Committee on Ways and Means, Subcommittee on Oversight, 3-5-01 Statement for the Record

Statement of the American Petroleum Institute

I. INTRODUCTION

These comments are submitted by the American Petroleum Institute (API) for inclusion in the record of the March 5, 2001 House Ways and Means Subcommittee on Oversight hearing on the impact of federal tax laws on the cost and supply of energy. API represents more than 400 member companies involved in all aspects of the oil and gas industry, including exploration, production, transportation, refining, and marketing.

Over the past year, U.S. energy consumers have experienced sudden increases in oil and gas prices, and extreme regional price volatility in response to events such as unusual weather, and refinery and transportation accidents. Such events have brought national energy policy to the forefront of public debate, with a prominence not seen for several decades. These events have also served as a vivid reminder that oil and natural gas remain essential to fueling the growth of both the U.S. and the world economies. Together, these products supply over 61 percent of the world's energy needs, and 62 percent of U.S. energy needs, and their role in fueling future economic growth is expected only to increase.

The Department of Energy's (DOE) most recent International Energy Outlook estimates that by 2020, world energy demand will be more than 60 percent higher than in 1997. Three-quarters of that total energy demand growth is expected to be for oil and gas, so that the share of oil and gas in the global energy mix will rise to 66 percent by 2020. An ever-increasing share of this growth, especially in the United States, is expected to be for natural gas due to its comparative energy efficiency, clean burning characteristics, and abundance of supplies in North America.

From strictly a resource standpoint, there is no reason to doubt that the resource base is adequate to satisfy expected growth in energy demand for well beyond the next several decades. Global oil and gas reserves are at or near all time highs. Global oil reserves have reached 1.03 trillion barrels, over a third higher than a decade earlier, and sufficient to last 42 years at current production rates. Global gas reserves have reached 5278 trillion cubic feet (TCF), more than 20 percent higher than a decade earlier. Furthermore, technology has greatly increased industry's ability to pursue this development without adverse environmental impact. Advanced seismic technology, horizontal drilling, and a variety of new control technologies greatly reduce the environmental footprint associated with oil and gas development.

Nevertheless, there are a number of challenges that potentially stand in the way of realizing this potential. Generally, these problems stem not from resource scarcity, but from self-imposed policy restrictions on key remaining domestic supply prospects, an insufficient U.S. downstream infrastructure, resurgence of OPEC market power in global oil markets, and regulations that have diminished the flexibility of the existing infrastructure to respond effectively to unexpected events. In addition, the technology and increasingly sophisticated production methods necessary to secure adequate supplies of oil and natural gas are expensive and will require huge capital investments by U.S. oil and gas companies. For example, DOE projects that producers will have to invest some $650 billion through 2015 in order to meet the anticipated growth in U.S. natural gas demand alone.

While the United States has a strong strategic and economic interest in maintaining a vibrant domestic oil and gas industry, we also need a wide diversity of international supplies. For over half a century, the United States has relied to varying degrees on imports for a portion of its oil needs. Over the last 30 years, imports as a percentage of U.S. petroleum deliveries have risen from 23.3 percent to 55.6 percent. As our reliance on global oil markets has grown, we have learned that this dependence carries both opportunities and risks. On the one hand, it affords us access to energy supplies less costly than could be produced domestically. On the other hand, it exposes us to two inherent risks associated with that marketplace, namely the potential for short-term supply interruptions, and the potential for long run vulnerability to adverse actions by OPEC. But the experience of growing dependence has also taught us a few important lessons about the potential for U.S. policies to successfully manage these risks, and the hazards of misguided policies that have aggravated them.

Recognizing that 90 percent of the world's proven oil reserves are in the hands of foreign government-controlled oil companies (more than two-thirds of those are in the Middle East), U.S. energy security is best served by U.S. companies being competitive participants in the international energy arena. If the U.S. oil and gas industry is not provided the tools to economically compete overseas, those energy resources located abroad will still be produced. However, they will be produced without the security of supply that would be realized with U.S. oil and gas companies producing the oil, without any benefit to the U.S. economy, and without U.S. companies, their shareholders, or American workers deriving any direct or indirect income from the foreign production activity. The U.S. oil and gas industry already possesses the experience and technical prowess that will ensure success at finding and producing oil and gas from sources all over the world. However, U.S. energy policies must support this necessary international risk taking and encourage the tremendous capital investment that will be needed to meet U.S. and global energy demand growth.

Currently, the ability of the U.S. oil and gas industry to compete globally is hampered by the unintended consequences of two sets of U.S. policies, namely the adverse tax treatment of foreign source income earned by U.S. companies operating overseas, and the persistent tendency of the United States to utilize unilateral economic sanctions against oil producing countries as an instrument of foreign policy. The U.S. international tax regime imposes a substantial economic burden on U.S. multinational companies, and to an even greater degree on U.S. oil and gas companies, by exposing them to potential double taxation, that is, the payment of tax on foreign source income to both the host country and the United States. In addition, the complexity of the U.S. tax rules imposes significant compliance costs. As a result, U.S. oil and gas companies are forced to forego foreign exploration and development projects based on lower projected after-tax rates of return, or they are preempted in bids for overseas investments by global competition not subject to such complex rules. Congress can help to stem further losses in the global competitive position of the U.S. oil and gas industry by adopting tax measures that allow U.S. oil and gas companies to compete more effectively both at home and in the international marketplace.

We cannot afford to constrain the development of oil and natural gas supplies at home or abroad without regard to the potential vulnerability threatened by such neglect in light of energy demand growth projections. It must be remembered that oil and gas projects require large amounts of capital and are high risk, long lead-time ventures. The tax treatment of the financing and structuring of these ventures is one of the essential elements of decisions whether to proceed. If allowed to compete, our industry has the capability to capture a significant share of the expected growth in demand, limiting OPEC's market share and contributing to the diversity of global supply. But barriers to supply expansion offer the threat of renewed vulnerability. Given this prospect, recent events should serve as a wakeup call for the United States to adopt a national energy policy, which includes revised tax rules, that begins to tear down these barriers.

II. DOMESTIC TAX PROVISIONS

While most other countries encourage energy development, flawed public policies--especially discriminatory tax provisions, excessive restrictions on access to federal lands and unreasonably burdensome regulations--continue to place substantial restrictions on the exploration and production of oil and gas in this country. Moreover, continued high corporate tax rates limit the capital available to U.S. oil and gas companies at the very time huge investments in exploration and production must be made to ensure the nation's energy future. The most important thing Congress and the Administration can do is enact a national energy plan that will change these policies to promote the environmentally sound and economic recovery of domestic reserves, thus helping reduce U.S. reliance on imported oil.

In 1999, a united oil and gas industry proposed a series of tax changes designed to spur domestic oil and gas production. The need for these changes has only intensified over the last couple of years as OPEC has reestablished its ability to profoundly impact the available supply of oil--and most importantly, the price paid by consumers.

While not the sole answer to ensuring adequate oil and gas supplies for U.S. energy consumers, tax measures such as the expensing of geological and geophysical (G&G) costs and delay rental payments, a marginal domestic oil and natural gas well production credit, eliminating limitations on use of percentage depletion of oil and gas by independent producers, and Alternative Minimum Tax (AMT) relief will promote greater U.S. exploration and production. Most of these items were previously adopted by both the House of Representatives and the Senate as part of the conference report to the Taxpayer Refund and Relief Act of 1999 (H.R. 2488), which was ultimately vetoed by Former President Clinton. Other provisions, including an expansion of the enhanced oil recovery (EOR) credit to include certain nontertiary recovery methods and a heavy oil production credit, would further encourage increased domestic petroleum activity.

Geological and Geophysical Expenses

Oil and gas exploration companies incur huge up front capital expenditures, including geological and geophysical (G&G) expenses, in their search for new oil reserves. G&G expenses include costs incurred for geologists, surveys, and certain drilling activities, which help oil and gas companies locate and identify properties with the potential to produce commercial quantities of oil and/or gas. Currently, these costs must be capitalized, suspended and then amortized over a period of years in the form of cost depletion after production begins. Forcing oil and gas companies to capitalize G&G costs exacerbates the economic burden imposed by these significant cash outlays that must be made prior to or at the beginning of an exploration project. In order to encourage the discovery of new domestic oil and gas reserves, and thus increase overall supply, Congress should pass legislation to permit the expensing of G&G costs.

In addition to having been included in the vetoed 1999 tax bill, proposals to expense both G&G costs and delay rental payments were included in S. 2265, introduced by Sen. Kay Bailey Hutchison in March 2000, and S. 2557, the National Energy Security Act of 2000, introduced by Senate Majority Leader Trent Lott in May of last year. Even Former President Clinton expressed support for these tax provisions in his March 2000 proposal to "strengthen America's energy security." Finally, these proposals are included in S. 389, the National Energy Security Act of 2001, introduced in the Senate on February 26, 2001.

Delay Rentals

Delay rentals are paid by oil and gas exploration companies to defer the commencement of exploration and production on leased property without forfeiting the lease. Treasury regulations and case law clearly support the option on the part of a lessee to expense or capitalize delay rental payments, and until 1987, this right was essentially uncontested. However, with the 1986 enactment of the Section 263A uniform capitalization rules, the IRS began to challenge the deductibility of delay rentals during audits. In 1997, the IRS unequivocally adopted the position that for tax years beginning after December 31, 1993, delay rentals had to be capitalized unless the taxpayer could establish that the lease was acquired for some reason other than development. This position ignores forty years of history and long-established regulations. Congress should pass legislation that clarifies and reaffirms the long-standing rule that has permitted delay rentals to be expensed rather than capitalized. By decreasing the economic burden of paying delay rentals, more capital will be available for exploration and production.

Marginal Well Production Credit

A marginal well production credit of $3 per barrel for the first three barrels of daily production from an existing marginal oil well, and a 50 cent per thousand cubic feet (Mcf) tax credit for the first 18 Mcf of daily natural gas production from a marginal gas well, would help producers ensure the economic viability and slow the shutting-in of marginal wells. Like the proposed AMT relief, the credits would phase in and out as oil and natural gas prices fall and rise between specified levels providing the greatest benefit to producers when prices are low. Finally, the credit should be allowed against both regular and alternative minimum tax and to be carried back ten years.

This marginal oil and gas well production credit proposal is included in S. 389, the National Energy Security Act of 2001.

Percentage Depletion

Another way Congress could assist the domestic industry would be to permit, by annual election, elimination of the 65 percent taxable income limitation on percentage depletion, as well as elimination of the 100 percent net income limitation. Independent producers and royalty owners should be permitted to carry forward percentage depletion deductions for ten years. These proposals also are included in S. 389.

Alternative Minimum Tax

The Alternative Minimum Tax (AMT) was intended as an advance payment of federal income tax, and therefore, AMT payments are creditable in future years, though only against regular tax liability and not the taxpayer's tentative minimum tax. However, companies within the capital intensive petroleum industry often find themselves in a position where they are consistently unable to use their AMT credits because their regular tax liability in future years does not exceed their tentative minimum tax for those years. For those companies, the AMT constitutes a permanent tax increase and decreases the economic viability of certain domestic operations.

Recently, the problems associated with the AMT have again been all too real for many domestic oil and gas producers. Oil and gas drilling activity has accelerated rapidly since 1999 in response to the phenomenal growth in demand for oil and natural gas. However, a portion of this activity had to be curtailed, not because of a lack of product demand, but, rather, because the AMT preference item for intangible drilling and development costs (IDCs) exposed those producers to the AMT and rendered that additional drilling activity uneconomic. In other cases, producers were not in an AMT position because their regular tax liability exceeded their tentative minimum tax. However, the ability of those producers to utilize accumulated AMT credits was diminished due to a higher tentative minimum tax amount resulting from the IDC preference item. In both instances, the AMT served to restrict new oil and gas drilling activity at the very time the nation was seeking to spur oil and natural gas production.

Many of the AMT's most discriminatory provisions are targeted at the U.S. oil and natural gas industry. In order to reverse this inequity and promote capital investment in the oil and gas sector, Congress should, at a minimum, eliminate the preference for IDCs, fully eliminate the depreciation adjustment for oil and gas assets, eliminate the impact of IDCs and depreciation on oil and gas assets from the Adjusted Current Earnings (ACE) adjustment, and permit the EOR and Section 29 credits to reduce tentative minimum tax. This proposed AMT relief would phase in and out as oil and natural gas prices fall and rise between specified levels, thereby providing the greatest assistance to producers in times of low prices.

Another non-industry specific way to mitigate the adverse impact of the AMT would be to allow AMT credits to be applied against future tentative minimum tax. This specific provision was included in the vetoed 1999 tax bill.

EOR Credit

The Enhanced Oil Recovery (EOR) credit provides a credit equal to 15 percent of costs attributable to qualified enhanced oil recovery projects. Since the enactment of the EOR credit in 1990, new technologies have greatly enhanced the ability of oil producers to economically recover additional domestic reserves from existing wells with minimal environmental impact. By extending the EOR credit to certain nontertiary production methods such as horizontal drilling, gravity drainage, cyclic gas injection, and water flooding, the economic viability of these oil recovery methods would be greatly enhanced. In turn, the up to 70 percent of an oil well's reserves that otherwise would be left in the ground could be added to the nation's available energy supply.

Heavy Oil Production Credit

So-called "heavy oil" is one source of domestic petroleum that is significantly less economic, but represents a key component of the U.S. energy base. Currently, heavy oil accounts for over 11 percent of U.S. production. However, its potential is far more significant because the measured U.S. heavy oil resource base is over 100 billion barrels. Heavy crude oil is generally characterized by its high specific gravity or weight, as well as its high viscosity or resistance to flow. Because of these characteristics, heavy oil is substantially more difficult and expensive to extract and refine than other types of oil. Additionally, this oil is less valuable because a smaller percentage of high-value petroleum products can be refined from a barrel of heavy oil than from a barrel of higher quality crude oil. A heavy oil production tax credit would help the nation maximize its domestic energy supply by making that resource economic to produce.

III. RELIEF FROM DISCRIMINATORY INTERNATIONAL TAX RULES

In order to survive, the oil and gas industry must operate where it has access to economically recoverable oil and gas reserves. Since the opportunity for domestic reserve replacement has been substantially restricted by federal and state government policies, the tax treatment of international operations is critical to the industry's continued ability to supply the nation's hydrocarbon energy needs.

With OPEC market share and influence once again on the rise, and up to 90 percent of the world's proven oil reserves in the hands of foreign government-controlled oil companies, a key concern of federal policy should be that of maintaining the global supply diversity that has been the keystone of improved energy security for the past two decades. The principal tool for promotion of that diversity is active participation by the U.S. oil and gas industry in the development of these new frontiers. Therefore, while federal tax policy should promote domestic oil and gas production, it should also seek to enhance the competitiveness of U.S. companies operating abroad.

Tax measures that would enable U.S. companies operating overseas to better compete in the global oil and gas business environment include: reforming the foreign tax credit (FTC) rules, particularly the proliferous FTC "baskets," repealing the Section 907 foreign tax credit limitations, extending carryback and carryforward periods for foreign tax credits, accelerating repeal of separate limitation basket requirement for dividends received from 10/50 companies (i.e., foreign companies owned between 10 and 50 percent by U.S. owners), providing look-through treatment for sales of partnership interests, providing look-through treatment for interest and royalties from 10/50 companies, allowing recapture of overall domestic losses, and modifying the interest allocation rules to permit elective allocation on a world-wide basis.

The Foreign Tax Credit Rules Need Reform

Since the beginning of federal income taxation, the U.S. has taxed the worldwide income of U.S. citizens and residents, including U.S. corporations. The FTC was intended to allow a dollar for dollar offset against U.S. income taxes for taxes paid to foreign taxing jurisdictions in order to avoid double taxation of that income earned abroad. However, the many limitations on the FTC in our current rules often results in U.S. taxpayers paying tax on the same items of income in more than one jurisdiction.

The FTC is intended to offset only U.S. tax on foreign source income. Thus, an overall limitation on currently usable FTCs is computed by multiplying the tentative U.S. tax on worldwide income by the ratio of foreign source income to worldwide taxable income. The excess FTCs can be carried back two years and carried forward five years, to be claimed as credits in those years within the same respective overall limitations.

However, since enactment of the Tax Reform Act of 1986, the overall limitation must be computed separately for not less than nine "separate limitation categories" or "baskets." Some of the separate limitations apply for income: (1) whose foreign source can be easily changed; (2) which typically bears little or no foreign tax; or (3) which often bears a rate of foreign tax that is abnormally high or in excess of rates of other types of income. In these cases, a separate limitation is designed to prevent the use of foreign taxes imposed on one category to reduce U.S. tax on other categories of income. There are other examples of normal active-business types of income that also must be calculated separately. Examples of these normal business-types of foreign source income include dividends received from 10/50 companies, gains on the sale of foreign partnership interests, and payments of interest, rents and royalties from non-controlled foreign corporations and partnerships.

Section 907: Foreign Oil and Gas Extraction Income and Foreign Oil Related Income

Under the separate basket rules, foreign oil and gas income falls into the general limitation basket for purposes of computing the overall FTC limitation. But before determining this limitation for general operating income, U.S. oil and gas companies must first clear an additional tax credit hurdle.

Internal Revenue Code Section 907 limits the utilization of foreign income taxes on foreign oil and gas extraction income (FOGEI) to that income multiplied by the current U.S. corporate income tax rate. The excess credits may be carried back two years and carried forward five years, with the creditability limitation of Section 907 being applicable for each such year.

Congress intended for the FOGEI and foreign oil related income (FORI) rules to purport to identify the tax component of payments made by U.S. oil companies to foreign governments. The goal was to limit the FTC to that amount of the foreign government's "take" which was perceived to be a tax payment versus a royalty paid for the production privilege. But even the so-identified creditable tax component of those payments should not be used to shield the U.S. tax on certain low-taxed other foreign income, such as that from shipping.

These concerns have been adequately addressed in subsequent administrative rulemaking and legislation. In 1983, after several years of discussion and drafting, Treasury completed the "dual capacity taxpayer rules" of the FTC regulations, which set forth a methodology for determining how much of an income tax payment to a foreign government will not be creditable because it is a payment for a specific economic benefit. Such a benefit could, of course, also be derived from the grant of oil and gas exploration and development rights. These regulations have worked well for both IRS and taxpayers in various businesses (e.g., foreign government contractors), including the oil and gas industry. In addition, the multiple separate basket rules enacted in 1986 have restricted taxpayers from offsetting excess FTCs from high-taxed income against taxes due on low-tax categories of income.

Since concerns underlying Section 907 have been adequately addressed in subsequent legislation and rulemaking, that tax code provision has been rendered obsolete. Furthermore, Section 907 has raised little, if any, additional tax revenue because excess FOGEI taxes would not have been needed to offset U.S. tax on other foreign source income. Nevertheless, oil and gas companies continue to be subject to burdensome compliance work. Each year, they must separate FOGEI from FORI and the foreign taxes associated with each category. These are time consuming and labor intensive analyses, which have to be replicated on audit. Section 907 should be repealed as obsolete. This would promote simplicity and efficiency of tax compliance and audit with minimal loss of revenue to the government.

In fact, the House and Senate passed legislation that would have repealed Section 907 during the 106^th Congress. Unfortunately, Former President Clinton vetoed that bill, H.R. 2488.

Foreign Tax Credit Carryover Rules

The inclusion of income taxes paid to foreign countries within a taxpayer's FTC is limited to the U.S. tax owed on that taxpayer's foreign source income. Thus, an overall limitation on currently usable FTCs is computed by taking the ratio of foreign source income to worldwide taxable income and multiplying this by the tentative U.S. tax on worldwide income. As noted above, excess FTCs can be carried back to the two preceding taxable years, or to the five succeeding taxable years, subject in each of those years to the same overall limitation. If the credits are not used within this time frame, they expire.

Excess credit positions are frequent because of the ever-increasing limitations on the use of FTCs, coupled with the differences in income recognition between foreign and U.S. tax rules. Many of these differences occur as a result of timing variations resulting from different depreciation methods and useful lives. The present law's short seven-year total utilization (two-year carryback and five-year carryforward) period causes credits to be lost, most likely resulting in double taxation.

Strict adherence to the long-standing U.S. policy of not taxing the same income twice would seem to dictate that all carryover periods be eliminated in order to ensure that foreign source income is never exposed to double taxation. However, a practical alternative proposal to reduce the existing risk of double taxation would permit five-year carryback and 15-year carryforward periods for excess FTCs. At the very least, a two-year carryback and 20-year carryforward period would provide greater consistency within the tax code by aligning the FTC carryover periods to those provided for net operating losses.

Dividends Received from 10/50 Companies

The 1997 Tax Act repealed the separate basket rules for dividends received from 10/50 companies, effective after the year 2002. A separate FTC basket will be required for post-2002 dividends received from pre-2003 earnings. Because of these limitations, U.S. companies operating overseas will continue to forego foreign projects through noncontrolled 10/50 corporations. When fully implemented, the repeal will remove significant complexity and compliance costs for taxpayers and foster their global competitiveness.

The repeal of the separate limitation basket requirement with respect to dividends received from 10/50 companies therefore should be accelerated. This provision was included in the last few Clinton Administration budget proposals, as well as in the vetoed 1999 tax bill, H.R. 2488. In addition, H.R. 2488 appropriately would have eliminated the requirement of maintaining a separate limitation basket for dividends received from earnings and profits accumulated before the repeal.

Look-through Treatment for Sales of Partnerships

The distributive share of an at least 10 percent U.S. partner of a foreign partnership follows the partnership's income FTC basket classification. On the other hand, no such look-through applies to the gain on the sale of a 10 percent or more partnership interest in a foreign partnership. U.S. tax rules treat the gain as separate basket passive income, thereby limiting the opportunity of FTC utilization.

Economically, any gain on the sale of the partnership interest is attributable to unrealized or undistributed income. It is not only inequitable but also counterintuitive for the legal form of the value realization to control the FTC basket characterization. Accordingly, for a 10 percent or greater partnership interest, look-through treatment should apply to the gain in the same way that it applies to the distributive share of partnership income.

Look-through Treatment for Interest, Rents, and Royalties with Respect to Non-Controlled Foreign Corporations and Partnerships

U.S. oil and gas companies are often unable, due to government restrictions or operational considerations, to acquire controlling interests in foreign corporate joint ventures. Look-through treatment for interest, rents and royalties received from foreign joint ventures should be available, as it is in the case of distributions from a controlled foreign corporation (CFC).

Current tax rules also require that payments of interest, rents and royalties from noncontrolled foreign partnerships (i.e., foreign partnerships owned between 10 percent and 50 percent by U.S. owners) must be treated as separate basket income to the joint venture partners. Again, as in the case of corporate joint ventures, look-through treatment should be extended to these business entities. This would abolish distinctions in treatment of distributions that are based on participation percentages that may be beyond the control of the U.S. taxpayer.

Recapture of Overall Domestic Losses

When foreign source losses reduce U.S. source income (overall foreign loss or OFL) in a tax year, the perceived tax benefit has to be "recaptured" by resourcing foreign source income in a subsequent tax year as domestic source income. Of course, this re-characterization reduces the ratio of foreign source income to total income, which in turn reduces the ratio of tentative U.S. tax that can be offset against foreign taxes. However, if foreign source income is reduced by U.S. source losses, there is no parallel system of "recapture." Taxpayers are not allowed to recover or recapture foreign source income that was lost due to a domestic loss, resulting in the double taxation of such income. The U.S. losses thus can give rise to excess FTCs, which, due to the FTC carryover restrictions, may expire unused. Only a corresponding re-characterization of future domestic income as foreign source income will reduce the risk that FTC carryovers do not expire unused.

Allocation of Interest Expense

Current law requires the interest expense of all U.S. members of an affiliated group to be apportioned to all domestic and foreign income, based on assets. However, the current rules deny U.S. multinationals the full U.S. tax benefit from the interest incurred to finance their U.S. operations. For example, if a domestically operating member of a U.S. tax consolidation with foreign operations incurs interest to finance the acquisition of new environmental protection equipment, a portion of the interest will be allocated against foreign source income of the group and therefore become ineffective in reducing U.S. tax. A U.S. subsidiary of a foreign corporation (or a U.S. corporation--or affiliated group--without foreign operations) would not suffer a comparable detriment.

In addition, unless allocation based on fair market value of assets is elected, allocation of interest expense according to the adjusted tax bases of assets generally assigns too much interest to foreign assets. For U.S. tax purposes, foreign assets generally have higher adjusted bases than similar domestic assets because domestic assets are eligible for accelerated depreciation while foreign-sited assets are assigned a longer life and limited to straight-line depreciation. For purposes of the allocation, the earnings and profits (E&P) of a CFC is added to the stock basis. Since the E&P reflect the slower depreciation, the interest allocated against foreign source income is disproportionately high.

Rules similar to the Senate version of interest allocation in the Tax Reform Act of 1986, as well as those included in the vetoed 1999 tax bill, would help to alleviate these current anti-competitive results. The allocation group would then include all companies that otherwise would be eligible for U.S. tax consolidation, but for their being foreign corporations. Additionally, "stand alone" subsidiaries could then elect to allocate interest on certain qualifying debt on a mini-group basis, i.e., looking only to the assets of that subsidiary, including stock.

At the very least, taxpayers should be allowed to elect to use the E&P bases of assets, rather than the adjusted tax bases, for purposes of allocating interest expense. Use of E&P basis would produce a fairer result because the E&P rules are similar to the rules now in effect for determining the tax bases of foreign assets.

IV. SUMMARY

Our industry strongly supports tax law changes designed to encourage increased domestic petroleum activity, which, in turn, will help to expand overall product supply in the United States. Expansion of available supply is critical to meeting DOE projections of a 33 percent increase in U.S. petroleum demand and a 62 percent increase in U.S. natural gas demand by 2020. Existing oil and gas industry tax incentives, while helpful, do not begin to address how this nation will encourage the massive capital investment needed to meet this demand growth. Positive tax changes will help promote the use of new technologies for exploration, development and production, and help maintain the economic viability of mature production sites. Notwithstanding the benefits these new tax provisions would provide, their potential to help increase and sustain domestic petroleum production will be limited unless Congress also acts to reduce restrictions on access to federal lands and to rationalize the increasingly burdensome regulatory apparatus. Moreover, it must be recognized that expected growth in U.S. demand for oil and natural gas cannot be met merely through increased U.S. production. While U.S. reliance on imported oil can be reduced, restoring the global competitive position of the U.S. oil and gas industry through changes in U.S. international tax policy will be crucial to ensuring that U.S. consumers continue to enjoy adequate and cost-competitive supplies of our industry's major products.