What I know about the high finance of oil and gas production is not very much, but I do recall an economics class lesson about eggs.

Here's what the professor taught me: If people are hungry for eggs, the price will rise. Farmers will buy more chickens, build bigger henhouses and bring more eggs to the market.

But if eggs go out of style, the price will fall. Farmers will eat more omelets, have fried chicken on Sunday and turn their henhouses into tractor sheds.

If the government decides that eggs are important and pays farmers an incentive to put their tractors back in the fields and start bringing more eggs to the market, the supply of eggs will go up — a little.

But unless people want to buy those eggs, the price will stay low and so will the supply.

On the other hand, if eggs become fashionable again, the farmer gets a bonanza. He gets not only the egg money, but the government's incentive too.

The moral to this story: The market determines the price of eggs, which dictates the supply.

As with eggs, so too with oil and natural gas, a lesson Oklahoma hasn't learned yet.
Deep thoughts
Oklahoma has a complicated scheme of tax rebates designed to encourage oil and gas production.

Producers of qualifying wells can get six-sevenths of the state's 7 percent gross production tax rebated to them.

In fiscal 2000, that meant a $21 million rebate to oil and natural gas producers. That number spiked to more than $100 million in fiscal 2006, before going down to less than $50 million in fiscal 2007.

Seven types of wells qualify for the rebates, but they don't qualify equally because some of the incentives are inversely tied to market prices: If the price of natural gas goes up, the incentive goes down.

But deep wells — those completed at 12,500 feet or more —and horizontally drilled wells are not linked to the price of the commodity natural gas. The sharp 2007 decline in rebates was in part the result of a state cap of $25 million a year on deep well incentives, thanks to a prudent reform made just in time to prevent a massive hit to the state budget. But on horizontal wells, the sky's the limit — it's an open-ended obligation on the state treasury.

In fiscal 2008, 97.5 percent of the oil and gas incentives were claimed by horizontal and deep wells, according to figures gathered by the Oklahoma Policy Institute. Marginal wells — those that are producing so little oil or natural gas that their owners might close them (and where incentives might actually influence the choice) — are getting only a tiny bit of the rebates.

That's all very complex, but the punch line is as simple as scrambled eggs: The rebates don't stimulate drilling.

George Kaiser, who became the richest man in Oklahoma by knowing a lot about the high finance of oil and gas production, told the Oklahoma Legislature last year that those oil and gas incentives don't work. They don't impact his decisions about whether or not to drill wells.

He said the money could be better used doing effective things: funding health care for the poor, giving teachers a pay raise, cutting corporate income taxes or reducing college tuition.

In the end, like farmers and eggs, producers produce when the price is right.

The rebates just sweeten the deal when they were going to drill anyway.
The price is right
And the deal is about to get very sweet indeed.

Because the incentives are paid as rebates, the Oklahoma Tax Commission, which tracks production, already has a pretty good idea how big the oil and gas rebate bill is going to be next year.

While the state already faces a budget hole of more than $1 billion (which is creating the real possibilities of teacher layoffs, corrections officer furloughs and dozens of other unacceptable realities in programs supported by state taxes), the state is getting ready to pay out $150 million in oil and gas rebates.

It's like a blowout in the state treasury. Green gold is going to be raining down, especially horizontal and deep well producers.

It's a political perversity: Oil men are about to get rebates from the state for natural gas and oil that they were going to produce anyway.

This can be changed.

The Legislature can get economically smart and revise the incentives to make them more even-handed and less of an unlimited tap on state resources.

Here's three policy changes the Legislature should consider:

1. Cap all of the incentives in the fashion that deep well rebates were capped. If producers are making huge profits, they don't need incentives. That also would make state budgeting more predictable and allow everyone to enjoy benefits from periodic oilfield booms.

2. Tie the rebates to market prices. If the prices of natural gas and oil are already driving bits into the ground, there's no need for the state to be adding to the bottom lines of oil men.

3. Reshape the incentives to favor small, independent producers and marginal wells, which are largely left out of the deal currently. The impact on the state treasury wouldn't be as great and the potential for actually impacting decisions is much greater.

Do that, and we end up with something closer to a economically sound incentive. Don't do it, and we end up with egg on our faces.

The Oklahoma Policy Institute has gathered more information on the incentive program at: www.tulsaworld.com/okpolicyfactsheet.

Wayne Greene 581-8308
wayne.greene@tulsaworld.com, Read Wayne Greene's blog: www.tulsaworld.com/waynesworld

Read more from this Tulsa World article at http://www.tulsaworld.com/opinion/article.aspx?subjectid=261&articleid=20100502_261_G6_Wanwao731985