Tom Shepstone
Natural Gas NOW   

Severance tax politicking is reach new heights with the approach of Pennsylvania’s primary election in May, much of it tied to education. No severance tax is required, though, when shale gas development is already paying many of the bills.

There has, as we noted in an earlier post, been a lot of political demagoguing on the subject of using a shale gas severance tax to pay for our schools. And, the demagoguing hasn’t been limited to politicians. Public employee unions, who fund the Pennsylvania Policy and Budget Center, have gotten in on the act, too, hoping to secure easy money for more salary increases and to retain teachers in school districts that are rapidly shedding enrollment due to lack of rural growth in many areas. We’ve also see some very shallow studies, from people who should have known better, suggesting schools in shale gas areas weren’t benefitting from its development.

All this is confounded by some data recently brought to our attention by an article in the Montrose, Pennsylvania Susquehanna Independent Weekender this week, which provided a link to data from the Elk Lake School District (near Dimock) regarding how much shale gas income has meant to that district.

The Elk Lake School District facilities are all located on one site that also includes the Susquehanna County Career and Technology Center. Three well pads are located either on or adjacent to school property. Therefore, the district is part of three different production units, each of which generates royalties. The district also received a signing bonus when it leased its own land.

The district, because it’s a public entity, regularly posts its earnings from participating in these production units. Here’s a summary:

The Elk Lake School, in other words, has already earned a little less than $1.7 million in shale gas revenue and can reasonably be expected to have received a total of $1.9 million by the end of the current school year. Those are impressive numbers and these are from early wells that don’t produce nearly as proficiently as new wells using the latest horizontal drilling and hydraulic fracturing technology.

Notwithstanding that, these shale gas earnings are enough to have paid somewhere in the neighborhood of 25 teachers for a year at an average cost of $75,000 in salary and benefits. It’s enough to build 12,670 square feet of school building at $150 per square foot, which is about 8 classrooms. It’s enough to build 75+ high school ballfields. The  earnings for this school year (on trend for roughly $410,000) are also equal to 8.7% of what the district budgets to bring in from real estate tax. Real estate taxes, in other words, would be 8.7% higher without the shale gas earnings. That’s how much shale gas can be worth to a school in the gas region and that’s before considering the increases in assessed valuation due to property value increases, which is a separate subject.

Some Pennsylvania politicians are proposing a severance tax of as much as 10% on “drillers.” Now, if you’re a reader of this blog, you’re smart enough to realize “drillers” aren’t the only ones who pay the severance tax. Some of it will be paid by gas companies and some will be passed onto consumers. The rest of it will be paid by landowners. All of it will show up on the company’s income statement, as an additional line item expense, but there will also be a compensating decrease in the line item for royalty expenses. It can be no other way because royalty payments are, by their nature, calculated on the net value of production after assessments and taxes.

Moreover, even if a gas company wanted to absorb the landowner’s part of the severance tax, it could not because product is typically sold as a commodity months in advance at locked in prices based on a market it cannot control. And, if it were possible for a gas company to absorb that portion of the price it would, of necessity, do so at the expense of selling at far less profit, which would mean less to share and less ability to capitalize further development. The severance tax, therefore, will ultimately fall on landowners and disproportionately so because companies can shift their assets elsewhere and landowners cannot.

Do the math. If the Elk Lake School gets $410,000 this year and that represents a typical royalty of say 15%, that means the value of the production represented is $2,733,333. Apply a 10% severance tax to that and production costs go up $273,333 and revenue to the school district goes down by $41,000, a 10% reduction. But, this doesn’t account for reduced development activity or the slower velocity of that activity. Landowners will, in the end, bear the largest share of the severance tax burden.

This illustrates what the severance tax battle is all about for its advocates; redistribution of wealth. They want the money to pay Philadelphia teachers with money now going to Elk Lake teachers whose employers contributed the land to make it possible. If they combine a severance tax with the current impact fee they’ll not only squander the benefits secured by the Elk Lake School District but also destroy the asset altogether. That’s how envy works, after all. Let’s hope Elk Lake School gets to keep its wealth. Philadelphia can have their piece of action by building LNG terminals and its petrochemical industry but let’s keep the greedy politicians’ hands off all the money. A severance tax is an exceedingly dumb idea.