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Low natural-gas prices sink tax revenue

By Jessica Seaman

This article was published December 16, 2012 at 3:05 a.m.

— Severance-tax revenue paid to the state from natural-gas production has fallen about 32 percent through November, compared with the same period last year, because of persistently low natural-gas prices.

As a result, the state and local agencies the money is allocated to will get less funding this fiscal year.

As of November, the state Department of Finance and Administration has received about $36.85 million in natural-gas severance-tax revenue this calendar year. In 2011, excluding the month of December, severance-tax revenue was $54.4 million.

During peak drilling in the Fayetteville Shale in 2008, natural-gas prices on the New York Mercantile Exchange ranged from $6 per million to $10 per million British thermal units. That July, prices hit $13.50 per million Btu.

Prices this year have hovered below $3 per million Btu and have yet to hit $4 per million Btu. In April, the price of natural gas dipped below $2 per million Btu.

The price tried to rebound in November when it reached about $3.90, but warm autumn temperatures pushed it back. Natural-gas prices settled Friday at $3.31 per million Btu on the New York Mercantile Exchange.

The large amount of shale drilling across the country has also pushed natural-gas prices down this year, said James Williams, an energy analyst who operates WTRG Economics near Russellville.

“So we continue to have slow drilling activity” in the state, he said. “It won’t pick up here in Arkansas until prices get up to $4.”

There were 33 drilling rigs operating statewide at the start of 2012, but by April that number slid to 23 rigs and by June the number was in the “teens,” said Kelly Robbins, executive vice president of Arkansas Independent Producers and Royalty Owners Association. The number bottomed out at 15 rigs in October.

On Friday there were 17 rigs operating in Arkansas, according to oil field services company Baker Hughes.

An increase in natural-gas production in Arkansas since 2011 has not been enough to offset the drop in severancetax revenue caused by the low market price for gas.

There are about 9,300 natural-gas wells in Arkansas with about 4,450 of them in the Fayetteville Shale. At the end of 2011, there were 8,700 natural-gas wells in the state, 3,800 of them in the Fayetteville Shale.

Most severance taxes are determined by multiplying the quantity of the commodity by a tax rate determined by the state, said Tim O’Brien, miscellaneous tax section manager for the Department of Finance and Administration.

The natural-gas severance tax in Arkansas is calculated by multiplying net market value and the set tax rate. The net market value is determined by multiplying taxable production by the current market price of gas.

“So you have a threelegged stool there that can change and affect tax revenue,” O’Brien said.

The tax rate ranges from 1.25 percent to 5 percent, depending on the type of well and how much gas it produces. New wells, whether conventional vertical or high-cost horizontal, are initially taxed at a 1.5 percent rate.

Conventional wells stay at the 1.5 percent tax rate for two years. After that, the rate rises to 5 percent.

If a well cannot produce at a rate of 2,500 cubic feet per day, the well operator can ask the Arkansas Oil and Gas Commission to declare the well “marginal,” which would lower the tax rate to 1.25 percent.

Horizontal wells are taxed at 1.5 percent for 36 months, before moving to the 5 percent tax rate.

If there is no well payout, meaning the costs of leasing, exploring, drilling and operating have not yet been covered by production within the three years the well has been producing, then the operating company can ask the Department of Finance and Administration to hold the tax rate at 1.5 percent for another year or until the well becomes profitable.

After the additional year or when a well becomes profitable, it is taxed at the 5 percent tax rate.

Horizontal wells that can’t produce more than 1,000 cubic feet per day can be declared “marginal” by the Oil and Gas Commission and can be taxed at the 1.25 percent rate.

The number of wells being taxed at the 5 percent tax rate has increased from 2011, said Shane Khoury, assistant director of the Oil and Gas Commission.

In December 2011, about 23 percent of the wells in the state were taxed at the full rate. As of November 2012, about 28 percent of the wells were taxed at the full rate.

Khoury said more wells are being taxed at 5 percent because they have been in operation for several years.

“A lot of Fayetteville Shale wells are starting to move out of that three-year time period,” he said. “A lot of those wells drilled in 2008 are moving to that full-rate category.”

About 95 percent of the severance-tax revenue is allocated to state and local agencies for highway repair.

Since less money will come in from the collection of the tax, the state Highway and Transportation Department, which receives most of the severance-tax revenue, expects a funding shortfall for repair of highways in the 10 Fayetteville Shale formation counties in north-central Arkansas.

“We have been using the money to repair and rehabilitate the highways in the Fayetteville Shale area that have been damaged because of the natural-gas exploration and production,” said Highway Department Director Scott Bennett. “So it is going to slow down the rate we are going to be able to make those repairs.”

From the start of the department’s current fiscal year in July to October, when the latest numbers are available, the Highway Department has received $7.9 million in natural-gas severance-tax revenue — a 43.6 percent decrease from the $14 million it received last year during the same period.

“Actually, we’ve tried to budget for the decrease in revenue but it’s coming in short,” Bennett said.

Bennett said the slump in revenue will mean the agency will be able to repair some roads, but not as many as before.

Since the Highway Department’s fiscal year begins in July, the agency lets money build up during winter, and in the spring starts to “overlay roads,” or add between 2 and 4 inches of asphalt.

Bennett said trucks that carry the equipment used for construction and maintenance of natural-gas wells damage highways because one well requires between 1,800 to 2,000 truckloads of equipment.

“The roads weren’t designed to carry heavy truck traffic,” he said.

The department is not able to shift money from other revenue sources to cover the cost of repairs because the rest of the agency’s revenue is designated for other projects.

He said the revenue from the severance tax was supposed to be additional revenue for highways statewide, but the department needs it to pay for Fayetteville Shalerelated repairs.

A 2009 Highway Department assessment put the amount of damage caused to roads in the Fayetteville Shale counties by work on naturalgas wells at $450 million. At that time, the Highway Department had collected about $90 million in severance-tax revenue.

“It’s been tough to keep up with it,” Bennett said. “We’ve done as good of a job as we can do.”

Business, Pages 71 on 12/16/2012

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