BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 1017 HEARING: 5/7/14
AUTHOR: Evans FISCAL: Yes
VERSION: 5/01/14 TAX LEVY: No
CONSULTANT: Grinnell
OIL SEVERANCE TAX LAW (URGENCY)
Imposes an oil and natural gas severance tax to funds higher
education, state parks, and health and human services; creates
the California Higher Education Endowment Corporation.
Background and Existing Law
Industrialized oil extraction in California began in 1861, when
the Union Matolle Company first drilled in Humboldt County. In
1892, miners found oil near the present location of Dodger
Stadium, and five years later, Los Angeles County had 800
productive oil wells, creating the Getty fortune, among others.
In Kern County, the Kern River Field was producing 12,000
barrels of oil per day by 1901, and was responsible for seven
out of 10 barrels of oil produced in California two years later.
Oil extraction grew rapidly, reaching 34 million barrels in
1905, 15 million from Kern County, and 77 million by 1910,
making the state the largest oil producer in the United States.
Production peaked in California in 1968 at 375 million barrels.
Currently, the state produces almost 200 million barrels per
year, with 84% of wells in the Central Valley, putting it third
in the United States behind Texas and North Dakota. According
to U.S. government estimates, as much as 15.4 billion barrels of
oil could be locked within the Monterey Shale, a 1,750 square
mile rock formation situated mostly in the west Central Valley.
However, significant uncertainty exists regarding whether oil
and natural gas can be profitably extracted from the Monterey
Shale.
After firms extract oil, they sell or send it by pipeline or oil
tankers to refineries, where it's then refined into gasoline and
diesel, and once again sold or sent to refinery terminals and
distributors. It's then sold to branded gas stations, such as
Arco or Shell, or to distributors known as "jobbers," who supply
SB 1017 -- 5/01/14 -- Page 2
independent stations and other firms.
California natural gas production typically accounts for less
than 2% of total U.S. production and satisfies less than
one-fifth of State demand, having diminished from more than 860
million cubic feet in 1967 to 246 million in 2013. Production
takes place in basins located in northern and southern
California, as well as offshore in the Pacific Ocean. However,
hydraulic fracturing (fracking) has allowed firms to profitably
extract shale gas resources that previously had been
uneconomical to extract. Fracking involves injecting a
pressurized mixture of water, sand, and chemicals into deep
wells, typically drilled horizontally into shale formations. In
2000, shale gas production accounted for only 1.7% of U.S.
natural gas production, but today totals 35%. By 2040, the U.S.
Energy Information Administration (EIA) forecasts that over half
of the domestic natural gas production will come from shale
formations. Increased shale natural gas production has pushed
natural gas prices significantly lower, although critics argue
that fracking's environmental costs outweigh its benefits.
Municipal and public utilities don't produce natural gas;
instead, they buy it from suppliers on daily, weekly, or monthly
markets. Suppliers transport gas to utilities, who then deliver
it to customers, through pipelines.
State law imposed various taxes and fees on the oil and natural
gas extraction industry, but also allows the industry specific
tax benefits. Specific fees include:
Regulatory Assessment . State law imposes a fee on each
barrel of oil paid to the Division of Oil, Gas, and
Geothermal Resources (DOGGR) of the Department of
Conservation. Producers of oil and gas are required to pay
the fee, currently $0.1062988 per barrel, which pays for
the regulatory work of the division.
Oil Spill Prevention and Administration Fee .
Transporters of oil pay $0.05 per barrel on crude oil
received at a marine terminal from within the state. The
Board of Equalization (BOE) administers the fee, which
funds the Oil Spill Prevention and Administration Fund.
SB 1017 -- 5/01/14 -- Page 3
Oil Spill Response Fee . Specified marine terminal
operators, pipeline operators and refiners pay up to $0.25
per barrel to fund the Oil Spill Response Trust Fund.
However, because the Fund is currently capped at the legal
maximum of $50 million, BOE isn't currently collecting the
fee.
Specific benefits are:
Percent Depletion Allowance : Under state and federal
law, taxpayers may deduct up to 100% (oil and gas) of the
net income for resource depletion such as oil extraction.
California conforms to federal law to encourage taxpayers
to explore and develop oil, gas and other mineral
resources.
Enhance oil recovery costs: Certain independent oil
producers are allowed a nonrefundable credit equal to 5% of
the qualified enhanced oil recovery costs for projects
located in California, with restrictions on barrel prices
($48 in 2010). The credit hasn't been available since 2005
because oil prices have been too high.
Firms that extract oil must pay income taxes to the extent they
generate net income, sales and use taxes on property they
purchase, and property taxes on the assessed value of their
property. However, proven oil reserves are considered real
property and therefore afforded the protections of Proposition
13 that cap the growth in its taxable value to 2% per year and
prohibits reassessment unless the taxpayer sells the property.
When consumers buy gasoline and diesel pay, they pay excise
taxes. Additionally, at least three jurisdictions have imposed
local oil severance taxes: Long Beach, Signal Hill and Beverly
Hills.
Proposed Law
I. Severance taxes. Senate Bill 1017 enacts the Oil Severance
Tax Law, which imposes a severance tax for the privilege of
SB 1017 -- 5/01/14 -- Page 4
extracting oil or natural gas. BOE administers the tax under
the Fee Collection Procedures Law, set at 9.5% of the average
price per barrel of oil, and 3.5% of the average price per 1,000
cubic feet of natural gas, with average prices determined by
DOGGR according to a methodology specified in the bill. Anyone
with an interest in the oil or its value, including a royalty
interest, is liable for the tax, which the bill explicitly
states is in addition to all other taxes.
The bill also:
Considers a single operator two or more operators
controlled directly or indirectly by the same interests,
Exempts stripper wells, defined as a well certified by
DOGGR as incapable of producing more than 10 barrels per
day for a calendar month, or a gas well incapable of
producing more than 60,000 cubic feet of gas per calendar
month,
Directs DOGGR to notify BOE of stripper wells,
Exempts oil and gas owned or produced by the state or
any political subdivision of the state,
Requires operators to file returns with BOE in a form
prescribed by BOE, which are due on or before the last day
of the calendar month following the calendar quarter to
which it relates,
Allows BOE to adopt regulations to enforce the measure,
including emergency regulations exempt from the
Administrative Procedures Act.
SB 1017 requires that all proceeds from the severance tax, less
refunds and costs of administration, be deposited in the
California Higher Education Fund. The bill defines many of its
terms, and contains legislative findings and declarations
supporting its purposes.
II. Funding. SB 1017 creates the California Higher Education
Endowment Corporation (CHEEC) in state government, and
continuously appropriated to the California Higher Education
Fund to CHEEC for immediate expenditure to:
50%, in equal shares, to the Regents of the University
of California, the Trustees of the California State
University, and the Board of Governors of the California
Community Colleges, and used solely for the following
purposes in the following priority:
SB 1017 -- 5/01/14 -- Page 5
o Deferred maintenance,
o Instructional equipment replacement,
o Repay general obligation debt,
o Minor capital outlay projects.
25% to the Department of Parks and Recreation for the
maintenance and improvement of state parks.
25% to the Department of Health and Human Services
Agency to fund health and human services programs.
III. Governance. SB 1017 establishes CHEEC's oversight board,
composed of the following members to serve four-year terms:
Two members appointed by the Board of Trustees of the
California State University, including one non-management
employee,
Two members appointed by the Regents of the University
of California, including one non-management employee,
Two members appointed by the Chancellor of the
California Community Colleges, including one non-management
employee,
Two members appointed by the Senate Committee on Rules,
Two members appointed by the Speaker of the Assembly,
One member appointed by the Treasurer,
One member appointed by the State Superintendent of
Public Instruction,
Three student members who must be a current students in
CSU, UC, and Community Colleges, nominated by the
appropriate governing board from a list of three supplied
by the respective student organization,
Three ex officio members,
o The Chancellor of the California State
University,
o The President of the University of California,
o The Chancellor of the California Community
College,
The oversight board must annually select one of its members to
serve as chairperson.
IV. Director. The oversight board must appoint a director, who
is CHEEC's chief executive officer. The position is designated
as confidential and exempt from civil service provisions, and
serves at the pleasure of the board. The board may delegate any
power lawfully allowed to the director, who can then delegate
SB 1017 -- 5/01/14 -- Page 6
any lawfully allowed power to a designee.
V. General provisions. Each year, the board shall select an
auditing firm on a six-year rotation to conduct an annual audit
of each entity that receives funding from the bill, if the
entity received money, to ensure that the entity used the funds
for the bill's purposes. The audit must be paid for with
investment returns from the fund.
The Board must report to the Legislature annually by April 1st
regarding:
CHEEC revenue and expenditure data,
Fund revenue and expenditure data,
A review of compliance audits,
An examination of the level of General Fund
appropriations for UC, CSU, and the California Community
Colleges in light of funding provided by the fund.
If the board determines using the audits that any entity
improperly used the bill's funding, the board must:
Bar funding for an entity for the following fiscal year,
and require it to submit a remediation plan, which the
board must approve,
Bar funding for an entity for the following two fiscal
years upon a second finding that it mishandles funds within
five years of being barred from funding,
Bar funding for an entity permanently upon a third
finding that it mishandled funds.
The bill allows CHEEC's board to adopt regulations subject to
the Administrative Procedures Act to implement the bill.
SB 1017 provides that the taxes imposed by this act are "General
Fund proceeds of taxes" and must therefore be dedicated to
Proposition 98, but also counts its allocations toward
Proposition 98's revenue guarantee for community colleges.
Additionally, the measure provides that severance tax revenues
shall compensate local agencies for any local property tax
reductions. SB 1017 also contains legislative findings and
declarations supporting its purposes.
State Revenue Impact
SB 1017 -- 5/01/14 -- Page 7
According to BOE, SB 1017 results in revenue gains of $845
million in 2014-15, and $1.58 billion in 2015-16, but BOE
cautions that this estimate is based on future oil prices, which
are uncertain and may be volatile. For every $5 change in the
oil price, BOE expects an $80 million change in revenue.
Comments
1. Purpose of the bill. According to the author: "California
has come a long way in easing its wall of debt during the past
two years. However, our progress has come with many difficult
choices including cuts in funding for vital programs and
services. After an election in which the majority of the voters
in California voted to raise their own taxes to fund education
and other crucial services, now is the time for our state to
join the rest of the other oil producing states and enact an oil
severance tax on big oil companies to help strengthen our
economy. California is the only state of the top ten oil
producing states in the nation that does not charge a severance
tax on every barrel of oil taken from our state lands and sea
bed. Oil producing states such as Alaska charge a 25% tax and
the state of Texas charges 4.75%. Opponents of an oil severance
tax have claimed for years that the oil companies will pass any
taxes on to consumers, but that is not the case. According to a
study by the Rand Corporation, which investigated the impacts of
a 6% oil severance tax, the tax cannot be passed onto consumers
and it will not affect production. Virtually all economists
agree that the world market sets the price of oil, and that
underlying taxes whether from Texas, Kuwait or California, are
not passed through at the pump."
2. Nexus ? An old piece of tax policy wisdom attributed to
Louisiana Governor Russell Long states that, "Don't tax you,
don't tax me, tax the man behind the tree." SB 1017 imposes a
tax on oil and gas production to fund higher education, parks,
and health and human services. As such, the measure links the
bill's funding priorities to seemingly unrelated oil and gas
producers. While considerable debate exists regarding the
efficacy of severance taxes (see Comment #3), the measure pays
for services by billing a part of the economy that doesn't put
many demands on higher education, parks, and health and human
SB 1017 -- 5/01/14 -- Page 8
services. The Committee may wish to consider the precedent of
establishing a tax to pay for specific services without a clear
nexus between taxpayers and the uses of tax revenue.
3. Who pays ? SB 1017 would raise about $845 million annually
to fund its programs by taxing oil and gas producers.
Disagreements exist regarding who actually bears the incidence
of the tax. Opponents argue that the tax could be passed on in
higher gasoline prices, or higher prices on goods and services
that rely on oil and gas as an input. Additionally, a timeless
tenet of tax theory states that once you tax something, you'll
get less of it, so SB 1017 could reduce in-state oil production
and associated employment. However, the Legislative Analyst's
Office (LAO) argues that California oil and gas producers
compete in mostly global markets, so a severance tax would be
difficult to pass on. In its analysis of Proposition 86 (2006),
which would have imposed an oil severance tax, LAO says:
"Economic factors may also limit the extent to which the
severance tax is passed along to consumers. For example,
the global market for oil means that California oil
refiners have many options for purchasing crude oil. As a
result, oil refiners facing higher-priced oil from
California producers could, at some point, find it
cost-effective to purchase additional oil from
non-California suppliers, whose oil would not be subject to
this severance tax."
Additionally, to the extent that California produces less oil
and natural gas, the environmental effects on air and water
quality would be reduced. California's Central Valley is home
to 84% of the state's oil extraction, but also suffers from some
of the worst air quality in the nation.
4. Something different . Generally, revenues from state taxes
flow into the General Fund, and then the Legislature allocates
funding to various purposes in the Budget Act. SB 1017 imposes
a tax, but directs funding to CSU, UC, community colleges,
parks, and health and human services by way of CHEEC in addition
to allocations made in the annual Budget Act. If an oil
severance tax makes sense, why not impose it and allow the
Legislature the flexibility to use the revenue to fund its
priorities, especially since Proposition 98 will direct a
SB 1017 -- 5/01/14 -- Page 9
significant share to public education anyway?
5. Geography . An oil severance tax would reduce property tax
revenues to the extent that the severance tax reduces the
taxable value of oil reserves. Most of the state's oil
production occurs in the Counties of Fresno, Kern, Los Angeles,
and Ventura, so these counties could see some loss in revenue.
In response, the measure provides that the state will reimburse
counties for property tax revenues caused by the bill. However,
the bill neither provides a process similar to reassessment of
property tax losses resulting from reassessments of disaster
related property, nor directs moneys in the fund to pay for
these losses. The Committee may wish to consider amending the
bill to require payment of these losses from the fund, as well
as a process for counties to calculate, and the Department of
Finance to certify, these revenue losses.
6. Volatility . Oil prices can change rapidly, and so will oil
severance tax revenues pegged to them. SB 1017's funding
recipients could see big swings from year-to-year, making
long-term investments difficult. If the bill instead imposed
the tax as a fixed amount per barrel, both revenues and
expenditures would be more certain, as extraction patterns don't
change much from year to year.
7. Appropriate ? SB 1017 grants authority to the board to
invest assets of the fund in any financial instrument or
transaction not restricted by the Constitution or law, and to
make any investment, sell any security, obligation, or real
property. Earning a positive rate of return investing public
funds is hard, and a newly-created board without any financial
expertise will likely lack the sophistication and experience
necessary to successfully invest state funds. Additionally,
authorizing investment in basically any security without the
institutional capacity to assess the specific risk associated
with a security will likely lead to losses to the fund. The
bill also requires that its audits be paid for by investment
returns, but is silent regarding whether audits would still
occur if the fund doesn't make any money. The Committee may wish
to consider deleting this authority, and the requirement that
the audit be paid for by investment returns.
8. Once more, with feeling . Last year, the Committee approved
SB 1017 -- 5/01/14 -- Page 10
SB 241 (Evans), which imposed a tax on oil severance to fund
many of the same programs, but the measure subsequently died on
the Suspense File in Senate Committee on Appropriations. SB
1017 and SB 241 follow several other unsuccessful legislative
and initiative efforts in previous years.
9. Technicals . BOE and Committee staff recommends the
following amendments:
The measure provides that the tax is imposed on January
1, 2015, but DOGGR and BOE will likely need more time to
implement the bill, including BOE's charge to set up a
collections infrastructure. Instead, the bill should
specify July 1, 2015, and conform the bill's other
provisions to the later effective date.
The measure also needs clarity regarding when the tax is
imposed, such as the time of severance or when the taxpayer
acquires oil and gas.
Delete the measure's extension of tax liability to
anyone who owns an interest in the well, including
royalties, as it contradicts with the measure's definition
of "operator."
Delete the revocation of the exemption for stripper
wells that produce more than five barrels per month because
it conflicts with the bill's definition for stripper wells
found earlier in the bill.
10. Urgency and tax increase . SB 1017 is an urgency measure,
and increases taxes on any taxpayer, so the measure has been
keyed a 2/3 vote.
Support and Opposition (5/02/14)
Support : AFSCME; Alliance of Californians for Community
Empowerment; California Communities United Institute; California
Faculty Association; California Immigrant Policy Center;
California Nurses Association; California Partnership;
California Teachers Association; Community College League of
California; Courage Campaign; Fair Share; Parent Voices; SEIU
SB 1017 -- 5/01/14 -- Page 11
California. Student Groups: California College Democrats;
California State Student Association; CA Tax Reform Association;
Student Senate of California Community College; Refund
Coalition; University of California Student Association.
Opposition : Associated Builders and Contractors of California;
Association of California Cities- Orange County; Brea Chamber of
Commerce; California Business Properties Association; California
Chamber of Commerce; California City; California Grocers
Association; California Independent Petroleum Association;
California Manufacturers & Technology Association; California
Retailers Association; California Small Business Association;
California Taxpayers Association; California Taxpayer Protection
Committee; Camarillo Chamber of Commerce; Central Coast Energy
Alliance; Chamber of Commerce Alliance of Ventura and Santa
Barbara Counties; City of Bakersfield; City of Ridgecrest; City
of Shafter; City of Taft; Coalition of Labor, Agriculture &
Business Santa Barbara County; County of Kern; El Monte/South El
Monte Chamber of Commerce; Fullerton Chamber of Commerce;
Greater Bakersfield Chamber of Commerce; Howard Jarvis Taxpayers
Association; Independent Oil Producers' Agency; Kern County
Board of Supervisor; Kern County Firefighters IAFF Local 1301;
Kern County Superintendent of Schools; Kern County Taxpayers
Association; Kern Economic Development Corporation; Los Angeles
County Business Federation; McKittrick School District; National
Federation of Independent Business; Orange County Business
Council; Oxnard Chamber of Commerce; Placer County Taxpayers
Association; San Diego Tax Fighters; San Jose Silicon Valley
Chamber of Commerce; Santa Barbara County Taxpayers Association;
Santa Clara Chamber of Commerce; Superintendent Taft City School
District; Valley Industry & Commerce Association; Ventura
Chamber of Commerce; Western States Petroleum Association.
.