Governor Pitches Severance Tax Proposal

Governor Pitches Severance Tax Proposal

While stumping for the office, the current Governor made a Marcellus Shale severance tax a lynchpin of his candidacy.  Now that he occupies the seat he has officially proposed a five percent severance tax on the value of natural gas coming from the Marcellus Shale formation.  While most observers knew this was coming, see Policy Brief Volume 14, Number 59, he added an another twist—a flat fee of 4.7 cents per thousand cubic feet (Mcf).

 

As we wrote in that Policy Brief, a five percent severance tax was not going to raise $1 billion. At 2014’s average trading price ($4.20) and production rates (approximately 3.88 billion Mcf) it would have generated $817 million.  Now that the prices have fallen—closing at $2.62 on Monday February 9th, down $5.50 from this date one year ago—there is no chance of raising $1 billion from the severance tax alone.

 

Thus the flat 4.7 cents per Mcf has been tacked onto the proposed severance tax.  Taking 2014’s production rate as a base, 4.7 cents would raise another $182 million.  When added to the five percent severance tax of $817 million, the two taxes together magically produce $1 billion.

 

However at the current price and, assuming last year’s production—which might be too high—the two new taxes would produce just under $700 million.  If prices and production fall from where they are now, revenue from the proposed tax would fall further.

 

However, keep in mind his revenue predictions do not assume any reaction from the industry.  As we know when costs rise, production will fall.  Thus it is very likely that there will be contraction in the industry, especially from the smaller drillers who were just making it when the price of natural gas was significantly higher in 2014.  They may halt drilling, cap wells, and lower production which would bring the revenue to the state down as well.  We are already hearing of drillers holding back on tapping new wells when the price started to fall earlier this year.  This could also dampen any talk of Shell building the cracker plant in Beaver County.

 

The Governor then capped his stance by saying “The alternative is not really no tax.  It’s no drilling, a ban, as in the case of New York.”  Does he really mean to imply that he would recommend a ban? Has he thrown down the gauntlet to the Legislature?  Bad move if he has.

 

Finally, bear in mind that passing a severance tax would rescind the current impact fee and do away with substantial revenue presently being shared by municipalities, counties and state programs.  If the severance revenue is used to replace the impact fee, the net to the state for other purposes would likely be under $500 million.