Possible Taxes

Pennsylvania is among the nation's largest natural gas-producing states, but it does not impose any tax on methane extracted from underground. Challenging times are ahead for the oil and gas industry as Pennsylvania faces a potential $2 billion to $3 billion budgetary shortfall, and many county and municipal governments likewise are struggling to balance their budgets. With these intense budgetary issues looming, the governor and the legislature are studying this new phenomenon to determine what taxes, fees or other revenue-generating measures could be implemented.

In a sobering mid-year presentation to legislative leaders, the governor announced further actions that he proposes to balance the budget by June 30. This included using $174 million that the commonwealth realized in royalties for Marcellus Shale gas drilling leases. In addition to revenues already being realized from state-owned lands, the governor may propose a "wellhead" tax on oil and natural gas drilling as part of his fiscal year 2009-2010 budget, and some legislative leaders are contemplating imposition of a severance tax. Advocates for taxing the industry are asking for dedication of the proceeds to funding environmental monitoring of the gas field watersheds, subsidizing local infrastructure repair and supplementing general state revenue.

During the upcoming fiscal year 2009-2010 budget negotiations, the oil and gas industry will be competing with many factors, such as the governor's challenge to introduce a balanced budget and the constitutional mandate that a final budget be supported by sufficient revenues to be "balanced"; program demands, including funding for Medical Assistance and other human service programs; the stated opposition of Senate Republicans to increasing certain business taxes, like the corporate net income (CNI) tax; pressures from local government officials for funding; and pressures from environmental advocates for increased regulation and enforcement activities.

The only certainty going forward is the fact that the governor and the legislature plan to reap revenue benefits from this geological formation's potential.

Anticipated Environmental Regulatory Actions

In addition to the taxes being considered by the commonwealth, the Environmental Quality Board (EQB), the quasi-legislative body that adopts the regulations enforced and implemented by the Department of Environmental Protection (DEP), has a meeting scheduled for December 16, 2008, where it will propose final rules (bypassing the usual rulemaking stage) to substantially increase permit fees for Marcellus Shale gas wells. The current fee of $100 will be increase to a base fee of $900 plus an additional $100 per 500 feet of well bore greater than 1,500 feet. This regulatory proposal is expected to be final when published in the Pennsylvania Bulletin in the spring of 2009.

The EQB is proposing the increase "to assure adequate funding to cover program expenses for the review and inspections for permit applications within the Marcellus Shale formation." The review of the Marcellus Shale permit applications is more expensive due to extra depth and complexity of horizontal drilling and enormous quantities of frac water that must be sourced, treated and disposed of appropriately.

Possible Regulatory Implications

The EQB proposal is designed to enable the DEP to more thoroughly evaluate the environmental implications of the Marcellus Shale formation exploration, including unique water quantity and quality considerations not normally associated with traditional shallow gas well permit applications. Basic considerations that the DEP will most likely require to be addressed in a Marcellus Shale permit application include the source of the huge quantities of water needed for the hydraulic fracturing process, whether the extraction of water from the proposed source will deplete water resources and the applicant's proposed plan for managing, treating and disposing of the frac wastewater. Currently, water from oil and gas operations is often taken to municipal wastewater treatment plant and diluted with sewage before being discharged to the rivers and streams. The greatly increased quantities of contaminated water generated by each Marcellus well will require the DEP to evaluate new technologies for treatment and disposal. Until these technical issues are resolved, the DEP may not permit the wells with the speed that the producers would like or only permit a limited number of wells, for which the water quantity and quality issues are adequately addressed.

This release is a reminder of the importance of monitoring the current state of affairs surrounding the oil and gas industry especially in conjunction with the intense focus on the Marcellus Shale opportunity in Pennsylvania.