States eye trusts for new oil, gas revenue

• New drilling techniques bring unexpected oil and gas wealth
• Some states creating funds for handling revenues
• North Dakota fund expected to grow to $1.3B by June 30

What should be done with the nation's new oil and gas riches?

One answer rapidly gaining popularity: Set some aside for future generations.

North Dakota voters created a Legacy Fund in 2010 and the state expects to have $1.3 billion tucked away by June 30. Utah voters approved a constitutional amendment Nov. 6 to require up to half of new energy revenue be set aside in the future. West Virginia legislators are considering a Future Fund to divert energy revenue into a trust fund. And the idea has been raised in Kentucky, Ohio, Pennsylvania and South Dakota.

The Alaska Permanent Fund, which pays cash dividends to residents every year, is the most famous example of a giant savings account built from energy taxes and royalties. Created in 1975, it now has $42 billion. Other energy states — Montana, New Mexico, Texas and and Wyoming — have big trust funds, too. Alabama created one in 1985 after natural gas was found offshore.

Alberta, Canada, has a $16 billion fund, started in 1975. Norway's 5 million residents have the world's largest fund, worth $650 billion, more than that of any Middle Eastern oil state.

Today, non-traditional drilling techniques such as hydraulic fracturing, or fracking, are bringing unexpected oil and gas wealth to places that have little experience in managing such good fortune. New York doesn't tax oil and gas at all. Ohio has a minimal tax. Both states are located in geologic formations expected to generate massive amounts of oil and gas that was once inaccessible.

"Folks understand this boom is not going to be here forever," says North Dakota Treasurer Kelly Schmidt. "It makes sense to save some of the money. North Dakotans are traditionally savers anyway."

North Dakota is now the nation's No.2 oil producer, after Texas, by using fracking in the Bakken shale formation in the western part of the state. The financial return to the state is a "wow!" says Schmidt, a Republican. "And I do mean 'wow!'"

The Legacy Fund is exceeding all projections. It brought in $580 million in the first 12 months from 30% of the state's oil and gas revenue. North Dakota can't spend any of the Legacy Fund until 2017, and then, two-thirds approval from the legislature is required to say where the money goes.

North Dakota has a tax rate typical of longtime energy states: 5% to 7% of oil's value. A big property tax cut is likely in 2013, using oil money that doesn't go into the Legacy Fund.

State oil and gas trust funds have a few things in common. Voters approved most funds as part of the state constitution, limiting elected officials' access to the money. All funds limit how much and how fast the trust fund can be spent. And, once created, the funds remain politically popular — almost sacrosanct — in both parties.

How the money is spent varies widely. Texas' $39 billion is spent mostly on education. Alaska wrote $878 checks to 650,000 residents in October. Other states divide the money by a formula that gives legislators control of earnings but not the principal.

Statewide money sharing

The political effect is that oil and gas windfalls are spread statewide. The oil boom in sparsely populated western North Dakota will benefit the residents in the eastern cities of Fargo and Grand Forks.

"Our fund has been absolutely good for Wyoming in every way," says Erin Taylor, executive director of the Wyoming Taxpayers Association. It's why the state has low sales and property taxes and no income tax, she says.

The fund's distribution formula — giving 5% of the five-year average of assets to the legislature — is so inviolate that her association supports doubling the fuel tax to pay for highway improvements rather than dipping into the principal of the $5.4 billion fund.

While enjoying broad support in states after they exist, the funds are caught in the crossfire of today's divided politics when proposed.

In Utah, Republican state Rep. Jim Nielson proposed sending a constitutional amendment to voters on a permanent fund.

"I couldn't get a single Democrat in the House to go along," he says. In West Virginia, Democratic state Senate President Jeffrey Kessler had the opposite problem: GOP legislators prefer a business property tax cut to his proposed Future Fund. "Getting legislators to warm up to the idea can take a year or two," he says.

Utah and West Virginia show how two very different states headed toward the idea of a long-term trust fund. Utah is looking to the future. The state has relatively little oil and gas production now but has plentiful resources such as tar sands that may be released in the future.

Today's generation is morally obligated to set aside money for the future when it extracts a resource that can never be used again, Nielson says. "We ought to be funding our 401(k)," he says. On Nov. 6, Utah voters approved, 51% to 49%, putting a share of oil and gas taxes in a permanent fund.

Longtime mining state

West Virginia is looking to the past. The state is a longtime energy state, mining coal for a century and already fracking for natural gas.

"We have a second bite at the apple," Kessler says. "We didn't manage our coal resources well a century ago and have a chance to do it wisely this time" for natural gas.

The liberal West Virginia Center on Budget & Policy did a study of how a permanent fund would benefit the state. "I kept thinking to myself, 'We need something like Alaska,'" says executive director Ted Boettner.

He has met some resistance from some traditional liberal allies who oppose fracking for environmental reasons. "Some environmentalists have pushed back," Boettner says. "We work with a sister group in New York, and they won't even consider supporting a severance tax because they are against fracking altogether."

Trying to ban fracking in West Virginia won't work, Boettner says. "The chance of that happening is zero. We have a coal miner on the state flag. This is reality, guys."

The oil industry in new energy states has been skeptical of permanent funds, fearing higher taxes. Ohio Gov. John Kasich, a Republican, wants higher oil and gas taxes to fund an income tax cut rather than a permanent fund.

Permanent trust funds are easier to create in the West because state laws make it easier to put proposals on the ballot. Also, Western states have a long history with trust funds from many sources, such as land, that can date back to when they entered the union.

New Mexico has $11 billion in a land grant fund and $4 billion in its severance tax fund, says Charles Wollman of the New Mexico State Investment Council. Together, the funds will distribute $700 million this year for schools and other uses.

Until now, North Dakota's Legacy Fund has been kept in cash. Decisions on how to spend the money are several years off.

"We hope the Legacy Fund is an inspiration to others," says Ron Ness, president of the North Dakota Petroleum Council, an industry group. "It's not a direct benefit to the industry, but it's a great benefit to the people of North Dakota."