Over the past few years, surging shale gas production from Pennsylvania's Marcellus shale has propelled the state to become the second largest gas-producing state in the country, recently inching ahead of Louisiana and behind only Texas.
In addition to its positive impact on the state's economy, surging shale gas output from the Marcellus is also lining the state's coffers with hundreds of millions of dollars from so-called drilling impact fees. Yet some argue that Marcellus shale drillers should pay the state even more money. Are they right?
Pennsylvania's Marcellus cash cow
Major Pennsylvania gas producers paid some $225 million in drilling impact fees for the fiscal year 2013-2014, up from $204.3 million in the previous fiscal year and $204.2 million in 2011-2012. These fees, introduced as part of a law called Act 13 passed by Gov. Tom Corbett in 2012, fluctuate based on the price of natural gas and require operators to pay a certain amount for each horizontal well and each vertical well they drill, irrespective of the amount of natural gas the well produces.
Funds collected under Act 13, which are directly distributed to Pennsylvania's counties and municipalities, help pay for things such as infrastructure, emergency response, public safety, and environmental programs. In the less than three years through April 2014, Act 13 has added some $630 million to Pennsylvania's state revenue, according to Corbett, in addition to the $2 billion in state taxes Marcellus drillers have paid since 2007.
Are Marcellus drillers paying enough?
Range Resources (NYSE:RRC) shelled out the most money to the state of Pennsylvania, paying nearly $28 million in impact fees last year, while Chesapeake Energy (NYSE:CHK) was a close second with roughly $26.7 million. Other companies that contributed significantly to lining state coffers were Cabot Oil & Gas (NYSE:COG), which paid $13.3 million, Anadarko with $12.3 million, and Southwestern Energy, which shelled out $11 million.
For Chesapeake and Cabot, these impact fees aren't exactly an overwhelming factor, seeing as they're just a fraction of their annual profits, which came in at $474 million and $298 million, respectively, for the full-year 2013. For Range, however, $28 million in impact fees represents almost a quarter of its $116 million net income last year. Indeed, the company stated in its 2013 Annual Report that impact fees have increased the "financial burden" on its Marcellus shale operations.
But some want Range and other Marcellus drillers to pay even more. They argue that the state could have generated even more money had it adopted severance taxes, which are imposed on oil and gas producers in other states like Texas, Oklahoma, and West Virginia.
That's because revenue from severance taxes increases with production, unlike impact fee revenue, which depends on the number of wells drilled and the price of natural gas. According to an analysis by The Morning Call, the imposition of a 5% severance tax would have generated about $425 million for the 2013-14 budget, nearly twice as much as the $225 million generated from impact fees.
Is a severance tax the solution?
Pennsylvania's Democratic candidates for governor are all in favor of a new severance tax, which, they argue, would provide the state with much greater revenues in the years ahead. According to the Pennsylvania Budget and Policy Center, a 4% severance tax could generate $1.2 billion annually by 2019-20. However, opponents including Gov. Corbett argue that imposing a severance tax would risk driving away the Marcellus drillers that have been so vital to the state's job growth.
While the Marcellus shale is arguably the most economical shale gas play in the country -- with companies like Cabot, Range, and Chesapeake able to earn triple-digit rates of return at a wellhead gas price of $4 per Mcf -- a more challenging regulatory and tax climate could erode these returns and force them to cut back on drilling or look elsewhere for more profitable opportunities.
Beyond the potential negative impact on Marcellus drillers, landowners that have granted these companies leases to drill on their land could also suffer since most lease agreements would require them to pay a proportion of the severance tax, unlike the existing impact fee. As a result, they would receive less from royalty checks.
It's an interesting debate with good points put forth by both sides. What do you think is the optimal solution? Should Pennsylvania impose a severance tax, or are drilling impact fees the way to go?
Arjun Sreekumar owns shares of Chesapeake Energy. The Motley Fool recommends Range Resources. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.