2012 Drilling Fee Revenue Slips Below 2011 Collections

On April 1st, drillers operating in Pennsylvania’s Marcellus Shale formation were required to pay their annual well fees to the Commonwealth.  As discussed in Policy Briefs Volume 12, Numbers 11, 21 and 51, Act 13 of 2012 gave counties with unconventional (Shale) drilling within their borders the option of charging a fee on each well.  All counties have in fact done so.  Revenue from this new fee, collected in 2012, provided $206 million to be shared among state agencies, counties, and municipalities.  However, in 2013 fee revenue slipped to $198 million.  Is the revenue reduction a one-time event, or the start of a trend?



The fee as outlined in Act 13 is based in part on the market price of natural gas and is structured so that, over time, the charge on wells drilled in earlier years decreases.  There is also a distinction made for vertical wells in the Marcellus Shale formation which are only charged twenty percent of the fee since they are deemed less intrusive than multi-bore horizontal wells.  The Public Utility Commission (PUC) recognized 4,449 total wells in the formation with 4,031 wells being designated as horizontal wells subject to the $50,000 fee (the remainder was classified as vertical).  As 2012 dawned, these wells graduated into year two of the fee structure while any wells drilled in 2012 entered the first year in the system.


To understand why the fee revenue for 2012 is lower than 2011, we need to examine the two most important factors in this determination-the price of natural gas and the drilling activity that actually took place in 2012.


The fee structure takes into account the spot price of natural gas as traded on the market.  In 2011, the annual average price came in at just over $4.00 triggering the $50,000 per well fee.  But the price had fallen by more than 30 percent in 2012 to $2.79.  At this price, any well drilled (spud) in 2012 (their year one) will be charged $45,000.  Also, the second year wells will see their fee reduced by $15,000 to $35,000.  Therefore the wells that had generated $206 million in 2011 generated approximately $144 million in 2012. The other $54 million or so is coming from new well fees.  So as a result of the lower price there has been a reduction in the fee amount per well-both new and existing. The advent of extraction in the Marcellus Shale formation has increased the supply of natural gas, putting downward pressure on the trading price, helping to trigger the lower fees.  Through the first quarter of 2013 the price has begun to rise, reaching an average of $3.61 and could boost per well fees in 2013. Bear in mind that fees will fall again for older wells due to the aging provision. 


And of course the amount of money collected is also dependent upon the number of wells spud.  As mentioned above 4,449 total wells had been spud through the end of 2011.  In 2012, the PUC has documented 1,357 new wells.  This is a thirty percent drop from 2011 when 1,937 wells were spud.  In fact, 2011 represents the high water mark for activity.  In 2010 there were 1,454 wells spud and only 763 in 2009.  Thus it appears as though the increase in the supply in natural gas and the resulting drop in price has also curtailed new drilling in the Commonwealth. 


Where are the wells concentrated?  It has been suggested that the Marcellus formation is producing both wet and dry gas.  Wet gas, primarily found in the western Pennsylvania counties (as well as in Ohio and West Virginia), contains other compounds such as ethane that can be separated (cracked) and sold for other uses.  Dry gas, found mostly in the north/central counties is more limited in use.  The lower price of gas makes the wet gas more desirable as money can be made on the other compounds as well. 


Through 2011 there were 37 counties that contained wells linked to Marcellus Shale.  Two more counties, Crawford and Mercer, added wells in 2012 for a total of 39.  However as noted above, there were fewer wells drilled in 2012 than in 2011.  In fact twenty-two counties saw a decrease in drilling activity including northern tier stalwarts Bradford (-60 percent), Tioga (-53 percent) and Lycoming (-29 percent).  Only three of these counties were located in western Pennsylvania-Greene (-4 percent), Indiana (-91 percent) and Westmoreland (-35 percent).    Thirteen counties had an increase in drilling activity with only Sullivan (42 percent) not in the western part of the state.  The remaining four (Bedford, Huntingdon, Luzerne, and Wayne), not only did not have any change in activity they did not have any wells spud in either 2011 or 2012.


However, a drop in new wells being spud does not necessarily translate into a decrease in production.  State law requires that drilling companies report their output to the Department of Environmental Protection.  While this data is raw, it does allow us to approximate overall production statewide as well as within each county.  Total Marcellus Shale drilling production in Pennsylvania for 2011 was reported to be 1.070 billion mcf (thousand cubic feet).  Production in 2012 was reported at 2.065 billion mcf-an increase of 93 percent.  Thus even though fewer new wells came online in 2012, overall production from this formation nearly doubled. 


At the county level, of the 34 counties that produced gas from Marcellus Shale formation from 2011 to 2012, only four counties reported a decrease in production:  Cambria, Cameron, Potter, and Warren with the latter the only western county.  And with the exception of Potter (73), the other three don’t have many wells within their borders-Cambria (7), Cameron (14), and Warren (3).  In fact eleven counties reported output levels that had doubled from 2011. 


Even though there were fewer wells drilled in 2012 than 2011 or 2010, there remain a large number of permits issued that have yet to be used, which suggests that drilling in the Marcellus Shale formation will continue for quite some time. Bear in mind that the amount received by the state and then distributed to the counties and municipalities will vary from year to year as market conditions change.  Thus it would be unwise for any level of government to view the amount of revenues from Act 13 as set in stone.

County Wants to be Right on Rights

Though there has been a lot of talk about how Marcellus Shale drilling could be a boon for the County, specifically for the County’s coffers if drilling rights were leased on airport land, County officials likely have little firsthand knowledge on what the County owns, if anything, in the way of mineral rights-gas, oil, coal, etc.

That could change if action is taken on a motion that would instruct the County manager’s office to "…determine what mineral rights Allegheny County owns on any parcels within the County and the feasibility and economic value of conveying those mineral rights to other parties for development".

A similar motion was introduced into Council last June but no action was taken on it after it was referred to the Committee on Economic Development and Housing.

It could turn out that the County owns mineral rights under some valuable property in the area. It is doubtful that even if the County owned mineral rights in the middle of, say, a County park, that there would be extraction due to strenuous objections. Recall the 2008 proposal to extract coal in a section of South Park.

Conversely, it could be possible that someone other than the County owns the mineral rights under government structures, that of related County agencies, or perhaps under some of the shiniest new economic development projects carried out in recent years. Could there be drilling next to the County Courthouse in the near future? Or how about digging near the Convention Center?

The proponent of the study wants to use proceeds to reduce the increased property tax burden, which the proponent incorrectly assigns to the new assessments. How about the 21% millage hike passed by Council at the end of 2011? Besides, the County is limited to a 5% windfall that requires a vote of Council. Otherwise, there is no net increase in revenue from the assessment.

The proponent’s comment points out once again how ignorant even County officials are about the assessment process.

City’s Bill Sure to Heat Up Gas Debate

Last week Pittsburgh City Council discussed legislation aimed at defining requirements drilling companies must take should they decide to explore the potential of natural gas in the Marcellus Shale lying below the municipal boundaries of the City proper. Gas and oil drilling would be treated as a conditional use under the City’s zoning regulations.

Companies would have to submit copies of leases from landowners and all permits to the Directors of Public Safety and Planning; to have a minimum drilling site of 15 acres; to be 1,000 feet away from residential dwellings and public buildings such as schools, churches, public utility buildings, and recreation centers; to take a baseline chemical sample; to stay off of residential streets getting to and from the drilling site; and to minimize light, dust, noise, and vibration.

Reasonable protections all, no? Residents want to enjoy the disruption and negative externalities that can come from commercial and industrial activity, and that is largely the purpose of zoning and special exceptions and conditional uses. And the City likely thinks it is doing the right thing, just like Allegheny County when it passed a smoking ban a few years back.

But just like the County found out, there is a state preemption doctrine at work that gives the PA Department of Environmental Protection the responsibility of permitting and the state’s Oil and Gas Act says that "no ordinances or enactment…shall contain provisions which impose conditions, requirements, or limitations on the same features of oil and gas well operations regulated by this act".

That could mean a swift end to the ordinance or perhaps an appeal to the courts for interpretation.