Somber day at the Capitol

The faces of legislative leaders were sometimes somber on Thursday after a revised revenue forecast for North Dakota was released. From left, Senate Majority Leader Rich Wardner, R-Dickinson, House Majority Leader Al Carlson, R-Fargo, House Appropriations Chairman Jeff Delzer, R-Underwood, and Senate Appropriations Chairman, Ray Holmberg, R-Grand Forks, are still optimistic about the state's economy and the future oil and gas tax collections. 

When legislators congregated at the state's Capitol for the start of the 64th Legislative Assembly in January, uncertainty about oil prices served as a dark cloud hanging over their heads.

Even though only 3.6 percent of the state's general budget relies on oil and gas severance taxes, numerous other budgets are affected by the rippling effect of lost sales, income and property taxes.

The session started off with a slow start as lawmakers knew revenue projections released in December which factored oil prices at $72-$74 per barrel were no longer reliable. By mid-January, Democratic leaders were calling for a contingency budget to ensure K-12 education and property taxes are funded while allowing other projects to be funded if prices rebound. Senate Minority Leader Mac Schneider said the two-part budget concept guards against an overreaction by state legislators.

"We're calling for planning, not for panic," he said.

But at the end of January, Senate Majority Leader Rich Warder and House Majority Leader Al Carlson announced a revised forecast which assumes 1.2 million barrels of oil a day at $42 barrel for the rest of the current biennium, shifting to $45 to $65 a barrel in the 2015-17 biennium. The new forecast allows Appropriation committee members to determine more realistic budgets.

"We'll be forced to make some hard decisions and do a lot more prioritizing as we go through this process," Carlson said.

An official revenue forecast will be provided by Moody's Analytics in March, and Carlson said lawmakers will also get another "snapshot" of revenues in April before the session ends in case prices rebound allowing some additional projects to be funded.

"We're going to have provisions to increase various levels of funding," he said. "I can't tell you what that looks like today, but reality tells you we're not going to have two budgets like the Democrats want but we are going to have triggers ... that could kick in if revenues return to a certain level."

Trigger incentives to keep fracking

Much of the revenue picture is dependent upon current triggers that are already in place that provide tax incentives to operators. On Feb. 1, the state's "small" trigger, which was established in 2009, kicked in and cut the oil extraction tax from 6.5 percent to 2 percent on new wells for the first 75,000 barrels produced or the first $4.5 million of gross value during the first 18 months after completion. The trigger initiates when the price of West Texas Intermediate (WTI) crude which is set at Cushing, Okla., averages less than $57.50 a barrel for a single calendar month - which it did in January. The incentive can only be triggered off when the price of WTI reaches an average of $72.50 per barrel of oil as reported for a single month. The "large" trigger, which begins if WTI drops below $55.09 and stays there for five consecutive months, allows operators to not pay any extraction taxes on new wells for the first 24 months of production, whether or not they drilled prior to the incentive triggering. If wells are beyond their first 24 months of production, they would go to a 4 percent rate. The incentive requires oil prices of $72.50 for five consecutive months to trigger off. Historically, this tax incentive was triggered on for 17 years, triggering off in 2004.

"Through this incentive, the state is acknowledging the importance of the oil and gas industry to the state's economy by easing a portion of the tax burden during times of low oil prices," state Tax Commissioner Ryan Rauschenberger said.

January's revised forecast did factor in both incentives being triggered which slashed $4 billion in tax dollars from state coffers.

However, Carlson and Wardner believe the state is well positioned to deal with the low oil prices.

"This is a correction, not a bust," Wardner said. "We think we are in a position to have a soft landing."

"It's still a lot of money being collected," Carlson said. "The sky isn't falling," he continued. "This is responsible and it's realistic."

General fund revenue

In the 2015-17 biennium, revenues collected for the general fund are projected to be $5 billion, down $550 million from the December projection and $565 million less than the current biennium. One potential change to come is from House Bill 1176 which would adjust the gross production tax formula to give additional revenue to oil producing counties. The new revenue projections were still based on a 75 percent state, 25 percent counties formula distribution, but western North Dakota leaders requested a 60-40 split to give oil counties the greater share. However, the House passed the bill on Feb. 26 with a 30-70 split favoring the state.

The prime sponsor of the bill, Rep. Keith Kempenich, said the bill is interconnected with the surge bill which became law on Feb. 24 sending $1.1 billion primarily to oil impacted areas immediately, as well as a bill for funding Department of Transportation projects and even language within a Department of Trust Lands bill.

"We're going to have to lay those bills alongside each other and determine how we're going to match all that up and what we're looking at for a total package going out," Kempenich said. "I'm hoping we get better than half (in the formula), but obviously the landscape has changed over the last couple months."

Prior to the rate decrease on the formula bill, North Dakota Association of Oil and Gas Producing Counties Executive Director Vicky Steiner, who also serves as state senator from District 37 in Dickinson, said swings in oil prices leave her hoping the formula bill is not set to expire too soon.

"The 60-40 split would take the oil counties share from 14 percent to 28 percent, or roughly $1 of every $4 of oil tax money would go back to the west, but we're not going to get a lot out of the 60-40 now that the price has shifted," Steiner said. "I hope they don't sunset it too soon though, because when that price recovers and they start getting 60 percent on $72 oil that's the kind of money they need to maintain."

At this writing, the bill does not contain a sunset date.

Oil industry isn't going anywhere

Though oil operators are crunching numbers and subsequently tightening their budgets for 2015, they are not giving any indication they plan to exit the region. Having the large trigger potentially on the horizon is appealing to them, according to North Dakota Petroleum Council President Ron Ness but winter is the wrong season for the small trigger to be effective since additional heating costs immediately eat up any savings an operator may have received from the tax break.

However, the large trigger equates to a 130 percent reduction in operators' taxes, and while companies won't hold off operations in hopes of the trigger kicking in, once it triggers, the savings would add up and enable them to breathe a little easier.

"As you get closer to that date and the exemption comes, I think the hope is that you'd see some price recovery and then that price trigger would make a significant impact," Ness said. "The problem with these triggers is that five months is a very long period of time. You've made a lot of business decisions before you get to that point."

Rauschenberger estimates that the small trigger's impact to the state will be approximately $170,000 per well. It also equates to $120 million in lost tax revenue from February to June based on 650 completed wells during that time. If another 100 new wells were completed each month over the five month period, the state would lose another $85 million. The large trigger would cost the state $100 million per month of tax revenue, or $2.4 billion a year, based on 1.3 million barrels of oil per day at $50 a barrel.

Whether operators take advantage of triggers or not, Carlson is convinced activity will continue in the oil patch.

"This is still the honey hole. Of all the places in the U.S., this is number one for productivity," Carlson said. "They'll never leave because they know these prices will rebound ... They're not leaving; there will be consolidations, things that happen when markets turn. There may be less players in the end - bigger players - but the players aren't leaving because this is where they want to do business."

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