It was after midnight and every lawmaker in the committee room wanted to go home, but there was still time to sweeten a deal encouraging oil and gas companies to drill in the Gulf of Mexico.
"There is no cost," declared Representative Joe L. Barton, a Texas Republican who was presiding over Congressional negotiations on the sprawling energy bill last July. An obscure provision on new drilling incentives was "so noncontroversial," he added, that senior House and Senate negotiators had not even discussed it.
Mr. Barton's claim had a long history. For more than a decade, lawmakers and administration officials, both Republicans and Democrats, have promised there would be no cost to taxpayers for a program allowing companies to avoid paying the government royalties on oil and gas produced in publicly owned waters in the Gulf.
But last month, the Bush administration confirmed that it expected the government to waive about $7 billion in royalties over the next five years, even though the industry incentive was expressly conceived of for times when energy prices were low. And that number could quadruple to more than $28 billion if a lawsuit filed last week challenging one of the program's remaining restrictions proves successful.
"The big lie about this whole program is that it doesn't cost anything," said Representative Edward J. Markey, a Massachusetts Democrat who tried to block its expansion last July. "Taxpayers are being asked to provide huge subsidies to oil companies to produce oil — it's like subsidizing a fish to swim."
How did a supposedly cost-free incentive become a multibillion-dollar break to an industry making record profits?
The answer is a familiar Washington story of special-interest politics at work: the people who pay the closest attention and make the fewest mistakes are those with the most profit at stake.
It is an account of legislators who passed a law riddled with ambiguities; of crucial errors by midlevel bureaucrats under President Bill Clinton; of $2 billion in inducements from the Bush administration, which was intent on promoting energy production; and of Republican lawmakers who wanted to do even more. At each turn, through shrewd lobbying and litigation, oil and gas companies ended up with bigger incentives than before.
Until last month, hardy anyone noticed — or even knew — the real costs. They were obscured in part by the long gap between the time incentives are offered and when new offshore wells start producing. But lawmakers shrouded the costs with rosy projections. And administration officials consistently declined to tally up the money they were forfeiting.
Most industry executives say that the royalty relief spurred drilling and exploration when prices were relatively low. But the industry is divided about whether it is appropriate to continue the incentives with prices at current levels. Michael Coney, a lawyer for Shell Oil, said, "Under the current environment, we don't need royalty relief."
The program's original architect said he was surprised by what had happened. "The one thing I can tell you is that this is not what we intended," said J. Bennett Johnston, a former Democratic senator from Louisiana who had pushed for the original incentives that Congress passed in 1995.
Mr. Johnston conceded that he was confused by his own law. "I got out the language a few days ago," he said in a recent interview. "I had it out just long enough to know that it's got a lot of very obscure language."
A Subsidy of Disputed Need
Things looked bleak for oil and gas companies in 1995, especially for those along the Gulf Coast.
Energy prices had been so low for so long that investment had dried up. With crude oil selling for about $16 a barrel, scores of wildcatters and small exploration companies had gone out of business. Few companies had any stomach for drilling in water thousands of feet deep, and industry leaders like Exxon and Royal Dutch Shell were increasingly focused on opportunities abroad.
"At the time, the Gulf of Mexico was like the Dead Sea," recalled John Northington, then an Energy Department policy adviser and now an industry lobbyist.
Senator Johnston, convinced that the Gulf's vast reservoirs and Louisiana's oil-based economy were being neglected, had argued for years that Congress should offer incentives for deep-water drilling and exploration.
"Failure to invest in the Gulf of Mexico is a lost opportunity for the U.S.," Mr. Johnston pleaded in a letter to other lawmakers. "Those dollars will not move into other domestic development, they will move to Asia, South America, the Middle East or the former Soviet Union."
Working closely with industry executives, he wrote legislation that would allow a company drilling in deep water to escape the standard 12 percent royalty on up to 87.5 million barrels of oil or its equivalent in natural gas. The coastal waters are mostly owned by the federal government, which leases tens of millions of acres in exchange for upfront fees and a share of sales, or royalties.
Mr. Johnston and other supporters argued that the incentives would actually generate money for the government by increasing production and prompting companies to bid higher prices for new leases.
"The provision will result in a minimum net benefit to the Treasury of $200 million by the year 2000," Mr. Johnston declared in November 1995, denouncing what he called "outrageous allegations" that the plan was a giveaway.
He won support from oil-state Democrats, Republicans and the Clinton administration. Hazel O'Leary, the energy secretary at the time, said the assistance would reduce American dependence on foreign oil and "enhance national security."
Representative Robert Livingston of Louisiana, then a rising Republican leader, declared that the inducements would "create thousands of jobs" and "reduce the deficit."
Many budget experts agree that the rosy estimates were misleading. The reason, they say, is that it often takes seven years before a new offshore field begins producing. As a result, almost all the costs of royalty relief would occur outside of Congress's five-year budget timeframe.
Opponents protested that the cost estimates were wrong, that the incentives amounted to corporate welfare and that companies did not need government incentives to invest.
"They are going to the Gulf of Mexico because that's where the oil is," said Representative George Miller, Democrat of California, during a House debate. "What we do here is not going to change that. We are just going to decide whether or not we are going to give away the taxpayers' dollars to a lot of oil companies that do not need it."
Industry executives and lobbyists fanned out across Capitol Hill to shore up support for the program, visiting 150 lawmakers in October 1995. The effort succeeded. A month later, Congress passed Mr. Johnston's bill.
A Missing Escape Clause
To hear lawmakers today, they never intended to waive royalties when energy prices were high.
The 1995 law, according to Republicans and Democrats alike, was supposed to include an escape clause: in any year when average spot prices for oil or gas climbed above certain threshold levels, companies would pay full royalties instead.
"Royalty relief is an effective tool for two things: keeping investment in America during times of super-low prices, and spurring American energy production when massive capital and technological risks would otherwise preclude it," said Representative Richard W. Pombo, Republican of California and chairman of the House Resources Committee. "Absent those criteria, I do not believe any relief should be granted."
But in what administration officials said appeared to have been a mistake, Clinton administration managers omitted the crucial escape clause in all offshore leases signed in 1998 and 1999.
At the time, with oil prices still below $20 a barrel, the mistake seemed harmless. But energy prices have been above the cutoff points since 2002, and Interior Department officials estimate that about one-sixth of production in the Gulf of Mexico is still exempt from royalties.
Walter Cruickshank, a senior official in both the Clinton and Bush administrations, told lawmakers last month that officials writing the lease contracts thought the price thresholds were spelled out in the new regulations, which were completed in 1998. But officials writing the regulations left those details out, preferring to set the precise rules at each new lease sale.
"It seems to have been a massive screw-up," said Mr. Northington, who was then in the Energy Department. No one noticed the error for two years, and no one informed Congress about it until last month.
Five years later, the costs of that lapse were compounded. A group of oil companies, led by Shell, defeated the Bush administration in court. The decision more than doubled the amount of oil and gas that companies could produce without paying royalties.
The case began as a relatively obscure dispute. Shell paid $3.8 million in 1997 for a Gulf lease and soon drilled a successful well. But the Interior Department denied the company royalty relief, saying that Shell had drilled into an older field already producing oil and gas. The decision hinged on undersea geography and the court's interpretation of language in the 1995 law.
A typical field, or geological reservoir, often encompasses two or three separately leased tracts of ocean floor. Interior Department officials insisted that the maximum amount of royalty-free oil and gas was based on each field. Shell and its partners argued that limit applied only to each lease.
Perhaps shrewdly, the oil companies sued the Bush administration in Louisiana, where federal courts previously had sided with the industry in spats with the government.
The fight was not even close. In January 2003, a federal district judge declared that the Interior Department's rules violated the 1995 law. If the department "disagrees with Congress's policy choices," Judge James T. Trimble Jr. wrote, "then such arguments are best addressed to Congress."
What might have been a $2 billion mistake in the Clinton administration suddenly ballooned into a $5 billion headache under Mr. Bush.
But even as the Bush administration was losing in court, it was offering new incentives for the energy industry.
Mr. Bush placed a top priority on expanding oil and gas production as soon as he took office in 2001. Vice President Dick Cheney's task force on energy, warning of a deepening shortfall in domestic energy production, urged the government to "explore opportunities for royalty reduction" and to open areas like the Arctic National Wildlife Refuge to drilling.
Gale A. Norton, who stepped down this month as interior secretary, moved quickly to speed up approvals of new drilling permits. Starting in 2001, she offered royalty incentives to shallow-water producers who drilled more than 15,000 feet below the sea bottom.
In January 2004, Ms. Norton made the incentives far more generous by raising the threshold prices. Her decision meant that deep-gas drillers were able to escape royalties in 2005, when prices spiked to record levels, and would probably escape them this year as well.
She also offered to sweeten less-generous contracts the drillers had signed before the regulation was approved.
"These incentives will help ensure we have a reliable supply of natural gas in the future," Ms. Norton proclaimed, predicting that American consumers would save "an estimated $570 million a year" in lower fuel prices.
Ms. Norton's decision was influenced by the industry. The Interior Department had originally proposed a cut-off price for royalty exemptions of $5 per million British thermal units, or B.T.U.'s, of gas. But the Independent Petroleum Association of America, which represents smaller producers, argued that the new incentive would have little value because natural gas prices were already above $5. Ms. Norton set the threshold at $9.34.
Based on administration assumptions about future production and prices, that change could cost the government about $1.9 billion in lost royalties.
"There is no cost rationale," said Shirley J. Neff, an economist at Columbia University and Senator Johnston's top legislative aide in drafting the 1995 royalty law. "It is astounding to me that the administration would so blatantly cave in to the industry's demands."
Incentives Keep Growing
Last April, President Bush himself expressed skepticism about giving new incentives to oil and gas drillers. "With oil at $50 a barrel," Mr. Bush remarked, "I don't think energy companies need taxpayer-funded incentives to explore."
But on Aug. 8, Mr. Bush signed a sweeping energy bill that contained $2.6 billion in new tax breaks for oil and gas drillers and a modest expansion of the 10-year-old "royalty relief" program. For the most part, the law locked in incentives that the Interior Department was already offering for another five years. But it included some embellishments, like an extra break on royalties for companies drilling in the deepest waters.
Lee Fuller, vice president of the Independent Petroleum Association of America, said smaller companies wanted to prevent future administrations from cutting back on incentives. "Having a clear, stable royalty policy was of value to independent producers," he said.
And energy companies, whose executives had long contributed campaign funds to Republican candidates, pushed to block any amendments aimed at diluting the benefits.
The push to lock in the royalty inducements came primarily from House Republicans. The only real opposition came from a handful of House Democrats, in a showdown about 1 a.m. on July 25, according to a transcript of the session.
"It is indefensible to be keeping these companies on the government dole when oil and gas prices are so high," charged Representative Markey of Massachusetts, who proposed to strip the royalty provisions. "We might as well be giving tax breaks to Donald Trump and Warren Buffett."
Mr. Barton, the Texas Republican, brushed aside the objections. He reassured lawmakers that the new provisions would not cost taxpayers anything.
When Mr. Markey proposed a more modest change — having Congress prohibit incentives if crude oil prices rose above $40 a barrel — Republicans quickly voted him down again.
"The only reason they waited until after midnight to bring up these issues is that they couldn't stand up in the light of day," Mr. Markey said in a recent interview. "They all expected me to give up because it was so late and I didn't have the votes. But if nothing else, I wanted to get these things on the record."
A Royalty-Free Future?
It is still not clear how much impact the reduced royalties had in encouraging deep-water drilling. While activity in the Gulf has increased since 1995, prices for oil and gas have more than quadrupled over the same period, providing a powerful motivation, experts say.
"It's hard to make a case for royalty relief, especially at these high prices," said Jack Overstreet, owner of an independent oil exploration company in Texas. "But the oil industry is like the farm lobby and will have its hand out at every opportunity."
The size of the subsidies will soar far higher if oil companies win their newest court battle.
In a lawsuit filed March 17, Kerr-McGee Exploration and Production argued that Congress never authorized the government to set price cut-offs for incentives on leases awarded from 1996 through 2000. If the company wins, the Interior Department recently estimated, about three-quarters of oil and gas produced in the Gulf of Mexico will be royalty-free for the next five years.
Mr. Markey and other Democrats recently introduced legislation that would pressure companies to pay full royalties when energy prices are high, regardless of what their leases allow.
But Republican lawmakers and the Bush administration have signaled their opposition.
"These are binding contracts that the government signed with companies," Ms. Norton recently remarked. "I don't think we can change them just because we don't like them."
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