The administration of Ohio Gov. John Kasich is proposing to "modernize" taxes and regulations on the oil and gas industry, aiming to cut income taxes by capturing revenue from the prospective Utica Shale boom.

The comprehensive energy policy plan released Wednesday would shift taxes on unconventional oil and gas to a more progressive tax, a percentage of gross receipts that the governor expects will return between $500 million and $1 billion to the state over five years.

The proposed tax change initially would hit harder at the higher-priced oil and natural gas liquids (NGL) and relieve some of the burden on lower-priced dry natural gas. The new tax proposal is atop a10-pillar energy plan included in the mid-biennium review the Kasich administration recently unveiled.

The plan calls for restructuring energy taxes, toughening regulations and enhancing workforce development to prepare for a shale boom. It touches on common concerns such as chemical disclosure and pipeline safety, but also considers less commonly discussed problems, such as the need to boost electricity supplies across the state to accommodate increasing industrial activity.

The proposed tax changes include a shift to progressive taxes tied to price as well as to production, but also include a per well impact fee to help local governments offset development.

The first major update in the energy tax structure in 40 years would reduce income taxes "dollar for dollar" to the tune of $900 million to $1 billion over the next five years. At peak production from the Marcellus and Utica, those tax cuts could be as much as $500 million per year. "We believe that by modernizing our energy taxes, we can allow all 11.5 million Ohioans to benefit," Kasich said. "We are going to have low taxes, at the end of the day, on energy. The question is: who benefits? Do the out-of-state oil companies benefit or Ohioans benefit by having lower income taxes?"

The current tax structure includes what is effectively a 20 cent/bbl tax on oil, a 3 cent/Mcf tax on natural gas and no individual tax on NGLs. The proposed changes would separate conventional and unconventional wells, and also tax different products at different rates.

In an effort to let producers recover costs quickly, high-volume horizontal oil and NGL wells would initially be taxed at 1.5% of gross receipts for the first year. A producer that didn't recoup its investment in the first year could apply to extend the reduction for a second year, but would subsequently pay a standard rate of 4% of gross receipts for the remainder of the life of the well.

But for unconventional gas wells, the proposal would shift the tax rate from 3 cents/Mcf to 1% of gross receipts. At prices below $3/Mcf, that would represent a tax cut. As of Tuesday, Marcellus gas in southwestern Pennsylvania and West Virginia, the closest point to the Utica, traded for a combined average price of $2.11/Mcf, down 7 cents, according to NGI's Shale Price Index.

Producers would be taxed quarterly. The proposed tax would keep enough revenue to cover regulatory costs and place the remainder in a special fund to reduce income taxes in all brackets.

The proposal benefits existing producers, eliminating the severance tax on conventional gas wells that produce less than 10 Mcf/d, around 90% of the 44,500 wells already in the state. Conventional wells producing above that level would pay a 1% tax on gross receipts up to a cap of 3 cents/Mcf.

The tax structure for conventional oil and NGL wells would remain unchanged.

The proposal also includes a $25,000 per well fee that companies would pay upfront to local governments to offset the impacts of development, but the administration insisted the fee is "not a tax," is "revenue neutral" and is "simply delivering funds to locals more quickly that the current system allows." It also said that oil and gas companies would get the money back "over time."

Similar to Pennsylvania, where policymakers bundled taxation and regulations into an omnibus bill, the Kasich proposal includes numerous changes to the way the state oversees development.

Under the proposal the Ohio Department of Natural Resources would implement new well construction standards and require producers to disclose the chemical used for development; the Public Utilities Commission of Ohio would implement new pipeline safety standards; the Ohio Environmental Protection Agency would encourage wastewater recycling to reduce the reliance on underground injection wells; and the Ohio Department of Transportation would development a model road ordinance to help local governments manage increase truck traffic from operations.

The bill also aims to streamline permitting across the board for oil and gas operations.

Additionally, Ohio plans to request primacy from the federal government for wetlands permitting.

The policy emerged from a two-day energy summit in September 2011 where the state set out a goal to become energy independent and "identified shale as a major game-changer," according to Wayne Struble, policy director for Kasich (see Shale Daily, Sept. 28, 2011; Sept. 26. 2011).

As it crafted its regulations, Ohio spoke to officials in North Dakota, Pennsylvania and West Virginia and ultimately performed a risk assessment on activities, Struble said. "We tried to learn lessons from them, what they did well, what they did poorly and what we need to look out for."