Will oil prices and taxes help or hurt drilling in OK?
Readers who participated in Tuesday’s monthly chat with The Oklahoman’s energy writers Adam Wilmoth and Jack Money on NewsOK.com asked about future oil and natural gas prices and whether increased gross production taxes could impact drilling plans.
A transcript of the chat edited for clarity and space follows.
Q: Where are oil and natural gas prices heading?
Wilmoth: In general, oil prices are strong, as the global supply glut that tanked prices three years ago is largely under control. OPEC and Russia continue to meet or exceed their pledges to cut production. Venezuela’s production is off sharply, and many other larger producers — other than Russia and Saudi Arabia — have shown difficulties in maintaining production levels.
In the U.S., production is growing, particularly in Texas, Oklahoma and North Dakota.
But while oil prices are up, natural gas prices are flat, continuing a bear market that has lasted for more than a decade, since U.S. production still outpaces demand. Power plants and industrial consumers are switching to natural gas, and exports are up, both by pipe to Mexico and by liquefied natural gas exports overseas. But heavy production continues to grow, particularly in Texas and Oklahoma, where it often is produced as a byproduct of oil drilling.
Oil prices are up sharply over the past year, up 66 percent from June 2017, and they jumped again the past week or so because of continued production drops in Venezuela and speculation that President Trump would withdraw the country from the Iran nuclear deal. But it’s difficult to predict where they might be headed longterm.
Q: There is more to oil and gas companies’ profitability than commodity prices. Can you contrast the income of Oklahoma companies to the debt that these companies have currently?
Wilmoth: Debt is a big issue for oil and natural gas companies, and all the major Oklahoma companies have highlighted their efforts to pay down that debt using free cash and proceeds from asset sales. Not long ago, companies spent every dollar they earned — often much more than that — for drilling operations. But for most oil and natural gas producers, growing production is no longer the primary focus.
For example, Devon Energy paid back $807 million in debt in the first quarter, Chesapeake cut its debt by $581 million, and Continental Resources said it plans to cut debt by another $1 billion by next year.
Q: Do you think the Oklahoma Legislature is done raising taxes on the oil and gas industry, or do you foresee a situation in the near future where they do it again?
Wilmoth: It looks like the current tax rate of 5 percent approved this session will stay where it is a while. There are signs that the state economy is continuing to recover. Sales tax and other tax collections are up. But it’s difficult to project long-term what the state budget will look like.
Money: It is hard to predict where our Legislature will go when it needs future revenues. Regardless, it seems lately it has preferred to increase production taxes on oil and gas (and wind-produced electricity, though it failed this session to muster needed support), and to increase consumption taxes on tobacco and fuel. While there are organizations that lobby for the oil and gas and wind industries, consumers don’t seem to have anyone lobbying on their behalf. That’s why finding candidates you support and voting is important.
Q: With the recent teacher pay raises being tied to oil and gas production taxes, tobacco purchases and fuel consumption, what will happen if oil prices go down and people start smoking and driving less?
Money: We will see another revenue crisis, at some point. Production taxes on oil and natural gas are never a sure thing, as history has shown us, and tying raises to that source of revenue is risky. As for smoking, advocates of tobacco tax increases have argued before that increasing those positively impact smoking rates, so it would be logical to expect that source’s revenue to decline over time.
When it comes to fuel sales, we’ve all got to drive and there aren’t many good mass transit options. I don’t know those increased taxes will make much of a difference on fuel consumption.
Q: Is there any indication that drilling will decrease in the state because of the recent tax increase? Money:No. Wilmoth: The higher gross production tax rate will cost companies money and could reduce the amount they spend on drilling and other efforts.
But that tax rate is just one of many variables executives focus on. While the tax rate is up, oil prices also are up, at least for now. Companies also have to deal with the varying cost of sand, completion crews and drilling rig day rates and hundreds of other variables.
Devon CEO Dave Hager told me last week how the higher gross production tax rate is affecting his company: “It does impact the rate of return on Oklahoma projects. It’s going to cost us at least $30 million a year, perhaps more,” Hager said. “We think we are finding ways to offset that through drilling wells more efficiently, focusing on the most prolific parts of the STACK play where we have the best acreage positions and applying the best technology. But it’s a challenge. It certainly would have been a lot easier without that increase.”