Tax Analysts Blog

What the Frack?

Posted on Jun 22, 2016

This will be music to the ears of some incentive-philes. Royal Dutch Shell, the ginormous energy company, has announced plans to build a petrochemical plant in Beaver County, Pennsylvania. Shell will invest billions of dollars in a state badly in need of investment and create thousands of jobs in a state badly in need of jobs. So let's stipulate that Shell building a giant plant that will employ thousands of people is a good thing for my home state of Pennsylvania.

The newspapers in the Keystone State report that Shell is moving to Pennsylvania because of a tax incentive bill passed four years ago and that incentives work. If your firm does tax incentive business, you need to get some of these newspapers and distribute them to potential clients. Finally, proof that incentives aren't corporate welfare giveaways after all. Maybe they are not payments to companies that were going to invest regardless. Maybe Greg Leroy and I (the last two people on the planet who care) are wrong. Incentives are a good thing.

OK, I'm only kidding. The newspapers do say that Shell is building in Beaver County because of the incentives, but let's look at the facts. The incentives being given to Shell amount to about $1.6 billion over 25 years. That seems like chump change in the Tesla incentive world. Shell's revenue is about $270 billion. That's like 80 percent of the Netherlands' GDP. Shell has a market cap of about $188 billion. So I'll leave it to you to ponder whether a giant company would make a billion-dollar investment decision based on a benefit that comes out to about $64 million a year. Now, even a large company would rather have $64 million than not, but for a company that pays its CEO $27 million a year, this incentive package is a trifle.

But more significantly, think about what Shell is building and why it's building it in Beaver County. Those Dutch fellas aren't building an animal cracker plant or a Ritz cracker plant. They're building an ethane cracker plant. They are building it in western Pennsylvania because that's where the ethane is. Ethane is derived from natural gas that will be fracked out of the shale scattered around the Appalachian basin. Shell could build its plant in Boston, Miami, or Phoenix, but it chose Beaver County -- not by coincidence, but because it made sense.

Now, to be sure, Shell apparently considered building the plant in neighboring Ohio and West Virginia. Those locations are also sitting on top of shale fields and, more importantly, offered tax incentive packages similar to those offered by Pennsylvania. Pardon my skepticism, but Shell is moving to Beaver County because it's the right business decision. It would be going without the corporate welfare payments.

As an aside, Beaver County is located just west of the great city of Pittsburgh. If you want to impress someone on Match.com, tell them that Joe Namath, Pistol Pete Maravich, and Henry Mancini all hailed from Beaver County.

Read Comments (2)

Edmund DantesJun 22, 2016

I suspect that a factor as important as the tax incentives was that PA looks favorably upon fracking, in contrast to nearby NY, which has forbidden mining of its shale fields.

Although I agree with you that a tax incentive won't convert a bad economic decision into a good one, I believe that when the states are competing to be the situs of a new development those incentives will have a constructive role to play.

We know that taxes matter, just look at the exodus of people and businesses from tax-crazy CT.

Mike55Jun 22, 2016

"So I'll leave it to you to ponder whether a giant company would make a billion-dollar investment decision based on a benefit that comes out to about $64 million a year. Now, even a large company would rather have $64 million than not, but for a company that pays its CEO $27 million a year, this incentive package is a trifle."

As someone who has been on the corporate side of these deals, I can assure you the folks locating these plants absolutely care about the $64M. Large companies are really, really good at creating incentives that ensure their employees care about every last dollar, because all those little $64M items have a way of adding up. It's almost certain there was some junior level VP within Shell whose variable compensation was heavily tied to maximizing the incentives package obtained for the new plant.

The way all this works at the typical Fortune 100 company is as follows:

#1 - A cross-functional team of folks is made responsible for pursuing SALT incentives. Tax, Government Relations and Facilities will almost always have a seat at the table, along with a mish-mash of others.

#2 - When a large new facility must be located (or an existing facility significantly expanded, or several existing facilities consolidated), some qualified outside consultant (often from the Big Four) is retained to reduce the hundreds of potential locations down to those that make the most business sense. The vast majority of the time this results in a handful of supposedly ideal locations for the company to decide between.

#3 - The list generated in Step #2 is shared with the C-Suite, which will generally knock off at least one or two locations based upon their own personal experiences (or perhaps just subjective biases).

#4 - The cross-functional team then sets to work pitting the remaining locations against one another to obtain the best incentives deal. Whichever location provides the best offer at this stage always wins the investment. Always.

So no, Shell was never going to drop this plant somewhere that lacks ethane. But the reason the plant is in PA as opposed to OH or WV is the incentives. The only scenario where PA would have potentially been better off is if it could have made a pact with OH and WV that none of three would offer Shell an incentives package. Of course even this is somewhat dubious from PA's perspective, as paying $68M to get the plant may well be a superior result to paying $0 for a 33% chance of getting the plant.

You're correct that incentives are nothing more than "corporate welfare" at the macro level..... there's just no disputing that point. But the argument that offering incentives is bad policy for any one particular state just does not follow from that macro level truth. The states are well aware that they are being pushed into a race to the bottom, but that does not change the fact that no state can afford to lose the race.

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