Subsoil Privatization: The Ultimate Post-BP Spill Reform

Editor Note: This post complements a previous entry at MasterResource by Guillermo Yeatts,
Subsoil Oil and Gas Privatization: Private Wealth for the Common Good.]

Government intervention in free markets is prefaced on market failure. But no such rationale explains why federal and state governments have owned and managed hydrocarbon-bearing onshore and offshore lands. Government involvement can be explained by little more than the historical precedent of sovereign ownership of unowned property and of habit.

In a private property world, surface and subsurface areas would be unowned until the positive acts of discovery and intent to use. Under the “homestead” theory of first property title, the state of nature (unowned area) would not be the property of government but the first resource entrepreneur who, in the immortal words of John Locke, “tills, plants, improves, cultivates and can use the product of” the surface or subsurface to “enclose it from the common.”

Sovereign ownership would be displaced by a rational ownership system within the private sector, and individual accountability and economic incentives would reign over the inherent land-use conflicts on behalf of “all of the people.” The privatization process can follow many forms–such as a Cato Policy Analysis by Terry Anderson, Vernon Smith, and Emily Simmons, “How and Why to Privatize Federal Lands,” espousing a 20–40 year transfer. But other things equal, the sooner the transfer the better, so long as meeting the basic criteria as outlined by Anderson et al.: 

• Land Should Be Allocated to the Highest-Valued Use
• Low Transactions Costs
• Broad Participation in Divestiture Proceedings
• Recognition of Squatters’ Rights

As it is now, government ownership of a resource transforms authorities into central economic planners to answer the questions of who does what, when, where, and how much. Such is the position of the Minerals Management Service of the Department of Interior in regard to offshore leasing and publicly owned onshore development.

If all subsoil rights had been socialized in the United States, a severe economic calculation problem would have existed for the Department of Interior. But a coexisting (and much larger) private lease market, at least on dry lands, has provided crucial information that Interior over many decades has used to make decisions.

Nonetheless, political control over swaths of mineral-bearing subsoil for over a century has led to administrative problems at Interior such as:

· Alternating periods of artificially rushed development (from limited-term leases and due diligence requirements) and underdevelopment (from arbitrary public land withdrawals), both from property right uncertainty.

· Discouragement of voluntary unitization agreements, which drillers desired to overcome the “common pool” problems of overdrilling and drainage, followed by a mandatory unitization requirement.

· Inadequate audit and collection capacities, the subject of General Accounting Office and congressional concern from the late 1950s through the 1980s.

· Ill-conceived programs such as lottery leasing (officially known as the noncompetitive leasing program), since abandoned.

· Moratoria in recent decades for many of the most promising unexplored areas of mineral development in the country, the result of technologically obsolete environmental concerns waged by special interests.

Towards Subsoil Privatization

The most sweeping policy reform for oil and gas leasing of public land is subsoil privatization. A full privatization program would have all government property revert to a state of nature where ownership would accrue with discovery and use.

But in a second-best world (or as a transition program to full privatization) where the government holds the original title,

• Existing leases could be capitalized pursuant to a mutually acceptable valuation method to the lessee or lessor for sale and transfer;
• New leases would be awarded to the firm(s) or organization(s) submitting the highest qualifying bid (preferably by the pure bonus bidding method, explained below).

While title to the surface land (and water) would remain in the public domain, the lease rights would remain in perpetuity with the lessee. The grant would preferably be for exploration and production of all minerals, not just oil and gas, to enhance government revenue and encourage complimentary economic activity—all at market rates to encourage sustainable practices.

Under a market-conforming system of private ownership of the subsurface, government lease policy should:

· Proactively hold new lease auctions.

· Not restrict the universe of private eligible bidders, including bids made jointly by two or more companies or bidding by foreign entities, so long as minimum creditworthiness conditions are met.

· Grant the lease in perpetuity without “diligence” or “five-year” requirements that artificially encourage rapid development, while maintaining the desired level of environmental and safety safeguards and protection for adjacent properties.

· Grant full access to the winning bidder(s) to avoid multiple-use conflicts and obstruction attempts.

· Offer large blocks for lease from which the bidders can select contiguous tracts to avoid drainage competition and “piracy.” This would remove the need for mandatory unitization and other economic controls over drilling and production practices.

· Use a sealed bid procedure instead of oral bidding to avoid the single-bidder problem and reduce the probability of any successful collusion among bidders.

· Allow the new owner(s) to sublease or sell the rights to drill or produce to other parties, so long as all safety and environmental covenants in the original lease are honored and creditworthiness is not impaired.

· Avoid extraneous special-interest requirements such as mandatory sales to small or independent refiners.

A broad-based revenue distribution program where a number of jurisdictions share in the proceeds is also recommended to maximize the popularity of an active leasing program that promotes the national interest of abundant domestic energy resources.

Advantages of Subsoil Privatization

Subsoil privatization has a number of advantages over the status quo.

It would encourage timely drilling and production as economic conditions (costs and prices) dictated. A firm could choose to postpone drilling or production or quickly develop and extract any commercial quantities of hydrocarbons. The needs of tomorrow’s consumers would be efficiently accounted for vis-a-vis today’s consumers where the lessee can operate on a net present value maximization basis.

Government revenue would be in present dollars for immediate expenditure or reducing the national debt. Accounting costs on the private side and administrative costs from the government side could be minimized, and costly time-consuming royalty disputes between lessor and lessee would cease.

Non-energy companies (such as environmental groups) could translate their preferences into action—such as winning the right to preserve the subsoil in a state of nature for as long as they are willing to bear the costs. The problem of “getting individuals with diverse preferences to accurately and honestly reveal their values in the political setting” would be overcome through a competitive, open economic process.

Conclusion

In the wake of the BP oil spill in the Gulf of Mexico, the Obama Administration is cycling toward greater central planning at the Minerals Management Service. More rules, more regulation, and less cooperation with the regulated industry. Akin to Sarbanes-Oxley, such reform hurts the most diligent drillers to try to reform the least diligent operators.

The free market community should present another alternative to the pre-spill status quo and the post-spill rush to regulation.

Ibid., pp. 263–70.

Ibid., pp. 126–27, 269–80. Government intervention and legal missteps with private property law were a major factor in the “common pool” problem on private land as well. See idem., chapters 2–4.

Ibid., pp. 308–13; Federal Minerals Royalty Management, A Report Prepared by the Staff of the Committee on Interior and Insular Affairs of the U.S. House of Representatives with the Assistance of the General Accounting Office, 98^th Cong., 2^nd Sess. (Washington, D.C.: Government Printing Office, 1985). David Linowes, whose Commission of Fiscal Accountability of the Nation’s Energy Resources outlined reforms that were the basis of the Federal Oil and Gas Royalty Management Act of 1983, complained that problems still remained in 1988. Royalty Management Program, Hearing Before the Subcommittee on Mineral Resources Development and Production of the Committee on Energy and Natural Resources, U.S. Senate, 100^th Cong., 2^nd Sess. (Washington, D.C.: Government Printing Office, 1988), p. 3.

Bradley, Oil, Gas, and Government, p. 314.

In 1990, the American Petroleum Institute estimated foregone crude oil production in the U.S. from drilling bans on federal land at between 2 and 5 million barrels per day, which would be between 30% and 60% of current domestic production. API, “Energy Policy Priorities,” News Release, Washington, May 10, 1990. Even if this estimate was overly optimistic at the time, improved drilling and production techniques make this estimate more realistic today.

The case for full privatization—surface as well as subsurface—is not explored here. For such a proposal in the context of broader market reliance, including ocean homesteading, see, generally, Terry Anderson and Donald Leal, Free Market Environmentalism (San Francisco: Westview Press, 1991).

The Department of Interior has the option of capitalizing royalty streams pursuant to the Federal Oil and Gas Royalty Simplification and Fairness Act of 1996, Public Law 104-185, 110 Stat. 1700 at 1716 (1996).

Walter J. Mead and Dennis Muraoka, “Diligence Requirements in Federal Natural Resource Sale and Leasing,” Natural Resources Journal, vol. 27, No. 4 (1987), pp. 865-76.

Walter J. Mead, “Natural Resource Disposal Policy—Oral Auction versus Sealed Bids,” Natural Resources Journal, Vol. 7, No. 2 (1967), pp. 194-224.

Terry Anderson and Donald Leal, Free Market Environmentalism, p. 82.

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