Six months ago, oil — and money — began to gush out of a well called Blades 33 H-1, drilled by a Houston energy company in a Tangipahoa Parish pasture about seven miles from the Mississippi border.
The well bores two miles into the Earth’s crust, and then runs horizontally for another mile. It cost about $15 million to drill — money that Goodrich Petroleum Corp. can expect to recoup within two years, depending on the rate of production and the price of oil.
Under Louisiana law, Goodrich must pay the state a “severance tax,” 12.5 percent of the value of all of the oil it extracts. But under an incentive program passed with little debate two decades ago, the state will refund all of that tax to Goodrich — at least until the company has paid off the well.
As a result, Louisiana taxpayers will cut Goodrich a check for nearly $2 million, even though the firm, in calls with investors before a recent drop in the price of oil, has boasted expectations of profit margins ranging from 29 to 53 percent.
When the break was conceived two decades ago by then-Gov. Edwin Edwards, horizontal drilling was still in the experimental stage, and the hope was that a tax break would spur more of it. Analysts predicted the measure wouldn’t hurt Louisiana’s finances, and they were mostly right: For roughly 15 years, the break had little impact on tax receipts — or on oil and gas production.
But everything changed when energy companies in the last decade figured out how to combine horizontal drilling with hydraulic fracturing, or fracking, making gas and oil reserves locked in shale rock deposits accessible.
Suddenly, as the natural gas-rich Haynesville Shale in the northwest part of the state was tapped, an exemption that had cost Louisiana less than $1 million in lost taxes in 2008 had ballooned to $239 million two years later. Since then, the state has given back $1.2 billion in tax receipts due to the horizontal-drilling exemption. (The tax rebate applies to both oil and gas wells; the severance tax rate for gas is reset each year and is typically lower than the rate for oil.)
The money lost to rebates could soon spike much higher: If the much larger Tuscaloosa Marine Shale, where the Blades well is located, lives up to geologists’ expectations, Louisiana could soon be returning $1 billion or more in tax revenue to drillers every year. The shale has an estimated 9 billion barrels of oil reserves, enough to satisfy America’s oil demands for more than a year.
With Louisiana’s Legislature struggling to stay in the black each year, the tax break for fracking has taken some flak in Baton Rouge, but for the most part has not been a part of the debate over how to balance Louisiana’s books.
“The usefulness of this credit is long gone,” said Jan Moller, executive director of the Louisiana Budget Project, a Baton Rouge-based group that looks at how state fiscal policy affects low- and middle-income taxpayers. “We’re giving them an incentive to do what they would do without an incentive.”
Defenders of the severance tax rebate — led by Louisiana’s powerful energy industry — say it makes Louisiana competitive with other states, including Mississippi, which has a similar program and also sits over a portion of the Tuscaloosa Shale. Take the break away, they say, and drillers will go elsewhere.
Critics say the fear producers would flee makes little sense. Unlike, say, filmmakers, who can shop around to see which state gives them the best incentive, drillers ultimately have to go where the resources are. At most, they say, the break might affect which deposits get tapped first.
Even some industry boosters doubt Louisiana’s breaks for horizontal drilling are much of a factor.
“I don’t see the reasoning behind those exemptions as strongly as some of my friends do,” said state Sen. Robert Adley, a former natural gas buyer and reliable energy industry ally who led the legislative effort this year to shield oil companies from lawsuits over damage to Louisiana’s coastline. “I truly think that exploration is tied, more than anything, to geology — which means where the oil and gas play is — and to price.”
In a September speech at an energy forum, Chris John, who heads the Louisiana Mid-Continent Oil and Gas Association, warned the audience that underground shale rock knows no political boundaries.
The Tuscaloosa Marine Shale is about 500 to 800 feet thick and about 10,000 to 15,000 feet underground, running in an arc from south Texas, past the western and northern suburbs of Houston into central Louisiana, and then along both sides of the Mississippi state line, including Louisiana’s Florida parishes. So a company could choose to drill into the shale from Wilkinson County, Mississippi, rather than from a few miles farther south in West Feliciana Parish, John said. A less-friendly tax regime here would swing the decision in Mississippi’s favor, he argued.
But skeptics say that if the energy companies want Louisiana’s oil, eventually they’ll have to come here to get it.
“The oil is in the Tuscaloosa Shale. It’s not going to be moved,” said LSU economics professor Jim Richardson, an expert on Louisiana taxes who is leading a study of the state’s tax system. “If the price of oil stays in that $80-$100 (per barrel) range, I think they’ll figure out how to get there, with or without an exemption. Now it may slow them down a little bit, but that may be good too. At some point, they will do it because you are talking about a finite resource.”
“It’s a timing issue. Certainly, at the margins, a tax can cause some people to rethink a major investment. But for the most part, I think the real element is going to be the overall price.”
In moments of candor, the oil companies themselves say the severance tax is but one of many factors they consider before drilling. Other major variables include royalties paid to landowners, labor and transportation costs, the quality of the oil, its current price and the cost of accessing it.
Gifford Briggs, of the Louisiana Oil and Gas Association, which represents about 1,700 small and midsized firms, notes that the cost of drilling a horizontal well in the Tuscaloosa Marine Shale is about double that of a vertical well or of a fracking well in Pennsylvania’s much shallower Marcellus Shale. That can make the tax exemption a bigger enticement, he said.
So far, most of the drilling in the Tuscaloosa has happened in Mississippi rather than in Louisiana, but the decision appears to have had little, if anything, to do with the tax climate.
At a recent conference in Denver, Robert Turnham Jr., Goodrich’s president and CEO, told investors that the preference for Mississippi has mainly owed to the kind of rock found there. Otherwise, he said, the states are similar, with easy accessibility to barges and pipelines, plenty of experienced workers nearby and low royalties — and, of course, tax rebates.
Those factors give Louisiana and Mississippi an edge over some other oil- and gas-rich states.
“The reason you can spend more money in this play is exactly what I said earlier: lower royalties, no severance tax and better pricing,” Turnham told investors.
Charles Cusack, executive vice president and chief operating officer of Halcon Resources, another big player in the Tuscaloosa, was likewise bullish in an address to investors in August. When Halcon — which also has large-scale drilling rights in North Dakota and Texas — started moving into the Tuscaloosa, Cusack said the company’s scientists realized that the rock here has more oil reserves.
“We got more comfortable as we started seeing some good well results, and then realized there was an entry fee that was still very reasonable,” he said. “So when we jumped in — Halcon-style — we jumped in with both feet,” he said.
Officials from Goodrich and Halcon, as well as three other drilling companies active in the Tuscaloosa play, did not respond to requests to be interviewed for this article.
The larger tax becomes more of a factor in a company’s decision-making process. But Louisiana’s 12.5 percent severance tax may not be a game-changer with a commodity whose prices are as volatile as oil.
And, of course, there’s no reason the state could not simply tinker with the rate instead of refunding the tax outright.
Mississippi, for instance, changed its law earlier this year to recognize that collecting a smaller portion of the severance tax during a time of higher production would bring in more revenues, while extending the time period of the suspension would keep the industry happy. The Magnolia State now forgives a portion of its severance, effectively charging 1.3 percent severance tax for 30 months or until the rig is paid.
Generally, it’s hard to draw a close connection between any state’s severance tax structure and the health of its energy sector.
A detailed survey of 11 gas-producing states by Pennsylvania’s Independent Fiscal Office released in March noted that Texas was the nation’s biggest producer of natural gas, despite having the fourth-highest effective tax rate among the states examined.
Louisiana, the No. 2 gas producer, had the fourth-lowest tax rate. Pennsylvania, which is No. 3, had the lowest.
The report was prepared as Pennsylvania lawmakers launched a discussion of whether to impose a severance tax on gas. It is the only state among those studied that does not, instead imposing an “impact fee” on drillers.
A recent report by the Pennsylvania Budget and Policy Center concluded that Pennsylvania could impose a modest severance tax on gas without dampening activity, though the proposal is being fought strenuously by the energy industry. Whether or not to have a tax was a major issue in the recent governor’s race in Pennsylvania, in which Democrat Tom Wolf defeated Republican incumbent Tom Corbett. Wolf supports a 5 percent severance tax.
Ohio, which had the second-lowest gas taxes among the 11 states in the Pennsylvania study, voted to increase its severance tax earlier this year.
But some states are looking to move in the other direction. In Arkansas, for instance, energy lobbyists are grousing that the severance tax — 1.5 percent for up to 36 months — is not competitive with neighboring states. That’s one reason, they say, that the number of rigs in the Fayetteville Shale play has fallen from 60 to 15.
But many experts say a much bigger factor for drillers than the severance tax is the current price of oil or gas.
When natural gas prices bottomed out as shale plays across the country were tapped, many energy firms left northwest Louisiana’s Haynesville, figuring they’d come back when prices got better.
“It’s all fundamentally driven by the price of oil, and the price of gas, because that pays for everything,” said Greg Albrecht, chief economist for the Legislative Fiscal Office. “That’s why Haynesville was a big explosion when gas prices were going up to $10 a mcf (thousand cubic feet), and then as they collapsed, new activity has fallen off dramatically.”
In Albrecht’s view, “price is 90-plus percent” of what drives drilling.
That explains why a recent drop of about 20 percent in the per-barrel price of oil is cooling things off for now in the Tuscaloosa.
Oil is expected to remain in the range of $76 during the first quarter of 2015, experts believe. That’s very close to the current breakeven price for Tuscaloosa, although that number is predicted to fall as energy firms become more familiar with the shale’s intricacies.
As oil prices have sunk, Goodrich and Halcon have seen their stock prices tumble by almost 40 percent.
But just a few months ago, when oil prices were higher, the companies were flying high. Goodrich’s Turnham told investors in August that he expected returns on investment of between 29 and 53 percent, depending on the price of oil and the cost of the wells.
Were profits to remain in that range, a 12.5 percent tax would be unlikely to dim interest in drilling, experts say.
Benefits of drilling
Defenders of the break say that Louisiana’s ongoing industrial boom might not have been possible without the break for horizontal drilling.
“There’s been a lot of talk about how the state has lost a lot of money because of that tax credit, and that’s true, but in the big scheme of things, you built that pipeline, you built that plant because of that action caused by the tax incentive,” said Richard Metcalf, director of environmental affairs at Louisiana Mid-Continent Oil and Gas Association. “You take one domino and you may lose the whole thing.”
Public Service Commission member Scott Angelle, who as secretary of the state Department of Natural Resources from 2004 to 2012 was in charge of overseeing drilling activity in Louisiana, agrees with that assessment.
“I’m convinced, at least from what I’m seeing happening in Louisiana: The cost-benefit ratio of the incentive for horizontal drilling is going to prove one of the best investments this state has ever made,” said Angelle, who is one of four announced candidates for governor next year.
Angelle says the cheap natural gas extracted nearby, with the help of the exemption, has helped spur industrial investments of about $70 billion in Louisiana. Low-priced natural gas not only provides fuel for the newly announced plants, but it also is used as an ingredient in manufacturing processes.
A powerful lobby
Oil and gas interests have for decades cast a long shadow over Louisiana politics.
The industry has donated about $6 million — usually in increments of $500 to $1,000 — to all manner of politicians in Louisiana, from House members to commissioners of insurance, since 2010.
Over the past decade, Gov. Bobby Jindal’s campaigns received just over $1 million, according to a coalition of environmental groups, or about 1/20th of the money he raised during that period, making that sector the second-highest contributor to his campaigns behind the construction industry.
In addition to significant political contributions, politicians see job creation as a potent campaign issue. The energy industry frequently reminds the public that it is one of this state’s leading employers; a study funded by LMOGA earlier this year boasted that oil and gas companies provided about 287,000 jobs and about $20 billion in household earnings in 2011.
Given the clout the oil and gas industry has traditionally wielded in Louisiana, it qualified as a victory when the Legislature voted earlier this year to change a law that had allowed oil and gas companies to collect above-market interest on tardy severance-tax rebates — even when it was the companies’ fault the rebates were late. A February report by the state legislative auditor said the interest payments alone had cost Louisiana taxpayers $8.1 million in the most recent year for which data was available.
The trick in coming months will be balancing the powerful industry’s interests with the needs of state government. Right now, the two sides are circling each other.
The combination of active political lobbying and the employment numbers gives oil and gas significant sway over how government operates — and who holds the levers of power — in Louisiana, said G. Pearson Cross, a political scientist at the University of Louisiana at Lafayette. He suspects that however the horizontal well exemption sorts out, in the end it will be a repair that the oil and gas industry can live with.
“I’d be very surprised if more than a few elected officials pushed back,” Cross said.
Tim Barfield, who heads the state Department of Revenue, said industry officials were open to scaling back the exemption a couple of years ago. But he thinks his boss, Jindal, would be reluctant to back any change that could potentially result in higher natural gas or oil prices. Jindal has been leery of doing anything that could be construed as a tax increase, as a potential 2016 presidential candidate who signed a pledge promulgated by the group Americans for Tax Reform in which he promised never to raise taxes.
“They were willing to look at — in principle they were willing — not necessarily getting rid of the horizontal wells exemption, but they were open to changing how it worked,” Barfield said. “I haven’t talked to the administration to get the OK to say this, but I think the administration would be very reticent to do anything that would impact that manufacturing renaissance.”
Staff writer Gordon Russell contributed to this report.