Federal Oil and Gas Royalty and Revenue Reform – Center for American Progress
when the federal government last changed its royalty rate for oil and gas production on public lands in the united states, standard oil’s monopoly had recently been broken, the ford model had not yet come out of the assembly line, the teapot dome scandal was not yet over. burst and shake us uu. Department of the Interior and the Administration of President Warren G. harding, and the ’20s had just begun to roar. In the 95 years since the mineral leasing act first set the federal royalty rate for oil and gas at 12.5 percent, the federal government’s oil and gas revenue policies have remained firmly in place. fixed in the past, while state governments and private landowners have, time and time again, updated the terms for development on their land.
as a result of the failure of the federal government to modernize its oil and gas program, usa. uu. taxpayers are losing more than $730 million in revenue each year. at the same time, oil and gas companies are racking up leases and sitting idly by with the rights to drill on tens of millions of acres of public land. When companies have drilled for oil and gas, the American public has often had to pick up the tab to clean up the environmental damage left behind.
on april 17, the obama administration signaled that it would undertake much-needed reforms to bring the federal government’s oil and gas program into the 21st century. Through what’s known as Advance Notice of Proposed Rulemaking, or ANPR, the Bureau of Land Management, or BLM, is accepting ideas on how to reform its royalty rates, bond requirements, minimum bids and rental rates. These reforms will ensure that taxpayers are fairly compensated for developing their resources and that companies are responsible for paying for any cleanup related to their drilling activity.
this briefing brief provides a brief introduction to current oil and gas revenue policy, discusses the specific areas of that policy that the obama administration has committed to examining, and finally suggests some common sense reform ideas .
us federal oil and gas royalties are payments companies make to the federal government for oil and gas extracted on public lands and waters. with a royalty, owners of the resource, in this case, the us. taxpayers—collect a portion of the profits based on the value or volume of oil and gas extracted. on federal lands owned by taxpayers, such as those managed by the us. forest service and blm, oil and gas companies pay royalties to the u.s. treasury, making royalties one of the largest sources of non-tax revenue for the federal government. With the exception of Alaska, the revenue is split with about half going to the Treasury and half going to the state where the federal lease is located. While all taxpayers have a financial interest in ensuring that royalties on federal lands provide a fair return, oil and gas producing states, primarily those concentrated in the West, have a particularly high stake, as this money it goes to finance schools, highways and others. priorities.
Currently, the federal government charges a royalty of only 12.5% on oil and gas extracted from public lands. this rate has not been updated since 1920; Since then, technological advances and changing markets have made oil and gas extraction more efficient and much more lucrative. in 2014, the big five oil companies (bp, chevron, conocophillips, exxon mobil, and shell) made $90 billion in profits.
In response to changing market dynamics and to better reflect modern drilling practices, state and private landowners have updated their royalty rates. Texas charges a 25 percent royalty on leases for state college and school land (state land set aside to financially support these state institutions), while New Mexico and North Dakota charge 18.75 percent on production of oil and gas on public lands. Many Western states, including Wyoming, Utah, Montana, and Colorado, charge a 16.67 percent royalty rate on state-owned leases. a review of the cap found that private owners are also charging higher royalty rates than the federal government. For example, lease documents in Texas and Louisiana show that private landowners charge oil and gas companies a 25 percent royalty on resources extracted from their land.
In addition, the royalty rate on federal lands is 50% lower than the royalty rate for drilling in federal waters on the outer continental shelf. The administration of former President George W. Bush increased the royalty rate for offshore drilling twice to its current level of 18.75 percent. according to the center of western priorities, if the federal royalty rate on land were the same as the rate on the high seas, the u.s. the government would collect an additional $730 million each year. A review by the government accountability office, or gao, also found that, compared to other countries, the royalty rate for drilling in the u.s. federal land is one of the lowest in the world.
In its anpr announcement that it will publish a new rule to modernize the blm’s oil and gas revenue policies, the obama administration has requested information on a range of possible royalty structures, including a fixed royalty rate and a Flexible royalty rate that could be adjusted in response to changing market conditions. Based on a review of royalty provisions on state and private land, CAP recommends that the new regulations establish a floor of 18.75 percent for the royalty rate, while allowing the secretary of the interior the discretion to increase the rate in response to market conditions, no more. In a recent rulemaking report—“A Fair Share: The Case for Updating Federal Royalties”—the Western think tank suggested a sliding-scale royalty in which the interior secretary can raise fees based on oil prices and natural gas or known resource location where the rate could increase in an area of known production versus an area that is more speculative.
The concept of setting a new floor for the royalty rate and allowing discretion to increase the rate above that floor is similar to policies governing strip coal mining on public lands. This rule change would also represent a common sense expansion of the Secretary of the Interior’s authority to implement a sliding-scale royalty on particular oil and gas leases in limited circumstances. however, it is vital that the administration sets a floor above 12.5 percent for the royalty rate; Without a floor, future royalty policy will be highly susceptible to political pressure to provide royalty breaks at the expense of the American taxpayer.
For its part, the oil and gas industry has long argued that higher royalty rates will result in a significant decline in production; however, the evidence does not support their claims. The Permian Basin in West Texas, for example, has been the site of the largest regional increase in oil and gas production in the past eight years, with daily oil production more than doubling over that time from 850,000 barrels per day. to almost 2 million barrels per day. day. Much of the development and production in the Permian Basin is occurring on university land in the University of Texas system, on which oil and gas companies pay a 25 percent royalty.
From a resource perspective, the Permian Basin is not an outlier. according to the usa geological survey and potential gas committee—composed of experts from the oil and gas industry—advances in drilling and exploration technology give the Rocky Mountains and other areas in the West similar hydrocarbon potential to that of the Permian Basin ; that is, they have strong potential for significant and economically viable oil and gas deposits. given that much of these future plays for oil and gas extraction are on us. public lands, it is even more urgent that the obama administration raise royalty rates before taxpayers lose their share of the profits.
When an oil and gas company successfully bids for a lease, it must post a bond, or insurance, to guarantee that it will meet the terms of the lease, including hidden disaster cleanup costs during production and after the well stops. producer. bonding requirements on federal lands have not been updated in more than 50 years. Today, under rules established in 1951, a company can obtain a nationwide bond for all its oil and gas wells on public land for just $150,000. Adjusting for inflation, that $150,000 fee would be almost $1.4 million in 2015 dollars. Following this same inflation calculation, the state bond would increase from $25,000 to $270,500, and an individual lease bond, established in 1960, would increase from $10,000. at $80,000.
Because companies can pay so little for state and national bonds, bonds for individual wells can cost as little as $50 per well. In Wyoming in 2008, the cost to clean up a single oil or gas well was as high as $582,829. The State of Wyoming estimates the average cost of cleaning and reclamation for a single well to be between $2,500 and $7,500; This estimate does not include recovery costs for other parts of oil and gas operations, such as road stripping, compressor station sites, and containment ponds. some estimates are much higher. According to the director of the Department of Agriculture and Applied Economics at the University of Wyoming, recovering a single oil or gas well costs about $30,000.
cap recommends that the obama administration update current rules to establish bonding requirements based on the number of wells that should be recovered. The Texas Railroad Commission, for example, requires a company to pay $25,000 for 10 or fewer wells; $50,000 for between 10 and 100 wells; and $250,000 for 100 or more wells. Based on recovery cost estimates, even these requirements appear to be too low to cover potential cleanup costs. the bond required per well should reflect the average recovery cost for each site to protect taxpayers from the cost of cleanup. some experts have called for a $20,000 bond per well and further bond requirements for additional facilities associated with drilling operations.
minimum acceptable bonus offers
A bonus offer is a payment offered by an oil and gas company to purchase a lease on public land. If accepted by the federal government, the bonus offer gives the company the right to drill on the leased land for a period of 10 years. Currently, the BLM requires a company’s bonus offer to be at least $2 per acre (known as the minimum offer) to obtain the right to drill on a lease.
Under the current federal leasing process, parcels of land offered for lease by the BLM are typically nominated or suggested to the BLM by oil and gas companies. By nominating a parcel, companies express a financial interest in the land and, in theory, should be willing to pay a fair price for leases. however, in the first quarter of 2015, 25 percent of federal leases sold in seven western states were sold at $2 per acre, the minimum bid. In addition, non-competitive issued leases, where no bid was offered for at least two years, account for 40 percent of BLM leases currently in effect. This large share of leases for the $2 per acre minimum bid should be of concern to policymakers and taxpayers alike.
In many cases, rebate bids on federal public lands are significantly higher than the minimum bid, suggesting the floor can and should be raised. For example, the highest bid at the most recent federal parcel lease sale in Colorado, held in May 2015, was $10,100 per acre. For federal parcels in Montana, the highest rebate offer was also at a May 2015 lease sale and was $825 per acre. In Utah, it was $500 an acre. Similarly, average bonus offers per acre were also much higher than the minimum offer at the most recent lease sales in Wyoming, where the average bonus offer was $21 per acre, and in Utah, with an average offer of $21 per acre. $19 per acre. bonus offers on state land also appear to be well above the federal government’s minimum offer. The highest bid at the most recent lease sale in Texas for college land was $6,503 per acre.
According to some experts, the minimum acceptable offer should be increased to account for the so-called option value of the resource. Option value, or the ability to delay a decision until more information is available, is a concept that has long been incorporated into natural resource law to account for the uncertainty surrounding markets, technology and environmental and social costs. When the federal government sells a lease, it sells the taxpayer’s future option to develop those resources, even if the lease would be more lucrative at a future date. When the federal government leases a parcel for oil and gas drilling, for example, it also sells the future option to the public to use that land in some other way and for some other purpose. therefore, the minimum bid must be raised to ensure that taxpayers are fairly compensated for losing the ability to exploit these resources in the future when conditions are more favorable or to avoid the loss of a more valuable use of the land. Similarly, it can be argued that the government should not issue non-competitive leases. if the market is not generating a fair price for these lands, the government should maximize the value of the option and manage taxpayer resources for a more favorable use or timing.
To preserve their rights to drill under a lease, the lessee must pay an annual rental fee to the federal government. current rental rates are set at $1.50 per acre for the first five years of a lease and $2 per acre thereafter. In its announcement of upcoming oil and gas regulations, the Obama administration requested information on how to create “a greater financial incentive for oil and gas companies to develop their leases promptly or give them up.” in fact, oil and gas companies routinely sit idle on non-producing leases, putting these areas off limits to the American public, which owns them. At the end of fiscal year 2014, more than 34.5 million acres of federal land was under oil and gas lease, but only about 12.7 million of those acres (less than 37 percent) were producing oil or gas.
the texas general land office, which manages state-owned land for the benefit of public education, has created an incentive to use or give up leases on state school land through the use of a rental rate graduated. In the first two years of a lease, the rental rate is $5 per acre. In the third year of the lease, that rate increases to $2,500 per acre to incentivize drilling or return the lease to Texans. Federal public land leases have 10-year terms, but the federal government could take a similar approach to Texas. cap recommends that the federal government increase rental rates in the fourth or fifth year of a lease to discourage tenants from sitting idle on their rights to drill on public lands.
in texas, oil and gas leases on university land require companies to pay rental fees in advance for all three years of the lease term, as do many private landlords. this discourages oil and gas companies from buying leases in order to hold them and then reselling them when the market improves, undermining the American taxpayer. however, the deterrent effect of a “paid” lease would require rental rates to be high enough to more accurately represent the value of the land. An oil and gas company in New Mexico has argued that rental rates should be at least $100 per acre, noting that this price will not deter companies from submitting lease offers. this company also argues that paying full rent upfront eliminates the confusing and time-consuming process of paying rental fees each year.
Based on current royalty rates, bond requirements, minimum bids, and rental rates on public land, some of which has not been updated in nearly a century, American taxpayers and land-producing states energy are not receiving a fair return from development. of its valuable resources. From a business perspective, the federal government is falling behind the states and private landowners in defending the financial interests of its shareholders: the American taxpayer. the upcoming rulemaking addressing the federal oil and gas leasing process is a critical opportunity for the obama administration to reassess how public lands are leased and ensure that the public receives a fair and equitable share of these shared resources.
nicole gentile is the director of campaigns for the public lands project at the center for american progress.
The author would like to thank Matt Lee-Ashley, Carl Chancellor, Anne Paisley, Emily Haynes, and Alexis Evangelos for their contributions.