On January 8 and 15, 2014 the Ohio House of Representatives Ways and Means Committee received testimony on House Bill 375 (“HB 375” or the “Bill”).  The Bill, previously reported on this blog, would introduce a new tax on owners of horizontal oil and natural gas wells through which oil or natural gas are severed at the rate of 1% of the net proceeds of the well.  Four witnesses testified on January 8th, all of which are associated with the Ohio Oil & Gas Association, and all of which supported the Bill.  They included Thomas Stewart of the Ohio Oil & Gas Association, Dr. Benjamin Thomas of Thomas Consulting, Scott Zinace, an attorney representing the Ohio Oil & Gas Association, and Steven Downey of EnerVest Operating, LLC.  The two parties testifying on January 15th, Adrienne Dziak of the Nature Conservancy and Wendy Patton of Policy Matters Ohio, appeared as interested parties offering recommendations for changes to the Bill.  The Committee is scheduled to meet again to receive additional testimony on January 22nd.

            The first witness, Thomas E. Stewart of the Ohio Oil & Gas Association, testified in favor of HB 375 and regarded it as a “sensible modification” to the state’s severance tax.  His written statement articulated four reasons for OOGA’s support of HB 375.  First, they believe the proposed tax captures the total value of the well, regardless of the commodity price or whether the hydrocarbon produced is oil or gas.  Second, it provides fairness to Ohio taxpayers, in particular landowners who would have been burdened under earlier severance tax proposals, by offering an income tax credit for severance tax paid.   Third, the Bill reduces the economic burden on Ohio’s conventional producers by reducing the tax rate on natural gas from traditional wells and eliminating the cost recovery assessment.  Finally, HB 375 supports the Idle & Orphan Well Program, which plugs improperly plugged oil and gas wells for which no responsible person can be found.  OOGA’s attorney Scott Ziance echoed OOGA’s support for the Bill because it is equitable, adequate, simple and neutral.  Notably, his statement projects tax collections of $2.69 billion on horizontal wells, as opposed to $1.14 billion if HB 375 is not enacted.

            Dr. Benjamin Thomas is an associate professor in the Department of Petroleum Engineering at Marietta College, and testified before the Tax Subcommittee of the House Ways and Means Committee on severance tax issues last year.  His consulting firm Thomas Consulting LLC, prepared a report for OOGA in the fall of 2012, and his written remarks from January 8th recapped his prior research and supplemented it with new research commissioned by OOGA to provide a severance tax forecasting tool.  His presentation suggests that initial production volumes in newly-drilled horizontal Utica shale wells are very high during the first twelve months of production, but decline rapidly thereafter.  One chart indicates approximately 50% of a newly-drilled horizontal Utica shale well’s total expected output is extracted by the 10th year of production.  Despite these declines, his analysis concludes that revenues from the proposed tax will exceed $46 million in 2019 (the first year after the end of the initial five-year cost recovery period), and will rise each year thereafter, up to approximately $195 million per year in 2023 (the last year included in his analysis).

            The final proponent of the Bill on January 8th was Steven Downey, Vice President of Marketing and Business Development at EnerVest Operating, LLC.  His remarks are reflective of the concerns of those involved in interstate natural gas transportation and storage.  He supports the Bill primarily because the revenues and expenses associated with each natural gas component are easily determinable, making the tax simple to administer.

            Adrienne Dziak, Director of Government Relations for the Nature Conservancy in Ohio, offered a prepared statement by Nature Conservancy Ohio Director Josh Knights.  The Nature Conservancy supported Governor John Kasich’s earlier proposed tax increase, which was cut from the biennial budget in House Bill 59, and supports the portions of HB 375 that would re-invest severance tax revenues into the Department of Natural Resources (“ODNR”).  However the Nature Conservancy believes the existing Bill does not do enough to compensate for the environmental effects of well pad construction, road and pipeline development, and the development of other needed infrastructure.  It therefore proposes three principal changes to the Bill, dealing with the use of severance tax revenues.  First, they propose further support for the ODNR, particularly the Division of Parks and the Division of Forestry.  Second, they advocate for the creation of a special fund for local governments affected by shale oil and gas development (not limited to those with drilling sites) for conservation and restoration projects. Third, they advocate for the creation of a special fund comparable to the federal Superfund, to address future unknown impacts of shale oil and gas development.

            Policy Matters Ohio’s comments focused on eight recommendations for changes to HB 375.  First, they recommended increasing the tax rates, which would be lower than those of most other oil and gas producing states. Their second proposal follows the lead of the Nature Conservancy, and suggests additional ODNR funding.  Third, they proposed the tax credits and exclusions offered should incentivize desired behavior by requiring something in return from taxpayers (such as using local workers in construction projects).  A fourth recommendation is to eliminate or shorten the five-year cost recovery period, on the grounds that there is less need for the cost-recovery period when the technology is well understood, and the techniques used in horizontal drilling in Ohio are no longer experimental.  Fifth, Policy Matters Ohio also recommended eliminating the exclusion from the commercial activity tax because that tax was intended to have few exclusions.  As a sixth measure, they recommended narrowing or eliminating the income tax credit because they believe it will be difficult to audit.  Seventh, they believe the severance tax should be based on gross value rather than net proceeds because of the difficulty in determining allowable deductions.  Finally, Policy Matters Ohio believes the proceeds of the severance tax should not be used for an income tax reduction that would favor the wealthy.

            In the days prior to the hearing, the Ohio Legislative Service Commission issued its Bill Summary and Fiscal Note & Local Impact Statement.  HB 375 creates a significant income tax credit for businesses engaged in horizontal drilling, and the state General Revenue Fund is expected to experience up to an $8.5 million loss of revenue in Fiscal Year 2015 as a consequence.  The Fiscal Note also indicates that the Bill’s commercial activity tax exclusion would create losses to the School District Property Tax Replacement Fund and the Local Government Property Tax Replacement Fund, but these losses would be offset by subsidies from the General Revenue Fund.  Reductions in revenues to the Oil and Gas Well Fund and the Geological Mapping Fund likewise would be partially offset by a new Horizontal Well Tax Fund which is slated to experience a gain of millions of dollars in Fiscal Year 2015, with similar gains expected to grow in future years.  Any remaining proceeds would be transferred to a fund to reduce the state’s income tax burden, though the revenue losses from the reduction of the severance tax on non-horizontal wells and the repeal of the cost recovery assessment are not expected to equal transfers from the new Horizontal Well Tax Fund.

These commentators have given the Ohio House Ways and Means Committee a great deal to consider.  It is telling that despite the divergent interests and proposals for change, none of these commentators opposed the Bill.  All of the documents cited above and offered during testimony before the Ohio House Ways and Means Committee are available at its website, and additional reporting on these hearings is available here, here and here.