New tax could slow Marcellus shale development

"Low oil and gas prices have prompted many US state governments to alter their fiscal and regulatory regimes to better support continued development. In contrast, Pennsylvania has actually proposed a new severance tax to support education investment promised in the recent gubernatorial election. Between 2008 and 2014, the development of shale gas resources in the Marcellus Shale has spurred Pennsylvania to become the second largest state producer of natural gas in the US, with production growing from less than 550 million ft3/d to over 9000 million ft3/d. Although this new tax will provide an immediate boost to state finances, it could exacerbate the slowdown and loss of investment due to low gas prices.

"While Pennsylvania is the largest natural-gas-producing state without a severance tax, it has instead used income tax and other fees to gain revenue from gas production. It has an impact fee for drilling new wells, which has brought in over US$630 million since 2011, and the state also has the second-highest income tax rate, at 9.99%.

"This new law would significantly increase the tax burden on gas production. Dubbed the Pennsylvania Education Reinvestment Act, it would set a 5% severance tax on gas production in addition to 4.7 cents per thousand ft3 of gas, increasing the effective state tax rate from 9.9% to 15.9%. Pennsylvania would have the highest taxes of the major gas-producing states in the Lower 48.

"In addition, the law currently does not have the incentives or breaks for new wells or shale wells that are common in other states. Currently, only stripper wells (producing less than 50 000 ft3 annually) would be exempt from the proposed tax.

"This significant increase in the tax burden will have a negative impact on the dry-gas Marcellus play economics, already threatened by low natural gas prices. A typical breakeven price for the Marcellus is US$2.50 - 3.00/thousand ft3; however, the proposed tax will have an even more dramatic effect when gas prices are at their lowest and operations are already marginal.

"The act sets a minimum price that gas production should be taxed on: US$2.97/thousand ft3 for the first year. This is above recent Henry Hub spot prices around US$2.60, and well above that of local hubs in the state, many of which are below US$2.00. With the Leidy Hub price at around US$1.50, the effective severance tax rate would be 13% and the overall state effective tax would be 21.7%.

"While Pennsylvania can expect a tax windfall due to many wells waiting to be completed or connected to a pipeline, companies are already reducing investment in developing the Marcellus and the new tax worsens the investment outlook for Pennsylvania. Moreover, when gas prices rise again, companies may well consider other plays for investment before Pennsylvania."

Adapted from a press release by David Bizley

Published on 08/05/2015

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