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.

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.

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.

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.

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.

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.

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.

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.

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