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On Shale Gas and the Severance Tax

by | published April 11th, 2011

The U.S. hydrocarbon era began in 1859, when Colonel Edwin Drake (who wasn’t really a colonel of anything) drilled the first successful oil well at Titusville, Pennsylvania.

What is happening these days in the state capital of Harrisburg may one day loom as a watershed moment of equal importance.

This time, however, the subject is natural gas.

I was in Harrisburg Saturday to address the annual convention of the Pennsylvania AP Broadcasters Association – the statewide professional TV and radio organization.

My topic was off-the-radar news stories about drilling in the Marcellus Shale – the unconventional shale gas basin emerging as likely to be a main new source of natural gas, especially in the energy-dependent Northeast.

The prospect of a major local source capable of fulfilling energy needs for the next couple of centuries was enthralling for the journalists in the room. But how to report on the developments as they accelerate over the next decade (and more) is becoming a daunting task, to say the least.

There are a number of major ongoing concerns, but one that is central to the entire basin expansion involves taxes. And it’s this concern – and what happens next – that will inform the future of unconventional drilling around the world.

Battleground: Marcellus

This is all about whether the state is going to tax the production at the wellhead – that is, when the gas comes out of the ground.

Usually called a “severance tax,” the device or something acting like it is already used in every other state with significant gas production.

But in Pennsylvania, it is becoming a battleground over a rising budget deficit.

The tax story is one of those stories that broadcasters throughout the state have been covering… because it pits recently elected Governor Tom Corbett’s campaign pledge (for no new taxes) against a state budget in desperate need of revenue.

Now, the incoming administration has already signaled its intention to cut expenditures. Hit so far are public university and public school block grants. Up next on the chopping block are health care and entitlement programs.

On the other side of the pro-drilling argument are those who suggest that not taxing the companies would provide enticements to drill, added employment, and tax revenues from the traditional levies on profits and permits. In fact, the move to provide tax cuts and incentives to prompt additional drilling is already a subject of political contests in other states (see “The ‘Oil Battle’ in Alaska is Spreading,” April 4).

Those opposed to a severance tax point to an American Petroleum Institute (API) study released last summer indicating $24 billion added to the state economy, along with 280,000 jobs and $6 billion in revenues through 2020.

Yet those figures have themselves been a matter of some dispute. For example, my graduate students at Duquesne have concluded the data used in the study cannot be replicated to be verified.

But even if there is a tangible positive result from the drilling (and environmental concerns can be satisfied), other problems loom large.

Budget Cuts, Revenue Shortfalls

There are currently some 1,650 wells drilled in the state, with as many as 120,000 coming before the rush is over some time next decade. That means some fundamental questions need answering before the development curve spikes.

Without additional revenue, the Department of Environmental Protection (DEP) – the Pennsylvania office that issues the licensing permits – will have a hard time putting enough inspectors in the field to meet the avalanche of new drilling on its way.

This is a big problem, given the budget cuts resulting from the state deficit.

Other departments face similar additional expenses resulting from drilling and are under the same constraints. These include wildlife and fisheries, timber, rivers and streams, parklands, and conservation services.

Funding the additional expenses in these categories will be hard enough without a severance tax (which is why all other states have one). However, that’s not the only difficulty here.

I think a major issue is being ignored – not just in Pennsylvania, but elsewhere in the U.S. and Canada where unconventional gas and oil drilling are revving up.

This is not about the normal budgetary debate between the spenders and the cutters… This is about the impacts of a game-changing energy play in ways people aren’t even talking about yet.

Local Adverse Economic Indicators Are Mounting

We have indications in Pennsylvania that significant rises are forming in what I call “local adverse economic indicators” (LAEI).

These involve the following, just for starters:

  • damage to local infrastructure (especially roads);
  • additional demands on local services resulting from labor mobility (schools, assistance programs, hospitals, police, and fire);
  • decline in property values from contiguous drilling;
  • localized inflation (already seen in housing and dual-usage equipment/supplies);
  • imbalances in local sector employment patterns; and
  • water supply problems (hydrofracking for shale gas requires large volumes of water, putting it in competition with agricultural, industrial, municipal, and recreational uses).

Now, any primary revision in an economy will cause ancillary negatives.

In this case, those negatives will primarily hit the communities in which drilling takes place. Despite the companies spending more in those communities, prior experience in Texas and Arkansas indicates that these negative effects will hang on long after the drilling money stops.

This is what Harrisburg must understand… and why what is happening in Pennsylvania will be an important lesson for other U.S., Canadian, and foreign locations where shale gas production is intensifying.

Unless there is a genuine way to balance off the increasing local problems with sources of revenue to meet them, you end up with an unfunded mandate – the state sets down policy, but the localities have to figure out how to pay for it.

It would be the cruelest of ironies if the shale gas opportunity was lost. Yet it may well come down to that.

Because behind the debate on the severance tax lies a fundamental concern over something else – the quality of life… of the people who were there before the drilling started and who will be there long after it ends.

Sincerely,

Kent

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  1. Eric Allison
    April 11th, 2011 at 14:41 | #1

    Kent,
    I’d love to get your thoughts on fracing with LPG, or propane? It seems to be a “green” method of drilling that eliminates the negative aspects of hydrofracking such as high water usage and groundwater contamination. What is your opinion of Gasfrac (GFS in Canada or GSFVF.pk) that has patented this technology?

  2. Ed Marchok
    April 11th, 2011 at 14:48 | #2

    One need only to look at the “boney piles” that dotted our landscape long after the coal companies were gone. I like to think of this in two dimensions, one of which I call “negative externalities” – a negative we know of but feel it is offset by the good the change will do. Those are the sorts of things you document in the article and that our politicans point out the good transcends. The other is “unintended consequences” – somethings we have not even thought about that result from the change. Things like when we were using asbestos or coal, who ever thought of mesothelioma or black lung; I don’t know what they will be, but it seems they always come. To date, “lock box funding” for neither of these consequences has been funded – and they certainly should be included as a part of the product cost.

  3. Ventureshadow
    April 11th, 2011 at 15:15 | #3

    Tax is always taxing. It hurts the people being taxed. The issue here is precisely about comparing severance tax against other types of taxes, in terms of hurtful effects. You did not discuss this.

  4. Dr. Frederick J. Young
    April 11th, 2011 at 15:17 | #4

    1. The first oil wells in North America were drilled at Petrolia, Ontario. The first in the world recorded in history were drilled in the first century by Chinese. These are well documented with drawings of the drilling rigs and workers.

    2, Although there have been large amounts of gas produced in Bradford, McKean and Warren County for almost 150 years, a way to tax it has never been determined. Oil production used to be taxed as well as the oil and gas rights severed from the surface. A few years ago that was found to be illegal by the court of Jefferson County. As far as infrastructure being ruined by gas drillers, it is not as good as it was when there was a lot of activity here in the late 1930s. At that time the roads were smooth and the bridges new in contrast to the horrible cobble stone streets of Pittsburgh, Buffalo, NY and Toronto, Ontario. Isn’t is enough that the owners of large tracts of oil and gas rights have to pay at the maximum income tax level and the drilling corporations must pay federal and state income taxes?

  5. Leslie simon
    April 11th, 2011 at 15:17 | #5

    Very well said!!
    I see the financial opportunities but have been wondering about many of these same issues and agree that they need to be addressed. As wonderful as the shale gas seems, the companies are going in to make money and usually run rugged over the locals who just want the life they signed up for, the one they have had for years…. plus, the fracking seems to leave behind a host of health issues for those living nearby.

  6. John Rosling
    April 11th, 2011 at 15:18 | #6

    Concerning environmental issue [water] in the Marcellos shale, have you considered the new fracing technique developed by GASFrac [GFS. Canadian]?? Seems very promising and very “green”.

    Thank you.
    JR

  7. steve rutka
    April 11th, 2011 at 15:18 | #7

    Kent, very accurate assessment. There are several issues not addressed in the media: 1) Peoples Natural Gas is asking for a rate increase. Why would this be permitted when natural gas is so abundant? 2)What percentage of the natural gas will be exported for higher gas company revenues than selling/keeping it locally – or will the price charged locally be as high as what a gas company would get exporting it? 3) Water treatment rates are also increasing. My guess: the waste treatment has not been adequate to date. The average person is paying this and other ancillary costs without the benefits. It would definitely be a mistake to let anyone politically steal an asset.

  8. Richard Moses
    April 11th, 2011 at 16:58 | #8

    There are uses for the rock waste left over from strip mining, besides dumping it back into the hole from which it came, and these uses are as aggregate for construction, road rock, filler for land reformation, etc.
    Unfortunately, there seems to a lack of foresight by the companies which dug up the coal, or other minerals, and there fore that creates a need for some one to put the offending mounds of dirt and rock back into the hole(s). Seems to me that local folks might be well ahead to push local govt to “Fill in the hole!”?

  9. john m van zandt
    April 11th, 2011 at 19:04 | #9

    thank you for telling me about Westport Innovations…JP Morgan just tanked them for no reason.. anyway, i used gel hydrofracking by Haliburton to complete a well in Mississippi Chert formations in Rice county Kansas in 1956 with great success…however , there was little or no slant drilling then..which has made these these new shale gas formations so productive..my father was one of the first lease brokers out of Tulsa in 1915 and i am now reaping the rewards of oil royalties he bought then from new shale gas production in Woods County OK. Since HONDA has now come out with a natural gas car, isn’t this now the time to convert our auto transportation to mainly natural gas and get rid of over $4 gasoline forever and to hell with OPEC countries..

  10. john m van zandt
    April 11th, 2011 at 19:07 | #10

    do you think any state politician is going to miss the opportunity to tax separation of natural gas at the wellhead?

  11. john m van zandt
    April 11th, 2011 at 19:14 | #11

    sorry, i meant severance tax… they are already doing this in most states…

  12. george
    April 11th, 2011 at 20:00 | #12

    since fracking with propane is reported to reduce ground water contamination ans is all round more environmentally friendly, please advise on who are the players using propane

  13. Jan van de Linde
    April 11th, 2011 at 21:23 | #13

    As soon as there is a real need for oil and/or gas, for example when the fight between countries as Iran and Saudi Arabia goes from words to actions, these problems will quickly be solved. That can happen tomorrow or in next decade, but it is almost inevitable.

  14. kelly cranston
    April 12th, 2011 at 11:29 | #14

    Good analysis Kent. This country is in serious financial trouble because no one wants to pay for the cost of their own activities or for their unfunded services they receive, Be it either companies causing damage to infrastructure or health of citizens, or seniors on medicare and social security who did not pay in advance for the cost of their retirement. Sorry world, economies are in the end a zero sum game, either pay up or fail.

  15. Jack
    April 16th, 2011 at 01:30 | #15

    I posted on this subject myself earlier, and it was a pleasure to read your view on it Kent.

    Best wishes,

    cars2scrap

  16. Sumflow
    May 13th, 2011 at 20:28 | #16

    Leslie simon :
    Very well said!!
    The locals who just want the life they signed up for, the one they have had for years….

    @Leslie simon Perhaps they should ask for a refund.

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