Twenty cents for a barrel of oil. That's the mantra proponents of the severance-tax increase on oil and gas production have been repeating throughout the state since it was proposed in 2012. While it's a catchy phrase, it's not an accurate depiction of the tax reality facing Ohio's oil and gas producers.
In addition to the severance tax, which was increased only three years ago, oil and gas producers also pay income, sales, ad valorem (a property tax exclusive to oil and gas) and the commercial activities tax, or CAT. The administration's proposed tax increase of 4 percent on oil amounts to a 1,500-percent tax increase. I believe you would be hard pressed to find a taxpayer who believes that's a "modest" increase. Furthermore, the severance tax would also be collected whether or not a well was profitable, which means it equates to a 4 percent gross-receipts tax on oil.
Proponents of the severance tax increase often point to tax rates in other oil-and-gas-producing states to justify increasing the tax in Ohio. But once again, they often fail to take into account the fine print. For example, Texas has a 7 percent severance tax rate, but it offers very generous abatements to oil and gas companies to offset the tax.
There is also no income tax in Texas. Then there's Pennsylvania, home of the most active shale play east of the Mississippi. Pennsylvania debated a severance tax for several years, but decided against the move because of concerns that it could curtail investment and development. Conversely, West Virginia, which has a 5 percent severance tax rate, has seen drilling activity decline in recent years.
Oil and gas exploration is an incredibly expensive and risky endeavor. Companies could spend upward of $12 million per well with no guaranteed return on investment. Despite the risks, the companies drilling in Ohio's Utica shale are not asking for tax incentives or corporate welfare, just a competitive tax structure that will allow them to reinvest their profits back into the ground and, subsequently, into workers, businesses and communities throughout the state.
The benefits from shale-energy development are already being experienced in towns and cities throughout Eastern Ohio, many of which have struggled for decades. Today, unemployment rates are decreasing and sales-tax revenue is skyrocketing in communities with active drilling. Some municipalities have seen sales-tax revenue increase more than 20 percent in recent years.
According to a recent study conducted by the respected analytic firm IHS, Ohio currently has more than 38,000 good-paying jobs related to energy development within the state's Utica shale formation - a number that is expected to grow to more than 140,000 by 2020.
Now, with job numbers like those, one would think that the administration would put out the welcome mat for the energy companies that have invested billions to explore the Utica shale play. Instead the administration labeled those out-of-state businesses as "foreigners" and introduced the severance-tax increase on oil and gas production to keep said "foreigners" from taking profits made from Ohio's natural resources out of the state.
This is a ridiculous notion. First of all, many out-of-state companies have partnered with independent, Ohio-based oil and gas producers on exploration and drilling activity who are sharing in the risks and profits.
Secondly, a lot of the oil and gas produced in Ohio will stay in the state. Manufacturers throughout Ohio depend on oil and gas to fuel their operations and having a steady supply will help them grow, which means more jobs and economic opportunities for Ohioans.
With a diverse manufacturing base, Ohio will not fall prey to what some pro-tax advocates have called the "natural-resources curse," where resource-based economies are doomed to a cycle of boom and bust.
Thirdly, despite widely held public opinion, oil and gas production has a fairly low profit margin of approximately 7 percent. But even when a profit is made, the majority of oil and gas producers reinvest it right back into the next well. It should also be noted that Ohio land and royalty owners, many of whom are farmers, would also be burdened with the increased severance tax.
While Ohio has a long heritage of oil and gas production, the fact is that we're still in the research-and-development phase of Utica shale development. Though the Utica holds great potential, we may not know its real value or viability for months or even years to come.
If the severance-tax increase is enacted and the Utica fails to live up to expectations, the math may not make sense for some companies and they might choose to invest in one of the other promising shale plays in the U.S. or abroad. Already some companies have left Ohio or have substantially curtailed drilling activity. While Ohio's oil and gas producers support the governor's efforts to reduce the income tax for hardworking Ohioans, if Utica development is diminished, how will the administration fund its income-tax reduction?
Is increasing the severance tax a good idea? No. It's an ill-conceived, unsustainable tax proposal based on inaccurate information that could endanger the state's growing shale industry and place job creation and Ohio's economic future at risk.
(Stewart is the executive vice president of the Ohio Oil and Gas Association, which is located in Granville.)