The Statutory Depletion Allowance and its Relationship to Reserves, Production Rates, and Operating Conditions

The current statutory depletion allowance of 27.5% of gross sales is and has been the subject of much controversy. Critics claim the 27.5% figure is unjustifiably high and should be reduced. However, in practice, with few exceptions, the actual allowable depletion for oil producing properties is less than 27.5% of gross sales due to the provision that allowable depletion cannot exceed 50% of net income. The actual depletion allowance realized depends upon a variety of factors or conditions. This paper reviews the effect of assumed conditions upon allowable depletion for four hypothetical cases involving oil producing properties. The conditions investigated include various development densities and corresponding prorated top allowable rates for a given lease, adverse factors of high operating costs and a low crude price, varying reserves for a well with a fixed top allowable rate, and varying top allowable rates for a well with a fixed ultimate recovery. In all cases the allowable depletion was found to be considerably less than the 27.5% statutory depletion allowance.