Tax exemptions on LA minerals cost bigtime

By Tom Aswell
Capitol News Service

• Baton Rouge

Gov. Bobby Jindal and the oil and gas industry won a major victory in 2014 when the legislature voted to kill the lawsuit by the Southeast Louisiana Flood Protection Authority-East (SLFPA-E) against 97 oil and gas companies but an equally important piece of legislation was defeated at the same time that might have revamped the methods by which the oil and gas industry is held accountable in the payment of severance taxes.

Thousands of words were written about that lawsuit that was seeking repayment by the industry for the damage done to the state's wetlands but little, if anything, was reported about an archaic severance tax audit system that has cost the state hundreds of millions of dollars. The State of Louisiana has paid the oil and gas industry $2.4 Billion in severance tax exemptions over the past seven years, even as it was amassing today's $1.6 billion budget deficit.

Despite the state's largesse, the oil and gas industry used its influence inside the Department of Natural Resources and the Jindal administration to not only to limit audits that would have revealed the accuracy or inaccuracy-- of the industry's severance taxes and royalty payments to the state, but for three years, stopped those audits altogether.

That information has been contained in five performance audits of the Department of Natural Resources (DNR) and the Louisiana Department of Revenue (LDR) since 2010. Those audits, all conducted by the Legislative Auditor's office, focused on royalty collections from oil and gas produced on state-owned lands and water bottoms (two such audits), on severance tax collections, with mineral leases handled by the State Mineral and Energy board, and how the Office of Conservation has handled the orphaned and abandoned well cleanup program.

The relationship between DNR and the oil and gas industry, particularly as it pertains to the department's regulation of the industry, has always been a close one, perhaps too close.

When extended to state finances, the relationship has cost the Louisiana treasury and the citizens of the state. DNR is responsible for collecting oil and gas royalties, which account for roughly seven percent of state General Fund dollars, or approximately $800 million per year.

For a three-year period, between July 2010 and July 2013, DNR had jurisdiction to determine the accuracy of severance taxes and royalty payments and the industry was allowed self-regulate. Even as the state's finances spiraled downward, audits on severance tax revenue ground to a virtual halt. Rather than conduct oversight to ensure that the royalty and severance tax payments were accurate, DNR's Office of Mineral Resources (OMR) deferred to the oil and gas industry while programs such as healthcare and higher education, the unprotected portions of the state General Fund, were slashed time and again.

DNR's relationship with the oil and gas industry is an example of regulatory capture, a situation that occurs when an agency, created to act in the public interest, advances instead the special concerns of the industry it is charged to regulate.

Exempting severance taxes on the extraction of the state's vast mineral wealth negates the public's claim on that mineral wealth and undermines the state's ability to pay for needed services.

Severance tax exemptions are direct payments from the state to the oil and gas producers after the companies have submitted exemption certificates. Royalties are the property owners' share of the proceeds from the sale of oil and gas produced from wells on their land. Royalties represent the state's share of revenue from oil and gas produced on state-owned lands and water bottoms after severance taxes have been paid.

LDR publishes an annual report on tax exemptions called The Tax Exemption Budget, in which the department identifies each tax exemption and quantifies the cost of each exemption to the state. In making clear that tax exemptions are in fact a spending of state funds each report contains this explanation: "Tax exemptions are tax dollars that are not collected and result in a loss of state tax revenues available for appropriation. In this sense, the fiscal effect of tax exemptions is the same as a direct fund expenditure."

It can't be much plainer than that. Yet, between 2008 and 2014, according to the publication, the State of Louisiana paid oil and gas companies more than $2.4 Billion in severance tax exemptions. That money was being paid at the same time that the legislature was cutting funding for programs like aid to families of children with disabilities, behavioral health programs, home health care, and programs that assisted victims of domestic violence. During that same period, state funding for higher education was also cut by more than $700 million as the tuition and fees paid by those attending technical colleges, community colleges, and state universities were increased to cover the difference.

In the first performance audit on royalty collections, released in July 2010, the Legislative Auditor found that DNR's Office of Mineral Resources took a lackadaisical approach to verifying the accuracy of royalty payments from the 1,888 active mineral leases on state-owned lands and water bottoms.

The Legislative Auditor noted, accurately, that severance taxes and royalties are connected, that both are dependent on the amount of oil and gas produced, as well as the price of the resource.

Desk audits comparing the volume of oil and gas sold to the volume of oil and gas produced, are supposed to ensure that royalty payments are properly calculated and to verify that production wells on state lands are submitting properly calculated royalty payments.

Auditors discovered that OMR had not conducted a single such audit in a decade. Despite the Auditor's recommendation that it resume the audits, OMR waited another three years before getting around to doing so.

Amazingly, the Legislative Auditor also found that OMR did not compare royalty reports against severance tax reports filed with the state Department of Revenue, nor did it compare royalty reports to production reports submitted elsewhere in DNR.

In its response to the Legislative Auditor's Royalty performance audit findings, on June 24, 2010, DNR announced that "As part of the Streamlining Commission's recommendations, OMR will take over LDRs severance tax field audit program and the two audits will be integrated beginning July 1, 2010." (The Streamlining Commission was Gov. Bobby Jindal's early attempt to make state government more efficient.) In September of 2013, the Legislative Auditor released a follow-up performance audit on royalty collections, only to find that the revenue produced by OMR's audits had fallen below the levels reported in 2010 and that the State Mineral and Energy Board had even waived 45 percent of the $12.8 million in late payments penalties that were assessed against companies by OMR.

An audit on severance tax collection procedures in the Louisiana Department of Revenue was conducted in 2013 but, because severance tax audit functions had been transferred to the DNR in 2010, auditors, like a dog chasing its tail, had to return to OMR.

In that audit, it was found that oil and gas industry complaints about the LDR's use of GenTax software (which identified possible nonpayers of severance taxes) led first, to LDR shutting off the software, and second, audit power being transferred to DNR.

The scale of the oil and gas production not audited as a result of that shift was devastating, to say the least. DNR's field audits simply ignored oil and gas production on private lands which comprises 98.1 percent of all oil and gas leases in Louisiana for a three-year period.

Following the transfer of audit responsibility by LDR to OMR, revenue from severance tax audits fell a staggering 99.8 percent from the levels previously produced by LDR. The actual dollar amount fell from $26 Million in 2010 to $40,729 in Fiscal Year 2012.

For the three-year period that DNR's Office of Mineral Resources had responsibility for severance tax audits, the industry essentially operated under an honor system which had earlier caused problems. In the late 1990s, the Mike Foster administration filed lawsuits against more than 20 oil and gas companies claiming they had shortchanged the state by as much as $100 million on severance tax payments.

During the three-year period that LDR had the field audits, the Haynesville Trend emerged as the most productive shale gas field in the country. Even though the severance tax exemption on horizontal drilling meant that the state was denied severance tax revenue for much of that play, companies still managed to game the exemption system at taxpayer expense.

Under the rules for severance tax exemptions, the state pays back the taxes already paid once it receives the exemption certificate from the company plus judicial interest, which in the in period covered by the audit averaged about 4.5%.

That is, the state had to dip into non-exempt severance tax payments in order to cover the interest costs on those certificates that the companies chose to sit on for several months.

The audit found that over the course of four fiscal years running from 2009 through 2012, LDR issued 13,818 severance tax refund checks totaling $360,190,583 not counting an extra $23,859,012 in interest. Moreover, auditors found that LDR overpaid severance tax exemption refunds by $12.9 million between July 2010 and May 2012.

The decline in audit revenue, the interest paid to companies, the overpayment of severance tax exemption refunds, the decision by the State Mineral and Energy Board to waive 45 percent of fines for late payment of royalties combined to benefit the industry $68 million courtesy of Louisiana taxpayers.

These windfalls to the oil and gas industry came at a time when the industry was already receiving $2.4 Billion in tax exemptions and at a time when every dollar the state did not collect translated into deeper budget cuts.

Auditors also pointed out that hiring additional auditors within DNR and LDR would produce a great return on the state's investment. Each auditor costs a department between $50,000 and $60,000 per year, but they bring in an average of $1.3 million per year. LDR said it had requested additional auditors in its budgets but they were never approved by the Jindal administration, which was attempting to reduce the number of state employees.

Oil and gas companies control all of the information used in the severance tax and royalty payment process, which leaves the system vulnerable to abuse.

ORM has shown little interest in monitoring the industry and DNR's abdication of its oversight role on royalty revenue has adversely impacted state finances. When added to the three-year period when DNR failed to perform severance tax audits, the agency has likely cost the state hundreds of millions of dollars over the past seven years.

There were sporadic efforts to address the issue. In the 2014 legislative session, for instance, Sen. Rick Gallot (D-Ruston) and Rep. Joe Harrison (R-Gray) introduced concurrent resolutions to order LDR, DNR and the Legislative Auditor to agree upon a means to conduct a thorough audit of oil and gas production, severance taxes and royalty payments. Gallot's resolution passed the Senate by a unanimous vote of 35-0, causing all kinds of alarms and sirens to go off in the oil and gas industry as well as on the State Capitol's fourth floor.

But by the time the resolution reached the House floor in early June, the oil and gas and the Jindal administration, recognizing the threat the audit posed and in full battle mode, joined forces to kill it.

Gallot thought the 48-44 vote to pass the resolution in House meant success. Only much later did he learn of a rule that the resolution needed a majority of the full House (53 of 104 votes), and not just a majority of those voting.

Accordingly, the measure fell five votes short and the oil and gas industry had won yet another trophy to place alongside the one signifying defeat of the lawsuit against 97 oil and gas companies by the SLFPA-E for destruction of the state's wetlands which in turn exposed New Orleans to catastrophic damage from Hurricane Katrina.