Turning Black into Green

For too much of the lengthy debate over expanded access to oil & gas resources, participants on both sides have sought to pit renewable energy against conventional energy. There is nothing at all mutually-exclusive in our need to increase US energy supplies from both of these sources, and an op-ed in today's Washington Post suggests a way explicitly to align them to the ultimate benefit of companies, the country, and of the environment. The concept involved is not new, but it is significant to see it coming from two Congressmen, one a Democrat and the other a Republican. Taken together with the pending "Gang of 10" compromise proposal, it is heartening to see energy beginning to be treated as the enormous bi-partisan challenge it is.

The suggestion of Representatives Marshall (D-GA) and Bartlett (R-MD) looks quite simple, compared to the kind of detailed, more tactical proposals that have been swirling around in the last year or two. It describes a strategic approach to converting the value of oil and gas on federal lands and offshore into the means of funding a large ramp-up in non-fossil energy sources, including renewables and nuclear power. As I understand it, it consists of these steps:

1. Establish a national strategic plan for energy with aggressive but attainable goals for greatly reducing our reliance on fossil fuels in general and imported oil in particular.
2. Utilize the royalty revenue from expanded drilling to fund this transition, rather than sharing it with states or channeling it into the general fund, as is the case for revenue from current leases.
3. Increase the government's share of the market value of this oil and gas by boosting royalty rates.
4. Front-load the investment in alternative energy by issuing government bonds backed and repaid by future royalty revenues from the new leases.

On balance, this is a savvy approach that looks consistent with expanding our supplies of conventional energy over the next decade or two, while positioning alternatives to reduce greenhouse gas emissions in the near-to-medium term and replace fossil fuels in the long term. As with any plan, however, the devil is in the details. In implementing it, we would need to ensure that royalties were not set so high that, after paying them and then paying an effective 40% tax rate on the profits from these operations--plus a future windfall profits tax?--the companies that must invest billions of dollars developing the resources in question could still expect returns attractive enough to merit taking on the enormous risks inherent in these very complex projects.

The current federal royalty rate on leases in the Outer Continental Shelf of the Gulf of Mexico takes a flat 16.7% of the oil and gas revenue at the wellhead, in value or "in-kind". If the government's mean estimate of 18 billion barrels of untapped oil under federal waters proves correct, then at current oil prices the clean energy fund proposed in the op-ed would stand to capture as much as $330 billion over the producing life of these fields. Even if only a tenth of this resource could actually be developed, consistent with the pessimistic forecasts adopted by drilling opponents, that is still a sizable sum to invest in clean energy today.

Messrs. Bartlett and Marshall would also like to see royalty rates rise further, though part of their justification for that appears to rest on the flawed assumption that current royalty rates provide such lavish returns that companies are encouraged to slow development to defer their earnings. What is needed, I suspect, is royalty reform, not just higher royalty rates. Royalties ought to take into account the entire applicable tax regime on oil & gas producers. It seems reasonable for the government's share of oil revenue to rise when prices are high and fall when prices decline. Otherwise, we risk either seeing production shut in at prices at which it should still be economical, or blocking development entirely. Royalty structures must also contemplate all possible future price scenarios, not just current prices; that is the clear lesson of the royalty-relief debacle of a few years ago. Higher royalties will inevitably reduce lease bids, so that trade-off must be incorporated, as well. This is the sort of problem that seems well-suited to a bi-partisan commission to resolve.

The spirit of energy compromise is in the air, perhaps just for this brief interval before the November election. Representatives Marshall and Bartlett's plan deserves serious attention, either as part of the Gang of 10 initiative or separately. While I might dispute their assertion that we have benefited from locking away the contested resources for a generation, I certainly concur that tapping them now is timely, coinciding as it would with reduced US energy demand growth. Any effective plan for achieving our collective vision of greater US energy security must ultimately reduce to the simplicity of using less while producing more, ourselves. Capitalizing on our remaining "black gold" to grow more green energy--while also generating more of the other kind of green to reduce our trade and fiscal deficits--looks very smart, indeed.