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Marcellus shale gas production boom stirs debate over taxes

| Saturday, May 11, 2013, 5:57 p.m.

A boom in natural gas drilling in Pennsylvania is generating billions of dollars for companies and private landowners, but some experts question whether the state's low effective tax on the bounty makes long-term sense.

Unlike most leading oil- and gas-producing states, Pennsylvania doesn't link fees to how much gas comes out of the well. Instead, each well pays an impact fee no matter how much it produces. That means that even as Marcellus shale gas production has soared, revenue to local and state governments isn't keeping pace.

For example, the impact fee generated about $204 million in 2011, when production was about 1 trillion cubic feet of gas. But when production doubled in 2012 to just over 2 trillion cubic feet, the impact fee revenue dropped to about $199 million. One billion cubic feet of gas equals about 180,000 barrels of oil.

“That gap is going to get bigger and bigger” over time, said Michael Wood, a research director with the Pennsylvania Budget & Policy Center, a progressive research group based in Harrisburg.

The Marcellus shale formation, with wells in Pennsylvania, Ohio and West Virginia, is the country's most productive natural gas field and is expected to produce gas for decades.

Over 20 or 30 years, that means the current impact fee here may generate $10 billion or $15 billion less than a flat tax on production, Wood said.

The Pennsylvania fee is essentially based on the numbers of wells drilled and on the wholesale price of gas, so when prices plunged last year, the revenue took a hit. Wood estimated that the 2011 revenue was the equivalent of about a 4.1 percent effective tax rate, which at first glance appears to be far lower than Texas, at 7.5 percent, or Oklahoma, at 7 percent.

As time goes on, a policy center analysis and a review by The Associated Press came up with the same conclusion: Pennsylvania's effective tax rate on gas production could drop to as low as 1.3 percent over the next few years.

The AP found that at the current pace, production could grow to about 4 trillion cubic feet in 2015. That's the equivalent of $16 billion in company revenue if wholesale prices are at $4, which is the current range. At West Virginia's 5 percent tax rate, that would generate about $800 million.

But the policy center estimates that the Pennsylvania impact fee will generate $237 million to $261 million in 2015, depending on the number of wells drilled and prices.

Those aren't fair comparisons, said Kathryn Klaber, the president of the Marcellus Shale Coalition, an industry group. She noted that many other states give drillers a tax exemption for the first few years of production to allow companies to recoup costs. In Oklahoma, for example, a well that's drilled horizontally, like many Marcellus shale wells, gets up to a four-year tax exemption, because the capital costs are far greater than a traditional well.

Such details are “hugely important in an industry that has upfront capital outlay,” Klaber said. “The Pennsylvania fee puts money in the pockets of state and local governments even before gas is being produced. So you've got a timing difference.”

Klaber said that increasing tax rates on drilling would slow investments, thus leading to lower production. There's been a big debate over that very issue in Alaska, where last month the Legislature passed a multibillion-dollar oil tax cut in the hopes it will lead to more production. Klaber said the current impact fee has “probably hit as close as we're going to get to some middle ground” on such issues.

Patrick Henderson, Gov. Tom Corbett's energy executive, wrote in an email that oil and gas operators have paid more than $1.7 billion in corporate state taxes since 2007, so just looking at the impact fee revenue doesn't tell the whole story. He added that Corbett “was proud to partner with the General Assembly in crafting a fair impact fee intended to encourage development in Pennsylvania.”

One energy expert in Texas said the current impact fee structure did help encourage companies to invest in Pennsylvania and trigger the boom.

Kenneth Medlock III, a director at the Center for Energy Studies at Rice University, wrote in an email that as production grows, the state will be stressed to provide more resources for inspections, environmental and health monitoring, and other costs.

The impact fee is “going to get reviewed at some point. It's going to have to,” Medlock noted.

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