West Virginia And Pennsylvania Tax Policy For The Marcellus And Utica Shale Formations: Ensuing Border Wars?

In a tough economic climate where many states are cutting incentives and raising tax rates in an effort to increase revenue and close vast budget deficits, debate continues as to the extent that state and local taxation are affecting the exploration of natural gas from the Marcellus and Utica Shales. Such tax incentives may be overridden by logistical concerns such as access to production wells and ability to ship products to market via barge, rail, truck, and pipe. As the primary Marcellus Shale states, West Virginia and Pennsylvania are competing for the exploration, drilling, transportation, processing, and manufacturing of natural gas. The combined tax breaks and credits offered in West Virginia provide incentives for natural gas developers to extract natural gas in the state. In neighboring Pennsylvania, more than three years of legislative gridlock have given exploration companies a huge financial incentive to commence drilling operations in the Commonwealth.

Background

The Marcellus Shale formation may contain the largest single natural gas deposit in North America, and it lies in close proximity to premium East Coast markets.1 The Utica Shale, which underlies the Marcellus Shale by several thousand feet, is thicker than the Marcellus Shale and has the potential to be larger than any natural gas field known today. Less exploration and drilling has occurred in the Utica Shale, so estimates of the recoverable natural gas are still highly speculative, and it is unclear how this formation will respond to horizontal drilling and hydraulic fracturing. The Utica Shale also covers a wider area, including all of the Marcellus Shale states, but also covering portions of Ohio, Virginia, Kentucky, Tennessee, Lake Erie, Lake Ontario, and Ontario, Canada.2 This increased territory means the potential for more states to vie for shale drilling industry resources in the near future.

Marcellus and Utica Shale Development: Demand and Infrastructure

Access to potentially huge unconventional gas and oil resources has created a paradigm shift in the U.S. energy supply, with the potential wealth of this resource drawing attention from exploration and production companies, as well as ancillary pipeline, distribution, processing, and manufacturing companies that support the natural-gas industry. However, demand for natural gas is essential to ensure that market prices remain stable and that shale-focused exploration continues on an aggressive path. Arguably, the industry is at a crossroads for infrastructure to support production. While commodity prices remain low, it is imperative that Pennsylvania and West Virginia develop additional markets and industrial consumers to purchase the new supply of natural gas and that downstream companies fortify the existing infrastructure to ensure an affordable delivery system.

Industry Demand Adapting to Benefits from Plentiful Natural Gas Supply

In addition to local industrial and residential customers, large energy consumers are starting to relocate to the region to take advantage of the reduced costs of natural gas. As these energy consumers relocate, Pennsylvania and West Virginia have begun vying for this secondary boost to their economy and tax revenues. In addition to common energy-hungry industries such as steel production, electricity generation, and major manufacturing, other industries use the petrochemicals to create new products. Some natural gas, including much of the gas recovered from the Marcellus Shale, is "wet" gas. Wet gas includes petrochemicals, known as natural gas liquids ("NGLs"), in addition to methane. These NGLs include petrochemicals such as ethane, propane, and butane. NGLs must be removed in order to create "pipeline quality" methane, and at the same time, NGLs are useful in numerous applications. For example, polyethylene, a derivative of ethane extracted from wet gas, is an important raw material for the plastics industry.

Shell Chemicals Limited announced on June 6, 2011 that it will build a "world-scale" ethylene cracker in the Appalachian region.3 As a leader in gas technologies, Shell has an array of long-term options to monetize natural gas. The location of Shell's cracker facility will materially affect gas production and increase job growth in the selected state venue. Like Shell Chemicals, Dominion Resources, Inc. is proceeding with its next major project, the construction of a large natural gas processing and fractionation plant, in the Marcellus and Utica Shale regions.4 Dominion plans to locate the plant along the Ohio River in Natrium, West Virginia. The first phase of construction includes facilities that can process 200 million cubic feet per day of natural gas and fractionate 36,000 barrels per day of NGLs. The new facility is a response to the need for additional processing and fractionation capacity in the region. The rising price of oil and the low price of natural gas have shifted drilling activity in the Appalachian region from the dry gas areas to the wet gas areas, as producers look to capture the economic value of NGLs.

Natural Gas Infrastructure Strained to Keep Up with Production and New Demand

Pipelines and storage are essential to creating new markets for natural gas. Existing pipelines are used to transport large volumes of gas across state lines and to high-demand end users. Infrastructure at the right scale from the wellhead to major transport pipelines needs to be built, but the topography of the Appalachian Basin is a major challenge. The sharp production increase is already stressing some existing Appalachian gathering and processing infrastructure, which was originally built to service relatively small, low-pressure gas wells. The production profiles of Marcellus wells are significantly different; their high initial production rates, high pressures, steep decline curves, and significant liquids production in some areas represent challenges for midstream infrastructure developers. Pending completion of an integrated multistate distribution system, additional storage capacity in Pennsylvania and West Virginia is important to the continued development of the Marcellus formation.

Marcellus Shale Development in West Virginia

West Virginia has been greatly affected by Marcellus Shale development. According to the West Virginia Department of Environmental Protection, as of December 2011, approximately 2,290 Marcellus Shale wells had been drilled in the state.5 Also, West Virginia's underground natural gas storage...