Upfront costs of unconventional drilling techniques balanced against long-term prospects

NEW ORLEANS, La – A new study, commissioned by the Louisiana Oil and Gas Association, estimates that Louisiana would lose out economically over the long-term if policymakers discontinue the horizontal well severance tax incentive. But out of state industry figures have suggested that the incentive’s repeal would help close the state’s $1.6 billion budget gap.

Dave Meloy, an oil and gas consultant based in Colorado, is one such critic. He has argued that the tax incentive does not have any appreciable impact on drilling activity and is overly costly to Louisiana.

“Eliminating this incentive now will increase Louisiana’s revenue by $120 million per year for the next 40 years,” Meloy wrote. “From the beginning, oil and gas operators have needed no encouragement to drill for the Haynesville Shale. Haynesville Shale leasing activity has been called a modern-day gold rush.”

Dr. Loren Scott, author of the report and a former economics professor at Louisiana State University disagrees. Repealing the incentive would actually cause state revenues to decline, not increase, Scott concludes in his LOGA study.

State lawmakers created the tax relief program in an effort to spur unconventional oil and gas drilling and discovery efforts. The incentive is built around a two year severance tax exemption for horizontal and deep well operators

After examining the Louisiana Department of Revenue’s tax exemption budget data in 2010, Scott estimated that the state gave up $125.3 million, but gained $367.7 million.

“Thus, for every dollar of severance taxes given up under the horizontal incentive the state gained $2.94 ($367.7 million divided by $125.3 million) in revenues to the treasury, and the state got $16.9 billion in business sales, $4.3 billion in new household earnings, and 111,329 jobs to boot,” he writes.

Unfortunately for Louisiana, Scott notes, the recently discovered Haynesville Shale, located in the Northwestern portion of the state, sits at a competitive disadvantage.

To begin with, Haynesville wells tend to be deeper in comparison to those in other areas such as the Marcellus Shale located in the Appalachia region, which adds to the cost of drilling. Furthermore, the Haynesville operation includes mostly dry-gas production. This presents a challenge because oil prices are rising, while natural gas prices have remained steady.

Kevin McCotter, vice-president of corporate development and government relations with the Chesapeake Energy Corporation, anticipates that Louisiana will experience strategic gains over the next few decades that will balance out initial costs of the tax incentive.

“Development of natural gas in unconventional reservoirs like the Haynesville and Bossier Shales is a capital intensive process using new horizontal drilling technologies,” he says.  “A typical Haynesville well can cost between $8.5 – $10 million dollars.  With over 1000 wells already drilled and completed in the Haynesville, and thousands more to be drilled over decades to come, Louisiana is poised to take advantage of a renaissance in natural gas.”

Removing the tax incentive would only “sharpen Haynesville Shale’s competitive disadvantage and hasten the movement of exploration firms from the area,” Dr. Scott warns.

“Think of the Louisiana economy like one large economic pond,” Scott writes. “Into this pond is dropped a rock of $11.5 billion by the Haynesville Shale direct spending. That rock is so big that it makes quite a splash on its own. However, once hitting the pond it causes ripple effects out to the edge of the pond, creating new jobs in construction, retail trade, health care, etc. – what economists call the multiplier effect.”

Between 2008 and 2009, exploration companies spent $11.5 billion that was directed into the Louisiana economy, according to the study.

“Every natural gas drilling rig operating in the Haynesville is responsible for 180 direct and family-sustaining jobs in our economy,” McCotter said.  “The multiplier effect is enormous with contractors and other jobs created in other sectors of our economy.  In 2009 alone, the Haynesville was responsible for over 57,000 jobs, almost $1 billion in state and local tax collections, $10.6 billion in new business sales within Louisiana and nearly $5.7 billion in household earnings, including $957.3 million in lease payments and $305.9 in royalty payments.”

These results demonstrate that the tax incentive is fulfilling its policy objectives, McCotter added.

Kevin Mooney is an investigative reporter with the Pelican Institute for Public Policy. He can be reached at kmooney@pelicanpolicy.org. Follow him on Twitter.