Figure A - - ACKNOWLEDGMENTS - -This paper was prepared by Gail Cutler, Fiscal Analyst with the Senate Fiscal Agency. Jay Wortley and Rebecca Ross, Economists with the Senate Fiscal Agency, assisted in obtaining and interpreting the data. The cooperation of staff from the Department of Natural Resources and the Department of Treasury was most appreciated. Patricia Stinton-Harper prepared the final version of the graphs and documents. |
TABLE OF CONTENTS |
| INTRODUCTION |
| TRENDS IN STATE OIL AND GAS PRODUCTION |
| OIL AND GAS PRODUCTION REVENUES TO THE STATE |
| USES OF OIL AND GAS REVENUE |
| OIL AND GAS PRODUCTION ISSUES |
| CONCLUSION |
| REFERENCES |
This paper reviews the recent history of oil and gas production in Michigan, the collection and use of oil and gas revenues, and current oil and gas production issues.
The Department of Natural Resources (DNR) is the designated steward of 5.9 million acres of mineral rights, and is authorized by law to enter into contracts to lease these mineral rights to individuals or corporations for oil and gas exploration and development. The oil and gas leasing program has generated over $868 million for DNR programs since 1927. Currently, the DNR administers 6,300 active leases on 714,821 acres.
Not all of the State's mineral rights are on State lands. Of the total 5.9 million acres, the DNR owns 2.1 million acres of mineral rights under privately-owned lands and 3.8 million acres of mineral rights under State-owned lands. The DNR also owns 700,000 acres of surface rights only on State-owned lands, but this report will focus on the oil and gas production from State-owned mineral rights, regardless of surface ownership. There are no data readily available on oil and gas production from mineral resources not owned by the State but under State-owned surfaces.
In 1995, oil and gas production generated over $71 million in revenue to the State. The DNR collects revenue from royalty and rental income on leases. The Department of Environmental Quality (DEQ) charges an oil and gas privilege fee on all production. And, the Department of Treasury collects severance taxes on all oil and gas production, including production from State resources (excluding payment of royalties).
Return to the Table of Contents TRENDS IN STATE OIL AND GAS
PRODUCTION
Figure A depicts oil and gas production in Michigan for the past 10 years.
Figure A Oil production in Michigan has been decreasing steadily since the mid-1980s, primarily due to oil-bearing formations becoming less productive. As oil production began to decline, the natural gas production potential from Antrim Shale geological formations was explored. This activity coincided with passage of Section 29 of the Internal Revenue Code to encourage development of natural gas from nonconventional sources, which include Antrim Shale. Wells drilled between December 31, 1979, and January 1, 1993, are eligible for a Federal tax credit, which has ranged from 56 cents to $1 dollar per mcf (1,000 cubic feet) from 1980 to 1995. According to a research report prepared for the DNR by the WEFA Group and E3c Inc., this tax credit substantially reduces the cost of producing nonconventional gas relative to conventional gas. They concluded, however, that there are relatively low finding and development costs for this gas, and economical production could be sustained even in the absence of the tax credit (which expires in 2001).
In 1995, production from State-owned mineral rights represented approximately 27% of all oil produced in the State, and 44% of natural gas production. In 1992, over 50% of Michigan gas wells were on State land, compared with less than 30% 10 years earlier. During the period of 1986 to 1995, the State of Michigan became a more important source for natural gas, as production increased over 160% on State-owned land, and only 20% on private land, as shown in Figure B.
Figure B
As indicated in Figure C, most of the new drilling activity on State-owned land is for natural gas. This is generally from Antrim Shale formations, which are predominant in Otsego, Antrim, and Montmorency Counties (located in the northern part of the Lower Peninsula). Twenty years ago, annual production rates of Antrim gas resources were only 15% of the Statewide total, and now represent 60% of total production. In 1992, Antrim Shale well completions accounted for 15% of all well completions in the United States. This resource is considered to be one of the most active natural gas plays in the country, and is estimated to continue at rates of production near today's level for another 10 to 15 years.
Figure C
Over half of Michigan's oil production is now from "stripper" wells (low-flow wells at the end of their bearing cycle), whereas 10 years ago they represented less than one-fourth of the production. Michigan natural gas production is also obtained from a large number of very low flow wells. Wells from Antrim gas formations are not as productive as previous Salina-Niagran formations, which were prominent until the mid-1980s and responsible for the development of at least 18 processing plants in the State. Figure D shows the decrease in average production per well over a 10-year period.
Figure D
Return to the Table of Contents OIL AND GAS PRODUCTION REVENUES TO THE
STATE
In 1995, oil and gas production generated over $71 million in revenue to the State, $47.6 million of which was from State-owned production. These revenues include the $34.9 million in royalty and rental incomes provided directly to the DNR, $10.4 million in severance taxes paid on five-sixths of the State-owned production, and $2.3 million in oil and gas privilege fees paid on State-owned production. When adjusted for inflation, however, revenues attributable to State-owned production are almost 50% less than in 1986, as indicated in Figure E.
Figure E
The bulk of the revenue decrease is due to the almost 60% decrease in oil production that has occurred on both State and private lands. Estimated revenues from natural gas production are approximately the same as in 1986, when adjusted for inflation, as indicated in Figure F.
Figure F
State leasing policies have changed over the past 10 years due to a decrease in oil speculative activities, and an increase in the demand for natural gas leases. Smaller lots of land are now being leased, and the density restrictions of one well per 160 acres have been reduced to one well per 40 acres. In 1986, there was an average of 1,300 acres per well; in 1995 the average was 185 acres per well. Today there are half as many State acres leased as there were in 1977, as indicated in Figure G .
Figure G
This decline in acreage, combined with the increased number of gas wells, has resulted in adjusted revenues per State-owned acre increasing almost 30%, as indicated in Figure H.
Figure H
Return to the Table of Contents USES OF OIL AND GAS REVENUE
Royalty and Rental Revenues
In 1995, the DNR collected $34.9 million in royalty and rental revenues from production from State oil and gas leases. Since 1986, the bulk of this revenue has been deposited into the Natural Resources Trust Fund, which is used to acquire land for recreation, environmental, and scenic purposes, and provide grants to local units of government for development of recreation facilities. Since 1987, $211 million has been appropriated for land acquisition and $56.3 million for development projects. As of the end of 1996, the Trust Fund balance was $103.5 million. The fiscal year (FY) 1996-97 Natural Resources Trust Fund appropriation is $23.6 million.
In 1994, a constitutional amendment to the Trust Fund approved an annual diversion of up to $10 million of these revenues to a State Parks Endowment Fund. Since that time, approximately $15 million has been appropriated in the State Parks budget for operations and capital outlay projects. As of 1996, the State Parks Endowment Fund balance was approximately $52 million. The FY 1996-97 appropriation is $5.3 million.
Revenue from oil and gas production on lands purchased with Game and Fish Protection Fund money, or Federal wildlife money, is deposited into the Game and Fish Protection Trust Fund. Approximately $2.5 million is deposited annually, and the Fund balance is approximately $54 million. Interest from the Fund is annually transferred for use in programs supported by Game and Fish Protection Fund revenues.
Administrative costs associated with the oil and gas leasing program, property taxes, and the Trust Fund program are also covered with Trust Fund dollars. The FY 1996-97 appropriation for these functions is $1.7 million.
Oil and Gas Privilege Fees
Revenues from oil and gas privilege fees fund the Geological Survey Division of the Department of Environmental Quality. These fees represent 1% of the gross cash market value of all production, and are applied toward the costs of monitoring, surveillance, enforcement, and administration of Act 61 of 1939. In 1995, $8.1 million was appropriated and a total of $5.9 million collected, with $2.3 million from State-owned lands. The FY 1996-97 appropriation is $6.9 million.
Severance Taxes
Severance taxes of between 5% and 6% of the value of oil and gas production are charged on all production, including the five-sixths of production obtained from State lands that is not returned to the State as a royalty remittance. The proceeds from this tax are deposited into the State's General Fund and not earmarked for any special purposes. The 1995 total revenue of $30.9 million, with $10.4 million from State-owned lands, was 47% less than the 1986 level of $58.9 million.
Figure I depicts the disposition of the $47.6 million in revenue from 1995 State-owned oil and gas production.
Figure I
Return to the Table of Contents OIL AND GAS PRODUCTION ISSUES
Post-Production Costs
The DNR charges businesses that obtain gas and oil from State-owned resources one-sixth to one-eighth royalty, based on the value of the product. Historically, the value was established by utility companies through purchases of product at the wellhead. In the late 1980s, Public Service Commission policies changed regarding the costs utility companies could pass on to customers. This policy change, in conjunction with more competition, resulted in the product being partially processed prior to market, with the value established at the plant rather than the wellhead. In addition, Antrim Shale natural gas requires additional processing to remove carbon dioxide and water, and increased pressurization to meet pipeline standards. All these changes increased costs borne by the gas producer. Over the years, the DNR allowed deductions for "postproduction" costs to bring a product to market value at the wellhead, in accordance with the terms of the lease. In 1993, a DNR letter formalized the practice, which resulted in a broader interpretation of the cost-sharing policy than was intended. It has been estimated that excess post-production cost deductions cost the DNR $4 million in revenue annually , and also affected private landowner leases. In 1996, the letter was rescinded and a postproduction costs policy review committee formed. Since that time, a new lease document that eliminates two thirds of the deductible costs has been developed.
Strategic Plan
The objective of the DNR Real Estate Division's Minerals Lease Management section is to provide for the "orderly development of State-owned mineral resources consistent with the department's land management objectives". One of the conclusions of the WEFA/E3c research study was that policy changes over the last few years have undermined revenues and created controversy between the State and its oil and gas industry. Within the past year, the Department has been conducting an internal review of leasing practices and has developed a draft Strategic Plan that addresses the following issues:
Severed Mineral Rights
As noted earlier, not all State-owned mineral rights are under State-owned lands. Also, not all State-owned surface rights are accompanied by the mineral rights. This is termed "severed" mineral rights. The purchase of both mineral and surface rights is termed "fee simple".
The DNR owns 2.1 million acres of mineral rights under private or other governmentally owned lands. Over the years, private surface rights owners have protested the surface disruptions that occur when a resource development company leases the mineral rights and commences drilling on their property, and have expressed frustration that these rights are not available for purchase.
The 3.8 million acres of surface rights owned by the DNR are also subject to disruption as the owners of the mineral rights seek access to their resource. This latter issue has received considerable attention, with the "Miller Brothers" settlement of 1995 (where State regulatory action regarding mineral exploration under Nordhouse Dunes resulted in payment of over $90 million to mineral rights owners and lessees) and the most recent decision regarding prohibition of gas drilling in the Jordan River Valley area. The Governor has proposed that this issue be addressed by using the Natural Resources Trust Fund to purchase mineral rights under sensitive State-owned lands. In the meantime, considerable attention is now paid to any decisions made by the Department of Natural Resources or Department of Environmental Quality on land use restrictions that could affect mineral rights owners' access to their resource.
Return to the Table of Contents CONCLUSION
Production of oil and gas in Michigan has shifted markedly in the past 10 years, from a predominantly oil driven market to a natural gas market. Policy decisions such as Federal tax credits, and State regulation of utility companies have had a profound effect on production.
State-owned natural gas production has increased at a faster rate than has privately owned production, and the natural gas market is now heavily dependent on State-owned assets. Even though State-owned production has increased over 160%, estimated revenues to the State are down 50% when adjusted for inflation.
However, the State is making more efficient use of the acreage it leases, with the result that revenue per acre has increased substantially. The State has faced a number of issues affecting the ability to lease additional lands, which have also contributed to this decrease in acreage.
The State leases its oil and gas resources both to obtain revenues for recreational and capital improvement programs, and to satisfy the desire of the oil and gas industry to use State of Michigan mineral rights. Balancing the economic benefits associated with continued expansion of State oil and gas resources with alternative nonconsumptive uses for those lands will be the challenge facing the Department of Natural Resources in the years to come.
Return to the Table of Contents REFERENCES
"Economic Study of Oil and Gas Related Activities Affecting State-owned Minerals". Prepared for the Department of Natural Resources by the WEFA Group and Energy, Economic, and Environmental Consultants(E3c) Inc. June 1996.
Memo to Michael D. Moore. "1995 Annual Report - Oil and Gas Leasing Program". Department of Natural Resources. Real Estate Division. February 5, 1996.
"Michigan Oil and Natural Gas Lease Policy Report". Prepared for: Michigan Department of Natural Resources by E3c Inc. November 1996.
"Michigan Statistical Abstract 1996". Michigan Employment Security Commission Research and Statistics Division.
"Revisions to the Michigan Oil and Gas Leasing Program". Correspondence from the Michigan United Conservation Clubs. January 7, 1997.
Severance Tax Reports for Fiscal Years 1985-86 through Fiscal Year 1995-96. Michigan Department of Treasury, Motor Fuel, Cigarette, and Miscellaneous Taxes Division.
"Strategic Plan for the Department of Natural Resources Real Estate Division, Oil and Gas Leasing Program". November 1996.
Personal communication with: