It might be time to buy a bicycle.
The Biden Administration just made an announcement that could send gasoline prices higher and keep them elevated for longer. It’s a strange announcement that comes after efforts by the government earlier this week to try to mitigate sky high gas prices.
The news is that the White House says it wants to see an increase the royalty payments the government charges oil companies to drill on Federal land. Nominally, that would seem reasonable as the government is in the midst of a spending bonanza and needs more revenue. It also fits with the climate agenda of the Democratic Party.
What it doesn’t fit with is the stated desire of the administration to see more moderate gasoline prices, announced days ago.
In practice a higher royalty rate charged to exploration and production companies, such as those held in the Energy Select Sector SPDR Fund XLE exchange-traded fund, will reduce future oil supplies and so keep gas prices higher than they would have been.
It works like so. While many projects will be profitable under the new royalty arrangement, some will not make money. Those that don’t will be shutdown (possibly temporarily) so reducing the supply of crude oil in the U.S.
It’s important to understand that markets are always made at the margin. Even if the announcement today results in a higher royalty rate and most oil companies don’t change their behavior, some likely will either stop new drilling projects on public lands or be far more cautious about investing in exploration for oil on public lands.
What’s perhaps most surprising about this is that the oil release from the U.S. Strategic Petroleum Reserve, which was announced Tuesday, will likely have little lasting effect on oil prices. Hence, it will also have little lasting effect on gasoline prices as the two are joined at the hip.
But what will likely have a lasting effect on keeping oil and gasoline prices more elevated than they would have been is a higher royalty rate to be paid to the government.
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