chapter  22
US royalty relief, rent sharing and offshore oil production
Pages 5

Under the Deepwater Royalty Relief Act (1995), royalty relief is given as an incentive to increase offshore oil exploration, development and production; relief was given on leases awarded between 1996 and 2000 for drilling in water in the Gulf of Mexico deeper than 200 meters. When the program expired in November 2000, the responsible authority, the Minerals Management Service, continued with a similar relief arrangement. In August 2005 the Energy Policy Act came into force; section 344 extended royalty relief to gas production in US waters of more than 200 meters deep, and section 345 provided for additional mandatory royalty relief for deepwater oil drilling. 2 However, the 2008 federal budget proposed repeal of sections 344 and 345 of the 2005 Act. 3 This short chapter discusses why repeal of royalty relief is justifi ed in terms of fairer sharing of economic rents between oil companies and the owners of US submerged lands – American citizens. Admittedly, repeal of royalty relief could reintroduce a small tax distortion to offshore oil activity to the extent that royalty payments render some deepwater offshore oil production uneconomic. However, as the calculations by Ashton, Upton and Rothkopf (2005) discussed below imply, the distortionary effect of royalties on US deepwater offshore oil activity is slight, while their effect on lost government revenue is very great. A fair-minded observer might conclude therefore that the distortion-fair shares tradeoff offered by the ending of royalty relief was worthwhile accepting. 4

Ashton, Upton and Rothkopf (2005) calculate that royalty relief offered to oil companies for wells drilled in marginal, deepwater fi elds has little effect on oil production, but could cost the government a great deal in forgone royalty revenues. Projected total oil production was expected to increase by only 0.9 percent, gas production by 0.6 percent, and offshore oil reserves by only 1.1 percent. The cost of these small increases in reserves and output is estimated to be about $48 billion in present value (2003 constant dollar) terms, or 7 percent of projected offshore oil and gas royalty revenues.