Ensuring Americans Receive Fair Value for U.S. Oil and Gas Resources

Update: On April 18, 2022, the Biden administration raised the royalty rate for oil and gas leasing on public lands “to ensure fair return for the American taxpayer and on par with rates charged by states and private landowners,” the Interior Department said. This change is in line with the royalty rate increase recommended here. The scholars also offer further recommendations to improve the program. 

The Challenge

Six percent of total U.S. oil production and 8 percent of natural gas production comes from federal lands. The federal mineral leasing process is a critical stage that governs whether, where, and when these oil and gas resources are developed, the revenue the government takes in, and the extent to which the local environment is protected. These mineral leases contain both a primary term that dictates how many years a firm has to drill and complete a well, and a royalty that dictates the share of the revenue that the government receives. Leases are auctioned, and the government sets a reserve price that specifies the lowest bid. The terms around these lease agreements, however, are not delivering a fair return for taxpayers and put the environment and public health at risk.

Policy Context

Through the Federal Land Policy and Management Act (FLPMA) of 1976, the Bureau of Land Management (BLM) is statutorily obligated to: develop the country’s natural resources, ensure fair value for taxpayers, and preserve the natural environment. Its leasing procedures are governed under FLPMA and the Mineral Leasing Act (MLA) of 1920, last amended in 1987. BLM uses a 10-year primary term, a 12.5 percent (one-eighth) royalty, and a reserve price of $2 per acre. BLM’s 10-year primary term allows firms to “sit on” land far longer than do terms set by major oil and gas producing states. On top of this, BLM’s royalty and reserve price are at the statutory minima and fall well below norms set by states and by the private leasing market. The shortcomings of these overly generous terms are exacerbated by the fact that many of the tracts auctioned by BLM do not even attract a large number of competitive bidders. For instance, in the fourth quarter of 2019 (the last full quarter before the COVID-19 pandemic began) only 36 percent of tracts auctioned received any bids at all, and of those 34 percent were won with just the minimum bid of $2 per acre. Additionally, prior to drilling, firms must pay a bond to cover part of the future decommissioning of the well. The bond amounts required by BLM have not changed since the 1960s, are below benchmarks used by states, and are insufficient to conduct full reclamation.

“Across the board, the terms of BLM oil and gas leases favor oil and gas production companies over U.S. taxpayers. They allow firms to capture the lion’s share of oil and gas resources’ value, while at the same time letting them avoid liability for environmental harm.”

Recommendations

There are several steps that policy makers can take to better protect the environment and public health, and to deliver a fair return to taxpayers.

• Increase the federal onshore royalty rate. With a royalty rate at 12.5 percent, BLM gets as little as half as much as state or private landowners for every dollar’s worth of oil and gas produced from its lands. Such a low rate is consistent with a desire to emphasize resource development rather than taxpayer value—a prioritization out of sync with other major oil and gas producing states.
• Simplify royalty valuation by eliminating deductions. With the royalty based on a firm’s revenue, the value firms choose to place on production and the deductions firms take—such as transportation or processing costs—can lower the revenue the government receives and impose a substantial auditing burden. Instead, the Office of Natural Resources Revenue should eliminate deductions and use a transparent price index such as West Texas Intermediate or Brent for oil, or Henry Hub for natural gas.
• Increase the rate of tract development by shortening primary terms to no more than five years, aligned with state agencies and private markets. Establishing a short primary term, which can be accomplished through an amendment to the MLA, promotes timely resource development.
• Increase the minimum bid per acre to match policies adopted by state agencies, and terminate the noncompetitive leasing program. Requiring firms to pay a robust initial fee to lease federal land will raise federal revenues, help ensure that lands are leased by the most productive firms, and reduce the burden of administering leases for marginal parcels. Increasing the minimum bid can be accomplished through administrative rulemaking, and eliminating the non-competitive leasing program can be accomplished through an amendment to the MLA.
• Strengthen bonding requirements to protect the environment and public health. BLM requires that firms post a single $25,000 bond to cover reclamation for all the wells that they operate in a single state. This amount falls well short of realistic estimates of reclamation costs. Economic research shows that stronger bonding requirements improve environmental outcomes. For example, when Texas increased its bonding requirements in the early 2000’s, many small operators with poor environmental records left the industry, “orphaned” wells decreased by 70 percent, and water violations dropped by 25 percent. BLM could achieve similar results on federal lands by raising its bond amounts via administrative rulemaking.

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