Extracted from Law360
On Nov. 26, the U.S. Department of the Interior issued its "Report on the Federal Oil and Gas Leasing Program" following a review of onshore and offshore oil and gas programs.
The report's recommendations, coupled with ongoing regulatory and legislative action at the federal level, have the potential to increase the price of oil and gas and harm American energy independence.
The timing of the recommendations could not be worse. President Joe Biden's administration has already begged OPEC+ nations to increase their oil output amid rising oil prices, which has the potential to cause an economic slowdown.
This is particularly true if demand for crude recovers from what appears to be an overreaction to the omicron variant. It certainly is unclear what climate change goals, if any, the report's recommendations would help achieve.
Indeed, forcing Americans to buy gas produced from oil shipped thousands of miles across the oceans of the world is entirely counterproductive to the goals set by, among others, the Paris accords, to eliminate greenhouse gases while cratering the energy independence recently achieved in the United States.
The Federal Oil and Gas Program (Onshore)
The U.S. Bureau of Land Management oversees the management of mineral resource development on approximately 245 million acres of federal onshore lands and 700 million acres of subsurface federal minerals, which is guided by the Mineral Leasing Act.
Federal onshore oil and gas production accounts for approximately 7% of domestically produced oil and 8% of domestically produced natural gas. The BLM currently manages 37,496 federal oil and gas leases covering 26.6 million acres with nearly 96,100 wells.
The Federal Oil and Gas Program (Offshore)
The U.S. Bureau of Ocean Energy Management and Bureau of Safety and Environmental Enforcement oversee the development of mineral resources on the U.S. Outer Continental Shelf, or OCS. The OCS consists of submerged lands totaling nearly 2.3 billion acres in the Pacific, Atlantic, Gulf of Mexico and offshore Alaska and Hawaii.
In fiscal year 2020, the OCS produced approximately 642 million barrels of oil and 910 million cubic feet of gas, accounting for 16% of all oil production and 3% of natural gas production in the United States. Most of this production is in the Gulf of Mexico.
Of the more than 12 million acres under lease, about 45% is either producing oil and gas or is subject to approved exploration or development plans, which are preliminary steps leading to production.
Executive Order No. 14008
During the 2020 presidential campaign, Biden promised he would "ban[] new oil and gas permitting on public lands and waters." Biden's promise was met with mixed reactions. While climate activists favored the president's campaign promise, industry groups feared that a ban on new oil and gas permitting on federal lands would hurt jobs and increase reliance on foreign oil.
Once elected, Biden took steps to keep his campaign promise. On Jan. 27, Biden signed Executive Order No. 14008, "Tackling the Climate Crisis at Home and Abroad," which introduced the administration's policies to address climate change. At issue is Section 208, which instructed the secretary of the interior to "pause new oil and natural gas leases on public lands or in offshore waters pending completion of a comprehensive review."
Following Biden's signing of Executive Order No. 14008, 13 U.S. states sued the administration, challenging the pause of new oil and gas leases on public lands or offshore waters.[1] The states alleged that this pause violated the U.S. Constitution; Administrative Procedure Act; Outer Continental Shelf Lands Act, or OCSLA; and MLA.
In addition, the states alleged that the pause deprived them of a substantial share of the proceeds from leasing sales under the OCSLA, Gulf of Mexico Energy Security Act and MLA. The states also moved for a preliminary injunction to block the DOI and other federal agencies from implementing the pause of new oil and gas leases on public lands or in offshore waters.
On June 15, Judge Terry Doughty of the U.S. District Court for the Western District of Louisiana granted the plaintiff states' motion for preliminary injunction.
The court found that the states were likely to succeed on the merits because (1) neither the OCSLA nor MLA gives the DOI authority to pause lease sales and requires that it continue to sell eligible oil and gas leases; (2) the pause is arbitrary and capricious because Executive Order No. 14008 did not offer any explanation for the pause, other than to perform a comprehensive review; and (3) the DOI failed to provide a public notice and comment period.
The Biden administration has appealed the court's order.
DOI's Report on the Federal Oil and Gas Leasing Program
In addition to pausing new oil and gas leases on federal land, Executive Order No. 14008 also directed the secretary of the interior to conduct a review of federal oil and gas leasing and permitting practices.
The federal district court's order on the preliminary injunction in Louisiana v. Biden did not affect the requirement in Executive Order No. 14008 that the secretary complete this review.
Accordingly, on Nov. 26, the DOI issued its "Report on the Federal Oil and Gas Leasing Program," which focuses primarily on reforms to fiscal terms, leasing processes and remediation requirements related to the federal oil and gas programs. The report provides a high-level blueprint with recommendations on how to "modernize the onshore and offshore oil and gas leasing programs."
Royalties
The MLA was passed in 1920 and set royalties at a minimum of 12.5% for oil and gas produced from federal lands, but royalty rates have not been increased since the passage of the MLA. According to the DOI, states with leading oil and gas production apply royalty rates on state lands that are significantly higher than those assessed on federal lands — the royalty rate in Texas can double the federal rate.
Accordingly, the report recommends that the BLM adjust royalties for competitive leases offered in individual lease sales and initiate a rulemaking to establish a higher minimum royalty for onshore oil and gas leases. The report further recommends that the BLM consider limiting discretionary royalty relief, even though the BLM has provided discretionary royalty relief extensively to lessees in the recent past.
It appears the DOI's proposed increase in royalty rates is a purely fiscal measure and is unlikely to have any impact on the Biden administration's efforts to decrease production on federal lands or mitigate climate change.
Indeed, in June 2017, the Government Accountability Office reported that studies showed that raising federal royalty rates for onshore oil and gas could "decrease production on federal lands by either a small amount or not at all" but "could increase overall federal revenues."
The royalty rates also have the potential to increase oil and gas prices as the nation faces decreased supply and increased demand.
Bonus Bids
A bonus bid is the price paid at a lease sale for an oil and gas lease.
The minimum bonus bid is set at $2 per acre. According to the DOI, the Government Accountability Office has found that leases purchased with a higher bonus bid of more than $100 per acre are over 20 times more likely to be developed in their first lease term than leases purchased with the minimum bid of $2 per acre.
The report recommends that the BLM initiate a rulemaking to increase the minimum bid to discourage speculation and provide higher rates of return to taxpayers.
Again, the report's recommendation appears to be a purely fiscal measure since it is designed to encourage higher rates of return to taxpayers while incentivizing production within the first lease term.
Bonding
Current regulations require financial assurance from all lessees to ensure compliance with lease terms and requirements, which is generally provided in the form of a lease surety bond. A lease surety bond remains in place until all lease obligations have been met, including decommissioning.
According to the report, insufficient bonding levels provide an inadequate incentive for companies to meet their reclamation obligations and increase the risk that taxpayers will be required to cover the cost of reclaiming wells if the operator refuses to do so or declares bankruptcy. The report recommends increasing the minimum bond amounts.
But the report does not provide any justification for increasing bond amounts aside from the fact that they have not been adjusted for inflation. While the report states that increasing bond rates would incentivize companies to meet their reclamation obligations, the report does not identify any widespread deficiencies in companies failing to meet these obligations for onshore oil and gas activity.
Prioritizing Other Uses Over Oil and Gas
Through the land use planning process, the BLM determines what lands may be available for oil and gas leasing, what lease stipulations will be applied to protect other resources and values, and what conditions of approval may be necessary on permits to drill for additional protection. As an overarching policy, the report recommends that the BLM ensure that oil and gas is not prioritized over other land uses.
However, prioritizing other uses over oil and gas is an incredibly weak method to mitigate climate change, which is the ultimate goal of Executive Order No. 14008.
For example, deprioritizing oil and gas uses on federal lands has the potential to result in greater reliance on foreign production from nations with weaker environmental standards compared to production from U.S. federal waters and onshore lands, contributing to carbon leakage, damaging U.S. competitiveness, stifling U.S. production, and resulting in higher oil and gas prices.
In response to rising prices and supply concerns, the Biden administration has already urged OPEC countries to increase production. By prioritizing other uses on federal lands over oil and gas, it is likely that the U.S. will become more reliant on imported oil, which is often more carbon intensive than domestic oil.
Implications of the Report
The DOI's report has been criticized by both climate activists and the oil and gas industry.
On the one hand, climate activists hoped that the report would recommend a pause or phase-out of oil and gas leases on federal lands, but such a recommendation was unlikely in light of the district court's preliminary injunction order in Louisiana v. Biden.
On the other hand, industry views the report's recommendations as another attack on oil and gas that will harm American energy independence and lead to increased oil and gas prices.
While the report's recommendations hold little weight without congressional and regulatory action, they signal the Biden administration's commitment to take historic action to reform how the oil and gas industry conducts its business.
But will these recommendations help achieve the administration's goals of mitigating climate change? Probably not. By disincentivizing oil and gas production on federal lands, the government may risk increasing emissions of carbon dioxide and undermining the Biden administration's climate change goals.
As oil and gas production becomes more expensive and restrictive at home, the U.S. will face increased reliance on foreign oil. This is not an imaginary or speculative consequence of these regulatory actions. In the face of rising oil and gas prices, Biden has asked OPEC and Russia to increase oil and gas production.
While North American crude oil is transported via pipelines, oil from South America, Russia and the Middle East is transported via oil tanker ships, which make up a large proportion of maritime emissions. Increasing imports of foreign oil has the potential to kill good-paying American energy jobs and raises national security concerns as the U.S. becomes more reliant on foreign oil to meet domestic energy demands. Many of these foreign nations do not have the same environmental and human rights standards as the U.S.
The Biden administration and a large portion of Congress have signaled that the DOI's report is just one part of their effort to keep oil and gas in the ground. The U.S. House of Representatives recently passed a reconciliation text that would place millions of dollars annually in new fees on energy companies. These efforts will almost certainly be met with strong opposition and legal challenges.
[1] State of Louisiana, et al. v. Joseph R. Biden, Jr., et al. (W.D. La. Case No. 2:21-cv-00778-TAD-KK).