Moody’s: US tax law changes are a net positive for oil and gas companies

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The effects of recent U.S. tax law changes on the oil and gas industry range from mildly to significantly positive, Moody’s Investors Service says in a new report. While the changes are mostly positive for the refining and marketing sector, which generates considerable taxable income when refining margins are cyclically strong, for the much larger exploration and production (E&P) sector, the gains will be smaller.

“The new U.S. tax law is a net positive for the capital-intensive oil and gas industry, while retaining existing tax advantages that companies can continue to use for deductions and to recover certain costs,” said Moody’s vice president, Amol Joshi. “However, the law also caps the amount of interest payments that highly leveraged companies can deduct, potentially increasing taxes for those that can ill afford to pay them now.”

The implications of the new tax law for individual companies will depend on their income-generating and spending patterns, Joshi says. Many companies in the refining and marketing, oilfield services and unregulated midstream sectors are incentivized to invest in property, plant and equipment under the new law, since it increases bonus depreciation on such spending to 100 percent from 50 percent until 2023. Meanwhile, exploration and production companies retain their ability to deduct intangible drilling costs and recover certain geological and geophysical expenses, which boosts cash flow.

Conversely, the new law caps deductions of net interest expense above 30 percent of EBITDA with a change in the limit to 30 percent of EBIT after four years, further restricting the level of deductibility. For a cyclical industry like oil and gas, cash flow volatility could push interest coverage ratios lower during low commodity prices, unpredictably hurting interest expense deductibility.

The law not only repeals the corporate alternate minimum tax (AMT), but allows companies to recover past AMT credits, a positive for oil and gas firms, though most have small eligible tax assets on their balance sheets. However, it also limits the deduction of net operating losses (NOL) to 80 percent of taxable income, an eventual disadvantage for companies that deduct significant NOLs, likely resulting in a form of a minimum tax akin to the AMT.

Meanwhile, US companies that operate overseas will incur a ‘toll charge’ while marking a fundamental shift to a territorial system of taxation. Multinational companies incur a new deemed repatriation liability based on their un-repatriated foreign earnings as of the end of 2017. Companies have eight years to pay this liability, and beneficially will avoid incurring any significant amount of US federal income taxes on their future foreign earnings.

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