Political Problems With Severance Tax – July 19, 2015

Today we talk about five things in the news for the week of July 13, 2015:

  1. An Iran Deal Happened, Now What?
  2. Tea Leaves to Read from the Presidential Candidates
  3. House Natural Resources Looks Onshore and Off
  4. Slow Start to Mexico’s Reopening of its Oil and Gas Fields
  5. A Couple Notes on Fluid Disclosure

And our interview is with Charles Schliebs, the Co-founder and Managing Director of Stone Pier Capital Advisors in Pittsburgh, Pennsylvania.

Click below to listen or find us on iTunes or Stitcher.

1.  An Iran Deal Happened, Now What?

Unless you have been living under a rock, you probably already heard that the Obama Administration and a group of allies have negotiated a nuclear deal with Iran.  A few months ago, The Economist explained what Iran hoped to receive:

For Iran, the pressing need is to gain relief from sanctions that have ratcheted up in severity and are having a crippling effect on its resource-dependent economy. In particular, restrictions on its oil and gas exports, its ability to import technology to exploit its energy resources, and being cut off from SWIFT, the financial-messaging system used to transfer money between the world’s banks, have taken an increasing toll.

It sounds like Iran will get all that, but not right away, as Richard Nephew from the Columbia Center on Global Energy Policy explains:

The nuclear deal with Tehran has raised expectations that new Iranian oil would be available immediately and that opportunities for foreign investment would start the next day. As I have written throughout this year, this is not the case. A cursory review of the extensive nuclear text indicates that it will be easily 6 months before sanctions relief will be manifest…

In the longer term, he says, Iran will be fighting four problems:

  • Lost market share from the sanctions
  • Fatigued fields and antiquated equipment
  • Iranian bureaucracy is formidable and the country has offered unfavorable contracts in the past
  • Sanctions snap-back, where restrictions are reimposed because Iran cheated, is a real threat.

Nonetheless, Foreign Policy says to expect some investment:

Even so, for cash-starved Iran, desperate to rehabilitate a domestic oil and gas industry laid low by mismanagement, corruption and under-investment, there is now the real prospect of a new lease of life — and a huge increase in revenues from higher production and exports. Tehran is estimated by the US to have foregone $160bn in oil sales in the past three years as exports to Europe collapsed and Asian countries such as India sought alternative supplies.

“Iran needs investment and technology big time,” says Daniel Yergin, author of the classic history of oil, The Prize…  “Tehran will need to put a century of turbulent relations with the international oil industry behind it and focus on being commercial and competitive. The big companies are preoccupied with costs and profitability.”

Oil Price puts this into perspective for Natural Gas:

Although Iran has one of the highest global natural gas reserves, it contributes merely 1 percent to the total global natural gas trade with almost 90 percent of its natural gas exports going to Turkey, while the remainder goes to Armenia and Azerbaijan.

Iran is at a strategic location where it can benefit from the growing natural gas demand from Asian countries like India, China and Pakistan. It is therefore planning a number of gas pipelines once the sanctions are lifted.

World Proven Natural Gas Reserves

On the domestic front, many members of Congress, led by Sens. Lisa Murkowski (R-AK) and Heidi Heitkamp (D-ND), have been arguing that U.S. exports of oil and gas should no the restricted while Iranian oil is allowed to flow freely.

2.  Tea Leaves to Read from the Presidential Candidates

It was a great week for the parlor game of trying to decipher what the Presidential candidates are thinking on energy.  Scott Walker launched his campaign last week, and he repeated the ever-popular “all-of-the-above” line:

Then, put into place an “all-of-the-above” energy policy that uses the abundance of what God has given us here in America and on this continent. We are now an energy-rich country and we can literally fuel our economic recovery.

We need a President who will approve the Keystone pipeline on the very first day in office and then seek to level the playing field for all sources of energy.

Nothing too ground breaking there, as the “all-of-the-above” line is used by politicians on both sides of the aisle.  Not everyone agrees with that strategy.  In New Hampshire last week, Hillary Clinton was asked to commit to banning fossil fuel production on federal land.  That got awkward.  She suggested she hoped to phase out fossil fuels, but her answer was “not until we get satisfactory alternatives in place.”  She also spoke out in support of folks with jobs in energy.  That led to protestors chanting “act on climate.”  Hillary had earlier in the week stopped by Capitol Hill and discussed messaging on climate change issues.

Republicans and Democrats held “cattle calls” in Iowa this weekend, where most the candidates got together and give competing presentations on their candidacy.  Republicans did not really say anything interesting on energy.  Hillary’s nominal challengers, meanwhile, showed the differences in the Democratic field.  Martin O’Malley is calling for a 100% renewable power grid by 2050, for example.

3.  House Natural Resources Looks Onshore and Off

Last week the House Committee on Natural Resources Subcommittee on Energy and Mineral Resources held two hearings relating to oil and gas .  On Tuesday, the Subcommittee held a hearing entitled “The Fundamental Role of Safe Seismic Surveying in OCS Energy Exploration and Development.”  The hearing was led by Rep. Doug Lamborn (R-CO), who is bothered by delays in permitting for offshore exploration.

On Thursday, the Subcommittee turned their focus onshore with a hearing entitled “The Future of Hydraulic Fracturing on Federally Managed Lands.”  The Subcommittee Republicans challenge the need for the rule, explaining it this way in their hearing memo:

…BLM asserts that over 90 percent of wells being drilled on federal land are hydraulically fractured. Thus, the BLM concludes, this rule is needed to provide a baseline for those states without fracing regulations, and a failsafe for those states with regulations.

However, the BLM’s conclusion relies on a false narrative. First, the BLM, within the rule itself, acknowledges that at least 99.3 percent of the total well completions on federal and Indian lands nationwide occur in states that have existing hydraulic fracturing regulations….the BLM now seeks to upend those regulations that have been effective in ensuring the safe production of oil and natural gas from federal lands.

The BLM attempted to mitigate state and tribal concerns by inserting a “variance” provision into the final rule. That provision permits a BLM state director to issue a variance for a state or tribal regulation if the director determines “that the proposed alternative meets or exceeds the objectives for which the variance is being requested.” The BLM state director has the final say on whether a variance will be issued, and such determination cannot be appealed.

Wyoming has become a bit of a poster child, with BLM complimenting the state’s regulations but leaving in question what portion of Wyoming’s regulations would be upended.  In her questioning, Rep. Cynthia Lummus (R-WY) pressed the Neil Kornze of the BLM for some clarity and did not get much.

4.  Slow Start to Mexico’s Reopening of its Oil and Gas Fields

In 1938, Mexican President Lázaro Cárdenas expropriated the assets of the oil and gas companies operating in Mexico.  Most of Mexico’s production at the time was coming from what is now Shell, Exxon, and Chevron, and the government simply claimed their assets for a newly-created state monopoly called PEMEX.  In the midst of World War Two, Mexico did wind up paying the oil companies a settlement for those assets, but foreign companies have not worked in Mexican oil fields since.

In recent years, Mexico passed a series of reforms that culminated an auction last week that was the first opportunity for foreigners to obtain Mexican drilling rights.  The Economist reports it did not go well:

IT SHOULD have been a day of high excitement. A public auction on July 15th marked the end of a 77-year monopoly on oil exploration and production by Pemex, Mexico’s state-owned oil company, and ushered in a new era of foreign investment in Mexican oil that until a few years ago was considered unimaginable.

The Mexican government had hoped that its first-ever auction of shallow-water exploration blocks in the Gulf of Mexico would successfully launch the modernisation of its energy industry…When prices of Mexican crude were above $100 a barrel last year (now they are around $50), the government had spoken optimistically of a bonanza. It had predicted that four to six blocks would be sold, based on international norms.

It did not turn out that way. The results fell well short of the government’s hopes and underscore how residual resource nationalism continues to plague the Latin American oil industry. Only two of 14 exploration blocks were awarded…

Bloomberg Business reporter Alix Steel explained that most the major oil producers sat out, and elsewhere Bloomberg said the causes are many:

The auction’s results can’t be entirely blamed on the fall in oil prices, National Hydrocarbons Commissioner Juan Carlos Zepeda said in a press conference following the event Wednesday. Even though the auction didn’t have the expected results, it’s important to highlight the “impeccable, unprecedented transparency” throughout the entire process, he said.

The government lowered its investment estimate to $2.6 billion from an initial $17 billion, Zepeda said. The larger figure was based on selling all 14 blocks and an average investment of about $1.3 billion each.

The Wall Street Journal chronicled the successful bidders:

Two blocks were won by Mexican company Sierra Oil & Gas, in a consortium with Houston-based Talos Energy LLC and U.K.’s Premier Oil PLC, which offered to pay the government 55.99% of the operating profit from a first block and 68.99% from a second, in both cases offering to invest 10% above the minimum requirement. Other firms that submitted bids included Norway’s Statoil ASA, ONGC Videsh Ltd. of India, Hunt Overseas Oil Co. and Murphy Worldwide Inc. with Petronas Carigali International.

 5.  A Couple Notes on Fluid Disclosure

The State of Pennsylvania will be moving to a new disclosure system that it says is better than the current industry standard, the Trib Live reports:

Department of Environmental Protection Secretary John Quigley said the department will end its partnership with FracFocus, an independent online catalog of fracking records, and develop what he considers a more comprehensive and user-friendly online database.

“Our goal is to have a reporting tool that will provide … much more downloadable and searchable information than FracFocus,” Quigley said.

The EPA Office of Inspector General also released a report last week calling for the EPA to do more on fracking fluid disclosure, according to The Hill:

A 2005 federal law greatly limits the EPA’s authority over fracking, but the OIG’s report focuses on two areas where it says the agency can do more under the Safe Drinking Water Act: regulating the use of diesel fuel and considering mandating chemical disclosure.

The EPA lets some states regulate diesel use if their programs are up to federal standards.

“There is evidence that the EPA and primacy states have not been fully successful in their efforts to effectively control the use of diesel fuels for well stimulation,” the OIG said in its Thursday report.

Interview with Charles Schliebs of Stone Pier Capital on the Severance Tax (Starts at 23:25)

Charles grew up in Kansas City, where his father was a pipefitter.  He won a scholarship for children of pipefitters and that took him out to Pennsylvania where he earned his bachelors degree from the Wharton School.  After that, he went to Vanderbilt Law School and then returned to his hometown of Kansas City to practice law.  His legal career eventually took him to Pittsburgh, where he practiced corporate law in a range of industries outside of energy.  He then began a second career as venture capitalist, again not working in energy.

Now, Charles runs Stone Pier Capital, where he is an investment banker working primarily in the energy industry.  He was pulled into the energy business by none other than Aubrey McClendon, former CEO of one of the country’s shale-gas leaders, Chesapeake Energy.  Charles had a friend working as a senior officer at Chesapeake in 2008, and that friend was tasked with moving the company into the Marcellus.  Charles helped out a little bit, and the friend decided Chesapeake needed to hire Charles.  Charles resisted, but soon found himself out in Oklahoma City learning all about the natural gas business from Mr. McClendon and his team.  Charles spent the next two years consulting for the company, and he helped them become one of the largest operators in the area.

After that experience, Charles founded Stone Pier with a like-minded colleague.  The company focuses on mergers and acquisitions and also does various types of consulting.  The company does a lot of shale gas work, but is also active in renewables, nuclear, coal and more.  He is also on the Board of Directors of Pittsburgh’s Energy Innovation Center.  It is a formerly-derelict training center that explains itself now as a “6.6 acre urban complex that will promote energy-sector research and innovation and create direct and deliberate bridges to job creation, entrepreneurship and urban economic revitalization.”  The Center hosted U.S. Department of Energy Secretary Ernest Moniz last week.  Despite a full schedule of negotiating and now defending the nuclear deal with Iran, Sec. Moniz made the time to tour the facility and sign a coopration agreement, saying “Pittsburgh is one of the places that we want to bring a lot of things together, in terms of clean energy, in terms of education and training.”  Several oil and gas companies are involved, including Shell, Chevron, EQT, and Consol Energy.

Stone Pier publishes a free newsletter that covers different areas of the energy industry in Pennsylvania, and some of his writing on Pennsylvania’s proposed severance tax has been republished in other places.  The blog Natural Gas Now recently consolidated some of his work under the title “Tom Wolf’s Severance Tax Political Disaster.”  Charles does not come to this debate as a knee-jerk opponent to the Governor, however.  In fact, he was a supporter of Gov. Wolf’s campaign and was a part of the newly-elected governor’s transition team.  Charles does not consider himself a political person, and he was very impressed with Mr. Wolf’s business background.

Back during the primaries, Mr. Wolf refused to meet with oil and gas companies, but during the general election Charles helped arrange a meeting at the Energy Innovation Center that brought together Mr. Wolf and industry stakeholders.  Charles seems to have walked away with some mixed feelings.  The meeting was cordial, but Mr. Wolf seemed to assume everyone in the industry opposed his candidacy.  Charles feels like that was incorrect, and there was actually some support for slightly increasing taxes on natural gas.  Today, however, a growing coalition is opposing the new severance tax.

Charles sees two problems.  First, the price of natural gas has dropped dramatically and the industry is less able to absorb new costs.  Second, Gov. Wolf’s proposal has become more and more onerous along the way.  The existing impact fee is equivalent to somewhere between a 2% to 4.7% severance tax.  Gov. Wolf appears to have realized that he will not raise his promised $1 billion by simply imposing a 5% severance tax with a credit for impact fees paid.  Instead, he added to his proposal an additional volume-based tax, a disallowance of post-production costs, and a price floor.  All told, Pennsylvania’s Independent Fiscal Office, similar to the Federal Congressional Budget Office, says Gov. Wolf’s proposed severance tax would be about 17.3%(!).  The price floor is especially concerning in the current low price environment.  When natural gas is at $1.00 per MCF, for example, (which it has hit recently in the Marcellus region) a producer would be taxed as though it was getting $2.97.  That is like low-income individual being taxed at the top tax rate.  Gov. Wolf has also proposed capping the amount local governments can get from the impact fees, which has cost him a lot of support.

Charles says there is a zero-percent chance the Republican legislature in Pennsylvania will pass the current severance tax proposal.  It is way too high compared to any other states.  Nonetheless, Charles feels like the looming specter of a tax increase of that magnitude is already pushing business out of the state.  He was not willing to speculate on how things will work out.  He says the leaders of the legislature are not sure themselves, partially because there has been little contact between the legislature and the governor.  Overall, Charles says the future of the natural gas industry in Pennsylvania is bright.  The state will have a lot of gas for a very long time (just last week estimates for the Utica were greatly expanded).  The next step, in his view, it to utilize that gas for manufacturing and production of other feedstocks, like ethane.

If you want to hear more insights from Charles, you can contact him through his firm Stone Pier and ask to sign up for his newsletter and hear about his services.  He also encouraged folks to get involved in the Energy Innovation Center.