With various state legislatures gearing up around the country, it is timely to take a look at how the oil and gas industry might be impacted in some of the key oil patch states. Two of the big ones – Texas and Oklahoma – are especially interesting for different reasons.
When the Texas Legislature convened this past Monday, it inherited what is perhaps the most positive economic and budget situation in the state’s entire history. In his opening message to the biennial session, State Comptroller Glenn Hegar informed the legislators that the state’s booming economy has given them room for a two-year budget of $119.1 billion, up 8% from the $110.2 billion that covered the previous two years.
This healthy budget situation exists thanks largely to the enormous boom taking place in the Permian Basin, which spans much of West Texas and a portion of Southeast New Mexico. Mr. Hegar further estimated that the state’s Rainy Day Fund – which is funded almost entirely via the state’s oil and gas severance tax – would reach an unprecedented balance of $15 billion during the biennium.
All of this economic good news likely eliminates any real potential of the legislature seeking to increase taxes on oil and gas, but the industry will certainly face an array of other issues during the session, which runs through the end of May.
Eminent domain is likely to be one of those issues, thanks in large part to the massive build-out of pipeline infrastructure designed to transport rising volumes of Permian oil and gas to refineries, processing facilities and ports along the Gulf Coast. With a dozen or more significant projects traversing the breadth of the state, thousands of landowners are having the experience of negotiating damage agreements in exchange for the pipeline rights of way coming underneath their property.
Although well over 90% of these negotiations are resolved amicably, a portion of them aren’t, and that is when the pipeline company has to decide whether or not to exercise its eminent domain rights under Texas law. Obviously, that exercise will generate tension, controversy and complaints to members of the legislature.
The legislature has wrestled with bills related to eminent domain in each of the last four sessions, but ultimately has failed to pass bills containing major revisions to the law. While the industry will certainly be faced with other issues this session, involving roads, seismicity and an array of water-related matters, the issues around eminent domain may well assume the highest profile.
This state’s legislative session will be interesting for entirely different reasons. Oklahoma has found itself in a chronic budget deficit situation since the oil price collapse took hold in 2015. Production and ad valorem taxes on the industry fund a sizable portion of the state’s government, and the industry’s level of activity also impacts the state’s income and sale tax collections, either positively or, as during the downturn, negatively.
However, things are looking somewhat better going into this year’s session, which convened on Tuesday. State Treasurer Randy McDaniel informed legislators on Wednesday that the state’s revenue collections for 2018 rose by 13%. Leading the way was the state’s gross production tax (GPT) on oil and natural gas, which was up by a whopping 84% year over year.
This is no surprise for a couple of reasons:
- The Oklahoma GPT is a price-sensitive tax, and crude prices rose substantially for most of 2018; and
- The legislature, in its ongoing efforts to balance the budget during the downturn, raised the rate of the tax significantly in both the 2017 and 2018 sessions.
Unfortunately for the industry, the recent pullback in both oil and natural gas prices is causing concern that state revenue from the industry could drop again in 2019. This is encouraging the the same groups and individuals who agitated in favor of raising rates the past few years to once again push legislators to raise them even higher this year. One such group is the Oklahoma Energy Producers Alliance (OEPA), a coalition that represents a small number of vertical-well producers who don’t drill many wells in the state, and whose wells do not qualify for some of the lower initial production rates offered for the drilling of horizontal wells under the GPT rules.
Another vocal advocate for raising the GPT rates in recent years has been billionaire George Kaiser, one of the founders of the Kaiser Francis Oil Company that is based in Tulsa. Kaiser’s own investments are widely diverse and global, including investments in solar (his foundation held a $340 million stake in now-bankrupt solar panel manufacturer Solyndra) and an LNG company with both domestic and international operations headquartered in Texas called Excelerate Energy. Kaiser’s major investments in other states, countries and renewables, none of which bear any tax that corresponds to the Oklahoma GPT, make him seem an unlikely advocate for raising tax rates on Oklahoma producers. As a result, his vocal support for higher taxes caught many of his industry peers off-guard, and greatly complicated the issue for the industry’s advocacy groups.
While the prospect of oil and gas-related tax collections falling in 2019 is understandably concerning to the legislature, the members have a real balancing act to perform. Even with the higher oil price during 2018, the Baker Hughes rig count in the state’s prolific SCOOP/STACK play dropped by almost 20% as the GPT rates rose. This was a highly predictable outcome given that producers’ capital dollars will chase projects with the highest anticipated rate of return on investment.
It is no surprise that raising the rates each of the last two years has led to a lower horizontal rig count. These lower initial rates (they rise back to the standard 7% rate after an initial production period) were put in place to stimulate the drilling of horizontal wells and attract capital dollars into the state in the first place. A higher rate of tax equals a lower rate of return. It isn’t real complicated.
Incoming Governor Kevin Stitt gets it. He warned lawmakers in December not to consider the stronger revenue situation as some sort of “blank check,” and encouraged them to conserve as much of the surplus as possible. “Obviously, if commodity prices go down, that’s the reason we need to have a very tight savings plan,” Stitt said.
Meanwhile, representatives of the oil and gas industry at large are expressing their own hopes for a “quiet” session after the wild ones they’ve been through the past two years. Chad Warmington, President of the industry trade association OKOGA-OIPA, told reporters on Monday that “Peace and quiet was on our Christmas wish list.”
It will be very interesting to see if his Christmas wish is fulfilled. Given the complexity of the issue, it doesn’t seem likely.