By: Matthew Iak, executive vice president of U.S. Energy Development Corporation
Following the results from the Georgia Senate runoff, Democrats will control the balance of power in the Senate, House and White House for at least the next two years. Such wide-sweeping political changes from just a few months ago brings into question how the election results will shape the future of energy development in America, and specifically, how oil and natural gas direct investors will be impacted in the next couple of years.
Oil and gas investors have good reason to examine the long-term impact of the changing government. Under the Trump administration, America capitalized on one of its greatest strategic advantages with energy. In the last four years, U.S. oil production surged to 2.2 million barrels per day making America the world’s top oil producer much to the dismay of OPEC and Russia.
But of course, shifts in political power are nothing new. We can speak from experience, as during our 40 year history we’ve seen first-hand how policy changes from every administration has impacted the energy sector both positively and negatively. While political inflection points are inevitable, so too will be opportunities with direct energy investments that are well-positioned to capitalize on changes in the future.
Was Trump’s Support of the Oil Industry Self-Serving?
While the Trump administration was outwardly positive toward the oil and gas industry, in reality the administration’s actions and policies may have caused more harm than good over the last four years.
Yes, under Trump millions of Americans obtained high-paying jobs in the energy sector. Cheap energy and reduced corporate tax rates allowed American manufacturing to gain a stronger competitive advantage on a global scale, and low oil and natural gas prices left more money in consumer’s pockets for discretionary spending.
But while low energy prices benefitted the overall economy under Trump, advancement within the oil and gas industry as a whole was limited by the same low energy prices.
Why Change Can Be Good.
The Biden administration is poised to revert to several of the regulatory and tax frameworks from the Obama-era. While these agendas are likely to initially be perceived as negative, for oil and gas investors they are not. Alternative energy use is likely to increase its market share, but the overall winner will be the oil and gas sector and its investors.
Actions that are likely to be accomplished quickly under the Biden Administration include some that will not need congressional approval.
First, there will likely be limiting of oil and gas hydraulic fracturing on federal lands and offshore. This likely will result in less energy supply and higher oil and gas prices, which will also benefit alternative energy development. Through this action, both alternative energy and oil and gas sectors will benefit.
Second, it is likely that many oil and gas regulations that occurred under the Obama-era will return. This could coincide with increased litigation in the energy sector, especially if the Department of Justice continues to support presidential and party goals, instead of the nation’s goals as it has done over the last decade. Fortunately, President-Elect Biden has publicly stated he will reduce political influence at the Justice Department, however only time will tell under the new administration.
Tax reform, on the other hand, would potentially impact many direct energy funds and thus investors. Biden’s proposal includes:
For High-Net-Worth Individuals:
- Returning to the 39.6 percent top federal income tax rate, up from 37 percent.
- Additional payroll taxes for individuals earning $400,000.
- Decrease estate tax exemption by about 50 percent from the current level of $11.58 million, with a repeal of the step-up in basis.
- Those earning $1 million or more would pay ordinary income tax rates on investment income, instead of capital gains rates of 20 percent.
- Increasing corporate tax rates from 21 percent to 28 percent.
- A 15 percent alternative minimum tax for incomes of $100 million and higher.
There are of course other potential changes that could negatively affect the oil and gas industry, even though many appear extremely remote, including:
- The potential for carbon taxes that cut from the bottom line of profitability.
- Regulation so intrusive and abusive it cuts profitability and continues to harm the image of the industry.
- Negative press could result in further erosion of investor sentiment towards the oil and gas industry.
- Limits on energy production, sales, or ability to continue to build infrastructure (such as pipelines) that create efficiency and cost savings.
What Does This Mean for Direct Energy Investors?
Many of Biden’s plans represent a best-case scenario for established energy companies and oil direct investments for several reasons.
First, the return of previous environmental regulations will make previous domestic oil production levels unobtainable. Highly leveraged energy companies, marginal producers, and those without access to high-quality projects, will struggle the most and some will go out of business. Less competition will result in increased access to high-quality energy projects, all while global energy demand continues to grow at about 2 percent per year. Improved market fundamentals will put upward pressure on the price of oil, and increase profit margins and returns for investors.
Second, tax reform will increase the immediate need for advanced tax planning over the next several years. This would be especially meaningful for investors in direct ownership oil funds. Under the Trump administration, we experienced new tax planning solutions around qualified business income deductions, net operating loss (NOL) carrybacks, and capital gains planning with opportunity zones. Investors should expect similar advanced planning opportunities to emerge with Biden in office.
Lastly, established companies are poised to benefit the most from new regulations. These companies operate for the long-term, maintain high standards and have never stopped working under the previous regulatory guidelines. Furthermore, the growth of ESG (environmental, social and governance), which are a set of standards that socially conscious companies use in their day-to-day activity and decision-making processes, will allow the best companies to excel quickly under the new frameworks under the Biden Administration.
How Investors Can Prepare in 2021
Regulatory and tax changes are coming – and so are opportunities. Domestic oil production will likely fall under the Biden Administration, resulting in greater profitability for oil investments.
As a leader in tax planning strategies, we’ve discovered the formula for advisors to distinguish their practice as an expert in direct oil and gas investments. It is simpler than most would expect: Provide your clients with education on how tax law changes impact their specific situation and identify resources and a trusted sponsor who will help individuals reposition their portfolios as tax laws change and opportunities emerge.
Investors should be drawn to oil investments. To underweight energy investments in your portfolio is to not take advantage of the opportunity a majority blue government presents. The combination of an overlooked sector, future demand, and the potential for continued commodity price increases, should position energy investments to meaningfully outperform in the coming years.
Matthew Iak is the executive vice president of U.S. Energy Development Corporation and a member of the company’s board of directors. He has overseen the capital raise of more than $1.5 billion in capital since he joined the company in 2005 and has led the construction and underwriting of multiple new investment structures in the oil and gas space which include, energy 1031 exchange funds, private capital acquisition funds, and most recently qualified opportunity zone funds. A member of Forbes Council, he is frequently invited to present within the financial community on oil & gas economics, taxation, and financial planning. Iak holds his FINRA Series 7, 24, 63, and 66 licenses.
The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.