Tax alert

New adjustment factor and reference price for oil and gas incentives

May 10, 2022
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Tax policy
Federal tax Credits & incentives Business tax Energy

The IRS recently released three notices in the Internal Revenue Bulletin No.2022-18 related to oil and gas incentives. These notices, published annually, set forth various reference prices and inflation adjustment factors for the marginal well credit, the enhanced oil recovery credit and percentage depletion for oil and natural gas produced from marginal properties.

Section 45K reference price

Notice 2022-17 provides the reference price under section 45K(d)(2)(C) for calendar year 2021. While the credit under section 45K expired on Dec. 31, 2013 for facilities producing coke or coke gas (other than from petroleum based products), the reference price continues to apply in determining the amount of the enhanced oil recovery credit under section 43, the marginal well production credit for qualified crude oil production under section 45I and the applicable percentage under section 613A to be used in determining percentage depletion in the case of oil and natural gas produced from marginal properties. The published reference price under section 45K(d)(2)(C) for calendar year 2021 is $65.90.

Marginal well credit for qualified natural gas production

Notice 2022-18 provides the applicable reference price for qualified natural gas production from qualified marginal wells during taxable years beginning in calendar year 2021 for the purpose of determining the marginal well production credit under section 45I. The applicable reference price for taxable years beginning in calendar year 2021 is $1.52 per 1,000 cubic feet. The applicable reference price is the Treasury Department’s estimate of the calendar year 2020 annual average wellhead price per Mcf for all domestic natural gas.

Notice 2022-18 also provides the credit amount used for the purpose of determining the marginal well credit for taxable years beginning in calendar year 2021. The credit amount is determined using the 2021 inflation adjustment factor of 1.3402 and the applicable reference price of $1.52 per Mcf. The credit amount for taxable years beginning in calendar year 2021 is $0.67 per Mcf.

“Qualified natural gas production” means domestic natural gas produced from a qualified marginal well.

“Qualified marginal well” means a domestic well with the production from which during the tax year:

Is treated as marginal production under section 613A(c)(6); or 

1. Has average daily production of not more than 25 barrel-of-oil equivalents (as defined in section 45K(d)(5)), and 

2. Produces water at a rate not less than 95% of total well effluent. 

Crude oil or natural gas produced during any tax year from any well is not treated as qualified crude oil production or qualified natural gas production to the extent production from the well during the tax year exceeds 1,095 barrels or barrel-of-oil equivalents (as defined in section 45K(d)(5)). The number of wells on which taxpayer may claim the marginal well credit is not limited.

To claim the credit, a taxpayer must hold an operating interest in the qualified marginal well producing the natural gas to which the credit relates. Special rules apply if a well is owned by more than one owner.

No credit may be claimed if the taxpayer is also eligible to claim the section 45K nonconventional sources credit for the taxable year, unless the taxpayer elects not to claim the section 45K credit for the well.

The marginal well credit is not available if the applicable reference price for qualified natural gas production is $2.00 (adjusted for inflation) or more. However, because the applicable reference price is $1.52 per Mcf, the credit is available beginning in calendar year 2021.

Enhanced oil recovery credit

Notice 2022-19 announces the inflation adjustment factor and phase-out amount for the enhanced oil recovery credit for taxable years beginning in the 2022 calendar year. The notice concludes that because the reference price for the 2021 calendar year ($65.90) exceeds $28 multiplied by the inflation adjustment factor for the 2022 calendar year ($28 multiplied by 1.8607 = $52.10) by $13.80, the enhanced oil recovery credit for qualified costs paid or incurred in 2022 is phased out completely.

WNT takeaways

Based on the published reference prices and adjustment factors published in the three notices by the Treasury Department:

1. A marginal well credit may be claimed for qualified natural gas production from qualified marginal wells during taxable years beginning in 2021 under section 45I. The credit rate is $0.67 per Mcf.

2.  The marginal well credit for qualified crude oil production under § 45I is phased out for 2021. This credit has been fully phased out since it was enacted. 

3. The enhanced oil recovery credit under section 43 for qualified costs paid or incurred in 2022 is also phased out completely.  

4. The applicable percentage for marginal production for purposes of determining the percentage depletion for oil and natural gas produced from marginal properties under section 613A for 2021 will be 15%.

To determine whether you qualify for oil and gas incentives, contact your tax advisor.

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