Global Project Finance > Tax Equity Telegraph > Level Playing Fields
06 Mar '13

Many opponents of  renewable energy use the rhetoric that tax benefits for renewable energy should be eliminated, so renewables compete on a level playing field with conventional forms of energy.  An assumption in this statement is that other forms of energy do not benefit from tax subsidies.  Let’s examine the tax benefits for natural gas and oil.

Finite natural resources, like oil and gas, are subject to a cost-recovery calculation for tax purposes known as depletion.  It is their equivalent to depreciation.  There are two types of depletion: percentage and cost.  Big players, like ExxonMobil, are required to use cost depletion.  Cost depletion is analogous to straight-line depreciation and is not that sexy.

However, smaller players which produce fewer than one million barrels (or the natural gas equivalent) a year are permitted to use percentage depletion.  Percentage depletion is a deduction equal to 15 percent of the gross income from the oil or natural well for the year in question.  However, there is no cap on the amount of the deduction.  If the well keeps producing for decades, the owner of it gets to deduct 15 percent of the gross income every year. So eventually more than the cost of the oil can be deducted cumulatively. Although, ExxonMobil and its ilk are huge producers, more oil and gas are produced by small players eligible for percentage depletion than by the mega corporations.

The next tax benefit is expensing of intangible drilling costs.  Intangible drilling costs (IDC) are effectively start-up costs for an oil or gas well.  Similar costs in the renewable energy industry, and other industries, are required to be capitalized.   IDCs, however, can be expensed in the year in which they are incurred.

A third benefit is the master limited partnership (MLP) tax rules.  The Internal Revenue Code generally requires publicly traded entities to be taxed as corporations.  This means the corporation pays tax on its profits, and the shareholders pay tax on dividends and capital gains.  The MLP rules are an exception to that requirement.  They permit an oil and gas venture to be publicly traded and for the tax liability to pass through the business entity to its owners (a single layer of tax). 

The MLP rules provide a tremendous financial advantage.  There are a host of technical tax requirements to be met to become an MLP.  The most important of which is that 90 percent of income must come from qualifying sources (so called “good income”).  Congress has not included income from renewable energy projects as good income for this 90 percent test, but income from oil and gas is.

It is difficult to quantify the net effect of these three tax benefits, but it is substantial.  It seems unfair to ask renewables to play on a level playing field, while the oil and gas industry cruises down a bunny slope.