The promise and peril of energy tax revenues
Of the $763 billion in tax revenues that states collected in 2011, only $14.6 billion – less than 2 percent – came from severance taxes on coal, gas and oil. Energy production is very concentrated in the United States: Just nine states receive over 5 percent of their tax revenues from energy producers. Currently, the bulk of severance revenues comes from oil production. Alaska, a state floating on an ocean of oil, gets 76 percent of its revenues from a handful of big oil companies that have drilling rights on the North Slope of the state.
Although there has always been natural gas production in America, hydraulic fracking has given rise to substantial drilling activity in several Northeastern states along the Marcellus and Utica shale formations. Pennsylvania, West Virginia and Ohio have substantial reservoirs of natural gas, but the impact this boom will have on state finances is not yet known. These new supplies have come to market when demand is down and have swamped the nation’s usage and storage capacity, driving gas prices down to record lows. States that rely on, or plan for, revenues from energy severance taxes will face a lot of volatility from demand and price changes. Natalie Cohen, head of municipal research at Wells Fargo, sketched it out in a recent report:
Wyoming, for example, collects severance tax based on the taxable value of current-year production. With the drop in natural gas prices, it has had to reduce its forecast on severance tax revenue. The state is now looking to cut 4% out of next year’s budget, despite a current-year budget surplus. According to the state’s Economic Analysis Division, each dollar drop in natural gas prices costs the state about $226 million in revenue.
[...]
State severance taxes may be volume-based, value-based, or a hybrid of the two. When prices are high and the demand for commodities like oil and gas is robust, it is no coincidence that states with rich mineral deposits that tax extraction have weathered the economic downturn better than others.
Texas has managed to survive price fluctuations over the years and is one of the few states that does not impose an income tax. Texas, like New Mexico and Alaska, has created an endowment that was originally based on mineral lands to support K-12 and higher education. Some of the “newer” shale gas states, such as Pennsylvania and Ohio are concerned that severance taxes might chase away producers. But, high severance taxes have not hampered exploration in Texas, which levies the highest tax rate.
It is difficult for any state to forecast revenues accurately for future periods because so much is dependent on the general state of the economy. Most states derive the bulk of their revenues from sales and personal income taxes, which are very sensitive to economic conditions. But states like Alaska, North Dakota, New Mexico and Oklahoma rise and fall with the energy demand cycle. It’s unlikely in the near term that Pennsylvania, West Virginia and Ohio will see big windfalls from their gas production.
Further:
Kroll Bond Ratings: Potential Impact of Natural Gas Fracking on Municipal Bond Issuers
Pennsylvania’s proposed fracking law will exacerbate its budget shortfall
As Pennsylvania Governor Tom Corbett prepares to release the state’s fiscal 2013 budget tomorrow, the AP is reporting that Republicans in the state legislature are planning to cram through a law that levies a minimal tax on gas and oil drillers in the state. Although taxes on gas and oil production could be a means of plugging substantial revenue shortfalls, it’s likely that the legislation will require drillers to pay the smallest level of fees of any state with recoverable energy assets.
From the AP today (emphasis mine):
Pennsylvania’s top-ranking state senator says he’s hoping for a speedy vote in his chamber on sweeping legislation to impose a drilling fee and update safety regulations on the booming natural gas industry.
Senate President Pro Tempore Joe Scarnati said he hopes senators will vote on the bill by Monday night. The proposed compromise hasn’t been released publicly or amended into a bill, but Scarnati says he believes it will get enough votes to pass.
The provisions were agreed to by the Legislature’s Republican leaders and fellow Republican Gov. Tom Corbett, without input from Democrats.
Although it’s unclear what the final form of the drilling fee will be, the legislation passed in the Pennsylvania General Assembly imposed a stepped, multiyear flat fee on gas wells instead of the volume-based “severance,” or “production,” tax that all major energy producing states use. When I first wrote about the revenue the state would forgo I said:
There are shale gas fields covering more than half of the United States, but Pennsylvania has emerged as the rising star of domestic energy production with its “Mighty Marcellus” fields. This is a great resource for Pennsylvania, but I’ve been confused about legislation that would impose an “impact fee” on shale gas producers instead of the traditional volume-based royalty structure used by other states. The loss of revenues to the state over the next 20 years using the “impact fee” could be approximately $24 billion using current gas prices. If gas prices doubled (they are currently at 10-year lows), losses to the state could exceed $48 billion or more.
This loss of potential revenue from gas drilling comes as Pennsylvania has suffered revenue shortfalls. According to the Pennsylvania Office of the Budget Mid-Year Briefing, in the first five months of fiscal 2011-12, collections across nearly all revenue categories failed to meet estimates. Revenue collections were 3.6 percent, or $345.3 million, below estimate. There are current-year revenue shortfalls too, even though the state’s economic performance and employment picture is improving.
The senate president pro tempore who announced the desire to vote on gas-drilling legislation tonight also announced that harsh cuts are likely for the state budget. From the AP again:
Pennsylvania’s fracking competitiveness
In a post earlier this week I said that Pennsylvania would be forgoing approximately $24 billion in fracking royalties and that the adoption of an “impact fee” would shortchange the citizens of the state.
The Pennsylvania governor’s office responded to my post claiming that I had neglected to include other taxes collected related to gas drilling:
First, any fair consideration as to the value that Pennsylvania taxpayers will receive from natural gas development would include ALL taxes paid by operators, and landowners, engaged in the activity. Nowhere in the analysis is consideration given to the hundreds of millions of dollars paid annually already under the state’s existing corporate net income, personal income, capital stock and franchise, liquid fuels and other taxes.
Although I didn’t spell them out, I did include a link to a summary from the Pennsylvania Department of Revenue that summarized tax revenues the state had collected from the oil and gas industry. These collections totaled $373 million in 2011. Here is a chart of that data:
Pennsylvania is in the fortunate position of being very close to the East Coast, which consumes substantial quantities of energy that is now piped from the Gulf states and Northwest Canada. In the east Pennsylvania competes with New York, West Virginia and Ohio to service regional needs. Pennsylvania has a very good business tax climate compared with the other states it competes with, ranking 19th on the Tax Foundation’s Business Tax index. This compares with 23rd for West Virginia and 39th for Ohio. New York is not even in the running on how it taxes business — at 49th.
All of this is irrelevant if they can’t figure out how to stop fracking from causing earthquakes, and it doesn’t look like that will happen so look for the whole fracking industry to collapse within the next ten years.
The Pennsylvania governor’s office responds
On my post arguing that the state of Pennsylvania will forgo $24 billion in royalties from gas fracking, the governor’s office has responded:
The premise of the article – that PA will “forgo” billions in royalties because it does not adopt a severance tax – is simply misplaced – and misleading.
First, any fair consideration as to the value that Pennsylvania taxpayers will receive from natural gas development would include ALL taxes paid by operators, and landowners, engaged in the activity. Nowhere in the analysis is consideration given to the hundreds of millions of dollars paid annually already under the state’s existing corporate net income, personal income, capital stock and franchise, liquid fuels and other taxes. While many states [against] which Pennsylvania is actively competing for limited capital investment may impose some level of severance tax, they do not impose the same suite of taxes.
Second, and more importantly, Governor Corbett was elected under the premise that we do not tax ourselves to prosperity. Creating an economic atmosphere which grows jobs and attracts investment will do more to increase revenue than adding new layers of taxes on job creators and Pennsylvania landowners.
Natural gas development is an oasis in an economic desert we all hope to emerge from as soon as possible. This activity is putting tens of thousands of Pennsylvanians back to work. And guess what? They all pay taxes. Its lowering energy prices for Pennsylvania businesses – letting them hire more, produce more and yes, pay more in taxes as they do better.
It makes no sense to squander this opportunity.
Patrick Henderson, Energy Executive Governor Tom Corbett
Pennsylvania to forgo $24 billion in fracking royalties
There are shale gas fields covering more than half of the United States, but Pennsylvania has emerged as the rising star of domestic energy production with its “Mighty Marcellus” fields. This is a great resource for Pennsylvania, but I’ve been confused about legislation that would impose an “impact fee” on shale gas producers instead of the traditional volume-based royalty structure used by other states. The loss of revenues to the state over the next 20 years using the “impact fee” could be approximately $24 billion using current gas prices. If gas prices doubled (they are currently at 10-year lows), losses to the state could exceed $48 billion or more.
The energy states of North Dakota, Wyoming, Texas and Oklahoma historically have earned substantial revenues from energy royalties. It seemed odd that Tom Corbett, the Pennsylvania governor who received substantial campaign contributions from gas producers, barred his shale gas commission from even considering a royalty or gas tax.
When energy producers do cost-benefit analyses, they use very sophisticated modeling in which the primary input is the quantity of “recoverable” oil or gas in an area. The second input is the projected demand and supply for energy, which in turn determines its price. Finally, the modelers factor in business expenses, primarily the depth of well drilling required and the cost to haul the energy to a pipeline terminus or railroad depot. In the case of natural gas they might include the cost to liquefy the gas for easier transport. Generally at the end of all the calculations they look at the cost of paying mineral rights fees to landholders and royalty fees to the state. All these inputs move around constantly, and projecting them years or decades ahead requires quantitative wizardry.
The fees for mineral rights paid to landowners are negotiated costs. Mineral rights vary because landowners don’t have a central platform to see what other landowners are being paid and generally accept what the energy company offers. State royalty fees, though, are foreseeable: They’re set by the legislature and are generally clustered around similar levels across the nation. Oklahoma has a scale that starts at 7 percent when gas prices exceed $2.10 and slides downward if gas prices go lower. West Virginia, also a Marcellus shale state, imposes a 6.1 percent effective royalty rate, while Texas charges 5.4 percent of well revenue.
Pennsylvania is different in that the governor and legislature want to impose a fixed annual fee on drillers that changes over time, going from $50,000 in the first year to $20,000 a year from the fourth to 10th years and $10,000 annually for years 11 to 20. The impact fee will earn Pennsylvania $360,000 over the life of the gas well.
The Marcellus Coalition, the energy producers’ trade group, commissioned a study that found there were 2,300 Marcellus wells in Pennsylvania in 2012 that could produce almost 3.5 billion cubic feet of natural gas per day. At $3.62 per 1,000 cubic feet (the October 2011 EIA wellhead price) each well would earn about $5,500 per day, or $2,010,000 per year. Using the West Virginia royalty rate of 6.1 percent, a shale gas well could earn Pennsylvania $122,000 per year, or $2,440,000 over a 20-year production period. Instead, the proposed Pennsylvania impact fee will earn the state about $360,000 per well over a 20-year period. The Marcellus Coalition has estimated that Pennsylvania will have 11,500 wells operating by 2020, meaning the state is shortchanging itself by a minimum of about $24 billion in gas revenues over 20 years. If inflation or demand push up natural gas prices, the revenue losses to Pennsylvania will increase geometrically.
Tom Corporate: Owned and Operated by the Gas Drillers for $750,000. Good deal for them. They get 24 billion.
Fracking’s externalities
Fracking is under increased scrutiny in the U.S. and in Australia, in the state of New South Wales. Both nations have undertaken studies to examine the effect of fracking on groundwater supplies. But there are other potential socialized costs that need to be included in these public studies, including the possible cost of wastewater treatment plants, damage to local roads, air and water pollution and the linkages to earthquakes. The costs of these possible side effects to local communities may exceed the gains they’ll receive from extraction royalties and increased tax revenues. We need some accounting.
In the U.S. the Environmental Protection Agency has begun a study on fracking and water supplies, and it released a status report in December 2011. The EPA anticipates a first round of results by the end of 2012 and a final report to be released in 2014. The agency has conducted literature reviews, requested data from manufacturers of fracking fluids and scheduled case studies with landowners. It also released a startling preliminary report on possible groundwater contamination in Wyoming. From USA Today:
The EPA found that compounds likely associated with fracking chemicals had been detected in the groundwater beneath Pavillion, a small community in central Wyoming where residents say their well water reeks of chemicals. Health officials last year advised them not to drink their water after the EPA found low levels [of] hydrocarbons in their wells.
[...]
The fracking occurred below the level of the drinking water aquifer and close to water wells, the EPA said. Elsewhere, drilling is more remote and fracking occurs much deeper than the level of groundwater that would normally be used.
In Australia the national government has moved much more decisively and imposed a temporary ban on fracking that lasts through the end of April. The national government also allocated about $150 million to conduct an independent review of the health, safety and environmental risks of the process. From Bloomberg:
Prime Minister Julia Gillard said Nov. 21 that the government will allocate A$150 million ($153 million) to establish an independent committee to provide scientific advice on the impact of coal-seam gas projects on water supplies.
“The framework is not designed to add extra work or increase the regulatory burden for upcoming projects,” Gillard said in a statement. “It does mean, however, that their applications will be subject to rigorous and independent scientific assessment before states grant an approval.”
The efforts of both nations are a good start, but government oversight needs to be broadened to account for other environmental and social costs. There is already academic work that creates a framework for enviromental costs for the economy. In 2009, economists Nicholas Muller, Robert Mendelsohn and William Nordhaus published a methodology that weighed both costs and benefits to the economy from air pollution (page 3). Their work focuses on measuring damages and the value added from various industrial processes.
[W]e compare Gross External Damages (GEDs) to value added (VA). The purpose is to determine whether correcting for external costs has a substantial effect on the net economic impact of different industries. We find that the ratio of GED/VA is greater than one for four industries (stone quarrying, solid waste incineration, sewage treatment plants, and fossil fuel power plants). This indicates that the air pollution damages are greater than their net contribution to output of these industries. Several other industries also have high GED/VA ratios.
@ Cate Long: Thank you. And thank you, and thank you again. It is nice to see a balanced piece of journalism appear here, in the MSM.
The reality is that regardless of the size of LP/NG reserves in the U.S. (and contrary to the narrow and limited understanding of OneOfTheSheep, above), the resource is finite, and the U.S. will never, ever achieve “self-sufficiency” in energy production at the present (or foreseeable) rates of consumption.
The undeniably valid point you make in this piece is that if the costs are socialized and the profits taken privately, the American public are NOT served by permitting these practices. That American citizens do not, or cannot, understand that their support of such practices harms them in far greater measure than the curtailed/reduced production that may result. They don’t understand that in order to keep their fuel costs a dollar lower, they are handing three dollars to the producers.
Where does fracking water go?
Fracking — the extraction of natural gas from underground deposits of shale — is receiving an increasing amount of attention. The 2010 documentary Gasland brought the issue into the national spotlight and highlighted the problem of contaminated groundwater that can occur when a well casing ruptures and fracking fluids escape into the water table. In addition, there is the issue of used fracking liquids being injected into spent wells for permanent disposal. Of course, the fracking industry and environmentalists have a lot of disagreement about the extent to which these fluids contaminate groundwater.
There is another, less discussed, problem of used fracking fluids that are moved offsite for processing and disposal. Where are these fluids going and who is regulating them? The community of Kingston, NY (near where I live) decided they didn’t want to accept these fracking fluids for processing. From the Daily Freeman:
The city engineer says no spent hydrofracking fluid will be coming to the sewage treatment plant even though the state Department of Environmental Conservation lists the plant as a capable of handling the fluid.
“Technically we could accept it, but we’ve decided not to,” City Engineer Ralph Swenson said last week, only days after Woodstock residents voiced concern that treated water would end up being discharged into the Rondout Creek and flow into the Hudson River.
“We need to maintain the capacity for our own use and it’s not worth getting involved with this material,” Swenson said. “We’re not even thinking about it.”
Officials in 2009 turned down a inquiry about processing fracking fluid because the city’s plant was already averaging 88.23 percent of its 6.8 million-gallon daily capacity and because of the difficulties in providing treatment.
“It was Chesapeake Energy and we declined because of the strength of the liquid and volume-wise it wouldn’t make any sense for us to get involved with it,” Swenson said.
Other municipal water-treatment plants have been accepting the used fracking liquids, including the Municipal Authority of the City of McKeesport, Pennsylvania, which has filed plans for expansion even though it’s facing lawsuits and inquiries from the EPA about its fracking fluid treatment. The facility discharges into the Monongahela River and says that a private company, Green Disposal, pays the Authority about $1.6 million per year for fracking fluid disposal. It’s easy to see how lucrative this business could be.
Disposal of fracking fluids is an important issue that has inconsistent supervision. Until federal standards come into effect in 2014, citizen oversight will be critical. I was thrilled to see this project tracking political donations from firms involved in fracking. In our rush to develop more domestic energy sources we must protect the environment. Nothing is more valuable than clean water. It ranks above cheap energy in importance.
Map above courtesy of Earth Justice (click through to original which has many layers of detail including on the small symbols that denote fracking accidents)
Once again, Cate Long provides her readers with a clearly written and well-researched report about fracking. The Municipal Analysts Group of New York will be having a presentation about this topic on January 20th in New York City at the Yale Club.
http://www.magny.org/cgi-bin/0zyevent-ca ld.cgi?EventNumber=6\
Is fracking behind Oklahoma’s earthquakes?
One of the strongest earthquakes in the history of Oklahoma hit near the town of Sparks on Saturday night. At 5.6 in magnitude, it was the bell-ringer of a series of shakes. What is not clear is where this unusual seismic activity is coming from. The Oklahoman reported:
After the main shock, there were 12 temblors registering at magnitudes of 3.0 or higher and more than 70 quakes with magnitudes of 1.0 to 2.5, Oklahoma Geological Survey research scientist Amie Gibson said Sunday.
“We really hope that the 5.6 was the main shock because I don’t want to see anything like that again, personally. It would be ignorant to assume anything right now, because who would assume that we’d have the two biggest ones in one day?” Gibson said.
Before Saturday night, the strongest earthquake recorded was April 9, 1952, in El Reno, according to the geological survey. Its magnitude was 5.5.
U.S. Geological Survey geophysicist Don Blakeman said the agency doesn’t know why Saturday’s quakes struck so close together.
When the New York Times covered the story they got a quote on the increasing frequency of earthquakes in the state from Austin Holland, a research seismologist with the Oklahoma Geological Survey, a state agency:
“We have not a clue,” Mr. Holland said of the increase. “It could be a natural cycle; we just don’t know.”
Unfortunately the New York Times reporter either didn’t ask or didn’t know about a study that Mr. Holland published in August 2011 that explored the possible connection between hydraulic fracturing and increased seismic activity in a similar series of quakes that occurred south of Sparks. The report — “Examination of Possibly Induced Seismicity from Hydraulic Fracturing in the Eola Field, Garvin County, Oklahoma” — goes through the existing evidence linking fracking and earthquakes step-by-step. Holland says there is a possibility that the two are linked but that data uncertainties keep him from saying so with absolute conviction. From the summary of the report (emphasis mine):
On January 18, 2011, The Oklahoma Geological Survey (OGS) received a phone call from a resident living south of Elmore City, in Garvin County, Oklahoma, that reported feeling several earthquakes throughout the night. The reporting local resident had also offered that there was an active hydraulic fracturing project occurring nearby.
Upon examination there were nearly 50 earthquakes, which occurred during that time. After analyzing the data there were 43 earthquakes large enough to be located, which from the character of the seismic recordings indicate that they are both shallow and unique.
[..]
The strong correlation in time and space as well as a reasonable fit to a physical model suggest that there is a possibility these earthquakes were induced by hydraulic fracturing. However, the uncertainties in the data make it impossible to say with a high degree of certainty whether or not these earthquakes were triggered by natural means or by the nearby hydraulic fracturing operation.
You’re barking up the wrong tree. Fracture stimulations are not of a magnitude or at a depth to cause the large earthquakes experienced in central Oklahoma.
These are almost certainly being caused by the tremendous volumes of water being disposed into the Arbuckle Formation in this area. Most of this water is produced as a result of the exploitation of what is locally called the Hunton de-watering play.
The water injected into the Arbuckle is winding up in the pre-Cambrian basement through movement along an extensive vertical fracture system.
-
Resident Muniland expert
-
For a really nauseating time, research how that Severance Tax money is actually distributed and spent by the different Local Government agencies in the various states. “Education” turns out to have a remarkably fungible definition when money is concerned.