Steffy: There’s no free ride in the Gulf

Let us pause for a moment to gaze with perfect clarity in the rearview mirror and talk about the revenue that might have been.

That’s what Rep. Edward Markey, D-Mass., has done in attacking “free” drilling that he claims oil companies have enjoyed in the Gulf of Mexico.

A report released last week by Markey and other Democrats on the House Natural Resources Committee says royalty-free offshore drilling has cost the country $11 billion and predicts that number will rise by another $15.5 billion in the next decade.

It argues that more than 100 companies holding some 200 leases are benefiting from a 1995 law that offered companies relief from royalty payments collected by the government on wells drilled in federal waters. The law suspended royalties on the leases, sold between 1996 and 2000, until they reached certain production volumes. Most of those leases are still producing, and Markey estimates the relief program means companies don’t have to pay royalties on about a quarter of the current production in the Gulf.

The report goes on to call for ending “an unfair and unneeded handout that distorts the market and advantages oil and gas over cleaner energy sources.” Markey wants the companies to repay the royalties that were waived under the law and eliminate any future benefits related to it.

In doing so, he threatens to unravel one of the few bipartisan laws that contained something so often lacking in energy legislation: long-term vision. The law successfully sustained offshore drilling at a time when prices wouldn’t support it, and we are reaping the benefits today as domestic production surges to its highest level in 18 years.

Crude’s price then

Certainly, viewed through the lens of $90 oil, Markey’s calls for ending the royalty relief program might make sense. The law, however, was written in 1995, when oil was well below $20 a barrel. At those prices, drilling in the Gulf would have dried up because companies couldn’t have made money given the cost of offshore exploration.

“Markey’s case is a classic case of 20/20 hindsight,” said Stephen Arbogast, a finance professor at the University of Houston and an expert in energy tax policy. “The industry’s right that those wells would never have gotten drilled at that time. The government had to give favorable terms to induce people to do things.”

The program worked, and the lease sales during the period are still among the most active ever.

“The program was very successful,” said John Christiansen, a spokesman for The Woodlands-based Anadarko Petroleum Corp., which has benefited from it. “Even today, those leases were some of the most successful in terms of generating revenue.”

What’s left out

The billions raised in lease revenue aren’t factored into Markey’s report. Nor are the technological achievements that have come from active drilling in the Gulf of Mexico. Houston, in particular, has benefited from new technology such as 3-D seismic imaging that was first tested in the Gulf, then later deployed worldwide.

“The deep-water Gulf of Mexico has been the laboratory for technological advances,” Arbogast said. “Keeping the industry going from a continuity point of view had a lot of benefits.”

The past century is full of erroneous predictions about oil prices, and the 1995 law was no exception. For that matter, Markey’s prediction of $15.5 billion in future lost revenue from the law is likely to be wrong, too.

But the law wasn’t an open-ended gift to the industry. It tied the royalty relief to production, and the program stopped after 2000, when oil prices began to rise.

Although some of the companies involved, including one of Anadarko’s predecessors, later sued and struck down other restrictions to the program, the law basically worked.

It’s worth noting, however, that the law was another example of the government picking winners, this time oil, and the oil industry should remember that the next time it complains about favorable tax treatment for renewable fuels.

Energy has never traded in a free market, and government has an important role in securing supply, not just in policing price.

Markey may not like the terms now, but they are simply the long tail of a policy that was needed at the time to keep America’s domestic energy industry vibrant. The effort then has led to a sixfold increase in domestic production now, which has generated billions more dollars in royalties than the money Markey now seeks to reclaim.

Long-lasting effect

The surge in domestic production, which has redefined America’s energy outlook, grew in part from the drilling encouraged by the law.

In a difficult federal budget environment, it’s reasonable for lawmakers to scour existing tax policy for overlooked revenue sources.

Retroactively repealing the royalty relief program, though, isn’t a solution.

Markey has confused hindsight with insight.