corruption

Natural resource giveaways to friends and family have long been a global concern, and there is an extensive literature documenting the problem.  This 1999 paper by the International Monetary Fund, for example, finds a link between the degree to which a nation or state is dependent on natural resources and the level of corruption.  This paper from 2009 divides the problems into corruption and patronage:

Resource rents induce rent-seeking as individuals compete for a share of the rents rather than use their time and skills more productively. And resource revenues induce patronage as governments pay off supporters to stay in power, resulting in reduced accountability and an inferior allocation of public funds.

Diversion of extraction rights and payments from natural resource endowments is such a large problem, and so widespread, that a global effort has been made to address it systematically through the Extractive Industry Transparency Initiative.  By standardizing data and requiring reporting of key information along the value chain of this industry, EITI can make diversion and corruption much more difficult to hide.  If it is harder to hide, it happens less often.  And less corruption also has benefits for international competition.  If all parties know their side payments and special deals will be visible, and no one party can get a competitive advantage this way, the cost structure of the entire industry isn't eroded as it would be in a corrupt system. 

Trump administration seeking to strip transparency, pump up lease volume

Despite the benefits of EITI, the Trump Administration withdrew in November of 2017.  Bloomberg notes that the US joined Azerbaijan in this regard. It is notable that Azerbaijan is ranked in the bottom third of countries in terms of the Transparency International 2017 corruption perceptions index , with a score of only 31 out of 100. 

The American Petroleum Institute, along with some oil majors, fought behind the scenes against the required reporting under EITI.  While their polished PR staff have verbally committed to addressing corruption and transparency in other ways, their words are worthless absent required disclosure.  They obviously know this.

At the same time, the Trump administration has ramped up its effort to open all offshore areas for oil and gas leasing (a map showing planned sales in the lower 48 states is at the top of this post), and advocated more onshore activity as well. 

A number of detailed reviews of federal management of oil and gas leases released recently illustrate that the federal government is not doing a great job protecting taxpayer interests in the sale of these natural assets.  Poor management results in inadequate returns to taxpayers, elevated returns to private firms, and increased environmental damages.  Further assessment would be needed to evaluate whether the pattern of enrichment to private firms maps closely to political giving and personal relationships with politicians, or not.  If so, this is the classic example of patronage mentioned in so many of the global studies on natural resource-related corruption.   

Twenty years of non-competitive, low return federal offshore leasing

The Project on Government Oversight reviewed lease data from 1997 through 2017 to evaluate long term trends in offshore leasing.  Analysts David Hilzenrath and Nicholas Pacifo found that taxpayer returns on offshore lease auctions have been declining over time, that having more tracts open at once results in less competitive auctions (and lower returns), and that more than three-quarters of the federal offshore auctions drew only a single bidder.  Only 2% of the auctions had five or more bidders. 

The dynamics of weak competition being associated with low bids is not rocket science: any Joe with an e-bay store knows it.  Yet to see such well-know market problems playing out on the scale of an entire country's oil and gas sales is highly troubling.

POGO found that a majority (80%) of the leased tracts were also classified as "non-viable," allowing them to move towards auction despite the government lacking comprehensive geologic data on the area.  This classification also gave government officials more latitude to accept the "high" bid even if there were few bidders, or to accept the only bid so long as it exceeded a very low minimum threshold. 

It turns out that many of these leases were viable after all, with 69% of the tracts from all sales that went into production coming from this non-viable cohort. 

The lack of geological data by the resource owner (i.e., the government) might not be a big deal in a situation with many capable bidders.  A robust auction process can often generate adequate price discovery.  But with a single bidder, the lack of data and ability to accept bids from a sparse bidding field both contribute to taxpayer losses. 

POGO's analysis shows that from 1954-1983, offshore auctions generated on average more than 3 bids per acre, and bid payments averaging close to $9,100 per acre leased.  In 1983, area-wide leasing was introduced, which opened many acres at once to bidding.  Taxpayer returns fell sharply:  on average, each acre auctioned since the introduction of area-wide leasing garnered only 1.36 bids, and payments of less than $400 per acre leased. 

It should be noted that problems with uncompetitive auctions also apply to federal coal, with similar adverse impacts on taxpayer returns from the sale of natural resources from public lands.  For example, the massive Powder River Basin (PRB) coal deposit in the Western US leases most of its acreage using a "lease by application" process where existing producers initiate a request to mine nearby acreage.  There is rarely more than one bidder, and the prices gained by the Treasury are low.  For more on PRB coal subsidies, go here and here. 

The federal resource management agencies do have some history of liking to party.  Given the poor economics of dumping all of your supply onto markets at the same time, in a relatively low price environment, with too few bidders to generate competition on lease access even with fewer leases going to auction, and with no consideration on potential impacts on some of the richest fisheries in the US, the administration's current leasing plans are best viewed through the lens of drunken revelry.  My home state of Massachusetts alone has the third largest commercial fishery industry in the country, generating $7.3 billion in sales in 2015.  This is more than the federal government earned from offshore oil and gas that same year (see table below).  No wonder the states are looking to shut the party down. 

But the administration doesn't seem to care much about taxpayer return; rather the goal seems to be to pump up domestic supply as much as possible.  Rather than ration the leases to achieve better returns on auctions, the Royalty Policy Committee at Ryan Zinke's Department of Interior recommended lowering the royalty rate on new leases.  POGO notes that:

Of the 20 primary members, 16 work within the oil, gas, and mining industries or for states and tribes heavily dependent on those industries. Several representing academia and “public interest” groups have ties to industry, raising questions about how much balance they will bring to the committee’s deliberations.

You can read about each member's conflicts of interest at this website.  Jayni Hein at the Institute on Policy Integrity at New York University School of Law filed detailed comments against lowering the rates.  And, while their arguments (shared by many others) make a great deal of sense, overcoming the conflicts of interest will not an easy task. 

What's a little free gas between friends?

Let's say you go to dinner at a restaurant.  You are really hungry, so your order two dinners.  Turns out, the first one fills you up, and while the second one is equally tasty, you no longer want it.  So you tell the waiter at the end of the meal that you just want to pay for one. 

Nobody does this.  Because they know that the restaurant bought the food, cooked the food, and gave it to you.  If you don't use the food, they can't sell it and the value is gone.  You have to pay for it even if you didn't eat it. 

For some reason, oil and gas companies think the natural gas they take out of public reserves should be different.  If they don't stick it in their pipeline but instead flare or vent it, or they simply lose it, they think they shouldn't have to pay royalties on it.  But like the wasted dinner, wasted gas is gone.  It used to belong to somebody else, and whether you squandered it or your sold it, you need to pay the original owner.  There are good economic reasons for this as well:  nothing gets wasted more than something that is totally free.

But with the current system, if the extraction firms are getting more valuable oil from the hole, and the natural gas is expensive to process and pipe, they don't want to waste time building pipelines or processing stations before they can pull out their oil.  And they think it is just fine to just burn it off the and move on like nothing happened. 

These are not itty bitty bits of natural gas:  the push for high value oil in North Dakota resulted in so much gas flaring that it was visible from space, shining as brightly as some cities.  It took years to get any regulations in place on flaring in the Bakken, and those regulations continue to be fairly ineffective.  In part due to the huge amounts of gas flared in the Bakken region, the US has been among the world's top gas flaring nations for years now -- shifting between 4th and 6th place over the 2013 to 2016 time frame (see graphic below).  

And whether flared, vented, or simply lost, if the gas originated on federal lands, much of it was free to the extraction firm.  The most recent analysis (Gas Giveaways: Methane Losses are a Bad Deal for Taxpayers) was released by Taxpayers for Common Sense earlier this month.  They found that:

• In 2016, royalties were charged on just 16.3 percent of all natural gas lost by oil and gas companies operating on federal lands, down from 29.6 percent in 2015.
• Of all gas lost in the decade 2007-2016, only 11 percent was charged a royalty.
• Overall, oil and gas companies reported losing 25.4 billion cubic feet (bcf) of natural gas in 2016, bringing the total amount of gas lost over the decade 2007-2016 to 209.7 bcf.
• Gas losses from federal lands have increased in recent years. The 2016 lost gas total is more than double the amount reported in 2010, but it is down from the peak in 2015.
• The large increase in annual gas losses from 2007 to 2016 was driven by flaring from oil wells on federal lands. In 2007, oil well flaring composed just 17 percent of total lost gas, compared to 75 percent in 2016, the highest level yet recorded.
• The gas lost on federal lands in 2016 was worth an estimated $75.5 million, while gas lost over the decade was worth an estimated $1.07 billion.

This is not just a federal issue.  Since federal leases often share royalties with state and tribal authorities, those government entities also lose out from royalty-free gas.  Wells on state lands in key producing states may exempt flared and vented gas from royalties as well.  Salzman and Dillon note there are full exemptions in Kansas, Texas, Louisiana, and Wyoming; North Dakota has partial exemptions.  State laws may also govern what gas can be charged royalties even on private wells, extending the class of parties who lose from gas giveaways.  We can, and need, to do better.

1)  Nuclear economics continue to worsen.  In addition to widespread cancellations of new nuclear reactors and an increasing number of announced closures of older plants too expensive to repair and keep running (Crystal River in FL, Kewaunee in WI, and San Onofre in CA in the past six months), power uprate projects are also being terminated.  Exelon is taking a $100 million charge associated with ending planned expansions in Illinois and Pennsylvania due to weak market demand.  The firm cancelled two other power uprate projects in 2011.

Increasing output at existing plants, and keeping older plants running longer are two strategies that have historically been financial wins for plant owners.  The power output achieved required much lower overall capital investments than building a new facility with far lower risks of large cost overruns.  Both reduced financial risks substantially.  The continued cancellation and closure trend across the board of nuclear projects is another indication that the long-hyped nuclear "renaissance" is unlikely to happen.

2)  Southern Company CEO Tom Fanning upset government money isn't cheap enough.  One of the only remaining new reactor projects in the US is Vogtle 3 and 4 in Georgia.  Southern Company, through its Georgia Power Subsidiary, is a big player in that effort both in terms of ownership stake and its role in project management.  The Vogtle construction is by no means a case study in market economics:  the project benefits from a host of subsidies, including tax exempt debt, construction work in progress rules that shift financing costs onto current customers, long-term power purchase agreements with municipal customers that require payout even if the reactor is never completed or the power is above-market, and multi-billion dollar loan guarantees. 

But Southern is upset that DOE money in the form of a $3.5 billion loan guarantee (separate loans with different terms apply to the other Vogtle owners) is too expensive.  CEO Fanning refers to changes in the terms following the Solyndra loan guarantee default as being unwarranted.  A reasonable observer might instead suggest that the Fukushima nuclear accident, credit market meltdown, and plunging demand for electricity (as well as lower prices) due to recession and fracked gas, were also factors.  Such an observer might also point out that such changes on the part of a lender were both prudent and reasonable; and that Southern had been an important player in dragging out negotiations with DOE long enough such that the worsening market conditions could be addressed in the terms of the open loan. 

Or at least we can hope they were.  The most recent available version of the draft loan agreement between DOE and GPC (from January 2013) can be accessed here.  It is long and detailed, but still has some important gaps.  For example, much remains unknown about specific credit subsidy amounts DOE has proposed (2010 was the latest release of credit subsidy cost figures) and how collateral and owner repayment obligations would play out in a real bankruptcy.

The draft agreement includes a number of clauses about an obligation to repay the feds in the case of a Vogtle default.  However, a corporate guarantee from Georgia Power would provide less solace to creditors about being made whole than would one from its Southern Company parent.  Detailed clauses on collateral continue to suggest that there may be limits well short of the entire firm on what the borrower would be on the hook to use for full repayment in the case of a default.  It is notable that at least through the middle of 2012, many of the open issues between DOE and Georgia Power involved disagreements over what collateral DOE could tap into in the case of a project failure.

If the federal money is really too expensive, Fanning always has the option to forgo the federal loan entirely and tap private capital markets instead.  That is a course of action I personally would be quite happy to see.  It might actually be in the long-term best interest of the nuclear industry as well were it to demonstrate that new reactors could be (mostly) privately financed.

A review of issues related to the proposed Vogtle loans by Earth Track and Synapse Energy Economics released in January can be accessed here.

3)  Maybe this is one factor in why their reactor costs are so low.  Multi-country reviews of nuclear power costs, such as this one by OECD in 2010 quoted by the World Nuclear Association, regularly show South Korea as the lowest or near-lowest in the World.

Nuclear overnight capital costs in OECD ranged from US$ 1556/kW for APR-1400 in South Korea through $3009 for ABWR in Japan, $3382/kW for Gen III+ in USA, $3860 for EPR at Flamanville in France to $5863/kW for EPR in Switzerland, with world median $4100/kW. Belgium, Netherlands, Czech Rep and Hungary were all over $5000/kW. In China overnight costs were $1748/kW for CPR-1000 and $2302/kW for AP1000, and in Russia $2933/kW for VVER-1150. EPRI (USA) gave $2970/kW for APWR or ABWR, Eurelectric gave $4724/kW for EPR.

The figures for countries with extensive state involvement in particular sectors -- Eastern Europe and much of Asia are common examples -- are hardly clean market metrics.  Governments routinely provide large amounts of direct financing or credit support, and often underwrite accident, operating, and post-closure risks.  Where supplier firms are state-owned, economic murkiness grows still further.

But far more troubling than the role of an opaque state is the recent disclosure of corruption within the South Korean nuclear sector, deploying sub-standard equipment in reactor projects around the world.  The firms involved include core industry players, raising the obvious question as to whether the corruption and parts problem have been a factor in the domestic nuclear market as well.

4)  UK Parliament broad review of energy subsidies.  The UK Parliament has recently launched a significant information gathering effort on energy subsidies to inform the country's energy policy going forward.  The main link to background reports and testimony is here.  A brief submittal by Energy Fair, a UK organization focused on nuclear issues, covering UK nuclear subsidies, can be accessed here.