Sunday, October 3, 2010

PA's Natural Gas Tax: Questions I Hope Somebody Down There Is Asking

[Just so you know, up front, where I stand, here it is:  I am an upstate New Yorker, and I am pro-drilling, and even pro-fracking.  But I am also in favor of taxing fossil fuels.  In fact, I am in favor of taxing the hell out of fossil fuels — all of them, not just natural gas.  I think this kind of aggressive taxation is the simplest and most forceful way of, not only helping to run our government, but also getting our entrepreneurial sector finally moving toward alternative, renewable sources of energy.  This is pretty much the same idea as what most environmentalists say they want, but these guys also seem to be working overtime to choke off all drilling, especially shale gas drilling, by brute political force — which is an idea I don’t much cotton to.]
Close readers of the northeastern press will have recently witnessed a particularly touchy situation in Pennsylvania, where there has been unfolding a still-unresolved political struggle to enact a so-called “severance tax” on production of natural gas from Marcellus shale under that state.  I view the PA situation as a complete non-taxpayer in that state (except highly indirectly as a natural gas consumer, up here in New York, comfy and cozy, each and every winter — thank you very much), and as an observer with a certain amount of background knowledge of this industry and its sometimes counter-intuitive ways.  

Just observing, I’m not convinced that the citizens, or the citizen legislators, of the Keystone State have thought deeply enough about the full consequences of all their Marcellus shale tax proposals.  Here, let me explain by simply asking a number of pointed questions, from up here in upstate.
  • How shortsighted is it to tax natural gas from just Marcellus shale?  How long, for instance, will it be before we see more profit-motive-driven exploratory interest in the Utica shale, which sits deeper than the Marcellus?  Or, for that matter, are there any additional, soon-to-be-proven-viable shales under PA, or the rest of Appalachia?  (Is there a geologist in the house!?)  Maybe it would be smarter to tax all shale gas, and not specify the name of the actual layer of shale. 
  • Are these PA legislators, by the way they phrase their new tax, innocently neglecting a chance to generate public money on natural gas liquids?  A number of investor-oriented media articles have pointed out that much of the profit in the Marcellus and similar shale plays has less to do with natural gas, and more to do with longer-chained natural gas liquids — propane, butane, pentane, and beyond.  Pennsylvania legislators should double-check their fine print and make sure all this energy is taxed equally.  If they’re thinking of making a tax of so many cents per 1,000 cubic feet (MCF) of natural gas, for instance, they should instead phrase their charge against all hydrocarbons measured in 1,000 cubic feet equivalent (MCFE).
[I wonder how many millions in additional public dollars could get collected, every year, running forward, because somebody thought to include that one little extra word, “equivalent.”]
  • What about coalbed methane, which also usually requires intensive hydraulic fracturing for successful production?  Can’t coalbed methane also be developed (and taxed) in PA?  If you only tax shale gas in PA, aren’t you really just encouraging industry to set the shale aside and instead start fracking coal (which, by the way, usually sits way shallower and way closer to the domestic water table)?
  • For that matter, why stop with taxing only natural gas from tight, unconventional sources?  Why not tax natural gas from all possible sources, including existing, already-producing wells?  Why not also tax oil (which is still produced in Pennsylvania, pretty much right in the same region where it was first proven and developed as an industry)?  Also, why not tax coal?  If it’s all about mitigating impacts, as tax proponents claim, then let me be one voice in the wilderness pointing out that all of these resource-extraction processes have impacts.  Part of the reason I pose this sequence of tough questions is, if you only tax Marcellus gas, you’re creating incentives for industry to simply shift its focus toward meeting energy demands in other ways, such as different sources of natural gas, or coal itself, or oil (including foreign oil). [Or the alternatives, for which I fully support the notion of selectively encouraging though tax policy.] 
But, from a national point of view, how smart is this, really?  We Americans are expected to stand quietly by while certain states tax part of our own domestic supply of energy, but any supplier can go out on the international free market and substitute alternate BTU’s from Iraq or Kuwait or Russia or Venezuela — tax-free? 
  • What possible unintended consequences lurk behind the other PA severance tax proposal, which gives industry a break in each well’s early years?  Some of the more industry-friendly Republican legislators in PA have favored this kind of severance tax, which starts out at a low level in the early years of a gas well’s lifespan, but then gets steeper after the well ages and after it has already paid for itself.  If PA adopts this kind of tax, are we encouraging gas companies to over-produce their wells in the first year or two — even if that action physically and geologically injures the ultimate recovery from these wells?  And even if there’s a supply glut going on at the same time (and prices are consequently at rock bottom)?  Is there an old-school conservationist’s worst nightmare lurking here — a danger of tax policy unintendedly encouraging waste of a non-renewable resource?  (For god’s sakes, is there an environmentalist in the house!?)
  • Are Pennsylvanians really being honest with themselves about their reasons for this tax?  You ask me, I would say all levels of state and local government simply desperately need the money.  But proponents say it’s all about mitigating governmental expense and environmental impact (especially local impact, a pitch which always plays well, politically).  But, if that’s truly the case, then there’s going to be a lot of double-dipping going on here.  Industry is already getting tithed for its most obvious external costs.  Increased burdens of government inspection and oversight?  Industry already pays permit fees to cover this. (And some insiders have even suggested these charges should be dramatically increased.)  Road damage?  Most localities already know enough to insist gas companies buy road repair bonds before drilling (and to arrange for before-and-after video inspections).  Water contamination?  Well, in a methane-migration case such as Dimock, PA, the forces of contract (existing leases), ordinary lawsuits, the state’s written and unwritten environmental powers, and unprecedented public relations pressure are already combining to put the gas company (Cabot) on the hook for millions of dollars — even in order to fix things far beyond what any court of law would ever be able to conclude was caused by the drilling, or the fracking, in the first place.
  • Does taxing natural gas create a new, pro-drilling political constituency where one did not exist before?  Many Pennsylvanians probably assume the severance tax will slow down drilling — a scenario anti-drillers cheer, while pro-drillers fret.  But are both sides failing to appreciate the big picture?  This tax thing might just be a battle, but what about the war?  After the tax, down the road, how much harder will it be, politically, for PA, or any state, to increase controls on the oil and gas industry?  At some point in time, a much greater proportion of the public is going to see how much severance-tax-derived public money is at stake here.  It will be a Big Number.  And every proposed tightening of the regulatory screws is then going to be a Very Big Deal, politically.  In the future, I predict there will be some pro-gas howling — some of it possibly even coming from environmentally minded stakeholders, once they see their favorite programs threatened with de-funding. 
[This is kinda how it already works in the state of Alaska, where every citizen every year — even Total Granolas— receives a check written by a fund fed by oil and gas income on public lands.  When that happens, suddenly nearly everybody sees the benefit of oil and gas.  (I guess that’s probably how you wind up with somebody like Sarah Palin getting elected as governor up there, leading a crowd of supporters, chanting, “Drill, baby, drill!”)
  • Is the architect behind the PA flat gas tax idea sneakily intending to discourage production during time periods when the market value of gas is way low?  Remember OPEC?  OPEC is all about achieving for its members an “appropriate” international price level on oil by openly conspiring to stifle supply.  Within the United States, that sort of behavior is ordinarily considered illegal. 
But here’s the way the PA House passed its version of the severance tax: a flat $0.39 tax on 1,000 cubic feet of natural gas.  At different times, that tax is going to have different effects.  (I'm not saying it's wrong — I'm just saying it.)  The federal government’s most recent stats, available on the web, show a nationwide average wellhead price of $4.36 per MCF in July 2010, which is pretty low by modern standards.  This means the PA House’s tax would have been about a 9% tax over this past summer — which is a pretty steep tax, compared to other gas-producing states.  But if natural gas prices ever return to their record highs — for instance, $11.32 per MCF in July 2008 according to the federal tables— then the PA House’s tax is only a 3% tax.  (The Pennsylvanian tax passers say their tax will go up, if gas prices go way up, but I haven’t been able to find the necessary threshold triggers, and it all seems a little suspiciously vague to me.)

I predict that this PA flat tax will function as a legal scheme for helping stifle supply “when necessary.”  When wholesale prices are low, industry is going to be even more motivated to choke off the valves, and to put the rigs on standby, and to generally produce less gas than what’s technologically possible — because they are so much more strongly motivated, in order to avoid excessive taxes.  Right now, industry has no legal means of collectively making this kind of thing happen (without getting prosecuted for uncompetitive behavior).  But, if the PA flat gas tax law passes, that helps change things.

Anyway, in the end, I do hope PA finally gets some kind of significant, wisely constructed hydrocarbon tax approved, and that they raise lots of money for lots of good public causes by doing so.  It may seem painful, in the short run.  But, in the long run, I think this kind of thing has the potential to prove the value of shale gas for all of us, even hard-bitten environmental opponents.

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