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CBO Says Ending Royalty Relief Might Put Crimp in Federal Coffers

Senate legislation (S. 2314) that seeks to scale back royalty relief for oil and natural gas producers in the Outer Continental Shelf (OCS) would trigger an increase in the amount oil and gas royalties paid to the federal government, but it also would result in a drop-off in bonus bid revenues flowing into the U.S. Treasury, according to the Congressional Budget Office (CBO). Consequently, net receipts to the federal government from offshore leasing might not rise in the long run and could even fall over the next five years, it said.

"Proposals to reduce royalty relief for future OCS leases would increase future royalty receipts once production began on new leases, but they would also result in lower bonus bids. Over the long run, net receipts to the government might not change much. However, because of the delay between the time when a lease is sold (and a bonus bid received) and when production begins, such proposals could result in a net loss of receipts over the next five years," the CBO said in a recent letter to Sen. Ron Wyden (D-OR).

The OCS oil and gas leasing program generates three types of income for the federal government. Producers pay bonus bids up front at the time of the sale, regardless of whether the property ever produces any oil or gas. After acquiring the lease, they pay annual rents until production begins. And when production starts, producers pay royalties to the government -- a fixed percentage of the net value of oil and gas produced from the leased area. Royalties for OCS production average about 15%, according to the CBO. The terms of a lease also spell out the conditions under which a producer may qualify for lower royalty payments to the federal government (royalty relief).

Wyden asked the CBO to calculate the cost impact to the federal government of legislation, such as S. 2314, that proposes to significantly reduce royalty relief for oil and gas production on federal lands. The measure, sponsored by Sen. Dianne Feinstein (D-CA) and several other Democrats, directs the Interior secretary to suspend royalty relief on crude oil production when the price of crude in the United States is greater than $34.71/bbl over the most recent four consecutive weeks, and to end royalty relief for gas production when the price of gas in the U.S. is greater than $4.34/Mcf over a four-week period.

Producers that refuse to renegotiate by the one-year anniversary of the enactment of the bill would be barred from entering into any new leases that authorize production of oil or gas on federal lands.

The changes contemplated by the Senate bill "would increase royalties from affected leases once they begin to produce oil or gas -- typically five to seven years after the lease sale. But, by reducing the likelihood or amount of royalty relief, the legislation would lessen the expected future profitability of affected leases. Bidders would take this fact into account in formulating their bids," the CBO told Wyden.

"As a result, under S. 2314, we expect that bids for future OCS leases would be lower than they would be under current law, starting in 2007 when the new policy would take effect...We expect that such legislation would reduce receipts from bonus bids in each future year."

The Senate legislation comes amid heightened concern on Capitol Hill about the royalty relief that is being provided to producers, even as oil and gas prices have reached record levels. It's been estimated that the Department of Interior will forego $7 billion in royalties through 2011 as a result of royalty exemptions to producers.

Congress approved the exemptions in the Deep Water Royalty Act of 1995. The law was intended as a carrot to entice producers to drill in the deep waters of the Gulf of Mexico, where large reserves of oil and gas were believed to be located but where few producers ventured due to the high costs of drilling there and the risks.

The act exempted producers from royalty payments for large amounts of oil and natural gas produced from leases that were obtained between 1996 and 2000 if prices stayed within established thresholds. Lawmakers created the price thresholds to prevent producers from benefiting twice -- once from royalty relief, and again from high oil and gas prices.

Critics and a number of Capitol Hill lawmakers now are pressing to abolish royalty relief for producers, particularly as companies report record profits due to the run-up in oil and gas commodity prices.

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