The oil and gas industry is can be a challenging, but lucrative business, both for private operators as well as the State of Texas. The state receives massive revenue each year due to oil and gas production within its borders; in fact, statistics from the Texas Comptroller of Public Accounts shows that approximately $3.8 billion and $1.8 billion of revenue was collected in 2014 due to oil and natural gas production, respectively.
Recent efforts by some oil producers, however, could significantly cut into the state’s tax revenue, which would come along with other revenue decreases as a result of the slowdown. To be sure, these producers are attempting to reclassify their wells with tax incentives in mind, a move that could, according to an October 2015 article in the Texas Tribune, “cost the state hundreds of millions of dollars in tax collections and refunds.”
Tax Benefits Associated with Reclassifying Wells
According to the Texas Tribune report, nearly 850 oil wells were reclassified as natural gas wells in 2015, which is “more than triple the number from the previous year and nearly six times the reclassifications in 2013.” But why, exactly, are oil well operators attempting to reclassify their wells, and in such large numbers?
Ultimately, the answer lies in the tax benefits associated with operating natural gas wells versus their oil counterparts. Specifically, most natural gas well operators with wells completed after 1996 have access to a tax incentive that declares a majority of natural gas throughout the state as “high cost,” resulting in a significantly decreased tax liability for the owner. Because of this, oil well operators pursuing reclassification likely have their sights set on lower tax payments for their product.
Furthermore, well reclassification isn’t necessarily a difficult process. To begin, if a well operator accesses both oil and gas from a specific well, the Railroad Commission of Texas will assess the operation to decide whether it should be classified as a well for oil or gas (only one is allowed). If the well operator is unsatisfied with the decision, however, he or she may request a reclassification based on the amount of gas actually being produced.
Will Reclassifications Continue?
As long as the tax incentive remains associated with natural gas production, many operators will likely continue to attempt to reclassify their current oil wells. And, to be sure, while future legislative reform may alter these tax benefits, it is unknown when this may actually happen.
For now, the State of Texas may be forced to accept a heavy decrease in tax revenues coming in from oil and gas operations statewide. As always, we see the resiliency of the energy sector in the ongoing battle with the marketplace.