Risks| Rewards
Colorado’s system for collecting revenue from minerals — oil, natural gas, coal and metals — is volatile and subject to the whims of market fluctuations and world events. When the industry is rolling, as it is now, state coffers are flush. But when revenues drop off, as is forecast next year, the state — unlike some of its neighbors — hasn’t stashed away funds for a rainy day. The reason for that is complicated.
Colorado, like other states, taxes the natural resources that are “severed,” or removed, from the earth. But after two up years, those revenues are expected to drop by half, and possibly more, depending on how much a global economic slowdown weighs on commodity prices.
“Severance tax is the most volatile revenue source we have in Colorado,” said Larson Silbaugh, principal economist with the Colorado Legislative Council, who has the difficult task of trying to forecast what the state will collect.
Severance taxes are so volatile that local governments, which receive half the distributions, are advised to consider them “gravy” and not plan budgets or projects around them, said Natriece Bryant, deputy executive director of the Colorado Department of Local Affairs.
And the gravy train is about to slow down. Silbaugh estimates that state severance tax collections will drop 48% from $203.2 million last fiscal year to $106.2 million in the year that started July 1 and drop to $85.6 million the year after.
The Office of State Planning and Budget, which advises the governor, is calling for an even steeper 58% drop in severance tax revenues. And while that might sound huge, it isn’t an outlier.
“The OSPB projections are well within
historical ranges and state agencies are equipped to manage the volatility of these funds,” said Conor Cahill, a spokesman for Gov. Jared Polis.
Severance tax collections declined 96.2 percent in fiscal year 2015-16 after oil prices cratered, going from $271.5 million to $10.3 million. But by fiscal year 201718, when production rebounded, they shot up more than twelvefold to $132.8 million.
If someone deliberately tried to make a source of tax revenues as volatile as possible, they would be hardpressed to match what Colorado has achieved.
“I’m a CPA by training, and I can tell you that the guy who invented the taxation system for a lot of our minerals and metals is the guy who invented the sieve. There is no there there,” said Dick Lamm, who was Colorado’s governor when the severance tax was first implemented.
Mechanics of volatility
Volatility is nothing new when it comes to severance taxes. Silbaugh estimates that just the fluctuations in oil and natural gas prices, and the production shifts that follow, contributed to deviations or swings in severance tax collections averaging 38% between 2008 and 2016.
Domestic spot oil prices, which were as high as $75 per barrel in October 2018, dipped to $45 per barrel at the start of the year and are now around $55 per barrel.
But Colorado’s severance tax structure amps up the volatility even more. Oil and gas producers — after deducting the costs required to get their output to market — are allowed to also deduct 87.5% of the amount paid in property taxes or ad valorem on what they produce.
Property taxes are assessed in arrears, meaning that the property tax deduction producers take in 2019 is based on production that took place in 2017. That lag pushes up revenues in good years and pushes them down in soft years. Add that to the already volatile world of commodity prices, and the severance tax rises or falls around 70% a year each year.
Good luck trying to predict anything with that kind of variability. Weld County officials question the state forecasts, given that they are still seeing oil production in the county on the rise, enough that they think it will offset weaker oil prices.
“We would see it being pretty much level this year,” said Don Warden, Weld County’s director of finance and administration.
“If you look at our forecast, we are seeing a little bit of growth in production. This isn’t a bust,” Silbaugh said. But Colorado’s system is set up in such a way that even a flat or slightly down year can trigger big declines in severance taxes.
Beyond the timing of property tax deductions, Silbaugh estimates there will be $37 million less severance tax to distribute this fiscal year because of a lawsuit by BP America. BP America was successful in getting capital costs for pipelines and processing plants into the transportation costs that producers are allowed to deduct.
The state set aside severance tax money to cover any refunds producers might seek after losing. But producers claimed less than expected, which helped boost severance taxes last year. This year that boost won’t be available.
Where the money goes
Half the severance money collected each year stays with the state, while half of it goes to local governments.
The Colorado Department of Natural Resources claims half of the state’s half, enough this year to support about 154 full-time employees. That money goes to cover the costs of regulating natural resource industries, as well as a host of programs supported through grants.
Those include lowincome energy assistance, soil conservation, wildlife conservation, and invasive species control, among others.
“We are used to it going up and down. We have to be nimble,” said Dan Gibbs, the department’s executive director. Operating costs are given first priority, and if money is left over, grants are issued.
But sometimes the flows are so thin or the forecasts undergo such big revisions that the Colorado legislature has had to step in and backfill. In June 2017, the legislative council forecast $150 million in severance taxes. By December, it was looking more like $100 million, and that set the department, which had acted based on the higher number, scrambling.
To address that, the legislature passed a bill this year that will require the Department of Natural Resources to hold severance distributions in arrears rather than guess what might be coming in. Department budgets will be based on what is actually in hand.
While that makes it easier to plan, it doesn’t address how to handle sharp swings in severance collections, which can reduce or eliminate the grants the department can offer.
Zebra mussels, an invasive species that like to hitch rides on boats and clog pipes and take over bodies of water, will do their best to proliferate regardless of what oil and gas prices are doing. But a drop in the severance tax collections hinders the state’s ability to control them.
“That is a grant program that is least able to handle the volatility. You can’t halfway inspect boats,” said Carly Jacobs, a budget and policy analyst with the department.
The other half of the state’s share goes into a revolving loan fund for water projects administered by the Colorado Water Conservation Board. That fund
If someone deliberately tried to make a source of tax revenues as volatile as possible, they would be hard-pressed to match what Colorado has achieved.
has lent out or earmarked $350 million of the $400 million it had available. It spun off $7.6 million in interest last year.
The Department of Local Affairs handles the half that is directed to local governments, with 30 percent of that amount distributed directly to the counties, cities, towns and special districts most directly impacted by natural resource extraction.
That represented $17.4 million distributed last August, with Weld County the biggest recipient at $2.1 million, followed by Greeley at $1.4 million, Garfield County at $784,015 and Mesa County at $615,856.
Local governments say those severance payments aren’t something that they consider critical to county spending.
“We rely on property taxes. We don’t necessarily rely on the severance taxes,” said Barbara Kirkmeyer, Weld County commissioner.
The remaining 70% of the local government share goes out three times a year in a grant program that DOLA supervises. Governments and special districts can ask for grants of up to $200,000 or up to $1 million.
Some projects made possible with severance tax proceeds include Weld County’s expansion of 20 miles of County Road 49 to four lanes to take the pressure off Interstate 25, as well as fire stations and recreation centers throughout the county.
Some of the grants approved in July include $830,000 for renovation work on the Tabor Opera House in Leadville, $1 million for an automated water meter system in Center and $1 million to renovate the National Guard Armory Building in La Plata County.
“We use them for road projects a lot, and we have also used grants for buildings,” said Megan Graham, public affairs officer for La Plata County. “If we don’t get the grants, we don’t do the project.”
The county plans to use its grant to retrofit a National Guard facility it received from the state into a new sheriff’s office, a project on the to-do list since 2012, Graham said.
A lost opportunity
The state can’t do much about the swing in oil and gas prices, or coal or molybdenum. Commodities by nature are volatile. But Abbey Pizel, formerly a natural resource policy analyst at the Colorado Fiscal Institute, said there are changes that could be made to smooth things out.
Colorado’s stated severance tax rate ranges from 2% to 5%, with larger producers responsible for most of the production levied at 5%.
But after the property tax deduction, the effective severance tax rate in Colorado works out closer to 0.95% in northeastern Colorado, 2.44% in southeast Colorado and 2% on the Western Slope, calculates environmental attorney Matt Samelson.
Colorado has the lowest effective severance tax rates of any producing state, argues Samelson. That gives Colorado room to ask for more.
But adjusting severance tax rates and deductions is likely to face stiff resistance from the industry, and risks tripping limits set in the Colorado Taxpayer’s Bill of Rights. The extra revenues could end up going back to taxpayers in refunds.
Senate Majority Leader Steve Fenberg, D-boulder, said severance taxes and the property tax deduction are part of a larger conversation that legislators are having about the state’s overall fiscal sustainability.
“Relying heavily on a boom-and-bust cycle isn’t good for anybody,” Fenberg said.
Pizel said other steps need to be taken before adjusting rates or deductions. An important one would be to shift the responsibility for reporting and paying severance taxes to producers rather than the thousands of owners, small and large, of production and royalty interests.
A 2006 state audit of the severance tax program found that many small owners simply don’t bother paying severance tax. The tax is complicated, compliance costs are high, and the risk of getting audited very low.
Delaying severance tax collections to line up with the property tax deductions would also help smooth out swings. The highs would be lower and the lows would be higher, Pizel said.
And perhaps the most important thing Colorado could do would be to funnel more severance tax money into a fund that could act like a reservoir, capturing flows when things are flush and releasing them in dry spells.
For instance, Colorado coal mining firms have contributed $187.5 million in severance tax to the state since 1995. Now that demand for coal looks to be in a permanent decline, reserves to deal with that economic dislocation aren’t there.
“Colorado’s system hasn’t allowed those communities to make long-term savings and investments,” said Mark Haggerty, a researcher with Headwaters Economics in Bozeman, Mont. “We have created a fiscal crisis in these communities. They are being left on their own.”
Garfield County has taken its direct distributions from the state, as well as ones from the federal government, and built up a $16.3 million mitigation fund, said Theresa Wagenman, the county’s finance director.
The county has seen petroleum production — mostly natural gas — fall from 70% of its property tax base to 50%. It is trying to prepare for the day when the industry contributes even less.
And dark memories of “Black Sunday” drive the cautious approach. In May 1982, Exxonmobil pulled out of the county, wiping out thousands of jobs both real and promised.
“Because we went through those hardships, it did raise the awareness of the need for long-term planning,” Wagenman said.