Louisiana has forgone hundreds of millions of dollars in taxes every year recently to spur the use of an oil and gas drilling technique that was being improved when the subsidy was created two decades ago but is commonplace now, a legislative audit says.
The largesse may have been unnecessary, the report acknowledges, noting that no other state with significant horizontal drilling operations offers a full refund of so-called severance taxes — though some offer reduced rates.
The report’s findings track those of “Giving Away Louisiana,” an eight-part series on state tax giveaways, including the break for horizontal drilling, that was published last year by The Advocate.
During the past decade, advances in horizontal drilling and hydraulic fracturing — known as “fracking” — have allowed energy producers to tap into once out-of-reach oil and gas reserves locked away in shale deposits thousands of feet below the ground.
Since 2010, Louisiana has missed out on more than $1.1 billion in revenue that it would have received if not for the break for horizontal drillers, according to Louisiana Legislative Auditor Daryl Purpera’s report.
The report doesn’t directly argue that the incentive is a boondoggle. But it reiterates the conclusions drawn from a recent review of the state’s tax structure that was commissioned by the Legislature and conducted by a team of economists. The group recommended abolishing the horizontal drilling credit, which was passed to encourage production at a time when few energy producers embraced the technique.
In the five-year stretch that Purpera examined, almost all of the revenue that the state lost came from gas extraction. Oil production refunds to drillers totaled about $42.2 million, compared with almost $1.1 billion for natural gas production.
When the credit went into effect, analysts projected that it wouldn’t have much impact on the state’s bottom line. That held true for more than a decade: The exemption had little effect on tax revenues — or in driving oil and gas production.
From 1994 until 2007, just 393 horizontal wells were put into production and approved for the tax credit, according to the audit report. But over the next seven years, the number grew about sevenfold, with a total of 2,797 horizontal wells approved for the credit.
Under the rules of the credit, energy producers are refunded severance taxes on horizontal oil or gas wells for the first two years of production or until the well has paid for itself, whichever comes first. On average, drilling a horizontal well costs about $9 million.
But refunding revenues over the two-year period means the state is missing the most lucrative period of a well’s life, according to the audit. Because production from a horizontal gas well drops sharply after the first two years, some operators may escape severance taxes altogether.
“With those kinds of wells, pretty much all the research shows that within the first year is the time you get the most production, and it decreases pretty steadily after that,” said Karen LeBlanc, director of performance audit services for the legislative auditor.
The rapid advance of fracking has led to years of low-priced natural gas. The state’s powerful energy lobby says the credit has propelled an industrial boom that has seen an estimated $100 billion in investments in Louisiana planned or in the works.
“This renaissance is a direct correlation to the abundance of natural gas available in Louisiana,” Don Briggs, president of the Louisiana Oil and Gas Association, said Tuesday. “This abundant natural gas is only available due to the severance tax incentive being in place and operators recognizing the value of drilling in our state.”
But LeBlanc believes much of the state’s horizontal drilling would have taken place anyway.
“They’re going to come if there’s shale (formations) and if there’s natural gas,” she said. “In 1994, the technology was fairly new, and they may have needed an incentive at that point.”
The severance tax on oil is set at 12.5 percent of the value of the oil extracted. For gas, the tax is reset each year and is typically less than the rate for oil; in 2013, it was 16 cents per thousand cubic feet produced.
As they weighed deep cuts to rebalance a massive budget gap, state lawmakers during the 2015 legislative session considered several bills that sought to curb costs tied to the exemption.
The lone bill that passed sets severance tax rates for horizontal wells with the price of oil and gas for two years or until the well’s costs are recovered.
But with the price of oil slumping, critics of the measure say the benchmark outlined in the bill makes it unlikely that any severance tax will be paid by energy producers in the near future, according to the report.
The measure applies a tiered severance tax exemption to new oil and gas production based on the price of either commodity. But oil would have to rise above $70 per barrel, and natural gas above $4.50 per British thermal unit, for energy producers to end up paying a severance tax. The fiscal note accompanying the bill noted that it was not expected to generate any additional revenue for the next five years.
That catch comes as no surprise, at least for the time being: Oil is currently hovering in the low $40s per barrel, and gas is a few ticks below $3 per Btu.
Follow Richard Thompson on Twitter, @rthompsonMSY.