Severance Tax on Oil and Gas Production: What Investors Should Know

What Is Severance Tax?

Severance tax is a state-level tax on the extraction of natural resources — in this case, oil and gas. It's calculated as a percentage of gross production value and is deducted before you receive your revenue distribution. Every producing state charges it, but rates vary significantly.

State-by-State Rates

Oklahoma: 2% on oil for the first 36 months of a new well's life (incentive rate), then 7% gross production tax. Gas is taxed at 2% for new wells, 7% thereafter. Oklahoma's incentive rate for new wells is one reason operators favor drilling there.

Texas: 4.6% on oil, 7.5% on natural gas. No reduced rate for new wells, but there are exemptions for marginal wells and enhanced recovery projects.

North Dakota: 11.5% combined (5% extraction tax + 6.5% gross production tax). This is among the highest in the country and is a meaningful drag on Bakken well economics.

Other states: New Mexico 3.75% oil/4% gas, Wyoming 6% oil/6% gas, Colorado 2-5% depending on production levels.

How It Affects Your Returns

Severance tax comes directly off the top of your revenue. On a well producing $10,000/month in gross revenue in Oklahoma (at the 7% rate), that's $700 per month deducted before you see it. Over a year, $8,400 on a $120,000 gross revenue well. This is baked into every economic projection, but make sure you're comparing state-adjusted returns when evaluating projects across different basins.

Tax Deductibility

Severance taxes are deductible as a production expense on your federal return. They reduce your taxable income from the property, which partially offsets the cost. For a 37% bracket investor, the effective impact of a 7% severance tax is more like 4.4% after the federal deduction.

Oklahoma's competitive rates — especially the 2% incentive for new wells — are one reason BassEXP focuses its operations in the state. Lower severance taxes mean more of your production revenue reaches your bank account.