A Path to Global Leadership on Fossil Fuel Subsidy Reform: 3 Steps to Slash Domestic Federal Coal Subsidies Through Executive Action

President Barack Obama gestures as he answers a question from the media during a press conference at the conclusion of the G-20 summit in Brisbane, Australia, November 16, 2014.

At the 2009 G-20 summit in Pittsburgh, Pennsylvania, President Barack Obama won commitments from the leaders of the major advanced and emerging economies to phase out fossil fuel subsidies. Since then, some countries have made some progress—India and Indonesia, for example—but much work remains to be done to rein in inefficient fossil fuel subsidies. The upcoming G-20 summit in Antalya, Turkey, on November 15 and 16 and the U.N. Framework Convention on Climate Change, or UNFCCC, conference in Paris in December provide important opportunities for countries to demonstrate progress toward their pledge of phasing out wasteful fossil fuel subsidies—and in doing so, to build momentum for a strong new international climate agreement.

While the Obama administration has succeeded in keeping fossil fuel subsidy reform on the G-20 agenda and has stopped providing taxpayer support for the construction of new coal plants overseas, its efforts have been hampered by the persistence of fossil fuel subsidies in the United States. Despite President Obama’s repeated efforts to strip approximately $4 billion of annual fossil fuel production subsidies from the federal budget, Congress has refused to cut these subsidies.

The Obama administration, however, can use its executive authority to cut another category of fossil fuel subsidies. The federal coal program, administered by the U.S. Department of the Interior’s Bureau of Land Management, or BLM, currently provides billions of dollars annually in inefficient fossil fuel subsidies to companies mining federal coal on publicly owned lands. Specifically, the administration should take three important steps to cut these subsidies: end the sale of coal at below-market value; eliminate subsidies for the transport and washing of coal; and end subsidies that promote the mining of coal that otherwise would be economically unviable.

Although the Interior Department collects more than $1 billion annually in bonus bids and royalty revenues from coal mining operations on federal lands, this amount is artificially low due to subsidies and thereby shortchanges U.S. taxpayers.

Stop selling federal coal at below-market prices

One of the largest subsidies provided by the Interior Department for coal mined on federal lands occurs through its undervaluation and sale of coal at below-market prices. Although the BLM is required by the Mineral Leasing Act to hold “competitive lease sales,” which offer companies the exclusive right to mine a parcel of federal land for coal, the BLM’s lease sales have been noncompetitive for decades. Due in part to a flawed leasing system in which a handful of coal producers control leasing through the lease-by-application process, roughly 90 percent of all federal coal lease sales since 1990 have had only one bidder.

Additionally, in spite of a statutory mandate to ensure that accepted bids for federal coal reflect “fair market value,” the BLM’s methodology for calculating the value of lease sales does not align with the market value of coal. By undervaluing these sales, the BLM essentially subsidizes federal coal production. An independent analysis by the Institute for Energy Economics and Financial Analysis found that the BLM’s undervaluation of coal may have cost taxpayers as much as $28.9 billion over the past three decades. Based on 2012 production data, Carbon Tracker and others have estimated that coal companies mining on federal lands in the Powder River Basin—a coal-rich region in the United States that stretches across Wyoming and Montana and sources 90 percent of all federal coal—receive an effective production subsidy of $2.59 per metric ton.

The Interior Department Office of the Inspector General, or OIG, also has determined that the BLM is not obtaining fair market value for coal under modifications of existing leases, in which companies apply to alter existing leases to expand operations into adjacent lands. The OIG found that 45 such lease modifications since 2000 were, on average, 80 percent lower in price than new lease sales over the same period. This is due in part to the Interior Department’s goal of “achieving ‘maximum economic recovery’ of the natural resource by developing coal that would otherwise go unmined.”

The Interior Department’s regulations also require that the agency set a minimum bid for lease sales to ensure that taxpayers receive fair market value for federal coal from the auction. However, the current minimum bid requirements are inadequate and often lead to federal coal sales of less than $1 per ton—significantly less than what the same coal fetches on both domestic and international private markets. A Sightline Institute report found that low-cost federal coal is being bought readily at low prices and resold for much higher at a significant loss to taxpayers. The report outlined several instances; in one example, Cloud Peak Energy purchased coal at its Spring Creek mine for $0.11 and $0.18 per ton and sold much of this coal abroad for more than $60 per ton. The BLM should raise the minimum bid for federal coal to ensure that it is selling coal at fair market prices.

The constant undervaluation and sale of federal coal has had far-reaching effects. Federal coal from the Powder River Basin sells for $13 per ton, or roughly one-fifth of the price of Appalachian coal, which grossly undercuts Appalachian coal and distorts energy markets. Even after accounting for the differences in energy content, Powder River Basin coal sells for one-third of the cost of Appalachian coal.

Eliminate transportation and washing subsidies that lower the royalty obligation of companies

Under the Interior Department’s coal program, companies receive generous transportation and washing allowances for coal produced from federal lands. Companies can deduct unlimited transportation and washing costs from the total sale price upon which royalties are due, significantly reducing their overall royalty obligation.

This subsidy is akin to a tax deduction. Coal companies receive potentially unlimited deductions for the costs of transporting federal coal to a sales point remote from the mine and lease or to a washing plant. Because the transportation and washing subsidies depress the price upon which a royalty is calculated, the federal government is effectively subsidizing a coal company’s royalty obligation. By comparison, similar transportation deductions for the oil and gas sector are capped at 50 percent of the value of the commodity, and processing allowances for certain gas products are not even permitted.

Transportation and washing allowances should be eliminated because—as with refining oil or processing gas—washing is a process used to improve impurities of coal to make coal marketable and is thus a cost that should be borne by the coal company. The Mineral Leasing Act has been interpreted as obligating lessees to place mineral resources they extract in “marketable condition” at no cost to the government. Marketable condition is defined as “coal that is sufficiently free from impurities and otherwise in a condition that it will be accepted by a purchaser under a sales contract typical for that area.” Washing costs are costs associated with making federal coal marketable and should therefore be the responsibility of the lessor or coal company.

End royalty rate reductions that subsidize uneconomically viable coal

The Interior Department currently reduces the royalty rate it charges coal companies in instances of corporate financial hardship or when coal production would not be economically viable. The royalty rate is 12.5 percent for surface-mined coal and 8 percent for underground-mined coal. However, studies have shown that the royalty rate actually paid by coal companies is often significantly less. A review by Headwaters Economics—an independent, nonprofit research group—found that the average, effective royalty rate paid by coal companies on federal lands is 4.9 percent after accounting for royalty rate reductions, cost deductions, and other subsidies. The study also found instances of coal companies paying a royalty as low as 2 percent of the sales price if a mine becomes unprofitable due to adverse conditions, such as limited access to coal, a decrease in its quality, or a company’s claim of financial hardship. Estimates place the cost of the federal government’s royalty rate reductions on existing leases at $37 million annually, or an estimated $860 million total in subsidies for existing leases.

Conclusion

The subsidies provided by the Interior Department to mine and sell coal likely have cost U.S. taxpayers tens of billions of dollars. Moreover, federal coal program subsidies distort U.S. energy markets, incentivize the burning and export of U.S. coal, disadvantage cleaner sources of energy, and hamper the ability of the United States to push other G-20 countries to honor their own commitments to phase out fossil fuel subsidies. While Congress continues to block the administration’s efforts to eliminate oil production subsidies, the United States can still make progress toward building a clean and robust domestic—and global—economy by doing away with inefficient subsidies for coal on federal lands.

Nidhi Thakar is the Deputy Director of Public Lands at the Center for American Progress. Pete Ogden is a Senior Fellow at the Center.