Research Brief 2017-1 January 2017 2016 Impact Fee Estimate Pennsylvania imposes an annual impact fee on unconventional (i.e., shale) natural gas wells that were drilled or operating in the previous calendar year. This research brief uses recent data published by the Department of Environmental Protection to estimate collections for calendar year (CY) 2016, which will be remitted in April 2017.1 This brief also translates the impact fee into an annual average effective tax rate (ETR) based on recent natural gas price and production data. The ETR is a metric that quantifies the implicit tax burden imposed by the impact fee in a given year. Proceeds from the impact fee are distributed to local governments and state agencies to provide for infrastructure, emergency services, environmental initiatives and various other programs. Local governments receive funds based on the number of wells located within their boundaries or their proximity to jurisdictions where natural gas extraction took place. Historical and estimated distributions are shown in Table 1. The annual impact fee for an unconventional natural gas well is determined according to a bracketed schedule, based on the number of years since a well became subject to the impact fee (operating year), the type of well (horizontal or vertical) and, to a limited extent, the price of natural gas.2 Wells that produce below a certain threshold are exempt from the fee, depending on the type of well and the operating year. Horizontal wells in operating years four or greater that produce less than 90 Mcf (thousand cubic feet) per day are exempt. Plugged horizontal wells are exempt after remitting the fee in the first year. Vertical wells that produce below the 90 Mcf threshold are exempt from the fee in any operating year. The estimated amount of the impact fee for CY 2016 is $174.6 million, which is $13.1 million less than the amount collected for the prior year. Table 2 on the next page details the well count, fee schedule and estimated collections by operating year. The primary reasons for the decline in collections are as follows:  New wells insufficient to offset aging of wells. The impact fee is highest in a well’s first operating year, and declines as the well ages (see Table 2). Revenue from the 503 new wells spud is not expected to offset reduced collections from older wells as their fees decline. Estimated net impact: -$9.6 million.  Exempt status and other. Includes the net effect of: (1) reduced collections from newly-exempt wells as their production falls below the 90 mcf threshold; (2) collections from previously-exempt wells rising above the 90 mcf threshold; and (3) the resolution of late or disputed fees from previous years. Estimated net impact: -$3.5 million. The impact fee does not directly respond to the price of natural gas or the volume of production, and it does not provide a measure of tax burden relative to natural gas sales. For the latter purpose, this research brief computes an annual average ETR. The ETR is equal to the annual impact fee revenues divided by the total market value of unconventional natural gas production. The market value is equal to the product Table 1: Impact Fee Revenues and Distributions Total Revenues Counties, Municipalities and HARE Fund1 Marcellus Legacy Fund Commonwealth Agencies Conservation Districts/Commission 2012 $202,472 2013 $225,752 2014 $223,500 2015 $187,712 2016 $174,600 107,683 79,289 10,500 5,000 123,151 84,601 10,500 7,500 123,300 82,200 10,500 7,500 101,800 67,867 10,500 7,545 94,000 62,600 10,500 7,500 Note: Dollar amounts in thousands. Source: Pennsylvania Public Utility Commission. Estimates for CY 2016 by the IFO. 1 Housing Affordability and Rehabilitation Enhancement Fund. Independent Fiscal Office January 2017 1 Table 2: Well Count and Estimated Collections for 2016 Operating Year1 1 2 3 4+ Subtotal Late/Disputed Fees Total Number of Wells2 503 784 1,371 7,450 10,108 Number of Exempt Wells3 6 18 1,882 1,906 Number of Wells Subject to Fee 503 778 1,353 5,568 8,202 Fee Amount4 $45,300 35,200 30,200 15,100 Estimated Collections $22,800,000 27,400,000 40,600,000 82,800,000 173,600,000 1,000,000 174,600,000 1 Wells in operating year 4 or greater are subject to the same fee amount. the number of wells that have been spud, including both horizontal and vertical wells. 3 Includes wells exempt from the fee based on production level or plugged status. 4 Represents the fee for horizontal wells. The fee for vertical wells is 20 percent of the amount shown. 2 Represents of (1) the annual average regional price of natural gas net of post-production costs and (2) the total production of all unconventional wells.3 The ETR represents an average for all wells in operation during the year.4 Endnotes 1. Data from Pennsylvania Department of Environmental Protection’s oil and gas production reports and spud well reports from 2011 to 2016 (last accessed January 18, 2017). Production data are currently available through November; December is estimated by the IFO. The annual ETR fluctuates (increases or decreases) based on the movement of its three components: revenues, production and price. As shown in Table 3, the ETR for 2011 to 2014 decreased in each successive year. The main cause of that trend was the strong production growth through those years. For CY 2015, the ETR rose dramatically due to low prices, which caused a significant decline in market value. This factor had a stronger net effect on the ETR than the decline in revenues and continued rise in production. 2. The fee schedule is adjusted if the average price falls above or below certain thresholds, which did not occur in 2016. Pursuant to 58 Pa.C.S. §§ 2301 et seq., the price used is the annual average of the settled prices for near-month contracts on the New York Mercantile Exchange. 3. The price used for this calculation is a weighted average of spot prices at the Dominion South and Leidy trading hubs for the calendar year, converted to dollars per thousand cubic feet ($1.56 for 2016) using Pennsylvania-specific heat content, net of post-production costs ($0.87). Prices are from BENTEK Energy. Post-production cost estimates are based on a Range Resources investor presentation from October 3, 2016, adjusted for statewide wet and dry gas production. It should be noted that many producers hedge prices for a large share of their production (e.g., futures contracts). 4. An alternative to the annual average ETR is the lifetime ETR, which is the average tax burden over the lifetime of a single new well; this measure is best used to quantify the prospective tax burden on new wells across states. (See the IFO’s previous publication, Effective Tax Rate Comparisons Severance Taxes, for further information.) For CY 2016, the ETR is estimated to be 5.0 percent, a decrease of 1.9 percentage points from CY 2015. This is due to an increase in market value (28.6 percent) coupled with a decline in revenues (-7.0 percent), which both reduce the ETR. Table 3: Impact Fee Annual Effective Tax Rates Calendar Year 2011 2012 2013 2014 2015 2016 Impact Fee Revenues $204,210 202,472 225,752 223,500 187,712 174,600 Unconventional Production (MMcf)1 1,064,000 2,042,700 3,102,900 4,070,700 4,596,900 5,097,000 Price of Gas ($/Mcf)2 $3.40 1.93 2.70 2.33 0.59 0.69 Market Value3 $3,612,900 3,937,200 8,381,100 9,506,000 2,722,400 3,501,000 Annual ETR 5.7% 5.1 2.7 2.4 6.9 5.0 Note: Dollar amounts in thousands. MMcf is million cubic feet. 1 Production data through November 2016. December 2016 is estimated by the IFO. 2 Net of post-production costs, which were $0.87 in 2016. 3 Does not include natural gas liquids (condensate). Independent Fiscal Office January 2017 2