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Drilling For Tax Dollars

Shaking down the state treasury

March 1, 1996 | By Keith Schneider
Great Lakes Bulletin News Service

Message to the White House and Congress: Want a billion dollars to help balance the federal budget? Look in the nest of corporate welfare that Washington lays out for oil and gas producers.

There, along with the depletion allowances and exploration subsidies, federal budget balancers will discover a $1 billion-a-year tax credit for natural gas producers that long ago outlived its usefulness, and now is just a big juicy giveaway.

This federal gift to the energy industry already has cost taxpayers $4.4 billion since it was enacted in 1980. It will cost another $5.5 billion before it expires at the end of 2002, according to estimates by the U.S. Treasury Department.

Administered by the Internal Revenue Service, the Section 29 "Unconventional Fuels" tax credit is one of the most generous, and perhaps most senselessly expensive and environmentally damaging, energy programs ever devised.

A product of the 1973 Arab oil embargo and the perceived "energy crisis" that followed, the credit was enacted by Congress in 1980 as part of the Crude Oil Windfall Profits Tax Act. At the time, the nation had endured several hard winters when natural gas supplies were tight and prices were high.

Congress sought to address the problem by offering a generous incentive in the form of a tax credit, which is skimmed like cream off the top of income taxes. Exploration companies willing to drill in specific "unconventional" energy-bearing formations around the country — such as the coal methane beds of northern Alabama, Colorado, New Mexico, and Wyoming; the tight sands of eastern Texas; and the gas-bearing shales of Appalachia and northern Michigan.

The intent of the credit was to invent technology for tapping these gas-saturated but dense geological formations. In the 1980 tax year, the program offered drillers 52¢ per thousand cubic feet of gas produced, meaning that for the average well, producing 100,000 cubic feet a day, investors could deduct $18,928 a year from the amount of tax due.

Each well drilled in a defined reserve before December 31, 1992, became eligible for the credit. The Department of Energy estimated that 50,000 to 70,000 wells were drilled across the country to qualify. The tax credit was indexed for inflation, and now is worth $1.02 per thousand cubic feet of gas produced, or $37,200 annually for a well that produces 100,000 cubic feet daily. Is 100,000 still the average?


As a technology promotion program, the Section 29 credit worked quickly and well. By the early 1990s, engineers had figured out how to drill, fracture, pump, and process large quantities of gas from previously "hard to tap" reserves.

• About 2,500 wells were drilled in northwestern New Mexico’s San Juan basin, producing 700 billion cubic feet of natural gas annually, or 3.5% of the national supply.

• Wyoming, Colorado, and Alabama each year combine to produce 200 billion cubic feet more.

• In Michigan, the tax credit caused a natural gas rush — more than 4,500 wells that qualified for the credit have been installed in the Antrim Shale layer lying beneath the heavily forested counties of the northern lower peninsula. Of the state’s natural gas production — now 250 billion cubic feet a year and rising — 65% comes from Antrim Shale wells. Michigan is the nation’s 12th-largest producer of natural gas, and ascending in the rankings.

In all, about 5.5% of the nation’s natural gas is produced from wells eligible for the credit, or slightly more than 1 trillion cubic feet of gas a year.

On the plus side, the credit encouraged new exploration and drilling techniques that improved the nation’s energy supply picture. Even after eligibility expired, companies nevertheless continued probing for natural gas in unconventional reserves. According to the Oil and Gas Journal, a monthly magazine that covers the industry, three of every five new natural gas wells in the United States last year were drilled in the unconventional sources.

The problem with the program is two-fold. First, the tax writeoffs do not expire until December 31, 2002. The second is that the ingenuity of the engineers far exceeded expectations. Eligible wells are vastly more productive than Congress initially envisioned.

In effect, Congress designed a tax program of extraordinary largesse, an open-ended subsidy with long payout times and no cap on costs. What was initially seen for a 22-year period as a $500 million to $1 billion program has ballooned into a $10 billion program, according to Hudson Milner, a specialist at the Treasury Department.

Who are some of the players getting this huge tax break? Utilities like Consumers Power and MichCon, the two largest natural gas sellers in Michigan. And Belden & Blake, an Ohio-based company that operates more natural gas wells in the eastern United States than any other company.

Just last year, Michigan’s largest producer of Antrim Shale gas, Terra Energy, was sold for $63.6 million, the largest private energy company sale in the state’s history. Of the more than 1,400 wells drilled by Terra Energy in Michigan, roughly 800 qualified for the Section 29 tax credit.

There’s more. By linking deductions to production, the Section 29 credit encouraged far more drilling than was necessary to tap the reserves — as many as two out of every three wells installed in Michigan’s Antrim formation exist primarily to benefit from the subsidy.

The result? The Section 29 tax credit is among the most damaging land use policies enacted by Congress in the last two decades. Wells drilled to qualify for the credit needed roads, pipelines, pumping stations, processing plants, and purifying facilities to move the gas from the ground to the market. The credit encouraged the construction of a sprawling industrial manufacturing infrastructure that chewed up desert lands in the Southwest, and eroded hillsides in the East and South.

In eastern Colorado, the drilling of more than 3,000 new wells in the early 1990s caused a protest among farmers so fierce that the Colorado Oil and Gas Conservation Commission established new policies for notifying landowners about drilling before it occurs. The Commission also has proposed requiring larger bonds for plugging and cleanup when production ends.

Alabama citizens have battled to prevent streams and rivers from being harmed by erosion from access roads and pipelines.

No state, though, has been affected by Section 29-driven drilling more than Michigan. Installing the Antrim Shale gas fields in the last decade turned 500,000 acres of magnificent woodlands into an ugly and noisy maze of muddy access roads, deep pipeline trenches, and clear-cut drilling sites. Not since Michigan’s white pine forests were cut to the ground a century ago has the government sanctioned such wanton degradation of natural resources.

Millions of acres of the nation’s most beautiful rural landscape have been deformed by over-building of natural gas developments. And while there are reasonable arguments for natural gas burning more cleanly than oil or coal, at this end of the pipeline the environmental costs are grave.

There is no justification for continuing to require taxpayers to finance this wasteful gift to the richest among us. The United States is awash in natural gas. Prices have tumbled to the lowest levels in history, in part because of the productivity of thousands of Section 29 wells. In an era when every penny counts, it’s time for President Clinton and House Speaker Newt Gingrich to save a billion dollars a year. Ax the credit.

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