With oil prices still above $60 a barrel, do oil companies need inducements to find and produce more oil? That’s the underlying question of today’s NYT front-page article about an Interior Department report questioning the value of royalty rebates and tax breaks for gas and oil production.

The rebates are targeted at expensive and difficult exploration, usually in deep water or that requires deep drilling. The intention is to incentivize that exploration, allowing the United States to increase its domestic reserves using “unconventional oil.”

But it’s unclear how effective the incentive is, given the expense of producing such oil. Here’s the article’s punchline:

[The report] estimates that current inducements could allow drilling companies in the Gulf of Mexico to escape tens of billions of dollars in royalties that they would otherwise pay the government for oil and gas produced in areas that belong to American taxpayers.

But the study predicts that the inducements would cause only a tiny increase in production even if they were offered without some of the limitations now in place.

The article notes that royalties and corporate taxes deliver into federal coffers about 40 percent of the revenue produced from oil and gas extracted from federal property. The worldwide average government take is about 60–65 percent. A 40 percent federal take may have been fair at a time when oil prices and profits were lower, the article suggests, but the government should be getting a much higher cut from today’s prices.

Reading the article, I thought about a question that my colleague (and boss) Peter Van Doren has often asked: Why do we have federal royalty payments at all? Why not, instead, use the initial mineral rights auction as the sole source of government revenue from extracting oil or gas? 

A switch to auction-only taxation would yield much more money to the federal government up-front, as oil and gas companies would bid heavily for the leases. (I’ll be agnostic on whether the government receiving more money is a good thing.) An auction-only process would also be much more transparent and would do away with the “gaming” of royalty payments. And, perhaps most importantly, an auction-only process would better align oil companies’ incentives with consumers, vis-a-vis the current system.

In essence, the federal government uses a two-step tax process on oil and gas: up-front payment from the auctioning of the right to extract from a certain reserve, and ongoing royalty payments calculated from the amount of hydrocarbons extracted. To participate in the auction, oil and gas companies must estimate the value of the hydrocarbons they expect to extract over time, subtract the royalty payments they would have to make, and then determine how much of the remainder they would be willing to offer to the government as an auction price.

This system gives a decided advantage to oil companies that are willing to “game” the royalty system. Those firms can outbid competitors, because the gamers know their royalty payments would be lower than the other firms’ payments would be.

To get rid of the gamers’ advantage, the feds need only scrap the royalties scheme. That would force oil companies to bid heavily during the lease auction, where cheating is much more difficult. The brilliant feature of an auction is that it forces all parties to reveal exactly how much they value the product that is up for bid.

That feature would do away with the need to incentivize firms to tap into expensive but worthwhile unconventional gas and oil. Suppose there are two gas reserves up for auction: one an easy-to-tap reserve on government land in Wyoming and the other a similar-size reserve in the deep waters of the Gulf of Mexico. Extraction firms would bid heavily on the Wyoming reserves, but they would also bid (albeit not as much) on the Gulf reserve if they thought it worthwhile. No explicit incentive system would be needed — the firms would simply reveal to the auctioneer their own estimates of the Gulf reserve’s value.

Switching from an auction & royalty system to a straight royalty system would also better align oil and gas companies’ interests with consumers. Currently, as a well nears the end of its productive life, royalties would encourage the operator to take the well out of production sooner, because each hydrocarbon produced means more revenue taken from the oil or gas company and given to the government. By changing the tax to an up-front auction payment, oil and gas companies would have the incentive to continue operating the well until every profitable hydrocarbon has been extracted. That incentive change would be especially beneficial to consumers in times of tight supply and high prices.

As the NYT article notes, members of the incoming Democratic congressional majority are declaring that they will cut back on the royalty relief and tax cuts given to oil and gas companies. They would do the nation’s taxpayers and consumers an even bigger service if they would reconsider the royalty system altogether.

How can the G.O.P. get its groove back?  Michael Gerson, former speechwriter and top policy advisor to President Bush, has an idea: purge the small-government conservatives.  As he puts it in the current issue of Newsweek, “any political movement that elevates abstract antigovernment ideology above human needs is hardly conservative, and unlikely to win.” 

As Justin Logan has pointed out in this space before, Gerson finds the “small government” aspect of conservatism “morally empty.”  Gerson expands on that theme here:

As antigovernment conservatives seek to purify the Republican Party, it is reasonable to ask if the purest among them are conservatives at all. The combination of disdain for government, a reflexive preference for markets and an unbalanced emphasis on individual choice is usually called libertarianism. The old conservatives had some concerns about that creed, which Russell Kirk called “an ideology of universal selfishness.” Conservatives have generally taught that the health of society is determined by the health of institutions: families, neighborhoods, schools, congregations. Unfettered individualism can loosen those bonds, while government can act to strengthen them. By this standard, good public policies—from incentives to charitable giving, to imposing minimal standards on inner-city schools—are not apostasy; they are a thoroughly orthodox, conservative commitment to the common good.

A speechwriter’s job is to make the president talk pretty; it’s generally a bad idea to give him a policymaking role.  Yet Gerson had one in the Bush White House.  “He might have had more influence than any White House staffer who wasn’t chief of staff or national security adviser,” according to Bill Kristol.  As the Washington Post reported upon Gerson’s departure last summer: 

He was a formulator of the Bush doctrine making the spread of democracy the fundamental goal of U.S. foreign policy, a policy hailed as revolutionary by some and criticized as unrealistic by others. He led a personal crusade to make unprecedented multibillion-dollar investments in fighting AIDS, malaria and poverty around the globe. He became one of the few voices pressing for a more aggressive policy to stop genocide in Darfur, even as critics complained of U.S. inaction.

This is the Gerson vision: armed uplift abroad, compassionate statism at home, and boundless generosity with other people’s blood and treasure.  If you think the problem with American foreign policy is that it hasn’t been ambitious enough in the last five years, if you think the problem with the Great Society was that there wasn’t enough hymn-singing, then it may be for you.  But for those of us who favor limited, constitutional government, Gerson’s views are instructive.  That a man with such contempt for small-government conservatives had the ear of the president explains a lot about the wreckage that surrounds us.

Say what you will about Newt Gingrich, but he has that rare political gift: he sounds captivating and forceful even while talking complete dreck.  I witnessed that up close a couple of years ago when I crashed a meeting of conservative activists, and saw Gingrich take the floor to urge everyone to get behind the president’s prescription-drug bill.  Given that the plan represented the greatest expansion of the welfare state since the Great Society, you’d think this would be a tough sell.  But to hear Gingrich tell it, signing onto the president’s bill would be a stroke of genius for limited government activists.  The bill would cause a “plate-tectonic shift in the continental architecture of the modern welfare state.”  Or something.  I didn’t understand what that meant then and I still don’t.  Yet so confident was the pitch, so bold the hand gestures, that Gingrich probably convinced a few people who knew better. 

Those talents were on display again yesterday morning, when the former Speaker appeared on Meet the Press to play coy about his presidential aspirations.  He may or may not be running; but as always, he’s pushing Big Ideas.  Among the highlights: “The only exit strategy in Iraq is victory.”  That’s right: and the only treatment for cancer is remission.  To be fair, Gingrich did go into a little more detail on how we win.  It had something to do with FDR’s Civilian Conservation Corps. 

He also talked a bit about his latest passion: creating some kind of bipartisan debate or series of debates that would in turn create “a wave of new ideas, a wave of new solutions. And see how that ferments.”  Apparently, the catchphrase for this crusade is “Real change requires real change.”   Which is less a slogan than a mind-blowing zen koan.  

Host Tim Russert pressed Gingrich to explain his remarks in Manchester, NH a couple of weeks ago, where, as the featured speaker at the “Nackey S. Loeb First Amendment award” dinner, Gingrich called for rethinking the First Amendment.  On Meet the Press, Gingrich wouldn’t back down:

FMR. REP. GINGRICH: You close down any Web site that is jihadist.

MR. RUSSERT: But who makes that judgment?

FMR. REP. GINGRICH: Look, I—you can appoint three federal judges if you want to and say, “Review this stuff and tell us which ones to close down.” I would just like to have them be federal judges who’ve served in combat.

Now depending on the details, this could mean a major overhaul of First Amendment doctrine in the areas of incitement and prior restraint.  But put that aside. “Three federal judges who’ve served in combat?”  What does that have to do with anything?  Is this a legal question or a military one?  What a stunningly illiberal non sequitur.    

And on it went, for more than half the program.  A half an hour of that sort of thing, and you’re almost ready to put up with Tom Friedman’s soundbitten wisdom in the “roundtable” portion of the program.  Did you know that in Iraq, “the shortest distance between two points isn’t a straight line?”