On Tuesday, the Bureau of Land Management will hold a public meeting in Billings to hear from citizens about proposed reforms to the federal coal program; including raising the royalty rate, (BLM is also considering raising rates on other fossil fuels.)
Past policy changes have created winners and losers with significant implications for energy-dependent communities, so the current proposals deserve careful scrutiny and analysis.
In the 1970s, energy policy discouraged the use of natural gas and created significant demand for coal. Later, the Clean Air Act of 1990 resulted in dramatic shifts away from Eastern coal that is relatively high is sulfur content toward large Western surface mines such as the Powder River Basin.
Today, low natural gas prices from the fracking boom and new clean air regulations limiting mercury and air toxics (and potentially carbon emissions) are driving a transition away from coal. Natural gas surpassed coal as the largest contributor to electric production for the first time ever this spring.
Montana and Wyoming rely heavily on revenue from natural resources to fund our schools, fix our roads, and build parks and trails in our communities. However, dependence on volatile resource revenue can deepen our exposure to the risk of a commodity bust, placing our budgets and workforce at greater risk.
In light of this, what is the likely impact of reforms to coal royalties? First, it’s important to note that the current royalty structure is unwieldy, costly to administer, and not clear about whether taxpayers receive a fair return.
The effective royalty rate on coal — measured against market prices — is 4.9 percent, well short of statutory rates (12.5 percent and 8 percent on surface and underground coal), and lower than the effective rate on natural gas (9.7 percent), according to our research at Headwaters Economics.
Future reforms also should help create the resources needed for more predictability and stability in energy-dependent communities so they can better avoid energy booms and busts.
If coal royalties utilized the net delivered price and limited transportation cost deductions federal revenue would increase by $512 million annually (a 73 percent increase). Higher federal royalty distributions to states would exceed declines in state tax revenue: Montana would receive between $5.1 million and $8.8 million in additional annual revenue; Wyoming between $58 and $234 million more annually.
Headwaters Economics also analyzed scenarios in which rates rise to 16.67 percent and 18.75 percent on surface coal and natural gas — with a proportional rate increase for underground coal. These rates would increase federal revenue from between $191 and $288 million after five years, and $350 to $528 million after ten years.
Additional revenue can be realized without changing demand for coal. First, research shows the elasticity of demand for coal is low — meaning changes in prices have a limited effect on demand.
Second, if the BLM raises rates on other fossil fuels at the same time (which it should), the cost of delivering natural gas to power plants will rise by a larger amount compared to coal, giving coal a (small) advantage. This minor benefit is not full comfort for an industry losing ground to natural gas, but it is important that royalty reform will not make matters worse.
Higher royalties should not be viewed as a further challenge to the coal industry. Rather, higher royalties present an opportunity to rethink fiscal policy that can create greater resilience in resource-dependent communities as we move away from coal for other reasons.
Roughly half of new royalty revenue will be shared with states like Montana or Wyoming, allowing them to save and invest this new money in ways that avoid further dependence on volatile royalty payments.
In addition, the BLM should create a natural resources trust fund for the benefit of communities near public lands. We estimate BLM could build up a fund of more than $8 billion over 20 years that can fund infrastructure, schools, and economic development activities in communities exposed to the boom and bust dynamics of fossil fuel extraction.