The TWIP and changes in regulations

There has been some talk recently of the current Administration raising taxes on oil and natural gas companies. Specifically the suggestion is that Section 199 of the American Jobs Creation Act and Section 1.901-2 of the Treasury Regulations would be repealed. The API recently hosted a conference call on the topic, which I unfortunately missed. A report on the plan has recently been prepared by Dr. Joseph Mason at Louisiana State University , who succinctly describes the results as:

Section 199 was enacted by President Bush in 2004 to provide taxpayers benefits for production activities in the United States. The provision grants a “deduction equal to a percentage of the lesser of ‘qualified production activities income or taxable income.” Under the provision, labor- intensive corporations are particularly favored by being able to deduct a percentage of domestic production activity each year. The repeal would apply solely to oil and gas firms.

Dual capacity credit, (Section 1.901-2) on the other hand, allows companies to deduct taxes on incomes from abroad, offsetting relatively high U.S. taxes on foreign incomes.3 Hence, the dual capacity regulation is a way for American firms to compete efficiently against foreign competitors.

In repealing the dual capacity credit, however, the current administration would effectively double-tax firms conducting business in many foreign countries.

With the Australian intent to raise taxes on energy producing companies being one of the causes that led to the collapse of the last Government, this has not deterred the Prime Minister who is now re-committing the Government to a carbon tax. In short, given that governments around the world need to find some new pockets from which to extract the funding to keep their budgets closer to balanced, the energy industry seems to have been chosen as the sacrificial lamb.

In which regard it is interesting to note that the TWIP this week has been looking at the earnings of major oil and natural gas producers. It notes that average earnings were up over the same period last year, albeit still well below the 5-year average. Crude prices are up again, and the major companies have been increasing capital expenditures, with the increased availability of funds again. The oil and gas expenditures for the majors, for example, is not only up over last year, but is 19% over the average for the 2005-2009 timeframe.

Generally in the energy business, industry has to invest an increasingly large amount of money to find and then develop new fields of production. New resources are harder to find, and more expensive to develop, even when things go according to plan. Unfortunately the business is also one where impacts take some time to have an effect. Oil shipped in from the Arabian Gulf takes time to get to the United States, as a trivial example, but more germane, it takes years to find new fields, and then more years to develop them. The problem is that this usually slow response to change means that the impact of changes in the rules don’t always immediately appear to have the consequences that ultimately show up.

I have mentioned before (and will again) the dangers that the UK faces in long term energy supply as power stations are condemned to closure without a surety that there will be power in place and available to meet the evolving gap that this will lead. The world, at present, seems to believe that all will be well thanks to Russia, Turkmenistan and their neighbors who have a plethora of energy to offer. What is usually neglected in that review is the pipeline construction heading from those countries to China. The problem, of course, is that everyone assumes that the energy will be available, not recognizing the growing number of customers who are all bidding for volumes that will not meet global demand over the intermediate time interval. And the frequency with which gas pipelines seem to rupture as it crosses some of those borders is quite remarkable. The latest, between Kazakhstan and Russia occurred early Wednesday.

We are all, I fear, sadly complacent.

Turning just briefly to some of the graphs in the TWIP, and their possible meanings; Refinery inputs have leveled out, a little above last years numbers:

(Source TWIP)

Domestic crude is hovering around where it was at this time last year while imports have fallen from 10 mbd down to about 9.2 mbd since the middle of the summer, but this is a recognition of the change in driving as go go into the Fall. The drop in demand, that was holding off a little when I last commented on the numbers a couple of weeks ago, is now well under way.

(Source TWIP )

Since this is the first year that the EIA is showing ethanol numbers it is worth noting that while ethanol production continues to climb:

(Source TWIP )

the volume in stocks has been declining, though since this is the first year that the record is displayed, it is not yet clear how the seasonal trends will impact the shape of the curve.

(Source TWIP )

Given that, at the end of the month, the EPA is expected to rule on the use of E15 (i.e. 15% ethanol in the mix) ) it is perhaps not wise to make too many comments on the current shape of these graphs, since they are likely to change under that influence.

The anticipated benefit (apart from lowering the amount of crude that has to be imported) is based on an anticipated reduction in pollutants and better burning of the fuel in the engine. It remains to be seen what the unanticipated consequences are.

Since this is the political season our mayor dropped by our service club the other day to comment about the horrors of trying to run a budget as more and more mandates come down from the Federal Government, often written years ago, but only now showing up (so that he was careful to say that both parties share in the blame). His main theme (other than that we are not as bad as we might be, but that street repairs can only fix shorter stretches) was that many of the consequences only show up much later than the legislation, and regulation, and by that time it gets very difficult to correct initial mistakes.

Secure and timely energy supplies are a critical part of the success of industrialized nations. We need to remember that.