This week the administration issued its third budget since taking office in January 2009. In a year otherwise focused on belt-tightening, the proposal includes a 12% increase for the Department of Energy, focused on additional R&D for renewables and nuclear power. The increase would be offset by cuts in fossil energy programs and the elimination elsewhere in the budget of various tax deductions and tax credits--"tax expenditures" in Beltway parlance--that benefit the US oil and gas industry. Also new for this year are proposed additional fees on the industry to cover the increased cost of issuing drilling permits in the aftermath of the Deepwater Horizon accident, along with another provision to raise the cost of holding inactive oil and gas leases. Aside from the politics involved, this exercise reminds me of the periodic waves of cost-cutting I experienced at Texaco, Inc. in the 1980s and '90s. Unfortunately, the government hasn't yet learned the vital lesson that my former company and many in other industries finally figured out after years of experience: Reducing expenses only helps your bottom line when the items you are cutting contribute less in revenue than they cost.
Start with the oil and gas subsidies, which I've discussed previously. The newly submitted budget estimates these at approximately $4 billion per year. As we heard the President say in his latest State of the Union address, "I'm asking Congress to eliminate the billions in taxpayer dollars we currently give to the oil companies. (Applause.) I don't know if--I don't know if you've noticed, but they're doing just fine on their own. (Laughter.) So instead of subsidizing yesterday's energy, let's invest in tomorrow's." It's a guaranteed applause line, as the White House's own text indicates, despite including potentially serious errors of fact.
Now, one could argue in the abstract whether a tax credit or deduction constitutes a gift of "taxpayer money" (i.e., the government's) or an opportunity for the taxpayer in question to remit less of his own money to the government. I know how I feel about that when it comes to filing my form 1040. One might even arrive at different answers in different situations. As a practical matter, however, what counts in the current context is not whose money this is in the first place, but whether taking more of it leaves either the federal government or the US economy better off. Even from the perspective of tax revenue, a recent study found that after an initial increase, the long-term impact of higher taxes on the oil & gas industry resulted in reduced government revenue. Higher taxes on US oil & gas production will translate into less of both--and so less to tax--while also yielding more future imports and higher trade deficits, along with reduced energy security.
The President's remarks also suggested incorrectly that oil and gas are yesterday's energy, and not also today's and tomorrow's. In 2009 oil and gas accounted for 62% of our energy consumption, and the US Department of Energy expects them to continue to supply as much as 57% of our needs in 2035, after subtracting the contribution of liquid biofuels. Treating these key energy sources as undesirable could have serious consequences for our energy and economic security in the years ahead. Nor would it assist our efforts to reduce greenhouse gas emissions. Natural gas can contribute significantly to reducing the emissions from the power sector, which accounts for 40% of US CO2 emissions, and the main opportunities for reducing emissions from transportation, where most of our oil use takes place, are on the user side--conservation and more efficient cars, trucks and planes--and not on the extraction, refining and distribution side of the industry.
If the administration couldn't get these tax changes enacted in the previous Congress, they stand even less chance this term. However, that might not be the case for the additional "user fees" and lease fees, since they are new this year. The former are related to the redesign of the oversight agency for offshore drilling and were recommended by the Presidential commission investigating the accident. As I noted when their report came out, we already have a mechanism for recouping the expenses that the Bureau of Ocean Energy, Management, Regulation and Enforcement (formerly the Minerals Management Service) incurs in the course of reviewing leases and drilling permits and monitoring offshore activity. That mechanism is the lease bids and royalties that brought in $8 billion from onshore and offshore oil and gas in fiscal 2010. In a good year these sums could cover the entire Interior Dept. budget, let alone that of BOEMRE. Adding new fees on top of the existing royalties further reduces the attractiveness of drilling in US waters, on top of the "moratorium/permitorium" --now in its tenth month--for which critics finally received a belated explanation earlier this month. The net result of new fees would be less drilling here and more drilling in places like offshore Brazil.
Then there's the notion of "establishing fees for new non-producing oil and gas leases (both onshore and offshore) to encourage more timely production." This is clearly an outgrowth of the "idle leases" canard that was making the rounds in 2008. However, in light of protracted delays in issuing new permits and the likelihood that fewer permits will be issued in the future than in the past, it seems almost Kafkaesque to penalize companies for not drilling sooner on more of their leases. In truth, companies already pay twice for non-producing leases: once when they pay a bid bonus to acquire the lease, and then every year in the form of a lease rent that is due as long as the lease remains undeveloped. Companies factor this into the bonuses they bid, along with their assessment of the likelihood that a lease contains commercial quantities of oil or gas. Additional fees on non-producing leases seem likely to result in one or more of the following outcomes: lower bonus bids, fewer bids, and an increased focus outside the US. None of that would help either the deficit or energy security.
I'm entirely supportive of the government cutting expenses, including unwarranted subsidies, in order to begin the difficult task of bringing the federal budget closer to balance within the next few years. This seems essential if we're to avoid serious consequences for our credit rating, interest rates, and exchange rate. However, along the lines of what I saw when the oil industry reduced expenses in the aftermath of the big oil price drops of the mid-1980s and 1998-9, it would be counterproductive to do so in a manner that would actually result in lower overall tax receipts, while reducing domestic energy production in the bargain. Ultimately, it makes a lot more sense to target repealing the tax expenditures in question as part of the broader tax reform that seems inevitable if we want to get the deficit under control. That would eliminate specific tax breaks but simultaneously reduce overall corporate tax rates to make US industry more competitive globally, not less. A budget that proposes to double corporate income tax receipts by 2013--to a level higher than their 2007 asset bubble peak--is out of step with the competitiveness agenda that the administration has espoused, aside from its shortcomings in narrowing the long-term deficit.
Showing posts with label oil leases. Show all posts
Showing posts with label oil leases. Show all posts
Wednesday, February 16, 2011
Friday, May 14, 2010
Not-So-Grand Compromise
This week Senators John Kerry (D-MA) and Joe Lieberman (I-CT) finally released the draft energy and climate bill they had been working on with Senator Lindsey Graham (R-SC.) From all accounts, it was intended to serve as a response to the various criticisms of the climate bill the House of Representatives passed last summer, but in particular as a means for attracting support from Senators whose primary concerns about energy are focused on US energy security and competitiveness. Unfortunately, events have a way of disrupting even the sagest strategies. A cursory review of the new bill--all I've had time for thus far--reveals the degree to which it has been altered in response to the ongoing Gulf Coast oil spill. In the process, unless I've misread its revised provisions on offshore drilling, the expected "grand compromise" has turned into a poisoned chalice, at least for oil.
Like its climate-legislation predecessors and most major bills from the last several Congresses, Kerry-Lieberman (originally Kerry-Graham-Lieberman) starts out at 987 pages and is likely to grow much larger, as it accumulates support one vote--and thus typically one new provision or modification--at a time. I simply haven't had a chance to read the whole thing in detail, yet. Once I've done so, I'll comment on its other key provisions, including the cap & trade mechanism at its heart, which seems to have been influenced by the "cap & dividend" proposal of Senators Cantwell (D-WA) and Collins (R-ME). With so much attention currently directed at offshore drilling, that's where I focused my brief review.
While the bill was being prepared, there was much speculation about the incentives it would include for expanded offshore drilling, which, along with expanded support for new nuclear power, was regarded as one of the principal carrots to be offered to those in Congress who wouldn't otherwise be inclined to support a standalone cap & trade bill. Whatever form those incentives were expected to take, the bill's skimpy offshore drilling "subtitle" looks disappointing, if not downright negative.
On the positive side, it would extend the same royalty-sharing benefits to states pursuing new drilling that the four main Gulf Coast producer states of Texas, Louisiana, Mississippi, and Alabama currently receive from oil & gas exploration and production in the federal waters off their coastlines: 37.5% of lease premiums collected and the same percentage of production royalties. This is something that states such as mine, with an official state policy supporting drilling, have been calling for. But while it will be favorably received in Virginia, other states, particularly in the West and Midwest, regard this as an unreasonable diversion of federal revenue. Even if the Deepwater Horizon hadn't blown up, this provision would have been a tough sell.
The rest of the offshore oil subtitle appears to have been hastily modified in response to the spill. Among other things, it offers states a veto over new drilling within 75 miles of their shores. A glance at the map for the planned Lease Sale 220 offshore Virginia shows that at least a portion of it falls within 75 miles of the Delaware and Maryland coasts. Nor do I think this is an unreasonable provision; as we've seen in the Gulf, a spill off Louisiana clearly affects the shorelines and marine activities of neighboring states. By itself, this provision, which I believe was altered from an original 50 mile exclusion, would not rule out a resumption of new offshore leasing and drilling, once the causes of the current spill have been identified and new measures and regulations put into effect to reduce the risk of another occurrence to an acceptable level--however the Congress and administration might specify "acceptable".
The problem lies in Section 1205, which defines the impact studies that must be done prior to opening up an area for drilling. As drafted, paragraph (h)(2) effectively extends the 75 mile limit on the veto rights of non-drilling states, if the government's assessment "indicates that a State would be significantly impacted by an oil spill resulting from drilling activities within an area identified in a 5-year (leasing) plan". Under this paragraph, Florida or Alabama could potentially veto any new drilling off Texas or Louisiana. I'm not a lawyer, but that's what the text appears to say.
Without dismissing the legitimate concerns of neighboring states, this raises all sorts of practical problems. An exchange I had earlier this week with a Maryland-based blogger highlights one of them. He was blogging in support of Senator Ben Cardin's (D-MD) stance against any offshore drilling on the Atlantic coast. However, as I noted in my comment on his posting, Maryland consumed 272,000 barrels per day of oil in 2008, not one barrel of which was either produced or refined in that state. Just how far should offshore drilling be removed in order to satisfy the concerns of a state that is entirely reliant on energy produced by other states and foreign sources, which must bear whatever risks it entails? Is Louisiana far enough away? Is Saudi Arabia?
As compromises go, this one doesn't look very tempting. Unless I've misread the bill's offshore drilling provisions, it appears that their effective result would be to end all offshore drilling, not just in areas that were recently released from long-standing drilling moratoria, but in the long-established zones of the Gulf Coast that are becoming America's energy breadbasket. That would surely qualify as the kind of overreaction to the Gulf Coast spill of which the International Energy Agency has just warned, emphasizing the unintended consequences that we would risk. Perhaps those looking for something in exchange for supporting limits on greenhouse gas emissions will regard the bill's significant support for nuclear power as sufficient, though I'm skeptical. They could probably get the same thing in an energy-only bill, perhaps in exchange for a national renewable electricity standard. As for the crucial source of domestic transportation energy we would forgo if we turned our back on offshore drilling, there is currently no substitute available soon enough, or in sufficient quantities, to make up for its loss.
Like its climate-legislation predecessors and most major bills from the last several Congresses, Kerry-Lieberman (originally Kerry-Graham-Lieberman) starts out at 987 pages and is likely to grow much larger, as it accumulates support one vote--and thus typically one new provision or modification--at a time. I simply haven't had a chance to read the whole thing in detail, yet. Once I've done so, I'll comment on its other key provisions, including the cap & trade mechanism at its heart, which seems to have been influenced by the "cap & dividend" proposal of Senators Cantwell (D-WA) and Collins (R-ME). With so much attention currently directed at offshore drilling, that's where I focused my brief review.
While the bill was being prepared, there was much speculation about the incentives it would include for expanded offshore drilling, which, along with expanded support for new nuclear power, was regarded as one of the principal carrots to be offered to those in Congress who wouldn't otherwise be inclined to support a standalone cap & trade bill. Whatever form those incentives were expected to take, the bill's skimpy offshore drilling "subtitle" looks disappointing, if not downright negative.
On the positive side, it would extend the same royalty-sharing benefits to states pursuing new drilling that the four main Gulf Coast producer states of Texas, Louisiana, Mississippi, and Alabama currently receive from oil & gas exploration and production in the federal waters off their coastlines: 37.5% of lease premiums collected and the same percentage of production royalties. This is something that states such as mine, with an official state policy supporting drilling, have been calling for. But while it will be favorably received in Virginia, other states, particularly in the West and Midwest, regard this as an unreasonable diversion of federal revenue. Even if the Deepwater Horizon hadn't blown up, this provision would have been a tough sell.
The rest of the offshore oil subtitle appears to have been hastily modified in response to the spill. Among other things, it offers states a veto over new drilling within 75 miles of their shores. A glance at the map for the planned Lease Sale 220 offshore Virginia shows that at least a portion of it falls within 75 miles of the Delaware and Maryland coasts. Nor do I think this is an unreasonable provision; as we've seen in the Gulf, a spill off Louisiana clearly affects the shorelines and marine activities of neighboring states. By itself, this provision, which I believe was altered from an original 50 mile exclusion, would not rule out a resumption of new offshore leasing and drilling, once the causes of the current spill have been identified and new measures and regulations put into effect to reduce the risk of another occurrence to an acceptable level--however the Congress and administration might specify "acceptable".
The problem lies in Section 1205, which defines the impact studies that must be done prior to opening up an area for drilling. As drafted, paragraph (h)(2) effectively extends the 75 mile limit on the veto rights of non-drilling states, if the government's assessment "indicates that a State would be significantly impacted by an oil spill resulting from drilling activities within an area identified in a 5-year (leasing) plan". Under this paragraph, Florida or Alabama could potentially veto any new drilling off Texas or Louisiana. I'm not a lawyer, but that's what the text appears to say.
Without dismissing the legitimate concerns of neighboring states, this raises all sorts of practical problems. An exchange I had earlier this week with a Maryland-based blogger highlights one of them. He was blogging in support of Senator Ben Cardin's (D-MD) stance against any offshore drilling on the Atlantic coast. However, as I noted in my comment on his posting, Maryland consumed 272,000 barrels per day of oil in 2008, not one barrel of which was either produced or refined in that state. Just how far should offshore drilling be removed in order to satisfy the concerns of a state that is entirely reliant on energy produced by other states and foreign sources, which must bear whatever risks it entails? Is Louisiana far enough away? Is Saudi Arabia?
As compromises go, this one doesn't look very tempting. Unless I've misread the bill's offshore drilling provisions, it appears that their effective result would be to end all offshore drilling, not just in areas that were recently released from long-standing drilling moratoria, but in the long-established zones of the Gulf Coast that are becoming America's energy breadbasket. That would surely qualify as the kind of overreaction to the Gulf Coast spill of which the International Energy Agency has just warned, emphasizing the unintended consequences that we would risk. Perhaps those looking for something in exchange for supporting limits on greenhouse gas emissions will regard the bill's significant support for nuclear power as sufficient, though I'm skeptical. They could probably get the same thing in an energy-only bill, perhaps in exchange for a national renewable electricity standard. As for the crucial source of domestic transportation energy we would forgo if we turned our back on offshore drilling, there is currently no substitute available soon enough, or in sufficient quantities, to make up for its loss.
Thursday, April 15, 2010
Drilling and Climate Change
For the last week or so I've been scratching my head over news that the Bureau of Land Management, an agency of the Department of Interior, had delayed an oil & gas lease sale in Montana and the Dakotas by at least five months, while it studies how oil field activities contribute to climate change. BLM's press release on the subject mentioned a lawsuit related to a previous lease sale in the area, and I finally got around to tracking down what's behind all this. On one level it might be viewed as an effort by concerned citizens to ensure that BLM complies with the law regarding the environmental impacts associated with its activities, and that oil & gas development takes place in the most efficient and environmentally-responsible manner possible. Yet after reading through the filing in protest of the planned April 13 lease sale from the environmental groups behind the earlier lawsuit, I see a much more worrisome strategy aimed at impeding not just one sale, but the broader development of oil and gas resources that are essential to the energy and economic security of the US.
Let's start by stipulating that when you drill for oil, the various processes involved in producing, transporting, and refining it for use as fuels for vehicles and feedstocks for industry emit greenhouse gases (GHGs). Thus the basic concern behind the objections of the Montana Environmental Information Center, Earthworks Oil & Gas Accountability Project, and WildEarth Guardians is simultaneously validated and rendered as a blinding glimpse of the obvious. It's also true--though you'd never know it from their filing--that the emissions from oil & gas exploration and production represent just a fraction of the lifecycle emissions associated with their use. How large a fraction depends on the specifics of composition, geology and location, but in general roughly 80% of the emissions occur during consumption, with refineries accounting for more of the "upstream" emissions than exploration, production and transportation do. According to Shell's 2008 GHG reporting, that company's emissions from exploration and production averaged 0.11 metric tons of CO2-equivalent (CO2e) per metric ton of production. Using basic conversion factors, that works out to around 0.8 lb of CO2e emitted per gallon, compared with roughly 20.4 lb of CO2e from burning a gallon of gasoline in your car.
In other words, except for emissions-intensive extraction processes like oil sands, the fraction of greenhouse gas emissions attributable to getting oil out of the ground and to a refinery amount to no more than 3-5% of the total lifecycle emissions from petroleum. As a reality check on this I looked up the emissions for Production Field Systems within Petroleum Systems in the most recent EPA Greenhouse Gas Inventory. At 29 million tons per year of CO2e, including the methane emissions that the environmental groups objecting to the April 13th lease sale were so concerned about, this constitutes just 0.5% of total US energy-related emissions. Even if you cut them by half, the impact on global climate change would be negligible, and that's why the effort to derail the Montana and Dakotas lease sales makes me suspect it is aimed at more than just promoting lower-emitting drilling practices. When you include the groups' references to "climate tipping points" and the speculative impact of localized "CO2 domes", what these folks really seem to have in mind is shutting down large portions of US oil & gas production entirely.
The leasing delays these groups have already achieved and the prospect of further delays beyond September, whether in additional BLM reviews or in the courts, are of particular concern, because the leases in question fall mainly within the Williston Basin of Montana, North Dakota and South Dakota. Many of them appear to overlap the Bakken Formation, which the US Geological Survey estimates to contain undiscovered, technically-recoverable oil resources of up to 4 billion barrels. So they're not just holding back a few marginal wells in the middle of nowhere; they're impeding development of a region that, with help from improved technology, is becoming one of the most important domestic oil sources in the onshore lower-48 states--even without all the hype about the Bakken that has been circulating in the blogosphere and the email rumor mill.
BLM must follow the law in terms of evaluating the environmental impact of drilling activities on its oil & gas leases, but that surely does not extend to withholding leases from future sales on the basis that drilling them in any manner will make climate change worse. Whatever the motives of the groups attempting to block the legitimate exploitation of the oil resources of the Dakotas and Montana, they are tackling the climate problem from the wrong end. Impeding US production does little or nothing to reduce end-user consumption, where most of the GHG emissions in the oil and gas value chain occur. So while not reducing emissions in any globally- or even locally-meaningful way, they are making our trade deficit bigger. If successful, they might even inadvertently increase global GHG emissions, depending on where and how the additional oil we must import is produced. I hope that BLM can dispense with these misplaced efforts at obstructionism and reschedule the April 13th lease sale promptly.
Let's start by stipulating that when you drill for oil, the various processes involved in producing, transporting, and refining it for use as fuels for vehicles and feedstocks for industry emit greenhouse gases (GHGs). Thus the basic concern behind the objections of the Montana Environmental Information Center, Earthworks Oil & Gas Accountability Project, and WildEarth Guardians is simultaneously validated and rendered as a blinding glimpse of the obvious. It's also true--though you'd never know it from their filing--that the emissions from oil & gas exploration and production represent just a fraction of the lifecycle emissions associated with their use. How large a fraction depends on the specifics of composition, geology and location, but in general roughly 80% of the emissions occur during consumption, with refineries accounting for more of the "upstream" emissions than exploration, production and transportation do. According to Shell's 2008 GHG reporting, that company's emissions from exploration and production averaged 0.11 metric tons of CO2-equivalent (CO2e) per metric ton of production. Using basic conversion factors, that works out to around 0.8 lb of CO2e emitted per gallon, compared with roughly 20.4 lb of CO2e from burning a gallon of gasoline in your car.
In other words, except for emissions-intensive extraction processes like oil sands, the fraction of greenhouse gas emissions attributable to getting oil out of the ground and to a refinery amount to no more than 3-5% of the total lifecycle emissions from petroleum. As a reality check on this I looked up the emissions for Production Field Systems within Petroleum Systems in the most recent EPA Greenhouse Gas Inventory. At 29 million tons per year of CO2e, including the methane emissions that the environmental groups objecting to the April 13th lease sale were so concerned about, this constitutes just 0.5% of total US energy-related emissions. Even if you cut them by half, the impact on global climate change would be negligible, and that's why the effort to derail the Montana and Dakotas lease sales makes me suspect it is aimed at more than just promoting lower-emitting drilling practices. When you include the groups' references to "climate tipping points" and the speculative impact of localized "CO2 domes", what these folks really seem to have in mind is shutting down large portions of US oil & gas production entirely.
The leasing delays these groups have already achieved and the prospect of further delays beyond September, whether in additional BLM reviews or in the courts, are of particular concern, because the leases in question fall mainly within the Williston Basin of Montana, North Dakota and South Dakota. Many of them appear to overlap the Bakken Formation, which the US Geological Survey estimates to contain undiscovered, technically-recoverable oil resources of up to 4 billion barrels. So they're not just holding back a few marginal wells in the middle of nowhere; they're impeding development of a region that, with help from improved technology, is becoming one of the most important domestic oil sources in the onshore lower-48 states--even without all the hype about the Bakken that has been circulating in the blogosphere and the email rumor mill.
BLM must follow the law in terms of evaluating the environmental impact of drilling activities on its oil & gas leases, but that surely does not extend to withholding leases from future sales on the basis that drilling them in any manner will make climate change worse. Whatever the motives of the groups attempting to block the legitimate exploitation of the oil resources of the Dakotas and Montana, they are tackling the climate problem from the wrong end. Impeding US production does little or nothing to reduce end-user consumption, where most of the GHG emissions in the oil and gas value chain occur. So while not reducing emissions in any globally- or even locally-meaningful way, they are making our trade deficit bigger. If successful, they might even inadvertently increase global GHG emissions, depending on where and how the additional oil we must import is produced. I hope that BLM can dispense with these misplaced efforts at obstructionism and reschedule the April 13th lease sale promptly.
Thursday, March 05, 2009
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?
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?
Friday, January 16, 2009
Paying Not To Drill
I'm spoiled for choice concerning topics on which to blog , including the first glimpses of the energy provisions of the proposed American Recovery and Reinvestment Act of 2009--better known as the stimulus package--and a rift within the US business community over the best way to set a price on greenhouse gas emissions, between a carbon tax and cap and trade. I'm sure I'll come back to those topics soon, but I must admit the story that most intrigued me this week concerned an event last month, when a young environmentalist disrupted the quarterly oil & gas lease auction of the Utah office of the Bureau of Land Management by successfully bidding on a clutch of leases, the terms of which he at least initially seemed unlikely to be able to fulfill. In the process, he has become a momentary Internet celebrity, with his own website and organization, apparently raising $45,000 with which to make the first payment on the leases and thereby potentially avoid prosecution.
At the outset, let's dispense with all the hyperbole about brave acts of civil disobedience in the cause of saving the planet. Let's also be clear that nothing I say here in any way justifies walking into a duly-authorized auction of a department of the federal government and bidding for mineral leases without the ready means of paying for them. I am not qualified to assess whether Mr. DeChristopher broke the law, but I can certainly relate to the reaction of other bidders when the situation became clear. Nor am I inclined to accept the excuse that the ends justify the means in this case. Having said that, it's hard not to admire the chutzpah that this took, at least a little bit.
According to the article in Monday's Washington Post, Mr. DeChristopher, a.k.a. "Bidder 70" outbid the assembled oil and gas companies on 13 leases totaling 22,000 acres in "the scenic southeast corner of Utah." He bid a total of $1.8 million for these leases, roughly 25% of the total of $7.2 million of winning bonus bids received for the 148,598 acres sold. If he intends to keep these leases, then in addition to coming up with the remainder of the bonuses he bid, he would also need to pay the contractual rental on them, amounting to $33,000 per year for the first five years and $44,000 per year for the balance of the 10-year lease term--not "decades" as the Post's reporter erroneously suggested. $45,000 is a good start, but he and his supporters would have to pony up another $2.1 million over the next decade to keep from defaulting, unless their strategy is merely to tie them up until the new administration halted leasing in the area, as noted in Mr. DeChristopher's letter of January 9 to his supporters.
If we ignore for the moment the part about not having the $1.8 million in hand or in prospect when bidding, this event might actually offer a model by which concerned citizens or groups could preserve onshore or offshore acreage that they prefer not to see drilled, either out of concern for the viewscape or for the environmental consequences of the production and consumption of oil and gas--notwithstanding the implication that it would be produced elsewhere, possibly under less scrupulous conditions. If properly financed, such efforts would be a lot more constructive than tying up the leasing and permitting process in the courts, particularly from the perspective of taxpayers such as myself, who do not share their viewpoint. The outcome might still increase US oil imports, but at least without depriving the government of its income on the leases, although it would forgo the substantial increase in revenue that accrues if oil or gas are found and produced, when modest rental fees are superseded by the 12.5 % royalty rates applicable to such contracts. Oil and gas rents and royalties earned the federal government nearly $13 billion in 2008.
I will be very interested to see how this case turns out, and whether Mr. DeChristopher's idea catches on--with the proviso that there is a crucial difference between backing up one's beliefs with real money and merely gumming up the works at the expense of the rest of us.
At the outset, let's dispense with all the hyperbole about brave acts of civil disobedience in the cause of saving the planet. Let's also be clear that nothing I say here in any way justifies walking into a duly-authorized auction of a department of the federal government and bidding for mineral leases without the ready means of paying for them. I am not qualified to assess whether Mr. DeChristopher broke the law, but I can certainly relate to the reaction of other bidders when the situation became clear. Nor am I inclined to accept the excuse that the ends justify the means in this case. Having said that, it's hard not to admire the chutzpah that this took, at least a little bit.
According to the article in Monday's Washington Post, Mr. DeChristopher, a.k.a. "Bidder 70" outbid the assembled oil and gas companies on 13 leases totaling 22,000 acres in "the scenic southeast corner of Utah." He bid a total of $1.8 million for these leases, roughly 25% of the total of $7.2 million of winning bonus bids received for the 148,598 acres sold. If he intends to keep these leases, then in addition to coming up with the remainder of the bonuses he bid, he would also need to pay the contractual rental on them, amounting to $33,000 per year for the first five years and $44,000 per year for the balance of the 10-year lease term--not "decades" as the Post's reporter erroneously suggested. $45,000 is a good start, but he and his supporters would have to pony up another $2.1 million over the next decade to keep from defaulting, unless their strategy is merely to tie them up until the new administration halted leasing in the area, as noted in Mr. DeChristopher's letter of January 9 to his supporters.
If we ignore for the moment the part about not having the $1.8 million in hand or in prospect when bidding, this event might actually offer a model by which concerned citizens or groups could preserve onshore or offshore acreage that they prefer not to see drilled, either out of concern for the viewscape or for the environmental consequences of the production and consumption of oil and gas--notwithstanding the implication that it would be produced elsewhere, possibly under less scrupulous conditions. If properly financed, such efforts would be a lot more constructive than tying up the leasing and permitting process in the courts, particularly from the perspective of taxpayers such as myself, who do not share their viewpoint. The outcome might still increase US oil imports, but at least without depriving the government of its income on the leases, although it would forgo the substantial increase in revenue that accrues if oil or gas are found and produced, when modest rental fees are superseded by the 12.5 % royalty rates applicable to such contracts. Oil and gas rents and royalties earned the federal government nearly $13 billion in 2008.
I will be very interested to see how this case turns out, and whether Mr. DeChristopher's idea catches on--with the proviso that there is a crucial difference between backing up one's beliefs with real money and merely gumming up the works at the expense of the rest of us.
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