Economists at odds over natural gas

The state of Louisiana would intake more revenue by maintaining a tax break for natural gas extraction companies, according to a study released by a prominent economist with ties to the oil and gas industry.

Dr. Loren Scott, professor emeritus of economics at Louisiana State University, said reneging on the 16-year severance tax exemption on horizontal wells would remove the incentive for exploration and extraction companies to utilize a disadvantaged Haynesville natural gas shale.

“There was so much economic activity created [at the Haynesville Shale] that the state collected a very large sum of money off of the incomes that were generated up there and that way more than offset what they lost from mineral revenues, not having the tax on for two years,” Scott said.

In Scott’s report, titled “The Economic Impact of the Horizontal Well Severance Tax Investment Incentive” and commissioned by the Louisiana Oil and Gas Association, he estimated economic activity from the Haynesville Shale contributed $367.7 million to the state’s coffers.

The Louisiana Department of Revenue said it lost $167.5 million directly from the tax exemption in the 2010 fiscal year.

Scott argued the economic activity would go the way of the tax exemption, which serves as an incentive to bring drilling and exploration companies to an area with an inherent disadvantage – higher drilling costs and a lower return on investment.

As per the report’s sensitivity analysis, if the severance tax exemption were repealed and the shale suffered a 25 percent reduction in play, the state would lose out on $3.5 million in 2012, $13.1 million in 2013 and $20.9 million in 2014. The report also calculated a 50 percent reduction.

Louisiana Chief Economist Greg Albrecht said the analysis implies an exodus, which Albrecht said is not likely considering the exemption only relieves the companies of about a 4 percent increase in costs. The tax rate is 16 cents per thousand cubic feet.

“Economic theory will say if costs go up for any reason, whether it’s a tax, labor costs, shortage of raw material, for whatever reason, you will typically get less of whatever activity it is you are studying, if you are looking at everything else held constant,” Albrecht said. “But everything else is not constant.”

Albrecht said he doesn’t doubt that companies would leave Haynesville if the incentive were repealed. But he added that the costs of doing business are in a constant state of flux, with technological advancements bringing down costs.

“The increase of a cost from a severance tax increase, in this case, or any other reason that might raise costs are never happening in isolation,” Albrecht said. “I don’t think it’s entirely realistic that if costs go up by 4 percent because the exemption goes away, you get dramatic changes in activity.

“I can’t see a reduction in the production of gas, which, from my perspective, that’s really what’s most important. It’s really not about drilling and wells, it’s about gas production because, to me, the direct mineral revenue is the first thing we’re looking at.”

In his report, Scott outlined the reasons Haynesville is disadvantaged when compared to other oil and gas plays throughout the country before he quantified the loss in sales tax revenue and general economic activity the state would suffer if an exodus were to ensue.

Haynesville ranges from $9 million to $9.7 million in cost to drill a well, the report said. Well costs in Marcellus Shale in Pennsylvania and the Eagle Ford Play in south Texas hover around $6 million.

Haynesville rigs average a 15.9 percent return on equity, compared to 22.9 percent in Marcellus and 34.5 percent in Eagle Ford, according to a Credit Suisse survey referenced in the report.

The success rate at Haynesville is consistent with those at other regions, around 98 percent, the report said.

Albrecht said that while he doesn’t believe a dramatic downturn in production would occur if the exemption was repealed, “there may be a steady downgrade in their activity for all the reasons he talked about but had nothing to do with the exemption.”

The Haynesville Shale rig count declined from 137 to 115 from February 2010 to February 2011, according to Scott’s report.

“Plus in the Eagle Ford and some in the Marcellus, when you drill you can get natural gas and oil,” Scott said. “Because oil is so high-priced right now relative to natural gas that is a real plus.”

The Haynesville Shale has been estimated to hold 200 trillion cubic feet of natural gas. Natural gas futures were between $4.30 and $4.40 per thousand cubic feet last Friday, when crude oil futures were trading for $105.

Act 2 of the 1994 Louisiana Legislature Regular Session suspended severance tax on any horizontally drilled wells. The exemption lasts for two years from the start of production or until the well produces enough revenue to match the well cost, whichever comes first.

Drilling in the Haynesville Shale must be done horizontally, which requires the rig to go about 2 miles vertically into the ground and one mile horizontally through rock, which is done via fracking.

The Associated Press reported in March that Gov. Bobby Jindal said he would not sign a law that changed natural gas tax exemptions.