Tax Breaks Make $50 Oil Profitable in the U.S.

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Yves here. Another OilPrice post tonight raises doubts about the profit potential of US shale gas plays, most importantly the Permian Basin. Key sections from that story:

Shale companies spent just $5 billion on land deals in West Texas in the last six months, a fraction of the $35 billion spent in the prior nine-month period, according to the Houston Chronicle, citing Wood Mackenzie data.

It’s the latest piece of evidence to suggest that “Permania” might be easing. The hottest shale basin on the planet has suffered from rising costs as too many companies pour money into West Texas. The crowded field has pushed up the price of land, labor, oilfield services, rigs and more. That has led to a rude awakening for a lot of shale drillers. “It’s just taken the edge off the Permian,” said Greig Aitken, head of upstream oil and gas mergers and acquisitions at Wood Mackenzie, according to the Houston Chronicle.

Many signs suggest that the falling costs of production have stopped falling. In fact, production costs are on the rise again, for a few reasons. First, the low hanging fruit of cost cutting has ended—there’s no fat left to cut and deeper reductions would mean cutting into bone. Second, as mentioned before, there is cost inflation in a lot of areas, including labor, fracking crews and acreage.

But arguably the most troubling development for shale drillers would be if the production figures from the oil well disappoint—and there are pieces of evidence that indicate there is cause for concern.

Over the summer, Pioneer Natural Resources reported a much higher than expected gas-to-oil ratio (GOR), raising alarm bells for investors worried about Permian production problems. The anxiety was compounded by the fact that many consider Pioneer one of the stronger shale drillers in the Permian. The company also revealed that it drilled some “train wreck” wells, although it reassured investors that it had solved the problem.

But as The Wall Street Journal notes, the “solution” added an additional $400,000 to each well. In other words, costs are adding up in many places, which will ultimately push up the breakeven price for shale drilling.

Note that Wood McKenzie’s analysts have a regularly been hard core bulls, so any signs of doubt from them about industry fundamentals should be taken seriously

By Tsvetana Paraskova, a writer for he U.S.-based Divergente LLC consulting firm. Originally published at OilPrice

While the U.S. administration is pushing for a tax code overhaul and supports American “energy dominance”, an environmental group suggests in a new study that at the current oil prices of $50, the development of U.S. oil resources may be much more dependent on tax deductions and provisions than previously thought.

The study, conducted by researchers at the Stockholm Environment Institute and Earth Track, concludes that at a $50 oil price, around half of discovered and yet-to-be developed oil resources in the U.S. would depend on existing tax deductions to go from unprofitable to profitable.

The researchers divided U.S. fields into four groups: the Permian Basin, the Williston Basin, the Gulf of Mexico, and a fourth group to include all other basins. Then they studied how each of the tax provisions influence the return on investment for new U.S. oil resources of more than 800 fields that have been discovered but not yet developed. Assuming a minimum return of 10 percent needed for investors to justify proceeding with a project, researchers found that “tax preferences and other subsidies push nearly half of new, yet-to-be-developed oil investments into profitability, potentially increasing U.S. oil production by 17 billion barrels over the next few decades.”

The lowest “subsidy dependence” for new projects at $50 oil is found, not surprisingly, in the Permian, where 40 percent of the economic oil resource is “subsidy-dependent”. This compares with 73 percent in the Gulf of Mexico and with 59 percent in the Williston Basin.

The high Gulf of Mexico ‘subsidy-dependence’ isn’t a surprise either, considering that mostly integrated oil companies operate there, and they’re not enjoying as much tax deductions as the independent producers that are doing business in shale basins.

“About 10 billion barrels of Permian oil are in fields that would be profitable at $50 per barrel even without subsidies, but subsidies bring on enough extra fields to produce an additional 6.5 billion barrels of oil,” the study says.

The effects of the tax deductions are highly connected with oil prices. At $30 per barrel oil, almost no new fields would be profitable to develop, even with those tax provisions, the researchers say. Of course, at $100 oil, revenues from new projects would be enough to sanction nearly all developments without any tax provisions. “In such a case, nearly all of the subsidy value would go to extra profits,” the study says.

“Our findings show that removal of tax incentives and other fossil fuel support policies could both fulfill G20 commitments and yield climate benefits,” researchers say.

Almost simultaneously with this study, environmental advocacy group Oil Change International said in a report that “U.S. taxpayers continue to foot the bill for more than $20 billion in fossil fuel subsidies each year.”

In the other camp, the American Petroleum Institute (API) says that “It’s out there; the myth that America’s oil and natural gas industry receives federal subsidies. Subsidies are cash outlays from the U.S. Treasury, and the oil and natural gas industry doesn’t get them.”

API points to the fact that other industries also get tax-deductible expenses and other tax provisions and breaks.

The debate about tax breaks for the oil industry is certainly not new. Those who support the current provisions argue that they have supported an industry critical for the U.S. economy and energy security. Those against say that the provisions are singling out favorites while shifting the tax burden to others.

Environmentalists say that with climate change a real threat, it’s just illogical and wrong to support fossil fuel development with tax breaks.