O&G Companies Fear Higher Royalty Payments under Obama Effort

WASHINGTON (Dow Jones Newswires), June 9, 2011

Energy companies are concerned they could be forced to pay higher oil and gas royalties under a new Obama administration effort to revamp royalty calculations for energy extracted from federal lands and waters.

The Interior Department, which launched the effort last month, insists the proposed changes will simplify how oil and gas is valued and should not increase or decrease the royalty payments themselves.

Oil and gas companies are not so sure. They say changes could create an unfair calculation that leads to higher royalty payments, which would dampen the industry's profits and hurt smaller producers particularly hard.

"It makes us nervous when we hear of the government trying to simplify things," said Kathleen Sgamma, director of government affairs for the Western Energy Alliance, a group representing oil and gas producers in western U.S. states.

This debate comes as the energy industry has battled the Obama administration on other matters, such as a bid to eliminate billions of dollars of tax incentives for oil and gas companies.

The new royalty formula also comes as the Obama administration looks for ways to trim the widening deficit. Generating nearly $9 billion in reported revenue last year, oil and gas royalties represent one of the largest sources of non-tax revenue for the federal government.

The Interior Department is also considering, through a separate effort, an increase to onshore production royalty rates, now at 12.5%. The royalty rate for offshore production is 18.75%.

Government watchdogs have said the Interior Department's royalty program fails to collect the government's fair share of revenue from the industry. Earlier this year, the Government Accountability Office identified the program as being at a "high risk" of fraud, waste, abuse or mismanagement.

When calculating royalty rates, the Interior Department can often rely on the sale price between the buyer and seller to determine the value of the oil or gas. But in many cases--such as when affiliated companies sell to each another--the Interior Department questions whether this sale price reflects the true market value and conducts its own review. This creates a burden for government officials and leads to disputes with the industry.

Hoping to simplify the process, the Interior Department is considering a process where it relies on standardized prices to calculate royalty payments. These could be published prices from trade publications or prices at which the products are traded on exchanges.

But the industry is concerned standardized prices could lead the Interior Department to assign a higher value to oil and gas than what producers receive from a sale. And that would lead to bigger payments to the federal government.

Such a system could hurt smaller producers particularly hard because they often receive less money for their production than large multinational companies, said L. Poe Leggette, partner-in-charge at Fulbright & Jaworski's Denver office.

Interior Department spokesman Patrick Etchart said they welcome the industry's comments. Interior wants a system "that provides fair certainty to us that we get paid the proper amount," he said.

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