Oil and Gas Royalties

Amid rising oil and gas prices and reports of record oil industry profits, a number of governments have taken steps to reevaluate and, in some cases, increase the share of oil and gas revenues they receive for the rights to develop oil and gas on their lands and waters. For example, the State of Alaska has recently passed new oil and gas legislation that will increase the state's share of revenue received from oil and gas companies operating state leases. In January 2007, the Department of the Interior announced an increase in the royalty rate for future leases granted in the deepwater region of the Gulf of Mexico. Companies engaged in exploration and development of oil and gas resources do so under terms of concessions, leases, or contracts granted by governments or other resource owners. The terms and conditions of such arrangements are established by law or negotiated on a case-by-case basis. One important aspect of the arrangements is the applicable payments from the companies to the resource owners--in the United States, these include bonuses, rentals, royalties, corporate income taxes, and special fees or taxes. The precise mix and total amount of these payments, referred to as the "fiscal system" varies widely across different resource owners. The total revenue, as a percentage of the value of the oil and natural gas produced, received by government resource owners, such as U.S. federal or state governments is commonly referred to as the "government take." For example, a government take of 50 percent means that the government receives 50 percent of the cash flow produced from an oil or gas field. In fiscal year 2006, oil and gas companies received over $77 billion from the sale of oil and gas produced from federal lands and waters, and the Department of the Interior's Minerals Management Service (MMS) reported that these companies paid the federal government about $10 billion in oil and gas royalties. Clearly, such large and financially significant resources must be carefully developed and managed so that our nation's rising energy needs are met while at the same time the American people are ensured of receiving a fair rate of return on publicly owned resources, especially in light of the nation's daunting current and long-range fiscal challenges. As requested, this report documents the information provided to Congressional staffs in March 2007 on the U.S. government's take and implications associated with increasing royalty rates. Specifically, this report discusses (1) the United States' government take relative to that of other government resource owners and (2) the potential revenue implications of raising royalty rates on federal oil and gas leases going forward.

Based on results of a number of studies, the U.S. federal government receives one of the lowest government takes in the world. Collectively, the results of five studies presented in 2006 by various private sector entities show that the United States receives a lower government take from the production of oil in the Gulf of Mexico than do states--such as Colorado, Wyoming, Texas, Oklahoma, California, and Louisiana--and many foreign governments. Other government-take studies issued in 2006 and prior years similarly show that the United States has consistently ranked low in government take compared to other governments. In deciding where and when to invest oil and gas development dollars, companies consider the government take as well as other factors, including the size and availability of the oil and gas resources in the ground; the costs of finding and developing these resources, including labor costs and the costs of compliance with environmental regulations; and the stability of the fiscal system and the country in general. All else held equal, more investment dollars will flow to regions in which the government take is relatively low, where there are large oil and gas deposits that can be developed at relatively low cost, and where the fiscal system and government are deemed to be relatively more stable. Regarding the deepwater areas of the U.S. Gulf of Mexico, the current size of the government take, the relatively large estimated amounts of oil and gas in the ground, and the proximity to the large U.S. market for oil and gas make this region a favorable place to invest. However, the high costs of operating in deepwater may deter some investment. Increasing royalty rates on future federal oil and gas leases would likely increase the federal government take but by less than the percentage increase in the royalty rate because higher royalty rates would likely reduce some taxes and other fees and may also discourage some development and production. A lower royalty rate can encourage oil companies to pursue oil exploration and production and thereby provide an economic stimulus to oil producing regions. As part of an energy strategy to meet the nation's energy needs and balance the impacts of energy use on the environment and climate, a healthy domestic oil and natural gas industry is essential, and that means that the United States must continue to create a market that is competitive in attracting investment in oil and natural gas development. Such development, however, should not mean that the American people forgo a competitive and fair rate of return for the extraction and sale of these natural resources, especially in light of the current and long-range fiscal challenges facing our nation. The potential trade-offs between higher revenue collections and higher oil production highlight the broader challenge of striking a balance between meeting the nation's increasing energy needs and ensuring a fair rate of return for the American people from oil production on federally leased lands and waters.