Change the Terms and Conditions for Federal Oil and Gas Leasing

The federal government offers private businesses the opportunity to bid on leases for the development of most of the onshore and offshore oil and natural gas resources on federal lands. By the Congressional Budget Office’s estimates, under current laws and policies, the federal government’s gross proceeds from all federal oil and gas leases on public lands will total $127 billion over the next decade; after an adjustment for payments to states, the net proceeds will be $108 billion.

This option would change several aspects of the federal oil and gas leasing programs. It would increase the acreage available for leasing by repealing the statutory prohibition on leasing in the Arctic National Wildlife Refuge (ANWR) and by directing the Department of the Interior (DOI) to auction leases for areas on the Outer Continental Shelf (OCS) that are unavailable for leasing under current administrative policies. The option also would eliminate payments of interest on overpayments of royalties by lessees. (Royalties are assessed on the value of oil and gas produced from leased areas.) Finally, the option would increase the federal government’s share of the returns on leasing federal lands by imposing a fee on all new leases of tracts from which oil or gas is not being produced.

CBO estimates that implementing all of those changes would reduce net federal outlays by $6 billion from 2015 through 2023 by increasing offsetting receipts from oil and gas leasing. Of that total, $3 billion would result from leasing in ANWR and an increase in leasing on the OCS, $2 billion would result from eliminating interest payments on overpayments, and the remainder would result from the new fees.

One rationale for offering leases in ANWR and additional leases on the OCS is that increasing oil and gas production from federal lands could boost employment and economic output, especially in the affected regions. Additional leasing also could raise revenues for state and local governments; the amounts would depend on state tax policies, the quantity of oil and gas produced in each area, and the existing formulas for distributing portions of federal oil and gas proceeds to states. The primary argument against expanded leasing is that oil and gas production in environmentally sensitive areas like the coastal plain in ANWR or other coastal areas could pose a threat to wildlife, fisheries, and tourist economies. Moreover, increased development of resources in the near term would reduce the oil and gas available for production in the future, when prices might be higher and the products might be valued more highly by households and businesses.

A rationale for eliminating interest payments on overpayments of royalties is that doing so would stop the federal government from paying a higher return on funds it receives through such overpayments than on funds it borrows through selling securities. Under current law, DOI is required to pay interest on overpayments at a rate that is 2 percentage points higher than the short-term interest rate the Treasury pays on securities that represent borrowing from the public. In a different context, the Treasury also pays interest that is the same amount higher than its borrowing rate for overpayments of federal corporate taxes, but provisions in the tax code limit the amount of money eligible to earn such interest, and no such provisions apply to overpayments on oil and gas leases. One result is that the amount of overpayments by lessees and the corresponding interest payments by DOI have grown in recent years. In 2012, overpayments exceeded $3 billion, which was equivalent to more than 30 percent of the $9 billion due as royalties on production from all federal lands. One argument against eliminating the incentive to overpay royalties, from lessees’ point of view, is that it would increase the risk of underpaying the amounts due and then being liable for paying interest on the difference. Alternative approaches that would generate smaller savings include reducing the interest rate on overpayments or limiting the volume of overpayments eligible to earn interest.

Besides increasing federal offsetting receipts, a rationale for imposing a new fee on all “nonproducing” oil and gas leases—pegged at $6 per acre per year for the purpose of this option—is that doing so would give firms a financial incentive to be more selective in acquiring leases and to explore and develop those leases more quickly. Firms holding nonproducing leases, which currently account for about 85 percent of offshore leases and about 70 percent of onshore leases, have the option to pursue production on those tracts but may postpone making any investment until conditions become more favorable—for example, if oil or gas is discovered on leases nearby or if the price of oil or gas rises more than expected. Although oil and gas resources might be more valuable in the future than they are today, if leasing does occur, the federal government’s return would tend to be larger if firms that acquired leases began production quickly.

An argument against assessing higher fees prior to production is that they would cause some firms to bid less for the leases they acquire or to acquire fewer leases, which would reduce federal proceeds from the sale of new leases—although by only a small amount, CBO expects. In auctions, the amount that firms are willing to pay for a lease depends on a number of factors, including expected future drilling costs, trends in oil and gas prices, the quantity of oil or gas resources that may be covered by the lease, and the probability that other firms will compete to acquire the lease. Firms strive to set bids at levels that are lower than the value they assign to leases but higher than what they expect other firms to pay. Although imposing an annual fee of $6 per acre paid by leaseholders until leased areas produce oil or gas would reduce the expected value of the leases (because production rarely begins in the first year of a lease), the effect of the fees would generally be small relative to other factors affecting firms’ bids and, in CBO’s view, would have only a small effect on bids and, therefore, offsetting receipts. Moreover, leases that were not acquired would be those with the lowest expected economic value and the lowest likelihood for development, so the production of oil and gas and the federal revenues from leases and royalties that would be given up because of the higher fees would probably also be quite small.