Monday, January 23, 2006

Big Oil as Big Jackpot

The New York Times reports with the usual high dudgeon (as high as dudgeon can afford to be, at any rate, in nominally objective news reporting), that Big Oil is in essence ripping off the taxpayers by unfairly calculating what it “owes” them in royalty payments when it leases drilling rights:

At a time when energy prices and industry profits are soaring, the federal government collected little more money last year than it did five years ago from the companies that extracted more than $60 billion in oil and gas from publicly owned lands and coastal waters.

If royalty payments in fiscal 2005 for natural gas had risen in step with market prices, the government would have received about $700 million more than it actually did, a three-month investigation by The New York Times has found.
But an often byzantine set of federal regulations, largely shaped and fiercely defended by the energy industry itself, allowed companies producing natural gas to provide the Interior Department with much lower sale prices - the crucial determinant for calculating government royalties - than they reported to their shareholders.

As a result, the nation's taxpayers, collectively, the biggest owner of American oil and gas reserves, have missed much of the recent energy bonanza.

The piece cavalierly assumes, without any evident introspection, that the purpose of oil leasing is to maximize the money flowing to government coffers. It is replete with phrases like “losses to taxpayers” – as if “taxpayers” had any claim on the profits that come from the risk-taking that goes on when crude oil buried under thousands of feet of water is transformed into gasoline at the pump available at the prevailing price for use in your car. (Leave aside that when the press is reporting some benevolent use of taxpayer funds, the benevolence never comes from “the taxpayer” but from “the government, while here, it is the former rather than the latter deprived of their just shares of higher oil prices.)

The drilling program apparently allows oil companies to use a highly complex set of rules to calculate the value of the oil they received, and then fork over to the government some fixed share of that value. The rules are as complex as they are because of some long-since-forgotten interest-group struggle involving oil companies who wanted to fork over as little as possible to the government and advocates for extracting money from the oil companies to fund their pet spending causes.

But why do oil company workers, shareholders and people who use a lot of oil have any unusually large responsibility to fund government? It is not clear to me why high oil prices should translate into more resources available for funding whatever government projects can currently command the most political support. That is a basic violation of the rule of law as Hayek understood it – the idea that, whatever the proper sphere of government is, we all bear equal responsibility for funding it. (This is a specific example of what I once more generally called the Money Tree fallacy.)

I propose an alternate objective to guide us in deciding how to allocate oil-drilling leasing rights – the maximization of gains to trade for oil buyers and sellers. Assuming that the government should be in the position to decide who gets to drill offshore to begin with (more than debatable, but possible if property rights in the ocean are sufficiently costly to establish and enforce), this suggests that the rights should simply be auctioned off. Once those fees have been paid, the government should simply leave oil producers alone to work their magic, whatever the prevailing market price of oil happens to be today. When it is lower than expected under an auction system, oil companies will be left holding the bag for having guessed wrong, but if it is high, they get rewarded for risk-taking and guessing right. That, one supposes, will be an incentive to try to guess better. It will also avoid the situation we are in now, where the oil companies are simply a giant grab bag to fund everyone’s special programs. But, oil companies being what they are in the public mind, the politics of that are much more complicated than the economics and the morality.


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