This article appeared in the April 2012 edition of the Oklahoma Economic Report, a publication of the Office of State Treasurer Ken Miller. It is reprinted here in its entirety with permission.
It seems that each day brings another story of record low natural gas prices and record high supplies. A warmer-than-normal winter in the United States drove down natural gas demand this year at a time when prices usually rise and supplies are reduced.
As a result, natural gas in storage is at or near record levels while prices are at their lowest in more than a decade. The U.S. Energy Information Administration (EIA) estimated natural gas in storage at the end of March at 2.48 trillion cubic feet, about 57 percent higher than at the same time last year.
According to Bloomberg, the average spot price in April at the Henry Hub in Louisiana was $1.99 per thousand cubic feet (mcf) as of April 27.
In February, the State Board of Equalization certified estimated collections from the gross production tax on natural gas at $188 million for the General Revenue Fund during Fiscal Year 2013. The estimate assumed an average price for natural gas of $3.64/ mcf.
At that time, board members expressed concerns that the price estimate was overly optimistic, but ultimately agreed to approve the estimate as compiled by the Oklahoma Tax Commission and Office of State Finance using statutory guidelines.
Those urging passage argued the constitutionally-mandated five-percent difference between appropriations authority and anticipated revenues would provide enough flexibility to keep the budget in the black next fiscal year. The five-percent cushion amounts to approximately $250 million.
Tax rates and timing
For most natural gas wells, the gross production tax rate is seven percent. However, if the average price for a month drops below $2.10/mcf, the tax rate is cut to four percent. If the average price falls below $1.75/mcf, the rate is set at one percent.
The rate, however, is set month-by-month and gauging the potential fiscal impact requires an understanding of the difference between timing of production and tax remittance to the state.
Remittance of gross production taxes is made two months after the production occurs, which means, for example, that May collections will reflect production and prices from March.
Spot prices from the Henry Hub are used as a general benchmark of natural gas prices, but don’t necessarily equal prices paid for Oklahoma-produced natural gas due to a number of factors including contracted rates.
However, should the average price paid for Oklahoma-produced natural gas match or come close to the March average price of $2.06/mcf at the Henry Hub, the state would see those reports and remittances in May and the trigger to the lower rate of four percent would be pulled. Assessment of that lower rate would then be made on production during the next month, June, with remittance made in August. The lower rate would remain in effect until reports reflect an average monthly price at or above $2.10/mcf.
Due to the timing of gross production tax reporting, there would be a three-month lag between reports triggering the lower rate and remittances at that reduced percentage.
Ball-parking the impact
Arriving at an exact number of what the impact of low natural gas prices will be on the state budget is nearly impossible. A total of 85.72 percent of collections from regular production wells, taxed at seven percent, is collected by the state with the remainder passed down to counties and schools.
Three-fourths of collections from deep gas wells, taxed at four percent, flow to the state. The one percent collected on horizontal wells provides no funding for the state. Also, revenue estimates are based in part on production volumes, which vary greatly as prices rise and fall.
A glimpse, however, at potential bad to worst-case scenarios shows a budgetary impact is possible if prices don’t rebound.
Should natural gas prices during FY-13 be one dollar lower than the estimated rate of $3.64/mcf, the loss to the state budget would be approximately $70 million. If prices for the entire fiscal year averaged $2.00/mcf, when the top tax rate would be four percent, the negative impact to the budget would be approximately $175 million.
In the worst-case scenario, with prices below $1.75/mcf at a tax rate of one percent for a full fiscal year, the state would be required to pay back to the natural gas industry more than is collected to account for payments due from deferred tax credits.
Natural gas production doesn’t just provide direct gross production revenue to the state. It provides thousands of jobs and hundreds of millions of dollars of economic activity as well.
Should prices stay in the cellar for an extended time, it could also mean the loss of jobs and economic activity. As a result, income tax collections (personal and corporate) could be impacted, along with consumption taxes such as sales and motor vehicles.
Higher than estimated crude oil prices could make up for some anticipated losses from low natural gas prices. A quick analysis shows it could make a difference.
The FY-13 revenue estimate anticipates an average price of crude oil at $96.92 per barrel with contributions to the General Revenue Fund of $188.6 million.
However, should prices average $10 more per barrel than the estimate ($106.92/bbl) during the coming fiscal year, ballpark calculations show it would add approximately $40 million to the General Revenue Fund.
In April, the spot price at Cushing for West Texas Intermediate crude oil averaged $103.27/bbl.
In brief, it appears that higher crude oil prices could offset some but not all of the losses experienced by low natural gas prices, but by exactly how much depends on too many variables to calculate with any degree of certainty.
Guessing the future
The EIA issues a monthly Short-Term Energy and Summer Fuels Outlook in which it forecasts, among other things, the price of oil and natural gas.
In its March Outlook, the EIA estimated the average natural gas price for 2012 at $3.27/mcf and the price for 2013 at $4.08/mcf. The April report, however, lowered those expectations with the 2012 price forecast at 21 percent less, $2.59/mcf, and the 2013 price reduced by 14 percent at $3.50/mcf. The EIA estimates crude oil at $106/bbl this year and next.
The EIA uses a calendar year for its estimates, while the state’s fiscal year includes the last six months of one calendar year and the first half of the next.
Because the energy industry is one of the bigger drivers of Oklahoma’s economy, many are hoping the EIA estimates are accurate. If so, it means Oklahoma will avoid facing the worst-case scenario. But even so, it appears unlikely the state will realize the gross production collections originally estimated in February and questions linger of what the impact will be overall to the state economy, related jobs and total tax collections.
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