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Severance Tax Hearing synopsis

Last Friday, the House Appropriations Subcommittee on Fiscal Policy held a hearing on the proposed severance tax for natural gas. Below is a synopsis of the hearing with links to the testimony of individuals.

J. Scott Roberts, Deputy Secretary for Mineral Resources Management for the Department of Environmental Protection (DEP), gave an overview of the Commonwealth’s natural gas exploration and production history with a focus on the Marcellus Shale. He cited that nearly 8,000 drilling permits were issued last year, 1,662 this year and of those 476 permits were issued for Marcellus Shale exploration. Read Roberts’ complete testimony.

Dan Hassel, Deputy Secretary for Tax Policy for the Department of Revenue, clarified the proposed severance tax rate would be 5% of the value of the natural gas at the wellhead plus 4.7 cents per thousand cubic feet of natural gas severed. He said the Administration estimates this will generate $107 million during fiscal year 2009-10. Hassel noted that the Commonwealth is the fifteenth largest gas producing state and is the only state with significant natural gas production that does not have a severance tax. Hassel noted that the proposed tax is modeled after West Virginia’s tax. Read Hassel’s complete testimony.

Subcommittee Chairman Greg Vitali (Delaware) noted that the Governor’s proposal provides for severance tax revenue to go to the General Fund. He asked if the administration has a position on how the money should be distributed. Hassel replied the budget proposal merely provides for the revenue to be deposited in the General Fund. He further stated that the administration is open to discussing further distribution.

Minority Chairman Dave Reed (Indiana) asked for the considerations that led to the proposed tax and if it will impact the industry. Hassel said the administration does not anticipate much impact on the industry citing that other states have severance taxes and therefore the Commonwealth will not be at a competitive disadvantage. He said transporting the gas accounts for a large portion of the costs of natural gas, so there will be a local price advantage due to decreased transportation needs.

Minority Chairman Reed disputed that a new tax will not impact the industry. He noted that the industry is already paying taxes, such as the corporate net income tax, and has to comply with "our cumbersome regulatory process." He said he has heard testimony indicating that it costs $1 million more to drill in the Commonwealth than other states. Hassel said the department has not quantified regulatory costs. He acknowledged that the Commonwealth’s tax structure is high, but pointed out that a majority of companies do not pay those taxes.

Minority Chairman Reed noted that industry has argued that 50,000 jobs will be lost due to the severance tax and the Administration says no jobs will be lost. He said even if the most accurate answer is somewhere in the middle, jobs will be lost. Minority Chairman Reed also cited the potential loss of jobs in other industries. Hassel could not answer noting that he does not know how the 50,000 job statistic was arrived at. He then restated the administration’s belief that this tax will have zero impact.

Michael Wood, Research Director for the Pennsylvania Budget and Policy Center, testified that severance taxes are common among state revenue systems in the US. According to Census data, 35 states collect some form of severance tax. The reasoning behind severance taxation is that the "harvesting of these resources imposes costs on society that are not adequately recaptured through profit-based taxes." Read Wood’s complete testimony (3 MB).

Chairman Vitali asked if the Governor’s proposal takes into account the lessons learned from other states. Wood replied the proposed tax is efficient because it is a mix of price and volume. He said the proposed tax addresses these lessons. Vitali asked how many states that have a severance tax also have a CNI. Wood thought the vast majority do and said he would provide that data. Vitali asked Wood if he is aware of any research indicating the impact of the severance tax on jobs. Wood said there are a several studies that look at increasing existing taxes. He cited a Montana study that found even a quadrupling of the tax rate would have virtually no impact.

Minority Chairman Reed quoted Wood’s testimony about lessons learned, saying "the most backward systems allow low rates or exemptions for stripper wells and perhaps for low volume or high cost wells." Reed said that is an interesting point in light of the Commonwealth’s history with shallow wells. He asked Wood if he has looked at the impact of the tax on other states with shallow wells.

Wood cited Arkansas as a good example, noting they recently raised its tax from 0.3% to 5%. He said the state has not seen a negative impact from that increase, saying the big concern with shallow wells is the price of gas not the tax. Minority Chairman Reed cited Wood’s comments that the industry should be taxed as it grows and asked if that should be applied to all growing industries. Saying that his comment applies to the energy industry, Wood explained that natural resource extraction is different because the resources are a part of the Commonwealth and are no longer available once they are extracted.

Stephen Rhoads, President of the Pennsylvania Oil and Gas Association, explained how the proposed tax would affect various entities. He noted property owners will pay the tax on royalty share of the natural gas, while gas companies will pay for the rest. For every $1,000 of taxes from natural gas production, a gas company would pay no more than $875, while a property owner would pay no less than $125. He noted the higher the royalty, the more the property owner will pay. Rhoads remarked Pennsylvania’s conventional natural gas supplies come from marginal wells producing small volumes of gas and operating on the lower edge of profitability. He said the severance tax will cripple conventional shallow gas producers by levying an effective severance tax rate of 34.95% on net income. "The severance tax drains away limited capital available to marginal well operators for new well drilling," Rhoads said. He asserted that to meet the governor’s severance tax projections through 2013, natural gas production would need to increase 735% over the next five years and, at least 6,800 Marcellus Shale Wells would need to be drilled in that time. View Rhoads’ complete presentation.

Chairman Vitali said that Rhoads argued the natural gas industry will be crippled, yet other testifiers say there will not be an impact. He asked if the industry has been crippled in other states with a severance tax. Rhoads explained the Commonwealth’s production rate is well below that of other states because currently the state’s natural gas extraction industry is based on shallow wells and production will be crippled. Vitali asked Rhoads to square his comments with those of Wood’s that this tax is a low percentage of total cost. Rhoads explained that the price of natural gas will determine if a well is drilled. He acknowledged the price is very volatile and said the breakeven price in the Marcellus Shale is $4.50-$5.00 and said at today’s price of $3.75 the economics aren’t there. Vitali asked about Rhoads’ discussion on the needed increase in drilling and noted that the administration is projecting such growth. Rhoads agreed, but explained without the actual growth PA is "taxing a ghost".

Minority Chairman Reed questioned if competition would drive producers to other states. Rhoads said there is potential for investment to be shifted to areas with cheaper operations. He commented there is no need for a severance tax at this point because it will not generate any income. Reed asked who will ultimately bear the cost of the tax. Rhoads replied the producer and the landowner. He explained the cost of the tax will not be passed to consumers because natural gas is a commodity and the prices are set nationally by supply and demand. Reed suggested workers will bear the burden of the tax, to which Rhoads said "indirectly, yes."

Representative Ellis asked if a severance tax was ever suggested before development began in the Marcellus Shale. Rhoads replied no. Ellis pointed out there are several regions for deep well gas production and a finite number of drilling rigs. Rhoads agreed, stating that is competition for the limited capital and limit equipment and producers will go to the least expensive place. Ellis commented that the state spends millions of dollars to encourage retailers, like Cabelas, to locate in the Commonwealth, but is burdening an emerging industry that could create thousands of well-paying jobs with additional taxes.

Rep. Evans said he met with representatives from the Farm Bureau who oppose the severance tax. He asked why they would oppose the tax. Rhoads said farmers view the tax as counterproductive to the growth of the industry and they will have to share in the burden of paying the costs.

Andy Loza, Executive Director of the Pennsylvania Land Trust Association (PLTA), said the association supports a severance tax. He said "it is reasonable that drillers pay an extraction tax as they draw down this nonrenewable resource. It is fair that they pay the tax as they impact our communities.” Read Loza’s complete testimony.

Thomas Au, State Conservation Chair for the Sierra Club, said "natural gas drilling and production comes with a cost to the Commonwealth." He said that the rush in the Marcellus Shale will cause water pollution problems in the state’s rivers and streams, and added there will be other "unavoidable and damaging environmental effects" from gas drilling. He indicated the Sierra Club supports a gas extraction tax as a proper tool for compensating both the Commonwealth and local governments for the "long term damage done by gas exploration and drilling," and also supports allocated a portion of that tax to the Environmental Stewardship Fund and to the state Fish & Boat and Game Commissions. To read his testimony, click here.

Ed Troxell, Government Relations Director for the Pennsylvania State Association of Boroughs (PSAB), remarked that in light of an "unscheduled cooling-off period in the race to tap the Marcellus Shale," due to the decline in natural gas prices, the legislature has the opportunity "to create a fair and equitable tax and permit format and to get it right the first time." On behalf of Pennsylvania’s boroughs, Troxell appealed for the use of "a reasonable level of income generated by the tapping of these underground resources to ensure that all communities are held harmless from any unexpected unwanted impacts of accessing those resources." He also warned against using Marcellus Shale tax and fee revenues for addressing General Fund budget gaps without first allocating the resources to protect those in and around the Marcellus Shale region. View Troxell’s complete testimony.

Doug Hill, Executive Director of the County Commissioners Association of PA (CCAP) offered brief comments. He noted that restoring the property tax on oil and gas is more important to the Association than the severance tax. He explained counties had the authority to assess a property tax on oil and gas reserves until a 2002 court decision. Hill noted the Association has been advocating for the restoration of this authority since 2002. Discussing the impact that Marcellus drilling has on municipalities, he argued that a revenue stream is needed to meet demand on local resources and services. Hill stated the Association does not specifically support the severance tax, but said if it is instituted supports the provision of a portion to local government. To read his testimony, click here.
Chairman Vitali asked what share of a severance tax, if imposed, should go to municipalities. Hill said that is a difficult determination to make, but suggested a share should go to shoe with well and an additional share should go to those impacted by Marcellus.

He noted CCAP has "anxiety" about revenue coming from state government because the state has a history of eroding revenue streams. Troxell suggested to options: use a PERDA model; or distribute the revenue on a percentage basis, as revenue from the Motor License Fund is distributed. Troxell stated he is "very favorable on the PERDA model".

Minority Chairman Reed asked Hill if his primary concern is to ensure counties can deal with the impact of drilling. Hill said yes restating his support for a property tax. Reed then cited Troxell’s association of coal mining to the current situation and asked if the negative impacts from coal mining would not have happened had a severance tax been in place. Troxell agreed a severance tax probably would not have prevented the aftereffects of coal mining.

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