Income from natural gas tax bounces back

Revenue from the state’s severance tax on natural gas has rebounded this year after sinking 30 percent in 2012 because of weak natural gas prices.

Rather than a sign of renewed drilling in the Fayetteville Shale, the increase is attributed to aging wells that are now being taxed at a higher rate, an industry analyst and state officials said.

As of June, the Department of Finance and Administration had received about $30.8 million in natural gas severance tax revenue. In the same six month period in 2012, the department collected $21.1 million.

This year’s severance-tax revenue has also already surpassed the $28.2 million collected during the same period in 2011, even though natural gas prices were similar.

“Surprisingly, there is actually a decrease in overall market value of the gas,” said Tim O’Brien, miscellaneous tax section manager for the Finance Department. “The shift of the market value, from a lower tax rate to a higher tax rate, brought about a higher revenue.”

The increase in revenue is likely short-lived, because production levels in the state are expected to drop as natural gas drilling in Arkansas declines, said James Williams, an energy analyst who operates WTRG Economics near Russellville.

“Early last year we had slightly higher production,” he said. “The second half of this year’s production will probably be lower than the second half of last year.”

Severance-tax revenue lags two months - taxes on January production are not collected by the Finance Department until March - so 2013’s mid-year number represents production from the last two months of 2012 and first four months in 2013.

In the past year, natural gas drilling in Arkansas has slowed as companies shift their interests to liquid natural gases, which are more profitable at current market prices.

At the start of 2012, there were 33 drilling rigs operating statewide, but the number has started to slide. Last week there were 14 rigs in the state, with only 12 operating in the Fayetteville Shale, according to Baker Hughes, an oil-field services company.

The Arkansas Oil and Gas Commission has also seen a decrease in the number of new drilling permit applications.

As of June, only 428 drilling permits have been approved, a significant decrease from the 862 and 1069 issued in the same period in 2012 and 2011, respectively.

Last month, BHP Billiton Ltd., one of the top operators in the shale, said it planned to move its only two drilling rigs out of the state as it scales back operations there.

The Australian-based company said it needed more confidence in natural gas prices before it restarts operations in the shale. BHP Billiton acquired its natural gas assets from Chesapeake Energy in2011.

In 2008 - the height of drilling in the Fayetteville Shale - natural gas prices on the New York Mercantile Exchange mainly ranged from $6 per million British thermal units to $10 per million Btu, with prices occasionally exceeding $13 per million Btu.

But since 2011, when prices hovered around $4 per million Btu, natural gas prices have steadily fallen, said Williams.

Last year, prices didn’t even reach $4 per million Btu and in April briefly fell below $2 per million Btu.

Prices have slightly recovered this year, but they need to be above $4 per million Btu to encourage more drilling in Arkansas, Williams said.

Natural gas prices settled at $3.61 per million Btu on the New York Mercantile Exchange on Thursday.

As a result of waning natural gas prices in 2012, severance-tax revenue for the calendar year was just under $41 million, down from total revenue of $58.9 million in 2011.

The state’s severance tax on natural gas is calculated by multiplying net market value by the set tax rate. The net market value is determined by multiplying taxable production by the current market price of gas.

The tax rate ranges from 1.25 percent to 5 percent, depending on the type of well and how much gas it produces. New wells, both conventional vertical or high-cost horizontal, start at a tax rate of 1.5 percent.

Conventional wells stay at the 1.5 percent tax rate for two years and then the rate moves to 5 percent.

If a well fails to produce 2,500 cubic feet per day, the well operator can ask the state commission to declare the well “marginal”, which lowers the tax rate to 1.25 percent.

Horizontal wells are taxed at 1.5 percent for 36 months, before the rate moves to 5 percent.

If the costs of leasing, exploring, drilling and operating a well have not yet been covered by production within its first three years of producing, then the operator can ask the Finance Department to keep the tax rate at 1.5 percent for another year or until the well becomes profitable. Once the year is up or the well is profitable, the well moves to a 5 percent tax rate.

Horizontal wells that can’t produce more than 1,000 cubic feet per day can also be declared “marginal” by the commission and taxed at the 1.25 percent rate.

“Wells are getting older and starting to get out of those introductory rates,” O’Brien said.

The state Highway and Transportation Department will benefit from the increase in severance-tax revenue - even if briefly - because it receives about 70 percent of the revenue.

The department uses the revenue, about $30 million, to repair highways in the counties where the Fayetteville Shale is located.

The department has had to scale back on some of its improvement projects because revenue decreased last year, said spokesman Randy Ort.

He said the agency has struggled to keep up with damage to the highways - caused by trucks aiding drilling and hydraulic fracturing operations - because it hasn’t received as much money as originally expected.

“No one foresaw the amount of damage that was going to take place,” Ort said. “We’ve not kept up with it. We’re thankful to have the revenue … but as it turns out, the amount of that revenue has obviously been considerably less then it was projected to be.”

Business, Pages 61 on 07/14/2013

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