TheFiscalEffectsofFrackinginOtsegoCounty,NY

ByHarryLevine August15,2011 Summary Thispapercomparestheadvaloremtaxespayableongaswellswiththelosttaxrevenuefrom decliningassessedvaluesonrealestatehouses,buildings,andlandaroundthosewells.By carefullysettingtheassumptions,wecanassessthefuturefiscalhealthoftownsthatallow hydrofracking. Thisanalysisfocusesonincomefromtaxation.Itdoesnotincludethepubliccostsofdrilling, suchasroadmaintenanceandrepair,emergencyservices,policeprotection,andothercosts thatdrillingcompaniesundertodaysregulatoryregimearenotobligatedtocover.1Wealso haveassumedthattherearenospillsorseriousaccidentsthatrequireemergencyactionsor longtermabandonmentofdomesticwaterwells.Anysucheventswillhaveafurthernegative impactonpropertyvaluesandthetownsfinances.Finally,qualityoflifeissuesareoutsidethis discussionaswell. Accordingtothemodeldevelopedbelow,itislikelythattown,countyandschooldistrict revenuesfromtheadvaloremtaxwillbesubstantialbutwillnotequalthelossinrealestate taxesresultingfromdecliningrealpropertyvaluesintheareassurroundinggaswells. ! Thedeficitwillbelargeandlonglasting. ! Localgovernmentsandschooldistrictswillbefacedwitheitherincreasingtax ratesordecreasingspendingtobalancetheirbudgets. ! Thisproblemarisesduetotheconflictbetweengasdrillingandalocaleconomy basedupontourism,recreation,retirementhousing,agricultureandother businessesthatareincompatiblewithheavyindustry. Ofthe24townsandonecityinOtsegoCounty,18,oralmostthreequarters,willexperience significantandlonglastingfinancialstress.Takingthecountyasawhole,thenetlosswould

Towns have the ability to enter into road use agreements with drillers to recover the costs of damage done by drilling truck traffic. These agreements are designed to cover the direct costs of repair and not the indirect costs of inconvenience to local residents, damage to private vehicles, or loss of business due to reduction in other traffic. No such agreements are currently in place in Otsego County.
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exceed$133millionduringthefirst11yearsofhydrofracking.Thisimpactisconcentratedin Oneonta(boththetownandthecity).Butevenforrestofthecounty,theannuallosswouldbe $3.7millionwithanaggregatelossduringthefirst11yearsof$41million.Ifgasdrillingresults inareductioninrealpropertyvaluesof5%ormoreovertheentirecounty(excluding Oneonta),thenannuallosseswillexceedthegainsfromtheadvaloremtaxescollectedfrom gasproduction.Thesestarkfinancialexpectationsarebeforeaccountingfortheotherpublic coststhatwillbeexperiencedwithgasdrilling. I. TheValueofGas Itisdifficulttopredictthesuccessofagaswellgiventhevagariesofgeology,liftingcosts,and commoditypricefluctuations.Somedrywellsormarginalproducerscanbeexpected.Given thatthedepthtothetargetformationsinOtsegoCountyisshallowerthanthatinPennsylvania andthattheactualwidthoftheMarcellusshaleformationpinchesoutinOtsegoCounty,we canexpectwellsinourcountytohavelowerproduction.Wealsoknowthatgaswellshave theirhighestproductiononthefirstdaywithdecliningyieldsthereafter. Buthowsteepisthedeclineandhowlongisthewellproductive? Forouranalysis,wehavechosentouseaRoyaltyCalculatorpreparedbyPennState University. 2Thistoolwascreatedtohelplandownersevaluatethepotentialincomefrom leasinglandtodrillers.Itisaflexibletool,allowingtheusertoinsertdifferentassumptions aboutthemaximuminitialproductivityofawell,thelifespanofthewell,thedeclinerateinthe wellsproduction,thepriceofgas,andthelandownersshareofroyaltyincome.Forouruse, weneedonlylookatthewellsproductionoveritsestimatedlife.Thekeyassumptionsused forthecalculator: ! Initialproductionof4.0millioncubicfeet(4MMCF)perdayofgas. 3

WhatifRoyaltyCalculator,createdbyKenBalliet,PennStateCooperativeExtension,2008.

ThisestimateisbaseduponrecenthistoricalgasproductioninTiogaandPottercounties,PAprovidedbyPADEP. DuringfiscalyearendingJune30,2010(themostrecentreportedfullyear),atotalof61operatinggaswells producedatotalof20millionMCFforanaverageproductionrateperwellof306,000MCF.Forthefivewellsthat werestartedinthesetwocountiesduringtheprioryearandwereinfullproductionduringFY2010,theaverage productionratewas422,000MCF.SeePennsylvaniaDepartmentofEnvironmentalProtectionwebsite,Oiland GasProductionReportsbyCounty [https://www.paoilandgasreporting.state.pa.us/publicreports/Modules/Production/ProductionByCounty.aspx]. ThesetwocountieswereselectedbecausethegeneralthicknessoftheMarcellusShaleisapproximatelythesame asinOtsegoCounty.However,thedepthtotheshaleisdeeperinTiogaandPotterthaninOtsego,whichshould resultinlowerproductionexperienceinOtsego,allothervariablesheldconstant.SeeThicknessoftheMarcellus

Declineratesof70%forthefirstyearandvaryingdeclinesforsucceedingyears. Atotalproductivelifeof20years4includingonerefrackinginyear13. Thismethodologyisadequatetoestimatetheonesourceofrevenuethattowns,countiesand schooldistrictsinthestateofNewYorkarenowentitledtoreceive:advaloremtax.UnderNYS law,gaswellsarenotrealestateandthereforepaynorealestatetaxes.However,theState hasinstitutedanadvaloremtaxongasproduction.TheStatesOfficeofRealPropertyServices usesaformulatocalculatetheUnitofProductionValue(UPV)foreachactivegaswell. 5This UPVismultipliedbytheannualproductionfromthepreviousyear(asreportedbythedriller)to arriveatavalueofthewell.Thenthelocalassessorappliestheequalizationrateandthemil ratetoarriveattheamountoftaxdue.ItisfairlystraightforwardtotakethePennState calculator,theUPV,andlocalassessorsdatatodeterminetheamountoftaxtobecollected fromthegasproducer.6 Foranexample:ifawellinitsfirstdayproduced4MMCF,thenitproduced438,000MCFover thefirstyear.7TheUnitofProductionValueissuedbyNYSORPShasnotyetbeendetermined forMarcellusShaleduetolackofhistoricaldatabutissetat$9.80perthousandcubicfeet (MCF)forallunspecifiedformationswhichwouldincludetheMarcellusformation.8The resultingvalueforthewellis$4,292,000.Iftheequalizationrateis0.50(assessedvalue=50% offullmarketvalue),thenthetaxablevalueofthewellis$2,146,000.Ifthetownstaxrateis

ShaleinPAinfeet,MatthewKelso,DataManager,CenterforHealthyEnvironmentsandCommunities,University ofPittsburghGraduateSchoolofPublicHealth,February17,2011. http://data.fractracker.org/cbi/snapshot/page?concept=~014f5fdd5ca34911e093dffc6b80437eef InsidersSoundanAlarmAmidNaturalGasRush,IanUrbino,TheNewYorkTimes,June26,2011:Our engineershereprojectthesewellsoutto2030yearsofproductionandinmymindthathasyettobeprovenas viable,wroteageologistatChesapeakeinaMarch17[2011]emailtoafederalenergyanalyst.InfactImquite skepticalofitmyselfwhenyouseethe%declineinthefirstyearofproduction.

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SeeNewYorkStateOfficeofRealPropertyServices,StateValuationServices,OverviewManualforValuation andAssessmentofOilandGasProducingPropertyinNewYorkState,January,2010. InNewYorkState,theadvaloremtaxispayablebytheownerofthegasandnotbytheowneroftheproperty fromwhichthegasistaken.

AccordingtothePennStateRoyaltyCalculator,declineratesintheBarnettShale,Texaswere70%duringthefirst year.WeusedthissamedeclinecurveforOtsegoCounty.PennStateisnowintheprocessofanalyzinghistorical datatodetermineifadjustmentsshouldbemadetothisdeclinecurveforuseinPennsylvania.

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NewYorkState,DepartmentofTaxationandFinance,OfficeofRealPropertyTaxServices,CertificateofFinalOil andGasUnitofProductionValues,April1,2011.

$43/$1000,thentheadvaloremtaxpayablewouldbe$92,300.Averynicechecktobe receivedbythetown.Ofcourse,itmustbesharedwiththecounty,theschooldistrict,thefire district,andthepubliclibrary.Butallinall,itsanicepaydaytohelpwiththecostofrunning government. Sincecurrenttechnologyallowsmultiplewellsatawellpad,wealsoassumedthattherewould besixwellsdrilledonapad.Sowemultipliedtheadvaloremincomebysix:$554,000peryear payabletothelocaltaxcollectorfordistributingtothevariousgovernmentalunits.Aneven betterpayday! II. TheLossofRealPropertyTaxes

OtsegoCountyhasastableeconomythatisgroundedintourism,sustainableagriculture, secondhomes,medicine,retail,education,lightmanufacturing,andretirementhousing. Businesstendstobelightindustryorwhitecollarandtheservicesthatsupportallthese activities.Giventhisprofile,gasdrillingseemsincompatiblewiththecurrenteconomyofthe county.Thatis,whatisgoodfordrillingisprobablynotgoodformostexistingbusinesses. Withthearrivalofdrillingrigs,manypeoplewillchoosetoleavethearea,puttingtheirhomes onthemarket.Somebusinessesthatdependontourismwillbeforcedtocloseorrelocateas touristsselectothervacationspots.Therateatwhichnewcomersarrivewillslowdownor cometoanabrupthalt(exceptfortemporarygasemployees).Mortgagelenderswillshyaway fromprovidingcapitaltobuyersofhomesneargaswells.Currentresidents,whengiventhe choiceoflocatingnearawellorfaraway,arelikelytochoosethesecondoption(considerthe effectsoftrucktrafficand24hournoisefromacompressorstation). ForOtsegoCounty,anareathatiseconomicallybasedontourismandcertainoccupationsthat arenotcompatiblewiththeheavyindustryofgasdrilling9,thevalueofpropertynearanactive

9 Over275businessesinOtsegoCountyhavejoinedtogethertosupportastatementopposingnaturalgasdrilling.
Thesecompaniesincludebreweries,dairies,doctors,medicalsocieties,conventionalfarms,organicfarms,lawyers, manufacturersofmanykinds,restaurants,cattleraisingoperations,managementcompanies,hotels,architects, artists,historicassociations,historicsites,alpacaranches,museums,landscapefirms,engineers,musicians, cheeseries,wineries,B&Bs,inns,rentalpropertyowners,realestateagents,nurses,antiquestores,baseball interests,andothers.Source:LarryBennett,VP,BreweryOmmegang,emaildatedJune29,2011.

wellwilldecrease.10Forthisanalysis,weassumedthatanypropertylocatedwithinaonemile radiusofadrillingpadwillbeseverelyaffectedwithvaluedecliningby50%.Propertylocated betweenoneandtwomilesfromthewellpadwillalsobeaffected,soweestimated25% declineinvalueinthislocation.Andpropertybetweentwoandthreemileswillhavelossesas well(12.5%). 11Theanalysisignorestheimpactonpropertiesbeyondthreemiles. 12 WetookasampleOtsegoCountytown(Worcester)anddetermineditsaverageassessed propertyvaluepersquaremileandthenassumedthatawellwasplacedrightinthemiddleof thisaveragetown.Fromthereitwassimpletocalculatethelostrealestatetaxrevenuefor thetown. Ifthetownhasanaverageassessedvalueof$1,800,000persquaremile,theonemilecircle aroundthewellcontainsaboutthreesquaremilesoflandvalued(inaggregate)at$5,400,000. Ifthelossinvalueis50%inthisarea,thenthetaxablevaluewilldeclineto$2,700,000.In Worcester,themilrateisabout$43perthousandsotheresultinglossincollectedtaxwillbe $116,000abearablelosswhencomparedtotheadvaloremtaxof$554,000collectedfrom thewells.Butwemustalsoreflectreducedrealestatetaxesinthesecondaryandtertiary circleswhichamounttoabout$460,000.13 Althoughtheadvaloremtaxescollectedforthisfirstyearofproduction($554,000)significantly exceedtheexpectedlossofrealpropertytaxes($460,000,thedeclineinrealestatevalueswill

Oneimportantfactorsupportingthisstatementisthatmanymortgagelenderswillnotmakeloansonproperty thatiseithersubjecttoagasleaseornearapropertythatisapotentialwelldrillinglocation.AccordingtoGreg May,VicePresidentofTompkinsTrustCompany(GasandOilLeasesImpactonResidentialLending,March24, 2011),WellsFargo,FirstPlaceBank,BankofAmerica,ProvidentFunding,FidelityBank,FHA,andotherlenderswill notmakesuchloans.Thelackofmortgagefinancingalonewilldrivedownpropertyvalues. Theselossesinvalueareconsistentwithastudydonein2006forresidentiallandintheareaaroundGlenwood, Colorado.GarfieldCountyLandValuesandSolutionsStudy,BBCConsultants.

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Sincegasdrillinginvolvestransmissionpipelines,compressorstations,trucktraffic,andotherancillaryactivities alofwhicharenotnecessarilycompatiblewithresidentialproperty,itislikelythatrealpropertyvaluereductions willbemuchwiderthanthisthreemilearea.

Theareainthesecondringisthedifferencebetweentheareaofacirclewitharadiusoftwomilesandthearea ofthecirclewithaonemileradius:12.56sq.mi.less3.14sq.mi.=9.42sq.mi.Ataxablevalueof$1.8millionper squaremileproducesavalueinthistwomileringof$17million.A25%lossinthisvalueequatestoa$4.2million loss.Therealpropertytaxrevenuefromthislossinvalue(at$43perthousandoftaxablevalue)willbe$182,000. Thesameprocessisappliedtothethirdringbetweentwomilesandthreemilesfromthewell.Thisthirdringhas anareaof15.7squaremiles.Ata12.5%valuereduction,thelossintaxrevenuewillbe$160.000.Thesumofthe lossesfromthethreeconcentriccircleswillbe$458,000.

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probablyoccurwellbeforethelaggingpaymentoftheadvaloremtaxisreceived,creatinga shorttermproblemforthetown. However,inthesecondyear,theadvaloremtaxwillhavediminishedbyabout25%duetothe rapidproductiondeclineprofileofshalegaswells,whilethelossinrealestatetaxeswillnot haverecoveredandinfactmayhavebecomeworse.Secondyearrevenuefromthead valoremtaxfallsshortofreplacingthedeclineinrealpropertytaxes. Asthewelllosesproductivity,thistrendwillcontinuewiththepossibleexceptionofyear14 (whenarefrackingmighthaveoccurred). Eventually,thosepeoplewhoaredirectlyorindirectlyemployedbythegasindustrywillbegin tosupporthousingprices.Andthosewhodontmindlocatinginatownfilledtocapacitywith drillingrigswillbuyproperty.Wehavethereforeforecastthatpropertyvaluesrecoverafter year11by10%peryearuntilfullyrecoveredinyear21.Whetherornothousingpricesfully recoverwillbedeterminedbythedifferingvaluesplacedonshelterbythenewbuyersthat replacetheformerhomeowners. III. ComparingNewTaxRevenuefromGasProductionwiththeLossofRealPropertyTaxes Worcesterhasalandareaofabout28,000acres(orabout44squaremiles). 14About1,300 acresarenowleasedfordrilling.Thetownspopulationofabout2200hasanoldermedianage (41)thantheaverageforNYS(36)whileitsmedianhouseholdincome($40,000)fallsbelowthe NYSaverage($55,000)for2009.Itstaxableassessedvalueis$82millionthroughouttheentire town,andthisfigurecreatesanequalizationrateof57.5%.Theaveragetaxrateisabout $43.71perthousandoffullvalue(therearemultipleschooldistricts,firedistricts,libraries, eachhavingsomewhatdifferentmilrates). 15 Ourchartforecaststheadvaloremincomefor21years(includingafirstyearwhenthereareno taxreceiptsfromgasproduction)usingthePSUmodelmultipliedby6.Wethenestimatedan

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AlldemographicinformationabouttownsisfromWikipedia.

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AlltaxinformationisfromOtsegoCounty,OfficeofRealPropertyServiceswebsitewhichpublishes2011 tentativeassessmentsandequalizationrates.Taxratesare2011forcountyandtownsand2010forschool districtsandlibraries.Theassumptionsinthepreviousexamplewerebasedupontheactualinformationfrom Worcesterbuthavebeenroundedtomakeiteasiertofollow.

11yearreductioninpropertytaxesfollowedbyagradualrecoverybycalculatingtheaverage lossintaxablepropertyvaluesineachofthethreeonemileconcentricringssurroundingour imaginarywellpad.Theyellowlineinthegraphbelowrepresentsthecumulativeincomefrom theadvaloremtaxwhiletheredlinerepresentsthecumulativelossofrealestatetaxes.Forall timeperiods,thenetcumulativeimpactofgasdrillingisnegative,asrepresentedbytheblue barsatthebottomofthegraph.

Observations Clearlytheincomefromadvaloremtaxesisagainforthetown.However,thelossesin propertytaxesduetodecliningmarketvaluesmorethanoffsetthisgain.Fromthisonewell pad(albeitwith6wells),thetownwillloseabout$1,800,000overthe20yearperiod(assuming nochangeinthetaxrate).Mostofthislosscomesintheearlyyears.Thisdeficitmustbe

coveredbyeitherincreasingthetaxrate 16(whichwillfurtherexacerbatethedeclineinhousing valuesandstartadownwardspiralinrealpropertytaxreceipts)orbycuttingthecostofpublic services.Sincethemostsignificantcostsingovernmentalspendingareforschoolsandroads, anycutsintheseareaswillhaveanotherindirectnegativeimpactonhousingvaluesandonce againresultinadownwardspiral. Onlyifandwhentherealestatemarketrecoversdoesthesituationimproveforthetown, 17 anditisquitepossiblethattherecoverywillnotbeasrosyasweforecast,dependingon whetherornotthenewbuyersarewillingtopayasmuchforshelterastheformerresidents. Whatifthereductioninpropertyvaluesisnotassevereasweforecast?Theadvaloremtax revenueweestimatetobeabout$342,000peryearonaverageoverthefirst10yearsofthe productivelifeofthesewells,andthecurrentreceiptsfromrealestatetaxesinWorcesterare about$3,600,000.Atownwidereductioninpropertyvaluesoflessthan10%willmeanthat morepropertytaxesarelostthanadvaloremtaxesaregained. WhathappensifmorethanonewellpadisdevelopedinWorcester?Thetownhasabout42 squaremilesandspacingunitsfortheMarcellusareonesquaremileeach.Theoretically,the towncanhaveasmanyas42wellpadsjustliketheonewehavemodeled.Whatdidnotwork foronesamplewellwillnotworkfor42wellsusingthesameparameters.Theproblemforthe townwillactuallybeworse:everypropertywouldlikelybewithinonemileofawellpadand thereforeallpropertyintownwouldsufferseverevaluationlosses.Theinitialyearwouldlook badandthensubsequentyearswouldgetworse.Thespiraleffectwouldkickinandthetown wouldbetransformedintoacompanytown. ThisgraphisastarkwarningsignalforthetownofWorcester.

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Whenthetaxrateincreases,theadvaloremtaxfromthegasproductionwillalsoincrease,resultinginthegas producerbearingaproportionateshareofthedeficitproblem.Theamountofthissharingwillbedirectlyrelated tothevalueofthegaswellincomparisontothetotalvalueoftaxablepropertyinthemunicipality.Asthevalueof thewelldecreasesyeartoyearduetotheexpecteddeclinecurveinvolumeofgasproduced,thisameliorating effectwilldiminish.

SusanChristopherson,professorintheDepartmentofCityandRegionalPlanningofCornellUniversityhassaid, afterfracking,thereisnootherindustry.Thatwillbeallthereiseconomicallyforthenexttentotwentyyears. Forgetaboutagriculture,tourism,wine,tourism,andanythingelsebesidesenergy.Afteradecadeortwo,or more,thingsmightreturntonormal...Source:AwebinarhostedbyCornellUniversity'sCommunityandRegional DevelopmentInstitute(CaRDI)onMay9,2011.

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OtherCommunities IsthecaseofWorcesterunusual?Whatmightbeexpectedinothertownsinthecounty? Weranthenumbersforeachoftheother23townsinthecountyandtheCityofOneonta.The gasproductionremainedasestimatedforWorcesterwhilethepropertyvaluesandtaxrates wereadjustedforeachcommunity.For18ofthe24townsandtheCityofOneonta,thelossof realestatetaxesexceededtheaggregateincomefromadvaloremtaxesduringthefirst11 years.Takingthecountyasawhole,thenetlosswouldexceed$133millionduringthefirst11 years(anannuallossof$12million).18 ThisimpactisconcentratedinOneonta(boththetownandthecity).Butiftheimpactin Oneontaisignored,theannuallossfortherestofthecountywouldbe$3.7millionwithan aggregatelossduringthefirst11yearsof$41million.Ifgasdrillingresultsinareductioninreal propertyvaluesof5%ormoreovertheentirecounty(excludingOneonta),thenannuallosses willexceedthegainsfromtheadvaloremtaxescollected.Thewarningsignsthatappearedin theWorcesteranalysisexistfortherestofthecounty.Thedrainonthelocaltreasuriesdueto gasdrillingissignificantandlonglastinganditisworseintownswithhigherpropertyvalues persquaremile. Thesestarkfinancialexpectationsarebeforeaccountingfortheotherpubliccoststhatwillbe experiencedwithgasdrilling.

Assumingthateachtownhasonewellpadwithsixwellsaggregating150wellsintheentirecounty(138wells whenthecityandtownofOneontaareexcluded).
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 ProjectedGain(Loss)byTown 19

SomeCaveats ! Ourestimatedinitialproductionfromthetypicalgaswellisgenerous.OtsegoCountyis atthenorthernedgeoftheMarcellusplay.Bonuspaymentstolandownersexecuting leaseshavebeenafractionofthepaymentsreportedfarthersouth.Webelievethat drillersareestimatingmuchlowerproductionforthisarea.

Themodeldevelopedherehighlightsthenetlossintaxrevenue.Inactualpractice,towns,schooldistricts,and thecountymustoperateunderbalancedbudgetsandthereforewilleitherraisemilratesorreduceexpenditures tobalancetheirbudgets.

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PennStatebaseditsmodelonresearchingactualexperiencesintheBarnettShaleplay inTexas.LocatedatthenorthernedgeoftheMarcellusshaleformation,Otsego Countyshouldexperiencelowerinitialproductionratesandmayexperiencemore dramaticdeclinerates. Estimatesoftheproductivelifeofawellvarywidelyandaredependentonmany factors.Forthisanalysis,20yearsseemedareasonabletimeframetousethatwould givethebenefitofdoubttothedriller. Forthispaper,weassumedthatpropertyvalueswilldeclinebetween50%and12.5%in concentricringsaroundawellpadwithamaximumradiusofthreemiles.Wealso lookedatmoregeneralvaluedeclinesandfoundthatanydeclineabove5%would completelyoffsetthegrossgainsfromadvaloremtaxincomeforthecountyasawhole. Ifseveralwellsaredrilledinthetown,thentheseconcentricringswilltendtooverlap creatinglargerlossesthanhavebeenestimatedhere. Wedidnotattempttodistinguishpropertybytype,condition,occupants,orother variables.Ourdataaregrossaverages.Itmaybetruethatindustrialvalueswillnot declineatallwhilesinglefamilyvaluesmaydeclinemoreseverelyandforlongerthan 10years.

TheauthorthanksChipNorthrup,LouAllstadt,DanCrowell,andLinVincentwhoreadand commentedondraftsofthispaper.Anyerrorsinthispresentationarethesoleresponsibilityof theauthor.Forcommentsorquestions,pleasecontactHarryLevine (harryxlevine@gmail.com). HarryLevinehasbeeninvolvedinrealestatedevelopmentforover40years.Agraduateof YaleUniversity(AB)andtheUniversityofChicago(MBA),hedivideshistimebetween Princeton,NewJerseyandthetownofSpringfieldinOtsegoCounty,NY.

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