Mistake by Interior Department may cost taxpayers billions in lost royalty payments

June 8th, 2008 by Rod Adams

Bashing oil companies is a popular water cooler sport these days. At the risk of piling on, I just had to share my anger about some information that I learned on Thursday while listening to NPR’s Marketplace program.

The General Accountability Office released a report on June 5, 2008 that computed that the US Treasury may have to forgo oil royalty payments in excess of $53 Billion over the next 25 years because of an error made by the Interior Department. This forgone money is not uncollected taxes, it is the government’s (taxpayers’s) share of the revenue produced by selling oil that originated from reservoirs under publicly owned sea beds.

Here is what happened. Congress, recognizing that drilling in deep water is difficult and costly, passed a law in 1995 giving the Interior Department’s Minerals Management Service authority to provide “royalty relief” for off shore leases. For those who do not keep long term oil prices readily at hand, the price of a barrel of oil in 1995 was between $12 and $18. For the leases issued under this authority in 1996, 1997, and 2000, the MMS included a trigger price where royalty payments would begin if market prices reached certain levels.

For some reason that is not well explained, the MMS failed to include any trigger price limit for the leases issued in 1998 and 1999. The production from areas leased during those two years may be royalty free for the entire length of the lease, no matter how high oil prices get. (In 1998, oil prices dipped below $10 per barrel in the late fall.)

The GAO report provides a number of scenarios that show how the lost revenues to the government will vary depending on actual production and prices and there is quite a range in the estimates from a low of a few billion to a high (assuming oil prices of $100 per barrel) of about $53 Billion. Of course, we all know that $100 per barrel might be a low ball estimate for future prices since we have already seen prices in excess of $130 per barrel.

Of course the oil companies are fighting any ex post facto imposition of royalty payments for 1998 and 1999 probably with good justification. However, what really gets me fired up is that Kerr-McGee has challenged the Interior Department’s authority to impose the trigger price for any of the years in question. I also felt like yelling at the radio when I heard that an oil industry spokesman defended the royalty free production as important for encouraging companies to drill domestic wells for improved energy security.

According to ExxonMobil’s summary annual report for 2007 (available in the investor information section of the company’s web site) it has spent $118 Billion during the years 2003-2007 simply purchasing its own stock. Its capital investment program for new drilling, tankers, pipelines, etc. was less than $90 billion during the same period. The company leadership has a right and a responsibility for making prudent capital allocation decisions, but please do not try to tell me that even a majority of the money saved by not paying royalties is plowed back into providing more energy resources for consumers.

ExxonMobil is not alone in its use of capital for stock buybacks instead of new drilling programs – see, for example Chevron Announces Stock Buyback Program

Though I am generally not a huge fan of government investment programs, it seems to me that even the Department of Energy could figure out ways to invest several billion dollars in new energy supply technology instead of using it to buy financial instruments like company stock.

Oops – I just realized that I might be confusing some people by advocating that the government could do a better job when I started the article with a description of a “mistake” (or was it – see Interior Staff Had Inappropriate Relationships with Oil Industry) by government employees that led to the loss of revenue in the first place. I guess I a just a hopeless romantic that believes that there could be such a thing as “good government” if we return to the concept of “public servants” who really do focus on developing career expertise and a service mindset. For you young people – such a thing used to be possible!

Photo credit – Rigjobs.co.uk

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