Energy Independence

How Government Intervention Impacts Economic Growth

Howard Riley
BUS 528

Energy Independence. When Rudy Giuliani campaigned for the Republican Nomination for the Presidency of the United States of America he touted the ability to achieve energy independence. Unfortunately for the former mayor of New York City this was received by the general public as nothing more than a pipe dream, trying to stir up a sense of patriotism to get voters to the polls. As it turns out, Rudy Giuliani was just able to see a little further down the line than everyone else. Energy Independence has transformed from a buzzword used by politicians and lobbyists to an actual plan to progress the United States presence in the global energy market. This has been made possible by capturing trapped hydrocarbons buried deep below the surface of the United States. Several thousand feet below the earth’s surface lies tightly packed rock formations, known as shale. The shale formation is very dense and traps the natural resources that lie within it very tightly making it previously difficult and costly to recover. The shale that lies below Pennsylvania is known as the Marcellus Shale. The Marcellus Shale is an organic-rich black shale that was deposited in an oxygen-deficient marine environment during the Middle Devonian Time (approximately 390 million years ago). The Marcellus is not just any shale formation either; it is the largest producing gas basin in the United States and accounts for almost forty percent of all United States shale gas production. Natural gas production in the Marcellus Region has exceeded fifteen billion cubic feet per day (Bcf/d). It has the potential to be the second largest natural gas field in the world, behind only the South Pars/Asalouyeh field shared between the nations of Iran and Qatar. Converted to British Thermal Units (BTUs), the natural gas found in the Marcellus could be the equivalent to the energy content of eighty-seven billion barrels of oil, enough to meet the demand of the entire world for nearly three years. While the presence of these reserves has been known throughout the industry far before the recent boom in production, the ability to efficiently recover them has only been recently developed. Expansions of hydraulic fracturing and horizontal drilling have allowed producers to capture more of the hydrocarbons than they could previously. The Marcellus shale is a broad formation that spans from upstate New York through most of Pennsylvania, West Virginia, and into Ohio. Traditional vertical wells limited the amount of the contact zone with this specific formation, which in turn led to low yielding wells. This is where the technological innovation comes in to play. Two very innovative methods of completing a Marcellus shale well are horizontal drilling and hydraulic fracturing. Horizontal drilling involves drilling vertically until the “pay zone” is reached and then establishing a kick-off point and directing the drill out horizontally. The fractures (also known as “Joints”) in the Marcellus shale are vertical. So, a vertical borehole would be expected to intersect very few of them. However, a horizontal well, drilled perpendicular to the most common fracture orientation should intersect a maximum number of fractures. The second method that Marcellus shale producers employ is known as hydraulic-fracturing, or the more commonly used term “Fracking.” The goal is to increase the number of fractures in the contacted shale area, which was previously expanded through the deployment of horizontal drilling. Hydraulic fracturing uses high-pressure water, or a gel, to induce fractures in the rock surrounding the well bore. It is done by sealing off a portion of the well, using plugs, and creating controlled perforations into the shale formation using explosives. The “fracking” is then done by injecting water, or a gel, under very high pressure into the isolated portion of the hole. This high pressure fractures the rock and pushes the fractures open further. In order to prevent the fractures from closing when the pressure is reduced several tans of frac sand, or propant, is pumped down the well and into the pressurized portion of the hole. When the fracturing occurs millions of sand grains are forced into the fractures. If enough sand grains are trapped in the fracture it will be propped partially open when the pressure is reduced. This provides an increase in the permeability of the formation and will allow for an increased rate of hydrocarbon recovery. Pennsylvania’s now become a clear choice destination for countless energy producers looking for a great return on their investment. Major producers in the Oil & Gas have set up operations throughout Pennsylvania, as well as countless start-up companies looking to hit it big. This has led to a resurgence in the local economy that has not been experienced since the booms of coal mining and steel production ruled the local communities. Quality jobs, and careers, have come with this resurgence and have benefited the local communities. In 2009 the amount of jobs created through Marcellus shale development was around 44,098. The forecasted demand for jobs in 2015 in the Oil & Gas sector, within the Marcellus shale is 160,205. This kind of economic growth has also been experienced during one of the worst recessions that the United States economy has endured in nearly a decade. These impacts are being experienced throughout the local community and reach far beyond those that are direct shareholders in the Oil & Gas industry. This impact has been studied and quantified by Pennsylvania State University and they have found that for every one dollar that the Marcellus industry spends within the state, one dollar and ninety cents of total economic output is generated. This multiplier rate is far outpacing other Oil & Gas regions, including: Louisiana, New Mexico, and Oklahoma. Another representation of this multiplier effect is viewed by gathering the entire picture, the Marcellus gas industry directly added $1.98 billion dollars to the economy of Pennsylvania, which then generated indirect and induced impacts that increased the total value added generated in the Commonwealth by $3.87 billion dollars. While Pennsylvania clearly benefits from being on top of this vast natural gas depository and sharing a close proximity to heavily dense populated metropolitan areas there must be additional reasons why the major producers find it more attractive than the competing shale plays. While the perception of the amount of gas lying in the Marcellus may be unlimited, the amount of available drilling rigs is surely not. The government of the Commonwealth of Pennsylvania has incentivized drilling and production of the natural resources here. The policies that have been enforced, created and implemented and sustained have made Pennsylvania a viable competitor on the national energy stage. This has a direct, and immediate, correlation with the amount of jobs that have been created and the growth, through a recession, that the Commonwealth and local economies have enjoyed. Pennsylvania’s sales tax, corporate net income tax, and franchise tax provide powerful incentives to mining companies for operating within the Commonwealth. These exemptions and exclusions were added to the tax law in the 1960’s and then 1970’s when Pennsylvania’s economy was driven by steel production and coal mining. The Pennsylvania Department of Revenue has classified the hydraulic-fracturing process as mining for Pennsylvania tax purposes. These mining exemptions go beyond just income from hydrocarbon production. The mining exemption also removes sales tax for all purchases of equipment used for mining operations. This is important not only because it entices producers to choose Pennsylvania for their investment dollars, but also because it establishes the link between the Marcellus activity and the benefits to Pennsylvania’s economy. Through this provision Marcellus operators are encouraged to purchase their machinery and equipment from other Pennsylvania-based retailers. In addition to the exemption of intra-state purchases for mining equipment, Pennsylvania also allows for an exemption on any equipment that is purchased in order to control and prevent water and pollution. This exemption not only again incentives purchasing from other Pennsylvania organizations but also incentivizes environmental responsibility and controlling the impact of their operations. While these mining tax exemptions play a role in luring producers to our region they are not the portion of the tax code that has gained the most publicity in our current gubernatorial race. The highest profiled point of contention between the incumbent candidate, Tom Corbett, and the democratic nominee, Tom Wolf, is known as “Act 13.” Act 13 was a major overhaul of Pennsylvania’s oil and gas law and was passed through legislation on February 8, 2012. There were several key pieces of this legislation that were deliberated on, specifically around zoning restrictions and who had the authority to establish zoning laws. However, the primary piece of Act 13 focused on how these producers were taxed. Act 13 called for an “Impact Fee” versus a more commonly used practice of a severance tax. The so-called Impact Fee is a tax placed on every well drilled for gas in the Marcellus shale formation in Pennsylvania. The specific amount changes from year-to-year to correspond with market prices of natural gas and the Consumer Price Index, but it has hovered around $50,000. The alternative, and more commonly employed, severance tax reduces the initial “Impact Fee” and opts to tax each well individually based on its specific production of natural resources. Pennsylvania’s choice to employ the per-well taxation method has made this region extremely competitive when compared to other shale plays in the United States. It has also been extremely profitable for the state generating $630 million in direct revenue since its inception, retroactively, in 2011. This revenue also stays local, where the drilling is occurring, with sixty percent staying at the county and municipality level. Governor Corbett has come under fire for this policy and is often accused of leaving valuable tax dollars on table that could be utilized elsewhere in the Commonwealth, primarily to overcome deficits and cutbacks in education. Governor Corbett has defended his position by saying “Equally important is ensuring that the next generation has jobs waiting when it graduates. We have added nearly 180,000 new jobs in the private sector since I took office, including many in the Marcellus shale region.” He also commented directly on the Impact Fee taxation method, “While some would argue we must apply a special tax on an industry that is thriving and responsible for creating thousands of jobs, I believe punishing success with new taxes should never be our answer and ignoring the $2.2 billion in state taxes the industry has paid since 2008 is deceitful. It is not financially wise to implement additional burdens on an industry when we are competing with other sates for limited drilling rigs. Additionally our one-of-a-kind impact fee has reinvested of $636 million in our local communities for environmental and transportation projects related to drilling, a use more beneficial than growing the size of Harrisburg’s coffers to distribute to counties where drilling does not even occur.” Governor Corbett’s thoughts and beliefs are not shared by everyone in this state as indicated by the early leads in the polls that candidate Tom Wolf has experienced. Mr. Wolf is running on a platform that will lead to a drastic change in the way that taxes are levied on oil and gas producers. Mr. Wolf promotes the severance tax method and wishes to tax actual production on a well-by-well basis at a rate of five percent. Mr. Wolf has stated: “As governor, I will begin laying the foundation for a modern economy by restoring Corbett’s education cuts. This begins with a reasonable five percent severance tax on natural gas. With natural gas production at an all-time high, a five percent severance tax would generate $1 billion dollars in 2015-2016 and nearly $1.5 billion dollars by 2018-2019.” While Mr. Wolf clearly believes that further taxing the Oil & Gas producers in this region will lead to deficit-ending revenues for the Commonwealth he makes a large assumption that production, and continued exploration, would continue to grow at the same rate that has been noted over the last five years. Through the enactment of this severance tax policy Mr. Wolf will remove much of the competitive advantage that Pennsylvania has previously established in this sector. The main point of emphasis that is reiterated is that Pennsylvania is the largest gas producer that does not currently have a severance tax system in place. Texas is often cited as a model, as it employs a 7.5% severance tax rate on all oil and gas produced within the state. What is often under-reported is that Texas does not have a corporate income tax, Pennsylvania’s is ten percent. Texas Governor Rick Perry is quoted saying that there is a waiting list in Texas for any rig that is not needed in Pennsylvania, further highlighting the competitive demand of the industry.
What is more compelling is to look at the immediate competition within the same shale play, that being Ohio and West Virginia in this case. Ohio employs a severance tax policy with its rates being $0.025 for every metric cubic foot (MCF) of gas and $0.10 for each barrel of oil produced. West Virginia has a flat rate of 5% on all oil and gas produced within the state. These two tax policies give Pennsylvania an immediate advantage and lures producers into the Commonwealth, rather than choosing the other states. If Pennsylvania’s tax policy were to conform more closely to the neighboring states there would be no added reason to continue to invest in Pennsylvania over Ohio and West Virginia. Recent results from the Utica shale in Ohio have returned significantly more oil production, valued higher than natural gas on the market, and therefore would make Ohio a more investment friendly option – even with comparable tax laws. The unrest that this policy has created is more than just theory, companies are speaking out, and even more alarming – they are acting. The nation’s largest producer of natural gas, XTO Energy’s President Randy Cleveland is quoted as saying; “We need a transparent, fair and reasonable tax and regulatory scheme that’s predictable and stable, and that’s competitive compared to other opportunities.” Some were more outspoken, specifically Jim Tramuto, Vice President at Southwestern Energy; “We pay our fair share. I think it’d be a mistake to look to our industry as the only funding source for all programs at the state level.” The largest producer in the region, Range Resources, has offered their take on the proposed changes. Range Resources Corp. CEO Jeffrey Ventura said an extraction tax like that proposed by gubernatorial front-runner Tom Wolf, on top of the per-well fee they’re paying the state could push big companies to other shale plays. He added, “I think you’ll see companies like Range or some of the smaller people stay pretty active, but at the end of the day, it clearly will impact the play overall.”
These words are powerful when you consider the economic impact that could result in the termination, or even slowing, of current Oil & Gas production rates. More powerful than words however, are the actions that are already taken place. Several companies are looking to diversify their portfolio of land leases. This has been made visible by several different producers in south-western Pennsylvania. Rice Energy Corporation has recently moved from their only developments in Washington County, Pennsylvania and expanded drastically into the Marcellus/Utica shale plays in Ohio. When I interviewed Virginia Naryka, production engineer at Rice Energy, about the reason for moving further from current assets and offices she stated that they believed that they needed to ensure that they were not solely dependent on the current incentives in place in Pennsylvania. In fact, she stated that Rice Energy was putting the largest portion of its development budget into Ohio in order to create a better balance on their asset list. Another large producer in this area, EQT, has looked to move south in order to ensure a broader scope of assets. They have swapped land-leases with Range Resources allowing two major players to acquire land outside of Pennsylvania. EQT traded some of their holdings they had already established in Ohio to Range Resources, in exchange for land in Texas. This marks the first time EQT will produce natural resources outside of the tri-state region and also marks Range Resources first expansion outside of Pennsylvania in the Marcellus. A source from EQT, who wished to remain anonymous, said the company is unsure of the stability of the competitive nature of Pennsylvania’s resources. The source stated that operating in Texas, while headquartered in Pittsburgh, Pennsylvania is going to be very foreign for them, expensive, and difficult. However, the source stated that they felt that it was something that needed to be done to ensure that they were not dependent on the current state of the tax policy remaining the status quo. Another observation of a major global producer expressing uncertainty in Pennsylvania is Shell Oil and Gas. Shell sold off every parcel of land that they had acquired in the Marcellus at a loss. It also plays a part in the reason that some major producers have yet to enter Pennsylvania, despite the documented success of the wells that are in production. Daren Rader, Senior Production Engineer at Antero Resources says that they will continue their rapid growth and expansion in Ohio. A decision that was made due to the uncertainty of the sustainability of the current tax environment in Pennsylvania and the availability of drastic oil production being experienced in Ohio.
The gas industry is not alone it its concern over potential changes to state tax policy. Shirl Barnhart is a Democratic Supervisor for Morgan Township, in Green County. He is also first vice president for the State Association of Township Supervisors. He says that when the gas boom first began, it felt like his community was invaded. Later, drillers threatened to leave over the notion of having to pay the Impact Fee. “At that time I said, ‘I’ll help you pack.’ But now that the impact fee is in place, they’re giving back to the community. I want them to stay.” This Democratic Supervisor is concerned that his community could lose this money if Mr. Wolf is elected. He even stated, “I’m not a big fan of Tom Corbett to start with, but Tom Wolf really scares me.”
This brings us to our impasse, how do you incentivize investment for your state and ensure that you are competitive, but also avoid being taken advantage of by large corporations? I think that it comes back to growing the market. Pennsylvania is currently saturated with natural gas without the ability to transport it efficiently to other markets that need it, both domestically and internationally. Growing this market will create a more efficient flow of resources, increase demand, and therefore help to restore gas prices to closer to the previously experienced rate. Implementing a severance tax, not necessarily as high as five percent, would be more feasible if there were fair market prices established. These prices will not be realized until the infrastructures, and legislation/regulation, are enacted to allow this commodity to be exported globally. The final hurdle may have been cleared recently. The Federal Energy Regulatory Commission, or FERC, has approved Dominion Energy’s Cove Point plant to be retrofitted and transformed from an inactive import facility to the first liquefied natural gas export plant with readily available access to the Marcellus shale. Dominion has already secured agreements with energy companies in both Japan and India to begin supplying them large amounts of natural gas. The research shows that while domestic consumption rates may increase slightly; this will be far outweighed by the taxable revenue stream and the jobs that will be created. American Petroleum Institute’s CEO Jack Gerard says that an export market for shale gas will mean increased production in Pennsylvania. “And what that means – jobs, well-paying jobs.” Gerard said. “These are careers, something we desperately need in our current economic state.”
Regardless of whom the elected candidate may be in the Pennsylvania Governor’s race they must be cautious of the current fragile state of the region’s fastest growing industry. They cannot take a short-sighted view and strangle their golden goose. They must weigh each viable option carefully to ensure that Pennsylvania remains the dominant producer of natural gas that it has become and that our local economies continue to grow and our communities continue to flourish. They need to strive for Energy Independence.

Works Cited
“Marcellus Shale.” Pennsylvania Department of Conservation and Natural Resources. www.dcnr.state.pa.us 10 October 2014

“Marcellus Region Production Continues Growth.” Jozef Lieskovsky, Richard Yan, Sam Gorgen. U.S. Energy Information Administration. www.eia.gov

“Marcellus Shale – Appalachian Basin Natural Gas Play.” www.geology.com/articles/marcellus-shale.shtml 28 September 2014.

“The Economic Impacts of the Pennsylvania Marcellus Shale Natural Gas Play: An Update.” Timothy J. Considine, Ph.D., Robert Watson, Ph.D., P.E., Seth Blumsack, Ph.D. The Pennsylvania State University College of Earth and Mineral Sciences Department of Energy and Mineral Mining

“Pennsylvania Tax Incentives for Marcellus Shale Activities.” Daniel M. Dixon, Brent K. Beissel, and Stephen Blazick – Reed Smith LLP. www.oilgasmonitor.com 10 October 2014

“The Oil and Gas Law of the Land: Your Guide to Act 13.” Scott Detrow. State Impact: Pennsylvania. http://Stateimpact.npr.org 28 September 2014

Tom Corbett. Various Sources – captured from the Pittsburgh Tribune Review. 28 September 2014

Tom Wolf. Various Sources – Captured from the Pittsburgh Tribune Review. 28 September 2014.

“Shale Gas Industry’s Ad Campaign Aims to Promote Fracking.” David Conti. The Pittsburgh Tribune Review. 21 September 2014.

“Gas Industry Nervously Awaits Outcome of Governor’s Race.” Marie Cusick. State Impact: Pennsylvania. http://Stateimpact.npr.org 28 September 2014

“Final Hurdle Cleared for Marcellus Gas Exports.” Susan Phillips. State Impact: Pennsylvania. http://Stateimpact.npr.org 28 September 2014

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[ 1 ]. “Marcellus Shale.” Pennsylvania Department of Conservation and Natural Resources.” www.dcnr.state.pa.us 10 October 2014
[ 2 ]. “Marcellus Region Production Continues Growth.” Jozef Lieskovsky, Richard Yan, Sam Gorgen. U.S. Energy Information Administration. www.eia.gov 4 October 2014
[ 3 ]. “The Economic Impacts of the Pennsylvania Marcellus Shale Natural Gas Play: An Update.” Timothy J. Considine, Ph.D., Robert Watson, Ph.D., P.E., Seth Blumsack, Ph.D. The Pennsylvania State University College of Earth and Mineral Sciences Department of Energy and Mineral Mining
[ 4 ]. “Marcellus Shale – Appalachian Basin Natural Gas Play.” www.geology.com/articles/marcellus-shale.shtml 28 September 2014.
[ 5 ]. “Marcellus Shale – Appalachian Basin Natural Gas Play.” www.geology.com/articles/marcellus-shale.shtml 28 September 2014.
[ 6 ]. “The Economic Impacts of the Pennsylvania Marcellus Shale Natural Gas Play: An Update.” Timothy J. Considine, Ph.D., Robert Watson, Ph.D., P.E., Seth Blumsack, Ph.D. The Pennsylvania State University College of Earth and Mineral Sciences Department of Energy and Mineral Mining
[ 7 ]. “The Economic Impacts of the Pennsylvania Marcellus Shale Natural Gas Play: An Update.” Timothy J. Considine, Ph.D., Robert Watson, Ph.D., P.E., Seth Blumsack, Ph.D. The Pennsylvania State University College of Earth and Mineral Sciences Department of Energy and Mineral Mining
[ 8 ]. “Pennsylvania Tax Incentives for Marcellus Shale Activities.” Daniel M. Dixon, Brent K. Beissel, and Stephen Blazick – Reed Smith LLP. www.oilgasmonitor.com 10 October 2014
[ 9 ]. “The Oil and Gas Law of the Land: Your Guide to Act 13.” Scott Detrow. State Impact: Pennsylvania. http://Stateimpact.npr.org 28 September 2014
[ 10 ]. Tom Corbett. Various Sources – captured from the Pittsburgh Tribune Review. 28 September 2014
[ 11 ]. Tom Wolf. Various Sources – Captured from the Pittsburgh Tribune Review. 28 September 2014.
[ 12 ]. “Shale Gas Industry’s Ad Campaign Aims to Promote Fracking.” David Conti. The Pittsburgh Tribune Review. 21 September 2014.
[ 13 ]. “Gas Industry Nervously Awaits Outcome of Governor’s Race.” Marie Cusick. State Impact: Pennsylvania. http://Stateimpact.npr.org 28 September 2014
[ 14 ]. Virginia Naryka. Production Engineer, Rice Energy Corporation.
[ 15 ]. Daren Rader. Senior Production Engineer. Antero Resources.
[ 16 ]. “Gas Industry Nervously Awaits Outcome of Governor’s Race.” Marie Cusick. State Impact: Pennsylvania. http://Stateimpact.npr.org 28 September 2014
[ 17 ]. “Final Hurdle Cleared for Marcellus Gas Exports.” Susan Phillips. State Impact: Pennsylvania. http://Stateimpact.npr.org 28 September 2014