Percentage depletion is a tax provision that allows oil and natural gas producers to recoup some of the costs involved in exploring for and producing oil and natural gas.
What is Percentage Depletion?
Percentage depletion is a tax provision that allows oil and natural gas producers to recoup some of the costs involved in exploring for and producing oil and natural gas. It is only allowed for independent producers and royalty owners.
Elimination of percentage depletion would cause an economic ripple effect because of the change in incentives for the many small, independent oil and natural gas producers, and their royalty owners.
The percentage depletion provision has been a part of the U.S. tax code since February 11, 1926, when the Senate Committee on Finance passed it into law after extensive debate. Since 1954, all minerals produced or mined in the U.S. have been able to use percentage depletion.
However, it has recently become under attack again. President-elect Biden is planning to "get rid of subsidies for fossil fuels" which would include the elimination of the percentage depletion allowance for oil and natural gas producers. We at NSWA are continually meeting with legislative representatives to protect percentage depletion for our members.
Why is Percentage Depletion Important?
This provision supports the development of U.S. oil and natural gas, along with other mineral resources, that would otherwise be uneconomic to produce. This provision also enables independent producers (businesses with an average of 12 employees) to keep revenues that are vital to the future of their businesses and the operation of their oil and natural gas wells. It is because of percentage depletion that these operators can retain their earnings and many are reinvesting 150% of their cash flow back into American energy development. Royalty owners also rely on this tax provision.
Loss of percentage depletion would place marginal well production in jeopardy. Stripper Wells, that rely on percentage depletion, make up a significant portion of America's oil and natural gas production. These wells may produce less than 15 barrels of oil a day, but they account for nearly 19% of U.S. oil production. These wells also produce less than 90 thousand cubic feet a day, yet account for 12 % of U.S. natural gas. (Energy Tax Facts)
Image by Energy Tax Facts
How is it Calculated?
Percentage depletion is calculated by applying a 15% reduction to the taxable gross income of a productive well's property. The reduction is determined on a property-by-property basis and is limited to the taxpayer’s first 1,000 barrels of oil (or 6,000 mcf of natural gas) of production per day. It is also capped at the net income of a well and limited to 65 percent of the taxpayer’s net income.
See our percentage depletion calculator here.
Percentage Depletion Economic Impact Study
In October 2014, NSWA completed a study on the economic effects of eliminating percentage depletion from the tax code. As the small business owners of America’s oil and gas industry, we use the percentage depletion allowance to keep the cash on hand we need to drill more wells and rework old ones.
The data shows how percentage depletion benefits all Americans and the nation’s continued economic strength by supporting energy production.
Due to recent tax law changes and the price of oil, the NSWA recently commissioned a study update to reflect the current U.S. economy and how percentage depletion benefits the entire nation. A new report will be available in early 2021.