The Empire Strikes Back: Shale Industry Minimizes Potential Severance Tax Revenue, But It’s Still More than Impact Fee

Sharon Ward |

Pennsylvania would benefit from switching from its current impact fee to a severance tax. Depending on the estimate, the severance tax could raise two to four times as much revenue as we expect from the impact fee, with this difference growing over time.

Pennsylvania would benefit from switching from its current impact fee to a severance tax. Depending on the estimate, the severance tax could raise two to four times as much revenue as we expect from the impact fee, with this difference growing over time.

Whether the revenue gain from switching to a severance tax is $400 million, $600 million, or more, this is exactly the type of recurring revenue needed to help restore harmful cuts to our schools, help bridge an estimated $2 billion state budget gap in 2015-16, and help close the state’s ongoing structural deficit where revenues grow more slowly than spending.

Hand-wringing about differences between tax revenue estimates (due almost entirely to differences in projected future natural gas prices) misses this important point.

Diving into the numbers

We currently project that a 5% severance tax on natural gas (based solely on the sales value of natural gas with no deductions) would yield $881 million in 2015-16, based on an average selling price of $3.48 per thousand cubic feet (MCF) of natural gas produced in the state. We based our estimates on recent U.S. Energy Information Administration (EIA) price forecasts, which we discounted to reflect current, lower local selling prices for gas. The projected tax yield is roughly three times the $270 million in impact fee revenue expected for the same fiscal year.

As new production and price data are released, we update our estimates to reflect changes in the market.

A recent AP story, based on figures likely provided by the Marcellus Shale Coalition, projects less revenue from a severance tax – “only” $675 million in 2015-16.  This works out to an average natural gas price of $2.67 per MCF, seemingly making permanent the current lower Pennsylvania prices. The clever reader will note this is still several times more revenue than we could expect from the impact fee.

If the gas industry gets their wish and can deduct processing and distribution costs before figuring the tax, they think the tax yield could be as low as $525 million in 2015-16. (Such deductions have been at the heart of a number of lawsuits between gas producers and landowners, who have seen their royalty payments gutted by this hard-to-verify accounting sleight-of-hand.) Such potential deductions, if brazen and generous enough, could eventually whittle the tax down to $0.

We could quibble about the selling price of natural gas in the future, but one fact remains – a 5% severance tax (on the selling price of natural gas) generates more revenue than the impact fee – a lot more. As the outgoing state budget secretary noted last week, we are going to need the money in 2015-16 and beyond.

Impact Fee versus Severance Tax

A proposed 5% severance tax on natural gas will generate more revenue than can be expected from the current impact fee. The value of natural gas production in Pennsylvania is increasing at a much faster rate than the number of unconventional, or shale, wells being drilled. The difference we have already seen makes revenue from a 5% severance tax on the value of natural gas sold several times larger than revenue from the impact fee, with the difference between the two growing over time.

Even with low natural gas prices, as is currently the case in parts of Pennsylvania, the difference is massive.


Note. Drillers made two impact fee payments in 2012-13: one payment based on wells in existence as of 2011, and a second based on wells in 2012. The chart above compares the 2011-based payment to severance tax revenue that would have been generated during the 2011-12 fiscal year.

Actual production, drilling, and price figures demonstrate how far short the impact fee falls from a severance tax

In 2013, gas well operators paid $224 million in impact fees for 6,215 horizontal wells and 274 vertical wells.  Producers paid these yearly assessed impact fees by April 2014, during the commonwealth’s 2013-14 fiscal year.

During that same fiscal year, unconventional wells produced 3.638 trillion cubic feet (TCF) of natural gas. Conservatively assuming an average sales price of $3.90 per thousand cubic feet (the national average price during this period was $4.40 per MCF), the gas produced would be valued at $14.2 billion. A severance tax of 5% of this value would yield more than $700 million. This eclipses impact fee collections in the same period by more than $480 million.

Had a severance tax been in place since fiscal year 2011-12, Pennsylvania could have raised an additional $1.2 billion over its impact fee collections. If you go back to when Governor Rendell first proposed such a tax in 2009, the amount left on the table grows larger.

Local Pennsylvania prices have fallen, for now

In October, the U.S. Energy Information Administration (EIA) reported low prices at several of the hubs where Marcellus Shale gas enters the pipeline system, but noted, “These expansions of takeaway capacity (pipelines) should alleviate the supply backup that has kept prices low at many Marcellus trading points.”  In December, the EIA noted that up to a third of existing pipelines would be modified by 2017 to help move natural gas from the Marcellus region to other markets.

Another factor likely to increase prices for Marcellus-produced natural gas will be the opening of a newly approved liquid natural gas exporting facility in Maryland in 2017.  Likely overseas customers for this gas include Europe and Asia. Higher demand tends to lead to higher prices.

It seems curious that gas drillers would increase Pennsylvania drilling in 2014 over 2013 if they thought current, lower prices are here to stay.

Delay costing Pennsylvania hundreds of millions of dollars each year

Even if local prices stay lower than the national average, a 5% severance tax would yield significantly more revenue than the impact fee.

This additional revenue could be used to address unresolved damage caused by this industrial process, and help restore education funding, close the projected $2 billion state budget shortfall for 2015-16, and ensure funds are available for critical services we all rely on – schools, hospitals, infrastructure, and public health & safety.

The longer Pennsylvania delays enacting a severance tax — and we’re the only major gas-producing state since Marcellus Shale development took off in 2008 without one — the more the gas industry profits, and Pennsylvania loses.