Radical and reckless: The truth about SB 2336, the GOP oil tax plan

Summary

During the 2013 legislative session, the GOP majority has advanced SB 2336, legislation dealing with the taxation of oil activity in North Dakota. Misleadingly billed by GOP legislators as a mere “restructuring of the state’s oil taxes[,]“  SB 2336′s operative component is a dramatic 31% reduction in the state’s oil extraction tax (from 6.5% to 4.5%) for new wells drilled after December 31, 2016.

SB 2336 has also been sold as a mechanism to close the “stripper well” loophole. Instead of closing this loophole, however, the legislation effectively enshrines it for existing wells while simultaneously ensuring that high-producing wells will someday be considered stripper wells and, therefore, exempt from the oil extraction tax.

While the legislation makes other seemingly-benign changes to existing law, the inclusion of these unrelated provisions in SB 2336 serves only one purpose: To sow confusion and hide the dramatic cost of the proposed oil extraction tax cut to the people of North Dakota.

In truth, the extraction tax cut contained in SB 2336 is projected to cost North Dakota nearly $595 million in the first five years of alone and, literally, tens of billions of dollars in the coming decades.

SB 2336 is not a simple restructuring. It is radical and reckless.

Section by section analysis of SB 2336

Section 1

WHAT IT DOES: Requires annual certification of “stripper wells,” which are low producing wells that are exempt from oil extraction taxes. Presently, a well that is certified as a stripper is not subject to recertification or review at any time after it is granted stripper well status (i.e., “Once a stripper, always a stripper.”). This diverges from the national norm. In the absence of stripper well recertification in North Dakota, even high-producing Bakken wells are often exempt from the extraction tax because they were long-ago certified as strippers.  The Tax Department estimates that this loophole costs the state around $50 million per year.

THE CATCH: Because “[t]he requirement of annual classification . . . applies only for wells drilled and completed in the Bakken or Three Forks formation[,]” the legislation essentially draws a perimeter fence around one part of the state when it comes to addressing the unfairness of stripper well tax policy. In so doing, it creates another loophole outside of this area. Further insight on why this bill falls short of correcting the stripper well problem is provided in the summaries of sections 3 and 6 below.

Section 2

WHAT IT DOES: Makes changes to withholding requirements for payments made to royalty owners who are non-North Dakota residents.

THE CATCH: The only reason for including this provision in SB 2336 is because it serves the tactical purpose of showing a positive fiscal effect on the treasury in the short term, thereby muddling the issues and masking the massive cost of the extraction tax cut in the long run.  As stated in the fiscal note, which only accounts for the effect of the bill during the next biennium, the changes in this section are “expected to increase state general fund revenues by an estimated $4.2 million” in the next two years “due to a speed-up of income tax collections from the withholding on royalty payment provisions.” Prior to the introduction of SB 2336, the withholding issue was addressed in SB 2104, a routine “housekeeping” bill introduced by the Office of the Tax Commissioner. The provision was amended out of that bill on February 12, 2013 so that it would exist only in SB 2336.

Section 3

WHAT IT DOES: Redefines “stripper well property.” Specifically, stripper well status would adhere to individual wells in the Bakken and Three Forks formations only if they produce 40 barrels per day or less (this is actually up from 30 barrels per day under current law). For the sake of perspective, the national average for classifying a well as a stripper is an average daily production of 10 barrels per day. Neighboring Montana also sets stripper well status at 10 barrels per day.

THE CATCH: In a moment of candor to the Bismarck Tribune on January 28th, House Majority Leader Al Carlson said, “Our stripper well tax policy is just plain bad tax policy[.]” This provision arguably only makes bad tax policy “less bad” by redefining stripper wells as those producing 40 barrels per day or less. Again, this is four times higher than the industry standard nationally. Further, as discussed more thoroughly in section 6 below, the relatively complex  issue of when stripper status adheres depends not only on production level, but also on when the well is drilled.

Section 4

WHAT IT DOES: Amends several definitions which impact the extraction tax. Most operatively, this section removes the “trigger price[,]” which was set at “thirty-five dollars and fifty cents” in the 1980s and continues to be“indexed for inflation.” These triggers provide a measure of protection to the oil industry against full taxation in the event of a sharp drop in the price of oil.

THE CATCH: Senator Dwight Cook stated in a February 9, 2013 op-ed in the Bismarck Tribune that SB 2336 “eliminates current price triggers that would reduce oil tax revenue by $2 billion per biennium.” This statement — that the triggers “would” reduce revenue by this amount — lacks candor. Under current law, if the average price of oil is less than the trigger price for each month in any consecutive five-month period, extraction tax exemptions and rate reductions go into effect. Admittedly, such a scenario “would” reduce revenues significantly. However, the trigger price for the 2013 calendar year, as calculated by the Office of the Tax Commissioner, is $52.50. Considering the price of oil (West Texas Intermediate Cushing, the measure used in the Century Code) was at $94.92 as of February 21, 2013, there is virtually no chance that the “trigger” would be activated prior to the 2015 legislative session. The GOP majority’s intimations that eliminating the triggers somehow balances out the dramatic cost of the oil extraction tax cut do not square with reality.

Section 5

WHAT IT DOES:  Lowers the rate of the oil extraction tax from 6.5% to 4.5% for new wells starting in 2017 or potentially earlier in the event that statewide production reaches 1 million barrels per day prior to that time.

THE CATCH: This section is the centerpiece of the legislation and, really, SB 2336’s reason for being: A radical and reckless proposal to dramatically cut the oil extraction tax on new wells that stands to cost North Dakota billions upon billions of dollars in future revenue which would otherwise be used to address oil impacts, fund education, and provide tax relief to our state’s citizens.

As demonstrated in the attached chart, which was compiled by the strictly non-partisan Legislative Council, the proposed reductions in the oil extraction tax would mean a $595 million hit to the treasury in the first five years alone. Indeed, the sharp reduction in the oil extraction tax may occur sooner than 2017 in the event that statewide production reaches 1 million barrels per day — a distinct possibility considering the rapid pace of development and improvements to oil recovery techniques. Notably, if this 1 million barrel per day threshold is reached — however briefly — the extraction tax cut will stay in place forever even if production slides below this amount. Under any scenario, a fair extrapolation of the cost of the oil extraction tax cut proposed by the GOP across future biennia demonstrates a lasting and significant impact on future budgets.

In his op-ed, Senator Cook has accused Dem-NPL legislators of “bas[ing] this fiscal analysis on the generous assumption that the oil industry will be drilling 1,750 new wells per year and the price of oil will stay at $80 per barrel.” To the contrary, this data comes straight from the Department of Mineral Resources with regard to the projected number of new wells and takes the anticipated price of oil from the executive budget. Accordingly, these numbers constitute best evidence. Indeed, they are probably conservative.

Section 6

WHAT IT DOES: States that wells drilled and completed on stripper properties after June 30, 2011 would no longer be exempt from the oil extraction tax. Additionally, any well on a stripper property that exceeds 150 barrels of daily production would not be eligible for stripper tax status unless it meets stripper well qualifications under annual certification.

THE CATCH: Certifying individual wells for stripper status, rather than automatically granting exemption to all wells on a stripper property, is a vital step in correcting the stripper well loophole. However, SB 2336 not only falls short in this regard, it actually reinforces existing loopholes and creates others which stand to substantially reduce revenues separate from and in addition to the revenue reductions caused by the oil extraction tax cut.

Specifically, SB 2336 effectively cements open the loophole for wells drilled prior to or on June 30, 2011: Only if these stripper wells “exceed[] an average of one hundred fifty barrels of oil production per day[]” will they be subjected to the oil extraction tax. In other words, old wells which are capable of producing much more than 40 barrels per day, but are incapable of producing more than 150 barrels per day, will maintain their stripper status. Separately, the 150 barrel threshold creates a strong — and arguably prohibitive — disincentive to increase well production above 149.99 barrels per day even where enhanced oil recovery could achieve such a result. This zone of 40 to 150 barrels per day is almost by design tailor-made for the Bakken, as the typical decline curve will move most of these wells to this zone in 3 or 4 years.

Separately, setting the stripper well exemption for new wells at 40 barrels per day (as discussed more thoroughly in section 3 above) virtually guarantees reduced revenues from new Bakken and Three Forks wells as their production declines over the years. Once these wells dip below 40 barrels per day, they will no longer be subject to the oil extraction tax. Allowing previously high-producing wells to revert to stripper status, by any objective measure, serves no valid policy purpose.

The GOP majority has alleged that the change to stripper well taxation contained in SB 2336 “increases the taxes paid on Bakken and Three Forks wells located on stripper property[,]” and “will generate an additional $500 million in oil taxes.” First, such a result is unachievable considering the 150 barrel per day “grandfathering” of old stripper wells discussed above. Second and tellingly, the GOP’s allegation omits the period of time in which the alleged “additional” revenue will be generated. If fairly examined over the coming biennia, the negative fiscal impact of the GOP’s proposed changes to stripper well taxation cannot be validly disputed: By grandfathering in old stripper wells producing less than 150 barrels per day and allowing Bakken wells to benefit from stripper status once production declines below 40 per barrel, these changes guarantee substantial reductions in oil revenue in the decades to come.

Further, the above changes would give rise to the following unreasoned and unreasonable scenario: Two wells drilled and completed at the same point in time each produce at an average of 100 barrels per day.  However, well X previously qualified for stripper status because the well site was located on a stripper property. Well Y did not. Well X would pay no extraction tax, while well Y would pay the full extraction tax. Again, no credible policy rationale supports such a result.

Section 7

WHAT IT DOES: Provides a 2% tax reduction for the first 75,000 barrels or first 18 months for wells outside of the Bakken or Three Forks formation.This section is intended to incentivize companies to drill outside of the Bakken and Three Forks formations.

THE CATCH: Even Ed Schafer, former North Dakota Governor and current board member of Continental Resources, has blasted this aspect of SB 2336. In a recent blog post, Schafer wrote, “The incentive for drilling outside the Bakken is not needed. If one would just track what is happening in ND, it is easy to see that the drilling activity outside the Bakken will increase.” Governor Schafer’s comments further reiterate that oil exploration decisions are driven largely by geology, technology, and availability of oil.

Section 8

WHAT IT DOES: Removes existing “price trigger” exemptions from Century Code.

THE CATCH: None. This provision is a language cleanup corresponding to the elimination of the price trigger definition under section 4.

Section 9

WHAT IT DOES: Cleans up statutory language to reflect changes in certification of individual wells and comply with earlier sections of this bill.

THE CATCH: None.

Section 10

WHAT IT DOES: Strikes language from existing law that would be redundant or irrelevant if this bill is enacted.

THE CATCH: None. Again, this section cleans up the language in the code to stay consistent with previous sections of this legislation.

Section 11

WHAT IT DOES: Provides effective dates at which the various sections of the bill would go into effect should the bill be passed.

THE CATCH: None.

. . .

North Dakota Legislative Council’s Estimated fiscal effect of the oil extraction tax reduction included in Senate Bill No. 2336

Based on production projections relating to new wells drilled and completed for the period 2017 through 2021 provided by the Department of Mineral Resources and anticipating an oil price of $80 per barrel for this period, the estimated fiscal effect of a 2 percent reduction in the tax rate is shown on the schedule below.  The production projections are the Department of Mineral Resources’ “probable” projections and anticipate 1,750 new wells being drilled and completed during each of these years.  The estimated price per barrel is the projected price for June 2015 as included in the 2013-15 executive budget recommendation forecast.

 

 

Fiscal Year

Estimated Barrels per day from new wells

 

Barrels

per year

Revenue subject to taxes at $80 per barrel

Oil extraction tax revenue

at 6.5%

Oil extraction tax revenue

at 4.5%

Estimated reduction in oil extraction tax collections

2017

85,000

31,025,000

$2,482,000,000

$161,330,000

$111,690,000

($49,640,000)

2018

155,000

56,575,000

$4,526,000,000

$294,190,000

$203,670,000

($90,520,000)

2019

215,000

78,475,000

$6,278,000,000

$408,070,000

$282,510,000

($125,560,000)

2020

260,000

94,900,000

$7,592,000,000

$493,480,000

$341,640,000

($151,840,000)

2021

305,000

111,325,000

$8,906,000,000

$578,890,000

$400,770,000

($178,120,000)

 

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2 thoughts on “Radical and reckless: The truth about SB 2336, the GOP oil tax plan

  1. Pingback: Giving Away Lots Of Money In ND To Oil Companies | An Angry Dakota Democrat

  2. This is what happens when a state has a super majority one party control of government. The Republican Party feels an obligation to “payback” the industry that put them in a super majority of the legislature and state government. Republicans have decided that they can get away with this political payback to their friends and the citizens of North Dakota can fend for themselves.

    If the Republican controlled House of Representatives follows suit and votes in favor of a reduction in the extraction tax and if the Governor signs the bill there will be a political price to pay at the ballot box in 2014.