Oil and gas industry anticipating fight over tax proposal

Oil and gas executives are bracing for a fight this year against an unlikely foe — a Republican governor with a pro-business reputation.

Ohio Gov. John Kasich wants to raise taxes on the oil and gas industry so he can lower the income tax Ohioans pay.

Kasich’s plan to raise taxes on oil and natural gas extracted from Ohio soil would hit high-producing “fracked” wells hardest, but Ohio oil and gas producers say the plan could sink smaller companies before they have a chance to tap the technology.

But oil and gas producers say higher taxes on them would stifle a premature industry. They say robust production in eastern Ohio will boost technology and manufacturing businesses in the Miami Valley and across the state more than an income tax cut.

A recent industry-supported study estimated unconventional drilling supports 38,000 jobs including 4,210 direct jobs in Ohio. That number is expected to balloon to 143,000 by 2020 and to 266,000 by 2035, according to research by Information Handling Services, Inc., a Colorado-based company that analyzes data for energy, security and environmental industries.

Kasich introduced the tax increases in February 2012 along with a dozen other priorities for state lawmakers to consider. Republicans in the Ohio House of Representatives axed the plan, saying it needed a thorough vetting. Industry leaders and analysts criticized Kasich’s revenue estimates and what they called minimal savings to most Ohio taxpayers.

Kasich told reporters last month that the tax plan will be back this year, although details won’t be known until he unveils the plan and his two-year budget in early February. The goal of the severance tax plan is to lower income tax rates and encourage business growth, especially among small business owners who file company taxes as individuals.

Ohio oil and gas producers say the plan flies in the face of what Kasich is trying to accomplish and it’s too early to tax a budding industry that has no guarantee it will be profitable enough to generate the revenue estimated by Kasich officials.

The Ohio Oil and Gas Association represents more than 3,000 people and companies exploring, producing and developing oil and natural gas. President Tom Stewart said most members are Ohio small businesses.

Stewart said increased activity in eastern Ohio has been good for counties hit hard by the recession and Kasich won’t get much support from farm bureaus, chambers of commerce and other businesses in the region.

“Here you have a part of Ohio that’s been an economic desert in decades and now they’ve finally gotten their opportunity, and the first thing that comes out of a Republican governor’s mouth is let’s tax it and redistribute?” Stewart said.

The Ohio Oil and Gas Association has lobbied hard against the tax plan saying it will drive the oil and gas industry away.

Kasich doesn’t buy it.

“Every single time I meet with the industry privately, you know what they say? They say we should take this (tax plan) and run. But then they get their lobbyists and all these other people and they obscure the issue,” Kasich said.

Ohio last revised its oil and gas tax policy in 2010 under Democratic Gov. Ted Strickland. Oil is taxed at 20 cents per barrel and natural gas is taxed at 3 cents per 1,000 cubic feet, equivalent to 1 percent at today’s price.

The revenue pays for regulation of all oil and gas wells in the state and geographical surveys used by private companies and the government.

Kasich’s plan from last year levies a smaller rate (1.5 percent instead of 4 percent) on wells during the first year of their production, while they recover initial drilling costs. After that, wells drilled horizontally would pay 4 percent on oil and natural gas liquids.

Horizontal wells use a procedure called hydraulic fracturing, or fracking, to extract oil and gas. Fracking involves injecting sand, water and chemicals underground to fracture the earth, allowing oil and gas to escape through the fractures.

The proposed increase is lower than taxes in neighboring Kentucky, West Virginia and Michigan. Pennsylvania, which shares the Utica and Marcellus shales with Ohio, does not levy a severance tax but drillers pay an impact fee per well, changing with inflation. In 2012, Pennsylvania drillers paid a $50,000 fee per horizontal well and $10,000 for shallow wells, generating more than $200 million for local governments across the state.

An eight-state study by Ernst and Young found the sum of Ohio’s taxes on oil and gas would be the lowest. The study, sponsored by the Ohio Business Roundtable, found the effective tax rate would be lower than Texas and North Dakota and surrounding states.

But Stewart said Ohio can’t be compared to Texas or North Dakota and other states that offer incentives that lower the actual rate drillers pay.

Unknown wealth

Ask Ohio’s oilmen what will happen if a severance tax is levied and they point to Arkansas.

Arkansas officials raised the state’s severance taxes in 2008 — at the height of the gas boom — to pay for road construction and repairs anticipated from drilling-truck traffic. Depending on production, tax rates range from 1.25 percent for marginal wells to 1.5 percent for new wells, to 5 percent for a completed well capable of producing high volumes.

Severance taxes generated $58.9 million in 2011 but have fallen short of expectations. Natural gas prices peaked in 2008 at $10 per 1,000 cubic feet. An overabundance of gas and warmer winters has pushed prices down to below $4.

Revenues were down 31 percent in 2012 compared to the previous year. Despite decreasing revenues, two attempts to further increase the tax have failed.

Activity has slowed, but industry officials in Arkansas don’t blame the tax. Lower prices mean less capital for companies to tap for new wells.

“Arkansas is competing for a limited amount of capital investment and drilling dollars,” said Kelly Robbins, executive vice president of the Arkansas Independent Producers and Royalty Owners. “It’s not a bottomless pocket of drilling capital or investment dollars and production companies are going to spend it wisely.”

Geologists at the Ohio Department of Natural Resources estimated last year the Utica Shale could provide between 1.31 billion and 5.5 billion barrels of oil and between 3.75 trillion and 15.7 trillion cubic feet of natural gas, assuming the shale holds one-third of its volume in natural gas and two-thirds of its volume in crude oil.

There may be “gold in them thar hills,” as Kasich likes to say, but it’s buried in thousands of feet of limestone, sandstone and other rock layers.

Chesapeake, the No. 2 gas producer in the U.S., announced in November it was pulling back from drilling for oil in eastern Ohio. Oklahoma-based Devon Energy Corp. announced in August disappointing results in Medina and Ashland counties last year and shifted east.

“Even with all the technology we have, those wells aren’t working out for a variety of good geological reasons,” Stewart said. “It’s very hard to get very large chain molecules to move through very dense rock even though you hydraulically fracture it.”

Economy saver

Jayne Wallace, who owns farmland with several oil and gas leases in Cadiz, said she’s already seeing positive effects from drilling activity. The unemployment rate hit 14.6 percent in 2009 in Harrison County — just west of Steubenville — and improved to 7.5 percent in November 2012, still above the national rate.

Wallace said the additional people living in Harrison County provide business for restaurants, barber shops, car dealerships and clothing stores, which generate sales tax revenues for local governments. A brand new store opened just to sell field-appropriate work clothing, she said.

“The benefits in the long run far outweigh the need to put a severance tax on,” said Wallace, who serves as president of the Harrison County Farm Bureau.

Wallace said eastern Ohio landowners could be hurt most by a tax increase. Many leases require the landowner to pay severance taxes, not the company.

“We’ve already paid tax on our property and now we’re being penalized because we have oil and or gas under our property,” Wallace.

Unconventional gas activity generated more than $910 million in state and local taxes in 2012, which the IHS study predicts will grow to $4.6 billion in 2020.

The proposed severance tax increase targets big drilling companies, but smaller Ohio companies are partnering with big names to drill high-producing horizontal wells.

Dave Hill, who owns a drilling company in Byesville, said companies like his lack the capital to drill expensive wells but they have plenty of land.

“They keep a big piece; we keep a small piece,” Hill said. “That’s how we survive in this deal.”

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