Budget hearings suggest another natural gas severance tax battle brewing

Budget hearings suggest another natural gas severance tax battle brewing

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The day of the initial quintet of hearings held by the Appropriations committees of the state House of Representatives and state Senate featured plenty of testimony regarding Gov. Tom Wolf’s severance tax proposal, with that testimony coming during hearings for the Independent Fiscal Office (in both the House and Senate) and the Department of Revenue.

Much that was imparted by the IFO to House and Senate lawmakers was the same information the agency supplied during its mid-November annual economic and budget outlook for Pennsylvania, with the same conclusion: without “permanent” changes regarding spending and/or revenues, Pennsylvania’s structural deficit won’t improve.

The agency was queried heavily about one of the governor’s revenue proposals – to impose an additional tax, beyond the current impact fee, on natural gas producers. However IFO Executive Director Matt Knittel indicated he didn’t have much to offer as the IFO is currently working on producing, by the end of March, an analysis of Wolf’s revenue package, including the governor’s 6.5-percent severance tax proposal.

During the IFO’s Senate hearing, Sen. Scott Martin, R-Lancaster, expressed concern  the Gov. Wolf’s tax proposal won’t deliver the revenue he estimates.

“Obviously there’s been a lot of discussion about where that revenue number could potentially be – and I personally have concerns what that would do to our competitiveness with other states, or energy prices, or whatever it might be – but in terms of our budget, and looking at revenues, this is looked to be just shy of $300 million coming in from that – are the various factors currently lined up to support those type of revenues coming in?” Martin asked Knittel.

Those revenue estimates were also on the mind of Rep. Garth Everett, R-Lycoming, earlier in the day. He said he was having difficulty “reconciling the numbers on the revenues to be generated – gross revenues – to be offset by the impact fee, how much the estimates of the impact fee are, whether post-production costs are going to be deducted before the severance tax is calculated, and whether landowner royalties are going to be deducted before the tax is calculated.”

Knittel told Martin it’s his agency’s understanding the governor’s severance tax revenue projection assumes $3 per MCF (thousand cubic feet of natural gas). He noted the current rate is closer to $2.25 per MCF based on an average of prices at the Dominion South Point hub, located just northeast of Pittsburgh, and the Transco-Leidy hub in Potter County. Earlier in the day, Knittel told House lawmakers the projections he’s seen for natural gas prices during the next five years range from $2.50 per MCF to $3 per MCF.

He also told the Senate that while natural gas production was up 10 percent in 2016 compared to 2015, “we expect that would drop off slightly going forward, down to something more like 5 or 6 percent.”

Knittel explained to Sen. Lisa Baker, R-Luzerne, that his agency, absent evidence to alter the IFO’s normal practices, would assume a higher tax will result in reduced production. As an example, he said if the price of gas would increase by 6 percent, the IFO expects output would decline by 6 percent.

Additionally, Knittel clarified to Everett the proposal would not allow the deduction of post-production costs, which he said, with everything else being equal, would increase the effective tax rate on gas producers. However, the proposal also allows for a credit for companies that pay the impact fee, which would “push down” the effective rate, said Knittel. During the IFO’s afternoon Senate hearing, Baker questioned the lack of a deduction for post-production costs, and was informed by Knittel that his agency could find no other state that doesn’t deduct such costs before the tax is calculated.

Martin referenced a recent IFO report that indicated as of April 2016 the existing impact fee had an effective tax rate of 6.9 percent, with the IFO projecting an effective rate of 5 percent for April 2017.

Knittel said that at a natural gas price of $2.75 per MCF, imposing the proposed 6.5-percent severance tax would result in “a slight increase in the effective tax rate – instead of 6.5 [percent], it would be 6.8 or 6.9 [percent].”

He also acknowledged that “compared to surrounding states, we would be somewhat higher,” with Knittel indicating West Virginia’s current effective rate is 5 percent (although an additional local tax pushes it closer to 6.5 percent), Ohio’s volume tax (2.5 cents per MCF) is a “fairly low effective tax rate,” while Texas’ effective rate is closer to 4.8 percent; Knittel said Pennsylvania is often compared to Texas.

Democrats were keen to argue that if a severance tax had been implemented several years ago, the state would be in far better fiscal shape than they are now.

Knittel wasn’t prepared to agree with that assessment, as voiced by both Rep. Madeleine Dean, D-Montgomery, and Rep. Kevin Boyle, D-Philadelphia. However, later in the day, the Wolf administration’s Revenue Secretary, Eileen McNulty, was, after Boyle repeated his question from earlier in the day.

“I can definitely say that we would have less of a problem than we have now,” said McNulty, although she said she couldn’t put a specific number on that.

When asked by Boyle “if it would be fair to say that we would have generated hundreds and hundreds of millions of dollars since 2011,” McNulty responded, “Yes.”

McNulty’s assertions were later challenged by Rep. Jason Ortitay, R-Allegheny.

“Do you think the state would have had the same level of gas production had we put a severance tax in place 3 or 5 years ago – would it have gone up, would it have gone down?” Ortitay asked, who also queried if Wolf administration production projections in future years factor in gas price impact on production.

While she didn’t address the first question, McNulty said, “We are anticipating production to increase,” although she clarified the administration anticipates a slight output drop in 2017 but a production increase in 2018, beyond 2016 figures.

“We’re still waiting for some additional pipeline capacity to come online,” she later added, when asked about the reason for the immediate output drop followed by a projected increase.

At about the same time McNulty was answering that question, Sen. Randy Vulakovich, R-Allegheny, was eliciting a response from Knittel regarding the impact on natural gas prices by the cost of those pipelines, and getting natural gas to market.

“We don’t know the exact infrastructure number – the spending on equipment – but we do know, and what’s reported by the companies usually in their annual reports, is the cost per MCF,” said Knittel. “If the price of gas right now is $2.30 [per MCF], the companies are reporting 87 cents of that is due to what we would call post-production costs, which is moving gas from the wellhead to the hub, and cleaned and processed so that it could be traded.”

Delaware County Democratic Rep. Leanne Krueger-Braneky said one of those pipelines will be going through her legislative district and will likely be carrying much of its natural gas to be exported from Pennsylvania.

“I don’t know if most is the case, but it’s definitely the case that some is being exported,” reacted McNulty, who later added, “I know that some of the pipelines are expressly being extended for purposes of export.”

Krueger-Braneky then questioned who would ultimately be paying the tax, particularly if at least some of the gas is leaving Pennsylvania.

“Generally speaking, you can be sure that although the business is the one that remits it to the state, they have to recover that cost in selling their product, and it would go to the people who are purchasing the product who are both in-state and out-of-state,” said McNulty. “Other states export their severance tax here when we purchase energy that’s drilled or refined in another state, and the same thing happens when our energy goes elsewhere.”

Wolf has now proposed a severance tax in all three of his budgets, with the first two attempts, which involved various iterations of such a tax, failing to get a vote in the General Assembly.