Taxing Fracking

North Carolina policymakers have taken a very important first step in ensuring that if fracking begins in our state, there will be revenue collected as the state’s natural resources are depleted. A tax on natural resource extraction, referred to as a severance tax, is an important tool to ensure that the costs associated with these activities—the construction of roads and environmental monitoring, to name a few—are paid for by producers.

It is critical, however, that the tax structure is set up at the outset in a way that is adequate to cover these immediate costs and the loss of these resources for the future as well as that the tax does not subsidize a profitable industry for their private economic activity.

The Senate gave tentative approval yesterday to the omnibus Energy Modernization Act which includes the severance tax for fracking. Here are the specifics on the tax itself:

  • The tax is applied to the total gross price delivered to market which allows the producer to subtract the cost of delivery of the natural gas from the total gross cash receipts from the sale of natural gas. The use of market value is similar to 18 states with severance taxes. However, the fact that producers can deduct costs is distinct from West Virginia and Kentucky and other states which do not allow those costs but instead levy the tax before transportation or transmission.
  • Various tax rates are phased in over the 2015 to 2021 period.  The important thing though is that the rates start very low. Beginning in 2015 and throughout this period, the tax rates would be 0.9 percent at current market value. To put that figure in context, West Virginia’s rate is 5 percent while Kentucky’s is 4.5 percent.
  • While additional higher tax rates are added if the value of gas increases beyond $7 and then $8 in future years, these higher tax rates are unlikely to be realized under current and projected market conditions.
  • The percentage rate for condensates—liquid hydrocarbon that can be recovered from gas- and oil increases from 3.5 percent to 5 percent over time.
  • The tax rate for a well determined to be marginal, that is, incapable of producing more than 100 MCF per cubic feet, is set at six tenths of one percent.
  • Finally, local governments are prohibited from establishing a tax on extraction through franchise, privelege, license, income or an excise tax. This represents another limitation on local governments to manage their local budgets. Study of how extraction of natural resources would intersect with property taxes will be conducted and findings report by January 2015.

No fiscal estimate was provided as to potential revenue gains from collecting the severance tax, so we don’t know how much revenue this new tax will raise.  This matters because research shows that the costs of fracking are quite high, while at the same time the economic case for fracking in North Carolina is very weak given the low market value of natural gas and the low deposits and lack of infrastructure in the state. So without additional evidence, it is likely that the costs associated with fracking far outweigh the revenue that is raised under this tax structure and taxpayers will be left footing the bill.

While it is important that North Carolina policymakers have established a severance tax, before passage they should adopt significant changes to ensure that the tax does not subsidize the oil and gas industry and does raise adequate revenue to mitigate the costs of fracking to the state.

  • Subsidizing the costs of extraction and delivery for the producer by allowing them to subtract those costs from their gross receipts is not necessary. As other states have found, if there is an economic case for extracting natural gas, companies will pursue fracking and do not need the costs of their profitable businesses to be subsidized by taxpayers.
  • The tax rate should be in line with North Carolina’s neighboring states. Again, West Virginia and Kentucky have rates at 4.5 percent or higher and many western states have far higher rates and still see profitable industries.
  • Many states have established funds to support environmental protection with severance tax revenues and North Carolina should consider adding a fund to be supported in part by the severance tax. In a 2012 study by DENR, it was recommended that revenues not only support the costs associated with the extraction of natural resources but also the conservation of land, water and the maintenance of water quality infrastructure, among other important environmental protections.

The extraction of natural resources is one of diminishing returns for North Carolina. As the state’s natural resources are depleted, it is critical that policymakers put in place a tax structure that ensures that taxpayers aren’t subsidizing the industry’s profits and that adequate revenue is available to support environmental protections—and remediation—as well as investments in other aspects of the quality of life and economic development in communities across the state.

One Comment

  1. Shel Anderson

    May 22, 2014 at 1:21 pm

    This is an excellent article. Thanks for digging out the actual impact!