By: Kristin Van Veen-Hinke/Vikki Cooper & Associates

July/August 2009

The 2009 Oklahoma State Legislative session included several bills aimed at the state’s Gross Production Taxes (GPT). Proposed changes included modifying apportionment of revenue from gas, modifying distribution of Gross Production Tax revenue, as well as modifying the time period during which an exemption may be claimed. Fortunately for the oil and gas industry in Oklahoma, State Bill 313 was signed by the Governor on May 26. This bill proposed extensions of the Gross Production Tax incentives which were set to expire on June 30, 2009. The extensions will keep the incentives on the books through 2012, with no other substantive changes made.

The list of incentives being extended includes:

• Horizontal wells, drilled after July 1, 2002, are exempt from GPT for 48 months or until payback.
• Non-producing wells put back on production are exempt for 28 months.
• Production enhancement projects such as workovers and re-completions are exempt for 28 months from the date of first sale.
• Discovery wells are exempt for 28 months.
• 3-D seismic wells are exempt for 18 months if the seismic was shot before July 1, 2000, and for 28 months if the seismic was shot after that date.

With the lack of uniformity associated with oil and gas prices, budgeting for the state government is a challenge. Opponents of the incentives believe that with recent declines in oil and gas prices, the industry should not be given these tax breaks. Proponents of the bill claim the repeal of such incentives would affect the amount of drilling performed in the state. For those concerned about the effect on drilling in the state, opponents call attention to a recent study by Oklahoma City University business professor Steve Agee. After surveying 25 local producers, Agee found that state tax incentives ranked last among 10 variables cited by Oklahoma oil industry executives as affecting their decision to drill. Less than half of the respondents said that the availability of a gross production tax incentive rebate was an influential part of their decision of whether to drill or not to drill a well.

Proponents support the incentives believing that Oklahoma would be at a competitive disadvantage since other oil and natural gas producing states offer similar tax breaks. Local producers stressed that the rebates received are reinvested in Oklahoma through additional drilling or in employee salaries and benefits. They emphasize that the money is spent in Oklahoma creating jobs and increasing production, which in turn adds to the state’s tax coffers. In this time of turmoil in the industry, proponents emphasize that this is the time for state lawmakers to support this industry that is providing a large majority of the revenue for the state and they applaud the Oklahoma State Legislature for continuing to support the industry.

What effect does GPT have on the state? Oklahoma has been one of the nation’s largest producers of oil and gas for many years. Crude oil production in the state for the year 2007 was 61 million barrels. This represents 3.2 percent of total production in the U.S. Oklahoma oil production trails behind the states of Alaska, Texas, California and Louisiana. Production of crude oil has declined nearly every year since 1990, falling by a total of almost two-thirds since its peak in the early 1980s.

On the other hand, natural gas production in Oklahoma topped 1.8 trillion cubic feet in 2008, representing 8.8 percent of total U.S. production. This natural gas production total trailed only Texas and Wyoming. During the 1990s, natural gas production fell; however, in the years from 2002 to 2008 it had increased almost 19 percent.

In Oklahoma, a Gross Production Tax or severance tax is assessed on the extraction of oil, natural gas and other minerals. The tax is based on a percentage of gross market value according to the average monthly price for each product as determined by the Oklahoma Tax Commission. For oil and natural gas, the basic rate is 7 percent; however, since 1999, if prices fall below a set level, the tax rate is lowered to 4 percent. This level for oil occurs when the price falls between $14 and $17 a barrel. For natural gas, the percent falls when the price is between $1.75 and $2.10 per Mcf. If oil falls lower than $14 per barrel and natural gas is below $1.75 per Mcf, the tax rate changes to 1 percent.

The GPT was a major stimulator to the Oklahoma state economy in 2008 as prices reached historic highs. Oklahoma collected $1.168 billion in Gross Production Tax revenues during that year. Of this amount, $808.2 million or 69.2 percent was collected from natural gas and $360.2 million or 30.8 percent was collected from the Gross Production Tax on oil. GPT revenue accounted for 14 percent of the total in taxes collected by the state in fiscal year 2008. It ranked third behind personal income tax ($2.8 billion, 31 percent) and the sales tax ($1.8 billion, 22 percent).

In fiscal year 2007, the Sooner state ranked third among states in total state severance tax collections behind Alaska and Texas. In regard to severance taxes as a percentage of total state tax collections, Oklahoma ranked sixth behind Alaska, Wyoming, North Dakota, New Mexico and Montana.

In the state of Oklahoma, GPT revenues for natural gas and oil are apportioned in different manners. If the tax rate is 7 percent, the revenues are apportioned as:

• 85.72 percent to the General Revenue fund
• 7.14 percent to county highways
• 7.14 percent to school districts

When the tax rate is 7 percent, oil revenues up to the first $150 million annually are divided in a more complicated formula. The distribution includes 77.16 percent divided between three education funds; 14.28 percent divided between county highways and school districts, 4.28 percent dedicated to county roads and bridges, and the remaining 4.28 percent divided between three small funds. Annual oil revenues in excess of $150 million all go to the General Revenue Fund. When the tax rate is 4 or 1 percent, oil and gas revenues are subject to different apportionment formulas.

With regard to the Gross Production Taxes, Oklahoma law provides exemptions for seven types of oil and gas drilling:

1. Enhanced recovery projects (economically at-risk wells)
2. Horizontally drilled wells
3. Inactive wells (reestablished production)
4. Production enhancement projects
5. Deep well drilling
6. New discovery wells
7. Three-dimensional seismic shoots

The exemptions, in most cases, are equal to 6/7ths of the GPT, meaning that exempt production is taxed at 1 percent. Enhanced recovery projects are fully exempt from the GPT.
These drilling exemptions may be limited in three ways:

• By Price – Most drilling exemptions apply only when the average annual index price of oil or gas is below a certain level or $5.00 per Mcf of gas or $30.00 per barrel of oil. The only exemptions not subject to a price trigger are those for enhanced recovery projects, horizontally drilled wells and deep wells below 15,000 feet spudded after July 1, 2005.
• By Duration – All oil and gas exemptions can be claimed only for a set length of time following a project’s initiation or completion. For most drilling, exemptions can be claimed for 28 months from the date of first sales. The exceptions are for horizontal wells, where the exemption is for 48 months or until all exploration and development costs are recovered; deep wells below 15,000 feet, where the exemption is for 48 months from the date of first sales for wells between 15,000 and 17,499 feet and 60 months for wells 17,500 feet and deeper; and enhanced recovery projects, where the exemption is for five years or termination of the secondary recovery project.
• By Amount – For deep wells of 15,000 feet and greater, the total amount of exemptions claimed is capped at $25 million per fiscal year as of fiscal year 2009. If allowable claims for the exemption are filed in an amount exceeding the cap, the amount of each claim is reduced proportionately. No other exemptions are capped as to their total amount.
From 2004 to 2008, the Oklahoma Tax Commission reports a total of $339.3 million in GPT rebates were claimed. During this same period, more than $4.5 billion was collected by the state in GPT. For fiscal year 2008, 97.5 percent of rebates were claimed for horizontal and deep wells.

It should be noted that in 2008, exemptions for other forms of drilling were suspended due to high prices.

(Information for this article provided by David Blatt of the Oklahoma Policy Institute and the Oklahoma Independent Petroleum Association.)