Altered Terms

While I've devoted my last two postings to the climate change aspects of the administration's first budget, some of its other provisions could also have a significant effect on our energy economy--perhaps more, considering their potential impact on a source that still contributes one-third of our total energy diet: domestic oil and gas production. The President's budget seeks to alter many of the financial parameters under which this energy is produced and processed, ultimately affecting the energy prices consumers pay. It's not even clear that these changes would result in a net revenue gain for the federal government, after all their offsetting consequences are tallied.

Let me start by stipulating that the proposed modifications, to the extent they don't breach contractual obligations, are the government's prerogative as the custodian of the public's interest in the resources and activities involved. That's certainly true in the case of oil and gas produced from public lands and the Outer Continental Shelf (OCS). All governments change tax rates and tax benefits periodically, as circumstances change, and businesses shouldn't be surprised or offended by this. (Altering the terms of existing contracts, or enacting punitive taxes to achieve the same result after the courts have upheld companies' legal rights, is a different matter.) What's at issue here is not the government's authority to make these changes, but the wisdom of its doing so, and the ultimate consequences for a nation that still relies on petroleum for 95% of the energy we use in transportation. When it proposes singling this industry out to bar it from taking the manufacturing tax deduction, or ending the expensing of intangible drilling costs, these issues can't just be viewed as isolated line items, without examining their broader implications. In several cases, the changes likely wouldn't even raise overall government revenues.

Consider a provision in the budget to impose a new annual fee on Gulf of Mexico leases not currently producing oil or gas. This is clearly an outgrowth of last summer's spurious "idle leases" debate, which arose from a fundamental misunderstanding of the mechanics of oil and gas leasing and the way that companies determine which prospects to drill first. In any case, the $115 million per year the government hopes to raise with this fee only reflects its direct revenue, without considering the lower bid premiums on new leases that would ensue.

With the exception of the enormously controversial late-1990s leases subject to royalty relief, companies have bid for OCS leases under rules that specify that after paying the bid premium, they must pay rental fees until a property is developed, after which they would owe a 1/6th royalty on any production. (Note that both parties to these contracts have significant incentives for the deals to yield substantial production, and both are harmed when they don't.) The new fee would increase costs for leases that turn out not to have sufficient quantities of hydrocarbons to merit commercial development--over and above the cost of learning that bad news--or that simply never rise to the top of a company's constantly-evolving project list before they expire. Since neither of these outcomes is unusual, the "non-producing lease" fee would become an important consideration in calculating how much to bid in the first place. Net result: decreases in new lease bids would offset the revenue from the new fee, and in the worst case we'd see a significant drop in overall oil & gas "bonus bid", rent and royalty revenue that contributed $23 billion to the federal budget last year. Most of the budget's other energy provisions entail similar risks.

It's not my intention to be naive, here. Other than their employees and stockholders, most people consider oil companies as at best a necessary evil. After another year in which many of these firms turned in more record profits--probably their last for a while--and with few other sectors looking as healthy, they make an inviting target for new taxes and fees. But whether the intention is merely to help stanch the red ink in the budget or to punish these companies for their success when everyone else was hurting, the outcome could be doubly counterproductive, reducing tax revenues by shrinking an activity we already tax pretty thoroughly. It's hard enough for companies to justify maintaining their drilling programs in a period of low energy prices, without making the fiscal terms under which they operate less attractive. How does that align with the administration's goals for energy independence, to which doubling the output of wind, solar and geothermal energy, from 1% to 2% of consumption, can only provide a partial answer?