Pennsylvania's Tax Level for Shale Drilling Sparks Debate
Pittsburgh Post-Gazette
27 September 2010
By Sean D. Hamill,
The battle over what type of severance tax Pennsylvania should impose
-- supposedly by Friday -- on the modern day Gold Rush that is the
Marcellus Shale natural gas reserve, has become a duel of two ideals.
On the one side is the severance tax approved two years ago in
Arkansas. That's a tiered system that the Marcellus Shale industry and
Senate Republicans in Pennsylvania prefer because it allows for a
lower, 1.5 percent tax on market value until drillers make a return on
their investment, after which it rises to 5 percent three or four years
after the well is opened.
On the other side is the structure used by West Virginia. Its two-tax
approach is favored by Gov. Ed Rendell because it applies a flat, 5
percent tax on the market value of gas sold and a 4.7-cent tax on each
1,000 cubic feet of gas produced, which he believes the industry can
more than afford.
To hear either side describe the other's approach, there would seem to
be no bridging the gap.
"When you look at it, West Virginia is lagging so far behind
Pennsylvania in [natural gas] development, and that's because it has
one of the most primitive tax structure rates in the country," said
Kathryn Klaber, executive director of the Marcellus Shale Coalition,
which represents the industry in Pennsylvania.
In pitching his West Virginia model two weeks ago in Washington, Pa.,
Mr. Rendell told an audience that the Arkansas model that the industry
prefers here was "ridiculous, and I won't sign legislation like that"
because some in the industry have projected a 64 percent return on
investment in drilling in the Marcellus Shale.
But both sides in Pennsylvania's debate leave out, or gloss over, some
interesting, crucial details about what has happened in those states.
Mr. Rendell said that before he announced his tax proposal as part of
his budget last year he called West Virginia Gov. Joe Manchin "and I
asked him, 'Has your tax depressed shale drilling? He said 'Absolutely
not. In the years following, permits and drilling went up
significantly.' "
That's partially true. Permits and drilling went up after Mr. Manchin
approved the 4.7-cent tax on production in 2005.
But West Virginia didn't even give out its first Marcellus Shale
drilling permit until 2005. The industry was just beginning, so of
course it dramatically increased -- rising from just two permits in
2005 to 400 or more each of the last two years, a figure the state
expects to hit again this year.
Moreover, unlike Mr. Rendell's proposal for a permanent tax, the
4.7-cent tax is supposed to be temporary. It is dedicated -- along with
other mineral taxes approved at the same time -- to paying off West
Virginia's old worker's compensation debt after a change in structure
of that program. Current projections have that occurring in 2019,
though Mr. Manchin said in an interview that "the governor and the
Legislature then" will have to decide to end the tax.
Mr. Manchin said when Mr. Rendell called him, "I said, 'Ed, I can
assure you they'll tell you everything, that it'll destroy your market.
And it never did destroy our market.' "
That 4.7-cent tax, though, was not imposed with the Marcellus Shale
riches in mind.
In 2005, the year Mr. Manchin first took office, "I had never heard
about the Marcellus; the tax went on shallow wells then."
The impact has been relatively small, only generating $10.5 million
last year, up from $9.1 million the year before, about what the state
projected.
Even so, Mr. Manchin said: "They said drillers would leave the state
(if the new tax was imposed), and I offered to buy the leases back.
We've never had to buy back one lease."
The other part of West Virginia's tax -- the 5 percent on market value
-- has had a much bigger impact, generating $75.9 million in revenue.
The state gets 90 percent of that revenue, and local governments
receive the rest. The total was down $6 million from the year before,
reflecting the change in the lower market value of natural gas.
But the 5 percent tax in West Virginia wasn't imposed in 2005. It has
been in place at that rate since 1989, and the state has had some level
of the tax for 90 years, as has nearly every state with natural gas
production.
However, state data shows a slowdown in both new wells that have begun
producing gas -- dropping from 358 such wells in 2008 to 117 last year
-- and a flattening out of gas production, at the same time
Pennsylvania's figures are rising fast.
State officials, gas companies and the state's gas association all say
they don't believe the taxes are a major reason for the slowdown, if
they have had any impact at all.
"I don't believe there's any preference for either state," said Kevin
West, spokesman for EQT Corp., the large Pittsburgh-based natural gas
producer that is drilling in both states.
Corky DeMarco, executive director of the West Virginia Oil and Natural
Gas Association, said: "It's probably not as prolific as it is in
Pennsylvania, but we're very active down here. But you have larger land
tracts that are in the sweet spots there compared to West Virginia. If
you're drilling gold mines, you're going to go where the big seams are."
Still, Mr. DeMarco said, taxes are "an influence."
"If you're a public company and you have investors to satisfy and your
rate of return is lowered by taxes, you might look to Pennsylvania
where there's no taxes," he said.
Like West Virginia, Arkansas has had a natural gas severance tax for
decades.
It had been unchanged from its three-tenths of 1 percent of market
value level for more than 50 years and was generating just $500,000 to
$600,000 annually.
But, not coincidentally in 2008, Arkansas, like Pennsylvania, was just
beginning to get into its own natural gas boom, thanks to what is
called the Fayetteville Shale, a deep, natural gas deposit similar to
the Marcellus Shale that is also now accessible thanks to horizontal
drilling.
The idea to raise the tax came from a longtime Republican leader and
utility executive in the state, Sheffield Nelson, who in November 2007
said he was going to call for a public referendum to push the tax to 7
percent.
"The tax was just too low and I had pushed it years ago and couldn't
get it through," Mr. Nelson said. "But it's a big battle if you take on
the natural gas industry in any state."
His argument was that the surrounding states -- Louisiana, Texas and
Oklahoma -- "all have thriving oil and gas industries and their taxes
were much higher than ours."
Louisiana charges 33 cents per 1,000 cubic feet of production of gas,
generating $911 million last year. Texas charges 7.5 percent of market
value on gas, generating $2.3 billion last year. And Oklahoma charges 7
percent of market value on gas, generating $1 billion last year.
But industry opponents and other Republican leaders, led by former
Arkansas Congressman Asa Hutchinson, cried foul, claiming that any
increase in the tax -- particularly one as large as Mr. Nelson's
proposal -- would cripple the fledgling Fayetteville Shale business.
"You've got to look at all the taxes together," said Mr. Hutchinson,
who is now a consultant. "We've already got a high income tax and sales
tax, so, just because you're low in one tax doesn't mean you need to
raise it."
A compromise was struck, led by Democratic Gov. Mike Beebe, who worked
out a deal between the industry and legislators.
The tiered tax system is expected to raise about $50 million for state
and local government roadwork this year. Overall gas production has
continued to rise, even as fewer gas permits have been taken out in the
state.
"The rate of increase in gas production has slowed," Mr. Hutchinson
said. "Is that because of gas prices being lower? Or because of taxes
and they're going somewhere else?"
From Mr. Nelson's point of view, the results show what he thought all
along: "In hindsight, it appears we need another jump."
"My idea is to take it to the voters and let them decide," he said. "A
state has to run on taxes of some sort, and it's either from the people
who reside in your state or on the things you produce, like natural
gas."
Sean D. Hamill: shamill@post-gazette.com or 412-263-2579.