The Marcellus Shale Formation: Pennsylvania's Natural Gas Severance Tax Controversy

Pennsylvania has a long history of producing natural gas from a large number of conventional shallow low-production wells, principally for domestic household use. Only Texas has more currently active wells.1 Pennsylvania ranks 15th in natural gas production among U.S. states, and it is the largest producer without a Severance Tax.

The advancement of drilling technology and water treatment has strengthened the economic viability and long-term return on investment of extracting natural gas from the Marcellus Shale formation. Marcellus Shale is a unit of marine sedimentary rock found in eastern North America. It extends throughout much of the Appalachian Basin extending across West Virginia; western Ohio; western, central, and northeastern Pennsylvania; southwestern New York; and small portions of Virginia and Maryland.2 The shale contains largely untapped natural gas reserves that, according to several studies, could conservatively supply U.S. consumption for nearly two decades.3 The Marcellus Shale formation is estimated to be 10 times larger than the Barnett Shale formation in Texas and is attracting attention from major Texas-based natural gas production companies and big oil companies.

The Pennsylvania General Assembly, divided by party lines in a gubernatorial election year, has been embroiled in a fierce debate over whether or not the Commonwealth should enact an extraction tax on natural gas that parallels the tax imposed by other shale-gas-producing states, including West Virginia, Texas, and Arkansas. On July 6, 2010, Pennsylvania Governor Edward G. Rendell signed Pennsylvania Act 46 into law, representing the Commonwealth's fiscal code for the year ending June 30, 2011. Under Act 46, the Pennsylvania's General Assembly committed itself to passing a severance tax on the extraction of natural gas by October 1, 2010, to be effective no later than January 1, 2011. Although 39 states currently have some type of severance tax, including taxes on both coal and natural gas, Pennsylvania, which has long been a major coal producer, has never imposed a severance tax on coal, natural gas, or any other natural resource. The Pennsylvania General Assembly has now missed the October 1 deadline and seems to be at an impasse. Governor Rendell remains hopeful that a compromise will be reached on the shale gas tax rate and on a plan to distribute the new revenue before the legislative session ends on November 30. However, Pennsylvania will elect a new governor on November 2, leaving Rendell a lame duck.

On November 14, the Pennsylvania Senate wrapped up its final scheduled work day of the 2009–2010 legislative session. The chamber took no action, however, on the proposed imposition of a tax on natural gas extracted from the Marcellus Shale. Neither legislative body is currently scheduled to return until the next legislative session after the November 2 elections, although they could be recalled.

The Issue in Context

A severance tax is a tax imposed on the extraction of a state's natural resources. In various states, severance taxes are charged for removal of natural resources including natural gas, coal, timber, and salt. In the case of a severance tax on natural gas, the tax is generally payable by both the gas well operator, who extracts the natural gas, as well as anyone else with a working or royalty interest in the natural gas.

The fact that significant amounts of natural gas exist underneath most of Pennsylvania has been known for some time. In 2002, the United States Geological Survey estimated that as much as 1.9 trillion cubic feet of gas existed in the Marcellus Shale. However, that gas was spread over a large area, and, until recently, the technology did not exist to profitably extract the gas. Recent advances in technology, along with anticipated future increases in natural gas prices, have significantly brought down the real and perceived costs of extracting natural gas from the Marcellus Shale, leading to a speculative investment and production boom during the last few years.

Shale formations, such as the Marcellus Shale, are not unique to the northeast United States. Early advances in natural gas extraction from shale formations occurred in the Barnett Shale located in Northern Texas. Techniques developed to extract natural gas from the Barnett Shale have since been successfully employed in the Fayetteville Shale in Arkansas and the Haynesville Shale in Louisiana along with the Marcellus Shale. Drilling companies hope to expand this technology to extract natural gas from previously ignored natural gas plays around the world.

Along with the possibility of significant natural gas production in Pennsylvania comes the possibility of additional revenue for the Commonwealth. In February 2009, Governor Rendell announced that he would seek the imposition of a severance tax on natural gas produced in Pennsylvania. Since that announcement, the tax has been the source of vigorous debate.

During the current 2009–2010 legislative session, there have been numerous separate bills introduced in the Pennsylvania House and Senate proposing various forms of a severance tax. The debate has been divided along traditional lines, with environmentalists and Democrats largely supporting a higher severance tax, while industry and Republicans seek lesser or no taxation.

Pennsylvania, like many states, is facing a substantial budget deficit as a result of shrinking stimulus funds, rising pension costs, and declining tax revenues. The Commonwealth needs to generate new sources of revenue or drastically cut spending to balance its budget. Both gubernatorial candidates, Corbett and Onorato, have cited wasteful spending as a principal basis for reform under new leadership. An extraction tax is one of the few options available that will not constitute an across-the-board tax increase on all Pennsylvanians. The Rendell admistration has argued that a severance tax is necessary partly to compensate local residents for the disruption and environmental degradation caused by gas drilling. A major policy question at this juncture, apart from the environmental risks, is whether or not a severance tax will negatively affect...