Court cases and severance taxes: some dark clouds out there for Pennsylvania natural gas producers

In the last five years Pennsylvania has grown from a marginal natural gas producer to an 8 Bcf/d-plus behemoth that will pass Louisiana as the US’s second most productive state this year. (Texas is far and away the top producer with more than 22 Bcf/d of gas production.)

What’s not to like: a shallow Marcellus shale formation, lots of fresh water, economically battered rural communities, and no severance tax.

But the honeymoon is over.

Earlier this month, the state Supreme Court ruled that towns and cities could use their zoning powers to regulate the locations of wells, pipelines and processing plants.

The state’s Act 13, written by a Republican governor and GOP Secretary of Environmental Protection with plenty of industry help, hoped to unify regulation among the state’s more than 2,000 municipalities, but putting all natural gas extraction under the state’s purview.

But the Keystone State Supremes went well beyond the question they were asked. They reviewed Pennsylvania’s history of degradation at the hands of the timber industry in the 19th century and the coal industry in the 20th and concluded that extraction industries need more, not less, regulation.

In reaching their decision, the justices invoked a little-used amendment to the state constitution that guarantees the right to clean air and water. The court granted standing in the case to an environmentalist who didn’t have any economic damages but could cite the loss of a nice view.

Very specifically, the majority — three Democratic appointees and the Republican chief justice — said that Act 13 was not only inappropriate state interference in a local matter, but the towns and cities also had the obligation to provide clean air and water.

The decision was a long way from industry’s wish as expressed by Act 13 that they would deal with one regulator — the Department of Environmental Protection — for the thousands of wells they drill each year.

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The state’s highest court derailed one of the Republican Governor Tom Corbett’s signature achievements, and voters may very derail the other: a refusal to impose a severance tax on natural gas production.

Corbett permitted a modest per/well impact fee to be instituted but has steadfastly resisted a severance tax, saying it will encourage drillers to head for other states, taking their jobs and leasing payments with them.

At the same time Pennsylvania’s Marcellus Shale production was doubling year-over-year, Corbett was making changes in education funding that some critics have labeled as major cuts to spending.

And there weren’t enough of the promised jobs to make a dent in unemployment numbers. Unemployment actually rose from 2010-2012 in the northeast dry gas part of the state (before falling slightly this year) and in the southwest wet gas part of Pennsylvania unemployment is below the national average but has only declined a half a percentage point in the last two years.

The gas rush didn’t hurt job numbers but Pennsylvania is far larger than North Dakota, and Scranton-Wilkes Barre is far more complex than Williston in the Bakken Shale.

Up for reelection in 2014, Corbett trails every Democratic opponent but one in the polls and half of the state’s Republicans tell pollsters they wish he’d just drop out.

The two announced Democrats that poll the best against Corbett — Congresswoman Allyson Schwartz and former DEP Secretary and Clinton administration advisor Katie McGinty — are from the Philadelphia suburbs.

The state’s former auditor general Jack Wagner of Pittsburgh hasn’t announced yet but he polls even better than McGinty or Schwartz.

What do all three have in common? A severance tax on natural gas production. With 10 Bcf/d worth of production expected early next year, according to the US Energy Information Administration, the industry isn’t going anywhere, they reason, and the state is leaving millions on the table.

The most common number? Five percent of well head price.

Producers will howl, but Marcellus Shale gas is so inexpensive to produce and so close to premium markets that most of the region’s producers are making well above the 15% internal rate of return benchmark.

A Platts’ analysis of the third quarter’s prices and all-in well costs found the Big Three Pennsylvania-focused drillers showing strong netbacks in the state. For example, EQT had a realized price of $3.58/Mcf. (All figures are per Mcf, exception production, which is per MMcf/d.)

EQT (1,000 MMcf/d production)

Realized price, $3.58; All-in-costs, $2.44; margin, $1.14

Range (739.4 MMcf/d production)

Realized price, $3.88; All-in-costs, $3.23; margin, $0.65

Cabot Oil & Gas (1,105 MMcf/d production)

Realized price, $3.36; All-in-costs, $2.97; margin, $0.39

Nobody’s going to go anywhere.

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