More than 800 wells in north Louisiana’s Haynesville Shale pump out billions of cubic feet of natural gas, yet state projections show Louisiana’s mineral revenue will fall by tens of millions of dollars for at least the next four years.
The reason? Horizontally drilled wells are exempt from severance taxes until a company recovers the cost of the well or for 24 months, whichever happens faster.
“For all practical purposes, we may essentially get little or nothing,” said Greg Albrecht, chief economist for the state Legislative Fiscal Office.
The state Legislature approved the horizontal well severance tax exemption in 1994 in an effort to promote the use of what was then a new technology that has since become a common drilling technique.
During the 2010 fiscal year, which ended June 30, the tax break meant Louisiana missed out on more than $200 million in severance taxes, Albrecht said.
Severance taxes are based on natural gas prices, Albrecht said. The current tax rates are about half what they were the last fiscal year, 16 cents per thousand cubic feet versus 33 cents, when natural gas prices were higher.
Even so, at the current gas production levels, the state will forgo more than $100 million in taxes in fiscal 2011, he said. Louisiana finds itself in the unusual position of lowering mineral revenue projections when oil prices are high and natural gas production is at the highest level since the early 1980s.
According to the Legislative Fiscal Office, mineral severance taxes will drop by an estimated $42 million to $700 million in the current fiscal year.
In fiscal 2012, severance taxes will drop $89 million; in fiscal 2013, they will be $121 million lower; and in fiscal 2014, severance taxes will be $162 million lower than they were in fiscal 2010.
Moreover, the Haynesville Shale is actually attracting rigs from areas where the wells actually pay severance taxes, further lowering the state’s mineral revenue, Albrecht said.
However, Albrecht said he doesn’t want to belittle the shale’s economic impact on the state.
All of the drilling and leasing activity has generated increases in sales tax collections, optimism about income tax collections and energy industry jobs in north Louisiana, he added.
In the 2008 and 2009 fiscal years, Louisiana received a total of around $194 million in bonuses, the payments energy companies made to begin leasing public land, Albrecht said. But last fiscal year, the bonus payments fell to around $27 million, around the usual level.
When the severance tax exemption was enacted in 1994, conventional wells drilled straight down, capturing the natural gas near the well bore.
In horizontal drilling, the pipe turns sideways when it hits the reservoir, collecting the gas for thousands of feet along the reservoir.
Nearly two-thirds of new wells in the United States are now drilled horizontally, according to the federal Energy Information Administration.
In spite of the common use of the technology, it’s unlikely that the horizontal drilling exemption will be removed. Gov. Bobby Jindal and many members of the Legislature oppose tax increases. In addition, the state constitution requires a two-thirds vote of legislators to eliminate a tax break
Even if state officials were willing to end the tax break, it might not be practical.
Economist Loren Scott said the basic problem is that Haynesville wells, which are much deeper, are also much more expensive than wells in other shales around the country.
The Haynesville Shale is a layer of rock about 10,000 feet underground. The formation extends from north central Louisiana to Arkansas and Texas.
The average Haynesville well costs $10 million, Scott said. A well in Pennsylvania’s Marcellus Shale is closer to $6 million; wells in Texas’ Eagle Ford also produce some nice, pricey oil to cover drilling costs.
Without the severance tax, Louisiana would see drilling rigs moving into lower-cost areas, Scott said.
“If Haynesville was the only game in town, the severance tax exemption might make no sense,” Scott said. “The problem is there are a number of competing fields, and rigs, of course, are very mobile. I think the only way to keep our play active is to keep that exemption.”
However, Albrecht said he doesn’t believe the tax break is what draws energy companies to the Haynesville Shale.
“They’re there, in my opinion, because it’s a 100 percent guaranteed hit on the formation, and you get your money quick,” Albrecht said.
Matt Ross, a spokesman for the Louisiana Oil and Gas Association, said the break-even mark varies from well to well and depends largely on the price of natural gas.
When the prices were $10 to $12 per thousand cubic feet, companies were recovering their costs in six months, Ross said. But with prices lower, it takes longer.
There were several months where the price fell below $4 per thousand cubic feet, Ross said. At those prices, it made no sense to drill, but companies continued to do so because they had already invested so much in the area.
Byron Henderson, a spokesman for the state Department of Revenue, said on average, it takes 18 to 20 months for energy companies to recover the cost of a well.
Albrecht said even after the exemption ends, Louisiana gains little in the way of severance taxes.
About 85 percent of the wells’ total production is generated in the first six months, Albrecht said. By the end of the first year, the well has basically been drained.