration's policy, or
lack of a policy, has forced us to become more dependent on all
of these foreign sources. It is not just a free situation. It
is forcing us to move in that direction. Chairman Greenspan was
sitting there at the panel, and I asked the question about the
fact of what is the benchmark to cap the levels that we are not
going to be penalized when--the oil patch is not going to be
penalized later on when prices are going up because, you are
right, the economy, the overall major economic climate that we
are in today is largely the result--and I've said we should
thank the energy industry because the lower the oil prices the
less inflation--or the less likelihood that any inflation is,
so Chairman Greenspan can make a decision on whether to keep
interest rates low or to do different things. It is the price
that we are paying in oil patch.
I wish that my colleague, Jim McDermott, were here,
because, as we talked about it awhile ago, there are policies
happening. And that's our policy to Iraq. Iraq has increased
from 500,000 barrels just a short few years ago to now over 2.5
million barrels today. And we are bombing Iraq. We are over
there putting our troops in jeopardy and lives in danger while
allowing him to go from on the black market, so to speak, to
selling over 2 million barrels of oil per day. That is quite
significant.
We also have changed our dependence since the end. And I
think that this is something that a lot of people don't realize
that would change a great deal from the Arab countries, but we
have in Venezuela, Mexico, and Canada increased. Like in
Venezuela, about 490 million barrels a year and somewhere in
that neighborhood in Mexico, and Canada is about 420 million
barrels a year.
We changed the dynamics, and it seemed like our
administration would prefer to go in either that direction of
depending more on foreign oil or--and a lot of people need to
understand this, environmentally speaking--offshore, or into
public lands. And our domestic production in the lower 48
States--which has produced 60 percent of the oil in the past--
is the area that is being jeopardized.
Mr. Chairman, I just wanted to make those points.
You have made a couple of good points, and we will get back
to some of yours after awhile.
Thank you.
Chairman Houghton. All right, thank you very much.
Mr. Lucas, have you got any that you would like to ask?
Mr. Lucas. I think that I would just address--thank you,
Mr. Chairman--a couple of general questions to the panel about
the effect that these energy prices have not only on the United
States but what is the impact in places like Russia and other
countries around the world who may not be, perhaps, considered
to be major oil exporters by the average citizen, but
nonetheless, a substantial portion of their operating budget,
cash, hard dollar currencies, come from oil sales. What is the
effect this situation is having on those kind of countries?
Mr. Hakes. Well, there is both the loss of revenues that
results from decreased demand, and, as was mentioned by the
other witness, there is a dropoff in investment. It is
interesting how these cycles go. In 1996, I was testifying
before another House Committee on the high price of oil. And,
through 1997, we were seeing a very healthy, positive
investment climate in the United States, and in some high-cost
areas--the Gulf was quite dynamic--and in places like the
Caspian Sea area and in Russia. And, so now, in the current
environment, the interest with the investment community has
dropped substantially, so they are getting hit several ways
from these lower prices.
Mr. Lucas. Their production tends to be more from State-
controlled entities. They have to have the cash flow. They are
going to continue to sell their crude at whatever the price may
be, I would assume. Which means that ultimately, because we
have a production capacity in this country, an exploration that
is based on individual companies and individual nongovernment
entities, that downward price pressure, then, disproportional,
isn't it a fair statement that impacts our producers? Because
they are not backed up by the king, the czar, the President or
whatever. They go it on their own. So, in this environment,
they disproportionately suffer more than other entities around
the world. Is that a reasonable statement?
Mr. Hakes. I think the evidence is that people tend to
produce oil as long as they are recovering their operating
costs, and, if they don't recover operating costs over some
period of time, then they would probably shut in.
I think the difficulty is for someone who might keep
producing, but they have also invested capital in that which
they are losing.
OPEC itself has tried to restrain production. We have done
some analytic work that shows what the impacts are in dollars
on their budgets, and they are huge.
OPEC and non-OPEC have been sort of cutting back at a
somewhat similar rate for a year or two, perhaps for different
reasons. But both have been cutting back.
Mr. Lucas. Thank you.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you.
Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman.
Mr. Fliakos, economic analysts report that the oil and gas
industry's current flow crisis will experience a small rebound
in 1999 but will not reach normal prices until 2001. Is that
pretty much what your analysis would indicate?
Mr. Fliakos. Well, I think that in terms of this year,
unless OPEC acts to lower production--OPEC is supposed to meet
on March 23--unless they act to lower production, the inventory
glut is going to continue, and the price of oil is going to be
under pressure. It could go under $10 a barrel. This is a very
severe inventory problem.
My point is that the worse it gets today, in terms of low
oil prices, the better it is going to get tomorrow, in terms of
oil prices. Depending on whether you are a consumer or a
producer, and what is better or worse from that perspective,
conditions can change materially.
Today's low oil prices are having, in my opinion, a
devastating impact on supplies. In 1 year from now, 2 years
from now, a combination of erosion of supply with a recovery in
demand because of an economic recovery in the Far East, and
maybe, statistically at least because of a cold winter, the
price of oil could explode. Most forecasts assume smooth
increases. We see charts, for example, suggesting that the
price of oil is going to go up by 2 percent a year. It doesn't
work this way. We are likely to go from $10 oil to $25 oil, and
if there is a political crisis somewhere, it will be higher. I
think that the situation is very serious.
Chairman Houghton. I just have a single question. You have
brilliantly outlined the problem and the issue, but I sure want
a solution. That is what we are looking for here. We all
understand the conditions around this, but what are the
solutions?
Now, maybe each one of you could tell us specifically the
most important single area that should be worked on in order to
protect this industry. One suggestion.
Why don't you start, Mr. Hakes.
Mr. Hakes. Well, the Energy Information Administration
tries to stay away from policy recommendations, but one of the
things that you could look at--I would make clear that I am not
recommending any policy--is how the Strategic Petroleum Reserve
could be used in perhaps a more expansive way than it is now.
There are some States, for instance, that get involved in the
heating oil market. They try to buy low and sell high. Again, I
am not advocating that, but there are ways, and the Western
economies have had some discussions among themselves about how
the Strategic Petroleum Reserve can be used. Under the current
statutes, I believe, it is only available for emergency
purposes.
But certainly that is one way of addressing the political
instability problem. Although the current statute doesn't
suggest it, it could be a way of dealing with the volatility
problem. Oil does tend to be more volatile than other
commodities, so it does have a certain status, I believe.
Chairman Houghton. So, that has been drawn down, quite
substantially. And so, to build that up and to use the reserves
as a place where independents could sell their production.
Would that take them through 1 year or 6 months or 3
months? What is it?
Mr. Hakes. Well, the current inventory is a little bit over
560 million barrels, and there was a small draw during the
Persian Gulf war which was replaced, and then there was a small
draw during 1996 which has not been replaced but is currently
planned to be replaced.
That would replace U.S. imports for a period of 60 to 70
days perhaps. But, in one sense, that doesn't sound like a lot,
but in international commodities markets sometimes differences
in that amount can make a big difference. The capacity of the
Strategic Petroleum Reserve is somewhat higher than that, so
there is still some room physically for the reserve to accept
more oil than it has now.
Chairman Houghton. OK. It doesn't seem like it is going to
help very much. It will help on a very, very small basis. Maybe
1 or 2 or 3 months, but not long.
Yes, sir?
Mr. Fliakos. Well, there are all kinds of patchwork
solutions that one can find to solving the problem. I think
fundamentally, however, what we need is a higher price of oil.
We have to get the price of oil higher. And I think that the
way to do this--and the question involves politics, and it was
pointed out very correctly that the buildup of Iraqi oil has
been a major factor in creating the inventory glut. With Iraq
it is politics. There was a war. There was an embargo. There
was----
Chairman Houghton. So, you are suggesting a higher price,
and that means a higher tax, is that right?
Mr. Fliakos. Well, not necessarily. I think that the way to
do it is so that the tax system can be a vehicle, but I think
that the way to do it is through more cooperation at the
international level.
I recall in 1986, when the price of oil collapsed, then-
Vice President Bush went to Saudi Arabia and discussed the
serious implications of low oil prices, not only for this
country but for the world at large.
I think that it is a much more broad issue than just tax or
the Strategic Petroleum Reserves.
Chairman Houghton. Well, unless there are any other
questions, I thank the panel for being here.
Thanks very much, and your testimony will be put on the
record.
Mr. Watkins. Mr. Chairman, may I make a point?
Chairman Houghton. Go right ahead.
Mr. Watkins. You alluded to it again, and I think that we
need to repeat it. This administration does have a policy, they
may not want to admit it, but--my friend, Jim McDermott left to
go vote awhile ago, but--Iraq was only producing about 500,000
barrels of oil a day. In 1 year, they have come to 2.5 million
barrels of oil a day. At a time when we have been in conflict
and bombing Iraq, we have allowed them to continue to turn the
spigots on, and our policy is for the people of that country to
have unrest and overthrow Sadaam Hussein. They are not going to
be if we are allowing the produce and bringing all the money in
the world from the sale of oil.
And the policy is the death of our domestic oil economy and
really putting lives in danger also. I don't understand this.
It is a crazy, crazy policy.
Chairman Houghton. Your solution would be to go to the
United Nations and ask them to crank down the production of
Iraqi oil.
Thanks very much, gentlemen.
Now, we have another panel. Julia Short, member of the
National Association of Royalty Owners from Norman, Oklahoma;
Bill Waller, vice president of business development of Somerset
Oil and Gas Co. in Buffalo, New York, and Indiana,
Pennsylvania; Mitchell Solich, president and chief operating
officer, Chandler and Associates, Denver, Colorado, and
president of the Chandler Development Co.; Don Macpherson,
president of the Macpherson Oil Co., and president of the
Independent Petroleum Association in Bakersfield, California;
Michael Cantrell, president of the Oklahoma Basic Economy Corp.
in Ada, Oklahoma; and John Bell, owner of the DBA Reata
Resources in Kermit, Texas. And I was hoping that Mr. Stenholm
would be here to introduce the next witness, and that would
be--but I'll do it on his behalf--Glenn Picquet, executive vice
president of C.E. Jacobs Company in Albany, Texas, on behalf of
the North Texas Oil & Gas Association, Panhandle Producers,
Royalty Association, and a variety of other producers and
owners.
If Mr. Stenholm comes in and would like to make a comment,
we would like to have him. Also, it was Mr. Thomas who--OK,
good.
All right. Ladies and gentlemen, thank you very much for
being here.
Ms. Short, would you begin the testimony.
STATEMENT OF JULIA A. SHORT, MEMBER, NATIONAL ASSOCIATION OF
ROYALTY OWNERS, NORMAN, OKLAHOMA
Ms. Short. Thank you.
My name is Julia Short. I am 71 years old and live in
Norman, Oklahoma. I am retired and live on Social Security
payments of $427 a month supplemented by royalty income from
some small, older oil wells in Oklahoma. My Social Security is
also small because most of the jobs that I had in my working
years were short term and paid minimum wage.
In 1997 my total royalty income was a little over $8,600.
In 1998 it dropped to around $5,300. That is a 40-percent drop
in 1 year for someone already living near the so-called poverty
level.
There are approximately 200,000 other Oklahomans in the
same boat who depend on investments or assets in oil and gas
mineral royalties. With 4.5 million royalty owners nationally
scattered across every State in the Union, although their
incomes may come from 1 of the 20 or 30 producing States.
I am here to talk to you about what is happening in my life
and in the lives of hundreds of thousands of Americans like me
because of the current oil collapse.
First, there is nothing royal about oil and gas royalties.
Please don't confuse royalty owners with the British use of the
term. American royalties are tied directly to the land from
which our mineral assets are drawn, and we exchange the rights
to produce oil from that land for a small share of the revenues
when oil is sold. Since the bulk of Oklahoma royalty owners are
either retired or rapidly approaching that state of economical
dispair, oil royalty income is badly needed for the economic
base of our entire State.
Royalty income has sustained countless families, small
farms, and ranches in rural towns for decades. Royalty dollars
circulate many times through a local economy by way of the
grocer, the pharmacist, the feed store, the doctor, small
shops, and those who provide the services to the elderly. When
those dollars disappear, whole communities can be financially
devastated. Family farms are sold to giant agriculture
corporations. The elderly and infirm lose their self-
sufficiency and become dependent on public welfare for
survival.
I was born October 27, 1927, in Duncan, Oklahoma, the
great-great granddaughter of pioneers who settled near Velma in
what was then the Chickasaw Nation. My grandfather, Sid Jones,
was primarily a rancher who worked land in various sections of
Stevens County, Oklahoma.
In order to provide a secure future for his family, my
grandfather began to save, acquire, and trade land. He learned
to hang onto the mineral interests when he sold surface
acreage. This was a customary hedge against the often
devastating brutality of drought, floods, the dust bowl, and
other harsh realities facing farmers and ranchers in the
southwest.
When he died in 1958, he owned small percentages of
minerals in over 30 tracts. When I say small, I mean fractions
as low as 0.0003360 percent. Of course, some were larger, but
he was still not what you would call a wealthy man by any
standard.
At his death, mineral interests, which when and if
producing are called royalty interests, were divided among
several family members: A son and daughter, my mother, my
sister and I and my cousins. None of us most certainly became
rich--but the extra income was welcome and needed to survive.
In the sixties, my monthly royalty checks rarely totaled
more than $300. At that time, like most women of my generation,
I was a stay-at-home mother and housewife, and the royalty
income was used to help feed, clothe, and educate three
children.
By 1970 oil prices and production had dropped and reduced
that income to an alarming $90 a month. But when things turned
around a few years later, it was a godsend. By then I was
single and supporting myself. My father had died and I was left
with the care of my 80-year-old mother.
Because of our royalties, she spent her last years with
dignity and good medical care. And I was able to devote myself
to her needs. When she died in 1991, I had reached retirement
age myself, and my share of the remainder of the family nest
egg--so carefully gathered by my grandfather and nurtured by
family management--has been, until this year, my financial
salvation.
I live modestly. I still drive my mother's 20-year-old car
and felt almost even until my medical bills began rising and my
royalty income started dropping. I have had to ask for
financial help from others, and it is distressing and
humiliating. My health is poor. I can't get a job at my age,
and I would like to keep my pride and some measure of
independence.
What really scares me is that, even if oil prices rise
again, it may be too late for me if some or most of those oil
wells that I have an interest in are plugged and abandoned.
Very few new wells are being drilled. It has been well over 1
year since I have been approached for a lease on my few
remaining undeveloped tracts. Right now, I have very few hopes
for my future.
If I am to survive, our domestic oil industry must survive.
I know that there is no magic cure for the many problems facing
small, struggling independent producers and many large entities
who are shutting in all the wells and not drilling new ones,
but there is surely something that you in Congress can do. Like
all of my friends, family, and neighbors throughout the State,
I am very confused. Why does the Federal Government continue to
aid, subsidize, and enrich foreign countries hostile to our way
of life with spoils for devastating our own small, elderly
royalty owners and independent producers?
Thank you.
[The prepared statement follows:]
Statement of Julia A. Short, Member, National Association of Royalty
Owners, Norman, Oklahoma
My name is Julia Short. I'm 71 years old and live in
Norman, Oklahoma. I'm retired and live on Social Security
payments of $427 a month, supplemented by royalty income from
some small, older oil wells in Oklahoma. My Social Security is
so small because most of the jobs I had during my working years
were short term and paid minimum wages.
In 1997, my total royalty income was a little over $8,600.
In 1998, it dropped to around $5,300. That's a forty percent
drop in one year for someone already living near the so-called
``poverty level.''
There are approximately 200,000 other Oklahomans in the
same boat who depend on investments or assets in oil and gas
mineral royalties, with 4.5 million royalty owners nationally,
scattered across every state of the union . . . although their
incomes may come from one of the 20 or 30 producing states.
I'm here to talk to you about what is happening in my life,
and in the lives of hundreds of thousands of Americans like me,
because of the current oil price collapse.
First, there's nothing ``royal'' about oil and gas
royalties. Please don't confuse us with the British use of the
term. American royalties are directly tied to the land from
which our mineral assets are drawn. And we exchange the rights
to produce oil from that land for a small share of the revenues
when oil is sold. Since the bulk of Oklahoma royalty owners are
either retired, or rapidly approaching that state of economic
despair, oil royalty income is badly needed for the economic
base of the entire state.
Royalty income has sustained countless families, small
farms and ranches and rural towns for decades. Royalty dollars
circulate many times through a local economy by way of the
grocer, the pharmacist, the feed store, the doctor, small shops
and those who provide services to the elderly.
When those dollars disappear, whole communities can be
financially devastated. Family farms are sold to giant ag
corporations. The elderly and infirm lose their self-
sufficiency and become dependent on public welfare for
survival.
I was born October 27, 1927, in Duncan, Oklahoma--the
great-great granddaughter of pioneers who settled near Velma in
what was then the Chickasaw Nation. My grandfather, Sid Jones,
was primarily a rancher who worked land in various sections of
Stephens County, Okla.
In order to provide a secure future for his family, my
grandfather began to save, acquire and trade land. He learned
to hang on to the mineral interest when he sold surface
acreage. (This was a customary hedge against the often
devastating brutality of drought, floods, the Dust Bowl and
other harsh realities facing farmers and ranchers of the
Southwest.)
And when he died in 1958, he owned small percentages of
minerals in over 30 tracts. When I say ``small'' I mean
fractions as low as .0003360 percent. Of course, some were
larger, but he was, still, not what you would call a
``wealthy'' man by any standard.
At his death, the mineral interests (which, when and if
producing, are called royalty interests) were divided among
several family members--his son and daughter (my mother), my
sister and I, and my cousins. None of us, most certainly,
became ``rich '--but the extra income was welcome and needed to
survive.
In the 1960s, my monthly royalty checks rarely totalled
more than $300. At that time, like most women of my generation,
I was a stay-at-home mother and housewife. And the royalty
income was used to help feed, clothe and educate three
children.
By 1970, oil prices and production had dropped and reduced
that income to an alarming $90 a month. But when things turned
around a few years later, it was a Godsend. By then I was
single and supporting myself. My father had died and I was left
with the care of my 80-year-old mother. Because of our
royalties, she spent her last years with dignity and good
medical care and I was able to devote myself to her needs.
When she died in 1991, I had reached retirement age,
myself, and my share of the remainder of the family nestegg--so
carefully gathered by my grandfather and nurtured by good
family management--has been, until this year, my financial
salvation.
I live modestly--still drive my mother's 20-year-old car--
and felt almost comfortable until my medical bills began rising
and my royalty income started dropping. I've had to ask for
financial help from others, and it's distressing and
humiliating. My health is poor. I can't get a job at my age.
And I'd like to keep my pride and some measure of independence.
What really scares me is that even if oil prices rise
again, it may be too late for me if some of, or most of, those
old wells I have an interest in have been plugged and
abandoned. Very few new wells are being drilled. It has been
well over a year since I've been approached for a lease on my
few remaining undeveloped tracts.
Right now I have very few hopes for the future.
If I am to survive, our domestic oil industry must survive.
I know there's no magic cure for the many problems facing
small, struggling independent producers--and many larger
companies--who are shutting in old wells and not drilling new
ones, but surely there is something you in Congress can do.
Like all of my friends, family and neighbors throughout the
state, I'm very confused. Why does the federal government
continue to aid, subsidize and enrich foreign countries hostile
to our way of life with spoils from devastating our own small,
elderly royalty owners and independent producers?
Thank you.
Chairman Houghton. Thank you very much, Ms. Short.
Gentleman, we have a bit of a time problem, here, and so,
if you could rather than reading just summarize your
statements, I would certainly appreciate that, and your full
statement will be put in the record.
Mr. Waller.
STATEMENT OF BILL WALLER, VICE PRESIDENT, BUSINESS DEVELOPMENT,
SOMERSET OIL AND GAS COMPANY, INC., INDIANA, PENNSYLVANIA
Mr. Waller. Thank you, Mr. Chairman. Congressman, I will be
quick with my comments since you have a timeframe here.
My name is Bill Waller. I am vice president of Business
Development for Somerset Oil and Gas Co. which is an
independent oil and gas company headquartered in Indiana,
Pennsylvania, operating in excess of 1,000 wells primarily in
the Appalachian basin. I am originally from Oklahoma, and I
married someone from Pennsylvania, so I have feelings from both
areas of the country here.
Chairman Houghton. No relation in New York?
Mr. Waller. Pardon me?
Chairman Houghton. No relation in New York? Just a few
miles there with homes--[Laughter.]
Mr. Waller. Today's hearing is intended to examine the
current state of the petroleum industry and to present possible
options to address these problems. I must say, at the outset,
that I have never seen the domestic petroleum industry facing a
more complicated and potentially devastating set of problems
that it now does.
The industry now has faced a low-price crisis for the past
year. But today's problems are very different and far more
threatening than the ones that began early on. A year ago the
price crisis was started by a combination of effects: The
collapse of the Asian economies, warmer than normal winters in
the Northern Hemisphere, and ultimately a market share fight
between Venezuela and Saudi Arabia.
The events created a surplus of oil in the international
market and prices fell. The production most at risk was
marginal oil wells in the United States, wells that produce
about 20 percent of America's domestic production, an amount
equivalent to our imports from Saudi Arabia.
Now, we have experienced more than 15 months of low oil
prices, historically, low prices that threaten the very heart
of United States production. If we look at domestic oil
production as divided into three general areas, as was
mentioned earlier: The lower 48 States, offshore, and Alaska.
The onshore lower 48 States account for about 60 percent of the
total of domestic oil production. Now, the Energy Information
Agency recently released a report that over 60 percent of this
onshore lower 48 State production comes from independents, a
percentage that has increased by 10 percent over the past 10
years. It reflects an irreversible trend. Major oil companies,
as you can see in the paper everyday, they are leaving the
onshore lower 48 States. Because independents are so vulnerable
to the price shocks, at current prices, most, if not all, of
this production is at risk of loss.
This hearing was convened to address what can be done to
address the crisis, that question keeps coming up. Clearly,
there are two options: raising prices and cutting costs.
To raise prices, the United States must recognize the need
to participate in decisions in the world-oil market. Make no
mistake about it, the world-oil market is not as free-market as
the administration frequently suggests. Rather, it is defined
by the political interests of oil-producing nations. Failure of
the United States to participate in this arena will result in
increased reliance on foreign oil. No mistake.
In 1995 the Clinton administration concluded that our
current oil level represented a threat to our--our import level
represented a threat to national security. But it concluded
that the threat could be met by diversifying import sources.
And that was a flawed strategy. Diversity is not necessarily
security.
Today we import twice as much oil, on a percentage basis,
from the OPEC countries that embargoed us in the early
seventies. If we build our energy lifeline on foreign,
particularly Middle Eastern oil, we are placing our economic
future in the hands of rogue nations like Iraq. In fact, recent
analysis by the Independent Petroleum Association of America
suggests that Iraq now controls world oil price. A year ago,
Iraq exported 700,000 barrels a day. In January 1999, it
exported 2.5 million barrels a day. By March you will have
another 500,000 barrels of capacity online.
Iraq was the only OPEC country to boost its oil level in
1998. As other OPEC countries have reduced production to
stabilize oil prices, Iraq has become the swing producer of
world oil, and the swig producer, as we know, in any industry,
can set the price.
This analysis argues that the current U.N. sanctions, that
their program has failed on two counts.
First, it has failed in its primary mission to provide
humanitarian aid to the Iraqi people.
Second, it has handed Sadaam Hussein the victory that he
lost in the gulf war.
If it is accurate, we oil producers can only wonder why our
President, our State Department, and our Congress and other
leaders are doing nothing. If we really want a world where our
economic future is defined on Sadaam Hussein, is this what we
really want?
But if the United States intends to sit idly by as Sadaam
keeps oil prices at levels that punishes enemies and rips the
underpinnings from our domestic production, then we must look
at the other side of the equation.
Now, can Congress act to reduce domestic production costs?
The answer is, yes.
One are where it could act is the creation of low-interest
loan programs or loan-guarantee programs patterned on disaster-
relief programs.
The second area is squarely within the jurisdiction of this
Subcommittee, and that is revisions to the Federal tax
structure. The oil industry has identified nine areas where tax
restructuring could reduce production costs and get cash back
into the hands of domestic producers. And I want to focus on
three of these, and I will do so quickly and highlight the
others.
First, Congress could pass Congressman Watkins' marginal
wells tax credit legislation, H.R. 53. This legislation would
create a counter-cyclical tax credit program that would phase
in as oil and natural gas prices fall. It is a concept
identified in the National Petroleum Council's 1994 marginal
wells report. However, to help in today's situation, there are
several key elements in the bill that must be included. It must
apply to both regular and alternative minimum taxes, and it
must include a 10-year carryback provision, and, regardless of
when it is enacted, it must apply for all of 1999.
Second, the net income limitations suspension on the use of
percentage depletion that was incorporated into the taxpayer
relief bill expires at the end of 1999. It must be made
permanent or further extended. Without this provision, the net
income limitation requires percentage depletion to be
calculated on a property-by-property basis. It prohibits
percentage depletion to the extent that it exceeds a net income
from a particular property.
Now, the typical independent producer can have numerous--a
small producer can have numerous oil and gas properties and
many of which could be marginal, marginal properties with high-
operating costs and low-production yields. During periods of
low prices, the producer may not have net income from a
particular property, especially from these marginal properties.
When domestic production is most susceptible to being plugged
and abandoned, the net income limitations discourages producers
from investing income to marginal and maintain those marginal
wells.
Third, as many small producers are trying to find ways to
keep their production operation, they are frustrated by other
constraints on the use of percentage depletion that are tying
up their resources and could be eliminated. In particular,
current law limits the use of percentage depletion to 65
percent of net taxable income. Percentage depletion deductions
in excess of this amount can be carried over to future years.
But, in certain circumstances, it will be unavailable as income
falls. Now this problem can be rectified by eliminating the 65-
percent limitation and allowing an annual selection----
Chairman Houghton. Mr. Waller, how long will this testimony
go on because the red light has been on for quite awhile.
Mr. Waller. Let me just go on down and touch on the other
matters.
Chairman Houghton. All right, thank you.
Mr. Waller. There are six other matters: Modifying the
current oil and mineral tax and allowing the expenses of
geological and geophysical and compelling that we capitalize
that expense: allowing the expensing of delay rentals as have
been done in prior years by the IRS actions; expanding the
definition of enhanceable recovery techniques and updating the
current limitation and providing for a net operating loss
carryback. Legislation has been introduced by Congressman
Thomas of this Committee for that. And enact a inactive well-
recovery program, and Congressman Thornbury has introduced
legislation for that.
This package of changes would address the bottomline issues
and would address the critical resources that we need to have
available. The domestic oil wells in the United States, that is
truly America's true strategic petroleum reserve.
Thank you for the time.
[The prepared statement follows:]
Statement of Bill Waller, Vice President, Business Development,
Somerset Oil and Gas Company, Inc., Indiana, Pennsylvania
Thank you, Mr. Chairman. My name is Bill Waller. I am vice
president of business development of Somerset Oil and Gas
Company, Inc., an independent exploration and production
company headquartered in Indiana, Pennsylvania and operating in
excess of 1,000 wells primarily in the Appalachian Basin.
Today's hearing is intended to examine the current state of
the petroleum industry and to present possible options to
address its problems. I must say at the outset that I have
never seen the domestic petroleum industry facing a more
complicated and potentially devastating set of problems than it
now does. The industry has faced a low oil price crisis for the
past year, but today's problems are very different and far more
threatening than the ones that began early on.
A year ago, the price crisis was started by a combination
of effects--the collapse of Asian economies, a warmer than
normal winter in the northern hemisphere, and ultimately a
market share fight between Venezuela and Saudi Arabia. The
events created a surplus of oil in the international market and
prices fell. The production most at risk was marginal oil wells
in the United States--wells that produce about 20 percent of
America's domestic production, an amount equivalent to our oil
imports from Saudi Arabia.
Now, we have experienced more than 15 months of low oil
prices--historically low prices that threaten the very heart of
U.S. oil production. If we look at domestic oil production, it
is divided into three general areas--onshore lower 48 states,
offshore, and Alaska. The onshore lower 48 states account for
about 60 percent of total domestic oil production. The Energy
Information Agency has released a recent report that over 60
percent of this onshore lower 48 production comes from
independents, a percentage that has increased by ten percent
over the past ten years. It reflects an irreversible trend.
Major oil companies are leaving the onshore lower 48 states.
Because independents are the most vulnerable to price shocks--
at current prices, most--if not all--of this production is at
risk of loss.
This hearing is convened to address what can be done to
address this crisis. Clearly, there are two options--raising
prices and cutting costs. To raise prices the United States
must recognize the need to participate in decisions in the
world oil market. Make no mistake about it; the world oil
market is not a free market as the Administration frequently
suggests. Rather, it is defined by the political interests of
oil producing nations. Failure of the United States to
participate in this arena will result in increased reliance on
foreign oil.
In 1995 the Clinton Administration concluded that our
current import level represented a threat to national security,
but it concluded that the threat could be met by diversifying
import sources. It is a flawed strategy. Diversity is not
security. Today, we import twice as much oil on a percentage
basis from the OPEC countries that embargoed us in 1973. If we
build our energy lifeline on foreign, particularly Middle
Eastern oil, we are placing our economic future in the hands of
rogue nations like Iraq.
In fact, recent analyses by the Independent Petroleum
Association of America suggests that Iraq now controls world
oil prices. A year ago, Iraq exported about 700,000 barrels/
day. In January 1999, it exported about 2.5 million barrels/
day. By March it will have another 500,000 barrels/day of
capacity on line. Iraq was the only OPEC country to boost its
oil revenue in 1998. As other OPEC countries have reduced
production to stabilize oil prices, Iraq has become the swing
producer of world oil. The swing producer sets the price.
This analysis argues that the current UN sanctions program
has failed on two counts. First, it has failed in its primary
mission to provide humanitarian aid to the Iraqi people.
Second, it has handed Saddam Hussein the victory he lost in the
Gulf War. If it is accurate, we oil producers can only wonder
why our President, our State Department, our Congress and other
leaders are doing nothing. Do we really want a world where our
economic future is defined by Saddam Hussein?
But if the United States intends to sit idly by as Saddam
keeps oil prices at levels that punish his enemies and rips the
underpinnings from our domestic production, then we must look
at the other side of the equation. Can Congress act to reduce
domestic production costs? The answer is yes.
One area where it could act is the creation of low interest
loan programs or loan guarantee programs patterned on disaster
relief programs. The second area is squarely within the
jurisdiction of this committee--revisions to the federal tax
structure. The oil industry has identified nine areas where tax
restructuring could reduce production costs and get cash into
the hands of domestic producers. I want to focus on three of
these and highlight the others.
First, Congress could pass Congressman Wes Watkins'
marginal wells tax credit legislation--HR 53. This legislation
would create a countercyclical tax credit program that would
phase in as oil and natural gas prices fall. It is a concept
identified in the National Petroleum Council's 1994 Marginal
Wells report. However, to help in today's situation, there are
several key elements of the bill that must be included. It must
apply to both regular and alternative minimum taxes. It must
include a ten-year carryback provision. And, regardless of when
it is enacted, it must be applied for all of 1999.
Second, the net income limitation suspension on the use of
percentage depletion that was incorporated in the Taxpayer
Relief Act of 1997 expires at the end of 1999. It must be made
permanent or further extended. Without this provision, the net
income limitation requires percentage depletion to be
calculated on a property-by-property basis. It prohibits
percentage depletion to the extent it exceeds the net income
from a particular property. The typical independent producer
can have numerous oil and gas properties, and many of which
could be marginal properties with high operating costs and low
production yields. During periods of low prices, the producer
may not have net income from a particular property, especially
from marginal properties. When domestic production is most
susceptible to being plugged and abandoned, the net income
limitation discourages producers from investing income to
maintain marginal wells.
Third, as many small producers are trying to find ways to
keep their production in operation, they are frustrated by
other constraints on the use of percentage depletion that are
tying up their resources and could be eliminated. In
particular, current law limits the use of percentage depletion
to 65 percent of net taxable income. Percentage depletion
deductions in excess of this amount can be carried over to
future years, but in current circumstances will be unavailable
as incomes fall. This problem can be rectified by eliminating
the 65 percent limitation and allowing an annual selection of
the percentage limitation to be made by the taxpayer. Secondly,
to free these resources for today's needs, the carried over
percentage depletion deductions should be allowed to be carried
back for ten years under the revised conditions. These changes
would assist producers in keeping existing operations going.
Let me touch on six other tax changes that would greatly
aid domestic oil producers:
1. Modifying the current alternative minimum taxable income
calculation to phase out critical preference items during times
of low oil prices.
2. Allowing the expensing of geological and geophysical
costs instead of compelling them to be capitalized.
3. Allowing the expensing of delay rental payments as they
have been done prior to a September 1997 IRS action
4. Expanding the definition of Enhance Oil Recovery
techniques to update the current list that was written in 1979.
5. Provide for a net operating loss carryback for oil and
gas production as has been proposed for farmers and the steel
industry. Legislation has been introduced in the House by
Congressman Thomas of this committee--HR 423.
6. Enact an inactive well recovery program. Congressman
Thornberry has introduced legislation--HR 497.
This package of changes could address many bottom line
issues for U.S. producers. They are not the only actions that
need to be taken, but if taken they can help keep critical
resources available--domestic oil wells that are America's true
strategic petroleum reserve.
Chairman Houghton. Thank you very much, Mr. Waller.
We do have this time problem, so if you would keep your eye
on that red light, I would certainly appreciate it.
Now, I would like to introduce William Thomas, the
Congressman from California, who would like to make a statement
and also introduce Mr. Macpherson.
Mr. Thomas. Thank you, Mr. Chairman. I apologize that I
haven't been with you. This obviously is of great concern to
me.
I want to thank you for putting my statement in the record,
and, for the record, the reason that I am interested is that my
district, a portion of California, produces more oil than the
entire State of Oklahoma. If Kern County were a State, we would
be behind Alaska, Texas, and Louisiana. So, we have an interest
in what happens in the oil patch.
I also have an interest in making sure that what we ask for
during this hopeful temporary time is not a complete read,
write, and swallow, of the Tax Code, notwithstanding a list of
wishes that may be wanted. My understanding is that Treasury
testified that even the very modest bill that my colleague is
sponsoring, and I am cosponsoring, on a tax credit phaseout,
and my even more modest bill of simply allowing for the current
downturn to be spread over a greater number of years where
there may have been a profit by someone, simply are not useful
in today's market. I find it ironic when last year the 5-year
carryback was used for agriculture in terms of getting them
over a difficult time, a freeze and a disaster, that this
afternoon our colleague from Pennsylvania and the Chairman and
others will be joining the Trade Subcommittee, of which I am a
Member, looking at the possibility of the carryback concept
being used for steel in a critical time. And for the Treasury
to say that there simply would be no use available for either
the carryback or the tax credit, is, to me, a rather amazing
statement to make.
When I introduce Don--Don Macpherson, Jr., is one of those
individuals who allows me to make the statement that we produce
more oil than the State of Oklahoma because we obviously have
major international oil concerns. But just as the west is
concerned about the mom and pops on the royalty end, and it is
real income to them, and if they don't, they don't have an
income--for us, it is mom and pop extended to a certain extent.
The particular kind of oil that we have, which is heavy
oil, high sulfur, which requires secondary and tertiary
recovery, means that if we ever shut a well in, you walk away
from that actual resource because you cannot get it back given
the investment necessary, and the potential and the substrata
that gets you to produce it again.
What I am looking for is an ability to create a modest
change in the Tax Code that gets us through this period. Not a
complete rewrite because, frankly, a complete rewrite is not in
the cards.
What amazed me--and I will underscore this--was that I have
been informed that the Treasury said that something as simple
as a 5-year carryback, in terms of losses, or a $3 credit
phasing out between $14 and $17 a barrel, is something that
would not be of any use to you folk, and therefore it is not
necessary to talk about this kind of a change.
What I hope you will do, in response to my question, is to
give your testimony, but for the record, make sure that you
answer the question that I ask you because I am not going to be
able to stay. And that is do you think H.R. 53 or H.R. 423, the
$3 tax credit or the 5-year carryback, is useful tax
legislation for you now? And that is the question that I would
like you to answer.
And with that, Mr. Chairman, I want to thank you very much.
Don, it is good to see you here. That is snow outside in case
you didn't know what it was. And that is a joke, because in
Bakersfield, less than 1 month ago, we had 8 inches of snow.
That was the first time that it ever happened, I think, and
most of us hope that it is the last time that it happens. We
are used to visiting it, not to living in it.
Don, good to see you.
Mr. Watkins. Will the gentleman yield?
Mr. Thomas. Certainly.
Mr. Watkins. I would like for the record to show that his
in-laws are from Oklahoma and those people who probably are
working to get it out of the ground are from Oklahoma that are
out in Kern County.
Mr. Thomas. Tell the gentleman that not only does my
district produce more oil than Oklahoma, I think that I have
more Okies than you do in my district. [Laughter.]
Mr. Watkins. We will take this controversy out to the
corridors.
Mr. Thomas. I am very sensitive whence our folk came.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you very much.
All right. Mr. Macpherson.
STATEMENT OF DON MACPHERSON, JR., PRESIDENT, MACPHERSON OIL
COMPANY; AND PRESIDENT, CALIFORNIA INDEPENDENT PETROLEUM
ASSOCIATION, BAKERSFIELD, CALIFORNIA
Mr. Macpherson. Thank you.
My name is Don Macpherson, Jr. I am president of the
Macpherson Oil Co. and president of the California Independent
Petroleum Association, known as CIPA. And, notwithstanding what
you heard earlier today about taxpayers, I can tell you that I
have paid taxes over the last 5 years.
I would like to thank you for the opportunity to speak
today. I would also like to start by thanking Congressman
Thomas, who is a distinguished Member of this Subcommittee, for
his leadership on oil and gas issues.
Macpherson Oil Co. operates 39 oil and gas leases producing
approximately 900 barrels of oil per day. These leases are
mainly located in Congressman Thomas's district in Kern County,
California. Macpherson Oil also has some production in Alabama.
Macpherson Oil Co. develops these leases that it operates by
extensive thermal steam recovery, water flooding and high-
volume lift operation techniques.
CIPA is a statewide trade association representing 500
independent producers, service, and supply companies operating
in California.
The first step to finding a solution is to let the people
know that there is a problem. And I can assure you that, from
California's producers' perspective, there is a big problem.
Last week I presided over a rally at the State capital in
Sacramento, California, to raise awareness of the serious
crisis facing the California oil and gas producers. We heard
from union members, small oil and gas producers whose wells are
shut in, a bipartisan delegation of State senators and
assemblymen, and from oil workers about just how bad the low
oil price crisis really is.
The message is that our industry really is important and
vital to the freedom of all Californians and the one that
powers the economic engine of California and the United States.
We cannot afford to lose it.
The current low oil price crisis puts about 75,000 direct
and indirect California jobs at risk. If Congress does not act
soon, California independents will be out of business. A 25-
year low crude oil price caused by a glut of foreign oil and a
reduced demand worldwide has put California producers on the
endangered species list.
Adjusted for inflation, California oil prices haven't been
this low since the Great Depression. California and other U.S.
producers will soon be extinct unless we get some help.
When California's other commodity producers, such as the
agricultural farmers, milk producers, hog farmers, and others
faced natural or economic disaster, the State and Federal
Government stepped in for help. Our industry, the oil and gas
producing industry, is in trouble, and we need help now.
California is the fourth largest producer behind Alaska,
Texas, and Louisiana. And, as Congressman Thomas states, Kern
County alone produces more oil than all of Oklahoma.
California's production is usually the first to feel the
effects of the price downturn because of the low gravity, poor
quality, heavy oil that makes up about two-thirds of the
State's production. The average price for California's
benchmark Kern River crude oil has been hovering in the $7 per
barrel range for several months and has been under $10 a barrel
for over 1 year. At current prices, oil producers receive less
than 15 cents a gallon. You can't buy water for 15 cents a
gallon.
The economic contribution for the exploration and producing
sector of California's oil and gas industry economy is about
$10 billion a year. In 1997 the industry provided approximately
$1.3 billion in direct payroll, and an estimated $2.3 billion
in total statewide employment wages. In 1997 the industry paid
about $400 million in State and local taxes and fees. None of
these figures included royalties paid to the State and Federal
Government and to individuals which are in the hundreds of
millions of dollars.
California producers supply about half of what Californians
consume. The rest comes from Alaska and foreign suppliers
including Iraq, Venezuela, Mexico, and Saudi Arabia. When
domestic producers are gone, who will make up the shortfall?
You can bet that South America and Mideast producers will fill
the void with high-price crude oil that will turn into high-
price gasoline for U.S. drivers. Without domestic oil and gas
producers, California and other Americans will be held hostage
to foreign producers.
One of the untold stories of this impact is what low crude
oil prices are petroleum service sector. A recent study
conducted by the California Independent Petroleum Association
shows that just amongst its members, capitals budget spending,
money that supports the maintenance and production levels, has
decreased by over $100 million during the last year. What this
means is that this money won't go to support jobs and families
for those companies and workers for independent producers.
Congress needs to act decisively to help producers in the
petroleum sector in California and the rest of the United
States. Without the help of Senators and Representatives in
Washington, DC, jobs, taxes and production will drop sharply.
The freedom of all Californians will be significantly impaired.
But it doesn't have to be this way. Several Members of
Congress have introduced or cosponsored legislation that would
help independent producers to get back on their feet. H.R. 423,
authored by Congressman Thomas, will allow domestic oil
producers to reduce their taxes by a carryback of net operating
losses for 5 years from their regular and alternative minimum
taxes during the past 5 years. If enacted, producers would use
this legislation to increase cash flow for current operations
and maintenance on production on wells that would otherwise be
abandoned.
This legislation would also allow independent producers the
ability to recover cash from earlier profitable years to be
used in the current operations when cash flow may be negative.
This bill would be effective for all years after December 31,
1997.
H.R. 53, authored by Congressman Wes Watkins, would give
producers a marginal tax credit for low-volume, high-cost oil
and gas wells. This legislation is vital to the oil and gas
producers with marginal economic production. This bill would
allow an independent producer to obtain a $3 credit from the
first for each 3 barrels of qualified production that may be
carried back 10 years. The credit is phased out as the price of
oil is increased. Similar rules would apply to natural gas
producers.
I urge Members of this Subcommittee to support these two
pieces of legislation and the myriad other legislation that are
being proposed to provide disaster relief to the U.S. oil and
gas industry. Oil is not a partisan issue. Oil is not an
environmental issue. Oil is a job issue. Oil is an economic
issue. Oil is a family issue, and oil is a freedom issue.
Producers are looking for a hand up, not a handout. We want
to do business on a free and fair market. Right now, we have
neither.
Thank you for your time and opportunity to address you
today.
[The prepared statement follows. An attachment entitled
``Review of the Economic Significance of California's Oil and
Gas Industry'' is being retained in the Committee files.]
Statement of Don Macpherson, Jr., President, Macpherson Oil Company;
and President, California Independent Petroleum Association,
Bakersfield, California
My name is Don Macpherson, Jr. I am the President of
Macpherson Oil Company and President of the California
Independent Petroleum Association (CIPA). Thank you for the
opportunity to speak to you today.
I would like to start out by thanking my Congressman, Bill
Thomas who is a distinguished member of this Committee, for his
leadership on oil and gas issues.
Macpherson Oil Company operates 39 oil and gas leases,
producing approximately 900 barrels of oil per day. These
leases are mainly located in Congressman Thomas' district in
Kern County California. Macpherson Oil also has some production
in Alabama. Macpherson Oil company developed the leases its
operates using expensive thermal steam recovery, water flooding
and high volume lift operating techniques.
CIPA is a statewide trade association representing
approximately 500 independent producers, service and supply
companies operating in California.
The first step in finding a solution is letting people know
there's a problem. I can assure you that from California
producers' perspective--there is a big problem.
Last week I presided over a rally at the state capitol in
Sacramento, California to raise awareness of the serious crisis
facing California's oil and natural gas producers. We heard
from union members, small oil and gas producers whose wells
were shut-in, a bi-partisan delegation of State Senators and
Assemblyman and from oilfield workers about just how bad the
low price crisis really is.
The message today is that our industry is important and
vital to the freedom of all Californians and one that powers
the economic engine of California and the United States. We
can't afford to lose it!
The current low oil price crisis puts about 75,000 direct
and indirect California jobs at risk. If Congress doesn't act
soon California independents will be out of business.
A 25-year low in crude oil prices caused by a glut of
foreign oil and reduced demand worldwide has put California
producers on the endangered species list. Adjusted for
inflation, California oil prices haven't been this low since
the Great Depression. California and other US producers will
soon be extinct unless we get some help.
When California's other commodity producers--agricultural
farmers, milk producers, hog farmers and others face natural or
economic disaster the state and federal government steps in to
help. Our industry--the oil and gas producing industry--is in
trouble. We need help now.
California is the fourth largest producer of oil behind
Alaska, Texas and Louisiana. Kern County alone--which is in
Congressman Thomas' district--produces more oil than in all of
Oklahoma!
California production is usually the first to feel the
effects of a price downturn because of the low gravity, poor
quality ``heavy'' crude oil that makes up about two thirds of
the state's production. The average price for the California
benchmark Kern River crude oil has been hovering in the $7 per
barrel range for several months and has been under $10 per
barrel for over a year! At current prices producers receive
less than 15 cents a gallon. You can't buy bottled water at
that price!
The economic contribution of the exploration and production
sector of the California oil and gas industry to the economy is
about 10 BILLION dollars. In 1997 the industry provided
approximately $1.3 BILLION in direct annual payroll, and an
estimated $2.3 BILLION in total statewide employment wages. In
1997 the industry paid about $400 million dollars in state and
local taxes and fees.
None of these figures include royalties paid to the state
and federal government and to individuals in the hundreds of
millions of dollars.
California producers supply about half of what
Californian's consume. The rest comes from Alaska and foreign
suppliers including Iraq, Venezuela, Mexico, and Saudia Arabia.
When domestic producers are gone who will make up the
shortfall? You can bet that South American and Middle East
producers will fill the void with high priced crude oil that
will be turned into high priced gasoline for US drivers.
Without domestic oil and gas producers, Californians and other
Americans will be held hostage to foreign producers.
One of the untold stories is the impact that low crude oil
prices have on the petroleum service sector. One recent study
conducted by the California Independent Petroleum Association
shows that just among its members capital budget spending--
money that supports the maintenance of production levels--has
decreased over $100 million dollars during the last year. What
that means is that this money won't go to support the jobs and
families of those companies that work for independent
producers.
Congress needs to act decisively to help producers and the
petroleum service sector in California and in the rest of the
U.S.
Without the help of Senators and Representatives in
Washington, D.C., jobs, taxes and production will drop sharply.
The freedom of all Americans will be significantly impaired.
But it doesn't have to be that way.
Several members of Congress have introduced or co-sponsored
legislation that will help independent producers get back on
their feet.
HR 423 authored by Congressman Thomas will allow domestic
oil and gas producers to reduce their taxes by carrying back
net operating losses for five years from their regular and
alternative minimum taxes during the past five years. If
enacted, producers will use this legislation to increase cash
flow for current operations and maintain production on wells
that would otherwise be abandoned.
This legislation would allow an independent producer the
ability to recover cash from earlier, profitable years to be
used in current operations when current cash flow may be
negative. This bill would be effective for all years after
December 31, 1997.
HR 53 authored by Congressman Wes Watkins would give
producers a marginal well tax credit for low volume, high cost
oil and gas wells. This legislation is vital to oil and gas
producers with marginally economic production.
This bill would allow an independent producer to obtain a
$3.00 credit from the first three barrels of qualifying
production that may be carried back 10 years. The credit is
phased out as the price of the oil increases. Similar rules
would apply to natural gas producers.
I urge members of this Committee to support these two
pieces of legislation and the myriad other legislation that is
being proposed to provide disaster relief to the U.S. oil and
natural gas production industry.
Oil is not a partisan issue. Oil is not an environmental
issue. Oil is a jobs issue. Oil is an economic issue. Oil is a
family issue. Oil is a freedom issue.
Producers are looking for a hand up, not a hand out. We
want to do business in a free and a fair market. Right now, we
have neither.
Thank you for your time and the opportunity to address you
today.
I have submitted a copy of the study ``Review of the
Economic Significance of California's Oil and Gas Industry''
for your information along with my written testimony to
document the economic importance of the California oil and gas
industry.
Mr. Watkins [presiding]. Thank you very much for those--
asking in the question again that Mr. Thomas' H.R. 53, the
marginal well tax credit, or the income averaging, would be a
great help. Is that correct? I don't know what you said--it
would be very vital.
Mr. Macpherson. Yes, the answer is that those two bills--
his bill and your bill would both help the industry. The answer
is absolutely that it would help.
Mr. Watkins. I would like to yield at this time to Mr.
McInnis who would like to introduce the gentleman from his home
State of Colorado to give his testimony, and let me say that we
will have your entire testimony that will be part of the
record, and if you would just summarize it.
Mr. McInnis. Thank you, Mr. Chairman.
Mr. Chairman, I would like to introduce Mitchell Solich.
Mr. Solich is a longtime friend of mine, and we go back a long
ways. He, in fact, has become my in-State expert on oil
matters, and briefed me, a person who is not in the oil
business, through some of the complicated tax credits and some
of the complications in your industry. So, he came to
Washington, DC, at his own expense and on his own time, and I
appreciate it very much, and it is a great honor for me to have
him here and look on the Nation's Capitol.
Mitch, I appreciate the points that you have to make
because we are here to try and figure it out. Obviously, it is
a catastrophe for us, and we, in our particular district, as
you know Mr. Speaker, my district has 22 million acres of
Federal land. My district, geographically, is larger than the
State of Florida.
And I have a gentleman like Mr. Babbitt, and some others,
like Earth First and the national Sierra Club who want to ban
all Federal lands from exploration. So, that is another
difficulty that we have up in my area.
Thank you for letting me introduce the witness, and I ask
that he be allowed to proceed.
Mr. Watkins. Thank you, Mr. McInnis.
Let me say again that your testimony will be a part of the
record, and if you could please summarize your remarks.
STATEMENT OF MITCHELL SOLICH, PRESIDENT AND CHIEF OPERATING
OFFICER, CHANDLER & ASSOCIATES, LLC; AND PRESIDENT, CHANDLER
COMPANY, DENVER, COLORADO
Mr. Solich. Yes, sir, thank you.
Mr. Chairman, my name is Mitch Solich. I am president of
the Chandler Co. which is an independent domestic producer of
oil and natural gas. We have been in continuous operation in
Denver over the last 44 years.
You, Congressman Wes Watkins, and Congressman Scott
McInnis, along with the other Members of the Subcommittee, are
to be commended for holding this hearing.
If Congress and the administration do not act quickly,
small, independent oil and gas producers will not survive. The
melt down in world oil prices is the cause of this crisis, but
the effects of the price collapse have been exacerbated by
discriminatory government policies, both tax and land access.
The price collapse began in 1997. It continued unabated
through 1998, and the carnage is expected to continue into
1999. Oil prices, adjusted for inflation, are as low as they
were in the thirties. Now these oil prices are not part of a
normal cycle, but are a catastrophic anomaly that has forced
many domestic producers out of business and has extinguished
tens of thousands of jobs and cost the Federal Government
billions of dollars in lost taxes, rents, and royalties.
Now, you have heard from others today about the gruesome
statistics about the condition of the industry. Let me just add
that in my own State of Colorado, companies have lost between
25 percent and 65 percent of their net revenues. To put it into
perspective, I wonder how the panelists from Treasury today
would deal with a 25- to 65-percent loss in revenues.
We have lost highly skilled, technical people as well. We
are not going to be able to get these people back or to replace
them and this fact is jeopardizing the basic infrastructure of
our company and companies like us.
While most other countries encourage energy development,
the United States, with discriminatory tax provisions and
excessive restrictions on access to Federal lands, seriously
and needlessly restricts the exploration and production of oil
and natural gas in this country.
The most important step that Congress can take now is to
change these policies. The marginal well production credit,
introduced by Congressman Watkins, is important to slow the
shutting in of marginal wells. Marginal wells are those
producing less than 15 barrels a day. And while that may not
sound like much, I should note that between 20 and 25 percent
of total domestic production comes from these marginal wells.
Relief from the alternative minimum tax, or AMT, is also
critically important. The AMT actually increases taxes on
companies that are struggling financially in periods of falling
prices. In order to alleviate the AMT's effect, the industry
proposes phasing in changes to the AMT preference and
adjustment as the price of oil drops.
Alleviating the restrictions on percentage depletion to
permit producers to take advantage of depletion allowances that
they have carried over is the third step that Congress could
take.
Three other tax provisions are: Inactive well recovery
incentives, the expensing of geological and geophysical costs,
and the expensing of delay rental.
All of these tax improvements will help, but they will fall
far short of their potential to sustain domestic oil and gas
production unless Congress also acts to solve the other
problems: unnecessary and arbitrary restrictions on access to
Federal land.
In my written statement I describe some of the government
action that adds up to an overall government policy that is
hostile to domestic oil and gas production. Hostile tax
policies, coupled with hostile access policies, is a
prescription for increasing dependence upon foreign oil.
The changes that I have discussed would not only rescue
this country's independent producer of oil and natural gas, but
would also slow a growing dependence on foreign oil.
Thank you, again, for holding these hearings. I hope that
they will bring about the action needed to help our independent
producers to deal with the difficult conditions.
I would be happy to answer any questions you may have.
[The prepared statement follows:]
Statement of Mitchell Solich, President and Chief Operating Officer,
Chandler & Associates, LLC; and President, Chandler Company, Denver,
Colorado
Mr. Chairman, I am Mitch Solich, President of The Chandler
Company, an independent, domestic producer of oil and natural
gas.
You, Mr. Chairman, and Congressmen Wes Watkins and Scott
McInnis, along with the other members of this committee are to
be commended for holding these hearings on the perilous state
of the U.S. oil and gas industry. For, unless the Congress and
the Administration act quickly, a vital national asset--
independent oil and gas producers--may soon disappear.
The catastrophic collapse in world oil prices is the
immediate cause of the industry's distress. But the effects of
that price collapse have been magnified by discriminatory tax
and access policies imposed by the federal government. Congress
can help by changing those policies.
The collapse in world prices began in 1997 and has
continued virtually unabated throughout all of 1998 and on into
1999. Oil prices, adjusted for inflation, have fallen to levels
not seen since the Great Depression, tangible proof that
despite more than a century of production, world oil supplies--
relative to demand--have become more abundant than ever.
But, that greater abundance on the world stage has also
meant accelerating dependence on foreign oil here in the United
States. Historically low prices have forced many domestic
producers out of business, extinguished tens of thousands of
jobs and cost the federal government billions of dollars in
lost taxes, rents and royalties. Loss of government revenues
has been especially severe in energy-producing states.
Since oil prices began falling in 1997, U.S.
independents have been forced to shut in more than 136,000 oil
wells and 57,000 natural gas wells.
Daily onshore production outside of Alaska dropped
nearly a quarter of a million barrels from 1997 to 1998.
Overall, last month (January) U.S. crude oil
production fell to the lowest level in more than 50 years,
according to the American Petroleum Institute (API).
The shutting-in of wells has already eliminated
24,000 jobs and threatens another 17,000 during the first half
of 1999, according to the Independent Petroleum Association of
America (IPAA).
In January alone, 11,500 jobs were lost in the
domestic oil and natural gas production industry--the largest
single-month drop since 1986--ccording to API.
Exploration and development has all but ceased.
Utilization of U.S. oil rigs has dropped by nearly two-thirds
from 361 in December 1997 to 125 in January 1999, the lowest
oil rig count since Baker Hughes began keeping separate records
for oil and gas in 1987.
In my own state of Colorado, companies have
literally lost between 25 and 65% of their net revenues
overnight because of the collapse in prices. With fewer dollars
to invest, drilling and project activity has been curtailed in
most areas, and we can expect additional cutbacks and job
losses. The job cuts mean further loss of highly skilled people
in technical disciplines -a condition which has been ongoing
and is only exacerbated by the current price meltdown. As
technical people leave the industry, there is a real risk that
these disciplines that are a necessary part of our industry's
infrastructure are being lost and that we will be unable to
recruit new expertise.
The current conditions also affect federal and state
government revenues.
The President's budget shows a decrease of $1.4
billion between 1998 and 1999 in rents and royalties from the
OCS, and a decline of $80 million from previous 1999 estimates
of onshore rents and royalties.
Oklahoma's gross production tax collections for
1998 were down more than half.
In Texas, oil severance tax revenues fell nearly
$95 million during the first eight months of 1998, a reduction
of more than a third.
Last month (January), according to API, domestic
oil producers received an average of about $9 a barrel at the
well-head, the lowest inflation-adjusted prices since the Great
Depression more than a half century ago.
But the history of the last 50 years also shows that low
prices and a world supply ``glut'' are the exception, not the
norm. A quarter century ago, millions of Americans were stuck
in long gasoline lines, triggered by the Arab oil embargo.
World oil prices tripled in a few years, sparking widespread
concern of a permanent ``energy crisis.'' Many feared that we
were rapidly using up the oil and natural gas left to us by
nature--a resource barrier that neither domestic price
decontrol nor human ingenuity could overcome. Growing demand
for a depleting, finite resource stimulated predictions that
world oil prices would reach, or even exceed, $100 by the year
2000.
Instead, however, soon after remaining price controls were
ended in 1981, domestic producers quickly proved that, with a
favorable economic climate and supportive public policies,
solutions could be found to the ``energy crisis.'' Producers
ended the supposedly ``irreversible,'' decade-long decline in
U.S. oil production within months. Annual domestic production
began increasing by 1982. Around the world, so much new
resources were found and developed that today--despite growing
demand--proved reserves represent nearly a half century of
supply (at current rates of consumption).
But while most other countries encourage energy
development, flawed public policies--especially discriminatory
tax provisions and excessive restrictions on access to federal
lands--are once again seriously and needlessly restricting the
exploration and production of oil and natural gas in this
country. The most important step that Congress can take now to
help independent producers is to change these policies.
The Marginal Well Production Tax Credit, introduced by
Congressman Wes Watkins, is an important step that the Congress
can take to help independent producers and also slow the
shutting-in of marginal wells because of historically low
prices for oil and natural gas. The bill provides a $3 a barrel
tax credit for the first 3 barrels of daily production from an
existing oil well and a 50 cent per thousand cubic feet (Mcf)
tax credit for the first 18 thousand cubic feet of daily
natural gas production from a marginal well. The credits would
phase in and out as oil and natural gas prices fall and rise
between specified levels. The credits would be allowed against
both the regular income tax and the AMT.
Relief from the heavy impact of the Alternative Minimum Tax
(AMT) is also high on the list of steps needed. The AMT was
enacted to make sure that companies reporting large financial
income also paid at least the prescribed minimum tax. It was
not intended to increase taxes on companies that are already
struggling financially or exacerbate the financial impact of
falling commodity prices. Yet, that is how the AMT actually
impacts the independent petroleum producers of today who face
historically low market prices for the products they sell--
forcing them to curtail their operations and consider closing
higher-cost wells--but who also have numerous preference items
under the AMT.
In order to alleviate the impact of the AMT, the industry
proposes that certain changes--such as eliminating specified
preferences--would begin to phase in when the annual average
price of oil falls below $23.50 a barrel and would be fully
phased in when the price falls below $18.50.
Alleviating the restrictions on using percentage depletion
by independent producers would be a third step the Congress
could take to help the industry pull itself out of its current
depression. For independent producers and royalty owners,
current tax law limits the allowance for percentage depletion
to 65 percent of a taxpayer's taxable income for the year.
Percentage depletion in excess of this 65 percent limit may be
carried over to future years until it is fully utilized. In
past years, many independent producers spent much of their
income to develop their properties, reducing their taxable
incomes and thereby limiting the use they could make of
percentage depletion. These producers accumulated deductions
for use in later years. Now, after the collapse of world oil
prices, independent producers are struggling to make any income
at all and, so, cannot use their carried over deductions. And,
even those independent producers that can use their deductions
currently may find that the AMT restricts their use of
percentage depletion, unreasonably constraining their cash
flow. Under the proposal:
--By annual election, the 65 percent taxable income
limitation would be reduced or eliminated for current and
future tax years.
Carried over percentage depletion could be carried
back for ten years subject to the same annual election on the
taxable income limitation. And,
The suspension of the 100% Net Income From The
Property Limitation would be extended.
Three other important steps that Congress can take to help
the industry and slow the decline in domestic production
include inactive well recovery incentives and the expensing of
geological and geophysical costs (G&G) and delay rentals.
Improving tax incentives for oil and natural gas
independents will fall far short of their potential to help
sustain domestic petroleum production, unless Congress also
acts to reduce restrictions on access to federal lands. These
lands contain a disproportionate share of the nation's best
prospects for new petroleum discoveries that are needed to
replace fields now in decline.
These restrictions have proliferated over the past decade
and a half.
Onshore, since 1983, access to mineral reserves on
federal lands in the western United States has declined by more
than 60 percent.
In 1983, over 114 million acres were under lease
compared to 32.5 million acres today.
Known domestic crude oil reserves have dropped
about a fifth during that period--from 29 billion to 23 billion
barrels.
The reduced access is due to a variety of actions that add
up to an overall government policy grown hostile to domestic
petroleum production, even though growing supplies of petroleum
are a prerequisite for continued U.S. economic growth.
The discretionary and arbitrary exercise by the
BLM and the Forest Service of their authority to close lands to
access.
The arbitrary interpretation and application of
key statutes by these two agencies--including NEPA, FLMPA, the
Endangered Species Act and the Clean Air Act.
The inability of the two agencies to coordinate
their land management programs.
Growing consumer demand for petroleum--coupled with growing
hostility by public policies to domestic production--is a
prescription for increasing dependence on foreign oil. At the
time of the Arab embargo, more than a quarter century ago,
Americans depended upon imports for a third of their supplies.
Now, we depend on foreign oil to meet more than half--about 55
percent--of the oil we use each day. According to the latest
(``reference'') projection by the U.S. Department of Energy, we
will be depending on imports for 70 percent of our oil by 2020.
And we will depend upon the socially and politically unstable
Persian Gulf for much of that 70 percent.
The changes I have discussed would not only help this
country's independent producers of oil and natural gas, but
would also slow our growing dependence on foreign oil.
Again, I want to thank Chairman Houghton, Congressmen
Watkins, McInnis, and the other members of this committee for
holding these hearings. I hope they will help bring about the
actions needed to help our independent producers deal with
these difficult conditions.
Mr. Watkins. Thank you very much for your comments.
I yield to Mr. McInnis to see if you have any quick
questions of your constituent there.
Mr. McInnis. Thank you, Mr. Chairman.
Mr. Chairman, I will reserve my questions. I know we are
trying to give all the witnesses an opportunity to talk. We are
coming to an end, so I will reserve my option to ask questions
after we conclude.
Mr. Watkins. I appreciate that. I didn't know exactly what
your timing was.
I would now like to turn to my State of Oklahoma longtime
friend. And let me say to Mrs. Short that I want to thank you
very much for your perspective as a mineral oil royalty owner
to bring a different phase of this problem. And a lot of people
are out there on the land. Many of them have farms and are
suffering on that angle along with others who have been
depending on some type of assistance. It is really very few
dollars per month. And we appreciate that enlightenment for a
lot of Members here.
But, my good friend from Ada, Oklahoma, Mike Cantrell, who
has been past president of OIPA and who personally, I've heard
him talk for many years about the oil patch and the meaning of
it--in a very patriotic way--about how important that it is,
but also has been sharing insight in what it is doing and the
obstructionist coming about in the oil patch today.
My friend, Mike Cantrell. Your entire statement will be
made a part of the record, and if you would summarize it and
give it from the heart, we would appreciate it.
STATEMENT OF S. MICHAEL CANTRELL, PRESIDENT/OWNER, OKLAHOMA
BASIC ECONOMY CORPORATION, ADA, OKLAHOMA
Mr. Cantrell. Yes, I will certainly summarize, Congressman.
We certainly appreciate you and your other colleagues for
holding these hearings.
I am Mike Cantrell. I am a small independent oil producer
from Ada, Oklahoma. I have 85 wells that I operate within 30
miles of my home in Ada, Oklahoma. I employ 10 people. We have
laid off two people. The rest of us have made a pact with each
other that we are going to stick this thing out as long as it
takes.
Some of my crews are out today. They make the wells in the
mornings, and they build fences in the afternoon. And that is
the sort of family atmosphere that we have at my company to try
to get by this.
This is a depression in the oil and gas industry. This is
not analogous to anything that we have had in the past in this
industry. We have had these up-and-down cycles before, but this
is by far the most severe. We have lost 6,000 Oklahoma jobs. We
have about 150,000 people in Oklahoma either directly or
indirectly employed through the oil industry, and we are in
danger of losing at least half of that in a relatively short
time. This is a death spiral that we are in in the oil business
in Oklahoma.
While oil prices in 1985, and the prices then hit $12 a
barrel for 3 months, they have hit under $11 a barrel for 1
year or 15 months this time. The last 3 months have been below
$10 a barrel in Oklahoma. That is an exponential death spiral
to our economy in Oklahoma. We have $1 billion a year that we
are losing in Oklahoma because of this crisis, and it is going
to escalate, and when it includes natural gas--when natural gas
gets hit along with it, that number will double. And most
experts believe that is going to happen in a relatively short
time.
I would limit my comments. We all have to point out how
really devastating this is. We are at a crossroads in America
today. We have not had an energy policy ever except for cheap
energy. It is the siren song, cheap energy. It reminds me of
the Thomas Payne ``Sunshine Patriot'' poem in the Revolutionary
War. As long as the sun shines today, we don't worry about
tomorrow. And that is the energy policy that we have had in
this country and have now.
We are at a crossroads. We have got to decide right now,
this is the critical time, if we are going to have a viable,
U.S. domestic petroleum industry. And that is for you to
decide.
I don't ask for help for independent oil and gas producers.
I heard an elderly woman say onetime, ``You all just take care
of the sick and the blind and the lame, and the rest of us will
get by OK.'' Well, I think that this is to take care of the
least of our citizens. In the long run, the American public is
not the winner with these cheap energy prices today. If you
believe that they are, if you believe that it is fine to get
rid of this domestic industry and we will rely totally on
foreign imports from unfriendly governments, then we don't have
any business talking to you here. We'll just go find something
else to do. We'll be OK. Now, those people that we employ are
going to have to get retrained, and the people who depend on
services and the income and the revenue that this industry
generates in America, that is painful, that is dislocating.
But, primarily, what you ought to focus on is, is America's
natural resource base worth preserving? Yes or no.
Our preeminent geologist in Oklahoma, Dr. Charles Mankin at
the Oklahoma geological survey, maintains that there are 18
billion barrels left to be produced in Oklahoma, in the ground.
We just celebrated our 100 anniversary of oil production in
Oklahoma last year.
We have produced 17 billion barrels so far. So, we have got
tremendous natural resources left in this country, that is
probably, in our opinion, viable for America for the future.
But if you walk away from them, and we are at the point now
where the strategies of the countries that are dumping oil on
America today and their international oil company partners--it
is a very good strategy. They dump oil on our marketplace. They
take out the high cost of production. And then what is left?
They take us out of the marketplace if you all allow that to
happen, and then they can get whatever they want for the price
of their product. I don't think that is in the best interests
either strategically or economically for the average American
citizen.
What could you do? We disagree with the Treasury official
who says there is no any evidence of dumping. A number of us
are right now in the process of filing a Federal Trade
Commission action against Venezuela and Canada and possibly
others for dumping oil on America for the express purpose of
taking us out of the marketplace. And that is an action that we
are pursuing.
There is no free market for oil. And the best thing you all
can do for us and for America and for the energy reserves of
this country is to determine the true cost of the imported oil.
Whether as a defense cost or whether it is environmental. We
have a $4 environmental fee on American oil today. It is $4 a
barrel to produce our oil, environmental costs, an artificial
burden that other countries of the world don't have. Perhaps
Congressman Stenholm is correct that we should have a
compensating environmental assessment fee on foreign oil.
Only by effecting the price are you going to materially
save the resource base of America. Now, I have to say,
Congressman, that the Treasury official testified that 75
percent of the corporations don't pay taxes now that are in our
industry. It makes me want to go back home and fire my
accountant, because I sure pay them, and I don't know anybody
that hasn't. And I think that your comment was appropriate that
most individuals, most independents who are not incorporated
are certainly paying taxes.
So, the tax provisions and credits that you all are working
toward would be very helpful.
But the main thing, I think is--I think what we are going
to find when we look into the subsidization or the producing
oil below cost and foreign countries that are dumping on our
shores, we are going to find out, regrettably, that those
companies are being subsidized, but they are being subsidized
by the United States of America. Mexico just got a sweetheart
finance deal to restructure their oil industry with nonrecourse
loans from America. Venezuela has an act in front of Congress
that would give their subsidiaries a United States tax-free
treatment on dividends. And we have to compete with people who
don't pay taxes.
The defense cost involved with keeping the shipping lanes
open. The Saudi Arabian concessions that are made with Treasury
so that they can manipulate currency transactions and not feel
the pain of low oil, is subsidizing our competition. That is
not in the best interests of America.
Thank you very much.
[The prepared statement follows:]
Statement of S. Michael Cantrell, President/Owner, Oklahoma Basic
Economy Corporation, Ada, Oklahoma
Thank you for the opportunity to share with this committee
just one man's view of the devastation that is taking place in
the domestic independent oil industry and the ramifications to
our nation of this oil price crisis.
I am a native Oklahoman and third-generation ``oilie.'' I
am a small independent oil producer from Ada, Oklahoma. I
employ 10 people. We operate 85 oil wells, all of them located
within 30 miles of my home.
The Oil Crisis is Real
The business environment for my company is the worst it's
been since the Great Depression. Without boring the committee
with a series of statistics, please allow me to provide the
following back-drop for my testimony:
Oklahoma's oilfields are among the most mature in
the world. Oklahoma has about 85,000 producing oil wells, which
pump a total of about 200,000 barrels a day. That means the
average well in our state produces about 2 1/2 barrels of oil a
day.
Average costs to produce an Oklahoma barrel of oil
is about $13. In other words, at the prices paid for Oklahoma
oil since November, Oklahoma producers, like me, have been
losing an average of $4/barrel or close to a million dollars a
day. No business--no industry--can survive for long in that
sort of cash-flow crunch.
At the beginning of last year, there were 45,000
Oklahomans directly employed in the oil and natural gas
industry. There were probably twice that many employed
indirectly because of oil and gas exploration and production.
Our state oil and gas organization, the Oklahoma Independent
Petroleum Association, estimates about 6,000 of those Oklahoma
jobs are already gone ... and the rate of layoffs in the
Oklahoma oilpatch is escalating at a rate of about 1,500 per
month. That means 50 bread-winners a day are being forced to
find new work, be re-educated or re-trained or relocate. Just
in Oklahoma.
Oklahoma's preeminent geologist, Dr. Charles
Mankin, estimates there are still 18 billion barrels of oil
under the ground in Oklahoma. We just celebrated the centennial
of our industry in Oklahoma. In 100 years, we've produced 17
billion barrels. But the remaining one-half of the energy
resource--the wealth, the tax base, etc.--may not be produced
if the access to the oil reservoir, the wellbores, are plugged
and abandoned prematurely because these marginal wells are too
costly to continue to operate at a loss over the near-term.
The Oil Crisis has a Face
Oklahomans are a proud people. Many of us stayed through
the horrible oil crash of the mid '80s. This crisis is deeper
and has gone on longer than the ``bust'' of '86. Pumpers,
welders, roughnecks, oilfield supply houses, pipe yards,
secretaries, accountants, landmen, and company owners. Nobody
in the oil industry is spared. But the Oil Crisis doesn't just
impact one segment, albeit a major segment, of the Oklahoma
economy. It impacts all of us. Hundreds of small ``oil towns''
across Oklahoma are facing an economic double-whammy as the two
staples of our rural culture and economy--oil and agriculture--
struggle to survive.
The decline in the value of oil just in the past two years,
is the equivalent to the loss of a billion-dollar-a-year
industry in Oklahoma. It effects the grocer, the pharmacist,
the convenience store owner, teachers and other government
service providers. The decline in oil-related tax collections
is estimated at $10 million a month to the state treasury,
perhaps as much as four percent of the overall state budget.
This means less money for schools, roads, services
The Oil Crisis ``Winners''
There are identifiable winners in this oil crisis. No, I
won't start by talking about American consumers, because--even
though all of us benefit in the short run from lower prices for
energy products--these savings won't last.
The winners are the foreign countries, and their oil
company partners, who are systematically decimating the U.S.
oil producing sector. Every time a U.S. oil well is plugged
prematurely, the Oil Barons of the New Millennium, come one
step closer to complete control of one of the staples of our
existence and one of the foundation pins of our nation's
freedom.
The former head of the Venezuelan oil regime announced 15
months ago: `` Lower prices will result in some marginal
production being shut in and force some high-cost producers,
particularly in the U.S., out of business.'' In the winter of
'97, with my oil selling for $18/barrel, that comment flew
right past me. Today, it slaps me in the face.
I believe it is Venezuela's goal to displace 1-2 million
barrels of U.S. production over the next 3-5 years. I believe
they are joined in this global struggle for market share by
Iraq, Iran, Canada, Mexico, Saudi Arabia, Norway and other
countries. I believe their plan is working. I know some of my
friends, neighbors and former colleagues in the oil business
are already victims. I understand my company could be a
fatality in the not-to-distant future.
What I don't understand is why the U.S. Government is
compelled to aid and abet this foreign seizure of control of
the global energy marketplace. Some will say it is not prudent
for Congress or the Administration to interject itself into the
``free market.'' Frankly, I have come to scoff even at the
term.
When U.S. taxpayers subsidize the world's largest oil
companies because our government allows these major companies
to call the royalties they pay to foreign governments taxes ...
which allows these companies to avoid paying taxes to our
government. When U.S. oil producers pay upwards of $4/barrel in
environmental/regulatory costs that producers in other parts of
the world don't face. When U.S. taxpayers provide ``free-of-
charge'' protection, via the U.S. Armed Forces, to tankers in
shipping lanes around the globe. There is no free market for
oil. There is no level-playing field for U.S. oilfield workers.
What can Congress do to address the Oil Crisis?
I would offer the following:
The appropriate Congressional committees and/or
federal agencies should begin immediately an investigation to
identify the true cost of imported oil.
--Differences in tax treatment of foreign oil production
--Differences in regulatory/environmental requirements for
foreign oil production
--Factoring in military costs.
The appropriate Congressional committees and/or
federal agencies should begin immediately an investigation into
the substantial harm caused to U.S. oilfield workers by the
overt and systematic taking of oil markets by foreign-
controlled interests.
Congress or the Administration should impose a
graduated tariff (tied to world oil prices) on imported oil and
petroleum products.
Congress should enact major tax changes
specifically aimed at preserving marginal oil wells, including
the redefinition for tax credit purposes of enhanced recovery
to include both new and existing hydro-injection projects.
Congress should provide small independent oil and
natural gas producers an exemption from anti-trust statutes for
the purpose of forming cooperatives to aggregate production and
improve the prospects for these small market players a more
reasonable opportunity to compete against the conglomerates
being formed by mergers of the majors and many larger
independent producers.
Mr. Watkins. Thank you, Mike, very, very much, and I always
gain something from your comments, and I appreciate it very,
very much here this morning. And I know you will have lots of
time to talk. I know you are part of the record, and I
appreciate your mentioning how important these tax provisions
are.
At this time, the gentleman from Colorado, do you wish to
comment?
Mr. McInnis. Thank you, Mr. Chairman. If I might, Mr.
Chairman, just make a couple of comments about this testimony.
Now, first of all, I should reflect to you that in my
particular family we have a fairly large-size cattle operation.
We are not producers on that property. The only thing that
saved the ranch this year was low fuel prices. I do want to
point out that there has been benefit throughout society, your
taxpayer dollars. The government has saved hundreds and
hundreds of millions of dollars as a result of these low
prices.
I have kind of a fundamental disagreement with some of your
testimony based on price. I don't think the way we look at this
is by affecting price by doing some kind of governmental
intervention that increases the price of the cost of fuel
because it has a ripple effect throughout society.
Where I think we have to approach it, which you also touch
in your comments, and I wholeheartedly agree with you on, is
the cost basis. And that percentage of the cost basis to you as
a producer that is forced on you by the government with unfair
and discriminatory taxes and nonenforcement of the dumping that
is going out there.
I agree very strongly with most of your statement, but I do
want to say to you that there are some positive benefits, and I
think we shouldn't look at the gross price of the cost for
fuel. But we need to look at how the government is hitting you
on the net, not gross, but on net, what comes out of it.
I appreciate your comments. And, Mr. Solich, you state it
very well, the discriminatory actions within your statement.
That's where we have to target because we are being unfair. The
government's being unfair to your industry in this taxing
policy.
Thank you, Mr. Chairman.
Mr. Watkins. The gentleman from Texas, you have a guest
here that's on the panel who's going to present his testimony,
would you like to make the introduction?
Mr. Bonilla. Thank you, Chairman. And before I introduce my
constituent, John Bell from Kermit, Texas, I do want to comment
very briefly on Mr. Cantrell's testimony. I leaned over to Mr.
Watkins during your testimony, Mr. Cantrell, and said you hit
the nail right on the head. I just appreciate that all of you
are here from different parts of the country to tell the truth
about the threat to national security, and about the dumping
problem that we have that we should be dealing with, especially
with a rogue nation like Iraq. With one hand we're bombing
them, on the other hand we're allowing them to dump oil on the
high seas. Not only is it a bad policy, it's domestically
threatening our national security domestically.
I just appreciate you all coming here, but I want to tell
you, very frankly, that I found out in my short time here in
Washington that truth and substance often is not enough to push
your case forward. But we're not going to give up. We're going
to keep talking about it, and with your help, maybe we will
prevail in the end and finally talking about the long-term
downside of allowing these things to occur that threatens our
country long term.
And as Mr. Cantrell pointed out, when you think the sun is
shining today and you see it out there, it doesn't mean it is
going to be shining tomorrow. You have to have a vision about
what these low prices are doing to us long term. I appreciate
you pointing that out.
At this time I would like to introduce, and I appreciate
the Subcommittee allowing me to be here today to introduce John
Bell, who's done more than any other Texan, in my view, to tell
the story, not only here in Washington but around our State. I
know you were the man behind the wonderful big show of support
for the producers in the Permian Basin in Austin in mid-
January. I appreciate all you do, Mr. Bell.
At this time, we'd be pleased to hear your testimony.
Mr. Watkins. Mr. Bell, your complete testimony will be made
part of the record. And you can summarize. Let us know your
answer to the question, will H.R. 53 and also H.R. 423 be a
benefit to the industry, despite what the Treasury Department
said?
STATEMENT OF JOHN D. BELL, DBA REATA RESOURCES, KERMIT, TEXAS
Mr. Bell. I appreciate that, and I will, rather than follow
my agenda--you have that testimony--and I will just tell you
briefly that I'm a small producer. I'm one of the smallest
producers probably in the business. I have nine wells and make
about 20 barrels a day. I primarily provide for my family by
working as a drilling and workover consultant and supervisor. I
purchased a few wells in order to try to provide a college
education for my children, and I had hoped at some point in
time to be able to retire selling those properties.
I have six children. The oldest is in college now. I have a
son who is a senior and a daughter who is here today behind me,
who is a junior. So I'm going to have lots of kids in college
right away, and that's going to be a real challenge.
I appreciate Representative Bonilla asking me to come here
today. I have to confess that when they first called and asked
if I could come, I told them I flat couldn't afford to with oil
prices at today's level I could not do it.
Some of my friends in Kermit, Texas, and Laura has a friend
back there with her named Shana Smith. And Shana's father has
been very supportive of me in doing this effort. And so, Ricky
Smith got some other producers together to be able to provide a
way for me to come, providing the airline tickets. I want you
to understand that we're not J.R. Ewing, this isn't Dallas, and
we're in a world of hurt.
I don't know much about politics, but I do know about the
pain our people are suffering and enduring in the oil business.
To tell you that the economy of west Texas and the other
producing areas across America, and of the world, are in a
severe state of depression--tens of thousands of workers are
being laid off. It just so happens that in our area, a large,
large percentage of those are of Hispanic descent. We have been
able to gather the support of LULAC as a help to us because we
are trying to save jobs.
This is a job issue; this is a school issue; this is a
community issue. In our community, in particular, we stand the
risk of losing our hospital. We are going to lose a substantial
proportion of income for education for our high schools, for
our schools there. We have some schools in Texas that may wind
up being closed if we can't get some other source of help. Our
district, in particular, is 89 percent dependent on mineral
values to provide an education for our children.
I want to give you a little background here to make oil
prices relative. Some people seem to think cheap oil is good
for America. And I think low energy prices, while they may have
a benefit to America, I want to tell you that there is a
serious problem with energy that is too cheap to preserve
itself.
Back in the early seventies, my father acquired some leases
down in Kermit, Texas, of which I have since purchased some of
those leases and continue to produce them. We were receiving
anywhere from $2.85 a barrel up to $3.25 a barrel prior to the
Arab oil embargo of 1973. I don't know if you guys have figured
out why the Arab embargo took place. But it took place because
oil was too cheap.
And I bought a new pickup. I was 19 years old. I bought a
new pickup in the fall of 1971. That pickup cost me $3,600. If
I go buy that new pickup today, it costs me seven to eight
times that much money. If you take and figure that you had an
average price of $3 a barrel, that translates to $21 a barrel
to keep up with pre-1973 embargo prices, pre-1973 prices, in
order to do that today. I received a check last month or in
December for $7.75. That's equivalent in 1971 to about $1.15 a
barrel. We can't produce it for that, and there is not anybody
else in the world who can.
As long as we're subsidizing foreign oil, as long as we are
providing for the common defense of the Persian Gulf oil, we
have a problem. Persian Gulf oil ought to pay for its own
stinking defense. The point is that worldwide production will
decline below market demand in a few years, but this will not
come until after the destruction of the domestic oil industry.
You are witnessing our industry being damaged now. If oil
corrections are not made soon, U.S. production will continue to
fall to historic lows. I started out by trying to let producers
take care of this problem, and I suggested the 10-day shut-in.
Ten days isn't very long, and I thought that might be able to
work. But I got warned if I did that and I continued that
effort--and I sent a couple of thousand letters around the
world. I got a nice thank you letter from OPEC, but they didn't
shut-in. I got warned, if I did that and pursued that area, I
could be violating antitrust issues. And I just thought, boy,
if John Bell from Kermit, Texas, violates antitrust issues, how
in the world can we merge major oil companies? Just doesn't
make a lot of sense.
So what we need is, we need some help; we need some
assistance here because we can't protect ourselves. That's
really the bottomline. This morning there was a question asked
over here that said, we come when prices are low, that we come
in here and talk. I don't remember. I know I certainly hadn't
been here before. I can tell you that our industry has provided
a lot for this country, and we need some help. I realize there
are some serious problems. I ask that you would give some help.
Yes, we need the tax help you have discussed, but it is
going to take more than that. And we would ask you to limit
Iraq's ability to export oil into our country, and we would ask
that you cause for those companies that are importing Iraqi oil
to stop that. As long as they are trying to shoot our pilots
down, we don't think that ought to be going on.
[The prepared statement and attachments follow:]
Statement of John D. Bell, dba REATA Resources, Kermit, Texas
Crisis in the Oil Patch--Is it Good for America?
Low oil prices are stealing the jobs, savings and future
from those of us who produce and work in the oil industry. I've
been repeatedly told that ``low oil prices are good for the
American economy'' but I ask, ``Are the American people willing
to close our children's schools and shut down our hospitals?''
Low oil prices have already stolen tens of thousands of our
jobs. My family's future including my children's education and
our family's savings for retirement are being taken from us
while I'm being told ``Low oil prices are good for America.'' I
refute that statement. Doesn't America remember the 1973 Arab
Oil Embargo?'' Are you willing to trade today's low oil prices
for the security of America's defense and future? How are you
as our elected representatives going to explain the gas lines
of tomorrow?
Today's extremely low oil prices are not good for America's
long term economy or the world's economy. Let's look at low oil
prices from a world view. This price war is devastating the
economies of countries around the world. The situation in
Russia is horrid. Russia and some of the countries of the
former Soviet Union earn most of their foreign income from the
sale of oil. I estimate that a $10.00 per barrel drop in the
price of oil is costing these FSU countries about $2 billion
per month. In a recent US New and World report article, the
situation in Russia has been compared to pre World War II
Germany prior to Hitler. Yelstin is very sick and Russia is
ripe for revolution. Today Russia is more dangerous than pre WW
II Germany due to Intercontinental Ballistic Missiles. How long
are you going to allow low oil prices to punish the people of
Russia?
While America's economy is booming, the Russian economy is
being destroyed. Why must the Russian people starve to death
while Americans drives around in large sport utility vehicles?
If Americans can afford SUV's, they can afford to pay a
reasonable price for the gasoline to fuel them. How selfish are
the American people? Oil is Russia's largest export commodity.
Oil is how they have earned most of their foreign income. Low
oil prices are not only damaging the Russian economy but also
the economies of Mexico, Venezuela, Indonesia, Malaysia,
Nigeria, Kuwait, Saudi Arabia, the United Arab Emirates,
Norway, and many other nations. Mr. Chairman and Honorable
Representatives, the world needs your help. Please listen.
The United States government recently approved an emergency
funding bill which uses our tax dollars to provide billions of
dollars as ``loans'' to the IMF. The IMF (International
Monetary Fund) is providing ``loans'' to help stabilize the
economies of these and other countries who are suffering from
deflation. Much of this money is being stolen by dishonest
politicians and never reaches the people for whom it was
intended. Increased oil prices would provide jobs which would
allow these countries to take care of their own needs rather
than receiving government to government welfare in the form of
``loans.'' Wake up America! Low oil prices are causing terrible
and painful repercussions to much of the world and we are
paying for the cost of low oil prices in the form of ``loans.''
As we endure the oil price collapse of 1998 and 1999, we
need to ask ourselves why is this occurring. Some have
suggested that it is a result of the economic depression which
occurred in the Pacific Rim Countries. While that may have
played a minor role, we need to look deeper to find the real
answers. OPEC countries are fighting an oil price war. This is
a battle over market share! Why are OPEC countries allowing
this price war to continue while it hurts their own economies?
It is to their advantage to eliminate the competition. OPEC
could make the necessary production cuts needed to balance
supply and demand and to stabilize oil prices now, but if they
do they will continue to face world wide competition. If John
D. Rockefeller were doing this, the trust busters world be
attacking him instead of allowing his former oil companies to
merge.
How long will the price war last? What are the battle
strategies? We need to find out what is happening and who is
involved. How does the rush for the majors to merge fit in to
the current scenario? In Austin, I requested that Governor Bush
order the Texas Attorney General to investigate the cause of
the recent price drop in order to see if the oil market is
being manipulated. Now we ask you to initiate an investigation
into the situation in order to answer these questions. This is
not a difficult request. We have a right to know why our
businesses and our lives are being destroyed!
Who is winning and who is losing? The obvious losers are
the people who drill, service, and produce oil wells. This
affects not only oil field workers but also their families and
their communities. Schools in West Texas and other oil
producing regions of the country are being financially
devastated by this war. Enclosed is a document from Carol
Rylander, our Texas State Comptroller, which shows how low oil
prices are hurting Texas schools. Many schools are facing the
probability of losing millions of dollars which will
financially devastate their ability to educate our children.
This may force some school districts in Texas to close next
year. Entire communities and counties are being severely
damaged by this oil price war. Ward and Winkler Counties in
West Texas are facing severe cuts. This will not just threaten
senior citizens centers and recreational centers but in all
probably will force the closure of their hospitals. My
neighbors in Kermit and West Texas face dire consequences. We
need serious help in order to deal with low oil prices.
Low oil prices are not just hurting people in Texas and the
Permian Basin but also those who live in the oil producing
areas of New Mexico, Louisiana, Mississippi, Oklahoma, Kansas,
Colorado, Wyoming, Montana, North Dakota, Utah, California, and
Alaska. Northeastern states such as Michigan, Pennsylvania,
Ohio, and upstate New York will be affected as well. The
publisher of the Rocky Mountain Oil Journal, Mr. Cody Huseby of
Bismarck, North Dakota, stated that not a single drilling rig
is operating up there for the first time since oil was
discovered in North Dakota in the early 1950s.
Who is benefitting from low gasoline and fuel prices? The
airlines, transportation, and the driving public seem to be
reaping the benefits of low prices. Yes, there are many areas
of the country and even the world that are currently reaping
the reward of low energy prices but I question ``How long can
low prices last?'' Are today's benefits worth the long term
costs? In order to answer some of these questions, we need to
understand what is happening. Due to the drop in oil prices,
drilling for oil has slowed in the US to the lowest level since
rig counts started being reported in 1949. Thousands of oil
workers have been laid off in the United States, Russia, and
around the world. Oil production is dropping sharply especially
in the United States and other so called high cost producing
areas of the world.
Who are the world's high cost producers? Some have
suggested that the high cost oil producers are US independents.
I maintain that Persian Gulf oil is more expensive than US oil.
The United States government is currently subsidizing foreign
oil production from the Persian Gulf by providing the military
build up there. A recent IPAA letter to Congress stated ``US
taxpayers are paying about $50 billion per year to maintain a
strong military contingent in the Gulf.'' This does not include
the additional billions which we spent to pay for the bombing
cost of Desert Fox and the continuing daily effort in Iraq. Why
should American taxpayers pay these costs? Why shouldn't
Persian Gulf oil pay the cost for its own defense? The real
cost to the American taxpayer for oil imported from the
countries in the Persian Gulf includes the cost of maintaining
stability in the region. How much are we really paying for
Persian Gulf oil? This cost can be calculated by dividing $50
billion by 2.5 million barrels per day multiplied by one year.
(In 1998 US imports averaged less than 2.5 million barrels of
oil per day from the Persian Gulf.) Therefore, Persian Gulf oil
cost US tax payers about $54.00 per barrel plus the purchase
price. The total cost is about $65.00 per barrel. By comparison
the United States produces about 6.2 million barrels per day
and it is worth only $23 billion per year at the current price
of $10.00 per barrel. Even at $20.00 per barrel it is still
worth less than $50 billion.
During the oil boom of the 1970's and early 1980's US oil
producers were penalized for excessive profits. About $77
billion were taken out of the US oil industry in the name of
windfall profits. Now when the oil industry is facing a serious
crisis due to low prices and severe losses, very little relief
is being offered to help us. The unfairness of the situation is
frustrating. Foreign oil is subsidized while domestic producers
are taxed and penalized out of existence.
In 1986 the Reagan administration, in their efforts to
destroy the former Soviet Union and win the cold war,
encouraged Saudi Arabia to lower the price of oil by increasing
oil production. The leaders of both the US and Saudi Arabia
felt their countries could benefit from lower oil prices and
increased market share. As I consider what occurred, I suppose
maybe the sacrifice of the US oil business was justified in
order to win the cold war. I feel that if an industry is going
to be sacrificed there should be some type of compensation. Why
have we not been compensated? Is a similar agenda being played
out today? If so, who is the enemy now?
Saudi Arabia is considering the option of inviting the
major oil companies back into their country. Is Saudi Arabia
trying to stabilize the market or increase their market share?
Who are they trying to drive out of the market place? US
Independents? Russia? Mexico? It is obvious that they intend to
increase their production in order to gain a larger market
share if they are willing to share part of their income with
the major oil companies. Have you considered what will happen
if the Saudis increase their production and continue to flood
the market? Major disruptions will continue to drive other
producers out of business. Why should Saudi Arabia be allowed
to increase their market share? Are they declaring an economic
war on other producers such as US independents, Russia, Mexico,
and even their neighboring OPEC producers? If so, is the US
military ready to defend Saudi Arabia from other oil producers
of the world?
Even more frightening is the UN decision which allows Iraq
to increase their market share while they shoot missiles at our
American pilots. It is obvious that Saddam Hussein is not using
Iraq's oil money to provide for the Iraqi people. We request
that Iraqi oil imports be severely restricted as long as Iraq
threatens the region's security. We should deny Saddam Hussein
the money to build missiles and weapons of mass destruction.
Please demand that American oil companies, such as Exxon and
Chevron, stop buying oil from Iraq while they are at war.
Low crude oil prices are a contributing factor in the world
wide deflationary crisis. Oil prices must be viewed in relation
to other industries. For example, the oil and gas industry is a
large consumer of steel products. A new oil well requires about
the same amount of steel required to manufacture 40 to 50 cars.
Low oil prices have reduced the number of wells being drilled
in the US to the lowest level since the late 1940s. Because
fewer wells are being drilled, the volume of steel needed to
manufacture rigs, tanks, casing, tubing, drill pipe, and
pipelines has been dramatically reduced. Due to low oil prices
and weak economies abroad, foreign steel manufacturers can't
find enough buyers so they increased their steel imports into
the US. This resulted in an over supply of steel in the US
which caused steel prices to drop. US steel companies have ask
Congress and the President to restrict steel imports. If you
agree to limit steel imports, we expect you to restrict oil
imports! If much of the steel industry's problems stem from a
drop in oil prices, don't independent oil producers deserve the
same protection as steel manufacturers?
Are today's extremely low oil prices really good for
America? We must consider the short and long term benefits and
costs. As consumers becomes dependent on cheap oil, the
available supply drops. The situation is like a drug addict.
The more we become addicted to cheap oil, the more we risk
supply disruption. We cannot find and produce enough oil to
meet the world's needs at current prices. The current posted
price of oil is below $10.00 per barrel while the price for
paper oil (NYMEX futures contracts) is about $12.00 per barrel.
There will not be enough $10.00 to $12.00 oil available to
supply the world's needs for very long. Oil needs to exceed
$18.00 per barrel in order for producers to have the incentive
to explore for and drill and the additional reserves needed to
stabilize production. If you do nothing and wait a few years
for the situation correct itself, you are risking a return to
supply disruptions similar to the 1970's. The market is out of
balance by less than 5%. When oil supplies are reduced below
demand, a price spike will occur. The domestic industry is
being permanently damaged and it will take years to reverse the
decline rate. Is America better off when oil supplies exceed
demand or when supplies are short?
The low price of oil will correct itself over a period of
time at a very high cost to consumers. This correction will
probably occur after much of the US oil industry is bankrupt
and destroyed. To find and produce large volumes of oil
requires major investments of money and time. The longer the
price is low, the higher the price spike will be on the other
end. It is a natural consequence. During the early 1970s the
low price of oil resulted in a shortage. This resulted in a
huge price spike, economic chaos, and inflation which took
years to correct. If oil prices remain too low for too long we
will repeat the same experience. If corrective actions aren't
implemented soon, I predict the price of oil may exceed $50.00
per barrel in a few years.
A serious supply disruption could take place as early as
January 1, 2000. Much of the world's oil loading and pipeline
capacity is located in third world countries. Most of these
facilities are controlled by computers or computer components
which may experience Y2K problems. Have you considered what
will happen if 25% to 50% of the world's oil supply is
disrupted for 30 days? We have less than a 30 day supply on
hand now. It won't take very long for oil shortages to occur
and oil prices to spike. It will take 5 to 10 years to revive
the US industry because our workers are leaving and our
equipment is being stacked. Serious corrective action should be
taken now.
I recognize that this committee is primarily interested in
tax matters. In that regard, the most meaningful tax relief
measures which would help the industry are a Marginal Well Tax
Credit as proposed by Senator Hutchison, an increase the
depletion allowance to the original 27\1/2\% level, changes in
the Alternative Minimum Tax to eliminate intangible drilling
costs as a preference item, and allowing geologic and
geophysical costs to be expensed in the current year. Most
important of all, a program should be developed to allow the
industry to recoup a substantial portion of the $77 billion in
Windfall Profits Taxes which it paid between 1980-1986, now
that we are making little or no money. That is nothing more
than basic fairness. While these tax breaks are not going to
fix our problems or save our jobs nor save our schools or
hospitals, our communities will benefit from some tax changes.
The troubled independent oil industry is similar to a seriously
hurt accident victim. First aid is required but a few Band-Aids
will not save our industry nor our communities. The surgery of
cutting off Iraqi oil is required. We request that you restrict
imports temporally until US production and prices are
stabilized and a responsible National Energy Policy is in
place.
The current US National Energy Policy is inadequate. A
responsible energy policy should be implemented to help level
out the price spikes on both ends. Prices that are either too
high or too low hurt America's and the world's economies. The
longer you wait and the more addicted America becomes to cheap
oil, the more our economy will be disrupted by the correction
which will inevitably occur. Chairman Houghton, and Honorable
Representatives, I implore you to take action immediately. For
the sake of America's future, please restrict imports now.
News Release from Texas Comptroller Carole Keeton Rylander
For Immediate Release:
Tuesday, February 2, 1999
Contact: Keith Elkins--512-473-4070
Comptroller Supports Emergency Legislation To Aid Oil And Gas Industry
(AUSTIN)--According to an analysis issued by the
Comptroller of Public Accounts today, a decline in oil prices
could have a devastating impact on some local school districts.
``While some consumers may welcome lower prices at the gas
pumps,'' Comptroller Carole Keeton Rylander said today, ``the
trickle down effect on some local property values could have a
serious financial impact for some Texas school districts.''
In some areas of the state, where oil and gas reserves
comprise more than 20 percent of the school's value or where
oil and gas are valued at more than $250 million, it is
estimated total school district losses for the next year will
be approximately $150 to $160 million.
The Comptroller's analysis estimates at least 30 districts
will sustain losses of more than a million dollars for fiscal
year 2000, ranging from a high of $8.3 million in the Iraan-
Sheffield school district located in Pecos to $1.07 million in
the Post school district in Garza.
``The financial shortages facing some school districts as a
result of the crisis in the oil and gas industry are
staggering,'' Rylander said. ``Without emergency assistance
Texas homeowners may see their property tax rates climb even
higher.''
An analysis of declining oil prices on individual school
districts can be found on the Comptroller's Window on State
Government Internet site at http://www.window.state.tx.us.
Potential Oil and Gas Property Tax Levy Losses To Texas School
Districts
The Comptroller's Office surveyed the appraisal districts
or their contract appraisal firms that appraise oil and gas
reserves for property tax purposes. These appraisers are
currently working on appraised values as of January 1, 1999.
Their appraisals will not be complete until about July 25,
1999, after they have been through a local appeals process and
are certified to each taxing unit. The appraisers' consensus is
that oil properties will decline in value from January 1, 1998
to January 1, 1999 by about 40% and that gas properties will
decline by about 15%. This decline in value is caused primarily
by oil and gas price declines.
The Comptroller's Office asked for more specific
information from the appraisers for school districts where oil
and gas reserves comprise more than 20% of the school's total
value or where oil and gas are valued at more than $250 million
as of January 1, 1998. These value losses were translated into
property tax levy losses. The losses will affect school
districts in FY 2000 and will affect the state (through the
school funding formula) in FY 2001. The total statewide FY 2000
school district loss will be approximately $150-160 million.
This is a very rough estimate based on our informal survey of
preliminary figures from local appraisers. 1998 tax rates and
1998 local values for oil and gas properties were reported to
us by school districts.
Below is a listing of FY 2000 school district oil and gas
property tax levy loss estimates sorted from highest to lowest
loss. These estimates may vary from the actual levy losses that
occur after the local appraisal process is complete.
------------------------------------------------------------------------
County Appraisal
School District District Levy Loss
------------------------------------------------------------------------
IRAAN-SHEFFIELD................. Pecos.............. $8,332,800
ANDREWS......................... Andrews............ 7,468,380
ECTOR COUNTY.................... Ector.............. 6,438,346
SEMINOLE........................ Gaines............. 5,486,371
DENVER CITY..................... Yoakum............. 5,250,000
CRANE........................... Crane.............. 3,905,638
MIDLAND......................... Midland............ 3,624,481
CARTHAGE........................ Panola............. 3,233,200
SUNDOWN......................... Hockley............ 3,094,789
LEVELLAND....................... Hockley............ 2,792,254
PINE TREE....................... Gregg.............. 2,448,679
FT STOCKTON..................... Pecos.............. 2,398,770
JAYTON-GIRARD................... Kent............... 2,333,697
CROCKETT CO..................... Crockett........... 1,933,014
ZAPATA.......................... Zapata............. 1,918,152
PLAINS.......................... Yoakum............. 1,875,000
MONAHANS-WICKETT-P.............. Ward............... 1,651,418
REAGAN.......................... Reagan............. 1,596,000
MCCAMEY......................... Upton.............. 1,580,250
WHITEFACE-BLEDSOE............... Cochran............ 1,533,445
GLASSCOCK....................... Glasscock.......... 1,461,129
UNITED.......................... Webb............... 1,355,525
RANKIN.......................... Upton.............. 1,309,000
BORDEN COUNTY................... Borden............. 1,305,000
EDINBURG........................ Hidalgo............ 1,197,232
WINK-LOVING..................... Winkler............ 1,170,000
CONROE.......................... Montgomery......... 1,145,670
CLEAR CREEK..................... Galveston.......... 1,116,226
WEBB CONS....................... Webb............... 1,107,173
POST............................ Garza.............. 1,074,930
KERMIT.......................... Winkler............ 939,000
REFUGIO......................... Refugio............ 852,183
STERLING CITY................... Sterling........... 830,363
SNYDER.......................... Scurry............. 825,000
LOOP............................ Gaines............. 816,204
WHITE OAK....................... Gregg.............. 802,329
WEST RUSK....................... Rusk............... 799,494
GUTHRIE......................... King............... 777,537
DUMAS........................... Moore.............. 763,095
PECOS-BARSTOW-TOYA.............. Reeves............. 757,979
CANADIAN........................ Hemphill........... 747,004
BROOKS.......................... Brooks............. 746,462
BROWNFIELD...................... Terry.............. 742,371
DAWSON.......................... Dawson............. 737,639
FORSAN.......................... Howard............. 734,082
IRION COUNTY.................... Irion.............. 729,682
BRECKENRIDGE.................... Stephens........... 707,865
BECKVILLE....................... Panola............. 689,108
CALDWELL........................ Burleson........... 684,600
LA GRANGE....................... Fayette............ 680,278
LA JOYA......................... Hidalgo............ 664,266
SONORA.......................... Sutton............. 662,400
HAWKINS......................... Wood............... 637,500
LA POYNOR....................... Henderson.......... 632,450
MIAMI........................... Roberts............ 626,503
------------------------------------------------------------------------
Mr. Watkins. Thank you, Mr. Bell, very impressive testimony
and one I know we all take to heart.
Let me ask my good friend from Texas, Congressman Charlie
Stenholm, to introduce his guest and make his remarks. We'll
enter the official remarks as part of the testimony and
summarize it.
We have a vote I think that's been called, but we'll have
time to make sure we get his testimony in, Charlie.
Mr. Stenholm. Thank you, Mr. Chairman. I will be brief, and
I thank you and Mr. Coyne again for holding this hearing.
Bringing folks like Glenn Picquet to the House Ways and Means
Committee helps put a real face on a very real problem which
has ramifications for the entire country to a degree far
greater than what has been expressed thus far. I hope this
hearing will begin to fill the record and paint the picture
which our oil patch is experiencing much more fully.
With all due respect to my colleagues, Glen Picquet is the
only VIP that we will hear from today. I know there are
different views on that, but he's the only voter in the 17th
District that we will hear from today. I just want to make that
comment, and recognize Glenn's tremendous leadership within the
district and the efforts he has made to reach out to others
regarding this issue. We have heard about the effects of low
oil prices on funding for our schools, and mentioned the effect
of low prices on hospitals. Obviously, the effects of hard
times on producers have a significant impact on all areas of
our economy.
To find a solution to this crisis, you have got to get
other folks involved. Glenn has been very active in reaching
out to build a coalition of folks to bring this issue to the
forefront. He comes this morning to testify on behalf of his
company, C.E. Jacobs Company, in Albany, also the West Central
Texas Oil & Gas Association, the North Texas Oil & Gas
Association, the Panhandle Producers & Royalty Owners
Association, the Permian Basin Petroleum Association, and the
Texas Independent Producers & Royalty Owners Association.
Glenn, I thank you and the other witnesses for taking the
time to be here. Your participation helps put a real face on a
very real problem.
STATEMENT OF GLENN PICQUET, EXECUTIVE VICE PRESIDENT, C.E.
JACOBS COMPANY, ALBANY, TEXAS; ON BEHALF OF NORTH TEXAS OIL &
GAS ASSOCIATION, PANHANDLE PRODUCERS & ROYALTY OWNERS
ASSOCIATION, PERMIAN BASIN PETROLEUM ASSOCIATION, WEST CENTRAL
TEXAS OIL & GAS ASSOCIATIONS, AND TEXAS INDEPENDENT PRODUCERS &
ROYALTY OWNERS ASSOCIATION
Mr. Picquet. Thank you, Congressman. I do appreciate the
invitation, the opportunity to testify. As Congressman Stenholm
noted, I do represent, together on these five associations,
more than 5,000 individuals and companies, primarily based in
Texas, that explore for and produce crude oil and natural gas.
These are small companies with less than 100 employees. Most
have less than 10 employees. I also have with me these
petitions, this stack of petitions here, signed by more than
12,000 individuals asking the Congress to take action to
preserve the domestic oil and gas industry.
I'm going to spare you the reading of my prepared
statement, as requested by the Chairman. That statement does
discuss the problems the crisis has created, and it also spells
out some possible solutions.
But I do want to tell you how this crisis has affected my
company and our employees. This is about Americans, American
workers, American jobs. It's about small, and in many cases,
family-owned, second- and third-generation American oil
producers competing with foreign governments. There are a large
number of hard-working, regular folks whose jobs are in danger
of being lost because of the unchecked flow of cheap crude oil
into this country at unprecedented levels.
This is not a fair situation. Foreign governments have
elected to flood the market, driving down the price of our
product, forcing layoffs of oil field workers, and causing the
premature closing of thousands of wells. This is a tragic loss
of investment and reserves, and it is creating a dangerous
threat to our national security.
My company, C.E. Jacobs Company, has been a successful
independent producer since shortly after World War II. We have
maintained a staff of between 15 and 20 employees during that
time, typically drilling between 10 and 20 wells per year. We
survived the extreme drop in oil prices in 1986 and have
managed to stay in business during the past 13 years despite
the low prices and the heavy tax load and high cost of
environmental protection that have been added to the cost of
doing business.
In 1997 we did have to reduce staff. And we have been
unable to drill any new wells to offset our production decline
for the past couple of years. And we have been hanging on with
hopes that crude oil prices will return to a level where we can
actually make a profit and have a positive return on our
investment again.
But with a further drop in crude oil prices during 1998, we
find ourselves in uncharted territory, and frankly, we are
scared. The most painful part of this crisis involves our
employees. They have had only a couple of salary increases in
the past 13 years, while they have seen their benefits packages
slowly eroding. We are now faced with either reducing benefits
further or reducing staff again.
Let me tell you about some of the people that used to work
for us that are no longer with us. We've lost a lot of talent.
In 1997 we closed our geological office in Abilene, terminating
a relationship with our chief geologist, Bill Burton, who was
responsible for the success of our wildcat drilling program for
four decades. We could no longer afford the overhead associated
with his office, nor could we come up with the capital to
finance his drilling programs.
Also released from employment at that time was his protege,
a young, promising geologist, Paul Zimmerman. We also lost our
production foreman, who decided to take a chance by purchasing
his own lease and operating it himself. I promise he wishes he
was back with us today. Then last year, our best heavy-
equipment operator, Steven Williamson, decided that the oil
patch probably would not be around long enough to provide him
with a job until normal retirement age, which is about 25 years
from now, so he went to work for a new cast-iron foundry
nearby.
Then our chief financial officer, Ken Thompson, left to
take a job leading the business division of Region 14 Education
Service Center in Abilene, ``because education will always be
there.''
Even with these losses of employees, we found that by this
past Christmas our operating company was still not profitable,
so effective January 1, 1999, we terminated two contract
pumpers, not because of a lack of ability or anything they had
done wrong, but because we simply could not afford to keep them
on the payroll with crude oil prices so low and with so many
wells shut in due to being unprofitable.
Now, this is not a scenario that is unique to my company.
We look around us and we see this story repeated over and over.
Good, experienced oil field employees are leaving the industry
and not being replaced. American jobs are being lost at an
unprecedented rate because of the actions of foreign
governments that export oil.
Therefore, on behalf of the 5,000 members of the combined
associations that I represent and the more than 12,000 petition
signers that are displayed here today, I urge you and the
Congress to take action to save the domestic oil and gas
industry.
That concludes my remarks, with the exception that I do
want to comment on Congressman Thomas' question: Yes, we
definitely can benefit from the proposed legislation, proposed
tax changes. And I also do want to reiterate what some of my
colleagues have said, that the Treasury Department spokesman
was definitely wrong. We independent producers do pay a lot
taxes, and we have paid a lot of taxes.
OK, that concludes my remarks.
Thank you.
[The prepared statement follows:]
Statement of Glenn Picquet, Executive Vice President, C.E. Jacobs
Company, Albany, Texas; on Behalf of North Texas Oil & Gas Association,
Panhandle Producers & Royalty Owners Association, Permian Basin
Petroleum Association, West Central Texas Oil & Gas Associations, and
Texas Independent Producers & Royalty Owners Association
Thank you Chairman Houghton for allowing me to make this
statement on behalf of the North Texas Oil and Gas Association,
the Panhandle Producers & Royalty Owners Association, the
Permian Basin Petroleum Association, the West Central Texas Oil
and Gas Association, and the Texas Independent Producers &
Royalty Owners Association. Together we represent more than
5,000 individuals and companies that are primarily based in
Texas that explore for and produce crude oil and natural gas.
They are generally small companies with a majority having less
than 100 employees, and most have less than 10 employees.
The decline in crude oil prices in 1998 has had a
devastating impact on independents. A December 1998 report of
the Interstate Oil and Gas Compact Commission (IOGCC), which is
composed of the Governors of the oil and gas producing states
from across the nation, notes that the U.S. oil and gas
industry is particularly susceptible to long periods of low
crude oil prices. This is true largely because about three-
fourths of the nation's oil wells are marginally economic.
About 436,000 of the nation's 573,000 oil wells produce less
than 10 barrels per day. On average, these low-volume
``stripper'' oil wells produce 2.2 barrels per day. At these
quantities, low crude oil prices may not cover production
costs. During periods of low prices, wells are idled, produced
only sporadically to meet minimum lease requirements, or
plugged and abandoned. Marginal wells provide about 25 percent
of the domestic crude oil production, excluding Alaska and
federal offshore.
Higher volume wells are impacted, too.
As revenue for domestic producers falls, there are usually
cutbacks in exploration and production expenditures;
corresponding reductions in taxes for state, federal, and local
economies; decreased revenue for royalty owners; job cuts in
the energy industry and supporting services; and an increase in
imports.
A dramatic illustration of vulnerability of U.S. oil wells
comes from the fact that the average oil production per well in
the U.S. is 11 barrels per day. Compare that to the average
production per well in Saudi Arabia is 5,773 barrels per day
per well.
Companies' ability to raise capital for drilling and
completion programs has also been affected. While low oil
prices made tapping debt and equity markets trying for much of
the year, recent turmoil in global markets now appears to be
shutting down capital markets entirely for most (energy) firms.
Energy concerns raised just $7.7 billion in capital markets
during the third quarter, the lowest total since the third
quarter of 1996. Independent companies, pinched by lower stock
prices and reduced cash flow, also are finding it more
difficult to obtain loans.
As a natural consequence, rig counts are down
significantly. Since its high in 1981 of 4,500, the total
number of rotary rigs running in the United States--including
oil, gas, directional, horizontal, vertical and miscellaneous--
decreased to an all-time low of 558 in January 1999.
Current revenue figures on the impact of lower production,
prices and royalty payments on the federal government are not
available. However, the August auction of leases in the Gulf of
Mexico reflects an industry slowdown.
Bids dropped sharply for the latest auction of offshore
petroleum leases in the western Gulf of Mexico, mostly near the
coast of Texas. The Minerals Management Service reports 486
bids were received in its most recent sale for 402 tracts in
the western Gulf. That's far off the record, 1,224 bids taken
on 804 tracts for the western Gulf sale in August 1997. High
bids for that sale totaled $616.2 million, according to IOGCC.
Several states rely on taxes and royalty income for their
general fund and for school funding. A decrease in production
results in lower revenues for states from severance taxes,
conservation taxes and ad valorem taxes. A decrease in
production from leases on public lands also impacts states by
reducing royalty payments, which are often used to fund public
education.
The IOGCC stated that in the first six months of 1998, an
estimated 48,702 wells have been idled or shut in, according to
a recent survey of 23 states. If these wells were plugged and
abandoned, it would represent a 142 percent increase over the
number of wells (20,087) plugged and abandoned in 1997.
In Texas, oil severance tax revenues have fallen $94.9
million in the first eight months. This represents a reduction
of 34 percent. About 2,800 jobs have been lost and 1,087 oil
wells idled or shut in.
The IOGCC report states that a group of large independents
posted a combined loss of $854.4 million in the first half of
1998, compared with a profit of $2.02 million for the first six
months of 1997. Revenues for this group fell 12.2 percent.
Despite an increase in revenue, a group of 30 small
independents posted a collective loss of $68.5 million for the
first half of 1998, compared with a profit of $47.2 million in
1997.
For major, integrated companies, earnings from domestic oil
and gas production declined 50 percent, according to the Energy
Information Administration.
In the past 15 years, the domestic production industry has
changed dramatically. In 1981, nearly 1.9 million people were
employed in the oil and gas industry. By 1996, the total
employment was 1.4 million. Forecasts indicate continued
employment losses.
States have estimated that nearly 11,000 jobs in the oil
and gas exploration and production sector have been lost this
year.
The list of companies that have cut employees is extensive.
The Independent Petroleum Association of America estimates that
24,415 jobs have been lost since the price decline began in
November 1997. Based a survey of independents, IPAA estimates
that if oil prices remain at $14 or lower for another six
months, and additional 17,279 jobs will be lost.
In general, the domestic oil and gas industry is heavily
dependent on smaller independent operators, as opposed to
large, integrated companies. Many of the major oil companies
are concentrating their expenditures abroad. Independent oil
and gas operators accounted for drilling 85 percent of the
domestic wells, producing 45 percent of the crude oil and 60
percent of domestic gas.
In addition to layoffs, the reduction in earnings has cut
back exploration and production budgets across the board. For
the third quarter of 1998, completions of oil wells, natural
gas wells and dry holes declined by 18 percent, compared with
the same period last year. In the third quarter, oil well
completions declined 25 percent to 2,361. Also for the quarter,
completions of exploratory wells were down 20 percent and
development-well completions dropped 17 percent, IOGCC said.
The United States continues to rely heavily on petroleum as
its major energy source. Petroleum demand is projected to grow
at 1.2 percent per year through 2020 with 70 percent of the
total used for transportation fuel, including gasoline, diesel
and aviation fuel according to the Energy Information
Administration's 1999 annual energy outlook. With domestic
demand increasing and domestic supply decreasing, the U.S.
relies heavily on imported oil and this trend is expected to
continue. Many within government believe that this could create
a national security problem.
In December 1994, the Department of Commerce found that
``...the reduction in exploration, dwindling reserves, falling
production, and the relatively high cost of U.S. production all
point toward a contraction of the U.S. petroleum industry and
increasing imports from OPEC sources. Growing import
dependence, in turn, increases U.S. vulnerability to a supply
disruption because non-OPEC sources lack surge production
capacity; and there are at present no substitutes for oil-based
transportation fuels. Given the above factors, the Department
finds that petroleum imports threaten to impair the national
security.''
President Bill Clinton stated in February 1995 that ``I am
today concurring with the Department of Commerce's finding that
the nation's growing reliance on imports of crude oil and
refined petroleum products threaten the nation's security
because they increase U.S. vulnerability to oil supply
interruptions. I also concur with the Department's
recommendation that the Administration continue its present
efforts to improve U.S. energy security, rather than to adopt a
specific import adjustment mechanism. (Emphasis added)'' The
situation is worse in 1999 than in 1995.
According to a poll taken by the Sustainable Energy
Coalition, more than four out of five registered voters believe
that the United States is still vulnerable to an energy crisis
that could be caused by foreign nations shutting off oil
supplies to this country. ``The poll...shows that an
overwhelming majority of Americans believe that rising oil
imports are a threat to our economic, environmental and
national security,'' said Bill Richardson, U.S. Secretary of
Energy.
The IOGCC report concludes that every key indicator of the
health of the domestic oil and gas industry--earnings,
employment, production, rig counts, rig rates and seismic
activity--is down. ``If crude oil prices remain at continued
low levels, there will likely be further contraction in the
industry, a negative effect on economies of the states and
nation due to a loss of tax revenues and jobs, the further loss
of skilled labor, and increasing imports of crude oil,'' the
report stated.
Additionally, exploration for and production of natural gas
is projected to be impacted as overall earnings reductions
result in lower capital expenditures in industry.
In conclusion, we believe that the U.S. Congress and the
Clinton Administration should enacted a national energy policy
that stresses trade fairness and that the domestic oil and gas
industry is a viable aspect of the country's national and
economic security. We believe that a new American consensus
must be forged to reduce our nation's growing dependence on
imported oil; to stabilize U.S. crude oil and natural gas
production; to ensure reliability of oil and natural gas
supplies; to protect our national and economic security; and to
save jobs of Americans. We know that the status quo has not
worked. Now is the time for bold and aggressive action!
Therefore, we suggest the following solutions:
Market stability--The Congress and President must
recognized that domestic oil and gas producers--publicly and
privately held companies--must compete today in a global
economy against foreign governments that control their
petroleum production. As stated earlier, U.S. producers are at
a competitive disadvantage against foreign governments when our
average production is 11 barrels per day per well and when
Saudi Arabia produces 5,773 barrels per day per well.
Additionally, foreign governments do not have to pay the many
taxes imposed on U.S. oil production (income, state severance,
property taxes, state franchise taxes and sales taxes) and
comply with a myriad of costly regulations.
Venezuela and Saudi Arabia have been fighting to increase
their market share in the U.S. Sheikh Ahmed Zaki Yamani, former
oil minister to Saudi Arabia, told and audience at Southern
Methodist University in December 1998 that upstream cash
squeeze is beginning to make serious inroad into drill rates
and could affect actual production on non-OPEC areas sooner
than expected. ``After all, if OPEC is to gain market share, as
it hopes to do, it must do so from their higher-cost producers
elsewhere,'' Yamani said. By driving down prices, OPEC can
drive out high-cost U.S. production and replace it with their
own. We believe that the U.S. government should recognize that
this will be detrimental to U.S. producers and consumers in the
long term. Many independent oil and gas producers have
suspected improprieties by foreign oil exporters and other
investors, that could benefit from crude price futures
fluctuation. The number of crude oil futures contracts traded
far exceeds worldwide crude oil production. Foreign oil
producers can influence the crude oil markets by increasing or
decreasing their production having a dramatic effect on the
world crude oil price. As a result, they have the ability to
directly influence their commodity price and the futures price.
They are in an unique position of being able to determine the
direction of the crude oil future price. In our opinion this
ability has serious anti-trust and restraint of trade
implications. Therefore, we urge the Congress to investigate
these allegations of improper trade practices within domestic
U.S. markets by foreign oil producers.
We also encourage the Congress and the President to
implement market stabilizing mechanism that would include a fee
placed upon each barrel of oil and refined product that enters
the U.S. by tanker or vessel. The American Petroleum Institute
reports that from 1980 to 1994 there were 58,159,000 gallons of
petroleum products spilled from tankers, barges, freighters and
other vessels compared to only 823,000 gallons from offshore
facilities. We believe that foreign oil and products should pay
for environmental remediation as does domestic production. In
Texas alone, producers have funded its own environmental
plugging and cleanup fund that has totaled more than $45
million from 1984 to 1996. Foreign oil should pay its fair
share.
Federal tax relief--Many oil and gas producing
states have recognized that as long as oil and natural gas
wells continue to produce they are an asset to the state,
providing jobs and tax revenues. The IOGCC has produced a
report, Investments in Energy Security: State Incentives to
Maximize Oil and Gas Recovery, that catalogues incentives in 17
states that have a combined economic impact of more than $16
billion each year. For each dollar invested in incentives,
state and some local tax streams receive an average of $2.27 in
return. In the process, high-paying jobs are created inside and
outside the industry and resources are recovered that otherwise
would be lost. We encourage the Congress to enact a tax package
that would provide similar results. These provisions--a
marginal well tax credit, an inactive well provision, immediate
expensing of geological and geophysical costs and delay
rentals, hydro and horizontal drilling classified as tertiary
recovery projects and a tax credit for new drilling--were
included in a comprehensive bill introduced in the last session
of Congress by U.S. Senator Kay Bailey Hutchison (R-Tx), S.B.
1929. I understand that a similar bill will be introduced
shortly by Senator Hutchison in the 106th Congress, and we
encourage the Congress to pass it quickly.
Other legislative solutions--(1) Independent oil
and natural gas producers need an exemption from anti-trust
laws to form cooperatives to sell our crude oil and natural
gas. The mergers within the major oil companies are creating
fewer and fewer outlets for products. Competition is dwindling
in the oil patch. If independents are to have a strong
bargaining position, they must be able to form cooperatives to
market their only source of revenue--the sale of oil and/or
natural gas.
(2) The federal government should purchase crude oil from
domestic oil producers to resume filling the Strategic
Petroleum Reserve (SPR) while prices are low. The Congress
should allocate funds in its budget for this expenditure.
(3) Enact royalty-in-kind legislation that allows the
federal government to take its oil in-kind when it does not
want the operator of its leases to sell the oil. Also, the
Congress should enact a law that allow for producers to defer
royalty payments to the federal government when prices drop
below $15 per barrel, and reduce federal royalty on marginal
leases (those producing 15 barrels per day per well or less).
Environmental laws and regulations--The petroleum
industry spent $8.2 billion in environmental expenditures in
1996, which is about one-fourth of the net income of the top
200 oil and natural gas companies, according to the Petroleum
Industry Environmental Performance Sixth Annual Report by the
American Petroleum Institute. This is more than the
Environmental Protection Agency's entire budget and comes to
$83 per U.S. household. Obviously, environmental regulations
have become a big cost of doing business for domestic oil and
gas producers. Since the 1970s the federal government has
passed 10 laws that impact the petroleum industry. And, this
does not take into consideration the many regulations that must
accompany these laws, and the laws and regulations implemented
by states. We believe that laws and regulations should take
into consideration the cost of compliance and the benefits
derived from society. If the cost are exorbitant and the
benefits small, then Congress should reject or strike these
laws from the books.
A few key areas that Congress should focus on to bring back
some common sense to environmental laws and regulations for oil
and gas are:
(1) Congress must ensure that the EPA does not expand the
Toxic Release Inventory program to include exploration and
production wastes. TRI reporting would provide virtually no
environmental or community ``right to know'' value because of
the remoteness of most exploration and production facilities.
In addition, the episodic nature of events within the industry
would make year-to-year comparisons of TRI data meaningless.
Expansion would created a huge new paperwork burden for
independent oil and gas producers, and would cost industry more
than $200 million in first year compliance costs and more than
$100 million each subsequent year, according to the American
Petroleum Institute.
(2) Congress should reject EPA's effort to remove oil and
gas production's exemption from Subtitle C hazardous waste
requirements under the Resource Conservation Recovery Act, and
let state continue adopting regulations that are pertinent to
their area.
(3) Compliance with procedures dictated in EPA's Spill
Prevention, Control, and Countermeasure Plans (SPCC) are
confusing and costly with little benefit to the protection of
surface waters. Tank batteries near ``navigable'' water must
have costly studies completed, then constructed with dikes or
berms around them, and detailed paperwork must be completed on
the continuous inspection and upkeep of the facilities. The
definition of ``navigable'' water is so broad that it applies
to dry creek beds in arid West Texas. It should be redefined
close to Webster's definition: ``deep enough and wide enough to
afford passage to ships.''
SPCC plans have expense built into them that is not
necessary for the oil industry when dealing with oil and gas
leases. For example, there is no need to require a registered
engineer to approve the plan, and to recertify if a material
Change is made in a lease facility. Spills that do not involve
contamination of fresh water needs to be addressed as a
separate issue, because crude oil is a naturally occurring
organic compound that can be reduced and cleaned up by
naturally occurring bacteria. Many wells are prematurely
plugged because the rule requires mechanical integrity tests
instead of allowing wells to be monitored at the surface.
Regulations concerning hazardous chemicals should be
different for oil and gas leases in remote areas. Annual
filings concerning crude oil in storage in remote areas is not
necessary.
(4) Current Department of Transportation rules require
``certain person'' that transport or ``offers'' for transport
crude oil in quantities of more than 83\1/3\ barrels to
register under its Hazardous Materials Registration Program
(HMRP) and pay a $300 registration fee. We believe that
legislation should be passed to clarify that crude oil
operators that sell their oil at the lease not be require to
register under HMRP.
Mr. Chairman, the members, officers and directors of NTOGA,
PPROA, PBPA, WeCTOGA and TIPRO encourage you and other members
of Congress to look favorably upon these proposals. We seek
only what is fair. We ask that you consider the fairness of
competition between foreign governments and small independent
producers. We ask that you consider what is fair in the tax
code when small independents must pay many taxes and yet
foreign oil pays little if any. We ask that you consider the
fairness of the mountains of environmental laws and regulations
that small companies must comply with just as major oil
companies.
Mr. Chairman, the members of these associations are not
asking for a hand out; all we seek is a helping hand up!
Thank you for allowing us the opportunity to submit these
comments.
Mr. Watkins. Thank you very, very much.
We are going to have to go and cast a vote, so we'll take
about a 5-minute recess. I figure maybe some of you may need a
rest stop, also a bathroom stop. We will return, and I'm
looking forward to having a discussion back and forth on some
of the solutions, what we think might be our high priorities,
and some of the things we can get done. So we will return in
about 5 minutes.
[Recess.]
Mr. Watkins. Before we bring the hearing back to order, I
wish my Congressman and good colleague, Bill Thomas from
California, were here. I would just like to say to him that
they may produce more oil, but we got more people here, we must
have more people hurting, to say the least. I think we are all
hurting in the oil patch.
Congressman Lucas and I are here. We want to have some
discussion. And I'd like to ask my colleague from Oklahoma,
Frank Lucas, whom I appreciate very much because he's one who
is willing to get up early and stay late to try to find
solutions.
Now, I'd just like to recognize the fact that the
Department of Energy must not have any priority on trying to
solve the problem. That is the only conclusion I can reach or
they would have had someone here. And that's a real shame and a
crime, an indictment, I think, against their not having
concern.
I just don't understand it, personally. But I know many of
us from Oklahoma discussed the fact that the energy industry is
paying the price of having, in some respects, a strong economy
because as long as the prices are going down, inflation is sure
not going to be going up.
Mr. Lucas, any questions?
Mr. Lucas. Yes, Mr. Chairman. Thank you for the
opportunity. I think, if I could for just a moment, I'd like to
turn to Mr. Cantrell. We both, I think, had our blood pressure
go up a notch or two at different times in the Treasury
gentleman's comments. Could you touch on for just a moment,
from your perspective as an active participant in the business,
the comment that 75 percent of the folks who are in the energy
industry business don't pay any taxes.
Maybe I misunderstood him. Could you expand on that for
just a moment?
Mr. Cantrell. That is really totally foreign, Congressman,
to my experience. With independent oil and gas producers, why
would we be pushing the marginal oil tax credit of Congressman
Watkins, why would we be in favor of that if it didn't do us
any good. I agree that most of us aren't going to pay taxes in
the calendar year 1998 cause we have lost so much money. We're
not going to pay taxes that year.
But over the last 5 years we have paid an enormous amount
of taxes. And I don't know, I'd like to further investigate
where that comes from. I know that as far as the multinational
companies are concerned, it doesn't surprise me they don't pay
taxes because they get to deduct as their royalty payments to
foreign governments like Saudi Arabia in the form of foreign
tax credits, which go right against their United States tax
bill. So it's no surprise they don't pay income taxes perhaps.
But as far as independent oil and gas producers, that's a
shocking statement. I just don't believe it to be true. Or why
would our folks continue to ask for tax incentives?
Mr. Lucas. I absolutely agree with you on the question.
Now, for the panel as a whole, another point that I found very
difficult to digest. When I characterized some of the things
going on in the international oil market, either as dumping or
predatory practices, we got what I understood to be a response
that no, that was not correct.
From your observations, and I'm addressing this to the
panel as a whole, whoever would care to, how else can you
describe what's going on out there in the international market
other than dumping or predatory practices as far as shoving so
much petroleum out there to exterminate the competition, being
U.S. producers. Inevitably then to lead to a situation with
fewer producers, ultimately higher prices. Isn't that dumping
with the goal of wiping out your competition? Is that predatory
practices? Anyone on the panel who would care to comment?
Mr. Macpherson. I'll just comment by saying that it's no
secret that OPEC has an objective to increase market share, and
we are their target. Our market is what they are after. They
are after our industry, and they are picking up that market.
And that's been open discussion around the world. So there's no
secret about that. We are the target. And if you compare our
costs of producing oil with all the environmental costs
associated with it, with the costs of foreign countries that do
not have those costs, I think there is a real unlevel
playingfield.
Mr. Lucas. If I could, Mr. Chairman, I think I would like
to enter into the record a newspaper story from the Daily
Oklahoman in Oklahoma City this morning referring to wheat
prices and the Iraqis, and they quote in there a wire service
report that an Iraqi government newspaper, the name of which
I'll not pretend to pronounce, ``said Tuesday that the Iraqis
won't buy anything in the future from the United States,
Britain, Japan, or Switzerland.'' They further quote the
executive director of the Oklahoma Wheat Commission, and I
paraphrase, that the Iraqis were the United States seventh
largest wheat customers last year.
I find it very ironic that these folks in this free-trade
world that we supposedly live in, while at the same time they
are shoving out 2 million barrels a day extra crude oil, are
withdrawing from participation in buying anything from us.
And that looks like an absolute--well, it stands for
itself.
[The information follows:]
Article from Daily Oklahoman on Wheat Prices Fall; Iraq Shuns Imports
by Bryan Painter
Many in the Oklahoma wheat industry watched low prices go
lower Wednesday.
The Kansas City March futures for hard red winter wheat
dropped 8\1/4\ cents to $2.75\1/4\.
Several elevators in Oklahoma reported a cash price of
$2.20 per bushel Wednesday, according to The Associated Press.
Mike Cassidy at Cassidy Grain Co. in Frederick said the
cash price was $2.89 per bushel Jan. 8 and $2.64 per bushel
Feb. 5.
By Wednesday that price had dropped to $2.28 per bushel,
Cassidy said.
``Last harvest most producers in my area entered the nine-
month government loan program, which expires March 31,'' he
said. ``So, I think the lower prices are a result of an
anticipation of loan redemptions hitting the market in the next
60 days.''
In other wheat-related news, a wire service has reported
that the United States has possibly lost a major wheat export
sales customer.
An Iraqi government newspaper--al-Ittehad--said Tuesday
that Iraq won't buy anything in the future from the United
States or Britain.
Last year, Iraq was the United States' seventh-largest
wheat customer, said Mark Hodges, executive director of the
Oklahoma Wheat Commission.
``But the important fact for Oklahomans is that they bought
100 percent hard red winter wheat,'' Hodges said. ``So they
were fourth in hard red winter wheat purchases.''
A year ago, Iraq had purchased more than 700,000 metric
tons of wheat. As of Feb. 11, it had purchased slightly more
than 250,000 metric tons.
``Obviously, this is a disappointment,'' said Nelson
Denlinger, of trade group U.S. Wheat Associates in Washington,
in a telephone interview with Dow Jones Newswires. ``Iraq likes
our hard red winter wheat, and they've been very good customers
over the years--before and after the Gulf War. We were lucky to
sell them well over 1 million metric tons in the last two years
despite the military situation, and we hope this isn't
permanent.''
Onukaba A. Oja, an information officer for the U.N. program
in Baghdad, said Wednesday the United Nations has no authority
over Iraq's buying decisions.
Mr. Watkins. Your point is well taken, my colleague from
Oklahoma. That article goes further to say they buy hard, red
winter wheat, which we produce. They are the fourth largest
buyers of hard red winter wheat. So they are turning,
definitely their backs there, at the same time, not only
killing our farmers, they are also killing the independent
producers. And I appreciate your point that you made there.
We are honored also to have a colleague from the State of
Washington that's joined us, a leader in the Congress in many
respects, in a lot of different areas. I'm delighted that
Congresswoman Jennifer Dunn has joined us. Would you like to
ask some questions or comments?
Ms. Dunn. Thank you very much, Mr. Chairman. And I'm sorry,
I apologize for coming in late. We had some required activities
that we had to do, having to do with tax relief. And I hope
some of it will help you in ways different from what we are
talking about here, but possibly in the long run.
I do want to express to you my appreciation for what your
colleagues help us to understand. Wes Watkins, Frank Lucas, Sam
Johnson, all the people who represent you and your industry in
the Congress, have been very helpful in explaining to us the
criticality of the situation in the oil patch.
I want to take this from a point of view, though, of what
we can do on a taxwriting Subcommittee. And I guess what I
would ask you first is, in your opinion, do you think that tax
incentives are the best way to address the consequences of what
you are going through now, the low oil prices, or do you think
we also ought to be paying attention to regulatory changes or
to other types of changes?
And anybody may answer, please.
Mr. Solich. I believe your question is a cogent question.
We are focused on tax right now because we are in front of this
Subcommittee. The regulatory burden on independent producers
has grown increasingly. In fact, the environment between
independent producers and the regulatory agencies has grown
more acrimonious and adversarial over the last several years.
Those agencies--for instance, our company is in Colorado.
We have been headquartered in Denver for 44 years and have
operated on Federal lands extensively. Those operations have
grown more and more costly, burdensome, extraordinary time
delays. I think the answer to your question is, we need to move
forward on both fronts.
And I think there is a significant disconnect in
perception. The perception that low oil prices now are good
because they help the economy, and one of the panelists today
quoted it as a siren song. I think that's right. The problem is
when the demand for domestic crude increases, the industry's
ability to respond to that is going to be substantially
weakened. We can't turn on and off like a light switch.
The lead time from ground zero to getting an oil well or a
gas well producing may be as long as 5 years or more. To the
extent the industry's infrastructure is damaged or the burdens
placed on us in accessing Federal lands, lengthen that time
delay, and that is going to result in substantially higher
prices in the long run and damage to the economy.
Mr. Cantrell. Could I also respond, too? Tax incentives
would be a tremendous help, but I would be less than honest
with you today if we didn't run up the red flag that that is
not going to be enough to save the basic infrastructure of oil
and gas in this country. Some way, we have got to come to grips
with the country of the true cost of imported oil. The
subsidization of other countries producing oil, the cost of
defense associated with that oil. Last time I looked, my
production on the South Canadian River isn't guarded by any
Coast Guard trawlers or battleships. We don't have any cost
associated with that for defense for our oil, and yet we do pay
$4 a barrel more for environmental costs than any other country
in the world.
So somewhere or another, if you want to save the domestic
infrastructure, pay me now, pay me later. If you want to save
the domestic infrastructure for the long-term benefit of all
consumers, and all Americans, then you are going to have to
address the price. We're not going to be a viable, domestic
industry as long as foreign governments can flood the market,
dump oil on our industry, take us out of business--and that is
oil that will never come back.
Our mature oil fields, once you abandon those and once you
shut them down, you are not going to get them back. And they
are not going to be profitable to drill for again. Oklahoma oil
wells average 2.5 barrels a day a well. We're just not going to
go back and get those again. And they make up a tremendous
strategic petroleum reserve all put together. But once they are
gone, they are gone. And that is a fundamental decision you all
need to make.
Mr. Bell. I'd like to address that just 1 second. I feel
like it's, we have been in a train wreck, and as the ambulances
start showing up, we've got to have some first aid to get us to
the point we need to get to. So we need the tax basis or a
start in their help in applying some first aid, maybe getting
an ambulance to the hospital. But the real surgery that we need
is, I think we need to surgically cut off Iraq. As long as they
are continuing to shoot at our pilots and to try to intervene
in world commodities and, I think, they are dumping oil, I
don't see how it is any other way.
This is a battle over market share. This is not, in
reality, it's not a fair line battle. It's a battle over market
share. Saudi Arabia and Venezuela--and the Saudis, I don't
guess I blame them, but I understand they are in a battle of
market share between Venezuela and Iran, and they have been
cheating for years. And Iraq dumps an additional 2 million
barrels a day on the market. What we are dealing with is
something that is just atrocious.
The gentleman that had referred to earlier that we didn't
pay taxes--we had $77 billion taken out of this industry in the
name of windfall-profits tax when things were good for us. And
now, when we are getting kicked and while we are down, we need
some help. We need--maybe just send us our $77 billion back and
we'll figure out if we can make that work. Somewhere here,
we've got to balance that. But we are for restricting imports,
and specifically we need to shoot out--Iraq ought to be a
pretty easy target. I think we are shooting at them every day.
We need to shoot a volley that way.
Mr. Picquet. Could I just add in response to that? On the
marginal well tax credit, I believe that is one of the more
important things put forward for the little operators, the
really small operators, because that will undoubtedly extend
the economic life of these wells and keep these jobs in place
for the longest period of time. And 25 percent of our domestic
production does come from marginal wells. And every well will
be marginal at some point in its life. So I think that would be
a huge help for small independents.
Mr. Watkins. Good point. I appreciate Congresswoman Dunn
being here. She had a very viable and sincere question about
taxes. I think you have answered it. I want to mention to
Jennifer that other places in this body could help us. With
Iraq right now, in 1 year, they have increased their production
from 500,000 barrels to 2.5 million barrels a day. That's over
2 million. And that's why we are lobbing bombs over there, and
we have had, with the United Nations Security Council, allowing
them to produce food for oil, and they have gone to the black
market, and no one is doing anything about it. They are
literally flooding with 2 million.
Now Venezuela has been up to 500,000 barrels more per day
than what they have said under their quotas. Other Arab
countries are over production. All this glut, dumping if you
please, dumping on. At the same time, the Asia market has gone
down. The steel industry's affecting that, and there's suits
coming on that. So, when you--there are other places if they
would cinch it up and try to help, could help us just within
the policies that they are supposed to be following.
They are violating the policies that we have set, and we do
nothing. The administration does nothing on this phase of it.
And I see my friend from Texas, Charlie Stenholm, has made
it back.
But I want to say to Mr. Picquet there, I didn't overlook
those 12,000 names that you had up on the side. I'm always
looking for ways that we can try to signal to the people up
here, get their attention. As Congresswoman Dunn indicated,
people want in some cases the help in work, getting to
understand. And it may be something that we may not want to
overlook out across this country.
I think it needs to be put in a way of national security
and national problems we have internationally now with some of
these countries. So we may want to follow up on that a little
later.
My good friend from Abilene.
Mr. Stenholm. I have a question for the panel: In the
earlier panel, Mr. Lubick wasn't very encouraging in his
remarks on the tax proposals, based on his opinion regarding
whether the tax proposals would be adequate or necessary. Mr.
Picquet, you indicated that the tax proposals certainly would
be of help to you. I believe you spoke for most of the industry
that there are some positive things to be derived from
additional considerations in the Tax Code. But the Secretary
also said we need to be looking at other ways to deal with the
problem, and that's price.
I have sensed in all of my conversations with the
independent oil industry that the problem is price. It's the
same discussion that we are having two floors up this morning
in the Agriculture Committee. We've got the same problem with
agriculture. It's price.
And it's the same entities that are causing our problem.
It's governments of the rest of the world. It is not a free
enterprise relationship that we have between producers in other
countries and producers in this country. It is governments, and
national and international policy. And I just wondered if
anyone had observations--what we've always used to do,
traditionally, until the 1995-96 farm bill took away the
general philosophy for this country for food has been that we
should set a minimum price, not a profitable price, but a price
in which, if the worst happened because of weather or
production in other countries or policy, that you would not
have what we are now beginning to see.
Any comments that any of you would care to make regarding
that kind of an approach in which we look at guaranteed floor
price? I believe it might be justified because it is in our
national interest. Any comment any of you would like to make on
that? If not, you can just think about it and proceed on, but--
--
Mr. Solich. Congressman, I think the issue is perhaps only
partly price. I think the issue may be net income as a
consequence of both price and cost. The observation was made
earlier today that when prices are down, we all come here and
we sort of whine to Congress, please help us. I think all of us
were sort of stunned by that statement. What we are asking for
today is for Congress to let us keep a larger portion of what
already belongs to us. And that's our income. That's why we are
addressing the tax measures.
I think it's unknown yet to what extent the tax measures we
are talking about will solve the current crisis. But those
measures, whatever they are right now, one of the panelists
described them as the ambulance on the scene of an accident,
and I think that is exactly right. So those measures will be
helpful.
Insofar as a minimum price, speaking from my own
perspective, I think that I question whether that is even
achievable in the dynamic that we are in. Question whether--I'm
not dead sure that is a good thing. I just don't know. We
believe in a free market economy, but I think it has been
pointed out that we are not in a level playingfield, and
perhaps another alternate solution to the problem is cause
others with whom we are competing on the foreign field to bear
the same kinds of costs that we are bearing. And then price
almost becomes a relative thing if they are bearing the same
kinds of costs.
Mr. Stenholm. You are obviously entirely correct. Cost as
well as price, therefore, the environmental regulations cost
that we impose upon you is a cost. And anything that we can do
that will alleviate unnecessary cost while still having the
protection of our land, water, and air is obviously something
we can do. I know it would be a big help to the independent
producers that drill on and around my farm, in west Texas.
Mr. Cantrell. Well, I think, speaking on behalf of
Oklahoma, in our board meeting last week at our petroleum
association, it's down to the point where we can say all day
long that you all aren't going to do something. But our
responsibility to our members and to the families that make
their living in this business is to tell the truth. We can't
hesitate to tell the truth. And the truth is, unless you do
something about the price, there is going to be a devastating
effect on the infrastructure of oil and gas in America.
We can talk all day long about what's possible politically,
but that's not our role; that's your role. You are the ones to
tell us you can or cannot do something politically. What we
have to do is tell you, I think, and our jobs as Americans that
are in this industry is to tell you the truth. And the truth
is, without affecting this low price, without some way of
taking into consideration other countries' practices and other
countries' subsidization by our own government, defense costs,
environmental costs. In Venezuela, for example, they dump salt
water from half their production. They don't have environmental
regulation.
But we're not advocating you do away with environmental
regulation. I don't know how much of that $4 a barrel I'd be
willing to give up, as a small producer. We are committed in
Oklahoma to protecting the environment. We have got a voluntary
where we are, the industry, has been spending $2 million a year
cleaning up past damage sites in Oklahoma. We are committed to
being good environmental stewards. We don't want to give that
protection up. But we think foreign governments that don't have
those same safeguards on the environment should through an
environmental assessment or some kind of a measure, be made to
have a level playingfield.
But we are just kidding ourselves if we think we are going
to solve this problem and save this infrastructure without
something that affects price.
Mr. Bell. May I address that just a second? This morning,
when Ms. Short made her statement from the royalty owners'
perspective, these tax things, again, we need first aid. We
need that ambulance to get us to the market, but without
cutting off some production from areas that are dumping it on
our market, it's not going to help Ms. Short; it's not going to
help the schools in Kermit, Texas, or all over west Texas.
Denver City is at risk of losing their entire school system.
It's not going to help those people. It's not going to save the
hospital in Kermit if we don't do something about price.
It does come down, there has to be a way to address the
price issue. I don't think we can set that price. I don't know
what that floor price would be. I'd love to see one. I think
that when you do, there could be some complicating factors, but
as long as, by my calculations, the oil that comes out of the
Persian Gulf is costing about $54 a barrel to defend it, to get
it out of there. For the amount that we import in the United
States is less than 2.5 million barrels a day.
IPAA recently had a letter come out that said the cost of
keeping our ships in the Persian Gulf is about $50 billion a
year. That didn't include firing one missile or shooting
anything down in Desert Fox. That's additional that we add to
that. At $50 billion a year, 2.5 billion barrels a day is about
$54 a barrel. Then we pay them another $11 a barrel once we get
it here. So we are paying $65 a barrel for that oil.
I just don't see that, if Persian Gulf oil was paying for
their own defense, the price would come up and we'd be able to
make a living.
Mr. Watkins. They have been very gracious letting us be
over about 15 minutes. I promised them we would be out of here
by 15 after. Any other questions or comments? I'm going to say,
I understand they've got to get this cleaned up for the next
meeting concerning dumping on steel. So that is what they have
got to do.
I'm in room 1401, and I'll spend the rest of the noon hour
meeting with any of you from Oklahoma or anywhere else that
want to come up there. So I wanted to share that with you.
Ms. Short.
Ms. Short. I have two things on my mind. One of them is
national security. If we do not have enough oil here, then if
we are ever engulfed by a number of other countries, we may not
be able to fight our way out. The reason we were able to
participate in both World War I and World War II, and be on the
winning side, was because we had the petroleum. You know those
German tanks stopped out in the desert because they didn't have
any fuel.
Mr. Watkins. That's a very good point.
Ms. Short. So this problem goes much further than the
economic resources which we have or do not have.
Mr. Watkins. I want to thank my colleagues. Any last moment
comment or question either one of you would make? I want to
thank them for being here. But also, I want to say how thankful
I am you are here helping us get this story out.
Let me ask the staff, how long do they have to get some
testimony in? Ten days? There may be some additional testimony
that you might want to make part of this record. Since you've
been here, you probably have a greater feel for some of the
comments and some of the questions and comments that were
raised by the administration and others that you may totally
disagree with. And I think good information would help us and
the staff.
I want to thank the staff very, very much for their
cooperation and help. They have done this. We put together this
hearing a lot quicker than what we thought we would be able to,
and it was because the staff wanted to work and put in a lot
longer hours to try to get ready for it.
Again, thank you so much for coming, and we will do
everything we possibly can within our power to move this thing
as rapidly as we can, and hopefully, we will get either H.R. 53
or some kind of legislation that will help us move forward--
knowing full well that some of you have said you have paid
taxes, and maybe we can utilize that factor to help us get
through this crisis we are in.
Thank you very much. And we stand adjourned.
[Whereupon, at 12:16 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Statement of American Petroleum Institute
This statement is submitted by the American Petroleum
Institute (API) for the record of the February 25, 1999 Ways
and Means Subcommittee on Oversight hearing on current law
incentives for domestic production of oil and gas, and the
status of the industry in light of current economic conditions.
API represents over 400 companies involved in all aspects of
the oil and gas industry, including exploration, production,
transportation, refining, and marketing.
The domestic oil and gas industry is suffering through its
worst times in recent memory. The collapse of world oil prices
that began in late 1997 continued and worsened through 1998,
and analysts predict the conditions that led to the price
collapse will not improve in the foreseeable future.
Background
By the end of 1998, U.S. wellhead crude oil prices had
fallen to their lowest inflation-adjusted levels since the
Great Depression. These record-low prices reflected a world-
wide petroleum market in which, even with production cutbacks
initiated by OPEC members and other major producing countries,
world crude supplies were still more than ample in relation to
flagging growth in world demand. One major cause of that slower
demand growth was the economic difficulties in Asia which,
during the 1990's, had accounted for well over half of the
growth in world demand. At year-end, 1998, the average U.S.
wellhead price was less than $8 per barrel, barely half the
$15.06 average for the same month one year earlier. For the
year, the annual average wellhead price was an estimated $10.85
per barrel, down by more than a third from $17.24 in 1997.
Domestic oil exploration and development activity suffered
dramatically from the lower oil prices. The total number of
operating rigs in the U.S. fell to 647 in December, down by
over 35 percent from one year earlier. The toll was especially
large on drilling directed at oil. According to the Baker-
Hughes Company's survey, there were only 155 rigs searching for
oil in the U.S. in December, down nearly 60 percent from a year
ago and the lowest since separate records for oil rigs began in
1987. In January of 1999, the number dropped to 125 rigs. As
recently as the mid-1990s, there typically had been 300 to 400
oil-directed rigs operating in the U.S. Rigs drilling for
natural gas averaged 491 in December, down 24 percent from a
year earlier. Similarly, data from API's Quarterly Completion
Report show a drop in oil well completions of nearly 50 percent
for the fourth quarter, with natural gas drilling declining
about 13 percent. Further, oil and gas companies' current
upstream spending plans for 1999 for the U.S. have been cut by
20 percent, according to a recent survey conducted by Salomon
Smith Barney.
Historically, the full impact of lower crude oil prices has
often taken several years to play out. However, already,
significant effects are being witnessed in U.S. production,
particularly for higher-cost and lower-volume wells. In
December, lower 48 production fell nearly 4 percent, a size of
decline not typically seen in over four years. For 1998 as a
whole, domestic crude oil production fell roughly 3 percent.
State governments have reported a sharp increase in the
number of wells shut down during 1998. The Interstate Oil and
Gas Compact Commission found that over 48,700 oil and gas wells
in 23 states had been idled as of mid-year. If these wells were
permanently abandoned, this would be nearly two-and-a half
times the typical rate of abandonment in recent years.
Industry employment has also suffered. Bureau of Labor
Statistics data show that from October 1998 to February 1999
the oil and gas extraction industry, including field service
companies, lost 26,000 jobs. That 4 month loss was 6,000 more
jobs than were lost during the entire year from October 1997 to
October 1998. The most recent decline reduced the number of
upstream jobs in the U.S. to about 291,000--60 percent less
than the peak in early 1982 of 754,000 jobs.
The long-term impact on domestic production remains to be
seen. Historically, another sharp, sustained drop in crude oil
prices occurred in 1986. In that year, the average U.S.
wellhead price fell by nearly 50 percent from the previous year
and continued at lower levels in subsequent years. Lower 48
crude oil production, which in the early 1980s had been flat to
increasing, began a sharp decline. From 1985 to 1990, nearly 22
percent of the lower 48's crude oil production had been lost,
in addition to Alaska's decline. Hundreds of nonmajor oil and
gas producers went out of business.
Conversely, a review of the last 50 years shows that world
oversupply and attendant low prices are the exception, not the
norm. Following the Arab oil embargo of 1973, world oil prices
tripled over the next several years and soon after remaining
price controls were ended in 1981, domestic producers ended a
supposedly ``irreversible'' 10 year decline in U.S. oil
production within months. By 1982 annual domestic production
was again on the increase. The risk this time is that if the
current conditions persist, they could cause permanent damage
to the U.S. oil industry's producing and service sectors and
that when conditions turn around, the basic infrastructure of
the domestic oil and gas industry will be so depleted it will
no longer be able to respond. Our domestic petroleum reserves
only have value if we maintain the expertise and risk capital
to bring those resources to market. Especially in a period of
low oil prices, we must preserve at risk marginal production
and stimulate development of new resources.
Tax Incentive Proposals
Several modest tax incentive proposals would assist in that
effort.
Alternative Minimum Tax Relief
At this time of financial crisis for the oil and gas
industry, the Alternative Minimum Tax (AMT) has the perverse
effect of exacerbating the financial impact of low commodity
prices. AMT was enacted to ensure that companies reporting
large financial income also paid at least the prescribed
minimum tax. It was not intended to increase taxes on companies
that are already struggling financially.
To alleviate the impact of the AMT on the oil and gas
industry during times of low prices, API proposes the following
changes. These changes would begin to phase in in equal
increments when the annual average price of oil falls below
$l7.00, and would be fully phased in when the annual average
price falls below $14.00 (average prices adjusted for
inflation).
Eliminating the preferences for intangible
drilling costs (IDCs) and depletion;
Eliminating the impact of IDCs, depletion, and
depreciation (on oil and gas assets) as adjustments in the AMT
computation; and
Permitting the Enhanced Oil Recovery (EOR) credit
and the Section 29 credit to reduce the AMT.
These changes would only be applicable in a year in which
the annual average price of oil is below $17.00. Because the
industry needs immediate relief, the proposed effective date is
for taxable years beginning after 1998.
Marginal Well Production Tax Credit
API supports H.R. 53 introduced by Congressman Wes Watkins
(R-OK) and others to provide a $3 a barrel tax credit for the
first three barrels of daily production from an existing
marginal oil well and a $0.50 per Mcf tax credit for the first
18 Mcf of daily natural gas production from a marginal well.
Designed to be phased in and out as oil and gas prices fall and
rise, the credit amounts ($3 and 50 cents) are reduced by an
amount which bears the same ratio to such amount as the excess
of the applicable reference price over $14 ($1.56 for qualified
natural gas) bears to $3.00 ($0.33 for natural gas), (dollar
amounts adjusted for inflation). ``Marginal oil wells'' are
those producing less than 15 barrels per day or producing heavy
oil. ``Marginal gas wells'' are those producing less than 90
Mcf per day. The credit is allowed against both regular tax and
AMT.
Expensing Geological and Geophysical Costs
Oil and gas exploration costs include costs incurred for
geologists, surveys, and certain drilling activities. The
function of G&G costs is to locate and identify the property
with the potential to produce commercial quantities of oil and/
or gas. Oil and gas companies incur huge up front capital
expenditures, including G&G expenses, in their search for new
oil. Current tax law requires that G&G costs which result in
the acquisition and development of an oil and gas property be
capitalized, suspended, and then amortized over a period of
years in the form of cost depletion after production begins. In
this period of historically low oil prices, availability of
capital is the crucial issue for continuing operation, and
forcing companies to capitalize G&G costs only exacerbates the
economic burden imposed by the significant upfront cash
outlays. Congress should protect oil and gas exploration
companies against this economic hardship by passing legislation
that provides that successful G&G costs may be deducted
currently.
Expensing Delay Rentals
The typical oil and gas exploration company does not
normally purchase the land on which it intends to search for
minerals but will lease the land and agree to pay royalties as
the minerals, if any, are produced. A typical lease expires in
a year unless exploration has begun or the lessee pays the
lessor a fee for the privilege of deferring development of the
property. This payment is called a delay rental. It is not a
payment for oil and gas to be produced; rather, it is paid for
additional time in which to explore or develop the leased
property.
Under Treasury regulations and case law, the lessee has the
option to expense or capitalize delay rentals. Current
deductibility of delay rentals has been allowed for more than
forty years. But the IRS has recently begun taking the position
that delay rentals must be capitalized rather than deducted
currently. This position ignores forty years of history and
long-established regulations.
Oil and gas exploration companies cannot afford to develop
new property in this economic environment. In order to retain
leases which will not be developed at this time, the companies
must pay delay rentals. Forcing them to capitalize these costs
exacerbates the economic burden of paying delay rentals.
Congress should assist the industry by passing legislation that
restates the long-standing rule that delay rentals may be
deducted currently.
Expansion of Enhanced Oil Recovery Credit
The enhanced oil recovery credit (IRC Section 43) was
enacted in 1990 to provide incentives to domestic oil producers
to invest in methods of capturing what otherwise might be
unrecoverable oil reserves. Section 43 generally provides a 15%
tax credit for costs attributable to qualified enhanced oil
recovery projects. In enacting the credit, the Congress
identified certain recovery methods (listed in the 1979
Department of Energy regulations) as qualifying methods. Since
that time, additional tertiary methods have been developed that
could significantly increase domestic recovery of oil. The list
of qualifying methods under Section 43 should be expanded to
include horizontal drilling and waterflooding.
``First Do No Harm''--Administration's Budget Proposals
In addition to the positive steps suggested above, Congress
could go far to help by ensuring that no additional harm is
done to an industry that is already reeling from the current
conditions. It is especially troubling that at this time the
Administration has come forward with proposals that would
increase taxes on the oil and gas industry by as much as $6
billion over the next five years.
Rules Relating to Foreign Oil and Gas Extraction Income
As part of its revenue raisers in the fy 2000 budget, the
Administration has again proposed to deny the foreign tax
credit with respect to all amounts paid or accrued to any
foreign country by a dual-capacity taxpayer if the country does
not impose a generally applicable income tax. As distinguished
from the rule in the U.S. and some Canadian provinces, mineral
rights in other countries vest in the foreign sovereign, which
then grants exploitation rights in various forms. This can be
done either directly, or through a state owned enterprise
(e.g., a license or a production sharing contract). Because the
taxing sovereign is also the grantor of mineral rights, the
high tax rates imposed on oil and gas profits have often been
questioned as representing, in part, payment for the grant of
``a specific economic benefit'' from mineral exploitation
rights. Thus, the dual nature of these payments to the
sovereign have resulted in such taxpayers being referred to as
``dual capacity taxpayers.''
The proposal also would convert the special foreign tax
credit limitation rules of current law section 907 into a new
foreign tax credit basket within section 904 for foreign oil
and gas income. This proposal, aimed directly at the foreign
source income of U.S. petroleum companies, seriously threatens
the ability of those companies to remain competitive on a
global scale, and API strongly opposes the proposal.
Because the U.S. taxes the worldwide income of U.S.
citizens and residents, including U.S. corporations, the
foreign tax credit (FTC) is designed to allow a dollar for
dollar offset against U.S. income taxes for taxes paid to
foreign taxing jurisdictions. The FTC is intended to offset
only U.S. tax on foreign source income. Thus, an overall
limitation is imposed on currently usable FTCs. In addition,
Congress and the Treasury have imposed special additional
limitations on the use of foreign tax credits attributable to
foreign oil and gas operations. For example, each year the
amount of taxes on foreign oil and gas extraction income
(FOGEI) may not exceed 35% (the U.S. corporate tax rate) of
such income. Any excess may be carried over like excess FTCs
under the overall limitation.
The Administration's concerns with the tax versus royalty
distinction were resolved by Congress and the Treasury long ago
with the special tax credit limitation on FOGEI enacted in 1975
and the Splitting Regulations of 1983. These were then later
reinforced in the 1986 Act by the fragmentation of foreign
source income into a host of categories or baskets. The earlier
resolution of the tax versus royalty dilemma recognized that:
(1) if payments to a foreign sovereign meet the criteria of an
income tax, they should not be denied complete creditability
against U.S. income tax on the underlying income; and (2)
creditability of the perceived excessive tax payment is better
controlled by reference to the U.S. tax burden, rather than
being dependent on the foreign sovereign's fiscal choices.
The unfairness of the provision becomes patently obvious if
one considers the situation where a U.S. based oil company and
a U.S. based company other than an oil company are subject to
an income tax in a country without a generally applicable
income tax. Under the Administration's proposal, only the U.S.
oil company would receive no foreign tax credit, while the
other taxpayer would be entitled to the full tax credit for the
very same tax.
If U.S. oil and gas concerns wish to stay in business, they
must look overseas to replace their diminishing reserves, since
the opportunity for domestic reserve replacement has been
severely restricted by both federal and state government
policy. Adoption of the Administration's proposal would
increase tax on foreign oil and gas income, and would severely
disadvantage U.S. oil companies in their competition with
foreign oil and gas concerns in the global oil and gas
exploration, production, refining and marketing arena, where
the home countries of their foreign competition do not tax
foreign oil and gas income. Congress has wisely rejected this
proposal in the past, and it should do so again.
Superfund Taxes
The Administration would reinstate the Superfund excise
taxes on petroleum and certain chemicals as well as the
Corporate Environmental Tax through October 1, 2009. API
strongly opposes imposition of any Superfund taxes without
comprehensive reform of the Superfund program and the tax
system supporting the Fund. It is widely recognized that
Superfund is a broken program that requires major substantive
and procedural changes. A restructured and improved Superfund
program can and should be funded through general revenues.
Superfund sites are a broad societal problem. Revenues
raised to remediate these sites should be broadly based rather
than unfairly burden a few specific industries. EPA has found
wastes from all types of businesses at most hazardous waste
sites. The entire economy benefited in the pre-1980 era from
the lower cost of handling waste. To place responsibility for
the additional costs resulting from retroactive Superfund
cleanup standards on the shoulders of a very few industries
when previous economic benefits were widely shared is patently
unfair.
The petroleum industry is estimated to be responsible for
less than 10 percent of the contamination at Superfund sites
but has historically paid over 50 percent of the Superfund
taxes. This inequity should be rectified. Congress should
substantially reform the program and fund the program through
general revenues or other broad-base funding sources.
Oil Spill Excise Tax
The Administration proposes reinstating the five cents per
barrel excise tax on domestic and imported crude oil dedicated
to the Oil Spill Liability Trust fund through October 1, 2009,
and increasing the trust fund limitation (the ``cap'') from $1
billion to $5 billion. API strongly opposes the proposal.
Collection of the Oil Spill Excise Tax was suspended for
several months during 1994 because the Fund had exceeded its
cap of $1 billion. It was subsequently allowed to expire
December 31, 1994, because Congress perceived there was no need
for additional taxes. Since that time, the balance in the Fund
has remained above $1 billion, despite the fact that no
additional tax has been collected. Clearly, the legislated
purposes for the Fund have been accomplished without any need
for additional revenues.
Statement of Friends of the Earth and U.S. Public Interest Research
Group
Introduction:
Mr. Chairman and Members of the Committee, we respectfully
submit these written comments for the record. Friends of the
Earth and U.S. Public Interest Research Group represent
environmentalists, consumers and citizens that are concerned
with an efficiently run federal government. Among our groups
staff, there are several experts who have spent years studying
and tracking tax breaks and other government subsidies
available to oil and gas industries.
Based on our research and study, we now strongly urge you
to oppose any tax breaks for the oil and gas industry. Tax
breaks would be unfair to U.S. taxpayers and harmful to the
environment. The oil and gas industry already enjoys billions
of dollars in federal subsidies, and it seems that no matter
what the challenge faced, the industry always suggests the same
solution--more tax breaks.
Taxpayer Argument:
Several tax breaks already exist which amount to a simple
production subsidy for the oil and gas industry. These special
subsidies benefit certain oil and gas producers to the
disadvantage of other energy competitors. For some companies
all profits may be due to government tax subsidies. These
subsidies distort the market by attracting investment that
could be used more productively elsewhere in the economy. Many
of these subsidies encourage the draining of scarce domestic
energy resources and in combination with other subsidies for
the oil and gas industry, often exceed 100 percent of the
actual value of the energy produced.
In general, subsidies promote oil and gas production and
energy waste rather than efficiency or conservation. Increased
profits for polluters are not the best use of taxpayers' money,
especially when the tax breaks encourage overproduction of
scarce resources at the expense of cleaner alternatives.
Environmental Argument:
Oil and gas tax policy has focused on production while
doing little to increase energy efficiency throughout the oil
and gas system, or conservation of petroleum in the
transportation sector. Tax breaks for the oil and gas industry
not only drain the treasury but also taxes the environment.
Subsidies encourage producers to prematurely tap marginally
economic oil and gas fields, resulting in the exhaustion of
energy reserves and the destruction of environmentally
sensitive areas such as estuaries, bays, and wetlands. Certain
subsidies encourage production practices that force oil and
sometimes chemical injectants into surrounding surface and
groundwater. This can lead to contamination of drinking water,
soil, crops, and wetlands. In addition, the oil and gas
industry enjoys special exemptions under our environmental laws
including Superfund, the Clean Air and Clean Water Acts, the
Safe Drinking Water Act, and the Emergency Planning and
Community Right-To-Know Act.
The Industry Solution:
Do you remember the gas pump crisis of 1996? Gasoline was
running about $1.35 per gallon and newspaper headlines declared
a crisis. Some political leaders fell over themselves to save
the U.S. economy. Former Senator Bob Dole, then candidate for
President proposed to slash the federal gasoline tax.
Fast-forward two years to the present day. Oil prices are
at historic lows. The world market is flooded with petroleum.
Gasoline is cheaper than it has been forever. Americans are
driving more, paying less, and buying bigger vehicles.
Consumers love it.
But it's crisis time again for the U.S. oil industry. They
are screaming for help and holding demonstrations at state
capitols in California, Oklahoma, Texas, and South Dakota. And
once again politicians are rushing to the rescue. Their
solution? Tax cuts.
If prices are too high or too low, the solution is always
the same: tax cuts. And why not? It's a strategy that has
worked for the oil industry. The tax code is riddled with
special exemptions and loopholes for the oil industry. All
told, tax subsidies for the oil and gas industry cost about $2
billion each year.
Who pays this $2 billion a year? The other American
taxpayers. What do we get for this investment? Not much.
Certainly not cheap gas. Oil and gas prices rise and fall
completely independently of these tax policies. In fact, prices
are mostly set by world markets in which U.S. oil production is
only a modest player. The U.S. influences oil and gas prices
more through our consumption than through our production.
Do we get independence from a foreign energy supply? No.
U.S. dependence on foreign oil has consistently grown over the
last 15 years and shows no sign of slowing. America currently
imports 53 percent of our oil for consumption. U.S. oil
producers are a weak medicine against our addiction to foreign
oil. In reality, our nation has decided not to reduce our
reliance. Instead, our government has invested heavily to
guarantee the supply with a heavy, costly military presence in
the Middle East and the Persian Gulf.
Do we get a cleaner environment for our taxes? Not hardly.
U.S. production and transport of oil is arguably cleaner than a
lot of foreign production and transport. But it's still a dirty
business. Ten years ago this March, the Exxon's Valdez spilled
11 million gallons of oil into Prince William Sound. That made
headlines for months. But hidden from the headlines are ugly
facts about oil pollution and the thousands of small oil spills
that routinely threaten wildlife and water supplies. Every
year, about 16,000 spills are reported in the U.S. Most of
these are small, but the oil industry spills, dumps, or wastes
20 times the Exxon Valdez oil spill on the ground and in the
waters of America every year. But the solutions--tax breaks for
the oil and gas industry--don't fit the problems.
Yes, we need to reduce our use of foreign oil. But the
solution is not to create a domestic oil industry more
dependent on taxpayer hand-outs. It hasn't worked and it won't.
Ultimately, we can only reduce our nation's dependence on oil
through increased energy efficiency and use of cleaner, home-
grown sources of energy like wind and solar power.
So if what we need is to clean up oil pollution, encourage
efficiency and cleaner energy sources giving more tax breaks to
a wasteful and dirty industry is not the solution. Reducing
existing tax breaks and directing the money to cleaner energy
is a solution and tying environmental performance to existing
tax benefits is a solution.
The Environmental Solution:
We understand that Congress is under pressure to provide
more tax breaks for an already highly subsidized industry.
Record-low oil prices are cutting into the profits of small oil
business in the U.S., and suffering businesses are seeking a
government bail out.
Small oil business in the U.S. already receive huge
subsidies like the percentage depletion allowance that cost
taxpayers billions and end up harming the environment. The
percentage depletion allowance allows oil producers to deduct a
flat percentage of their gross income, sales or revenue. In
some cases, up to 100 percent of a company's total net income
can be deducted. That means this subsidy often exceeds the
actual value of the energy produced.
While we are sympathetic to the plight of small business
and their workers, Congress must not react with misguided
policy responses. What Congress should really be considering is
cutting subsidies like the percentage depletion allowance.
Neither taxpayers nor the environment can afford more
government subsidies for such environmentally harmful
activities.
Green Scissors 1999, a joint report by Friends of the
Earth, U.S. Public Interest Research Group, and Taxpayers for
Common Sense, identifies more than $573 million federal
government subsidies to the oil and gas industry over five
years.
The 1998 Friends of the Earth report, Cool It, (available
on the World Wide Web at: www.foe.org) identified the
percentage depletion allowance for the oil and gas industry as
one of the eight largest carbon subsidies and a major
contributor to global warming. The report recommends shifting
government subsidies to alternative energy sources that will
help deal with global warming, or to fund programs that help
workers and their families deal with its impacts.
[Friends of the Earth, Cool It report, is being retained in
the Committee files.]
Statement of Gas Processors Association, Tulsa, Oklahoma
The members of the Gas Processors Association (``GPA'')
commend Chairman Houghton and the Members of the Subcommittee
for convening this hearing to address issues of critical
importance to members of the oil & gas industry. GPA is an
incorporated, non-profit trade association made up of
approximately 140 corporate members, all of whom are engaged in
the processing of natural gas into a merchantable pipeline gas,
or in the manufacture, transportation, or further processing of
liquid products from natural gas. The active membership as a
group account for approximately 90% of all natural gas liquids
produced in the United States. The active membership also
includes a number of Canadian and international companies that
produce natural gas liquids on a global scale.
The stated purpose of this hearing is to focus on how
current law affects the domestic production of oil and gas, to
assess the current status of the industry in light of current
economic conditions and to evaluate possible policy options.
GPA would like to bring to the Subcommittee's attention an
significant problem faced by members of the gas processing
industry pertaining to the interpretation of current law by the
Internal Revenue Service.
The IRS, both on audits and in litigation, has taken the
position that natural gas gathering lines are depreciable over
a 15-year cost recovery period rather than the 7-year period
that the Gas Processors Association believes is contemplated
under the Modified Accelerated Cost Recovery System
(``MACRS''). Courts have reached conflicting decisions on this
issue, and the continued uncertainty that has resulted not only
renders business planning difficult, but threatens to impose
substantial costs on the gas processing industry in audits and
litigation fees.
The useful life for determining the depreciation deductions
for specific assets is determined by reference to the asset
guideline class which describes the property. Asset class 13.2
clearly includes: ``assets used by petroleum and natural gas
producers for drilling wells and production of petroleum and
natural gas, including gathering pipelines and related
production facilities.'' (Emphasis added). Not only are
gathering lines specifically referenced in asset class 13.2,
but gathering lines are clearly integral to the extraction and
production process rather than transportation. Natural gas must
be carried from the wellhead to a central processing facility
for processing ``before'' it can be transported via trunk lines
to an end user such as a distribution facility. The
interpretation advanced by the IRS demonstrates a fundamental
misunderstanding of the role of natural gas gathering lines in
the natural gas extraction and production process. The Federal
Energy Regulatory Commission (``FERC'') has recognized this
clear distinction; gas processors' gathering lines are exempt
from FERC jurisdiction because they are classified as gas
gathering equipment that is part of the production facility not
pipeline transportation under FERC rules. Assets within asset
class 13.2 are subject to a 7-year cost recovery period.
Since 1995, GPA has worked to secure administrative
clarification of the proper treatment of natural gas gathering
lines for purposes of depreciation both through appropriate
inquiries from Members of Congress and through direct meetings
with officials from the Department of Treasury. In 1998,
Representative Sam Johnson introduced legislation (H.R. 3913)
to clarify that natural gas gathering lines are subject to 7-
year depreciation under current law. Although this legislation
was not enacted during the last Congress, Representative
Johnson, joined by original cosponsors Representatives Jim
McCrery and Wes Watkins, has once again introduced this
important bill (H.R. 674) to continue to seek legislative
clarification of the appropriate treatment of these assets.
As an individual company's gathering system represents a
significant investment and often consists of many thousands of
miles of gathering lines, continued uncertainty surrounding the
proper depreciation of these assets is causing great hardship
for members of the gas processing industry. As the Subcommittee
considers issues affecting the oil and gas industry, GPA and
its members would urge your consideration of this important
issue and ask that you consider including support for
legislation to clarify the proper treatment of natural gas
gathering lines in any recommendations that the Subcommittee
might make to the full committee on Ways and Means. Thank you
for your continued concern and commitment to addressing issues
important to our industry.
Statement of Hon. Bill Graves, Governor, State of Kansas; on Behalf of
Interstate Oil and Gas Compact Commission, Oklahoma City, Oklahoma
Chairman Houghton and members of the subcommittee, thank
you for the opportunity to submit testimony on two issues that
are vital to the future of our country.
My testimony represents the views of the governors of 30
member states that comprise the Interstate Oil and Gas Compact
Commission (IOGCC). IOGCC states account for nearly all of the
oil and natural gas produced onshore in the United States. The
IOGCC's mission is two-fold: to conserve our nation's oil and
gas resources and to protect human health and the environment.
You have heard from many in the oil and gas industry
regarding the effects of low oil prices on domestic operations.
Domestic oil and natural gas producers and those who benefit
indirectly from petroleum production are facing a battle for
the industry's survival. This battle has a direct impact on
IOGCC states and on the nation.
Specific incentive legislation is the key to effectively
assisting this critical domestic industry. I urge the Congress
to support H.R. 53, a timely piece of legislation introduced by
Congressman Wes Watkins of this subcommittee, that provides a
10-year ``carryback'' and a 20-year ``carry-over'' of unused
tax credits for producers of marginally economic wells. This
legislation will enable a producer of marginal oil or marginal
gas to recalculate past tax benefits, resulting in an immediate
refund for some producers. H.R. 497 is another piece of
legislation designed to provide tax relief for domestic oil and
gas producers. These and other measures are necessary for
domestic producers to survive. Successful incentive programs
already in place at the state level are documented in two IOGCC
publications attached to this testimony, Investments in Energy
Security: State Incentives to Maximize Oil and Gas Recovery and
its newly released update, the 1999 Supplemental Edition. State
legislatures are daily passing additional aid measures.
While domestic producers struggle to combat the low price
crisis, consumers continue to reap benefits from the low cost
of refined products. With gasoline, fuel and heating oil, jet
fuel and diesel prices hovering at record low levels,
individual consumers, energy-intensive industries and the
federal government have pocketed billions in savings.
These savings lining the pockets of consumers--including
the federal government--may feel good now but beware of future
consequences. Hidden costs to the states and nation reach far
beyond the oil and gas industry. I have attached to my
testimony the IOGCC publication, A Battle for Survival?: The
Real Story Behind Low Oil Prices, which is a timely
presentation of the widespread effects of prolonged low oil
prices.
As an organization, the IOGCC today speaks for the
following important constituencies.
First, our citizens. Several million of them benefit from
royalty income. Many have seen their checks cut in half. How is
this income used? A survey has shown that the No. 1 use of
royalty income is for the education of children and other
family members.
Hundreds of thousands more citizens hold jobs as a result
of the production of oil and gas. They are faced with the
prospects of layoffs or pay cuts. Many who leave these jobs
have vowed to not return to the industry. They see the actions
the federal government has taken to protect other domestic
industries from foreign competition and privately ask where
government stands on the future of the petroleum industry.
Many of these affected citizens also live in rural
communities that are built upon the production of natural
resources. Their state-funded services are financed at least in
part by tax revenues from oil and gas production.
Second, small business owners. These are the small
companies that you rarely hear about, who may employ a dozen
people. Their product may be the production of oil and gas, or
it may be goods and services required to support these efforts.
Gov. Frank Keating of Oklahoma said it this way: ``Each lease
generates revenue that results in the operator purchasing
materials and services, employing people, paying royalties,
paying taxes, mostly in the community where the production
occurs. Thus, petroleum production is a significant contributor
to the economic health of rural Oklahoma.'' Then, he concludes
with this: ``Each lease should be viewed as a small business in
the area where the production occurs. The loss of a lease is
just as significant as the loss of any local business.'' It is
important to be aware of the thousands of small businesses
affected by low oil prices. They are vital contributors to the
national and state economies, and to lose their productivity
and jobs has a significant ripple effect through many
communities. They also represent a part of the industry
infrastructure in danger of being further eroded.
Third, we speak as stewards for a non-renewable natural
resource that is being abandoned even as we need it the most.
Without question, the United States is losing a segment of a
critical domestic industry--production from low-volume, barely
economic oil wells. Taken singularly, each well is of little
significance. The average marginal well produces about two
barrels of oil per day. But collectively, they comprise an
important hedge against increasing reliance on imports, provide
tens of thousands of jobs, millions of dollars in payments to
landowners, royalty owners and government, and are a
cornerstone industry for hundreds of rural Americans.
In the first six months of 1998, an estimated 48,702 wells
were idled or shut in, according to a recent IOGCC survey of 23
states. Assuming these idled wells were eventually plugged and
abandoned, this figure represents a 142 percent increase over
the number of wells (20,087) plugged and abandoned in 1997.
For the first six months of 1998, oil production was down
in 19 of the 23 oil-producing states. The combination of
falling production and lower oil prices has lowered revenue
collections. In Wyoming, for example, the impact was estimated
near $100 million for the first six months of 1998. Severance
taxes were down $17.2 million, ad valorem taxes fell by $57.1
million, and the effect of 900 lost jobs totaled $25.5 million.
Eight percent--or 1,200--of the wells in the state were idled
or shut in.
In Louisiana, production declined by 8.2 million barrels
for the first six months. An estimated 1,375 wells were idled
or shut in. State officials estimate that the treasury loses or
gains about $20 million of direct revenue for each $1 change in
oil prices. With prices falling from $17.24 per barrel average
for 1997 to $12.45 in 1998, the direct loss of revenue exceeded
$95.8 million. Indirect revenue, such as sales tax and income
tax, would increase the impact to between $119 million and
$191.6 million.
In Texas, oil severance tax revenues fell $94.9 million in
the first eight months. This represents a reduction of 34
percent. About 2,800 jobs were lost and 1,087 oil wells idled
or shut in.
In Ohio, about 8,700 wells were idled or shut in, 500 jobs
were lost, and oil production dropped 15 percent. The state
suffered $128,900 in lost severance taxes.
Illustrating the impact of recent price drops, Oklahoma's
October gross production tax collections for oil were 74.1
percent lower than estimated. Collections were $2 million, $3.8
million below estimates. For the year, state gross production
tax collections were down 57 percent. The state estimates that
between 25 and 35 percent of the state's 80,000-plus wells have
been idled or shut in. Between 2,000 and 5,000 jobs have been
lost. Most state agencies have been asked to cut spending by
3.6 percent as a result of drastically decreased severance tax
collections.
Kentucky estimates an impact of $2 million on the state
budget, due principally to a decrease in gross production taxes
related to lower oil prices. In Nebraska, state severance taxes
declined by 29 percent, a reduction of $300,000 projected for
the year.
Even in the state with no stripper well production--
Alaska--the economy has been seriously affected. For each $1
per barrel decline in price, the state loses $100 million in
revenue per year.
As low prices continue to shut down marginal production
from the United States, each barrel lost will be replaced by
imported oil. The implications on national security and the
trade deficit are serious.
We agree with the findings of the U.S. Department of
Commerce four years ago that found: ``Growing import
dependence, in turn, increases U.S. vulnerability to a supply
disruption because non-OPEC sources lack surge production
capacity; and there are at present no substitutes for oil-based
transportation fuels. Given the above factors, the Department
finds that petroleum imports threaten to impair the national
security.''
We are far more dependent on oil imports today than at any
other time in history. I conclude with a call for action. Do
not dismiss the cries of domestic oil and gas producers. View
the current industry conditions from a new perspective, through
the eyes of our citizens, small business owners,
conservationists and those concerned about the energy future of
our next generation--all of whom are looking to you for help.
Thank you, Mr. Chairman and subcommittee members, for the
opportunity to be heard on this issue. We look forward to
assisting you with further information you may require and
working with you to address the country's energy concerns.
[Attachments are being retained in the Committee files.]
Statement of Hon. Edward T. Schafer, Governor, State of North Dakota;
on Behalf of Interstate Oil and Gas Compact Commission
Mr. Chairman and members of the subcommittee, I am pleased
to present comments on behalf of the Interstate Oil and Gas
Compact Commission (IOGCC) regarding the current oil price
crisis and how it is threatening a vital domestic industry.
The 30 member states that comprise the IOGCC have been
among the first to sound the alarm as the fall in oil prices
cut deeply into state budgets and thousands of our citizens
were laid off from high quality jobs. The IOGCC was the first
organization that I'm aware of to document the extent of the
crisis in its publication A Battle for Survival?: The Real
Story Behind Low Oil Prices.
Low oil prices are hurting the economies of many states.
For instance, in North Dakota we do not have a single well
being drilled right now--for the first time since 1950. Not
only is oilfield employment thus affected, but the impact also
resonates in each rural North Dakota community with an oil
presence.
The case has been clearly made for the serious nature of
this crisis and the need for immediate action. The question
remains, however, about how best to react to preserve what is
left of a withering industry. As you consider these options, I
encourage you to mirror steps taken to protect a comparatively
tiny industry--broom corn broom manufacturers--from foreign
competition.
On Thanksgiving Day, 1996, President Bill Clinton issued a
memo to the secretaries of Treasury, Commerce, Agriculture, and
Labor under section 203 of the Trade Act of 1974. The President
reported that the United State International Trade Commission
found ``...that imports of broom corn brooms are being imported
into the United States in such increased quantities as to be a
substantial cause of serious injury to the domestic
industry...''
The ``serious injury'' documented was a loss of 49 jobs
(yes, that is the total), from 1991 to 1995. By contrast, the
domestic oil industry lost that many jobs yesterday--and more.
We have documented the tremendous job loss in the IOGCC
publication, A Battle for Survival?: The Real Story Behind Low
Oil Prices,'' which IOGCC chairman and Kansas Gov. Bill Graves
has submitted to this subcommittee.
To assist the broom corn broom industry, the President
further directed the secretaries of Agriculture, Commerce and
Labor to ``...develop and present, within 90 days, a program of
measures designed to enable our domestic industry producing
broom corn brooms to adjust to import competition.''
The President proclaimed tariff relief for a period of
three years to provide time for the domestic industry to
implement adjustments to foreign competition. ``In short, this
action provided the domestic industry with substantial
temporary relief from increased import competition, while also
assuring our trading partners significant continued duty-free
access to the United States market.''
``I also note the substantial resources identified by the
Departments of Agriculture and Commerce that can provide loans,
grants, technical and in-kind assistance to the domestic
industry as it implements its adjustment plan,'' the President
said. He directed the departments ``...to give priority
consideration to adjustment assistance requests, with the
intent of providing the maximum appropriate assistance
available.''
As for the few employees of the domestic broom corn broom
industry (a total of 382 people in 1995), the President noted
that ``The Trade Adjustment Assistance (TAA) program of the
Department of Labor has already provided support for employees
of broom corn broom manufacturers that have been laid off due
to import competition. This assistance remains available, and I
instruct the Secretary of Labor to give priority consideration
to processing such TAA requests.''
The point I am making is that there can be concerted
efforts to assist a struggling industry that is threatened by
imports. I know of no industry more critical to the national
security than energy. In 1994, the Commerce Department found
that ``Growing import dependence, in turn, increases U.S.
vulnerability to a supply disruption because non-OPEC sources
lack surge production capacity; and there are at present no
substitutes for oil-based transportation fuels. Given the above
factors, the Department finds that petroleum imports threaten
to impair the national security.''
We are far more dependent on oil imports today than at any
other time in history. This critical domestic industry deserves
some of the ``priority consideration'' which the President
requested of various Departments to assist the broom corn broom
industry.
In its determination of the severity of the broom corn
broom industry's problems, the International Trade Commission
found that industry ``as a whole operated at a loss in 1994 and
1995.'' The Assistant Secretary for Tax Policy from the U.S.
Department of Treasury who testified before this committee said
essentially the same about the oil industry when he told the
committee more than two-thirds of the domestic oil companies
paid no income taxes in 1997. These companies are also,
obviously, operating at a loss and deserve some consideration.
I urge you to consider comprehensive steps to preserve the
industry infrastructure for the sake of our national security
and on behalf of the thousands of small businesses caught in
the crunch of low oil prices.
In conclusion, I seek your support for efforts to conserve
a non-renewable natural resource that is being abandoned even
as we need it the most. Without question, the United States is
losing a segment of a critical domestic industry--production
from low-volume, barely economic oil wells. As low prices
continue to shut down marginal production from the United
States, each barrel lost will be replaced by imported oil,
further escalating our dependence on imports.
This is a domestic industry which deserves at least the
same assistance which has been given to the domestic broom corn
broom industry. The problems of the domestic oil industry are
less easily whisked away because it is such a vital part of the
United States' economy.
Thank you, Mr. Chairman and subcommittee members, for the
opportunity to be heard on this issue. We look forward to
assisting you with further information you may require and
working with you to address the country's energy concerns.