Tag Archives: Marcellus Shale

Hike in permit fees latest shale industry hurdle

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Summary: Natural gas drilling and production in Pennsylvania’s shale formations have become a booming industry creating large numbers of jobs as well as producing royalties for many commonwealth residents. Pennsylvania is now the second-largest natural gas producer in the United States and the state’s economy has received a substantial boost from the sharp rise in gas production, specifically from wells in the shale formation using the fracking process which are also known as “unconventional” wells.

Moreover, state and local governments have benefitted from the taxes levied specifically on the shale gas industry, i.e., the annual impact fee and the application permit fee.  Since 2012 the state has collected $2 billion in Act 13 impact fees (Policy Brief Vol. 20, No. 29) from the industry.

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Unconventional gas well permit fees

On Aug. 1, the Department of Environmental Protection’s (DEP) Oil and Gas Program dramatically increased the cost of unconventional gas permit fees by as much as 200 percent.  The 2012 Oil and Gas Act gives the Environmental Quality Board the authority to establish the well fees.  The board is “independent” and adopts all DEP regulations as the secretary of DEP is the board chair. 

Previously, non-vertical unconventional well permits cost $5,000 and vertical unconventional well permits cost $4,200. Now a new fee of $12,500 applies to both types of unconventional wells.  Prior to the August change, the permit application fees were last amended in 2014 when the DEP did away with a sliding scale and established flat permit fees for the wells. The new permit fee increases the cost of the permit by 150 percent for non-vertical unconventional wells and just under 200 percent for vertical unconventional wells. Pennsylvania now has the highest unconventional gas well permit fees in the nation. 

DEP claims the substantial increase in permit fees was necessary to continue to fund the Oil and Gas Program and maintain current staff levels. DEP insists that to maintain the program’s current staff levels, currently 190 people, it needs a budget of approximately $25 million per year ($131,578 per employee). DEP argues that the number of permits has been declining and to continue paying for the program, it needed to increase the permit fees on unconventional wells. It also claims that, at the newly established rates, 2,000 permit applications per year would be needed to fund the program.

Unfortunately for the DEP, over the last five years permit counts have fallen well short of 2,000. DEP has not issued 2,000 or more permits since the 2014-15 fiscal year (FY) when 2,533 permits were granted. In FY 2015-16, 1,646 permits were issued, with 1,993 permits in FY 2016-17, 1,674 permits in FY 2017-18, and 1,684 permits in FY 2018-19.

Based on the most current data available—the number of permits in the first half of FY 2019-20—it is very likely that fewer than 1,600 permits were issued in FY 2019-20.  And, with data showing the number of new wells drilled declining dramatically since FY 2014-15 as gas prices remain low, it is highly improbable that the program will receive 2,000 permit applications per year for quite some time.

Therefore, even the considerable August increase in permit fees will not be sufficient to meet the program’s budget for the foreseeable future.

All this raises the obvious question.  At the pre-August fee levels, the recent number of permits would have raised far less than the $25 million DEP says it needs. Where did the money come from to fund the 190-person program?

It turns out that permit fees for unconventional wells are not the only source of revenue for the DEP’s Oil and Gas Program. It receives $6 million annually from the impact fee. Other major sources of revenue include the Well Plugging Fund, Conventional Well Permit Application Fees, and fees from violations and penalties.

Why is the fee being raised so dramatically when the program has seen a decline in permits? 

Three questions arise:

Is the permit fee being raised to enable the other funding sources to be cut back?  Is it being done in an ill-disguised attempt to deter new drilling?  Is DEP hoping to fund its stated goal of 226 employees with the option to hire extra staff in the future as well?

Serious concerns about the significant increase in unconventional well permit fees are more than justified.  First, DEP’s claim that it expects 2,000 permit applications per year is not supported by the recent five-year issuance rate data.  Second, the $25 million budget has not been subjected to a stringent assessment of staff levels and/or salaries and other cost-cutting strategies. Did DEP consider the effect of the enormous increase of permit fees on the natural gas companies and the new drilling they will undertake?

Pennsylvania should be more focused on being a competitive state for gas drilling rather than being the state with the most restrictive gas regulations. Instead, the program’s questionable budget needs seem to outweigh the impact of higher fees on the state’s economy.

Well Counts

Since 2014 the number of wells drilled has declined substantially.  The greatest number of wells were drilled in 2014 (1,372). The largest decrease in drilling occurred between 2014 and 2015 with 43 percent fewer wells drilled. The year 2016 saw the fewest number of wells drilled (504) since shale activity began in 2011. Between 2016 and 2017 there was a rise of 60 percent in wells drilled, but since 2017 the number of new wells has dropped each year—falling 4 percent from 2017 (810 wells) to 2018 (777 wells); a further slide of 21 percent occurred between 2018 and 2019 (615 wells).  Bear in mind, too, that as of the end of August 2020, 326 wells have been drilled, on pace for 489 wells in 2020 which would be a 20 percent decrease from 2019.

It should be pointed out that for some reason the DEP provides permit data for fiscal years but new well drilling data is for calendar years.  Fortunately, that does not affect the overall industry trends indicated by each measure.   

Natural Gas Production

Although there has been a decline in the number of wells drilled since the high levels reached in 2014 and 2015, the status of the state’s natural gas industry remains reasonably robust as indicated by its production volume. Indeed, gas production has increased every year since widespread unconventional drilling commenced in 2011.  That year the total for statewide production of natural gas was 1,065 billion MCF (one thousand cubic feet of natural gas) and in 2012 the total was 2,043 billion MCF—an increase of 92 percent. In 2013 the total climbed to 3,102 billion MCF—an increase of 52 percent from 2012. In 2014 total production reached 4,070 billion MCF—a jump of 31 percent from 2013.

However, since 2014 the pace of expansion of production slowed through 2019, rising an average 13.5 percent per year. Output in 2016 was 5,096 billion MCF, a 25 percent two-year gain above 2014.  Total production in 2018 was 6,123 billion MCF, 20 percent higher than 2016.  In 2019, production was 6,822 billion MCF, 11 percent above 2018.

Note that even with the negative impacts of COVID-19 on the state and national economies, January to June’s 2020 output of 3,491 billion MCF was still 5 percent higher than the same six-month period in 2019. Obviously, it will be very important to see what has happened to production since June.  

Conclusion

The higher permit fees are yet another burden placed on the commonwealth’s unconventional natural gas industry. Permit fees increased by as much as 200 percent making Pennsylvania’s permit fees the highest in the nation. Meanwhile, despite natural gas prices being historically low as a result of weakened demand and greater production elsewhere—and the numbers of new wells being drilled falling sharply since 2014—Pennsylvania’s natural gas production has increased every year since 2011.

The situation with production continuing to rise and the number of new wells being drilled falling is likely to be unsustainable over a long period. DEP’s August increase in drilling permit fees was exactly the wrong action to take. It further worsens the already antagonistic stance DEP and anti-fracking groups have demonstrated for years.

With the promise of so much clean energy from natural gas, the efforts to weaken the financial situation of the industry are hard to fathom. The potential for job loss and weakened economic growth should not be dismissed as readily as DEP seems willing to do.

Impact fee revenues dip in 2019

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Summary:  The Pennsylvania Public Utility Commission (PUC) recently issued a news release detailing the 2020 distribution of impact fee revenue collected from 2019 activity.  While the amounts distributed are less than last year, owing to lower natural gas prices and aging wells, the funds will help the counties and municipalities receiving them.

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In Pennsylvania, the impact fee is a tax imposed on unconventional gas wells. Act 13 of 2012 instituted the impact fee, in part, to compensate local governments for the degradation of infrastructure stemming from natural gas extraction and its related activities. The fee is based on the average annual trading price of natural gas and the age of the gas well. Over the past nine years, from 2011 to 2019, a total of $1.9 billion in impact fee revenue has been distributed to local governments throughout the state.

The impact fee revenue totaled $200 million for 2019. The dissemination of the revenue as required by Act 13 is as follows: $109 million has gone to county and municipal governments directly affected by drilling; the Marcellus Shale Legacy Fund received $72 million, which funds environmental, highway, water and sewer projects, rehabilitation of greenways, and other projects throughout Pennsylvania; and state agencies have received $18.3 million as stipulated by Act 13.

The 2019 amount is $42.6 million lower than 2018—the highest year since the impact fee was imposed—due in large part to the decrease in the average price of natural gas. In 2019 the average trading price of natural gas was $2.63 per thousand cubic feet (Mcf) versus 2018’s $3.09 per Mcf—a drop of 15 percent.  

The age of the well is also a determinant.  The fee matrix (see Policy Brief, Vol. 12, No. 11) looks at both the natural gas price and age of the wells to set that year’s impact fee for each well.  Wells are charged the most in the first three years, when they are presumably most productive.  That fee then drops by about half for years four through 10 and then by half again for years 11 through 15.  While no well has yet reached 11 years of age (the first year is set at 2011), those drilled from 2011 through 2015—8,790 of the 10,155 eligible wells in 2019—are at least four years old and their impact fees have been reduced as per the Act 13 matrix. 

All counties receive impact fee money from the Marcellus Shale Legacy Fund. The minimum is $25,000 per county based on the fund balance. Three counties—Fulton, Juniata, and Montour—received only the minimum from the Marcellus Shale Legacy Fund in 2019 and were not entitled to any other impact fee funds.

While Philadelphia County has no wells it still received a total of $1.3 million in 2019 impact fees based on its population.

Among all counties, Washington County received the most revenue from the impact fee. It garnered $6.6 million in 2019 a 21 percent decrease from 2018. In the rest of Pittsburgh’s seven-county Metropolitan Statistical Area (MSA), Allegheny County’s   $1.5 million was down 17 percent from 2018; Armstrong County’s $520,478 was down 15 percent; Beaver County’s  $634,058 was lower by 13 percent;  Butler County’s  $2.1 million was 31 percent lower; Fayette County, at $1 million, was lower by 13 percent and Westmoreland County’s  $1.1 million was off by 27 percent.

Statewide, the number of impact fee-eligible wells increased by 595, going from 9,560 in 2018 to 10,155 in 2019.  Washington County has the highest fee-eligible well count (1,745) in the commonwealth with 90 new wells in 2019. Butler County ranked seventh statewide (533). Every county in the Pittsburgh MSA posted an increase in wells in 2019 except Westmoreland County where the number decreased by six wells to stand at 234.

Allegheny County added 20 wells for a total of 150. Armstrong County raised their count by 14 to total 126 wells.  Beaver County added 21 wells to 134. Butler County added 33 to reach 533.  Fayette County’s number rose by 29 to 253.

The PUC provides guidelines as to how counties and municipalities who receive impact fee money from the Unconventional Gas Well Fund can spend it. The money must be allocated to one or more of 13 designated categories.  They include public infrastructure construction; emergency preparedness/public safety, environmental programs; social services and a capital reserve fund. All counties and municipalities that receive impact fees from this fund must submit a report indicating which of the 13 categories funds were spent. There is no requirement that revenues are to be spent in the calendar year received but can be placed in the capital reserve fund to be used in any of the eligible categories at a later date.

Municipalities also receive funds from the impact fee if they have a well within their borders or are in a county with wells.  Amwell Township in Washington County stands out in the Pittsburgh MSA because it ranked fourth in the state for highest municipal distribution ($793,670). It also ranked seventh in the state for municipal well counts (175).

Forward Township located in Allegheny County had 63 wells and received the highest distribution ($241,936) in the county. The City of Pittsburgh does not have any wells.  Nonetheless, it received an allocation of $47,544 in 2019 impact fees.

The impact fee distributions are beneficial to local governments and this year they will be especially welcomed as an infusion for the government coffers hit by lower tax revenue due to the coronavirus’s impact. It is important to emphasize that the economic impact of this industry goes far beyond the payment of the impact fee. It has added direct jobs at the drilling companies themselves as well as jobs created at industries providing support and equipment to the drillers.   Indeed, the state government must avoid any temptation to over-tax the gas industry that is providing so much to the state’s economy currently and to its potential for future growth.

Shale Gas Impact Fees Jumped in 2017

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Summary: Impact fees from drilling in Pennsylvania’s shale formations jumped in 2017 by 21 percent over 2016.  The impact fees, authorized by Act 13 of 2012, are distributed not only to select state agencies and to municipalities and counties hosting such wells, but to all counties across the commonwealth.  Thus far more than $1.43 billion has been collected.

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In late June the Pennsylvania Public Utility Commission (PUC) reported that $209,557,300 in impact fee revenues was collected from owners of unconventional natural gas wells in 2017.  The 2017 figure represents a jump of 21 percent over 2016’s collections.  It reverses a three-year trend of declining revenues from the 2013 peak of $225.75 million. The 2016 tally of $173.26 million represents the lowest point in the seven-year history of the impact fee.  To date more than $1.43 billion in impact fees have been paid.

Act 13 of 2012 authorized an impact fee to be assessed on all unconventional wells (those drilled in the shale formations using the hydraulic fracturing method) drilled in the state (retroactively covering 2011 as the first year).  The fee follows a schedule based on two factors:  the trading price of natural gas on the New York Mercantile Exchange (the spot price representing dollars per million Btu) and the age of the well.  Older wells will presumably produce less gas over time as the pool of gas is expended so the fee schedule lowers the amount they pay as they age.

One of the reasons impact fee revenues slid from 2014 through 2016 was a glut of natural gas due to a rise in production from Marcellus and Utica shale formations. The resulting over supply contributed to the drop in the market price that fell from an average yearly price of $4.13 in 2014 to $2.62 in 2016, a drop of 37 percent.  This plunge in gas price led to a decline in the number of new wells being drilled.  In 2014 there were 1,371 wells started, the second highest behind 2011 (1,956).  In 2016 only 504 wells were started—a decline of 63 percent since 2014.  Thus the number of aging wells outweighed newer wells, which would presumably pay a higher impact fee, as the pace of drilling had fallen off.

However, 2017 saw the gas price move up to an average yearly price of $3.02, 15 percent over 2016’s average. The rise in gas price encouraged a major rise in new wells with 810 drilled in 2017, a 61 percent surge compared to 2016. In total, there were 8,518 unconventional wells representing an increase of 4.9 percent over the total reported for 2016.

It is too early to tell if this uptick in prices, drilling activity, and the subsequent jump in the impact fee collection, is the start of a new trend, but it is certainly welcome news to those who benefit from this revenue stream.

Act 13 specifies how the impact fee will be distributed.  State agencies get the first $10.5 million off the top.  These agencies include the PUC; Department of Environmental Protection; the Fish and Boat Commission; the Emergency Management Agency; Office of the State Fire Commissioner and the Department of Transportation.  Also another $7.75 million is given to the State Conservation Commission for county conservation districts.  For the 2017 distribution, that leaves $114.78 million for counties and municipalities with the remaining $76.52 million for the Marcellus shale legacy fund (section 2315.a1 of Act 13).

From the legacy fund, $15.3 million is allocated to the Commonwealth Financing Authority (CFA), an agency whose purpose and impacts we questioned in Policy Brief Vol. 14, No. 8.  Since 2012, the CFA has reaped $87.7 million in impact fee money.  Other components of the legacy fund go to county rehabilitation of greenways ($11.48 million); highway bridge improvements ($19.13 million); water and sewer projects ($19.13 million); a hazardous sites cleanup fund ($3.2 million) and an environmental stewardship fund ($7.65 million).  Since inception, the Marcellus shale legacy fund has collected more than $515 million to be distributed among these causes.

All counties across the commonwealth receive money from the Marcellus shale legacy fund, whether or not they host any unconventional wells, from the county rehabilitation of greenways fund (section 2315.a1.5).  The amount received is based on the county’s share of statewide population.  For example, Philadelphia County has a population of 1.57 million or 12.26 percent of the state’s population and thus receives the largest share of greenways monies ($1.39 million).  In fact, since the implementation of Act 13, Philadelphia County has received over $9.3 million.

However, a minimum amount of $25,000 is given to counties with small populations (for example, Fulton, Juniata and Montour Counties).  None of these counties sit atop the Marcellus shale formation and thus do no host a well yet benefit from the legacy fund, and by extension, the impact fee, having received $175,000 each over the time period.  As mentioned above, all 67 counties split $11.48 million in 2017 and since the beginning have shared $65.8 million.

The focal point of the impact fee is to tax the drilling industry and then return the money to those communities that are most impacted by the activity.  Thus those counties and municipalities impacted the most split the largest share of the money ($114.78 million) as outlined by Act 13 (section 2314.d).  Of this amount, more than $39.52 million in 2017 was allocated to counties hosting unconventional wells, with the rest dedicated to municipalities hosting, or being in proximity to, such wells.

For those counties hosting an unconventional well, their allocation is determined by the number of wells they host.  For example, the county with the most unconventional wells in 2017 was Washington County (1,528) and as a result collected the largest amount of money ($7.09 million) from this section of Act 13.  The runner-up is Susquehanna County (1,274 wells), earning $5.91 million.  As two of the top counties with wells, Washington has collected more than $38.85 million over the years while Susquehanna has collected more than $35.53 million.  Allegheny County, with only 125 eligible wells, a fraction of the total, has received $2.15 million over time.  As largely rural counties, Washington’s population is 207,981 and Susquehanna’s is just 40,862.  These totals are quite significant and most likely larger than if the state would switch to a severance tax instead and the money was allocated from Harrisburg at the whim of those viewing the shale industry as a cash cow for their own pet projects.

And of course that was the intent of Act 13—to place a fee (tax) on those drilling in the Marcellus and Utica shale formations using the technique of hydraulic fracturing (unconventional wells).  The money would then bypass the political machinations of Harrisburg and send the money directly to those counties and communities most impacted by the activity surrounding the drilling and to those state agencies that would also be impacted from the activity.  The money distributed even has strings attached as to how it can be spent such as on public infrastructure construction, storm water/sewer systems, emergency preparedness/public safety and environmental programs, among others.

Yet the clamoring for a severance tax continues.  But what those favoring a severance tax fail to consider is that not only do drillers pay the impact fee, they also pay the assorted business taxes levied by the commonwealth and pay royalties to leaseholders.  According to the Marcellus Shale Coalition president in a recent op-ed, that has amounted to $4.5 billion to date on top of the impact fees total of $1.43 billion.  The latest proposal from Harrisburg will leave in place the impact fee and couple it with a severance tax amounting to double taxation on the industry.

A severance tax has the potential to curtail production causing a reduction in these payments as drilling will likely be reduced or shifted to neighboring states that are also above the Marcellus and Utica shale formations.  The impact fee has struck a balance between holding drillers accountable for their activities and generating much needed revenues to those counties and municipalities most affected.

Shale Gas Impact Fee Revenue Continues to Slide

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Summary: Pennsylvania enacted an impact fee on any natural gas well drilled in the state’s shale formations in 2012.  Since then it has brought $1.216 billion in revenue.  Thus far the money has benefitted counties and municipalities across the Commonwealth, various state agencies, and a legacy fund designed to help with environmental concerns.  Annual impact fee revenue has declined significantly since 2013 primarily due to weakness in the price of natural gas.

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In mid-June, the Pennsylvania Public Utility Commission (PUC) released data on 2016 revenue generated by the state’s impact fee. A total of $173.26 million was collected based on 8,121 unconventional wells (those drilled in the shale formations using the fracturing method). This represents the lowest annual revenue since collection of the impact fee began in 2012. In the years since the impact fee was enacted, it has generated a total of $1.216 billion in revenue.

Peak annual impact fee revenue occurred for the 2013 reporting year when collections reached $225.75 million. In that year just 6,550 wells were subject to the fee. Since 2013, revenue has fallen steadily despite increases in the number of wells eligible to pay the fee.  The $173.26 million figure for 2016 is 23 percent below the high set in 2013.

Act 13 of 2012 authorized the impact fee for each operating well using a schedule based on the natural gas trading price from the New York Mercantile Exchange and the age of the well. Thus, the three year decline in impact fee collections since 2013 reflects three major factors.  First, the major drop in the price of natural gas due to the glut of gas in the market brought about, in large part, by the substantial rise in production from Marcellus and Utica Shale. Second, the number of new wells has been trending lower. And third, because the impact fee is lowered as wells age and with each passing year the average age has risen owing to the fact that the number of aging wells is significantly greater than the number of new wells.

Not only has the slide in market prices led to lower impact fee revenue, it has been a contributing factor in the significant decline in drilling activity.  Since 2011 when there were 1,956 wells started, the new well count has fallen in every year except 2014 to stand at 504 new wells started in 2016.  In total, 3,878 new wells were started in the four years 2013 through 2016.  However, as indicated above, the total number of eligible well rose by only 1,571. That means roughly 2,300 new or existing wells were capped or taken out of production.

The impact fee is divided among a handful of state agencies, a Marcellus Shale legacy fund, and the municipalities and counties across the Commonwealth.

Thus far state agencies have benefitted greatly from the impact fee since its first collections in 2012.  The Department of Environmental Protection ($36M) has received the largest sum since collections began.  Other agencies receiving money include the PUC, the Fish and Boat Commission, and the Department of Transportation ($6 million each).  The State Conservation Commission has received $37.7 million which it in turn has distributed funds to County Conservation Districts across the state.  In total, the state agencies have received $120.68 million since the impact fee collections commenced.

The Marcellus Shale legacy fund has received a total of $438.49 million from the fee.  This fund is used to provide financing for: (1) for highway and bridge improvements ($109.6M), (2) water and sewer projects through two different state authorities (PA Infrastructure Investment Authority and the Commonwealth Financing Authority—$54.8 million each), (3) the Commonwealth Financing Authority ($87.7M for environmental items such as acid mine drainage or well abandonment), (4) an environmental stewardship fund ($43.8), and (5) a county rehabilitation of greenways program ($65.8M).  The intent is to help offset the negative impacts natural gas drilling may have on the communities in which they occur.

Through the first six years of collections, counties and municipalities have shared $292.65 million generated by the impact fee. One of the goals for imposing the impact fee is to return money to the municipalities and counties that are most affected by the activity.  However, all counties receive money whether or not any drilling takes place within their borders.  Counties with drilling activity shared $248.57 million while those without activity have split over $44 million.  The latter’s allotment is based on population.  Thus Philadelphia County, the largest in the Commonwealth (by population) has received over $7.9 million since the impact fee has been imposed.  Even the smallest counties receive at least $25,000 per year.

In the Southwest corner of the state, Washington County has received $32.8 million from impact fee revenue, statewide, second only to Bradford County’s $38.4 million. Allegheny County has received $7.8 million, Westmoreland $8.7 million and Butler $9.6 million.  The impact fee has greatly benefitted many local governments as well as many statewide programs.

However, absent a major uptick in gas prices, new drilling activity and production are likely to be far from robust for some time, at least until pipelines are completed that open up more markets and boost demand for Pennsylvania gas.

The impact fee has accomplished what it set out to do; impose a tax on the shale gas industry in order to: (1) provide revenue to counties and municipalities most impacted by the activity,  (2)  finance a legacy fund that addresses environmental issues, and (3) to help fund several state agencies.  More than $1.2 billion in impact fee revenue has been collected thus far.

Unfortunately, since the current Governor took office, there has been talk that an impact fee is not enough and there has been a renewed push for a severance tax to close a large gap in the state’s budget. Currently, a bill has passed the State Senate that includes a severance tax.  Act 13 of 2012 that created the impact fee contains a provision (§2318) that requires elimination of the impact fee if a severance tax is enacted.  Will that stipulation be overturned leaving the industry saddled with both the impact fee and a severance tax, as well as the corporate income tax and all the other fees and taxes the gas companies pay? Would that not be reneging on a commitment made to the industry when the impact fee was enacted?

Governor Proposes Severance Tax—Again

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Summary: The Governor’s third budget address did not ask for increases in personal income or sales taxes to patch over the State’s budget deficit, but he did trot out an old favorite of his—the severance tax on extracting gas from the Marcellus Shale formation.  It is widely assumed to be a non-starter with the Legislature, but it has been put on the table and as such must be analyzed.

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This year’s budget proposal calls for a severance tax of 6.5 percent on Marcellus Shale gas production to go into effect July 1, 2017 (the start of the new fiscal year). In the past two budgets the severance tax proposal called for a five percent levy on the value of the gas coming from Marcellus Shale wells (also called unconventional wells) plus an add-on of 4.7 cents per thousand cubic feet (Mcf) (see Policy Brief Volume 15, Number 10).

While proponents of the severance tax are quick to point out that Pennsylvania is the only major gas producer without a tax on the value of gas produced, they fail to mention that the Commonwealth is the only state with an impact fee.

We have written extensively on the impact fee which was instituted by Act 13 of 2012 (see Policy Brief Volume 12, Number 11).  The impact fee is to be paid on any well drilled within the Marcellus Shale formation.  The amount of the fee depends upon a few things:  (1) the trading price of natural gas on the New York Mercantile Exchange (NYMEX)—the higher the price, the greater the fee; (2) the age of the well—there is a gradual reduction in the fee as a well ages; and (3) the volume produced with wells producing less than 90,000 Mcf per day would be exempt as are any wells that are subsequently capped.

A key difference with the impact fee compared to the severance tax is that most of the money is returned to the communities where the activity is taking place, both at the municipal and county level.  However, some money is distributed to all counties (with or without wells), and seven state agencies.  None of the money goes back to the general fund.

In his first two budget proposals, the Governor stated that producers would still be responsible for paying the impact fee as well as the severance tax.  In this proposal (FY 2017-18) he is offering a credit against the severance tax for any impact fees paid.  Act 13 stipulates that if a severance tax is enacted, it voids the impact fee.  While laws can be amended so that both can exist, what would be the point of having both?  If the severance tax is passed, eliminate the impact fee.  Take the amount the impact fee would have generated (the average for the first five years is $213.3 million) and distribute it to those communities and state agencies receiving impact fee money in the same ratios.

As proposed the Governor’s severance tax, along with the impact fee credit, is projected to net $293.8 million in FY 2017-18. How much gross revenue would the 6.5 percent severance tax produce?  Of course the answer depends upon the trading price of natural gas and the volume produced by unconventional wells.  Production has been steadily growing in the Commonwealth with 5.09 billion Mcf reported in 2016.  This is up from 4.6 billion Mcf removed in 2015 and the 4.07 billion in 2014.  Thus, the rate of increase has slowed sharply—2016’s production is up 10.6 percent over 2015 which was 13 percent higher than 2014 while 2014 was 31.2 percent higher than in 2013.

The price of natural gas, as measured by the Henry Hub price (the terminal out of Louisiana, traded on NYMEX and the basis for the impact fee) has fluctuated over the past few years.  In 2016, the average annual price of natural gas fell to its lowest point over the last five years ($2.46 per Mcf).  The high point was $4.46 per Mcf in 2014 and the average since 2011 is $3.16.

Thus, had a severance tax of 6.5 percent been in place for 2016, and using the Henry Hub price, it would have grossed $814.1 million—5.09 billion Mcf multiplied by an average selling price of $2.46 gives a market value of $12.5 billion.  But as we mentioned in Policy Brief Volume 15, Number 16, while the Henry Hub price is the basis for calculating the impact fee, Pennsylvania natural gas producers sell their gas at five local hubs in the state such as the Transco-Leidy hub in Potter County and the Dominion South hub near Pittsburgh.  At these hubs the prices have been lower than those of the Henry Hub, due in large part to the expanding supply being removed from the Marcellus Shale and lack of pipeline capacity.  As a result the actual value of production and the tax revenue will likely be far less than if calculated using the Henry Hub price.  And under the Governor’s proposal the net from the severance tax would be reduced by crediting companies with the amount of the impact fee paid—that fee has been around $200 million a year.

If the severance tax passes at the proposed rate, Pennsylvania would go from not having such a tax to having one of the highest rates in the nation.  Neighboring Ohio’s rate is 2.5 cents per Mcf while West Virginia charges five percent of market value.  West Virginia had an add-on of 4.7 cents per Mcf which had been dedicated to paying off a workers’ compensation debt, but that debt has been paid off and the add-on has been dropped (July 2016).  There is also a bill in committee that would reduce the severance rate to four percent and three percent over the next two years.  Thus at a time when Pennsylvania is looking to impose a severance tax, West Virginia is looking to lower theirs.

A final point to consider is the effect the severance tax will have on royalty payments received by mineral rights holders in Pennsylvania.  In states with severance taxes, producers are allowed to deduct the amount of the tax from royalty payments.  These deductions would in turn reduce the royalty payments to Pennsylvanians, implying lower income tax revenue to the state.

In 2006, before the Marcellus Shale boom in Pennsylvania, the state recorded 246,889 returns that claimed income from a category called “rents, royalties, patents, and copyrights”.  The amount claimed came in at $3.6 billion.  In 2014 (the most recent data available), the state recorded 342,889 returns—an increase of 39 percent in eight years.  The accompanying income claimed was $6.9 billion—nearly double the 2006 amount.  At the personal income tax rate of 3.07 percent, remittances to the state would have risen from $109.4 million to $211 million.

Unfortunately, the proposal to enact a severance tax on Marcellus Shale gas production is once again on the table.  It would place Pennsylvania from being the only major gas producer not levying a severance tax, to having one of the highest in the nation.  Another question is what to do with the impact fee.  After all Pennsylvania is the only state with an impact fee.  The current proposal is to give the producers a credit against the severance tax.  But it will further underscore Pennsylvania’s status as an unfriendly to business state and lower the profitability of gas production in Pennsylvania and the incentives to produce gas in the state as more business friendly states get a bigger share of expanding production.   For example, Ohio and West Virginia have lower tax rates and also sit on the Marcellus Shale and Utica Shale formations.  At a time when the industry is just recovering from low prices and a subsequent reduction in its workforce and drilling activity, there needs to be encouragement for growth, not more disincentives as represented by a severance tax.

Marcellus Shale Impact Fees Fall

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The Pennsylvania Public Utility Commission (PUC) released the impact fee totals for 2015 at $187.7 million—sixteen percent lower than those collected in 2014.    In fact the high-water mark to date occurred in 2013 when the impact fee garnered $225.7 million.  In 2014 that number fell slightly to $223.5 million.  The impact fee has been collected for five years (since 2011) and had not been less than $200 million (2012 realized $200.5 million).

 

Of course this new total reflects the steep decline in the price of natural gas as traded on the various exchanges based on the sale at various gas hubs—specifically the Henry Hub in Louisiana but also at local Pennsylvania hubs.  As the trading price has fallen, the number of new rigs being drilled has also declined.

 

To refresh our readers’ memories, the impact fee is a graduated fee based on the average price of natural gas as traded on the New York Mercantile Exchange based on activity at the Henry Hub.  It also is dependent upon the age of the rigs as they tend to be charged less as they get older, of course depending upon the price of gas (see Policy Brief Volume 12, Number 11 for a fee schedule).  An upcoming Policy Brief will look at the details more closely.

 

There is no doubt that the low price of natural gas has had a ripple effect throughout the industry.  When the technology first became feasible and the first wells were drilled, news accounts were full of stories of booming towns and growing employment levels.  However, over the last year or so, we have been hearing about falling natural gas prices which have caused natural gas companies to scale back activity.  The stories have been there, but up until now had not seen the tangible results.

 

The Marcellus Shale industry had been propping up the state and local economies for the last five years.  Many counties and municipalities have been relying on the local share payments from the impact fee.  Is 2015 the first sign of a shrinking industry or is it a small drop that is temporary?  One thing is certain it is very foolish to pin economic hopes on one industry, especially one that is so dependent upon supply and demand.

Another Punitive Wrinkle to Severance Tax

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In his first budget address the newly inaugurated Governor carried through with his promise to go for a severance tax on Marcellus Shale gas production.  He has proposed a five percent severance tax on the value of natural gas being pumped from the Marcellus Shale formation in Pennsylvania plus a 4.7 cent tax per thousand cubic feet (Mcf) fee.  As we outlined in previous Policy Briefs (Volume 15, Numbers 10 and 14) there are questions as to whether a net of one billion dollars in revenue will be forthcoming from the tax scheme and, just as important, whether using Marcellus tax revenue to fund huge increases in education spending without first proving the additional funds will improve education quality should be a non-starter in the General Assembly.

 

As we demonstrated in the earlier Briefs the problem is quite simple: the price of natural gas has been on a downward trend since late 2014 and does not seem to be coming back up anytime soon, with the Henry Hub price closing at $2.72 on March 23rd—38 percent lower than its trading price one year ago.  In one Brief (Volume 15, Number 10), using 2014’s unconventional well production of just under 4 billion Mcf, and the average Henry Hub price for 2014 ($4.13) and factoring the per cubic foot fee, the estimated amount generated will be about $1 billion.  However, in mid-February, that price had fallen to $2.75 and the amount realized would be around $735.5 million.  With the most recently recorded trading price at about the same level, our revenue estimate would be essentially unchanged.

 

Here it is important to note that the price used in the above calculations is the Henry Hub price as mentioned in Act 13 which is used to set the price for the impact fee schedule.  Henry Hub is a natural gas pipeline hub in Louisiana that is the national benchmark, as traded on the New York Mercantile Exchange, but it is not necessarily the price at which natural gas is sold in Pennsylvania.  Pennsylvania has its own hubs where drillers bring gas to the market. Hubs in the southwest, near Pittsburgh, such as the Dominion South, are a little closer to Henry Hub.  But for the Transco-Leidy Hub in Potter County, the selling price is much lower due to the oversupply being brought to the market and the inadequate pipeline infrastructure in moving it out to other regions.  News reports note that at the Dominion South hub, the selling price as of March 20th was $2 per Mcf, while at Transco-Leidy, the price was $1.49.

 

Of course the problem the severance tax proposal faces is that prices do in fact fluctuate.  The original announcement said the tax would be five percent of the value of gas produced. And then we learned that an updated proposal included a 4.7 cent per thousand cubic feet add on fee. And now that prices have continued to stay low and revenue forecasts are not moving higher, we are learning through the media that an updated severance tax proposal will set an arbitrary minimum gas price for tax calculation purposes at $2.97 per Mcf.  This is obviously an attempt to get more money when prices are low and add stability to revenue. But this would create a serious problem when prices are as low, or lower, than they are now.

 

Setting a minimum price near $3 per Mcf means that for producers who are getting half that price the severance tax rate would be much higher than five percent. And the flat 4.7 cents per Mcf adds to the total tax rate.  Consider a producer with a monthly volume of one million Mcf selling at a price of $1.50 per Mcf. The value of the produced gas is $1.5 million. At five percent, this producer would pay a tax of $75,000 and another $47,000 from the 4.7 cent per Mcf add-on for a total of $122,000 per month—an 8 percent tax rate.  However, with the artificial price floor of $2.97, the severance tax will be based on $2.97 million in value and this producer would pay $148,500. On top of that the company would still pay $47,000 in the per Mcf fee for a total of $195,500 in taxes that month.  That is a total tax rate of 13 percent of actual market value.  At that level, the tax becomes extremely punitive.

 

Of course, the tax paid will reduce the profit by that amount and will lower the corporate income tax somewhat but it will also lower the amount available for royalty payments and reduce the rate of return on investment.  In effect, the tax is an added cost on production.  When costs go up and cannot be passed on in prices, it hurts investment and production. The ramifications for the future of this industry in Pennsylvania need to be weighed carefully before this tax grab is even considered seriously by the Legislature.  And where is the proposal to apply the severance tax to shallow wells? Note that conventional vertical wells tapping into the Marcellus formation are also subject to the tax, but they represent a very small fraction of total production.

 

Finally, the Governor’s stated purpose for levying this tax is to use it for education. As we have shown in an earlier Brief (Volume 15, Number 14) adding dollars to education spending without demonstrating how they will improve education is folly. For the most part, advocacy for more money is special interest pleading by the education establishment that cares little or not at all about cost management.  There is never a willingness to entertain significant reforms such as ending teacher strikes or creating a voucher system that would let children get out of failing public schools. Any discussion of meaningful pension reform, a main driver of higher education costs, is met with derision.  The General Assembly should demand some concessions on these points before it considers increasing spending for education. It should also ask why some districts can achieve sterling academic results while spending well below the state average per pupil and some districts spend far more than the state average and have dreadful academic results. And it would be useful to critically review spending in other areas as well.

 

A “left leaning” think tank spokesman advocating the severance tax said that Pennsylvania is the only gas producing state with no severance tax and it is high time we had one.  Perhaps the spokesman might consider that several states do not have a personal income tax, does that mean Pennsylvania should get rid of its personal income tax? Twenty-five states have a right to work law, including important recent additions in Michigan, Indiana and Wisconsin. Should Pennsylvania not have a right to work law as well?

 

Only three states have significant numbers of teacher strikes and only eleven even allow teacher strikes. Pennsylvania for years has led the nation in teacher strikes.  Should we not outlaw teacher strikes as well? Moreover, only two states, one of which is Pennsylvania, have state owned liquor stores. Should the Commonwealth not join the 20th century and 48 other states and privatize its stores?

 

If Pennsylvania is out of  touch with  better economically performing states, it is because of its outdated laws regarding public unions, pension crises, prevailing wages, liquor stores, antiquated property assessment laws and so much more. The severance tax arguments are a red herring to take people’s minds off the real fundamental structural problems the state is beset with and cannot bring itself to deal with.  And it is also an effort to make people believe there are easy and quick fixes to the state’s financial woes that can be dumped on the backs of the Shale industry.

Governor Pitches Severance Tax Proposal

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While stumping for the governorship, the current Governor made a Marcellus Shale severance tax a key campaign promise.  And true to his promise, 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 were sure this proposal was coming (see Policy Brief Volume 14, Number 59) they did not see the added twist coming—a flat fee of 4.7 cents per thousand cubic feet (Mcf) of gas extracted.

 

As we wrote in that Policy Brief, a five percent severance tax was not going to raise $1 billion based on recent production and gas price levels.  At 2014’s average trading price ($4.13 based on the formula from Act 13 that created the impact fee) and production rates (approximately 3.99 billion Mcf from unconventional wells) a 5 percent severance tax would have generated $822.2 million.  At recent lower prices—gas closed at $2.75 on Tuesday February 17th, down from $5.80 from this date one year ago—there is no chance of raising $1 billion from the severance tax alone; unless there is an enormous and unexpected surge in production.

 

This no doubt explains the add-on flat 4.7 cents per Mcf to the tax proposal. This combined tax proposal follows West Virginia’s scheme of a five percent severance tax plus the 4.7 cents per Mcf.  The latter was added in 2005 to provide money for a worker compensation fund.  However, a major difference is that West Virginia also allows deductions for annual industry operating expenses—a feature not included in the Governor’s proposal.

 

Taking 2014’s production rate as a base, the 4.7 cents per Mcf would raise another $187.4 million.  When added to the five percent severance tax, which would have generated $822 million, had it been in place in 2014, the two taxes together just top the $1 billion mark.  This matches the campaign talk of generating $1 billion to be spent on education.

 

Remember that to get to a billion dollars in revenue it was necessary to use last year’s production and prices—and the add-on flat fee.  At the recent price, $2.75 as of February 17th and, assuming last year’s production, the two new taxes would produce just under $735.5 million.  If prices and production fall from where they are now, estimated revenue from the proposed tax scheme would fall further.

 

Keep in mind too, that these revenue predictions assume no reaction from the industry.  When costs rise that cannot be passed along to buyers in the form of higher prices, it could negatively impact production and specifically new well drilling. Thus, depending on market conditions, there could well be contraction in the industry, particularly from the smaller companies who were operating with very thin margins when the price of natural gas was significantly higher in 2014.

 

We were already hearing of drillers holding back on tapping new wells when the price started to fall earlier this January.  2014’s production levels from unconventional wells (Marcellus Shale) were 28.5 percent higher than in 2013.  But this represents a decline from the growth in 2013 when production was up 52 percent above 2012, which in turn was 92 percent better than 2011.  The production growth rate could well slow further or stop altogether if the Governor’s tax proposal is enacted. Thus, it is important to have a much better and clearer sense of the industry’s probable reaction when making revenue projections.

 

In addition, there are other considerations to be weighed before the tax proposal gets very far in the General Assembly. For instance, will the levying of the taxes have a chilling effect on talks with  complimentary industries or businesses the Commonwealth is trying to lure to the state—such as the  cracker plant which separates the chemical compounds in natural gas for use in the manufacturing of other products?

 

Second, bear in mind that passing a severance tax would—as required in Act13—rescind the current impact fee and do away with substantial revenue presently being shared by municipalities, counties and state programs.  The impact fee over its first three years has generated more than $632.4 million in revenue at an average over $210.8 million per year.  Therefore, any money collected by the proposed severance tax will have to backfill Act 13 promises to these entities.  It is unlikely the current recipients of the impact fee money will sit still and watch those dollars disappear. This is especially true of the counties with heavy concentrations of rigs that receive significant payouts from the impact fee revenue.

 

If the Governor is looking for an additional $1 billion to fulfill his campaign promises, he will almost certainly need to raise more than $1.2 billion to do that and replace the impact fee.  Given our estimations above, using 2014’s production report and the current gas price, the net gain to state coffers (total severance tax revenue minus impact fee obligations) would be just shy of $525 million.  Certainly well off the billion dollar mark trumpeted on the campaign trail.

 

While the Governor has made good on his campaign promise to propose a severance tax, it is not clear how it will be received by the Legislature.  In areas where the impact fee money has had a positive effect, and drilling had boosted employment and local tax coffers, this will be a tough sell.  The Governor was quoted in the news media as 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? If so, that will be a total non-starter and a very poor choice of words considering the large economic benefit this new industry has produced for the Commonwealth.

Marcellus Impact Fee Benefits for Western PA Counties

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Act 13 of 2012 set an impact fee on drillers for each unconventional well started (spud) into the Marcellus Shale formation within the Commonwealth’s borders.  Act 13 sets the parameters and ranges for the fee which is determined by a formula using the average selling price of natural gas on the market and the age of the well itself.  A description of how the rate is set can be found in Policy Brief Volume 12, Number 11.

 

Each year the Public Utility Commission (PUC) sets the fee for that year, collects payments from the drillers, and then distributes the funds to state agencies, counties, and municipalities across the state.

 

Act 13 also specifies how the impact fee is to be returned to these governmental entities.  The purpose of this Brief is to report the impact fee revenue received by the seven counties that make up the Pittsburgh metropolitan statistical area (MSA) (Allegheny, Armstrong, Beaver, Butler, Fayette, Washington, and Westmoreland) after the first three years of disbursements.

 

There are two sections of Act 13 pertaining to the distribution of revenues to the counties.  The first section, 2314(d), allocates money to counties based on the number of unconventional wells in the county as a proportion of the number of such wells in the Commonwealth.  Funds distributed through this section can be spent only on specified areas. These categories range from public infrastructure to tax reductions to social and judicial services.  The following table shows the amount each county in the MSA received from this section of Act 13 over the first three years.

table 1

 

Act 13 mandates that counties receiving funds from section 2314(d) submit a report to the PUC on how the money was spent.  According to these reports, Allegheny County spent its 2011 and 2012 distribution on the category of emergency preparedness/public safety.  Armstrong County also spent its entire 2011 allocation on this area, but divided its 2012 allocation between this category and on environmental programs.  The PUC did not have either county’s 2013 expenditure report available as of this writing.  The PUC also did not have an expenditure report available for either 2011 or 2013 for Beaver County, but did show 2012’s distribution to have been spent on a capital reserve fund.

 

Butler County was more diverse in spending this portion of its impact fee money.  In 2011 it spent money on social services, emergency preparedness/public safety, its capital reserve fund, environmental programs, and on judicial services.  For 2012 they spread the money even further to include public infrastructure construction, storm water/sewer systems, and on information technology in addition to repeating the same categories from 2011.  2013’s expenditure report is not yet available.

 

Fayette County’s 2011 report consisted of expenditures on emergency preparedness/public safety, information technology, a capital reserve fund, and planning initiatives.  In 2012 they split the money between emergency preparedness/public safety, and the capital reserve fund.  The 2013 report is not yet available.

 

Washington County, which has the most unconventional wells in the Pittsburgh MSA, has received the most money from this part of Act 13.  The 2011 expenditure report for Washington County shows the most money spent on public infrastructure construction followed by their capital reserve fund, information technology, social services, and emergency preparedness/public safety.  In 2012 the list was not as extensive as they spent money on emergency preparedness/public safety, information technology, the capital reserve fund, and social services.  In 2013 the list of expenditures included the capital reserve fund, information technology, public infrastructure construction, emergency preparedness/public safety, social services, and judicial services.

 

Finally, Westmoreland County in 2011 put its money toward capital reserves and social services.  In 2012 the money was spent mostly on emergency preparedness/public safety with only a very small fraction being used for environmental programs.  2013’s report is not yet available.

 

Act 13 also sets up the Marcellus Legacy Fund to deal specifically with environmental issues. Section 2315(a.1)(5), distributes money to counties from this fund.  All counties, regardless of whether or not they host an unconventional well, receive revenues from this section.  This money is allocated based on population of the county as a proportion of the statewide population.  There is a minimum of $25,000 allotted for the smallest of counties and of course the allocation depends on available funds.  The following table shows how each county fared under this section of Act 13.

table 2

 

As mentioned above these funds are restricted to environmental purposes, but they do not have to be reported to the state.  The areas for which this money can be spent include the development, rehabilitation, and repair of greenways, recreational trails, water resource management, and community and beautification projects.  It can also be used for land damaged or prone to drainage by storms or flooding.

 

Thus counties in the Pittsburgh MSA have been the direct beneficiary of the Marcellus Shale natural gas boom.  Over the first three years of impact fee distributions, counties in the MSA have received a total of $10.38 million, $10.84 million, and $13.44 million respectively.   Of course while these funds have been restricted in their usage from the specific sections of Act 13, it does free up money from their general fund budget for use elsewhere.  How much money they will receive going forward remains to be seen.  The impact fee, and thus the amount received by these counties, is affected by variables such as the price of natural gas, age of wells, and number of wells not only within each county, but across the Commonwealth as a whole.

 

Across Pennsylvania as a whole, the total amount of impact fee revenues distributed to counties and municipalities reached $632.4 million by 2013 with another significant allocation coming from the 2014 collections.  The Governor’s plan to impose a severance tax and flat per thousand cubic foot fee would require the elimination of the impact fee, setting up substantial resistance from local governments who are benefitting from the impact fee revenues. Likely this will mean that if the severance tax bill is to have any chance at all of being passed, there will have to be a provision that will essentially replace the dollars lost by the local governments.  Not to mention the impact fee revenue that is allocated to state programs. What will happen to them?

Governor Pitches Severance Tax Proposal

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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.