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October 26, 2017

A Final Word on Vox and Oil Change International: The Myth of Lost Royalties

October 26, 2017
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Let’s break down this idea of lost royalties and revenue.

The Oil Change International study that we’ve commented on here and here this week cites two very large numbers for supposedly lost federal revenues: royalties from deep-water drilling and from low-cost leasing in the Powder River Basin. Together these categories add over $2.1 billion to the subsidy figure OCI reports.

But wait a minute, how does OCI know that those revenues were “lost”? What is the “correct” royalty rate or development cost for minerals on federal land? There is no market for these rates; the federal government arbitrarily sets them. To call a given royalty rate “low” is entirely subjective, it is in the opinion of whoever writes up the estimate.

Many commentators, like the authors of this report, seek to compare federal royalty rates to rates on state and private land, but that is an apples to oranges comparison. State and private royalty rates are highly variable, depending on all sorts of conditions. The report specifically mentions the minimum oil royalty rate in Texas, which is 20%. But Texas has a very streamlined permitting system, a state government that is knowledgeable about energy and pro-development, a clear legal regime for energy development and well-proven reserves. All these factors substantially reduce the risk of a given well, meaning that a company may be perfectly happy to pay that higher royalty rate. On federal lands there is often substantially more risk. For example: a capricious administration might choose to jack up royalties; permitting delays from hostile bureaucrats raise costs; federal lands are often well removed from pipeline infrastructure as well as refining markets requiring greater transportation outlays; environmental regulations of all kinds can slow or potentially stop exploration and production at any time; the constant threat of litigation from anti-development special interests hangs over any project; and to top it off, federal subsurface resources are often less carefully mapped, so it is less certain what will actually be found. With all these additional risks, perhaps this “low” royalty rate is actually the correct level needed to compensate.

But the sophistry of the report is put in even starker relief when looking at the details. Under the category of “lost royalties on deep-water drilling,” the largest component is a little over $1 billion “lost” on leases issued from 1996-2000. For those old enough to remember (which may not include many Vox readers) that was a period of very low oil prices. Indeed, adjusted for inflation, the annual average oil price reached a record low for the second half of the 20th century in 1998. In that price environment, those wells may not have even been drilled, which would have resulted in no potential revenues of any kind. So it is a bit rich to claim that revenues were “lost” when in the alternative scenario they would not have existed at all.

The report uses similar obfuscation to claim that coal mining in the Powder River Basin benefits from just under $1 billion in “subsidies.” But this number again is entirely arbitrary, based on another anti-fossil fuel organization’s own interpretation of federal law combined with some arbitrary economic calculations. Whatever the merits of this assertion (which have not been endorsed by the courts), disagreement about the correct application of federal law is not anyone’s definition of a “subsidy.” Furthermore, the assertion that leasing in the Powder River Basin is offered for below market value suffers from the same fallacy discussed above, what is fair market value? Given all the risks involved in developing coal on federal land (as the constant nuisance lawsuits from anti-development groups attest to), fair market value is subjective. The Bureau of Land Management calculates minimum bids that it believes reflect fair market value, and if a coal company surpasses that minimum, its gets the lease. That in the opinion of the report’s authors fair market value should be higher does not suddenly prove the existence of “subsidies.”

And keep in mind that revenue from coal mining and oil and gas activity is far more than just royalties. Companies must bid on the leases in the first place, the companies pay taxes on their profits, the companies employ (well-paid) individuals who pay taxes, the various contractors and suppliers to these companies all pay taxes and so on down the line. In the absence of coal mining or oil and gas drilling, all that revenue and economic activity goes away. And that is without even considering intangible benefits that domestic energy production provides by reducing imports as well as the lower energy costs that abundant domestic production brings to the entire economy.

Conclusion: The Usual Dishonesty

Ultimately, though, what this report is about, and why anti-development organizations and their fellow travelers in the media cite it so enthusiastically, is preventing energy development. This has been the animating force behind the environmental left for decades now. They have failed to persuade the public of their global warming religion, so they grasp for this false equivalency, attempting to convince the public that the government handouts and mandates for their ideologically preferred renewables are nothing compared to the supposed subsidies for coal, oil and natural gas.

Vox and Oil Change International don’t have any real economic argument to support their obsessive promotion of wind and solar, so they are reduced to deception. Anything to avoid acknowledging the truth: affordable, abundant energy derived from fossil fuels has been, and continues to be, the greatest boon to the welfare of mankind in its history.

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