TEI Tax School: Tax Topics in Turbulent Times. Enhanced Oil Recovery Credit and Marginal Well Credit

Transcription

1 TEI Tax School: Tax Topics in Turbulent Times Enhanced Oil Recovery Credit and Marginal Well Credit February 24, 2017

2 Agenda Why Are We Talking About O&G Industry Tax Credits? Tax Credit Opportunities Wrap-Up and Questions 5 mins 45 mins 10 mins 2

3 Why Are We Talking About O&G Industry Tax Credits?

4 Historic Crude Oil Price 4

5 Enhanced Oil Recovery Credit

6 EOR Credit: Overview EOR credit provides a credit of 15% of the qualified costs incurred during the year attributable to qualified domestic enhanced oil recovery projects Credit has been phased out and inapplicable for 10 years due to the commodity prices While the US government has officially published the relevant inflation indexes and reference price for the underlying phase out computation for As a result of the reference price of oil, $44.39, and the inflation adjustment factor, the full 15% credit will apply in

7 Qualified EOR Costs Certain designated expenses associated with an EOR project, including: Amounts paid for depreciable tangible property Intangible drilling and development expenses Tertiary injectant expenses Construction costs for certain Alaskan natural gas treatment facilities 7

8 Qualified EOR Projects Definition: A certified domestic project that involves the application of a recovery method that is reasonably expected to result in more than an qualified tertiary insignificant increase in the amount of crude oil that will ultimately be recovered Qualified tertiary recovery methods include: Steam recovery methods Gas flood recovery methods Chemical flood recovery methods Mobility control recovery method 8

9 Qualified EOR Projects (cont.) Rules envision the qualification of other methods as technological advances occur (PLR may be requested) These do NOT qualify: Waterflooding, cyclic gas injection, horizontal drilling, gravity drainage, & other methods not specifically designated Increased v. Accelerated recovery: Merely accelerating recovery does not qualify 9

10 Qualified EOR Projects: Certification Initial Year Operator (or operating mineral interest owner designated by the operator) must submit a petroleum engineer s certification meeting the requirements outlined in the Treasury regulations Subsequent Years Same party must file an annual operator s certification that the project is being implemented substantially according to the petroleum engineer s certification Due Dates Must be filed not later than the due date (including extensions) of the party s income tax return for the applicable tax year Project Termination Notice must be filed for the year in which the project is terminated; notice due no later than the tax return due date (including extensions) for the year of termination 10

11 EOR Credit: Other Considerations Reduced deductions: To the extent the EOR credit is allowed for qualified costs, an income tax deduction otherwise allowed must be reduced Reduced basis adjustment: Increase in the basis of property that is otherwise allowable for costs for which an EOR credit is claimed must be reduced by the amount of the credit Election not to claim: Credit applies unless an election is made not to apply the credit for a particular year Election (or revocation thereof) may be filed at any time before the expiration of the 3-year period beginning on the due date for the tax return for such year (excluding extensions) Election for flow through entities is made at the partnership or S corporation level 11

12 EOR Credit: Other Considerations (cont.) Is a General Business Credit? Subject to Section 38 limitation on utilization Can t offset more than approximately 75% of tax liability with GBCs Can t offset AMT Carry back 1 year, forward 20 Non-refundable Unused credit remaining after the expiration of the carryforward period is deductible (section 196) 12

13 EOR Credit: Phase Out Credit is phased out as the average wellhead price for crude oil rises from $28 to $34 (adjusted for inflation) Reduction is equal to an amount that bears the same ratio to the amount of the credit as the excess of the reference price for the calendar year before the calendar year in which the tax year begins over $28 (inflation adjusted), bears to $6 Reference price: Secretary s estimate of the annual average wellhead price for domestic crude oil the price of which is not subject to regulation by the US Inflation adjustment factor (IAF): Fraction, the numerator is the GNP implicit price deflator for the preceding calendar year and the denominator is the GNP implicit price deflator for

14 EOR Credit: Hypothetical Phase Out Assume reference price for 2016 is $44.39 (EIA) Assume IAF for 2016 is Hypothetical GNP implicit price deflator for 2015 = GNP implicit price deflator = w/out rebased Credit Reduction = ((2015 reference price)-(28 x IAF))/6) Credit Reduction =($44.39)-(($28)(1.6409))/6 Reference price is less than $28 adjusted by inflation factor, so no phase out 14

15 Marginal Well Tax Credit

16 MWC Credit: Overview MWC credit provides a $3-per-barrel* credit for the production of crude oil and a $0.50-per cubic-feet* credit for the production of qualified natural gas from a qualified marginal well Only the first 1,095 barrels or barrel-of-oil equivalent per year qualify (Natural gas - 6,570 Mcf/year (18 Mcf/day)) Since its enactment in 2004, the credit has been fully phased out for both marginal oil and gas wells due to the relevant commodity prices While the government has not yet published the relevant reference prices and inflation factors, we believe a credit for qualified natural gas production in 2016 will be available, but not for qualified crude oil production Legislative history indicates inflation adjusted 16

17 MWC Credit: Phase Out MWC is unavailable if the reference price exceeds certain price thresholds The $3 and $.50 credit amounts are each reduced by an amount which bears the same ratio to such amount: i. The excess (if any) of the applicable reference price over $15 ($1.67 for qualified natural gas production), bears to ii. $3 ($0.33 for qualified natural gas production) Based on this formula, Oil: Phase out begins at $15 and fully phased out at $18 (per barrel) Gas: Phase out begins at $1.67 and fully phased out at $2.00 (per Mcf) Phase out amounts adjusted for inflation factor 17

18 MWC Credit: Phase Out (Cont.) Reference Prices: Applicable reference price for a taxable year is the reference price of the calendar year preceding the calendar year in which the taxable year begins Oil: Annual average wellhead price per barrel for unregulated domestic crude oil Gas: Secretary s estimate of the annual average wellhead price per 1,000 cubic feet for all domestic natural gas Crude oil reference price exceeded $18 every year since enactment in 2004 Government has never published reference price for natural gas; EIA published until recently, but prices always well above $2 threshold Inflation adjustment factor (IAF): Statutory dollar amounts increased to an amount equal to such dollar amount multiplied by the inflation adjustment factor for such calendar year (determined under section 43(b)(3)(B) by substituting 2004 for 1990 ) 18

19 MWC Credit: Hypothetical Phase Out Government has not published the relevant IAF or reference price for natural gas Based on an analysis of the underlying price indexes and the inflation adjustment factors published by the IRS for other purposes, we have estimated an IAF for 2015 Based on this estimated IAF and an estimated crude oil reference price of $44.39 (EIA), we estimate that the MWC credit for crude oil production in 2016 will remain fully phased out Based on a range of estimated natural gas wellhead prices for 2015 developed from publicly available information, we estimate that the MWC for 2016 natural gas should be partially available 19

20 MWC Credit: IAF Per Internal Revenue Code Assuming No Change to 2004 GNP Implicit Price Deflator A Numerator (2015 Deflator) B Denominator (2004 Deflator) = C Per Internal Revenue Code Assuming Rebased 2004 GNP Implicit Price Deflator Step 1 Determine relationship between FRED graph and GNP Implicit price deflators Rebased 1990 GNP Implicit Price Deflator fr. Notice Average 1990 GNP Deflator per FRED Graph fr. Tab "FRED Graph" Difference - ties to IRS guidance w/o/e Step 2 Utilize FRED Graph to determine an estimate of what the rebased 2004 GNP implicit price deflator will be Estimated 2004 GNP Implicit Price Deflator 89.09fr. Tab "FRED Graph" Step 3 Use new estimated rebased 2004 deflator in IAF estimate Numerator (2015 Deflator) Denominator (Rebased 2004 Deflator) = To Tab "MWC Calc" Notes The inflation adjustment factor is a fraction, the numerator of which is the GNP implicit price deflator for the preceding calendar year and the denominator of which is the GNP implicit Note A price deflator for 1990 (I.R.C. 43(b)(3)(B)). The inflation adjustment factor for the MWC is calculated as described in Note A, though, substituting "2004" for "1990" (I.R.C. 45I(b)(2)(B)). Per IRS Notice , the un-rebased 2004 Note B GNP implicit price deflator was Considering that the 1990 GNP implicit price deflator has been rebased eight times since 1995 (and four times since 2004), the MWC is calculated assuming that the 2004 GNP implicit Note C price deflator will be rebased. As detailed in part C above, Deloitte Tax identified the implicit price deflator, by quarter, as reported on the Federal Reserve Economic Data ("FRED") database. The average implicit price deflator for 1990 per the FRED database tied without exception to the rebased implicit price deflator published in IRS Notice As such, Deloitte Tax has estimated the rebased 2004 GNP Implicit Price Deflator using the average GNP Implicit Price Deflator for 2004 as reported within the FRED database. 20

21 Calculation of 45I Credit Marginal Well Credit Oil Credit: The credit for oil for any tax year equals $3 multiplied by the Inflation Adjustment Factor (IAF) times the qualified oil production $3 x IAF x bbls produced Natural Gas Credit: The credit for any tax year equals $0.50 multiplied by the IAF times the qualified natural gas production $0.50 x IAF x Mcfs produced 21

22 Phase Out of 45I Credit Marginal Well Credit Oil Credit Reduction: The reduction amount equals the inflation-adjusted credit amount ($3 x IAF) multiplied by the reference price excess over $3 multiplied by the IAF $3 x IAF x reference price excess $3 x IAF Natural Gas Credit: The reduction amount equals the inflation-adjusted credit amount ($0.50 x IAF) multiplied by the reference price excess over $0.33 multiplied by the IAF $0.50 x IAF x reference price excess $0.33 x IAF - The reduction amount may not be negative IRC Sec. 45I(b)(2)(A) 22

23 Reference Price Excess Marginal Well Credit Oil Reference Price Excess: The reference price excess for oil equals the reference price minus $15 times the IAF reference price - ($15 x IAF) Natural Gas Reference Price Excess: The reference price excess for natural gas equals the reference price minus $1.67 times the IAF reference price - ($1.67 x IAF) 23

24 Estimated Natural Gas Credit Marginal Well Credit: Full Phase Out Hypothetical Natural Gas Reference Price and Inflation Adjustment Factor: Natural Gas Reference Price $ Inflation Adjustment Factor Credit Calculation $0.50 x IAF ($0.50 x IAF x = reference price excess $0.33 x IAF ) $0.50 x ($0.50 x x $ ($1.67 x ) $0.33 x ) = $0 24

25 Estimated Natural Gas Credit Marginal Well Credit: Zero Phase Out Hypothetical Natural Gas Reference Price and Inflation Adjustment Factor: Natural Gas Reference Price $ Inflation Adjustment Factor Credit Calculation $0.50 x IAF ($0.50 x IAF x reference price excess $0.33 x IAF ) = $0.50 x ($0.50 x x $ ($1.67 x ) $0.33 x ) = $

26 Estimated Natural Gas Credit Marginal Well Credit: Partial Phase Out Hypothetical Natural Gas Reference Price and Inflation Adjustment Factor: Natural Gas Reference Price $2.19 Inflation Adjustment Factor Credit Calculation $0.50 x IAF ($0.50 x IAF x = reference price excess $0.33 x IAF ) $0.50 x ($0.50 x x $2.19 ($1.67 x ) $0.33 x ) = $

27 MWC Credit: Other Considerations Must hold an operating interest General business credit Special carryover period applies; back 5 years, forward 20 Not available if also claiming nonconventional sources credit If a well is owned by more than one owner, the credit is allocated among the owners in proportion to their share of the revenue interests of all operating interest owners Not available if also claiming Section 45K nonconventional sources credit 27

28 Marginal Well Credit 28

29 State (Texas) Marginal Well Revenue Exclusion

30 Texas Margin Tax Revenue Exclusion Target Company Profile: Producers that paid margin tax in the past 4 years Favorable Adjustment: When the Comptroller certifies NYMEX prices meet statutory thresholds for a given month, total revenue for that month from a qualifying well is excluded from both the tax base and apportionment calculation ($5/MMBtu for gas, $40/barrel for oil) Qualifying Well: Production must meet the statutory thresholds for the period (250 mcf/day, 10 barrels/day) Things to Keep in Mind: Cash benefits may be substantial Not a severance tax benefit; the thresholds and calculations are different Data needs/leverage 30

31 Wrap-Up & Questions

32 Presenter Trey Cornelius Manager Direct: Trey is a Manager in Deloitte s Business Tax Services practice based in Houston, Texas. He currently serves numerous independent producers in the upstream segment of the oil and gas industry including private equity oriented energy funds and public companies. Trey also has experience serving clients in the midstream segment, as well as clients in the construction and telecom, foodservice, hedge fund and professional sports industries. Trey has assisted clients in various areas including tax compliance, restructuring, ASC 740, tax basis balance sheet assistance and transaction consulting. Trey holds a BBA in Accounting and a Master of Professional Accounting from the University of Texas at Austin. He also holds a Juris Doctor from the University of Houston. He is a licensed CPA in Texas and a member of the Texas Bar. 32

33 About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. Please see for a more detailed description of DTTL and its member firms. Please see for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright 2016 Deloitte Development LLC. All rights reserved. Member of Deloitte Touche Tohmatsu Limited