Do You Know the Drill on Federal Revenues from Oil, Natural Gas Development?

Mark Green
Posted October 17, 2013

With the ongoing budget debate in Washington serving as backdrop, let’s review ways America’s oil and natural gas industry generates revenue for our government – and the smart path to increasing that contribution in coming years.

First, our industry currently supplies $85 million a day in revenue to the U.S. Treasury via income taxes, royalties, rents and other fees. Second, industry is paying its fair share and more with an effective tax rate of 44.6 percent averaged over 2007-2012 – compared to 37.7 percent for retail, 25.6 percent for computer and peripherals and 21.3 percent for pharmaceuticals. And it could deliver more through increased domestic production made possible by greater access to U.S. reserves:

• More than $800 billion in additional, cumulative revenue to the federal government by 2030, according to Wood Mackenzie.
• $2.5 trillion in cumulative federal, state and local tax receipts generated between now and 2035 as a result of the U.S. shale revolution, according to IHS Global.

These are significant numbers, yet some apparently are in denial, evidenced by proposals of counter-productive measures that include higher taxes on oil and natural gas companies and a larger government “take” from production on federal lands, onshore and offshore.

We’ve addressed tax hike proposals before (including here, here and here). So let’s discuss government’s “cut” from production on federal lands. Again, some numbers:

• Federal revenue from 2003 to 2012 totaled more than $101.7 billion – from royalties, rents and bonuses.
• The figure above includes more than $77 billion in revenue from offshore activity and more than $24.6 billion in revenue from onshore activity.
• In 2012 alone, the industry supplied more than $9.7 billion in royalties, rents and bonuses.
• In 2010, the last year for which data is available, industry paid about $8.5 billion in federal income taxes.

These figures are substantial – even though production of oil and natural gas on federal lands has been declining since 2008, as reported by the U.S. Energy Information Administration. So, although U.S. oil and natural gas production is surging – to the point we’re projected to out-produce Saudi Arabia in combined oil and natural gas this year – the surge is largely occurring on private and state lands.

All of the above is important context for discussion of whether the federal government takes a big enough cut from oil and natural gas activity on U.S. lands. The market reality is that federal costs associated with drilling in areas controlled by Washington weigh into whether companies drill in those areas or go elsewhere – as do restrictions on new access and challenges with the permitting process. Thus, policymakers have to consider the impact of higher royalties and other fees on energy development. Shorter version: Government could increase its “take” but less development could occur, defeating the goal of increased revenue. As it is, with most of the production growth occurring on state and private lands, the U.S. taxpayer already is missing out on the current oil and natural gas surge.

What about lease payments? One recent report suggested that taxpayers lose because of the starting point for lease bidding on federal acreages. It’s a silly argument because in a competitive bidding situation the lease will command the maximum the market believes the lease is worth. In other words, it’s not where the bidding starts, it’s where it ends. In 2012, all leases sold through the U.S. Bureau of Land Management generated more than $233 million. When production occurs, the U.S. government receives royalty payments – paid even if the company doesn’t record a net profit. Increasing the starting bid will simply reduce the likelihood of production in marginal areas to zero – which is what the incremental government revenue would be: zero.

The U.S. fiscal system associated with oil and natural gas production is fair game for debate and study. Some critics of the system cite an outdated 2008 report by the U.S. Government Accountability Office (GAO) that suggested the government wasn’t getting a fair return from leases in the Gulf of Mexico. But an updated 2011 IHS CERA study for the Interior Department, commissioned specifically in response to the 2008 GAO report, found flaws in GAO’s methodology:

That finding, however, appears to be based on a ranking of government take rather than an analysis of the bid adequacy procedures or an accounting of the amounts received via signature bonuses and income tax. Based on the ranges of the (Gulf of Mexico) government take reported by the GAO, we have concluded that the specific GOM government takes did not include signature bonuses or account for exploration risk. Studies that factored in risk and present value in the mid-1980s and late 1990s reported the U.S. OCS government take closer to 77 percent. If not accounted for in the government take statistic, a significant source of revenue accruing to the U.S. government is being overlooked.

IHS CERA compared 29 oil and natural gas upstream fiscal systems across the world, including six in the U.S., and analyzed government share of profit, rates of return, revenue risk and fiscal system stability. The study developed a 0-to-5 scale to compare the various fiscal systems, showing which ones resulted in a high government take and a less-favorable investment environment (5) and those that achieved the opposite (0). Here’s the report’s fiscal terms index:

The index combines comparison of government take statistics with profitability indicators such as internal rate of return (IRR) and measures of capital efficiency such as profit-to-investment ratio (PI), as well as measures of fiscal system progressivity/regressivity. IHS CERA:

A ranking of fiscal terms based on all four variables puts all U.S. federal jurisdictions in the top half of the index, which indicates high government take, low IRR, low PI, and highly regressive fiscal terms.

Additional points from IHS CERA’s study:

• Four of the six U.S. areas included in the analysis ranked in the top half of the fiscal index, with scores of greater than 3.
• Government’s take in the Gulf averages 79 cents per dollar of net revenue for the shelf and 64 cents per dollar in deepwater. In other words, the government can make up to four times more than industry on Gulf projects.
• The Gulf of Mexico shelf ranked second worst in attractiveness to potential energy investment on fiscal terms – only behind Venezuelan heavy oil.

Now, returning to an earlier point: The best way to increase revenue to government from oil and natural gas development is to allow more of it. That can be encouraged with greater access to U.S. reserves, a sound approach to regulation – including more lease sales and a streamlined permitting process – and by fostering a better investment climate. With pro-development policies America’s oil and natural gas wealth can do more for Americans in terms of jobs and economic growth while providing additional revenues to government.

(This post has been updated with new statistical information.)