US House members launched their newly formed natural gas caucus on Oct. 21 with a hearing designed to rally support for a domestic fuel they believe could play an increasingly significant role. One witness quickly injected a note of reality into the otherwise optimistic proceedings, however.
Bruce H. Vincent, president of Houston-based independent Swift Energy Co. and vice-chairman of the Independent Petroleum Association of America, warned that proposals being made by Congress and President Barack Obama's administration could harm an industry that is already feeling pressure from lower commodity prices. Bills restricting commodity trading to discourage excessive speculation could keep independents from using hedges that are vital cash-flow management tools, while proposed repeals of incentives that have been in the federal tax code for more than 75 years would slash new drilling and domestic production, Vincent said.
"Natural gas, particularly shale gas, can and will play a pivotal role in America's future energy supply. Independent producers are the key to its development," Vincent said, adding, "If the nation's tax, financial, resource access, and environmental regulatory policies encourage development, gas can live up to its expectations, and our country will be the better for it."
Producers aren't the only ones feeling the impact of severely reduced drilling. States' revenues from oil and gas taxes have dropped along with other business levies.
"If minerals are the cornerstone of the Wyoming revenue forecast, then natural gas is undoubtedly the cornerstone of the minerals forecast," the state's Consensus Revenue Estimating Group said in its Oct. 19 forecast. "By itself, and without counting the contributions made by the condensate portion of the gas stream that is considered to be oil production, natural gas made up greater than 50% of the state's total mineral valuation, and fully 41% of its overall total assessed valuation," it said.
Gas hit hardest
The recession's impacts hit gas valuations hardest of the major minerals, the Wyoming forecast said. Mild summer temperatures exacerbated electrical demand declines brought about by manufacturing slowdowns, resulting in historically high gas storage volumes. With no major supply interruptions occurring this summer, burgeoning gas supplies filled storage to capacity, reducing gas well drilling in the state by nearly two-thirds from Summer 2008 levels. "The number of rigs operating in Wyoming fell from 90 in May 2008 to 33 in May 2009," the report noted.
Conventional oil and gas drilling in Wyoming is recovering from earlier this year, reflecting higher crude oil prices and stable-to-slightly-increasing gas prices for producers in the state, according to Thomas E. Doll, supervisor of the Wyoming Oil & Gas Commission. "Production from conventional natural gas, particularly in southwestern Wyoming, continues on an increasing trend and has not yet reflected the drop in drilling activity. In fact, built-for-purpose rigs and new drilling technology have increased efficiencies resulting in increased number of wells drilled per rig with drilling times down to 16 or so days per well," he said.
"Production of conventional oil from Wyoming's older fields continues [its] historic decline. However, production of condensate from southwestern Wyoming continues to mask this decline in the older oil fields' production rates. Also, five active carbon dioxide-enhanced oil recovery projects continue their increase in oil production each month," Doll continued.
He said coalbed methane in the Powder River basin has been of greater concern as wells are being shut in not only because of pricing, but because many were producing only water and not effectively depressuring the coal formations to allow gas to flow, were in marginal geologic settings, or had operational problems. Also, the expected significant increase in drilling activity, typically seen each August after the US Bureau of Land Management lifts wildlife stipulations did not occur. "The drilling rig count in the Powder River basin remains one-third of the prior year's activity," Doll said.
Oil and gas production in Michigan also is down, a state official told OGJ. "Our production, particularly of gas, dropped significantly in the past year. Some of it is shut in because of low prices. Oil production seems to be following the usual trend, with a little new production coming on this year," said Harold R. Fitch, chief of the geological survey division within the Department of Environmental Quality.
Basic choice
States face a basic choice when their officials consider how to restore lost oil and gas revenues: They can either raise volumes through incentives for increased activity, or they can simply raise taxes. Responses so far have been mixed.
Arkansas's legislature had increased the state's severance tax at a special session earlier in the year when the economic recession hit in October 2008. "They modernized the old tax structure and based it on price instead of volume. Even though the price went down and the revenue was less, the new system still generates more revenue than the old," said Lawrence E. Bengal, director, Arkansas Oil & Gas Commission. The higher rate became effective on July 1, 2008.
J. Kelly Robbins, executive director of the Arkansas Independent Producers & Royalty Owners Association, said, "This year will show the highest amount ever paid in the state's history, but it won't be because production has grown and the value has increased."
Robbins said, "Collections of severance tax revenue were less than expected because it changed from a volume-based to a value-based tax. With the steep decline in prices, the collection amount fell."
Increased production because of the Fayetteville shale play was one reason, Robbins told OGJ. Another was that Arkansas' severance tax was low compared to other states' taxes. Industry officials worked with Gov. Mike Beebe and his officials to present a proposal to lawmakers, he said. Activity is down not only in the Fayetteville shale but also in southern Arkansas, where production including stripper wells nevertheless produces $1 million of total revenue daily, and the Arkoma basin.
"Our permitting is down a little bit, but the number of wells being drilled is holding steady. Development is moving ahead and production is steadily increasing statewide. It's certainly not as big as it's been in the past, but it's still moving in a positive direction," Bengal said.
Holding back
Governors in Rocky Mountain states don't seem to be moving quickly to raise oil and gas taxes, according to Kathleen Sgamma, vice-president for government relations at the Independent Petroleum Association of Mountain States in Denver. She said Colorado Gov. Bill Ritter failed to get an initiative passed in 2008 that would have raised taxes, but has since recognized that the downturn in oil and gas activity has reduced the state's budget. "He seems to have come on board and realized the contribution natural gas makes to his state and is trying to promote it more," she said.
Elsewhere, some groups in Utah have made noise about trying to increase that state's severance tax when its legislature meets in 2010, but they're getting no encouragement from lawmakers or Gov. Gary Herbert, Sgamma continued. "[Herbert] realizes that while it looks like Utah has a lower severance tax than other states, raising it would hurt Utah producers more because there's so much federal land there. It's already a very expensive place to operate. Even a small tax increase would drive out production," she said, adding, "Wyoming's governor strongly supports the industry because he realizes how much of his state's budget comes from gas and oil."
"Our permitting is down a little bit, but the number of wells being drilled is holding steady. Development is moving ahead and production is steadily increasing statewide." —Lawrence E. Bengal, director, Arkansas Oil & Gas Commission
Severance taxes have been discussed during 2009 in California and Pennsylvania, however. Pennsylvania Gov. Edward G. Rendell withdrew his proposal for one on gas from the Marcellus shale in early October. Pennsylvania Oil & Gas Association Pres. Stephen W. Rhoads explained, "It was a nonstarter for this year's budget because there were no significant revenues from such a tax with the Marcellus shale play at such an early stage of development. He has made it clear that he plans to revisit this tax option, perhaps as soon as the next budget cycle which begins in about 6 months."
"Pennsylvania has no history of any extraction industry tax," Rhoads said, adding, "We have a wide range of other taxes which apply to the business, and when you look at other states' tax structures, those with severance taxes also provide offsets for other taxes. They also provide incentives for drilling, such as tax holidays for high-cost wells and to keep marginal wells operating to ensure gas supplies. None of these ideas are considered in the governor's tax proposal. It's a long way from being anything remotely reasonable, from my point of view."
Provisions to encourage more leasing of state forest land were part of the budget adopted by Pennsylvania's legislature, Rhoads told OGJ. It doesn't include any mandate on how much land should be offered or a royalty rate, but does require a specific amount of revenue to come from the oil and gas lease fund. "It's that use of funds that don't exist which will require the Department of Environmental Conservation to go ahead and lease some state forest land. We're looking forward to that. We think that could provide some revenue for the state government which could offset the desire for a severance tax," he said.
'More desperate'
California legislators have considered a severance tax every session for 5-6 years, and it has come before voters as an initiative three times in the last 30 years, most recently 2006 when Proposition 87 was defeated by a 10-point margin, noted Rock Zierman, chief executive, California Independent Producers Association. "The budget deficit has made some legislators more desperate for new revenue. In California, there is a two-thirds vote threshold for passage of a budget as well as a tax increase," he said.
The state already has an ad valorem tax that assesses oil and gas in the ground, compared to other states which tax the minerals when they reach the surface, Zierman said. "We've analyzed other producing states and we're right in the middle on a per barrel basis. Every state has a different way of collecting taxes on oil, but it comes out pretty similar," he said.
"There are two legislators running against each other for attorney general who plan to introduce severance tax proposals. They're trying to out-hate domestic oil," Zierman continued. "The irony is that they talk about reducing dependence on foreign oil, yet foreign oil would be exempt. Very few of the majors get a significant amount of their revenue from California operations. That's where all of my members produce," he said.
Overall economics there are relatively positive, Zierman indicated. "Any time you have stable prices, it's good. Although lifting costs are higher than historically and most of the new finds are deeper, tighter, and more difficult, stable prices such as we've had the last few months provide incentives to invest dollars in new drilling programs," he said, adding, "Natural gas has been quite a roller coaster, even though prices have largely been decoupled from oil. Activity went down at the end of 2008, but it's started to creep back up. One reason is that drill rig availability is up, where they're readily available now compared to a year ago when a producer had to wait 6 months to a year for one."
Zierman cited two instances which suggest that California could remain one of the nation's leading oil and gas producers for some time. The first was Occidental Petroleum Corp.'s July 22 announcement of an estimated 150-200 million boe in Kern County, which Oxy Chief Executive Officer Ray Irani said was the largest in 35 years within the state. The second was a possible revival of Gov. Arnold Schwarzenegger's proposal to let Plains Exploration & Production Co. directionally drill into state waters from an existing platform in federal waters. On July 24, California's assembly rejected the plan, which the governor and legislative leaders included in a budget rescue package, after the state senate approved it. "It could very well be back, adding $2 billion to the state and $250 million to the adjacent county's revenues," Zierman said.
'The real deal'
Pennsylvania's prospects also look bright because of the Marcellus shale's potential. Rhoads said, "We've had several large independent producers for some time. There's a lot of Marcellus interest emerging and getting stronger. Lease prices are going up. This is the real deal," he said, adding, "The larger independents are very interested in this, and the majors are starting to show interest as well. Judging by the interest from all sections of the industry, the bet is that this play has a lot to offer."
Robert W. Watson, an emeritus associate oil and gas engineering professor at Penn State University, testified at the House Natural Gas Caucus's hearing on Oct. 21, stating, "Over the next 5 years, the Marcellus industry will likely transform Pennsylvania into a net exporter of natural gas. In slightly more than 10 years, the Marcellus industry could be generating nearly 175,000 jobs annually and more than $13 billion in value added. Also, over this time frame, the present value of state and local tax revenues earned from Marcellus development is almost $12 billion."
Producers in the state are trying to combat campaigns by some environmental groups to stop development because recovering gas from the Marcellus requires hydraulic fracturing, as it does in other shales. Rhoads said, "There are some very real efforts from some of the environmental community to create the impression that this is a very dangerous activity. We've been fracturing thousands of wells yearly in Pennsylvania since the 1940s. The only difference in the shale wells are the volumes of water used and how the flowback water is handled." Many operators are investigating recycling the water or reinjecting it deep under the surface, which has been used extensively in the US Southwest, he added.
Penn State will hold its second annual natural gas summit, focusing on the Marcellus shale and its potential, on Nov. 16-18. Last year's initial event was so successful that the Interstate Oil & Gas Compact Commission is cohosting this year's. "It's unique. It's decidedly not an industry conference, but one for all stakeholders including county and state officials and some landowners as well as various nongovernment organizations," said Dave Messersmith, a Penn State University extension education official and the conference's planning committee chairman. He added, "We see it as a forum for all groups to come together and talk about issues arising from development of gas from the Marcellus shale."
He told OGJ, "It was well received last year. After that event, there was no doubt we were going to do a second one. The response this year, so far, has been outstanding."
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