The Facts on Why Now is Not the Time to Tax Drillers

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Permalink Reply by BuckinghamGasMan on June 26, 2009 at 3:07pm

Mr. Rhoades makes number of good points, but raises some questions, at least in my mind.
1) The $107 million expected in the next budget year is too high. That is probably right.
2) Small well owners would be hurt. That would also be correct and there probably should be a "Homestead provision" that would tax production above a minimum/base production amount.
3) Pa has a very high Corporate Income Tax. Correct, but it is also riddled with loopholes. How much did the out of state gas companies pay in Corporate Income taxes last year or expect to pay this year?
4) Landowners would also pay the tax. Wouldn't that first depend upon how the individual lease is written and secondly, isn't the minimum royalty supposed to be on gross production, not after costs such as taxes are subtracted?

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Permalink Reply by Rita McConnell on June 26, 2009 at 5:00pm

Here's some feedback from Matt Benson at POGAM, who works closely with Steve Rhodes:

"The PA House Resources & Energy Committee approved a heavily amended version of severance tax legislation this week that exempts stripper wells (capable of producing <60 mcf/d). Without these small wells and based on estimated Marcellus production and projections of drilling for the remainder of the year, we calculate the tax would generate just $26.5 million for the coming fiscal year. Further, the amended bill sends just 60% of the revenue to the state general fund, while 40% would be dividied up among local governments, the state's Liquid Fuels fund, the home heating assistance program, the Fish and Game commissions, and some environmental funds. In a nutshell, the Democrats no longer see the severance tax as a way of helping to plug the big budget hole. We are still against the tax at this stage in the development of the Marcellus play."

"The question of the deduction of post-production expenses before royalties are paid is before the PA Supreme Court, and we believe the court will rule that this is an acceptable industry practice as long as it is negotiated up front in the lease."

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Permalink Reply by terry hazlett on June 29, 2009 at 10:36am

Rita, i understand that it is an acceptable industry practice , but is it fair to the landowner? the og companies already get 87.5 % of the well profit. i think the industry makes out quite well even if they have to pay post production cost! why not be fair with the landowner & keep everyone happy, instead of money grubbing the landowner to death. after all it is our gas. and yes i know it costs alot to drill a well, but it costs alot to own property too!

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Permalink Reply by Rita McConnell on June 29, 2009 at 11:12am

In my experience Terry, the key is the lease. I know some saavy land owners who have negotiated post-production expenses off the table, as noted in their leases. Once again, it all goes back to knowing who your working with and being smart about your investment. And why it makes sense to have competent legal representation.

But keep this in mind, without the driller, who invests heavily in upfront geological study, research, permitting, land leases, court house searches, drilling contracts, pipeline taps, pipeline construction, and so on and so forth, that gas would likely never make it out of the ground (vertical Marcelllus can cost $1million +; horizontals over $3 million). From that point of view, a resource that remains in the ground isn't worth much at all, regardless of who owns to.

In the current drilling environment, and even in better times, for most independent drillers, the percentage of the well production it "collects" is rarely if ever pure profit. It pays upfront costs leveraged against production and is most often re-invested back into production and operations. Thats not to say drillers don't make money, but its not in the volume most would imagine.

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Permalink Reply by terry hazlett on June 30, 2009 at 8:08am

Rita , i understand drilling a well costs around 3 million, but from a range report gas at $ 6.00 Mcf NYNEX THE rate of return is 64% over 20 yrs and even at $ 3.25 Mcf you still have a 20% return on your money! Pretty good return for the gas company,not so good for landowner who gets a pidly bonus and might never see a penny in royalties in their lifetime, especially at $25- 100 an acre bonus payment, i just think it should be a partnership, i have the gas & eventually they're going to want it! at % 12.5 I think they could afford to pay post production costs.

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Permalink Reply by Rita McConnell on June 30, 2009 at 9:23am

Terry --

I can't comment on specific reports from Range or any other company -- I can only tell you how things work here. We do approach things fom a partnership perspective -- and we know under our own current budget conditions what we can offer and what we can't. And its not what people were seeing last summer and fall.

No one is taking (and I don't know who is offering) $25 an acre now, and very few leases are signed at 12.5 perecent these days -- even under these conditions. But one thing we try to make clear to all of our land owner partners is this -- don't come into this expecting to strike it rich. Risks are still real -- to the royalty owner and the driller -- until that well is completed and in production.

The "profit" you are seeing that O&G companies make is not pure return. As I said, there are contractors and employees to pay, and operations expenses to be satisfied, and a host of other costs that allow us to do what we do, like insurance, and other overhead. Those huge returns you estimate are in part what makes drilling in the Marcellus possible. We've known about this formation for years -- it just wasn't financially possible to tap without a higher gas price, which we saw in the last few years, and is now gone.

You may indeed have the gas, but that doesn't necessarily mean eventually someone will want it. Just because you sign a lease that allows us to explore doesn't mean we'll find its economical to get to it. Thats a fact of geology, topography and regulation. From what I see, within my own company, the days of holding someone's property with a lease for ages and not drilling are over. If we're paying for that land we need it to produce. If it turns out we don't like the geology, that we choose to focus somewhere else, or that perhaps a competitor well nearby doesn't produce, we likely won't renew.

But again -- its all about the lease, and the practices of the company your working with. Land owners can bargain for better leases -- many of our landowners have leases that are quite favorable to them. The bonus payment is nice, but the royalty is what matters. In this play, 12.5 is the low end (and the minium required by law)-- its likely a few percentage points higher now. A lease between a driller and landowner is a business transaction -- and when doing business, both sides need to have done their homework, and negotiate for what they want. The landowner can decide that they don't like the offer, but the driller can also decide it doesn't like the counter.

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