Democrats Say Chesapeake’s Taxes Show Need to Update Old Law

Democrats said a report that the second-largest U.S. natural-gas producer paid an effective income tax rate of 1 percent makes it harder for the energy industry and Republicans to justify a 100-year-old exemption for drillers.

“Every revelation like this increases the likelihood that these tax subsidies will disappear,” said Representative Edward Markey, a Massachusetts Democrat who has introduced a bill to repeal tax breaks to the five largest oil companies operating in the U.S. “Oil and gas companies don’t need 100-year-old tax breaks to make hundreds of billions in profits every year.”

Chesapeake Energy Corp. (CHK) has been able to postpone much of its income-tax bill thanks to a provision designed to offset inherent risks in drilling, Bloomberg News reported yesterday.

Critics say the policy is no longer needed as improvements in technology reduce chances a well will come up dry. Chesapeake, of Oklahoma City, which struck oil or gas in 99.6 percent of its wells this year, has paid $53 million in income taxes on $5.5 billion in pretax profits since its founding 23 years ago. Its income tax bill is less than half of Chief Executive Officer Aubrey McClendon’s compensation in 2008, Bloomberg reported.

Senator Robert Menendez, a New Jersey Democrat, said oil subsidies “were a waste of taxpayer dollars, plain and simple.”

Menendez Legislation

Menendez introduced legislation last year to repeal breaks for oil and gas companies with revenue in excess of $100 million a year, which would include Chesapeake. That measure hasn’t been voted on in Congress.

Republicans have said the breaks encourage domestic production and create thousands of jobs during a shaky economic recovery.

“Energy development is a costly endeavor and we need to be careful to not make it more difficult to produce energy here in the United States,” Antonia Ferrier, a spokeswoman for Senator Orrin Hatch of Utah, the top Republican on the tax-writing Senate Finance Committee, said in an e-mail.

Republicans have also objected to singling out oil and gas companies. Ferrier said Hatch supports a review of the entire U.S. tax code as a way to stimulate growth.

The issue of energy taxes is a perennial topic in Washington, particularly in recent years when average gasoline prices have at times exceeded $4 a gallon, leading to record profits at oil companies but also frustration among motorists.

Obama’s Efforts

President Barack Obama has tried without success to end subsidies for fossil fuel producers, which are valued at more than $40 billion over 10 years, and using the money to fund clean-energy innovation.

That includes taking away the “intangible drilling costs” deduction that has reduced the tax bills of Chesapeake and other energy companies.

Obama believes the breaks are “unwarranted subsidies,” Clark Stevens, a White House spokesman, said in an e-mail.

Republicans and a few oil-patch Democrats turned back efforts to repeal another Senate bill by Menendez that focused on the five largest oil and gas producers by revenue operating in the U.S., an effort that would produce about $24 billion for the government. The law would cover Exxon Mobil Corp. (XOM), Royal Dutch Shell Plc (RDSA), BP Plc (BP/), Chevron Corp. (CVX) and ConocoPhillips. (COP)

The intangible-drilling tax break, which has been around since at least 1916, allows companies to count most of the cost of drilling a new well against their taxes at the time the money’s spent, rather than recognizing it over several years.

Failure Rate

An average of 80 percent of all the wells drilled failed to strike oil and gas when the tax policy first came into use, according to a 2008 Congressional Research Service report on the history of energy tax policy.

Chesapeake drilled or invested in 13 dry holes in 2011 out of 2,979 total wells drilled, a 0.4 percent failure rate, according to company filings. Exxon had a 1.2 percent failure rate, according to a public filing.

Repealing intangible drilling costs would generate $3.5 billion in 2013 and $13.9 billion in 10 years for the U.S., according to Obama’s budget request.

Data compiled by Bloomberg show that other oil and gas companies besides Chesapeake were also able to cut their taxes well below the corporate income rate of 35 percent. Range Resources Corp. (RRC) paid income taxes of about 0.4 percent of pretax income over the past decade, the data show. Southwestern Energy Co. (SWN) paid 2.1 percent and EQT Corp. (EQT) paid 5.3 percent, the data show.

Reduce Production

Domestic producers said repealing intangible drilling expenses would reduce domestic production, thereby increasing oil imports, and cost jobs.

“The elimination of the current policy would reduce U.S. independent producers’ capital budgets by about 25 percent,” Lee Fuller, vice president for government relations at the Independent Petroleum Association of America in Washington, said in an e-mail. “The number of dry wells may be lower because of better technology but the cost of drilling is higher and the business is still more risky than most.”

Harold Hamm, chairman and chief executive officer of Continental Resources Inc. (CLR), which says it is the largest leaseholder in the Bakken formation in North Dakota and Montana, told the Senate Finance Committee last month that his company would drill about one-third less oil without the ability to expense drilling costs.

Hamm, who is also advising presumptive Republican presidential nominee Mitt Romney on energy policy, said he was speaking for himself and not his company or the campaign.

Romney Campaign

The Romney campaign didn’t respond to an e-mail seeking a comment. Romney’s website says Obama has waged “war against oil and coal.”

Michael Kehs, a spokesman for Chesapeake, said the company has paid out more than $5 billion in cash toward taxes over the past 12 years, a figure that includes income taxes.

The income-tax rate for accounting purposes has varied from 36 percent to 40 percent since 2000 in years that the company reported a profit, he said.

Bloomberg analyzed the companies’ rates by comparing their cash income taxes -- what they actually paid -- to the pretax profits on their income statements over at least a decade. This long-run cash-effective tax rate was described by three accounting professors in a 2007 paper on tax avoidance.

The measure is different from the tax rate publicly reported by companies in their income statements, which compares pretax income to the amount of tax the company accrues for accounting purposes. That figure can bear little relation to what the company actually pays to the government.

When production from old wells outstrips the expense of drilling new holes, companies that postponed taxes will have to pay up. Chesapeake had a deferred income tax liability of $3.4 billion as of Dec. 31.

“The politics of allowing the largest oil and gas companies, along with the richest earners in America” to keep their tax breaks as federal programs are being cut, “will become increasingly difficult for Republicans to defend,” Markey said.

To contact the reporters on this story: Jim Snyder in Washington at jsnyder24@bloomberg.net; Kathleen Hunter in Washington at khunter9@bloomberg.net

To contact the editor responsible for this story: Jon Morgan at jmorgan97@bloomberg.net

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