The Policy Institute, based in Helena, Montana, blends authoritative research and hands-on political engagement to create public policy based on economic justice, fair taxation, corporate accountability and environmental responsibility.

Montana's Oil and Gas Tax Holiday: Analysis and Recommendation for Change

By Bob Decker

Executive Director, The Policy Institute
February 26, 2009

SUMMARY

Over the past 30 years, the Montana Legislature has steadily reduced the tax responsibility of the oil and gas industry in the state. Decisions by the 1999 Legislature alone reduced tax revenue to the state and counties by hundreds of millions of dollars in subsequent years. The most influential of tax reduction methods has been the oil and gas tax "holiday," which discounts tax rates on new wells for defined periods of time.

This analysis finds that academic research, empirical data, and the actions of other oil- and gas-producing states collectively refute the assertion that the level of taxation is a significant factor in decisions related to oil and gas development, and that questions of reserve quantities, market prices, technological advances, and access to markets are more important considerations. The analysis concludes with a recommendation for a new structure of oil and gas taxation in Montana that will both increase revenue to state and local governments and assure fairness through tax rates that vary with market prices of the resources.

BACKGROUND

Taxation of the oil and natural gas industry by local, state, and federal governments has long been used to generate revenue for the support of public programs. This analysis examines oil and gas taxation by the State of Montana, with particular emphasis on a policy currently in place and known as the oil and gas tax "holiday."

Oil and gas taxation takes many forms, including severance (production) taxes (usually applied to the gross taxable value of the produced resource), ad valorem taxes, excise taxes, indemnity taxes, net proceeds taxes, and various kinds of fees. Several oil- and gas-producing states apply a mix of taxation methods, and many states utilize different formulas or tax rates for oil and gas, respectively.

Over the years, Montana has utilized several forms of oil and gas taxation. The idea of a tax "holiday," or a period of time during which the production from an oil or gas well, usually a newly drilled one, is allowed a discount from the standard severance tax rate, dates to at least 1979, when the Montana Legislature exempted production from natural gas wells drilled to depths of 5,000 feet or more.

Another useful benchmark is 1981, when the Legislature increased the state's severance tax on oil from 2.65 to 5 percent for 1982-83 and to 6 percent thereafter. Montana's severance tax on oil had not been increased since 1962, and the 1981 increase was proposed to offset a reduction in vehicle license taxes.

Since 1981, however, the predominant theme in the modification of oil and gas taxation in Montana has been to reduce the tax responsibility of oil and gas producers. In several of the legislative sessions since that year, Montana lawmakers have enacted various tax "incentives" for the oil and gas industry, justified as necessary to promote exploration and development during times when prices, especially for oil, had fallen from the levels of preceding years. Those changes usually took the form of reduced severance tax rates for new wells, stripper wells (those approaching the end of their economic life), horizontally drilled wells, and enhanced oil recovery projects (those utilizing new methods or technology to extend production). In addition to generally reducing taxes for the oil and gas industry during this period, the changes enacted by the Montana Legislature often contributed to the complexity of the state's oil and gas taxation structure.

By 1995, Montana had, in addition to a State Severance Tax (for support of the state's general fund), a Privilege and License Tax (to support the operation of the State Board of Oil and Gas Conservation), a Resource Indemnity and Groundwater Assessment Tax (for a reclamation trust fund), a Local Government Severance Tax (to finance county governments), and a Net Proceeds Tax (a flat severance tax in lieu of property tax on oil and gas used to fund local governments). In that year's legislative session, Montana lawmakers enacted Senate Bill 412, which consolidated the state's various oil and gas taxes and, according to the bill's promoters, simplified the state system. In the same year, Senate Bill 338 expanded the holiday concept by providing a 24-month exemption from state severance tax on production for oil and gas wells drilled after March 31, 1995.

In 1999, again under the banners of "simplification" and "incentive," the Montana Legislature reduced tax rates for various methods of oil and gas production. With enactment of Senate Bill 530, severance tax rates for all oil wells drilled before 1985 were reduced from 13.9 to 12.5 percent (natural gas was reduced from 18.55 to 14.8 percent). For new wells, i.e., those drilled after 1999, the basic severance rate on oil was reduced from 12.5 to 9.0 percent (natural gas from 14.8 to 9.0 percent). For horizontally drilled wells, the top severance rate on oil was reduced from 12.5 to 9.0 percent for wells drilled after 1999 (natural gas from 15.5 percent to 9.0 percent). The defined size of stripper oil wells was expanded from 10 to 15 barrels per day, and the severance rates for stripper wells were also reduced.

In addition, the 1999 Legislature redefined the tax holiday for oil and natural gas. Applying to wells drilled after 1999, the holiday period was set at 12 months for vertical wells and 18 months for horizontal wells. During the holiday period, the severance rate is 0.5 percent (for both oil and gas); upon expiration of the holiday period, the rate returns to the basic level of 9.0 percent (both oil and gas).

In 2005, the Legislature enacted a "bonus" tax reduction for oil stripper wells producing 3 barrels per day or less, dropping the severance rate from 12.5 to 6 percent when the price of West Texas Intermediate crude oil was above $38 per barrel. (Note: Unless otherwise noted, oil prices provided in this analysis are for West Texas Intermediate, the most common benchmark for U.S. oil prices. Montana-produced oil typically sells for less than West Texas Intermediate because of transportation and marketing factors.)

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