Colorado’s oil and gas regulatory agency is running out of money – fast

Oil and gas development in new housing subdivision on Collier's Hill. (Photo by Ted Wood/The Story Group.)
Oil and gas development on Collier's Hill in Erie. (Photo by Ted Wood/The Story Group.)

As the state grapples with the aftermath of last April’s fatal pipeline explosion in Firestone and a fervent demand by residents to better regulate the oil and gas industry, the agency in charge of enforcing those regulations has a problem: it may not even have the cash to make payroll come summer.

About a third of the $18.6 million budget for the Colorado Oil and Gas Conservation Commission, or COGCC, comes from one of the state’s most unpredictable sources of income: the severance tax. Oil and gas companies pay the tax on the total value of what they extract from the ground. When prices and production are up, the state reels in hundreds of millions of dollars. In other years, programs get by. But this year, the state faces a shortfall.

Since April, state economists have been adjusting their forecasts for how much severance tax money the state will collect. In May, projected revenue looked rosy. But in December, it plummeted. This is a reflection of both mediocre oil and gas prices and a 2016 Colorado Supreme Court decision that required the state to issue an estimated $120 million in refunds to oil and gas companies. The state expects to issue an estimated $72 million in remaining refunds over the next 16 months.

This budget dilemma is also the result of lawmakers using the fund to pay for new programs during good revenue years. And when revenues are down, like this year, the fund comes up short.

Now, state officials say the agency will not have enough money to pay staff, including its three flowline inspectors, if projections hold up. The state may also have to delay hiring two new flow line inspectors responsible for inspecting the entire Western Slope. Its workload includes mapping hundreds of thousands of flowlines and plugging hundreds of abandoned oil wells. The COGCC will have to operate on a shoestring budget, if, its budget director says, it’s able to operate at all.

“We’re not going to be able to pay expenses,” said Bill Levine, the budget director for the Department of Natural Resources, which includes the COGCC. “If we do nothing, we will not be able to pay payroll” come July 1.

Severance tax dollars go to programs as the money comes in. And officials say it could be months before certain programs are back in the black.

These budget woes are not new. The severance tax, which is inherently volatile due to its dependence on the price of oil and gas, fluctuates about 82 percent each year on average, according to a state official. Programs that rely on a boom and bust budget are used to this.

“In the end, this is the horse we ride,” said Irv Halter, executive director for the Department of Local Affairs, which provides grants to small communities for infrastructure projects with severance tax money.

But what’s different this year is how severe the funding gap is.

In 2016, a Colorado Supreme Court decision in the BP America case allowed oil and gas companies to claim more deductions on the taxes they pay to the state—and amend their tax returns three years prior—throwing these budgets for a tailspin. And some of the money the departments of Natural Resources and Local Affairs borrowed from the General Fund last year to keep programs afloat — about $110.6 million, according to Levine — is supposed to be paid back at the end of the fiscal year. As a result, DNR estimates a total shortfall between $5.6 million and $13.8 million in severance tax revenue that is used to pay the salaries of inspectors and enforcement officers.

The projected shortfall comes at a time when the COGCC is facing pressure from residents concerned over drilling in residential neighborhoods. Dave Devanney, of Battlement Mesa, said he purchased a home atop a company’s mineral rights when he moved to the Western Slope town 14 years ago. Since then, new wells and injection sites have popped up closer to town, he said. Now, Ursa Resources is seeking permission to drill within 500 feet of several mobile homes.

Devanney said he is sympathetic to the COGCC’s budget issues. But he said the agency has become “morally bankrupt” as far as protecting the health and safety of Coloradans. And now, he said, residents depend more on oil and gas operators to be careful and citizens to police them.

“We’ve been dealing with these things for many years,” said Devanney, who chairs the citizen group called Battlement Concerned Citizens. “Instead of being out on the golf course or riding my bike, this is what I do now.”

The COGCC isn’t the only program affected by the projected shortfall. For the Division of Reclamation, Mining and Safety [DRMS], this means some programs that rely entirely on severance taxes may have to shut down, according to the Department of Natural Resource’s Levine.

One such program is responsible for overseeing the cleanup of anything from gravel pits to uranium mines. This includes a uranium mine west of Denver called the Schwartzwalder Mine that closed in 2000. In 2010, the Denver Post reported the mine was leaking arsenic, radium and uranium into a creek feeding the Ralston Reservoir, which provides some of the drinking water for 1.4 million residents in Denver. In a December letter to DRMS, Denver Water said they are currently removing uranium from water entering the Moffat Treatment Plant, and may have to make costly upgrades if concentrations increase. Severance taxes pay for over a third of this $3.3 million program.

Another DRMS program puts metal bars over abandoned wells to prevent people from wandering in and getting injured or killed by toxic gas and unstable rock. Last year, a 15-year-old boy was rescued after he fell while rappelling into an abandoned mine in Golden. This $3.1 million program gets nearly half of its state money from severance taxes to match federal funds.

And another program regulates the six coal mines across the state. Without the severance tax money, coal mines, which are inspected monthly, will go unchecked until funding is restored. The program also makes sure that companies have the money to restore sites when mining operations cease. If it stops operating due to lack of state funding, Colorado will lose its authority to regulate the mines to the federal government’s Office of Surface Mining Reclamation and Enforcement, according to state officials.

There is also the Department of Local Affairs, which gets half the state’s total severance tax revenue. The department uses most of this money to put out grants to small communities for infrastructure projects. Last year, $200,000 went to help upgrade a wastewater treatment plant in Crested Butte. The program also gave $1 million for upgrades to County Road 120 in Hesperus, which is heavily trafficked by mining trucks going to and from King II coal mine.

Severance taxes also fund over half a dozen other programs that deal with water conservation and invasive species control. The budget shortfall comes during a year when snowpack water levels are below average across most of the state and the year after veligers, zebra or quagga mussel larvae, were identified in the Green Mountain Reservoir.

Several measures to backfill the loss of severance tax money may help. But they will do little to deal with the fund that is perennially volatile and pays for more programs than it can consistently support.

A budget spread too thin

Senate President Pro Tem Jerry Sonnenberg at the Colorado Water Congress annual convention on Jan. 25. Photo by John Herrick

It’s no secret that the severance tax is volatile.

“It’s just like a farmer and his wheat crop; some years are better than others,” said Senate President Pro Tem Jerry Sonnenberg, R-Sterling. 

But, in flush years, sometimes the drought is forgotten. And lawmakers like to spend money, he said.

“When things were good with severance tax, everybody ran a bill to try to get some of that money,” he told The Colorado Independent.

In 2008, a year oil prices spiked to $147 per barrel (today, oil is about $61 per barrel), lawmakers voted to use severance tax money to put out grants for forestry projects, control the invasive plant tamarisk and inspect boats for aquatic invasive species like zebra mussels. The allocation totaled about $8 million in 2008.

Another peak production year came in 2014 when the state earned the most severance tax revenue since 2008. The following year, in 2015, lawmakers authorized five new programs that would be funded with severance tax revenue. These programs dealt with mine site reclamations, wildfire risk reduction grants, watershed restoration, tools for analyzing dam spillways, and controlling phreatophyte, a riparian invasive plant. Together, these programs required an additional $4.9 million in severance tax revenue in 2015.

But that same year, oil prices plummeted. Severances taxes paid to the state dropped from $263 million in 2014 to $24 million in 2015, according to Legislative Council. The next year, none of these “Tier 2” programs, which include water conservation programs, received any state severance tax money, according to DNR, though some were funded through other sources of revenue, DNR’s Levine said. 

“The total amount of spending that we have approved out of this fund probably was too much,” Levine said. “Even pre-BP, that was not sustainable.”

Rep. Bob Rankin, R-Carbondale, who sits on the Joint Budget Committee, said some of these programs, like wildfire mitigation, are critical. But year after year, lawmakers return to the question of how to fund them.

“Years ago,” Rankin said, “I believe they spread the severance tax too thin.”

Stop-gap measures proposed, but underlying problems persist

Lawmakers are looking for money to backfill severance tax deficits. They are working on a funding proposal to help plug the state’s hundreds of abandoned wells, which each cost about $82,500 to plug and restore, according to the Department of Natural Resources, and have introduced a bill that would use boat fees to fund an aquatic invasive species program in Colorado, a headwater state, among other proposals.

And last Monday, the COGCC voted to raise an additional $4.8 million through a bump to the mill levy, which is a tax based on the value of oil and gas at the wellhead, from .7 to 1.1 that will be used to support its budget.

Gov. John Hickenlooper called the mill levy increase a stop-gap measure. For his part, Hickenlooper is considering eliminating some of the deductions oil and gas companies can claim, but has yet to provide specifics. He said it would have to be a ballot initiative creating “a reasonable and fair severance tax more similar to what our neighbors have.” In New Mexico, for example, where total oil and gas production was similar to Colorado’s in fiscal year 2016-2017, the state netted about $338 million. Colorado’s take: $58 million.

Rep. Mike Foote, D-Lafayette, can think of at least three deductions he would like to do away with.

One allows companies to deduct any costs related to transportation, manufacturing, and processing, including costs of capital like interest payments on loans, dividends to shareholders, and the loss of profits due to the inability to use money elsewhere. Another allows companies to deduct 87.5 percent of their prior year’s property taxes on their state tax. This is known as the ad valorem tax credit, and it has saved companies $182 million a year on average since 2008, according to a memo by the Legislative Council. There is also the so-called stripper well exemption, which allows companies to pay no taxes on low-producing wells. This has saved companies an average of $32 million per year since 2008.

Together, the deductions have made Colorado’s effective severance tax rate the lowest of the western states, according to the memo. The statutory severance tax rate ranges from two to five percent based on production value, but the effective severance tax rate for the last fiscal year was about .6 percent.

Repealing these credits and deductions is not a new idea. In November 2008, former Gov. Bill Ritter’s Amendment 58 sought to do away with local property tax credits and to lower the production value that qualifies for the stripper well exemption. But it failed by 16 percentage points.

Sen. Sonnenberg said he is happy with the way the state taxes oil and gas companies.

“We have a consistent program now which allows us to collect more when the oil and gas industry collects more. It doesn’t make sense for me to collect more if the oil and gas industry collects less,” Sonnenberg told reporters late last month. “I think it’s fair. I think the industry believes it’s fair. I have no appetite to change it.”

Dan Haley, president and CEO for the Colorado Oil and Gas Association, said his members are already managing a mill levy tax increase—which the industry did not oppose—as well as additional regulations that add to the industry’s cost to do business. Haley said the industry has little appetite for a severance tax increase. But he said it is willing to work on a policy change dealing with deductions to help smooth the volatility.

Tracee Bentley, executive director of the Colorado Petroleum Council, which also represents the oil and gas industry, said CPC recognizes there are serious budget challenges at the state legislature and it wants to work with elected officials and the COGCC to find a solution that is fair and puts the agency on a sustainable path.

Rep. Rankin said he wants to ensure that severance tax money going to employee salaries is more predictable. He wants to change the law so that instead of spending the tax money as it comes in, it is budgeted for the following year. 

Rankin and others also want to pay back severance tax money that was used in prior years to patch up budget deficits. According to a February memo by the Joint Budget Committee, $322 million severance tax dollars have been transferred to the General Fund since 2001. 

“It’s been used kinda like a piggy bank,” Rankin told The Colorado Independent.   

Sonnenberg says he may introduce a bill after the March revenue forecast is released that would take about $300 million from the General Fund to pay back severance taxes.

That legislation, should it be introduced, would basically contradict the 2016 law that requires the departments of Natural Resources and Local Affairs to pay back about $46 million of the $110.6 million they borrowed from the General Fund last year. Under even the most optimistic revenue projections, that legislated payback puts programs at Department of Natural Resources in the red at the start of the fiscal year on July 1.

Lawmakers have a menu of options for how to deal with the severance tax revenue shortfall this year. Using General Fund money to backfill severance taxes will be a tough sell; despite the state’s revenue surplus, there are deficits in education and transportation that are a high priority for lawmakers this session. And lawmakers seeking reelection in November may be skittish about tinkering with tax policy.

This leaves the issue up in the air. But that’s not unusual. As Carly Jacobs, a budget analyst for DNR, put it: There is one thing you can always count on with severance taxes, “that you can’t really count on anything.”

Title photo: Oil and gas development in new housing subdivision on Collier’s Hill. Photo by Ted Wood/The Story Group.