Much of the discussion about oil and gas production in Ohio has focused on hydraulic fracturing used to facilitate production. But fracking, as it’s often called, is only part of the process that takes the oil and gas from the ground to consumers.
“The wells are just one part of the overall industry. You can drill a well and be prepared to produce gas and natural gas liquids, but these materials have no place to go until you have a pipeline and processing facilities,” says Scott Doran, director, Kegler, Brown, Hill & Ritter Co., L.P.A.
Smart Business spoke with Doran about the various stages in the production of oil and gas, and the permits and regulations that govern them.
What permits are required for oil and gas production operations?
In addition to the drilling permits, you generally need permits for the pipelines that will take the gas from the well pad to collection and processing points. The Ohio Department of Natural Resources (ODNR) manages drilling permits; The Ohio Environmental Protection Agency (EPA) has authority to issue air permits. The Ohio EPA, the U.S. Corps of Engineers and other agencies are involved in pipeline projects. Construction of the pipeline may necessitate impacts to streams or wetlands, and you have to consider historical preservation and endangered species issues.
You have to delineate every resource along the expected path of the pipeline, which means sending engineers or field personnel to identify streams, wetlands, historic properties and potential endangered species habitats. Of course, that also involves getting easements and permission from landowners. Those field people prepare voluminous reports, and you identify the best path for the pipeline that achieves project objectives while avoiding as many resources as possible.
If a project does impact streams or wetlands, you can apply for and obtain a permit authorizing the project, but you also have to mitigate those impacts by restoring the streams or wetlands at the site or somewhere else, or buying wetlands mitigation credits. It’s expensive, but there are a number of mitigation options to compensate for these unavoidable impacts.
Why are air permits needed?
Air emission of certain natural gas occurs during the drilling process, and the U.S. EPA and Ohio EPA have established strict permitting requirements regarding how to manage emissions during and after drilling. After drilling, there are emissions associated with the transfer and storage of materials.
It used to be that companies commonly flared off excess gas — they didn’t want to or were not able to manage the gas, so they would burn it. New permit requirements are being phased in that will require the capture of that gas.
What is required regarding wastewater collected from drilling operations?
In Ohio, a regulatory decision was made that the wastewater associated with oil and gas exploration and production is to be injected into permitted disposal wells. These disposal wells are generally off-site and operated by disposal companies that collect waste from tanks at the well pad. They’re injecting the waste 10,000 feet into the ground in porous rock, where it is designed to remain.
Drillers and wastewater treatment companies are working very hard to demonstrate effective mechanisms to treat and recycle that water, because millions of gallons are used for every well and fresh water is very valuable.
Do you expect regulations to change as the industry expands its operations here?
Regulations will undoubtedly continue to evolve, but the basic structure is in place. There is every indication that companies are continuing to make substantial infrastructure investments in Ohio, and there is a regulatory program that is overarching and impacts every step of the process.
This industry is going to have an environmental impact, but it can be done in a very responsible manner. Economically, it will be a good thing for the state. There will be some trials and tribulations along the way, but overall Ohio is doing a nice job to ensure a very substantial long-term benefit while protecting environmental resources in Ohio.
Scott Doran is a director at Kegler, Brown, Hill & Ritter Co., L.P.A. Reach him at (614) 462-5412 or email@example.com.
For more information on Kegler, Brown, Hill & Ritter, please visit www.keglerbrown.com.
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The recent accessibility of oil and gas in the Utica Shale rock formation, located throughout much of Eastern Ohio, will have a major impact on businesses and individuals alike. New businesses will be coming to the state due to the drilling, and companies currently here will likely see increased business.
As a result, companies should be considering the state and local tax ramifications of these operations in Ohio.
“Many businesses coming into the state may not have done work in Ohio before,” says Anthony Ott, CPA, senior manager, state and local tax services with GBQ Partners LLC. “For the first time, they will be subject to Ohio’s state and local tax structure, which does have some nuances that differ from other states.”
Smart Business spoke with Ott about how to prepare for the increased business and the resulting tax ramifications.
What are a few key state and local tax focus areas for businesses impacted by the shale boom?
Ohio is one of the few states that allows municipalities to enforce their own income taxes, which creates a very burdensome compliance process.
Owners of land leased for drilling will likely receive upfront lease bonuses, as well as royalty payments once the well is active and producing. This could produce a much larger municipal income tax liability for these individuals, depending on where they live. They may also be required to make estimated payments for municipal income tax, creating a new level of complexity.
It’s also very problematic for businesses to properly comply, especially those coming from out of state that are not familiar with the municipal taxing structure. Ohio utilizes a 12-day entrant rule — if you operate in a given taxing municipality for 12 days during any given year, you’re responsible for withholding and paying municipal income tax in those locations. Businesses with mobile work forces have to track the location of employees and property to apportion their income in Ohio to the correct municipality. This becomes difficult when you have crews working all over the state.
Ohio also imposes sales tax on certain services such as temporary employment. So, if businesses are utilizing temporary help and other taxable services, they will have an impact on the profitability of their jobs.
How do severance and real property taxes apply?
The severance tax is the hot topic right now. With the mid-biennium budget review, Gov. John Kasich proposed certain changes that would increase the tax above its current level and use the additional funds collected to provide an income tax credit to Ohio individuals.
The legislation would establish two categories of wells — hydraulically fractured horizontal wells and conventional wells — and tax each differently. If this legislation passes, it will raise the complexity for companies, particularly those with hydraulically fractured horizontal wells, given the opportunity to use a reduced rate for the first two years while they recoup costs associated with construction of the well.
The real property, or ad valorem tax, allows county auditors to value the oil and gas reserves for producing wells and assign a value for real property tax purposes. The value is determined based on an annual return filed with the county auditor.
What about the Commercial Activity Tax?
Ohio’s CAT is unlike the income/franchise taxes levied in many other states. In essence, it is a tax on a business’s gross receipts. The CAT’s unique requirements around what items are included in gross receipts and how receipts are sourced will have an impact on both businesses and individuals participating in the industry.
What is the overall risk of not understanding and complying with Ohio’s taxing structure?
The risk is that a company operating in the state fails to comply with all the statutory tax requirements. This could lead to an audit by the state or municipality, and the business would likely be subject to the tax assessment and associated penalties and interest.
What are some of the opportunities for companies participating in the boom?
The state and local tax impact can increase dramatically as the associated revenue dollars and investment rise. Depending on the project, there may be opportunities for incentives from the state and local jurisidictions that may help offset some of those increased costs. These may include incentives and tax credits for job creation, capital expenditures, training, etc.
Ohio law also provides a sales tax exemption related to items directly used in the production of oil and gas. I would encourage industry participants, as well as service providers, to fully understand what qualifies for the exemption in order to take full advantage and possibly reduce the overall dollar investment required.
How can companies stay up to date on these issues?
Participants in the industry should keep a keen eye on the severance tax legislation. The Ohio Oil and Gas Association is very active in this area and is a good resource for members of the industry to stay informed.
Regarding current Ohio taxes, businesses and individuals alike should review the structure and consult with a state and local tax professional to better understand how it will apply. Each industry segment, as well as the ancillary service businesses, will be impacted differently.
There are also many opportunities to attend informational seminars specifically related to these issues.
Anthony Ott, CPA, is a senior manager, state and local tax services at GBQ Partners LLC. Reach him at (614) 947-5311 or firstname.lastname@example.org.
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It was announced recently that the Utica Shale formation in Ohio is not only a source of natural gas, but oil as well. New technological advancements — especially in horizontal drilling techniques and the hydraulic fracturing of the shale (“fracking”) — along with the fact that the oil appears to be of high quality, is bringing drilling to Ohio a lot faster than originally thought.
“Drilling has been taking place in the Marcellus Shale in Pennsylvania and West Virginia for a while now,” says Jeffrey R. Huntsberger, a member of the Business Department and the Real Estate Practice Group at McDonald Hopkins LLC. “Geologists knew there was natural gas in Ohio’s Marcellus formations, but figured Ohio wouldn’t be as rich a source as Pennsylvania. All of that has changed now with the discoveries in the deeper Utica Shale formation. For example, the CEO of Chesapeake Energy Corp. recently said that his company expects to invest $10 billion per year in Ohio for the next couple of decades.”
Smart Business asked Huntsberger what Utica Shale drilling means for Ohio.
Why does the Utica Shale hold so much promise for Ohio?
The Utica Shale formation appears to hold significant amounts of ‘wet’ gas and oil. The wet gas has elements in it that are sought after by gas companies, including propane, ethane, butane, and other large molecule hydrocarbons and, in addition, there’s oil, which appears to be of high quality. Companies like Chesapeake Energy and others are excited about the wet gas and oil in Ohio.
How will drilling impact Ohio businesses?
Drilling in the Utica Shale is a game changing industrial event taking place right in our own back yard. Drilling is already taking place in southeastern and mideastern Ohio counties and promises to spread northward through the entire eastern part of Ohio. Manufacturers of tubular steel, pumps, valves, and fittings are already seeing substantial demand for their products as a result of drilling. If everything works out, we’ll have a cheap source of energy on our doorstep, which will give us an advantage in manufacturing. In addition, the byproducts of oil can be used for hundreds of industrial applications, and having a source of those byproducts right here in Ohio will be beneficial for a variety of industries. In the long-term, the drilling should stir growth.
What are the potential environmental impacts?
The major issue is water. Rural areas rely on well water (drawn from about 50 to 250 ft. deep). The shale layers are found at 5,000 feet and deeper below the surface but, in order to get there, the wells must be drilled through the water table. If the well is not drilled and cased properly, there’s a good chance that someone’s well water will be contaminated.
Fracking itself requires up to three million gallons of water per well. The crew has to drill down vertically several thousand feet and then sideways for as much as a mile. The fracking fluid, which is then inserted into the well and forced into the shale layers, is 98 percent water and sand with the remaining two percent made up of ‘nasty stuff’ — chemicals intended to help ease the hydrocarbons out of the shale. Huge pressure is created to break the shale, release the gas, and bring it back up. What comes up is contaminated with the chemicals as well as other environmentally damaging materials from the ground, such as heavy metals, which must be dealt with properly.
What kind of regulatory oversight is in place?
Almost all regulation in Ohio is through the Ohio Department of Natural Resources (ODNR). A number of years ago, the legislature took away the rights of local communities to regulate drilling. A new law (Senate Bill 165), enacted about a year ago, adds to the ODNR’s power to regulate the industry. Included in the many new provisions are restrictions on how close companies can drill to occupied dwellings and property lines; increased liability insurance required for drillers; tighter construction standards; and the requirement that fracking must not be done in a manner that creates any danger to the water or the environment.
At the federal level, the U.S. EPA is looking into the fracking process and studying the potential impact on the environment. The EPA expects that it will be well into 2012 before any preliminary comments are made, and then another two years for any regulations to be put in place. As a side note, as of September 30th, Ohio House Bill 133 authorized drilling in Ohio’s state parks.
How can landowners maximize their benefits if approached about leasing rights?
Some of the simple things you can negotiate with the companies leasing your land include the size and timing of the bonus payment; the amount of the royalty (the standard is usually around 12.5 percent of what gets produced from the well; however, this can often be negotiated to 15 or 18 percent, or even higher); and the time period for the company to hold the lease until drilling takes place. More complex negotiations involve placing restrictions on unitization (the right of the lessee to combine your property with that of other land owner lessors); prohibiting the storage of gas or the permanent disposal of toxic liquids on the property; obtaining mutual agreement on the placement of roads, wells and pipelines; and having the ground water tested before and after drilling.
Educate yourself through easily accessible materials such as those found on the Ohio Department of Natural Resources’ website. Hire an attorney who really knows this area. Don’t be quick to sign a standard lease presented to you, because these companies will negotiate.
JEFFREY R. HUNTSBERGER is a member of the Business Department and Real Estate Practice Group at McDonald Hopkins LLC. He focuses on real estate, business counseling and energy. Reach him at (216) 348-5405 or email@example.com.