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House-Passed Bill Strips Producers of Tax Breaks, Royalty Incentives

The House Thursday passed by a wide margin energy legislation (HR 6) that is a major blow to traditional oil and natural gas producers, but a significant boon to makers of renewable and alternative energy fuels. A key Senate energy panel, meanwhile, took its first look at problems with the royalty-collection practices in the Gulf of Mexico.

The Democratic measure, which cleared the House by 264 to 123, forces holders of flawed 1998-1999 offshore leases to renegotiate their contracts or pay a "conservation of resources fee" in order to bid on future government leases. It also repeals tax breaks for oil and gas producers and eliminates royalty relief for ultra-deep production in the Gulf of Mexico.

The Senate is expected to take up a bill, focusing primarily on the disputed 1998-1999 leases, in the near term. "I have asked that the House bill be placed on the Senate calendar," said Sen. Jeff Bingaman (D-NM), chairman of the Senate Energy and Natural Resources Committee. "I will be working on a bipartisan basis to develop an overall amendment to the House bill that will avoid legal pitfalls and provide a better financial footing for the energy and natural resources programs that are crucial to America's economic, energy and environmental future."

The White House objects to the House bill's provisions forcing producers to renegotiate the 1998-1999 leases, which are costing the federal government billions of dollars in lost revenues. The administration said it favors allowing producers to voluntarily rework the terms of the disputed leases. It did not say it plans to veto the bill. Producers have blasted the bill, saying it would deter investment in drilling and likely result in higher oil and gas prices that would be passed on to consumers..

Passage of the energy bill (HR 6), which was crafted by House Speaker Nancy Pelosi (D-CA) and key House energy committee chairmen, wrapped up the "first 100 hours" agenda of the Democrats. The measure did not go through the committee process, but rather went straight to the House floor. House Republicans were prevented from offering any amendments to the bill during debate.

The Democratic energy measure is expected to raise $14 billion in revenues over the next decade, which will be placed in a reserve fund to promote alternative and renewable fuels. The measure "creates a $14 billion piggy bank or slush fund" for nontraditional energy sources, said Rep. Robert Goodlatte (R-VA).

The Congressional Budget Office (CBO) reports the House energy bill would raise $6.31 billion by changes to the disputed 1998-1999 leases, including $4.35 billion through the assessment of a "conservation of resources fee" on producing deepwater leases and $1.75 billion by imposing a conservation fee on nonproducing leases. In addition, the CBO estimates the repeal of royalty relief for Gulf ultra-deep production and activities in other regions (Alaska) could yield $210 million.

The bill also would raise $7.6 billion over 10 years by disallowing a tax deduction for income attributable to domestic production activities, as well as $104 million by extending the amortization period for integrated energy companies for geological and geophysical expenditures, the CBO said.

On the other side of Capitol Hill Thursday, an Interior Department official told a Senate panel that the omission of language requiring producers to pay royalties on deepwater oil and natural gas production appeared to be a deliberate decision rather than a mistake on the part of the agency.

It appears it was a "conscious decision" to remove the price thresholds from the disputed 1998-1999 leases, but it was not intended to be "malicious" to the federal government, said Stephen Allred, Interior's assistant secretary for land and minerals management, during the Senate Energy and Natural Resources Committee's first hearing on the issue.

But Interior Inspector General Earl Devaney, who has investigated the missing price thresholds for nine months, disagreed. "I would say it was not a deliberate decision," he said. At the end of the day, it appears this was a "bureaucratic mistake, a very costly mistake." There was "no smoking gun" that the omission was intentional.

Devaney said Interior's Minerals Management Service (MMS), which issued the faulty leases, believed that the price threshold language was included in a 1995 royalty-relief law and regulations, and thus did not need to be inserted in the actual leases. He further noted that producers didn't know that price thresholds were missing when they bid on the 1998 and 1999 leases.

Committee Chairman Bingaman tended to agree with Devaney. "I take at least from your [Devaney's] statement that this was a mistake." He noted that producers holding the 1998-1999 leases need to renegotiate the terms of their contracts with the federal government, or Congress will resort to a legislative fix.

It's estimated that the MMS issued 1,032 deepwater Gulf of Mexico leases in 1998-1999 without price thresholds. Absent these price ceilings, producers have been able to escape the payment of royalties on certain volumes of offshore production despite the escalation of oil and gas prices. Federal auditors have estimated that the federal government has lost $900 million-$1 billion in royalties so far and could lose up to $10 billion over the life of the leases if they are not renegotiated.

The disputed leases were issued following enactment of the 1995 royalty-relief law, which offered producers royalty breaks when oil and gas prices were low to spur exploration and production in the deepwater Gulf. The royalty breaks were to end when oil and gas prices exceeded the established price thresholds in the leases. The thresholds were included in the 1996, 1997 and 2000 leases, but the MMS left them out in the 1998 and 1999 leases.

Devaney, in presenting the results of his probe to the committee, reported that the missing price thresholds first came to the attention of a former associate director for Offshore Minerals Management in 2000, but she chose not to inform higher-ups at the agency. Current MMS Director Johnnie Burton told a House panel last fall that she first learned of the issue in either late 2005 or early 2006. But e-mails turned up during Devaney's investigation showed that she may have learned of the missing price thresholds two years earlier. Burton was "genuinely surprised" when showed the 2004 e-mails, Devaney said. He noted several investigations are still ongoing, some criminal in nature.

Allred said there were no plans to remove Burton from her current position. "These mistakes that occurred did not occur under her management...I have not seen a reason yet to make a change in her status."

Interior said six companies so far have renegotiated the terms of the 1998-1999 leases to include price thresholds, but the thresholds would only apply to future production from the disputed leases, not past production. Allred estimated that the six companies account for about 20% of the future production from the disputed leases. Approximately 50 companies still have not reworked the terms of their royalty-free leases.

The Bush administration objects to the abrogation of the leases or barring companies from bidding on future leases if they refuse to renegotiate the terms of the 1998-1999. Allred said a company that's had its contract abrogated or that's prevented from bidding could challenge the action in court, holding up production in the Gulf and resulting in a significant loss of revenue to the U.S. Treasury.

The government must "avoid unintended consequences," he told the Senate committee.

To entice the companies to renegotiate their leases, Allred suggested that Congress propose incentives that would not result in any revenue loss to the federal government -- such as offering the holders of the 1998-1999 leases an extension of their deepwater leases. He noted that the current term for deepwater leases is five years.

Allred said Congress had a "suite of tools" at its disposal to bring oil and gas companies to the table to renegotiate their leases.

"I don't think we need sweetners" for the companies, countered Sen. Byron Dorgan (D-ND). The federal governments needs only to say "we're open for business to only companies who renegotiate" their faulty leases, he said. "Either you renegotiate, or sorry Charlie, we're not going to do business with you anymore...My sense is that the department has not been as aggressive" as it should be.

"I would hope that the companies that are still out there waiting come forward," said Sen. Larry Craig (R-ID).

The amount of royalties lost to the federal government could balloon in future years due to a "series of mistakes and unanticipated lawsuits," said Mark Gaffigan of the Government Accountability Office (GAO). He estimated that royalty liability could hit $60 billion if Kerr-McGee Corp. is successful in its legal challenge of Interior's authority to include price thresholds in 2,300 leases issued between 1996 and 2000. That $60 billion would include the potential $10 billion loss from the 1998-1999 leases.

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