Michigan officials are considering the need for a longer-term funding solution for the state’s oil and gas regulatory program as the recent drop in oil and gas prices have increasingly shifted oversight costs from the industry onto taxpayers.
Historically, the state Department of Environmental Quality’s Oil and Gas Program — which inspects oil and gas wells, reviews permit applications and monitors production — has been funded mostly by a “surveillance fee” on oil and gas companies, capped at 1 percent of the value of gross production.
When prices were higher, the program was able to fund itself while maintaining a targeted year-end fund balance of about $7 million.
But in late 2014, oil prices began to drop. Since then, fee revenue has dropped about 70 percent while the costs for running the program have only modestly decreased. And last year, the rainy day fund had been depleted to about $600,000, forcing state officials to approve a $4 million infusion into the program from the general revenue fund.
Gov. Rick Snyder has proposed another $4 million for the upcoming fiscal year to keep the program afloat. Amid current budget discussions, state House lawmakers have proposed cutting the amount to $3 million.
The Oil and Gas Program is now under a hiring freeze and and staffing levels have dropped about 18 percent from a few years ago, said Hal Fitch, director of the Oil, Gas, and Minerals Division of the DEQ. However, because well shutdowns also require oversight, the program’s work load is increasing.
With growing dependence on the general fund, the oversight program’s funding structure has raised questions about whether the existing assessment will be a reliable long-term solution, and whether Michigan taxpayers should continue what amounts to a subsidy for oil and gas development.
“If we only get $3 million, we’re going to be scrambling to make some additional cuts,” Fitch said of the legislature’s budget plan. “I don’t think natural gas prices are coming up anytime soon. Oil is creeping back up of course, but I don’t know if it’s going to be enough.”
“Long term, if prices don’t come up, we’re going to have to have a longer-term structural fix to our funding — unless the Legislature decides it’s OK with us using general revenue funds,” Fitch said. “We can’t go year to year asking each time for a supplement.”
While the program will continue essential operations, Fitch said it would likely cut back on well inspection rates.
“We’re already seeing some effect with that,” he said. “The problem with declining oil prices is that it doesn’t mean a declining work load for us — it’s more likely the reverse.”
A drop in prices means smaller profit margins for companies, which in turn means shutting more wells, Fitch said. The state is then responsible for making sure those wells are properly closed. In an even worse scenario, Fitch said smaller companies with less capital “just go out of business and leave wells on our hands that we have to plug, and the work load continues.”
He said the state deals with hundreds of abandoned wells a year. Michigan has more than 15,600 active oil and gas wells and more than 3,000 gas storage wells, while another 35,000 wells “have been plugged as nonproductive or depleted,” according to the state. If a well is not properly plugged, it’s subject to leakage and contaminating well water supplies.
Who should pay?
Between fiscal years 2014 and 2015, revenues for the program dropped from $11.8 million to $5.5 million, though expenditures only dropped by about $600,000, from just under $10 million to $9.4 million.
Expenditures are now around $8.5 million, while revenues have dipped below $4 million.
The 2014-’15 decline also reduced staffing levels from 64 to 57 positions, but the number of site inspections actually increased from 22,812 to 23,138, according to recent DEQ reports.
Michigan is not a major player when it comes to oil and gas production. Last year, the state saw the fewest amount of drilling permits issued and oil produced in decades, leaving the industry in a sort of holding pattern if or until prices rebound. Oil production increased slightly between 2009 and 2013, remaining between six million and eight million barrels a year. Natural gas production has been steadily declining in Michigan since 2010.
But it’s the drop in prices within the past three years — down from about $100 a barrel in mid-2014 to below $40 a barrel in late 2015 — that have caused budget problems for Fitch’s program.
The Oil and Gas Program is also funded by permit fees, gas storage well fees, indirect federal revenue, cost recovery and interest, but the surveillance fees account for nearly all of the revenues.
The surveillance fee is set every year based on estimates of what the value of production will be. It is currently at the 1 percent cap, Fitch said, and increasing it could make it even more challenging for companies with low profit margins.
As the compliance burden has shifted more to taxpayers, Fitch said “there are some differences of opinion among the public as to whether the industry should be paying for their own regulation or not.
“Some would say if (industry) is paying for it then our agency is beholden to the industry — I’d argue that’s not the case — and if we’re dependent on a fee for production then we have an incentive to increase production regardless of impacts,” Fitch said. “Some people would rather see us funded from some other source. That’s a policy question that’s way above my pay grade.”
A similar situation played out in Pennsylvania around the same time as natural gas prices declined, leaving the state to seek other funding options outside of an “impact fee” levied on wells. Those fees, as well as fines and other permit fees, meant the state didn’t have to rely on the general fund for the oversight program.
Subsidizing oil and gas development
Last month, environmental groups criticized state House lawmakers for reducing the $4 million supplement to $3 million during the budget process.
“What we’re seeing in Michigan now is both a drop in the amount of oil and gas coming out of the ground and a drop in the value of it,” said James Clift, policy director for the Michigan Environmental Council. A $3 million general fund infusion, he added, would result in a “reduction in the amount of staff enforcing regulations under the Oil and Gas Program.”
Clift said the state needs to “go back in and recalculate how they do that assessment on the industry to make sure the industry is paying for that program. Right now, Michigan residents are subsidizing oil and gas development in Michigan. We don’t think that makes any sense.”
The leaders of the Michigan Oil and Gas Association and the Michigan Electric and Gas Association did not respond to multiple requests for comment.
Clift said taxpayer money should be used to enforce environmental regulations and “making sure they’re doing it right,” while the industry should be paying fees to oversee actual drilling operations.
“These are people basically exploring for oil and gas — we shouldn’t be subsidizing that at the state level,” Clift said.
Anne Woiwode, conservation director for the Michigan chapter of the Sierra Club, agrees.
“Generally, Sierra Club calls for the costs of environmental compliance to be borne by those who are benefiting from the production of the product or pursuing the activity,” Woiwode said in an email. “The oil and gas industry needs to pay for the full costs of oversight of the industry, including ensuring that as there are sufficient funds to safely close and seal wells when they are exhausted or deemed to be uneconomic.”
In addition to monitoring and overseeing compliance with the wells, Woiwode said the state should make companies responsible for paying back any costs that exceed funds raised through the fees.
“However, Michigan’s laws tend to favor and encourage the development oil and gas deposits but fall short when it comes to considering and preparing for the full life cycle of health and environmental impacts. As a result, the full cost of these fossil fuels is not incorporated into the cost of the product,” she said.
As lawmakers continue debating the program’s funding, Fitch said it’s hard to speculate on what the long-term solution is.
“The choices come down to increasing the cap on that fee — which is not going to be popular and is going to hurt the profitability of companies on the margin — or find some other funding source,” he said. “There’s not a lot of other options out there.”