BILL ANALYSIS AB 1693 Date of Hearing: May 10, 1993 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Johan Klehs, Chair AB 1693 (Margolin) - As Amended: May 3, 1993 SUBJECT Imposes a 6% oil severance tax DIGEST 2/3 Vote Required. Tax Levy. Fiscal Committee. Existing law: 1) Levies a fee $0.026136 per barrel of oil on all producers of oil to fund regulatory programs of the Department of Conversation. 2) Authorizes a 1.0% ad valorem property tax, to be imposed by counties, on the full cash value of property where the value of the property includes underlying gas and mineral rights. This bill: 1) Imposition of the Tax. Imposes a 6% severance tax on any individual or entity that produces or extracts any oil with a specific gravity of 16 API or higher in excess of 30,000 barrels during any month of the current or preceding year. This tax is in addition to any ad valorem property tax, business license tax, or yield tax that may otherwise be imposed. 2) Definition of a Producer. Defines as a "producer" any person who: a) Acquires in excess of 30,000 barrels of oil during any month of the current or preceding year from a person or agency exempt from property taxation under federal or state laws; or b) Owns any royalty or other interests in any oil or its value in excess of 30,000 barrels during any month of the current or preceding year, whether produced by him or her, or by some other person on his or her behalf, either by lease, contract, or otherwise. Two or more producers that are corporations and are owned or controlled directly or indirectly by the same interests, as specified, shall be considered a single producer for the purposes of this tax. - continued - AB 1693 Page 1 AB 1693 3) Exemptions from the Tax. All oil owned or produced by political subdivisions of the state, including that subdivision's share of oil produced under any unit, cooperative, or other pooling agreement. 4) Definition of Production. Defines "production" as the total gross amount of oil produced, including the gross amount attributable to a royalty interest. 5) Value of the Oil. Defines "gross value" as the sale price at the mouth of the well. If oil is exchanged for something other than cash, if there is no sale at the time of severance, or if the relationship between the buyer and seller is such that the transactions price is not reflective of the true market value of the oil subject to the tax, the tax shall be based on the cash price paid to producers for like quality oil in the vicinity of the well. 6) Administration. Authorizes the Board of Equalization (BOE) to enforce the provisions of this tax in accordance with existing procedures provided under the Sales and Use or Timber Yield Tax laws, whichever are most applicable. 7) Disposition of the Tax. Provides that all taxes, interest, and penalties imposed by this tax shall be remitted to the Board of Equalization for deposit to the General Fund. 8) Effective Date. This measure takes effect immediately as a tax levy with an operative date of January 1, 1994. FISCAL EFFECT State: Annual General Fund revenue gain of $97 million based on estimates š provided by the Board of Equalization. This estimate assumes an average price for oil of $12/barrel and taxable production of 134.5 million barrels/year (see comment 8). Local: Unknown, but probably minimal, revenue loss due to the reduction of š value of oil-producing property subject to the local property tax as a result of the imposition of the tax. COMMENTS 1) The Purpose Of The Bill The purpose of this bill is raise General Fund revenues to help balance the budget. According to the proponents, this bill levies a tax on a non-renewable natural resource of the state, which should be used to the benefit of the state's residents, and that it is only fair that producers pay for the utilization of this resource. - continued - AB 1693 Page 2 AB 1693 Supporters note that California is the only major oil producing state that does not levy a severance tax. 2) What Taxes Do Oil Companies Currently Pay? Oil producers are currently subject to the local property tax (for on-shore) producers, state income tax, a small state fee to support regulatory programs, and any local business license taxes that may apply. Oil property is valued for property tax purposes based on the income stream produced by the property. However, the annual increase in assessed value is capped by Proposition 13's reassessment provisions. Opponents argue that oil production is capital intensive and, hence, the industry pays relatively high property taxes. Moreover, an increase in production costs (such as that resulting from imposition of a severance tax) would decrease the economic viability of the property, resulting in lower property values and reduced local property tax revenues. Assuming the severance tax is not passed on to consumers and is, instead, borne by oil producers, bank and corporation and personal income tax revenues also would decrease as a result of this measure. To the extent the tax is borne by consumers, it would not affect bank and corporation or personal income tax revenues. 3) Practice Of Other Oil Producing States California is the fourth largest oil producing state in the U.S. and is the only major oil producing state in the U.S. without an oil severance tax. Oil taxes levied by other oil producing states are summarized in Attachment 1. State severance tax rates range from 1% to 15.0%. Eight of the major oil producing states, including California, impose property taxes on oil producing lands. Fourteen states, including California, levy miscellaneous fees or taxes. Oil companies are also subject to the corporate income tax in all states except Texas and Wyoming, which have no corporate income tax. A 1982 study by the Legislative Analyst's Office concluded that an oil severance tax of 6.5% would be needed in order to bring California's combined property and severance tax levy up to the average of the nine major oil producing states. Oil severance tax rates have since increased in a majority of the states studied by the Analyst's Office. 4) Who Bears The Burden Of The Tax? Proponents of this measure argue that oil prices are determined in a world market and that producers do not raise their prices in response to imposition of oil severance taxes. A 1982 study by the Rand - continued - AB 1693 Page 3 AB 1693 Corporation evaluating the impact of an oil severance tax on California concluded that, "The tax would affect final consumers very little." This conclusion šis based on the fact that California production represents a very small šfraction of world and domestic production. The Rand study concludes that šif producers are unable to pass the tax on to consumers, the burden of the štax is shared by producers, royalty owners, and refiners. 5) Impact On California Oil Industry Opponents of this measure contend that California oil is of lower quality and production costs are higher than producers elsewhere. To the extent that the severance tax raises the cost of production, the economic viability of high cost, low profit margin wells will be disproportionately affected. Supporters note that to the extent production is reduced by the tax in the near term, it is more appropriate to consider this a postponement. When world oil prices increase due to supply or political factors, production at these marginal facilities will once again become profitable. In particular, a significant fraction of California production is heavy crude. The market for heavy crude is limited both by demand and the availability of refinery capacity to transform heavy crude into a usable commodity. Opponents argue that even a marginal increase in costs would endanger the viability of this segment of the industry. This measure exempts oil below 16 API from taxation. Supporters of the exemption argue that this oil is most expensive to produce and most difficult to market (see comment 6). 6) Should Quality Determine Whether Oil Is Taxed? This measure exempts oil with a specific gravity less than 16 API from the tax. Oil is graded by specific gravity. Lower gravity oil is considered of lower quality and is generally, but not always, more expensive to produce. A considerable fraction (56%) of the oil produced in California would be exempt from taxation as a result of this provision. The author argues that this exemption is reasonable and reflects the fact that this lower quality oil tends to be less competitive and more expensive to produce. Imposing the tax on oil of this quality could result in putting marginal producers out of business. Opponents of this provision note that their is no precedent in state tax law for taxing a product based on its quality. To the extent low quality oil sells for a lower price, the tax on the oil will be lower. Opponents continue that it is more appropriate for the tax to be based on price that to draw an arbitrary dividing line between taxed and exempt oil. - continued - AB 1693 Page 4 AB 1693 A number of states impose a lower tax on oil produced using tertiary recovery methods. Supporters of this approach argue that it is more reflective of production costs that an exception based on API. Similarly, if the author's intent is to exempt oil that is expensive to produce from tax, a full exemption could be provided for oil produced using tertiary recovery methods. Is this a more desirable approach than an exemption based on API? 7) Small Producers Are Exempt This measure exempts producers of under 30,000 barrels per month from the severance tax. According to the Board of Equalization, approximately 78% of all oil with API over 16 is produced by "large" producers and subject to this tax. While the bill defines related entities as a single producer, it is possible that the small-producer exemption may provide an incentive for producers to reorganize their operations so as to obtain an exemption from this tax. Is the current language sufficient to prevent this from occurring? Opponents of this exemption note that the threshold for the exemption is exceedingly high compared to that in other states. A number of states use production in the range of 10-25 barrels/day for defining a small producer. The size of the exemption could encourage producers to keep production artificially low to escape taxation. 8) Revenue Issues The two exemptions for quality of oil produced and small producers exempt an estimated 82% of all oil produced in the state from the tax. The impact is to significantly reduce the revenues as compared to what would be raised by a broad-based tax. If the state is going to impose a severance tax, is it reasonable to exempt 82% of the oil produced from the tax? California oil prices typically vary between $12 and $15 dollars per barrel. Approximately 60% of California production, according to the Western States Petroleum Association, consists of Kern River crude, which currently sells for approximately $12 per barrel. Each $1 per barrel increase in California oil prices will increase severance tax revenues by $8.1 million as this bill is currently drafted. Revenues from a tax imposed as a percent of value would vary directly with the price of oil. Over the past year, oil prices have fluctuated widely. A tax levied at a fixed rate per barrel would produce a revenue stream that varied only with production levels. Given the volatility of oil prices, should a percentage tax be imposed? - continued - AB 1693 Page 5 AB 1693 Furthermore, California oil production has declined slightly over recent years. Hence, severance tax revenues will decline if this trend continues. Supporters of this measure argue that increases the viability of California producers. Opponents argue that the state should not adopt a tax which will produce declining revenues over time. Local property tax revenue may be reduced as a result of this measure. Oil producing properties are valued based on the income stream produced by the property. However, this reduction is likely to be minimal since actual assessed values will only be reduced if the reduction in value is sufficient to lower the value below the adjusted based year value determined pursuant to Proposition 13's assessment rules. 9) Should The Tax Be A Flat Amount Per Barrel? The Board of Equalization is concerned that it may be difficult to assign a price at the well-head, particularly in the case of integrated oil producers who do not price their product until a later stage of production. This measure states that in the event there is no price is set at the well-head, the price for similar oil produced in the area will be used. The Board suggests that it might be simpler to set the tax at a flat amount per barrel. If the average price for California crude is $12/barrel, a 6% tax is equivalent to $0.72. Is a flat tax preferable? 10) Oil Produced On Municipal Lands Is Exempt This bill exempts from taxation all oil produced by political subdivisions of the state. Exempt oil appears to include all oil produced on tidelands and submerged lands granted in trust by the State of California. According to the Attorney General's Office, lands granted in trust by the state include the Long Beach oil fields and smaller tracts granted to the cities of Newport Beach, Redondo Beach and Los Angeles. Royalty payments from the Redondo Beach, Newport Beach and Los Angeles offshore tracts go directly to these cities. Supporters of the exemption note that imposition of a severance tax on the Redondo Beach, Newport Beach and Los Angeles tracts could potentially reduce revenues to these cities, depending upon the structure of the lease between the city and the oil producer. The state and City of Long Beach currently receive royalties amounting to 95% of the net profits made on oil produced from the Long Beach tidelands. The state's share of revenues go to support the State Lands Commission, the Special Fund for Capital Outlay, and certain other programs specified in budget control language. The effect of a tax on these lands would be š - continued - AB 1693 Page 6 AB 1693 to shift revenues to the General Fund (via the severance tax) from their šcurrent use (via royalty payments). This measure would impose a tax on šoil pumped from state-owned lands or related royalties. Is this the šauthor's intent? 11) Amendments Needed The Board of Equalization has identified several amendments that are needed in order to implement this bill: a) The appropriate administrative provisions should be specified. b) The conditions which the API of oil are measured should be specified. c) To either define or delete the term "borne ratably" in the imposition of the tax. Attachment 1 Summary of Severance Taxes Imposed In Oil Producing States Severance Property State Tax Rate Other Taxes Tax Note Alabama 8.0% 2.0% NA 1 Alaska 15.0% $0.054/barrel * 2 Arkansas 5.0% $0.02055/barrel NA California none 0.026% yes 3 Colorado 4.0% 0.13% yes 4 Florida 8.0% NA 5 Idaho 2.0% 0.005/barrel NA Indiana 1.0% NA Kansas 8.0% 1.35% yes 6 Kentucky 4.5% NA Louisiana 12.5% no 7 Michigan 6.6% 1.0% * 8 Mississippi 6.0% $0.035/barrel * Montana 5.2% 7.7% yes 9 New Mexico 7.08% 3.34% yes 10 North Dakota 11.5% * 11 Oklahoma 7.0% 0.085% * 12 Oregon 6.0% NA Texas 4.6% see note yes 13 Utah 5.2% 4% - 5% yes 14 West Virginia 5.0% NA Wyoming 3.5% yes Notes: NA- Information not available *- Severance tax levied in lieu of ad valorem property tax. - continued - AB 1693 Page 7 AB 1693 1- Severance tax rate is 6% for wells producing under 35 barrels/day. 2- Reductions and incentives reduced average effective rate to 13.62%. 3- Department of Conservation regulatory fee. 4- 87.5% of the local property taxes are creditable against severance tax. 0.11% conservation tax an 0.02% Environmental Response Tax. A lower rate is imposed on producers with gross income under $100,000. A 5% tax is imposed on producers with gross income in excess of $300,000. 5- Rate is 5% on small wells and oil produced using tertiary recovery methods. 6- Conservation fee. Credit of up to 3.6% against property taxes also allowed. 7- Rate is 6.25% on small producing wells. 8- Rate is 4% on wells producing less than 10 barrels/day. 9- 7% local tax in lieu of property tax, plus 0.5% resources indemnity tax and 0.2% conservation tax. Rate is 2.5% on wells using tertiary recovery methods and 3% on "stripper" wells. 10- Additional taxes include a school tax of 3.15% and conservation of 0.19%. 11- Rate is 9% for wells completed after 4/27/87 or those using tertiary recovery methods. 12- Petroleum excise tax. 13- 3/16 of 1 cent per barrel regulatory tax. 14- The tax is levied at a rate of 3.2% of the 1st $13/barrel and 5.2% on the price above $13. A 0.2% conservation tax is also levied. Source: National Conference of State Legislatures Advisory Committee on Intergovernmental Relations - continued - AB 1693 Page 8