By Luc Cohen and Joshua Schneyer
NEWCASTLE, Okla. (Reuters) - After intense lobbying, Oklahoma’s oilmen scored a victory two years ago. State lawmakers voted to keep in place some of lowest taxes on oil and gas production in the United States - a break worth $470 million in fiscal year 2015 alone.
The state’s schools haven’t been so fortunate. In Newcastle, 23 miles from the capital of Oklahoma City, John Cerny recently learned that the school attended by his five-year-old granddaughter, Adelynn, will open just four days a week next year. The Bridge Creek school district will slash spending because of a projected $1.3 billion state budget shortfall next year.
Beth Lawton teaches first grade at Broadmoore Elementary in Moore, a city of 59,000 bordering the capital. In April, she and several colleagues were told their contracts won’t be renewed because of funding cuts. Broadmoore’s class sizes are expected to rise next year as a result.
“I think our lawmakers have failed us, and I don’t understand how little they value education,” Lawton said.
Oklahoma’s school-funding crisis is part of the pain inflicted by falling oil prices on energy-rich states across America that rely on natural-resources taxes to pay their governments’ bills. But the crisis in Oklahoma is especially dire, exacerbated by a legacy of large tax breaks bestowed upon oil companies.
Before the recent 60 percent decline in oil prices, a drilling bonanza minted millionaires and billionaires in Oklahoma. The boom turned sleepy Oklahoma City into a thriving hub for drillers like Devon Energy, Chesapeake Energy and Continental Resources - the troika that lobbied hardest for the tax-break extension. The rebuilt downtown hosts top notch dining, hotels, arts venues, and a top NBA basketball team.
But as private oil wealth created these emblems of prosperity, public services have come under severe strain. In contrast to other energy states, Oklahoma didn’t fill state coffers during flush years.
Oklahoma taxed new oil and gas production from its prolific horizontal wells - the big money-makers of the fracking industry - at rates as low as 1 percent throughout the shale boom. In North Dakota’s giant Bakken oilfield, the going rate was 11.5 percent.
The state actually began cutting back on funding for Oklahoma school children before the bust, and education funding is likely to contract much further, said Ryan Owens, a co-director at the Cooperative Council for Oklahoma School Administration, a professional association of educators.
“Oil was $100 a barrel, and we still had less money per student,” Owens said. “We had an opportunity and we missed it.”
Shale regions are hurting across the country. Since 2014, the U.S. energy industry has shed more than 100,000 jobs. But during the drilling spree of 2008 to 2014, oil-rich states like North Dakota and Texas saw a sharp rise in oil-and-gas tax revenue and salted away a chunk of it for education. Over the same period, Oklahoma’s oil and gas production tax revenue slid 32 percent, in spite of soaring oil prices and a doubling of oil output.
“The state legislature can’t help when oil and natural gas falls,” said David Morrow, the Bridge Creek schools superintendent. “What has got the state of Oklahoma, in my opinion, is everything we gave away.”
Oklahoma lawmakers voted on Thursday to eliminate a separate subsidy for the worst-performing wells in order to help plug the budget gap. While barely utilized during the boom years, the cost of that tax credit grew to more than $130 million in 2015, as sinking prices made more wells unprofitable.
Overall, Oklahoma’s $3 billion education budget has been cut by $58 million since January. Though next year’s funding remains uncertain, the state’s projected 18 percent budget deficit has schools preparing for the worst.
Across the state, at least 100 Oklahoma school districts are considering shorter weeks or school years, and 1,000 school jobs are at risk, according to the Cooperative Council.
A SMILING BOY
Among the hardship measures being implemented, according to recent school surveys: bigger class sizes, teacher pay cuts and hiring freezes, cutbacks in arts, athletics and foreign language instruction, fewer offerings for special needs and gifted students, and a moratorium on field trips.
The Oklahoma oil industry is publicizing the role energy taxes play in helping fund schools. In March, a poster in the lobby of driller Continental Resources’ headquarters featured a smiling boy and read, “Oklahoma oil & gas produces my education.”
Kristin Thomas, a spokeswoman for Continental, said the industry and its employees are the state’s largest bloc of taxpayers, while drillers pay billions more in royalties to landowners. She said tax breaks for other industries, such as wind energy, have hurt education funding.
“We don't have a revenue problem in Oklahoma,” Thomas said. “We have a spending problem.”
The wind industry received tax credits and exemptions worth $306 million from 2004 to 2015, the Oklahoma Tax Commission said. State revenue data reviewed by Reuters show the horizontal-drilling tax breaks topped $1 billion between fiscal years 2012 and 2015 alone.
Oklahoma’s education spending per pupil fell by 24 percent between 2008 and 2016, the biggest drop in the country, according to the Center on Budget and Policy Priorities, a Washington D.C. group that tracks budget and tax issues on behalf of low-income people.
In North Dakota, where recent budget cuts have been less severe, spending per pupil grew 26 percent over the same period, the biggest gain in the country.
Tax revenue on oil production helped North Dakota stash away more than $3.2 billion in an investment fund, in addition to $614 million set aside exclusively for schools. In Oklahoma, Governor Mary Fallin recently used the state’s $300 million rainy day fund for a $50 million “one-time fix” for public schools. Fallin declined an interview request. A spokesman said the tax breaks were created by her predecessors.
A large portion of the tax on oil and gas production is funneled into Oklahoma’s General Revenue Fund, which provides schools with around half their funding. Many school districts also receive oil-production tax money directly, based on output in their counties.
“HAPPY TO KEEP THIS AT ZERO”
In 1994, Oklahoma began taxing new output from horizontal wells at just 1 percent, compared to 7 percent for conventional vertical wells. When the so-called incentive rates were first enacted, they were meant to be temporary support for what was then a nascent drilling technology.
Horizontal wells have bores that extend lengthwise into reservoirs of oil and gas trapped in porous shale rock. The fossil fuels are typically unleashed by the process known as hydraulic fracturing, or fracking - blasting the rock with a mixture of water and chemicals. Horizontal fracking wells have become central to the recent shale oil and gas boom in Oklahoma and around the United States.
Over the years, Oklahoma’s lawmakers repeatedly extended the tax breaks on horizontal wells, even as the technology became common and far more productive, oil prices rose and output surged.
State tax regimes are often complex. In Oklahoma, horizontal wells were taxed at a discounted rate in their first years but subject to the nominal 7 percent rate after several years of production. The incentive rates were set to expire in 2015, a scenario that would have made all wells subject to 7 percent taxes through their lifespan.
But the biggest drillers were keen to protect the reprieve from the higher rates: Horizontal wells often pump out their bounty quickly, generating their highest production by far during their first few years.
So in 2014, the three big drillers made a lobbying push for lawmakers to make permanent the favorable tax treatment on early production.
They had to fend off warnings about falling state energy tax revenues from critics of the breaks, such as Tulsa billionaire George Kaiser.
Kaiser, whose interests include drilling, banking and philanthropy, urged lawmakers to let the tax breaks expire as planned. The benefits mainly went to out-of-state shareholders in oil companies, he told them, while ordinary Oklahomans paid the price through underfunded public services.
Some lawmakers agreed. Mark McCullough was one of the few House Republicans to oppose extending the incentive. Horizontal drilling technology “is now very mature and widely used,” he said during the 2014 debate. “Is it really an incentive anymore? Or are we now getting into something else?”
Today, McCullough says, it’s clear that the enduring tax breaks were disastrous for state revenues, but a majority of lawmakers were quick to side with drillers during the boom.
"Oil and gas has a ton of weight, and by darn they wanted their credit,” McCullough told Reuters. “By golly they got their credit.”
To help win over lawmakers, Devon hosted dozens of them in its Oklahoma City skyscraper before the 2014 floor vote. The company had several talking points, according to state legislator Pat Ownbey, who attended the meeting. Among them: Higher taxes would only hurt state revenue, by prompting frackers to abandon Oklahoma for other states.
“While some may think that raising taxes on the oil and gas industry could provide additional funding for education, drilling less wells in the state will end up decreasing total revenue traditionally designated for education in the long-run,” Devon wrote in a later public statement.
On April 29, 2014, three weeks before lawmakers voted to extend tax breaks, Fallin and Oklahoma’s finance secretary, Preston Doerflinger, held a private meeting at the governor’s mansion with Devon’s chairman and the chief executives of Chesapeake and Continental. The topic was oil production taxes, Doerflinger’s spokesman said.
Those same companies were hoping for a 2 percent tax rate on horizontal wells for their first four years in operation, according to local media reports.
The following month, a 2-to-1 majority of Oklahoma lawmakers voted to tax all horizontal and vertical wells at 2 percent for the first three years of production. That’s when horizontal wells yield the most oil - and the most potential tax. After three years, output from a typical horizontal oil well in the state has declined by 86 to 89 percent from peak levels, according to industry consultant Drillinginfo.
Drillers cheered the outcome, which was similar to their own proposal. For the first time, the vote would make the tax breaks permanent. Though it lifted the tax burden from 1 percent to 2 percent during a well’s early years, oil companies were now guaranteed some of the most driller-friendly rates in the country.
Chesapeake declined to comment for this story. Devon referred Reuters to an industry trade group, the Oklahoma Independent Petroleum Association.
"I PAY MY TAXES"
Its president, Mike Terry, said the low production taxes kept Oklahoma competitive and have helped make it “the most resilient in the nation at weathering the downturn in oil prices.” The number of rigs exploring for oil and gas in Oklahoma has fallen by 59 percent since late 2014, compared with a decline of 66 percent nationwide, he said.
The legislative record shows that oil companies found a sympathetic audience at the capitol.
“I find it odd that we’re thinking about castigating our number one industry instead of getting down and thanking them,” state representative Leslie Osborn said during a legislative debate before the vote. “I would have been happy to keep this at zero percent.”
Osborn's district includes Oklahoma City, which in March announced plans to lay off 208 teachers and in April said it would fire 92 school administrators. The steps will save about $13 million a year.
Osborn didn’t respond to requests for comment about the school cuts.
Over Oklahoma’s boom period, energy production tax revenues fell instead of rising. The opposite happened in North Dakota and Texas, which saw big increases in revenue. In 2014, Oklahoma’s take was $860 million, down from a $1.3 billion peak in 2008.
That’s partly because over time, more and more of Oklahoma’s production came from horizontal wells, taxed at the far lower rate.
To be sure, lower natural gas prices also explain part of Oklahoma’s revenue crunch. Between 2008 and 2014, gas prices fell by around 50 percent, even as oil prices frequently topped the $100 a barrel mark.
Still, the tax breaks alone cost Oklahoma around $800 million over the same period, according to the Oklahoma Policy Institute, a Tulsa think tank that draws some of its funding from Kaiser.
Driller tax breaks have taken a toll in some other states. Louisiana exempts horizontal wells from tax for up to two years if drilling costs aren’t recouped first. The state’s Legislative Auditor said the breaks cost $1.1 billion from 2010 to 2014. But Louisiana hasn’t cut school funding as sharply as Oklahoma has. Per pupil spending is down 1.4 percent since 2008.
In Inola, Oklahoma, 30 miles east of Tulsa, 37-year-old machinist Jack Foster has four young sons enrolled in public school, where four-day weeks are already in effect. The family is unhappy about the cost cuts, and has to make alternative plans for the boys once a week.
“I pay my taxes,” said Foster. “I want my kids to have a good education.”
(Edited by Michael Williams)