The combination of hydraulic fracturing (commonly known as “fracking”) with the development of horizontal (rather than vertical) drilling capability has served to make accessible the vast reserves of natural gas and other chemicals contained in the massive Marcellus and Utica shale preserves that are partially located in southeast Ohio. A second offshoot of the accessibility of this large new supply of natural gas is the need to transport the extracted resources to the marketplace. As a result, roughly 800 miles of natural gas pipeline has been constructed in Ohio over the past several years, the two largest of which are the Nexus (256 mile total length) and Rover (713 mile total length) pipelines. In addition, compressor stations are required along the pipeline in order to facilitate natural gas flow through the pipeline.
Both the pipelines and the compressor stations are taxable as Public Utility Tangible Personal Property and have become part of the local property tax duplicate in the 2018 and 2019 tax years. While precise estimates of local property tax revenue are difficult to obtain due to data confidentiality restrictions, information made available publicly has suggested that property tax revenues for Ohio local governments will total to several hundred million dollars.
While fracking is not without its critics (many environmental groups have expressed concerns about the potential contamination of groundwater supplies and have expressed frustration with many drillers’ refusal to identify the chemical compounds injected into the shale out of concern for revealing “trade secrets”), the new drilling techniques have appeared to be tremendously successful in their primary goal of extracting natural gas from the previously inaccessible underground shale preserves. In fact, natural gas extraction has been so successful that there is now such a glut of natural gas that prices are at long-time lows. While this is good for consumers of natural gas who now have lower heating bills, it is not such good news for the oil and gas companies themselves (this issue was the subject of an article in the January 12, 2020 edition of the Columbus Dispatch).
According to the Columbus Dispatch, “Just last summer, seven large [oil and natural gas] producers that operate in the region spent $500 billion more on drilling than they earned in selling oil and gas”. Furthermore, one repercussion of these financial difficulties has been that the natural gas pipeline companies have begun appealing the taxable values assigned to their pipelines and compressor stations by the Ohio Department of Taxation. One aspect of the appeals process is that taxpayers are allowed to pay only the taxes that are due based on the lower appeal value rather than on the assigned taxable value. In instances where this has occurred, school districts and other local governments have received lower tax payments than they were expecting, which can create a variety of fiscal problems at the local level. However, if the appeal is unsuccessful (or partially successful) then the taxpayer would still owe the remaining tax payment.
The appeals process for public utility property works as follows:
1) First the taxpayer makes an appeal to the Ohio Department of Taxation (ODT) questioning the original assessed value.
2) The Tax Department is then required to send notices to county auditors in the counties affected by the appeal that the appeal has been lodged.
3) ODT holds a non-public hearing in which the taxpayer can present evidence supporting the appeal. Only the taxpayer and its representatives and ODT are present at this hearing.
4) ODT makes a ruling on the appeal, which typically takes several months.
5) After ODT’s ruling, either the taxpayer or the county auditor(s) can appeal to the State Board of Tax Appeals. Note that school districts and other local government units that actually receive the property tax revenues do NOT have the legal standing to appeal a ruling they view as unfavorable. This is different from the appeals process for real property where both the property owner and the school district are allowed to challenge the assessed value assigned by the County Auditor.
At this moment, it appears that the ruling on the pipeline tax valuation appeals will not be made by the Tax Department until June 2020.
Likelihood of the Lower Values Being Upheld on Appeal
While it is probably never a good idea to speculate about the outcome of any case pending before the Tax Department or the Board of Tax Appeals, a few facts about how the pipelines are valued can be instructive. According to Ohio Department of Taxation publication “A Brief Summary of Major State & Local Taxes in Ohio”, the default method of establishing the “true value” of public utility tangible personal property is cost, which is then reduced by an annual depreciation allowance. (Note that “true value” is another term for market value, and taxable value is true value times the 88% assessment percentage applicable to pipelines.) Since the cost measure referenced above is supposed to be construction cost in accordance with the company’s records, it is difficult to see how a lower than expected price for the natural gas flowing through the pipeline can lead to a reduction in the taxable value of the pipeline itself.
So why are the pipeline values being appealed? The most likely answer to this question is that the lower price of natural gas resulting from the oversupply has led to a reduction in the amount of gas flowing through the pipelines. This in turn reduces the revenues of the pipeline companies. If they can in turn reduce their property tax payments, they can then (most likely partially) recoup the lost revenues.
The bottom line impact on schools and other local governments of reduced pipeline values is either reduced revenues compared to what was expected based upon the information initially provided by the pipeline companies and the initial assessed property values from inside millage and fixed rate (i.e. typical operating and PI) levies, or an increase in the taxes owed by other local taxpayers (again compared to what was expected) in the case of fixed sum (bond and emergency) levies. In terms of state aid, because FY20 and FY21 and state funding is essentially frozen at FY19 levels, there will be no immediate impact on state aid as a result of the appeal of the pipeline valuations.
However, the bottom line from the perspective of the pipeline companies may well be that they have nothing to lose and everything to gain by appealing the values, as the worst case scenario is that they will still owe taxes based on the original values and the best case is that they will owe less.