Another Reason to Dislike Coal Companies

Western coal-mining companies enjoy a pretty handy loophole when they lease land from the federal government. It's the kind of thing that seems like it should be illegal, but is arguably legit. Like flamethrowers.

Companies that buy the right to mine coal on federal land are required to pay a royalty to the government. The royalty is calculated as a percentage of the sale price of the coal they extract (with a bunch of deductions for transportation, preparation, and doing their best to scrape up every last bit of coal). On its face, it seems fair enough. The taxpayers own the coal, so they ought to get a cut of the profits. And the arrangement worked reasonably well for the better part of a century.

Things began to change in 1990, when the Clean Air Act created incentives for coal-fired power plants to burn low-sulfur coal in an effort to reduce acid rain. Most of the nation’s low-sulfur coal is located in the Powder River Basin, a remote region straddling Montana and Wyoming. The coal had to be transported vast distances, so middlemen started buying it at the mine and selling it to far-off utilities for a profit.

Here comes the loophole. Since the federal government’s royalty is based on the first sale—from the miners to the middlemen—some companies eventually opened their own brokerage and transportation operations. Rather than selling to third parties, the miners “sell” the coal to their own affiliates. They were essentially buying their own coal, so they can set an artificially low price, minimizing the royalty paid to Uncle Sam. Then the corporate affiliate sells the coal to a utility at market rates.

Over the past decade, these so-called captive transactions have become an epidemic on federal lands out West, where the majority of U.S. coal is located. Captive transactions represented just 4 percent of Wyoming coal sales in 2004, but 42 percent in 2012. Some of the coal companies have more than 100 subsidiaries.

The government knows this is a problem, and regulations exist that allow the U.S. Department of the Interior to increase the royalty if there is reason to believe that the initial transaction was rigged against the taxpayers. The problem is, the system for determining whether a transaction was legitimate is unwieldy, and correcting the price when a mining company is trying to put one over on Uncle Sam is also hopelessly complicated. (We are, after all, talking about a government bureaucracy.)

This isn’t some small-time three-card monte game: The stakes are high. Mineral rights leases are among the government’s largest revenue streams after taxes. Coal royalties alone account for nearly $900 million annually, and the government shares half its take with states, which use it to build highways and schools.

The Government Accountability Office and the Department of the Interior have each published reports acknowledging that we should be earning far more money from coal leases. The state of Wyoming—which doesn’t enjoy begging the federal government for help—complained to the Obama administration about the loophole as far back as 2011. Environmental and community groups are also blowing the whistle. The problem is that there is a big disagreement on how to fix the problem.

There are two solutions on the table. The Department of the Interior has drafted a rule that would ignore any captive transactions in the royalty calculation—the first genuine “arms-length transaction” would form the basis of the payment to the government. (The rule is open for public comment until May 9, in case you feel strongly about this.) The proposal has several things going for it. It closes the loophole, it’s workable, and it has buy-in from both government regulators and many reform advocates.

“The rule will close a loophole that has been sleazily exploited by coal companies and save taxpayers millions,” says Theo Spencer, senior advocate at NRDC’s Climate Center. (Disclosure.) “We need further reforms to the federal coal-leasing program to bring taxpayers the money they deserve, but this is a big step in the right direction.”

The Center for American Progress and the nonprofit group Headwaters Economics, however, say it doesn’t go far enough. They want to calculate the royalty based on the price paid by an end user, such as a utility that intends to burn the coal. Under this system, the utilities, rather than the mining companies, would send a check to the government. This idea also has merit. The royalties would be more transparent, since the market price of coal is a matter of public record. (The price paid by middlemen and brokers is not.) It would also net quite a bit more money. According to a January report by Headwaters, the government could double its coal royalty revenues by basing the royalty on the market price.

For all its supposed elegance, this second plan has some major drawbacks. For example, utilities don’t always burn the coal they buy. They, too, can sell onward to buyers or exporters. When would the royalty calculation occur in that scenario?

More importantly, the change may not be politically feasible. The Department of the Interior’s draft rule has a legitimate shot at being finalized and adopted before the end of the Obama administration. Rulemaking is a long, cumbersome, complicated process. If the department has to go back to the drawing board, reform would be very difficult under this president. The agency, already understaffed, would have to redirect personnel, and several levels of government would have to review the work a second time. Many call this solution an example of the perfect (or at least the slightly better) being the enemy of the good.

The real enemy in this case, though, is coal-mining companies—they are shortchanging taxpayers through a corporate shell game.