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Pennsylvania Senate Debate of House-Approved Gas Tax Looms

With less than a month remaining before an election that could change the makeup of both chambers of the Pennsylvania General Assembly, the state's Republican-controlled Senate is preparing to take up legislation (SB 1155) approved last week by the Democratic-controlled House that would impose a 39 cents/Mcf (about 10%) severance tax on natural gas drilling in the state.

The fate of the tax is far from assured as Republican leaders in the Senate blasted a "punitive" tax rate that they said would drive business to other states.

The final House vote on the bill, taken late Wednesday, was 104-94 (see Daily GPI, Sept. 30). Republican opponents of the bill have been touting their own proposal for a 1.5% tax for a well's first three years and then increasing to 5%. Gov. Ed Rendell, who has for some time said he favors a 5% extraction tax plus 4.7 cents/Mcf, last week told reporters that he would not sign legislation that would phase in the severance tax.

The House-approved bill would send 40% of the revenue generated by the tax, which would go into effect Jan. 1, 2011, to Pennsylvania's general fund and the remaining 60% would be divided up between environmental uses and allocations to municipalities and counties to deal with costs caused by drilling.

The bill had originally called for 60% of the revenue to go to the general fund, which faces a deficit. The House reversed the 60/40 allocation by a 154-45 vote on an amendment with some Republican support. But, while Democrats said they were encouraged by the bipartisan effort, one House Republican suggested the bill would be "dead on arrival" in the Senate, and GOP members of the upper chamber made it clear they want a much lower tax rate.

"Watching the debate and what seems to be the final product coming over from the House raises serious red flags with us here on the issue of Marcellus Shale policy here in the Commonwealth," said Pennsylvania Senate President Pro Tem Joe Scarnati (R-Jefferson). "First and foremost, the process that the House has embarked on didn't involve at all consultation with the Senate to try to get a product that we can get to the goal line...we're not going to entertain a tax rate here in the Senate that's punitive to this industry."

Scarnati and other Senate Republicans said the House may have violated the state's constitution by adding the severance tax language to a county bonding bill. Even if they were to pass the bill, it could get overturned in court, they said.

Marcellus Coalition President Kathryn Klaber said the "massive tax" approved by the House would have a negative impact "on job creation and investment in Pennsylvania," but said she was confident the bill would be altered in the Senate.

"A competitively structured tax in Pennsylvania that allows for critical capital reinvestment, coupled with smart regulatory and legislative modernizations, is key to ensuring that this historic opportunity is realized in ways that benefit each and every Pennsylvanian," Klaber said.

The Senate's task, according to Elizabeth McGinley, a tax law partner at the Bracewell & Giuliani law firm in New York, will be to find the tax rate that marks the tipping point between revenue enhancement and loss.

"Pennsylvania, like many other states, is in need of revenue, so you can understand" their interest in imposing the tax, McGinley told NGI. "But the countervailing concern is, are you going to drive business away? And I don't think anybody really knows what the tipping point is -- is it the 39-cent tax, the 20% tax? -- what is it? What is going to be the tipping point?

"It's really going to depend upon on two things: what the rate is set at, and where do people think gas prices are going to go?"

The House version of the bill set a floor of 39 cents with the ability for the rate to follow gas prices up, but no possible adjustment if prices fall.

"This could become really burdensome should gas prices fall even further," McGinley said. "It's entirely possible that that could be the case. With the 39-cent floor, that becomes much more onerous as the price drops dollar by dollar, or even by fractions of a dollar. People are saying that some producers are operating at a loss already but they need to produce to maintain their leases. Presumably they...expect that it's going to be profitable for them to do so in the long run. But if you really cut back short-term profits or increase short-term losses, I think it's going to be harder and harder for producers to make that decision."

The House-approved bill may be little more than a starting point for negotiations when it reaches the Senate and the two chambers begin their search for an acceptable middle ground. "A likely compromise is an industry-friendly 5%," according to analysts at FBR Capital Markets, who said there are indications that Republicans will gain seats in the legislature in the Nov. 2 elections, "empowering the industry in ongoing negotiations." In the end, Pennsylvania's severance tax rate will probably be about the same as that proposed by Rendell, they said.

"I have not heard any widely held view on the particular rate that they will settle on," McGinley said. "Obviously the dynamic we're looking at now is the relatively high rate passed by the Democrats in the House, and the Senate coming out and saying they're considering a lower rate and they're considering some other business-favorable provisions, including the pooling and the phase-in for the early years, but I have not heard a consensus around any particular rate." Rendell has said that pooling should be considered separately from the severance tax.

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