Mandatory Spending Option

Function 270 - Energy

Increase the Royalty Rate for Oil or Gas Production on Offshore Federal Lands When the Price Rises Above a Threshold

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

The Bureau of Ocean Energy Management (BOEM) imposes a single royalty rate for all offshore leases in federal waters, regardless of whether the parcel is producing oil, gas, or both. Various laws have reduced or eliminated royalty payments in certain areas if prices fall below a particular threshold: In 2014, for parcels in deep water or deep wells in shallow water, the threshold was set at about $5 per thousand cubic feet for gas and about $40 per barrel for oil. In addition, BOEM has the authority to waive royalty payments for leaseholders who request such a waiver. The value of a productive parcel decreases as the price of oil or natural gas falls; however, when BOEM auctions a parcel for leasing, bidders do not know the future market price of oil or natural gas and thus bid on the basis of their best estimates of future prices. If prices fall unexpectedly, the leaseholder makes less profit than anticipated; conversely, if prices rise unexpectedly, the leaseholder makes more profit than anticipated. The current approach offers some leaseholders protection from falling oil and gas prices but does not benefit the government if prices rise. One alternative would be to create a royalty schedule that increased with prices.

If the royalty rate for oil rose to 25 percent when the real (inflation-adjusted) price of oil climbed above $100 per barrel and the rate for natural gas rose to 25 percent when its real price rose above $8 per thousand cubic feet, additional net federal income would be less than $25 million over the next decade, CBO estimates; it could be significantly larger in the following decade, depending on market conditions. That effect is the net result of increases in income from royalties and decreases in income from auction bids, because the option would reduce slightly the expected profitability of leases. Because leases become more profitable for the firm holding the lease at higher oil or gas prices, the option would probably have a negligible effect on production.