What to Do with Montana's Oil Wealth?

Montana is one of a number of U.S. states that has a sovereign wealth fund.  Some of these funds were originally created in the 1800’s through Congressional action (the land trust funds), but several of them, including the Alaska Permanent Fund, are of more recent vintage.  In fact, these newer funds owe their existence to the State of Montana, which was the first state to successfully defend a severance tax on mineral production.  The Supreme Court case, Commonwealth Edison Co. v. Montana, 453 U.S. 609 (1981), held that Montana’s severance tax did not violate the Commerce Clause of the U.S. Constitution.  Other mineral-rich states, following Montana’s lead, established severance taxes on mineral extraction, and many of them created permanent funds to safeguard some of this wealth for future generations.

The most impressive recently-created state SWF is North Dakota’s Legacy Fund, at least in terms of how quickly the fund has grown.  North Dakota’s oil wealth comes from the Bakken Formation, which holds several billion barrels of extractable oil.  The Bakken Formation extends into Montana, and as oil production wanes in North Dakota and waxes in Montana, what will Montana do with its oil wealth? 

It could create an oil-specific SWF, like North Dakota.  Alternatively, it could amend Article IX, Section 5 of its constitution in order to allow the state to put oil revenues in the existing coal tax permanent fund.  If I am reading Montana’s tax policy correctly (and I hope I am not), it would also need to be amended to get the most from the state’s oil revenues.  A research paper by Headwaters Economics and the Bill Lane Center for the American West at Stanford notes that Montana performs poorly in relation to its neighbor states in generating tax revenue from oil extraction “because the state has no sales tax on drilling and support services, and grants an 18-month holiday on production from new horizontal wells. The tax holiday delays significant revenue collection from new production until nearly two years after drilling has impacted infrastructure and services.”

The tax holiday is especially problematic given the production curve for Bakken Formation oil wells, as a chart from the report makes clear:

 The solid green line shows the average drop in production over the first 36 months of production.  The report summarizes:

Based on these data, [in its second year] the typical Bakken well will produce only 55 percent of what it produced in the first year, a 45 percent decline. The decline rate slows to 32 percent in the third year. After three years average daily production of 78 barrels is only 21 percent of the peak average daily production of 372 barrels achieved in the second month of production.

Montana is sacrificing taxes from the best months of production (a fact I’m sure they recognize and have heretofore balanced against competing factors).  My bet is that tax policy will change as Montana looks across the border and sees the success of the North Dakota Legacy Fund, and seriously contemplates how the state can maximize the value of its own extensive oil reserves.

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