Act 46 of 2010, more commonly known as Pennsylvania’s 2010-2011 budget bill, contained a commitment by the General Assembly to pass a natural gas severance tax by October 1, 2010, with an effective date of no later than January 1, 2011. This article will provide a brief summary of things to watch for as the General Assembly “makes the sausage” this month.

Severance taxes throughout the United States are generally based on the volume of gas extracted, the value of gas extracted, or a combination of the two. In the case of a tax based on the volume of gas extracted, there is a flat rate in terms of cents per thousand cubic feet (MCF). The gas is simply metered through the well as it is extracted. The problem with the volume method is that it does not take into account the value of the gas being extracted. For instance, when gas prices are very high, the taxing jurisdiction will not share in the increased revenues. Conversely, when gas prices are very low, the tax may be a severe impediment to extracting the gas at all.

The alternative is to tax the value of gas extracted “at the wellhead,” which means before any deductions are made for transportation and distribution costs. The downside of this type of tax is that it is difficult to forecast for state budgeting purposes. It is also more difficult to enforce the tax, because sales and prices must be monitored and audited, rather than simply reading a volume meter at the wellhead.