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.
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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
Watching Harrisburg crash and burn
We are now watching Harrisburg crash and burn. The busted Pennsylvania capital of 49,000 is crushed by $463 million in city debt and an additional $282 million in debt for the public school system. The state senator representing the area, Jeff Piccola, used his power last June to pass state legislation (Act 47 amendments) that shackled Harrisburg with accepting a receiver appointed by the governor and barred the city from filing bankruptcy until June 30, 2012.
Adhering to the Act 47 requirement that the mayor work with the city council to approve a fiscal recovery plan, Mayor Thompson fought a months-long war that resulted in her plan being rejected three times and the governor’s appointment of a receiver, David Unkovic. After the Dauphin County court approved Unkovic last November, he tried to help the city balance the budget, sell assets and negotiate with bondholders. Amid all that action, a subset of the city council, against the mayor’s wishes, filed a Chapter 9 municipal bankruptcy petition that was ultimately rejected by a federal judge as a result of Senator Piccola’s Act 47 legislation.
Harrisburg’s biggest albatross is its responsibility for the debt of the Harrisburg incinerator – a monstrosity of design and a debacle of public financing. The responsibility for this debt first lies with the city and then with Dauphin County and bond insurer Assured Guaranty.
On Apr. 2 Unkovic inexplicably announced his resignation in a letter to the governor. This followed a dramatic press conference Wednesday in which Unkovic began to name names in the Harrisburg drama, beginning with State Senator Piccola, who recently announced his retirement from electoral politics. Also among those Unkovic named was the lobbyist who had worked with the staff of Governor Tom Corbett on the legislation to place Harrisburg into receivership and bar it from filing bankruptcy. Citizen journalist Tara Leo Auchey captured the Unkovic yarn-spinning at his hastily arranged press conference:
Which leads us to another player in the true Harrisburg debt story – Senator Jeff Piccola. During Unkovic’s press conference, he referred to the closing of the Dauphin Meadows landfill and Piccola’s position on that. Now, this is another history lesson but an important one. In 1990, Senator Piccola fought against the Incinerator and fought for use of the landfill for Dauphin County trash. The State agreed and all County trash went away from the Incinerator and to the landfill. When that happened, the Incinerator lost immense value over night.
Ten years later in 2000, Piccola switched sides, dramatically and flamboyantly. He decried the landfill [as] a nuisance and joined in a community-based lawsuit to shut it down. Piccola announced the Incinerator should be used for all Dauphin County trash.
And it was. Dauphin County entered into a municipal waste agreement with the City and The Harrisburg Authority. It is because of this agreement — and only because of this agreement — that the broken, deprived Incinerator was able to get financed to get fixed, since Dauphin County would guarantee the bonds. Piccola helped make it happen.
But Unkovic didn’t stop his list of naming names there. He called out the lobbyist Stan Rapp of Greenlee Partners, who is the lobbyist for both Dauphin County and for the bond insurer AGM [Assured Guaranty]. As we discovered last Fall, Stan Rapp was part of numerous meetings with the Governor and the Governor’s representatives about Harrisburg’s Act 47 process, which eventually became the City’s takeover by the State pushed by Dauphin County officials and Senator Piccola.
When I first wrote about Unkovic last November, I mentioned that he had worked for the law firm that represents Assured Guaranty, the city’s bond insurer, for 27 years:
The local paper has already highlighted that Unkovic has direct ties to some of the creditors in the Harrisburg case. The Harrisburg Patriot News reports:
The receiver Gov. Tom Corbett named to lead Harrisburg’s fiscal recovery is deeply connected to three firms that represented bondholders and Dauphin County in the incinerator debt crisis.
David Unkovic worked for Saul Ewing in Philadelphia for 27 years. Saul Ewing represents the biggest creditor of the incinerator debt, Assured Guaranty Municipal Corp., the company that insured much of the more than $300 million in incinerator debt.
There is also an excellent video of Unkovic responding to the conflict of interest question in the Roxbury News (clicking on the small picture on the upper left will launch a video). Reuters Legal also reported on the conflict story.
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.
Muniland’s most active states
In the municipal bond market, one of the most insightful ways to examine a state is to look at how actively its bonds trade. Broker-dealers make money by trading, so naturally they go where the action is and commit market-making resources to those states. It’s generally true that the most populous states are the ones with the most traded bonds, but if we map the wealth of a state’s citizens to how often that state’s bonds trade, we get some interesting results. For example, New Jersey, which has only 2.8 percent of the national population but a high proportion of its wealthy citizens, might have the highest number of municipal bond owners as a percentage of state population.
The municipal bond market does not trade on an exchange but rather on “alternative trading systems” (ATS). These are systems where dealers post inventories of bonds to be aggregated. The largest of the retail ATS is Bonddesk, which does some excellent data analysis for both the municipal and corporate bond markets.
From Bonddesk’s December Transparency Report I pulled the data for these charts showing the seven most actively traded states’ bonds. Bonddesk uses “investor buys” data, which represents trades that end up in a retail investor’s account. In the bond markets there are often many trades between broker-dealers before the securities land in an investor’s account, so Bonddesk scrubs the data to show the real level of investor demand.
California is the largest state by wealth, population and municipal bond issuance. Although it represents about 12 percent of the U.S. population, it dominates with 30 percent of muniland trades. Even with its substantial demand, the state still has somewhat higher yields, as seen below. All seven states are rated AA, but Illinois and California trade with higher yields given their weaker fiscal position.
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\
Harrisburg back to square one
Federal bankruptcy judge Mary France dismissed the Harrisburg City Council’s petition to file municipal bankruptcy last Thursday. According to Bloomberg her ruling stated:
“For Chapter 9 bankruptcy to work, all of the branches of the municipality must be on the same page,” France said. “Therefore I find that city council was not authorized to file the petition.”
Judge France has hit the nail on the head. The legislative and executive branches of Harrisburg’s government have been behaving like two sides of a family fighting over a deceased parent’s estate. The battle has been brutal and family members have talked past each other. Harrisburg mayor Linda Thompson seems to have little patience for others’ views, which is a tough way to govern.
So Harrisburg is cast into the arms of the soon-to-be-confirmed state receiver, who will have to return the city to fiscal solvency. But Harrisburg’s debts are just too high to pay off, and the incoming receiver has no authority to force bondholders and bond guarantors to take less than the face value of their paper. On Twitter Jim Warner, the CEO of the Lancaster County Solid Waste Management Authority, suggested that the leftover debt after the sale of the city’s main assets — its incinerator and parking garages — would be about $55 million.
But this doesn’t take into account the other debt of the city. My rough calculations show the city will have a debt load of about $224 million. And although it’s not consolidated, the city is also responsible for over $200 million of school debt.
This small city of 50,000 — where over 25 percent of residents live under the poverty line — is responsible for shouldering $425 million in debt. The new Harrisburg receiver needs to be Superman to bring this city back to fiscal solvency.
Harrisburg needs the bankruptcy option
Pennsylvania Governor Tom Corbett took the next step in the process of pushing the bankrupt capital of his state towards fiscal recovery today. Bloomberg reports:
David Unkovic, chief lawyer for the Pennsylvania Community and Economic Development Department, is set to run the finances of Harrisburg after Governor Tom Corbett nominated him as the state’s first municipal receiver.
Once approved by a state court, the overseer may act without the consent of the bankrupt capital city’s elected officials. Unkovic’s appointment may be reviewed as soon as Nov. 28.
Unkovic has 30 plus years of experience as a bond counsel. The governor has also hired a Washington law firm to assist Unkovic on his fiscal restructuring efforts. Harrisburg has an impossible pile of debt to service, and much of it needs to be discharged to make the city’s finances sustainable.
Fortunately the legislation that the receiver is working under relegates Harrisburg’s mayor, Linda Thompson, to a sideline advisory role. I’m sure the new receiver will have a few team photos taken with her and then promptly relegate her to parade and ribbon-cutting duty.
One of the biggest tasks that the soon-to-be-confirmed receiver has is to go down to the federal bankruptcy court on Walnut Street and withdraw the petitions that the mayor and state filed objecting to the city’s Chapter 9 bankruptcy filing. Bankruptcy should be the biggest tool in Unkovic’s toolkit to get Harrisburg to solvency.
The reason that Unkovic needs Chapter 9 is that as a state receiver he has no authority to “cram down” bondholders and bond guarantors. He has power to sell the assets of the city but it’s doubtful there will be enough to service the remaining debt even after a fire sale. It was always a little hard to figure this out because Mayor Linda Thompson had not presented a budget and there are no current financials for the city. It’s literally a fiscal mess.
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Resident Muniland expert
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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.