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F I S C A L I M P A C T R E P O R T

SPONSOR Hanosh

ORIGINAL DATE

LAST UPDATED

1/23/06

1/27/06 HB 144/aHAGC

SHORT TITLE Oil and Gas Produced Water Credits

SB

ANALYST Francis

REVENUE (dollars in thousands)

Estimated Revenue

Recurring

or Non-Rec

Fund

Affected

FY06

FY07

FY08

(0.3)

(0.3) Recurring General Fund

(Parenthesis ( ) Indicate Expenditure Decreases)

SOURCES OF INFORMATION

LFC Files

Taxation and Revenue Department (TRD)

Energy Minerals and Natural Resources Department, Oil Conservation Division (EMNRDOCD)

Interstate Stream Commission (ISC)

New Mexico Oil and Gas Association (NMOGA)

Responses Received From

Energy Minerals and Natural Resources Department (EMNRD)

Interstate Stream Commission (ISC)

New Mexico Oil and Gas Association (NMOGA)

SUMMARY

Synopsis of HAGC Amendment

The House Agriculture and Water Resources Committee amended House Bill 144 in response to

questions about the constitutionality of the Interstate Stream Commission being able to indem-

nify the operator from future liability. The amendment strips the bill of the indemnification.

This will not change the fiscal analysis.

Synopsis of Original Bill

House Bill 144 reinstates a credit for produced water, a by-product of oil and natural gas drilling,

delivered to the Pecos River. The credit was repealed effective January 1, 2006.

House Bill 144/aHAGC – Page

2

The credit is $1,000 per acre-foot of produced water, not to exceed $400,000 per year. It is ap-

plicable to either personal income or corporate income tax liability.

The operator (the party operating the oil or gas well) must deliver the water to the interstate

stream commission (ISC) in compliance with all ISC and federal quality standards.

Upon the delivery and approval, ISC takes title to the water and indemnifies the operator from

future liability.

FISCAL IMPLICATIONS

TRD reported in 2005 that the total credits issued since the bills inception in 2002 has been $300.

Several matters have impeded the adoption of this credit by operators. Since they appear to re-

quire significant legal issues involving the control, ownership and transmission of water re-

sources in the Pecos River Compact, it seems unlikely that the credits will be used to any further

extent in the near term future. Should legal and technical issues be resolved, the credit could

reach as high as $2.4 million, assuming six companies near the Pecos River qualify for the

maximum credit.

SIGNIFICANT ISSUES

Comments from the oil and gas industry indicate that the rules established for the delivery of the

produced water have made it prohibitively expensive. The original target was to provide some

type of economic relief for the producer, whose clean-up costs are far greater than the credit.

Millions of dollars have been invested in an attempt to clean produced water. The credit is an

incentive to operators to keep trying new ideas. One of the problems that the industry has en-

countered and why the credit has not been used very often is the requirement to deliver the pro-

duced water below the Avalon Dam, or downstream from the Carlsbad Irrigation District. This

would require a pipeline that the industry is not ready to build.

Interstate Stream Commission has identified several issues with the credit:

In order that the produced water delivered to the Pecos river contributes fully toward delivery

obligation pursuant to the Pecos River Compact, two things must happen: 1. The River Mas-

ter Manual of the Pecos River Master must be amended to assure that the produced water de-

livered to the Pecos River would not be accounted as flood water under the artifacts of the

compact accounting and thus actually increase New Mexico’s obligations; and 2. The state

engineer must be authorized to administer the produced water resulting from its point of di-

version from groundwater and delivered to the Pecos River so that it is not diverted for other

uses either before it reaches the Pecos River or after it reaches the Pecos River, and to insure

its delivery to the state line.

Section A(3) requires the Interstate Stream Commission to indemnify the “operator” (as de-

fined in the Bill). This Article is likely unconstitutional. Article IX, Section 8 of the New

Mexico Constitution has been judicially interpreted to preclude a governmental entity from

entering into an agreement subjecting it to contingent liability, the amount of which is uncer-

tain at the time of the agreement. See, Henning v. Town of Hot Springs, 44 N.M. 321, 102

P.2d 25 (1940); City of Santa Fe v. First Nat. Bank in Raton, 41 N.M. 130, 65 P.2d 857

(1937). Relying on these authorities, the Attorney General has interpreted this Constitutional

provision as proscribing any state agency from agreeing to indemnification of another party.

House Bill 144/aHAGC – Page

3

See, A.G. Op. 00-04. [Note: HB144 as amended corrects this constitutional question.]

If Section A(3) is unconstitutional, then only if the remaining provisions of the Bill are self-

sustaining and capable of separate enforcement from Section A(3) and not dependent on Sec-

tion A(3), will the remaining portions of the Bill be “severed” from Section A(3) and survive

constitutional scrutiny.

This Bill, read as a whole, appears severable, but such scrutiny ultimately lies within the pur-

view of the judiciary.

ADMINISTRATIVE IMPLICATIONS

Interstate stream commission reports that it has to develop guidelines for the manner in which

produced water can be delivered to the Pecos River. Also, the interstate stream commission is

required to provide legal confirmation of receipt of the produced water. The monitoring of the

produced water delivered to the Pecos River and providing legal confirmation will require addi-

tional staff time but difficult to estimate at this time without knowing exactly how many oil and

gas operators would participate in the program.

TECHNICAL ISSUES

The OCD points out that the definition of “operator” has changed in this bill from the 2002 law

that was repealed effective January 1, 2006. Operator now only refers to a person who operates

an oil or gas well. The original language defined operator as “a refinery, a natural gas processor

or a person who operates an oil or gas well.”

At present, produced water is injected back into the deep geologic formations. A permanent re-

moval of this water from the underground formations could, in the long-term, prove to have im-

pacts similar to additional groundwater withdrawal. The hydraulic connection between the deep

geologic formations, aquifer zones and the river is still matter of research and investigation

ISC recommends that the bill be amended at p. 2, line 7, after the 1st occurrence of “to” insert

“meeting the state’s” for clarity in meaning.

WHAT WILL BE THE CONSEQUENCES OF NOT ENACTING THIS BILL

The produced water credit in both the Income Tax Act and the Corporate Income and Franchise

Tax Act was repealed effective January 1, 2006, and so unless a new credit is enacted, this credit

will no longer be available.

NF/nt:yr