MARATHON OIL COMPANY,
Findlay, Ohio, May 20, 1980.

To: All Royalty Owners and Working Interest Owners.
Re: Crude Oil Windfall Profit Tax Act of 1980.

A. IMPOSITION OF WINDFALL PROFIT TAX

The recently enacted Crude Oil Windfall Profit Tax Act imposes an excise tax on all domestically produced crude oil and condensate, except for certain Alaskan and certain front end tertiary oil production. The tax is levied on all producers of crude oil and condensate except for the following producers which are exempt from the tax:

(a) qualified governmental interests:

(b) qualified charitable interests; and

(c) qualified Indian interests.

A "producer" is defined as the holder of an "economic interest" in the property. Under Regulation Section 1.611-1(b) (1) to the Internal Revenue Code of 1954, "an economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place . . . and secures, by any form of legal relationship, income derived from the extraction of the mineral . . . to which he must look for a return of his capital." Thus, as a general rule, all working interest, royalty, overriding royalty, net profit interest, or other similar interest owners are holders of an economic interest and are therefore classified as "producers" subject to the tax.

The Act generally requires the first purchaser of the oil to withhold the Windfall Profit Tax and deposit it with the U.S. Treasury Department on behalf of each economic interest owner.

B. THE TAX RATES

The tax rate on the windfall profit per barrel depends on three factors: 1) the tax tier of the oil; 2) the applicable tax rate of the producer; and 3) the type of crude oil produced (some of which, as stated above, is exempt). The following table illustrates the applicable tax rates.

Tier 1 oil is defined as all oil which is not tier 2 or tier 3 oil. Tier 2 oil includes stripper oil and oil produced from a National Petroleum Reserve. Tier 3 includes a) newly discovered oil; b) heavy oil (16.0° gravity and below); and c) incremental tertiary oil.

If you hold a royalty interest in a property, withholding is required at the rates shown above under "General Rule," unless you qualify under one of the "producer exemptions" enumerated above and certify as such.

If you hold a working interest in a property, withholding is required at the rates shown above under "General Rule" unless you qualify as an "independent producer" or "exempt producer" (as enumerated above) and certify as such.

C. INDEPENDENT PRODUCERS

If you own a working interest and 1) have gross receipts of less than $1,250,000 per calendar quarter from sales of oil, natural gas or products derived therefrom, and 2) do not refine more than 50,000 barrels of crude oil on any day during the calendar quarter, then you may qualify as an "independent producer." If you qualify as an "independent producer" you will receive favorable treatment under the law on production from "working interest" holdings only up to a maximum of 1,000 barrels per day of tier 1 and tier 2 oil. Where both tiers are present, the 1.000 barrels must be allocated between the two tiers.

D. GENERAL COMMENTS

The Windfall Tax deducted from your remittance is identified as legend codes (LG) 47 and 49 for crude oil and condensate, respectively.

Reduced Independent Producer tax rates have been used in calculating Windfall Profit Tax if we received your certification as an independent producer on or before May 7, 1980, indicating qualifications for the reduced tax rate. Corrections will be made in the following months on certifications received after this date.

Clearly, if you qualify for the reduced or zero tax rates, it is to your advantage to make that fact known to Marathon as soon as possible. If you hold a working interest in a property which Marathon operates, you should have received a producer certificate upon which you can designate your tax status. If you have not received Marathon's form you may also certify your status to us on Internal Revenue Service (IRS) form number 6458. Either form is acceptable and duplicate forms are not required; however certification must be furnished for each property.

The above noted information is not intended to provide you legal advice in interpreting the complex Windfall Profit Tax Act. If you should have questions about the interpretation or imposition of the tax, we suggest you contact your tax advisor.

MARATHON OIL COMPANY.

Our next witness will be Mr. Frank Pitts, who is the president of Texas Independent Producers and Royalty Owners Association. You may proceed, Mr. Pitts.

TESTIMONY OF MR. FRANK PITTS

Mr. PITTS. Senators, I appear as president of Texas Independent Producers and Royalty Owners Association, which is composed of some 4.300 independent producers and royalty owners, with an interest. in petroleum in the State of Texas. I have also asked to appear on IPAA as well.

Now I have here my written testimony, and I would like for it to be reported as though it were read.

Texas Independent Producers and Royalty Owners Association worked hard, as you know, for an amendment to this so-called windfall profit tax for 1,000 barrels per day exemption for independents and the royalty owners, but without success.

This tax is not anything but an excise tax, and it is having immediate and devastating results. Somehow, I don't know why, Congress seems to think royalty owners are like big oil and pass a tax at the same rate on them as on big oil.

Now, there are approximately 2 million royalty owners in this country and about 12 million of them collectively produce about 400,000 barrels a day production. That averages only about a quarter of a barrel per day per royalty owner.

This doesn't indicate to me big wealth. The royalty owner is an essential part of the extraction process of petroleum. Without the royalty owner's contribution of the basic mineral rights themselves to this process there would be no exploration and development of our oil and natural gas resources in this country. The so-called windfall profit tax is hurting the royalty owners and relief should be given to them. My purpose today [applause] is not to discuss specific hardships and injury to coal and royalty owners; they will testify to that themselves. I will discuss the energy aspects of the so-called windfall profits tax.

Now, when the President brought out his big propaganda campaign and recommended the windfall profit tax, he inferred that we were about to run out of oil and natural gas in this country and that the oil companies should be forced to pay this tax on production that remained, in order to raise funds to develop alternative means of energy. It appears most of the money to be raised from the windfall profit tax will not even be used for that purpose. But that is not my point.

My point is: I agree that alternative energy forms must be developed. I do not agree, however, that we are about to run out of oil and natural gas in this country. [Applause.]

Here is a map. This is a map that shows all the oil and gas produced in this country. [Applause.]

Here is a map. This is a map that shows all the oil and gas produced in this country has been produced only on 2 percent of the potential provinces of the oil and gas available. Ninety-eight percent of the potential sediment for the oil and gas, onshore and offshore in the United States, has been not touched by drilling. And let me say that that represents about 3 million square miles.

They say, "Why don't you drill more for oil?" Well, number one, it cost money and plenty of money. But we must drill more wells, deeper wells in this country and it cost double every 2,800 feet of drilling depth. I just want to give you some idea.

For example, let's say for a well in east Texas, 2,800 feet costs $42.000 to drill. If you want to drill it 6 times deeper, instead of the well costing only 6 times as much, it cost 63 times as much, or more than $2.5 million.

Therefore, you can see it takes money to do this development. We cannot do the drilling job needed with measures such as the Crude Oil Profit Tax of 1980.

Let's take Texas for example. This tax can take out of Texas $65 billion in 10 years, so it is estimated. Now, if you figure an average barrel with inflation costs $200,000 down to the point of setting pipe, we could drill 325,000 wells in Texas with this money that they will take out of Texas to send to Washington. [Applause.]

This is three times as many wells as we are currently drilling in the State of Texas. We drilled only 18,000 wells last year. The windfall profit tax takes money away from exploration and development of our natural resources at a time when incentives rather than disincentives are needed.

For this reason, Texas Independent Producers and Royalty Owners Association supports exempting royalty owners from the windfall profit tax.

Grant us this exemption. If you do, we will be able to bridge the energy gap. We will be able to provide America with the energy that is estimated we need to develop for the next 20-year period before the new and alternate forms of energy come on stream.

I thank you very much. [Applause.]

Senator BENTSEN. I know how much you and your associates have worked to try to protect the royalty owners and we are very appreciative of your testimony here.

[The prepared statement of Mr. Pitts follows:]

STATEMENT BY L. FRANK PITTS, PRESIDENT, TEXAS INDEPENDENT PRODUCERS AND ROYALTY OWNERS ASSOCIATION

Mr. Chairman and Members of the Subcommittee: My name is L. Frank Pitts. I appear here today as President of the Texas Independent Producers and Royalty Owners Association, which is composed of some 4,300 independent producers and royalty owners with an interest in petroleum in the State of Texas. Our royalty owner members are representative of owners affiliated with all domestic oil production.

You are aware, I am sure, that TIPRO worked hard throughout the legislative process resulting in the Oil Windfall Profits Tax of 1980 in support of amendments that would result in exemption for both independent producers and all royalty owners. We did not succeed, of course, although under the leadership of Senator Lloyd Bentsen and others, we were able to preserve percentage depletion on the wellhead price received for both independent producers and all royalty owners in the face of serious opposition.

Our Association has been besieged with letters and phone calls from disturbed royalty owners who are now beginning to feel the severe effects of the oil excise tax burden. The royalty entities hit the hardest are those who own stripper and new exploration oil, for they have experienced rollbacks in wellhead value received ranging from $5.00 to $14.00 per barrel. Later, as decontrol by the Department of Energy proceeds to conclusion, other royalty owner groups affiliated with flowing Tier I oil will become equally disturbed by the tax.

According to information available to us, there are some two million royalty owners of oil and gas in the United States with slightly over one-third located in Texas. About 1.6 million of this total are estimated to be involved with crude oil production. It is further estimated that 1.5 million of this total hold little more than 400,000 barrels per day royalty production, which averages about one-fourth of a barrel per day per owner. This refutes the widely held contention that all royalty owners are extremely wealthy and are, therefore, a logical group to tax heavily under the Crude Oil Windfall Profits Tax.

Thus, TIPRO is supportive of measures to ease the tax burden for royalty owners. In fact, our Association continues to support the 1,000 barrel per day exemption for independent producers and all royalty owners initiated by Senator Bentsen last fall. We are firmly committed to this position for several reasons, but our central purpose outweighs all the rest: the drilling of more domestic wells.

In our opinion, it is in the best interest of our nation to maximize domestic well drilling. Leading economists estimate it will take $1.6 trillion of investment to drill the wells necessary to maintain our current petroleum productivity and provide additional supply to cover a two percent annual increase in petroleum demand throughout the next decade. Without this level of effort, our reliance on expensive, insecure foreign oil will increase and not decrease in the years ahead. There is no other answer, since even the most optimistic estimates of synthetic or alternate fuel development do not begin to cover the problem during the next ten or fifteen years.

We cannot do the drilling job needed with measures such as the Crude Oil Windfall Profits Tax of 1980. This tax, in Texas alone, will withdraw from the oil industry at least $65 billions during the 1980's. Should these funds be available to the producing industry to spend in drilling wells at an average cost of $200,000, there could be an additional 325,000 wells drilled in this State. This would mean current drilling rates would be almost tripled in the years ahead, which is the kind of effort needed to meet the nation's energy objectives.

Speaking of independent producers, I can assure members of this Subcommittee that such tax funds left in their hands would indeed be spent in exploration. Since 1973, data shows that independents average 105 percent of their wellhead revenues in exploration and development. If that figure sounds impossible, one must keep in mind that most producers borrow heavily against the future to expand operations through drilling activity.

As for royalty owners, it is not generally understood that they are an integral part of the exploration process. Without their reasonable participation in the leasing of acreage necessary for exploratory drilling, there would be no new wells drilled. In those countries which do not have private ownership of land, development of petroleum reserves is a very slow and torturous process. In our own nation, huge portions of public lands overlying promising oil provinces have

been closed to petroleum development. Other areas are leased very slowly, tied up with unrealistic regulatory requirements initiated by misguided environmentalists. Should the entire country be subjected to Federal land leasing policy, our oil import requirements would already be unmanageable.

There might be some doubtful merit to the oil excise tax if its proceeds were, in turn, spent on increasing energy supply in the United States. We say doubtful, because it would be far more efficient and sensible to let the energy industry spend such amounts itself for new energy supply instead of routing the funds through Washington. Yet, not even this is the case. The nation's energy consumers will soon learn, if they haven't already, that they are the ones paying the $227 billion tax bill with absolutely no assurance it will lead to more energy they so desperately need. In passing the tax act, Congress indicated a desire to spend only 15 percent of the proceeds for energy purposes; but not even this amount is definitely earmarked. Congress has the authority to spend the entire sum in any manner it wishes in the years ahead.

The oil excise tax, the largest of its kind passed in history, is a dangerous, self-defeating measure which should never have been passed. It sets a serious precedent that will irrevocably harm the nation's energy objective throughout the remainder of this century. It severely dilutes the nation's ability to bridge the vital gap between the petroleum energy era and the hoped for era of renewable fuels.

For these reasons, our Association has consistently opposed the excise tax as extremely poor energy policy. While there may be little hope in achieving its repeal, we remain confident that its devastating effect on domestic energy will encourage substantial reduction in the tax in the near future. As part of that reduction, we renew our support for exemption for independent producers and royalty owners. In the main, they have no substantial source of livelihood away from the petroleum wellhead. Thus, they need relief to assure that they will do their full part in achieving the nation's goal of maximized domestic energy production.

Thank you for this opportunity to be heard.

L. Frank Pitts

Senator BENTSEN. Our next witness will be Mr. Jimmy Joe Key.

STATEMENT OF JIMMIE JOE KEY

Mr. KEY. Senator Bentsen, Senator Boren, it's good to be here and I am happy to have this opportunity to speak before you. I have no written statement, but I appear before you as a farmer and rancher from west Texas. I live in a little town-it's actually a little community by the name of Fluvanna.

I would like to tell you that my family has been in agriculture for many generations. My father, at 76, is still an active rancher. I have four brothers. They are all in farming. I am in farming myself; farming and ranching. I have three boys and they are going to pursue careers in agriculture. My oldest son is a sophomore at State college in Alpine, studying agriculture.

So we have a great stake in farming and agriculture. We were fortunate many years ago to lease our land and oil production began on the land.

As any prudent businessman would do, because we are interested in improving our farming, we had reinvested the money that we received from the oil lease in our farming operations to improve the equipment, improve the land, improve life.

So with that thought, that's the way we proceeded. Now what has happened over the years, because this is a royalty owned oil field, it has been in production since the early 1950's, especially in the last few years, oil production has been declining. As a result. in the last 5 or 6 years, oil production has dropped 50 percent of what it was 5 years ago.