from Energy, Security, and Climate and Energy Security and Climate Change Program

The Case for a Natural Gas Severance Tax

August 9, 2011

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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A big fight is underway in Pennsylvania over the possible introduction of a “severance tax” on natural gas producers. Severance taxes are paid when natural gas is extracted from the ground. They are taken either as a percentage of the wellhead gas price or on a per-unit basis, on the theory that natural resources are at least in part public property, and the public should thus be compensated when they’re extracted. Most of the country – Texas, Louisiana, Alaska, etc – imposes severance taxes on natural gas drilling. Pennsylvania, however, does not.

This has become the subject of heated debate. Last fall, the Pennsylvania House of Representatives passed a severance tax (39 cents per thousand cubic feet), but the Senate vowed to reject it. Then on Sunday, Pennsylvania Lieutenant Governor Jim Cawley published an op-ed arguing strongly against any severance tax. His political opponents were unimpressed.

Those opponents appear to have the better argument. Supporters of shale gas development have consistently underestimated how much of the public is skeptical (at best) of drilling. Modest steps that would deliver additional public benefit, particulary to those who are not yet profiting from the shale gas boom, would help consolidate public support for development, allowing shale gas production to proceed on more solid ground.

That argument would be undermined if a severance tax threatened to crush the industry. Indeed that is what Cawley has claimed: his op-ed suggests that gas drillers would flee the state if a severance tax were imposed. But the economics of don’t add up. The Marcellus shale is relatively cheap to produce: the recent MIT Future of Gas study, for example, shows breakeven gas prices that are much lower than for any other shale play. A modest severance tax would still leave the Marcellus as the place to be. To be fair, if natural gas prices crashed, it’s plausible that an excessive severance tax could deter production at the margin. But, assuming that gas can’t stay super-cheap forever, that’s not necessarily bad: rational resource management says that you should produce more when prices are high and less when they’re low.

This is not just important for residents of the Keystone state -- it has national consequences. If Pennsylvania and others can find a smart policy balance, whether on severance taxes or environmental regulation, that will help put shale gas on firmer ground, benefiting everyone. If policymakers and industry shortsightedly assume that public opposition will never amount to much, though, they could find themselves badly burned.

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