Pennsylvania Natural Gas Producers Wary of Severance Tax

Tom Wolf was sworn in as Pennsylvania’s 47th Governor on January 20, 2015.  In fulfillment of his campaign promise, and after less than a month in office, Governor Wolf announced his plans for implementing a natural gas severance tax targeting Marcellus Shale development in order to fund public education. 

On the surface, the tax seems relatively insignificant and is assessed based on 5% of the gross value of the natural gas and liquids produced at the wellhead.  In addition, there is a 4.7 cent tax on every Mcf of natural gas produced at the wellhead.  Governor Wolf’s severance tax plan includes an interesting caveat that “guarantees” a minimum return for the Commonwealth of Pennsylvania by placing a floor on the 5% rate at $2.97 per Mcf for natural gas

For Marcellus producers, current natural gas prices at the Leidy Hub were $1.38/Mcf as of Wednesday, April 22, 2015, significantly lower than the floor price proposed by Governor Wolf.  It is important to remember that the severance tax is imposed on the gross value of natural gas produced, not the net sales realized by producers.  For example, a typical producer will pay transportation and processing charges in order to get the gas to market and a royalty to the landowner.  These costs are subtracted from the producer’s gross revenue; however, for purposes of the severance tax, they may not reduce the gross sales subject to the tax.  Furthermore, Governor Wolf’s proposal specifically denies producers the ability to withhold severance taxes from the landowner’s royalty payments.

When considering these factors in the current operating environment, the net effect of a severance tax to the bottom line of a typical Marcellus producer may be as high as 36.78% of net revenue as illustrated below:

pennsylvania-natural-gas-severance-tax

Should the prices return to their previous $4/Mcf level, the net effective severance tax rate imposed on producers could be as much as 9.22% as illustrated below:

Producers have already signaled their intentions to reduce Marcellus capital and investment budgets due to market conditions.  A new severance tax, as currently proposed, would serve to discourage further capital investment associated with unconventional natural gas development.  The question for Pennsylvania residents will be:  if the severance tax is enacted in its current form, will the tax revenue generated be worth the potential decrease in unconventional gas development and the related economic development generated by the natural gas industry?

Contact us with questions on the possible implementation of a Pennsylaniva severance tax targeting Marcellus Shale development.

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