I Cannot Complete With Your Tax Scheme – Will North Dakota Tax Incentives Boost Crude Output?

Data from the North Dakota Industrial Commission (NDIC) indicate that production in January 2015 slowed by 37 Mb/d from record levels over 1.2 MMb/d in December. The number of new well completions also slowed in January – leading to a large backlog of wells drilled and waiting to start producing. Lower production and completions are in part due to producer caution following the crude price crash last year but producers waiting for a North Dakota state tax break and the usual impact of winter weather could also be responsible. Today we describe how new state tax incentives could boost summer output back to record levels.

Even at recent lower crude prices, oil production generates huge economic benefits for those states like North Dakota that are lucky enough to sit on top of prolific shale formations. States generally impose various taxes on oil and gas production at the wellhead and vigorously regulate drilling and production activity. As we described recently, North Dakota has been pro-active in trying to reduce the quantity of gas that is flared at the wellhead (see Fewer “Candles In the Wind”). Among many other regulatory requirements, they also require monthly reporting of well production and are involved in downstream regulations such as the rules for the conditioning of crude for rail transportation that came into effect this month (April 2015).

On the revenue side, North Dakota applies two taxes to most of the State’s oil production. The first is a 5% Gross Production Tax (GPT) applied to the gross value of all oil produced except for certain publically held or American Indian holdings. The second is a 6.5% Extraction Tax that is also applied to the gross value of oil produced at the well. Over time, the GPT has been applied consistently but the North Dakota legislature has implemented a couple of incentive schemes to encourage oil production by waiving or reducing the 6.5% extraction tax when crude prices are low. Low crude prices since last Summer led to the first of these incentives – known as the Small Trigger – coming into effect on February 1, 2015 and the second – known as the Large Trigger – looking increasingly likely to be tripped should average crude prices stay below $55/Bbl during April and May of this year.

Small Trigger

The North Dakota Legislature enacted the small trigger tax break in 2009 to incentivize new drilling of horizontal wells and encourage production through periods of low oil prices. The trigger comes into effect when the monthly average price of West Texas Intermediate (WTI) crude (the U.S. domestic benchmark) falls below $57.50/Bbl (see the purple line in Figure #1). In January 2015 the WTI average was about $47/Bbl meaning that the extraction tax incentive came into effect for new wells drilled after February 1, 2015. The small trigger incentive lowers the oil extraction tax from 6.5% to 2% on the first 75 MBbl produced or the first $4.5 million of gross value (whichever comes first) for up to 18 months following well completion. The small trigger only applies to wells completed after the incentive is triggered and is only effective through June 30, 2015 when its enacting legislation sunsets. The small trigger incentive is also disabled if average WTI prices exceed $72.50/Bbl during any month after the trigger. Effectively this means the 4.5% tax break will apply to all new horizontal wells completed between February and June in North Dakota unless there is a sudden oil price recovery above $72.50/Bbl – pretty unlikely.

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