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Federal government has lessons to learn on oil, gas leasing

 

 

By Thomas Covert and Ryan Kellogg

Guest Commentary

The U.S. federal government owns vast acreage of resource- rich public lands; $25 billion of oil and gas was produced from federal lands in 2019 alone. But thanks to decades of stagnant policies, these resources are being all but given away to oil and gas companies, to the detriment of taxpayers and the environment. The current pause on new oil and gas leasing offers the opportunity to turn these resources into a larger source of federal funds, while better protecting the local environment and helping to confront climate change.

Improving federal leasing policies doesn’t require novel policy ideas. The government can generate benefits for taxpayers and the environment simply by following practices that private landowners and major oil and gas producing states have pursued for years: high royalty rates, short lease lengths, high minimum bids, and strong bonding requirements.

Private landowners capture a high share of production revenue by demanding royalty rates that are often as high as 25%. These robust royalties help landowners earn fair value for their oil and gas, even when they are dealing with a sophisticated firm that knows more about the resource size than they do. Private landowners also demand that the work gets done quickly, giving firms 3 to 5 years to either start producing or surrender their drilling rights.

Individual states closely follow the private market. Texas sets royalties of 20 to 25% and lease lengths of 3 to 5 years on Texas state land. The lowest royalties used in Louisiana, New Mexico, and North Dakota are 20%, 18.75%, and 16.67%, respectively.

None of these states awards leases with terms longer than 5 years.

Being the largest landowner in the United States, one would think the federal government would follow similar successful practices. It doesn’t. The royalty rate on federal leases is only 12.5%, and firms that sign federal leases get 10 years to develop them.

These shortcomings are compounded by the fact that firms don’t need to pay much up-front to get this sweetheart deal. The minimum up-front purchase “bonus” to get a federal oil and gas lease via auction is just $2 per acre. In Texas lease auctions, minimum bids are often as much as $5,000 per acre.

To make matters worse, firms can avoid even the $2 per acre payment by not bidding at all and then paying a small fee to obtain a lease through a “non-competitive” award process. As a result, firms with little interest in drilling can easily speculate on federal leases with no up-front expenditure. No wonder that 53% of all federal onshore leased acreage is not producing.

The federal government already has the authority to require higher royalties and to increase the minimum bid in its auctions.

Reducing lease lengths from 10 years to no more than 5 and eliminating the non-competitive leasing program would, however, require amendments to the Mineral Leasing Act. Congress should act to pass such legislation.

Current federal lands policies also expose Americans to environmental harm and cleanup costs. Modern shale wells cost more than $24,000 each to properly plug and abandon. But the government only requires that firms post a single $25,000 bond to cover decommissioning of all of their wells on federal lands in each state in which they operate. Firms can then easily avoid their decommissioning liability by transferring depleted wells to poorly capitalized firms.

When these firms become insolvent, the wells are “orphaned” and pose an ongoing environmental threat until public funds are spent to permanently plug them.

To fix this problem, the federal government can again follow states’ leads. In 2001, Texas substantially increased its bonding requirements for wells on state or privately-owned land. This reform led to significant reductions in orphaned wells and environmental violations. Louisiana, New Mexico, and North Dakota also have substantially stronger bonding requirements.

Finally, it’s no secret that oil and gas production contributes to climate change. Adding a carbon fee to federal royalties—in combination with broader carbon policies to ensure that production doesn’t just shift to state and private land—can help federal land policy account for the climate damages inflicted by resource extraction.

Across the board, the terms of federal onshore oil and gas leases have long favored the oil and gas industry. The Biden administration can instead prioritize taxpayers and the environment by enacting leasing reforms modeled after states’ current leasing practices, while simultaneously implementing robust climate policies. The present federal leasing pause is an opportunity to undertake these essential reforms.

Thomas Covert is an assistant professor at the University of Chicago’s Booth School of Business.

Ryan Kellogg is a professor and deputy dean for academic programs at the University of Chicago’s Harris School of Public Policy.

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