There are shale gas fields covering more than half of the United States, but Pennsylvania has emerged as the rising star of domestic energy production with its “Mighty Marcellus” fields. This is a great resource for Pennsylvania, but I’ve been confused about legislation that would impose an “impact fee” on shale gas producers instead of the traditional volume-based royalty structure used by other states. The loss of revenues to the state over the next 20 years using the “impact fee” could be approximately $24 billion using current gas prices. If gas prices doubled (they are currently at 10-year lows), losses to the state could exceed $48 billion or more.

The energy states of North Dakota, Wyoming, Texas and Oklahoma historically have earned substantial revenues from energy royalties. It seemed odd that Tom Corbett, the Pennsylvania governor who received substantial campaign contributions from gas producers, barred his shale gas commission from even considering a royalty or gas tax.

When energy producers do cost-benefit analyses, they use very sophisticated modeling in which the primary input is the quantity of “recoverable” oil or gas in an area. The second input is the projected demand and supply for energy, which in turn determines its price. Finally, the modelers factor in business expenses, primarily the depth of well drilling required and the cost to haul the energy to a pipeline terminus or railroad depot. In the case of natural gas they might include the cost to liquefy the gas for easier transport. Generally at the end of all the calculations they look at the cost of paying mineral rights fees to landholders and royalty fees to the state. All these inputs move around constantly, and projecting them years or decades ahead requires quantitative wizardry.

The fees for mineral rights paid to landowners are negotiated costs. Mineral rights vary because landowners don’t have a central platform to see what other landowners are being paid and generally accept what the energy company offers. State royalty fees, though, are foreseeable: They’re set by the legislature and are generally clustered around similar levels across the nation. Oklahoma has a scale that starts at 7 percent when gas prices exceed $2.10 and slides downward if gas prices go lower. West Virginia, also a Marcellus shale state, imposes a 6.1 percent effective royalty rate, while Texas charges 5.4 percent of well revenue.

Pennsylvania is different in that the governor and legislature want to impose a fixed annual fee on drillers that changes over time, going from $50,000 in the first year to $20,000 a year from the fourth to 10th years and $10,000 annually for years 11 to 20. The impact fee will earn Pennsylvania $360,000 over the life of the gas well.

The Marcellus Coalition, the energy producers’ trade group, commissioned a study that found there were 2,300 Marcellus wells in Pennsylvania in 2012 that could produce almost 3.5 billion cubic feet of natural gas per day. At $3.62 per 1,000 cubic feet (the October 2011 EIA wellhead price) each well would earn about $5,500 per day, or $2,010,000 per year. Using the West Virginia royalty rate of 6.1 percent, a shale gas well could earn Pennsylvania $122,000 per year, or $2,440,000 over a 20-year production period. Instead, the proposed Pennsylvania impact fee will earn the state about $360,000 per well over a 20-year period. The Marcellus Coalition has estimated that Pennsylvania will have 11,500 wells operating by 2020, meaning the state is shortchanging itself by a minimum of about $24 billion in gas revenues over 20 years. If inflation or demand push up natural gas prices, the revenue losses to Pennsylvania will increase geometrically.

Given the fiscal challenges of Pennsylvania, it would seem important to earn as much revenue as possible for the state’s natural resources. Maybe it’s time for the Pennsylvania General Assembly to revisit the issue and really determine how much impact this fee will have.

Further:

Patriot News: Legislators would be wise to start over with Marcellus Shale bills

Bloomberg: Chesapeake Cuts Natural-Gas Output as Prices Hit 10-Year Low

Patriot News: PA DEP receives about $10 million per year of permitting fees

Pittsburgh Live: Tax collections on gas activity

Kroll Bond Ratings: Potential Impact of Natural Gas Fracking on Municipal Bond Issuers

MAGNY: Hydraulic Fracturing – What Municipal Bond Analysts Need to Know