NYT: Incentives on Oil Barely Help U.S., Study Suggests

Great article from the New York Times last week, fyi.

Original here. Or read on for pasted text.
New York Times
December 22, 2006
Incentives on Oil Barely Help U.S., Study Suggests
By EDMUND L. ANDREWS

WASHINGTON, Dec. 21 — The United States offers some of the most lucrative incentives in the world to companies that drill for oil in publicly owned coastal waters, but a newly released study suggests that the government is getting very little for its money.

The study, which the Interior Department refused to release for more than a year, estimates that current inducements could allow drilling companies in the Gulf of Mexico to escape tens of billions of dollars in royalties that they would otherwise pay the government for oil and gas produced in areas that belong to American taxpayers.

But the study predicts that the inducements would cause only a tiny increase in production even if they were offered without some of the limitations now in place.

It also suggests that the cost of that additional oil could be as much as $80 a barrel, far more than the government would have to pay if it simply bought the oil on its own.

“They are giving up a lot of money and not getting much in return,” said Robert A. Speir, a former analyst at the Energy Department who worked on the report. “If they took that money, they could buy a whole lot more oil with it on the open market.”

Oil closed Thursday at $62.66 a barrel in regular trading.

The Interior Department study, commissioned to analyze the costs of royalty incentives and their effectiveness at increasing energy supplies, was completed in fall 2005. But the study was not released until last month because senior officials said they considered it incomplete.

After repeated requests, the department provided a copy to The New York Times with a “note to readers” that said the report did not show the “actual effects” of incentives. Indeed, Interior officials contended that the cost of the incentives would turn out to be far less than the study concluded.

They also said that the nation benefits from even small amounts of additional domestic fossil fuels.

But industry analysts who compare oil policies around the world said the United States was much more generous to oil companies than most other countries, demanding a smaller share of revenues than others that let private companies drill on public lands and in public waters. In addition, they said, the United States has sweetened some of its incentives in recent years, while dozens of other countries demanded a bigger share of revenue.

In the United States, the federal government’s take — royalties as well as corporate taxes — is about 40 percent of revenue from oil and gas produced on federal property, according to Van Meurs Associates, an industry consulting firm that compares the taxes of all oil-producing countries.

By contrast, according to Van Meurs, the worldwide average “government take” is about 60 to 65 percent. And that figure, of course, excludes countries that do not allow any private ownership in oil production.

Democratic leaders in Congress have already vowed to roll back royalty incentives and tax breaks for drilling companies when they take control of the House and Senate in January.

“Royalty relief is the gift that keeps on giving,” said Representative Nick J. Rahall, Democrat of West Virginia, who will become chairman of the House Resources Committee. “It seems painfully obvious that when the government gives tax breaks in the form of royalty relief to Big Oil, the American people are footing the bill.”

Supporters of drilling incentives say they make sense for a country that wants to reduce its dependence on foreign oil and whose biggest untapped reserves are in water thousands of feet deep where the cost of drilling a dry hole can hit $100 million.

“The amount of exploration investment that a company has to endure to find and develop reserves in the U.S. is far more than in a place like Angola,” said Michael Rodgers, a senior economist at PFC Energy, a consulting firm that analyzes the tax regimes in oil-producing countries.

As oil and gas prices have surged in recent years, moreover, many countries have forced companies to give up a bigger share of revenues. Venezuela, Nigeria and Kazakhstan are among several dozen countries that have forced foreign oil companies to pay more money through either higher taxes or bigger equity stakes for the government.

“They’ve become emboldened by higher oil prices but they’re also being emboldened by muted response from investors,” said Michelle Billig, director of political risk analysis at the PIRA Energy Group in New York. “Companies don’t have the luxury of contesting and taking a hard line.”

Starting this year, Britain imposed the second of two new supplemental taxes on petroleum revenue from the North Sea, pushing the government’s share to 50 percent. Norway keeps at least 70 percent of revenues, but the government share increases automatically as oil prices rise and tops out at 78 percent.

Norway is on the growing list of countries that have adopted “progressive” systems that automatically increase the tax rate on oil and gas production as energy prices climb. Several Canadian provinces have adopted similar policies, and Alaska approved a tax system in August that automatically inches up as oil prices climb above $55 a barrel.

“The United States is not extracting sufficient benefit from oil and gas production,” said Pedro Van Meurs, president of Van Meurs Associates.

“The U.S. system worked fine when oil was $20 a barrel, but it wasn’t changed when prices went up,” added Mr. Van Meurs, who advised Alaska legislators on their tax system. When oil prices soar, he said, political leaders almost inevitably view the immutable bargain as too generous to industry.

In principle, the federal government has its own form of a progressive system. It offers royalty relief to companies that drill in very deep waters, but companies are supposed to pay the full rate — 12 to 16 percent — if oil prices climb above about $34 a barrel.

In practice, it does not always work out that way. Companies that signed leases in 1998 and 1999 enjoy an unintended loophole that entitles them to royalty-free oil and gas regardless of how high prices climb.

Last week, the Bush administration persuaded five companies to give up the loophole. But about 50 other companies have thus far refused to follow suit.

The Bush administration scaled back the incentive for newer leases, but in 2004, the administration offered lucrative new royalty incentives for companies that drill extremely deep natural gas wells in shallow water. Congress, meanwhile, added several billion dollars worth of new tax breaks in 2004 and 2005 for exploration and drilling.

James A. Watt, chief executive of Remington Oil in Dallas before it was acquired by Helix Energy Solutions in July, said the federal incentives help reduce the risks and high cost of exploring in more difficult areas of the Gulf of Mexico.

“Tax issues are extraordinarily important,” Mr. Watt said, in an interview this year. “Having said that, my view is that we just drilled a $50 million dry hole. That swamps the tax benefits we’re getting.”

The big issue for both lawmakers and the Interior Department is whether royalty relief has much of an impact.

The new study, prepared under contract to the Minerals Management Service of the Interior Department by Innovation and Information Consultants of Concord, Mass., is one of the few attempts to assess the impact through a rigorous econometric analysis.

The report estimates that the current incentives would have a tiny impact that is far exceeded by swings in market prices.

The report predicted that the current incentives would lead to the discovery of only 1.1 percent more reserves than if there had been no incentives at all. Total oil production from 2003 to 2042 would be about 300 million barrels more, or less than 1 percent, than it would have been anyway. Natural gas production would be 0.6 percent greater than it would have been otherwise.

But the cost of those royalty incentives would be high: about $48 billion less in royalty payments over the 40-year period. That loss would be offset by a slight increase in the prices that companies pay when bidding for leases in government auctions, but analysts said the net cost would still be above $40 billion.

The Interior Department, in a written response to questions, said the actual cost of its incentives would be much lower than $40 billion because most leases in the Gulf of Mexico include an escape clause that requires companies to pay full royalties if prices are above $34 a barrel.

But officials conceded that oil companies are still poised to escape billions of dollars in royalties in the next five years alone.

Dozens of companies signed leases in the late 1990’s under a Clinton administration program that offered highly generous incentives and, apparently because of a bureaucratic error, omitted the escape clause. The government has estimated that it would have received as much as $10 billion more over the next five years if the mistake had not been made. It is trying to renegotiate the terms.

But as much as half of that money is out of reach. The Bush administration also endorsed a new royalty holiday for “deep gas” drilling in shallow waters even if natural gas prices climb above today’s levels. According to internal budget estimates last year, the deep gas incentives account for half of the $10 billion that the government stands to lose.

To be sure, the newly released study found that the extra incentives prompted companies to pay more money upfront when bidding on offshore drilling leases and predicted that they would lead to a small increase in exploration and production.

The actual impact of the incentives depends on what happens to oil prices. But under any of the projections, the cost ended up exceeding the market price for oil.

Analysts said the meager impact of royalty incentives was not surprising: for oil and gas companies deciding whether to drill in deep water, the potential money involved in royalty incentives is small compared with the money at stake in changes of market prices.

Eliminating royalties on oil or gas will save a company 12 to 16 percent on some of its production. But those savings are minuscule compared with the nearly fourfold increase in oil prices from $15 a barrel in 1999 to more than $70 this summer.

At today’s prices, even the risk of a $100 million dry hole is not so daunting.

ENDS