Section 29 Tax Credits – Did They Bring Us Where We Are Today? #unconventional #onshore #technology #business #projectmanagement

By 30th December 2015 Industry News No Comments

It is very popular today to point fingers at those whom we perceive as culprits in the current price structure facing oil and gas production. KSA, OPEC, Shalers, Russia, ISIL, hybrid and electric vehicles, climate change criers and deniers… the list goes on.

Many Oilpros have been reviewing data in a broader context than those who just entered this field, and perhaps that is needed to place this event into historical perspective. This scrivener had the good fortune to begin his career in 1982, and recalls all too well this roller coaster that we have grown to know.

A bit of background into unconventional reservoir development is what follows. While not as exciting as much of the diatribe found online, it is the truth; so brace up to be less than overwhelmed. If exciting commentary were a goal, this would be on Reddit.

Unconventional Reservoir Development

The use of shale oil dates back as far as 1350, and in 1781 a patent was registered in England for the process of extraction and production of tar and pitch from coal and bituminous shales by Archibald Cochrane, the 9th Earl of Dundonald. As you see, it is far from a new concept.

Fast forward to 1976, when the Department of Energy and the Gas Research Institute were tasked by congress to research the viability of exploiting the many tight reservoirs that were known to contain gas, but were unattractive to produce because of the low margins involved. At that time, only about 7% of domestic gas production came from unconventional sources, while today over half of domestic production comes from unconventional, and the percentage is growing dramatically.

The Eastern Gas Shales Project was formally initiated in 1976 at the Morgantown Energy Research Center, in Morgantown, WV. Federal funding continued through 1992, and during that period many innovative ideas were propelled into realities. The gas production from the Appalachian Basin as well as several other basins increased dramatically between 1980 and 1992.

Much of the science used today to exploit shale has its origins in the research funded by the DOE. You see since the early 1980s, due to the low prices, the majors found it easier to ‘buy’ reserves than to spend money on the R&D needed to unlock this potential. Game changing advances in micro-seismic fracture mapping, nitrogen foam stimulation, and even the PDC (polycrystalline diamond compact) bit development can be traced back to this government funded research.

While this research was funded with the goal of increasing natural gas production, many of its breakthroughs were also applicable to the light tight oil production we are now seeing in the Bakken, Eagle Ford and Permian Basins; but more on that later….

The Windfall Profits Tax Act of 1980 established a production tax credit for gas produced from unconventional sources, and it was extremely generous. In what was called the Section 29 credit, production from qualified wells drilled between 1979 and 1993, and produced through 2002 would earn a tax credit equal to over $1.00 per mcf on average through the 1990s. When the wellhead price was about $3.00/mcf, the CREDIT amounted to about one-third of the price, making the monetary value of this credit worth more than actually selling the gas, assuming a 32% tax rate.

In fact, the Gas Research Institute and the Department of Energy were partners with Mitchell Energy in developing the Barnett Shale in 1991. It was there that the combination of horizontal drilling and slick water fracturing was demonstrated to be commercially viable.

The combination of horizontal drilling and high-volume fracturing was soon applied to oil-bearing shales with a degree of success that nobody envisioned. This juggernaut we call LTO utilizes many of the breakthroughs discovered in part through our government-funded research, making us victims of our own success.

Was this a bad investment? I think not, as the market situation is very different today than 1976. Back then we faced a serious shortage in domestic energy supply and this seemed like an innovative way of dealing with OPEC. There were also some really foolish laws passed then that also had serious ramifications to the market, including the “Tier System” for pricing oil, Fuel Uses Act of 1975, and the export prohibition, just recently lifted.

No, I think the current price debacle has its roots in several causes, which all contributed to our present condition. The main culprit should be those with the audacity to think oil would stay over $100 permanently. Same for natgas in this Marcellus/Utica region, where producers can see record IP’s and 52-week lows to their stock price posted simultaneously. Add currency manipulation, cheap credit policy and a seriously defective policy towards MENA, going back several decades, and you can now understand why we are here today.

Have a safe and prosperous New Year, and count on being surprised often.

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