Enhanced Oil Recovery Tax Credits: Then and Now, Drew Willey Law's Tax Planning Contributions
At the start of my legal career, I published an article entitled, Resurgence of EOR Credits: Oil Tax Planning Opportunity, in the Texas Tax Lawyer, Vol. 43 No. 2, Winter 2016: 116-17. Print and Internet. That article correctly predicted the return of EOR tax credits, as later validated by other industry experts. Today, we are working to help businesses take advantage of tax credits in EOR projects again when they utilize carbon sequestration in their CO2 EOR projects. For some historical review, I’m posting today an overview of EOR, and re-publishing the text of our successful entry into the world of energy tax law.
EOR Overview
Enhanced Oil Recovery (EOR) is a set of techniques used to increase the amount of crude oil that can be extracted from an oil field. Traditional oil recovery methods, which rely on natural pressure differences and pumping, typically retrieve only a fraction of the reservoir's total oil. EOR techniques improve the efficiency of oil extraction, often significantly increasing the field's output. One of the primary EOR methods involves the use of carbon dioxide (CO2).
CO2 Enhanced Oil Recovery Process:
1. Capture and Compression of CO2: The first step involves capturing CO2 from its source, which could be a natural CO2 deposit or the emissions from power plants and other industrial sources. After capture, CO2 is compressed into a supercritical state, which means it exhibits properties of both gas and liquid. This compression is necessary for the efficient transportation and injection of CO2 into the oil reservoir.
2. Transportation: Once compressed, CO2 is transported from the capture site to the oil field. This transportation is typically done through specially designed pipelines that can handle the high pressure required to maintain CO2 in a supercritical state.
3. Injection: Upon reaching the oil field, supercritical CO2 is injected deep into the oil reservoir. The properties of supercritical CO2 facilitate its mixing with the oil, reducing the oil's viscosity and increasing its flow. This process can also increase the reservoir's pressure, further helping drive oil towards the production wells.
4. Oil Extraction: The decreased viscosity and increased pressure help push the oil from within the reservoir to the production wells, from where it's brought to the surface. This process significantly enhances the amount of oil that can be recovered from a field, especially when compared to traditional extraction methods.
5. Separation and Sequestration: Once the oil is extracted, it's separated from the CO2 and other associated gases. The CO2 can then be re-compressed and re-injected into the reservoir to continue the EOR process. Over time, a significant portion of the injected CO2 remains trapped underground permanently, effectively sequestering it from the atmosphere.
Environmental Considerations and Controversy:
From an environmental standpoint, CO2-EOR can be a complex initiative. On the positive side, it uses CO2 that could otherwise end up in the atmosphere, contributing to global warming. By injecting this CO2 underground, EOR can serve as a form of carbon sequestration, potentially helping to combat climate change.
A planning and risk mitigation opportunity exists for producers that use EOR to primarily extract more fossil fuels, the use of which will generate more CO2 emissions. This opportunity maximizes oil and gas economics while sequestering some carbon, and can help conventional sources of energy engage with energy transition to limit greenhouse gas emissions.
CO2-EOR can help balance carbon emission reductions while societies work towards more sustainable energy solutions. As the world moves toward a lower-carbon energy future, the role and methodologies of EOR will likely continue to evolve, and we’re here to help you navigate the legal and tax considerations to help your business thrive. Like we were doing when we started:
Resurgence of EOR Credits: Oil Tax Planning Opportunity, Texas Tax Lawyer article re-publish (citations omitted):
“With oil prices dropping, the potential for claiming Enhanced Oil Recovery (“EOR”) tax credits may come back soon.
Why should we care now? For clients with already established marginal EOR projects, this credit could make it economical for them to begin producing those projects again. It could also attract clients to EOR projects. While most clients may not turn a field into a qualifying carbon dioxide (“CO2”) or water injector project because of a predicted tax break, a 15% savings on cost just might mean the difference at a time when oil clients need to get creative to bring profits. At the very least, it’s a bit of bright news to bring your oil clients when they probably need it.
Statutorily, the EOR credits are in effect when the oil price is $28 per barrel or below (adjusted for inflation), based on a yearly reference price issued by the IRS. The credit is phased out as prices increase, up to $6 above this inflation adjusted number. These numbers are all increased by inflation rates (inflation adjustment factors) issued by the IRS.
For the 2013 calendar year, that inflation rate was 1.5974. So, the EOR credit was at least partially available had the reference price been $50.73 per barrel (28*1.5974+6) or below. The reference price used for the 2013 calendar year was $96.13. The reference price used for the 2014 calendar year was $87.39, which ‘exceeds $28 multiplied by the inflation adjustment factor for the 2014 calendar year ($28 multiplied by 1.6245 = $45.49) by $41.90’. Each year’s phase out determination depends on the prior year’s reference price. Consequently, the EOR credit was completely phased out for 2014 and 2015, as it has been since 2006.
While we will not know what the reference price for 2016 will be until about October or November of this year, we can project. Even if the inflation rate does not increase, we are still looking at a reference price of about $51 per barrel as making EOR credits relevant again. The West Texas Intermediate (“WTI”) Crude Oil Price for 2015 is $48.67 per barrel. The projected WTI Crude Oil Price for 2016 is $38.54 per barrel. Therefore, it is reasonable to assume EOR credits will be available for 2016. This price drop means you can viably expect tax savings for your oil and gas clients who have the option of utilizing EOR projects.
So what amount of tax credit and industry impact are we talking about? The credit is 15% of qualified enhanced oil recovery costs. In 2010, the US had 114 active CO2 EOR projects producing over 280,000 barrels per day. The cost of CO2 alone can be $20-$30 per barrel. 15% of those costs would be about half a billion dollars. If this credit comes back, the U.S. oil industry could save a half a billion dollars, and probably much more. Some forecast EOR to increase U.S. oil output by as much as 25% in the coming years. Tax advisors and consultants need to be aware of this potential impact.
The administration has pushed to repeal such tax breaks in the past. This effort is likely in part due to the lack of need for them with high oil prices. However, we may see a renewed call to encourage U.S. oil production. With oil prices dropping and looking to continue to drop, Congress should be urged to expand this credit by increasing the phase-out prices. Hopefully, they will listen if presented with this idea.”