You cannot talk about the “Shale Boom” without talking about Pennsylvania. Coal and steel were once the lifeblood of the Keystone State but today’s industry is being re-born thanks to the natural gas reserves in the Marcellus Shale. The Appalachian range that stretches from the Southwest corner of the state to the Northeastern corner has provided a substantial large deposit of natural gas reserves for Pennsylvania.
In February 2012, Pennsylvania passed Act 13, providing a complete overhaul of the states natural gas drilling law. See P.a.C.S. §§ 3201 – 3274. Act 13 amended the states old Oil and Gas Act, 58 P.a.C.S. §§ 601.101 – 601.605, and provided significant changes regarding natural gas drilling operations. The amendment provided for enhanced environmental protections for the development of unconventional natural gas resources by authorizing the imposition, collection and distribution of an impact fee on the development of unconventional natural gas resources and to provide for municipal ordinances and zoning standards related to oil and gas development.
This enactment of Act 13 immediately created a flurry of debate. Most significant was the Acts limitations on local zone ordinances. A number of municipalities and counties challenged the Act and argued it violated local governments due process rights by restricting local governments abilities to zone and regulate drilling. In fact, on July 26, 2012, the Pennsylvania Supreme Court ruled zoning portion of Act 13 unconstitutional.
Outside of the constitutionality of Act 13, much debate has surrounded the states choice to impose an impact fee rather than severance tax on the gas industry. First, it is important to understand how Act 13’s impact fee works. An impact fee is essentially a flat rate fee and the law gives each county the power to impose a $40,000 - $60,000 flat fee on a well in its first year of operation, with the fee declining over the next 15 years. The fee is based on the price of natural gas and the year in which a well is drilled. Therefore the revenue from impact fees is based on the number of wells drilled each year and the price of natural gas. In contrast, a severance tax is structured like any other tax. Instead of a flat rate fee, the tax is a percentage and based on the amount of production.
The Pennsylvania Public Utility Commission (PUC) is responsible for collecting the revenue generated from the impact fees and dispersing the funds. Generally speaking, sixty percent of the funds generated remain at the local level, going directly back to the counties and communities that are affected. The remaining funds are given to state run agencies responsible for maintaining and regulating the states drilling. Act 13 also allows for local governments to use the funds for roads, bridges, schools, environmental projects, and other area affected by the influx of the gas industry.
According to a Pennsylvania 2013 Governor Report, in 2011 Act 13’s impact fees generated approximately $204 million for local counties and municipalities. Due to declining natural gas prices, 2012 saw a slight decrease in revenue, with the fees bringing in approximately $202 million.
However, studies suggest more revenue can be generated through a severance tax. In fact, most energy producing states impose severance taxes rather than impact fees. Pennsylvania neighboring states of Ohio and West Virginia both employ severance taxes. North Dakota, another state experiencing a boom in shale oil production, also employs a severance tax.
The problem with Pennsylvania’s impact fee is that as gas production increases, the revenue generated from the fees remains relatively flat. The volume of natural gas production since 2008 has grown significantly. Historical statistics show that production rose from 1.3 trillion cubic feet in 2011 to over 2 trillion cubic feet in 2012. This dramatic increase in production has had no significant impact on what the impact fees brought in from 2011-2012, as they remained the same.
Using a conservative outlook, the PA Budget and Policy Center has estimated that a 4% severance tax could generate an additional $206 million dollars in 2013-2014 in place of the existing impact fee. A further outlook goes on to suggest that in 2019-2020, the 4% severance tax would generate an additional $326 million dollars. Using a more moderate future outlook, the 4% tax is expected to generate an additional $261 million and $867 million in 2013-14 and 2019-20 respectively. The difference between the conservative and moderate outlooks is simply the projected new wells drilled and increase in gas prices where the moderate approach simply predicts are larger growth. A more detailed analysis can be found on the PA Budget and Policy Center’s Briefing.
Now, Pennsylvania has defended its choice of an impact fee over severance tax mainly on the grounds that the gas industry is new and the state already imposes a large number of other taxes. Thus, it does not want to discourage the growth of the industry by imposing more taxes on production. However, despite having the low impact fee, Pennsylvania saw a decrease in the amount of new wells drilled in 2012.
Although Pennsylvania believes it can encourage more growth in its energy industry through the imposition of impact fees rather than severance taxation, it is clear that this choice could ultimately cost the state potential revenue. Yes, the industry is still relatively new and impact fees make Pennsylvania more competitive and attractive. However, if Pennsylvania were to switch to a severance tax, it is unlikely gas companies would venture elsewhere as the demand for Marcellus Shale in Pennsylvania is too great. Furthermore, statistics have shown that Pennsylvania is lagging behind other states in terms of revenue generated. The potential revenue that can be generated through the use of a severance tax is too great to be ignored and Pennsylvania should reconsider the use severance tax on the ever expanding gas industry.