Pennsylvania is almost king of the hill in natural gas but success is threatened by Tom Wolf’s plan to take from landowners and give to public employees.
Tom Wolf, Pennsylvania’s trust-funder governor, owes his political success to public employee unions who have given him enormous sums of money to maintain their sweetheart pension deals. He has tried and tried to get a severance tax on natural gas for the purpose of paying them off. Fortunately, he’s failed as many times as he’s tried, as the result would be raid on the finances of rural landowners who are finally getting the some real economic development thanks to the shale revolution.
Meanwhile, that revolution has just about made the Commonwealth the king of hill in natural gas production, producing huge income for the state and localities, but it’s never enough for Tom Wolf who only sees a golden goose to be slaughtered.
First, the good news, from yesterday’s Today In Energy from the Energy Information Administration (emphasis added):
Pennsylvania’s marketed natural gas production averaged a record 15 billion cubic feet per day (Bcf/d) in 2017, 3% higher than the 2016 level. This production is largely from shale plays in the Appalachian Basin. Pennsylvania accounted for 19% of total U.S. marketed natural gas production in 2017 and produced more natural gas than any other state except Texas.
Pennsylvania has experienced an increase in permitting and drilling activity with the expansion of regional pipeline capacity capable of moving natural gas to market centers outside of production areas. According to the Pennsylvania Department of Environmental Protection, the state issued 1,352 natural gas drilling permits in 2016 and another 2,038 in 2017. The drilling rig count in the state has also increased, averaging 20 rigs in 2016 and 33 in 2017, based on data from Baker Hughes.
Pennsylvania is on the cusp of being king of the hill because it has a tolerable tax structure. Although the state has a relatively high corporate tax rate of 9.99%, its impact fee (a severance tax by another name, despite Tom the Trust-Funder Wolf’s lie to the contrary) puts it in the middle between Ohio on the one side and Texas on the other. This ensure the industry is capable of competing and landowners have an incentive to make their lands available for natural gas development.
Pennsylvania’s Independent Fiscal Office, in fact, has calculated Pennsylvania’s impact fee is currently equivalent to a lifetime effective tax rates (ETR) of 1.6%, compared to 1.5% in Ohio and 3.7% in Texas. “A primary advantage of the lifetime ETR is that it standardizes and facilitates interstate comparisons of severance tax structures. States that impose severance taxes generally base the tax on volume or market value (or both). The differences between these methods make them difficult to compare side-by-side, but the lifetime ETR compensates for this difficulty,” according to the Fiscal Office and here are the details from its report on the proposed Wolf budget for next year:
Notice Tom Wolf’s proposed severance tax would take Pennsylvania’s combined severance tax/impact fee take to 4.0%, which would then be higher than Texas, Arkansas, Louisiana. It doesn’t take a genius to figure out what this will do to that EIA chart from above. A quick view of that chart will confirm West Virginia, one of only two state that would have a higher severance tax if Wolf had his druthers, doesn’t even make the cut and the other, Oklahoma, is going nowhere with its production. Nor are Louisiana and Texas for that matter.
Only Pennsylvania and Ohio are growing substantially, putting huge amounts of new monies into the treasuries of both states, and the localities and landowners in them. But, Tom Wolf, trust-funder that he is and having no appreciation of the need for income, would like to move Pennsylvania into the slower growing group so he can pay back the public employee unions underwriting his political campaigns.
And, who would really pays? The landowners, of course, the leases bonuses and royalties going to them only being but reflections of the net after-tax value of the gas being developed. Once again, the Fiscal Office provides some perspective, this time in a March 16, 2018 letter responding to a query by Pennsylvania State Senator Lisa Baker (emphasis added):
Your letter asked about the potential impact of the proposed severance tax on future royalty payments. The proposed severance tax is a volume-based tax that levies a rate of 4.2 cents per mcf if the NYMEX price is $3.00 or less and 5.3 cents per mcf if the NYMEX price is greater than $3.00 per mcf but less than $5.00. Assuming a tax rate of 4.2 cents per mcf, the IFO estimates that the proposed severance tax would generate $210 million of tax revenue during the first fiscal year (ten months of collections only).
By the third year, the IFO assumes the tax rate would increase to 5.3 cents per mcf and tax revenues would increase to $379 million. It should be noted that these estimates assume that (1) natural gas output would contract by 3 to 4 percent in response to the new tax and (2) additional pipeline capacity that is projected to come online occurs.
States that levy a natural gas severance tax allow those amounts to be treated like a post-production cost. Hence, they are deducted from the base against which the contractual royalty rate is applied.
The analysis assumes that the average Pennsylvania royalty rate is 13.5 percent. If so, then $28 million ($210 million x 13.5 percent) of the proposed severance tax could be passed back to landowners. At $379 million of new tax, then $51 million could be passed back to landowners.
For simplicity, these amounts assume that the price received by extractors does not increase in response to the tax (i.e., the tax is not passed forward to consumers). In the longer-term, if the price did increase in response to the tax, then royalties would also increase and thereby offset some (or all) of the tax passed back to landowners. The amount of the offset would depend upon how much of the tax is passed forward to final consumers through higher prices.
As can be expected when dealing with a bureaucracy that claims to be non-partisan, these conclusions obscure more than they reveal, although they do acknowledge as much as $51 million of the severance tax burden would fall on landowners. There are several things to notice, beginning with the fact the Fiscal Office says here that the Governor’s proposal would average 4.2%, not 2.4% as suggested in their analysis a month later and that it could be as high as 5.3%, which would make Pennsylvania’s real rate (ETR for the impact fee plus new additional severance tax) also as high as 5.3%. That’s almost half again the lifetime ETR in Texas, which would be a killer. It would make Pennsylvania king of the dung hill at best, destroying our burgeoning rural economic future, by putting Pennsylvania’s taxes significantly higher than any other major gas producing state.
Secondly, the Fiscal Office admits a severance tax could cause “natural gas output [to] contract by 3 to 4 percent in response to the new tax.” This is, of course, exactly what would happen, but no basis is offered for this curiously helpful assumption for those promoting a new additional severance tax. Experience indicates the tipping point between coal and gas is very close to the current price, which could well mean much larger declines.
More importantly, though, it contrasts with the idea advanced a little further along that prices could well increase thus softening the impact on landowners. In the real world, prices of the gas itself will down relative to taxes and as demand drops prices of the gas itself will drop further, exacerbating the impact of the severance tax on landowners, exactly the opposite of what the Fiscal Office wants us to believe. Additionally, gas companies will move new production to lesser taxed states over time, swelling this effect to ever greater negative effects.
The major problem with the Fiscal Office analyses, though, is that it only addresses the impacts on those with existing leases. Gas companies will not only slowly move their production elsewhere to be competitive, but they will, also, start writing different leases that pay less in terms of royalties as well as bonuses, the latter having not been considered at all in the analyses. Both measures are necessary in their real world to survive and prosper. Both also mean the entire cost of a severance tax is eventually born by landowners, not just the royalty percentage. The burden starts at a minimum of 13.5% and reaches 100% over the course of the development of the remaining resources of a natural gas field.
This is the nonsense that is Tom Wolf’s obsession, because he wants to take from landowners to give to public employee unions. It’s despicable.