* Taxpayers stand to miss out on growing coal exports to Asia
* Changing royalty base could net billions more in future
* Former officials, taxpayer watchdog say program flawed
By Patrick Rucker
WASHINGTON, Dec 4 (Reuters) - U.S. miners who are booking big profits on coal sales to Asia are enjoying an accounting windfall to boot.
By valuing coal at low domestic prices rather than the much higher price fetched overseas, coal producers can dodge the larger royalty payout when mining federal land.
The practice stands to pad the bottom line for the mining sector if exports to Asia surge in coming years as the industry hopes, a Reuters investigation has found.
Current and former regulators say their supervisory work has lagged the mining industry as it eyed markets across the Pacific. They say they will now give the royalty question a close look.
"We are committed to collecting every dollar due," said Patrick Etchart, spokesman for the Office of Natural Resources Revenue, which collects federal royalties.
At issue is the black rock pulled from the coal-rich Powder River Basin in Wyoming and Montana. Miners there say they abide by the letter of royalty rules that call for the government to get a 12.5 percent cut on coal sold under federal lease.
The question is: At what point is that coal valued?
Most Powder River Basin coal is sold domestically, where prices have been depressed by a glut of natural gas and regulations meant to curb pollution.
But Asian economies rely on coal to sustain growth, so the ton worth about $13 near the Powder River Basin mines last year fetched roughly 10 times that in China.
After deducting costs like shipping by sea and rail, that ton of Powder River Basin coal sold in China last year would have returned about $30 to the miners, several industry analysts estimate.
Luther Lu, director at China-based Fenwei Energy Consulting, said the figure was closer to half that, with miners up against other costs that would have cut into their margin.
Whatever the take-home for miners, several royalty experts said, the taxpayer is due a share of the final sale price overseas.
Powder River Basin mining companies disagree and say that they are right to pay out royalties at the low domestic prices.
"If you look at the regulations, we are not required to do a net-back," said Karla Kimrey, a spokeswoman for Cloud Peak Energy, referring to the return on Asian sales. The taxpayers' bite would be based on that number.
The rules that govern Powder River Basin sales to Asia deserve a more rigorous review, and short royalty payments will not be tolerated, Etchart said.
The royalties question will remain an important one as coal exports to Asian look set to expand and the United States faces a fiscal crisis.
"How do you justify paying royalties at anything less than the true value, particularly in these times of tight budgets?" said Autumn Hanna of the nonpartisan Taxpayers for Common Sense.
Mining companies declined to explain how they book Asian coal sales, and their securities filings give only a partial picture of how miners operate in volatile energy markets.
Industry and publicly available data, though, indicates that taxpayers stand to lose out.
Paying royalties calculated on the net-back formula for exports to Asia from Wyoming and Montana rather than on the benchmark domestic price would have yielded around $40 million in additional revenue for the government last year alone, according to data from Goldman Sachs and other analysts, and figures from the U.S. Energy Information Administration.
Extended to the last few years of increased Asian demand, that total could exceed $100 million in forgone royalties. The sum could balloon into billions of dollars if mining giants are allowed to ship 150 million tons of coal a year or more through the Pacific Northwest, as the industry wants. [ID: nL2E8JU4LQ]
Of course, if the companies are more profitable because of lower royalty payments, they may well be paying more in corporate taxes, though some experts dispute the point.
"A certain $1 collected on royalties is worth more than the unsure tax take," said Tom Sanzillo, a former deputy comptroller for New York state who has studied the economics of coal exports with the Institute for Energy Economics and Financial Analysis.
For now, the debate over exports from the Powder River Basin is of limited scope: Less than 4 percent of the roughly 476 million tons of coal produced in Wyoming and Montana was exported last year, according to the EIA. Three-quarters of U.S. coal exports are bound for Europe or other non-Asian ports, much of that from private, not federal lands, in the Appalachian region.
But Asian economies such as India and China cannot grow without abundant electricity, and that demand has opened a window for a U.S. coal sector long focused on delivering domestic power.
Several large coal companies mine the Powder River Basin - a high, grassy plain in eastern Montana and Wyoming. Cloud Peak exclusively works that terrain, which is chiefly on federal land. The company was in a position to save tens of millions of dollars in recent years by their reading of royalty rules.
Less than 5 percent of Cloud Peak coal was shipped to Asia last year, but that accounted for nearly 19 percent of total revenue, or about $290 million. A year earlier, Asian sales were only 3.4 percent of the total volume but 12 percent of revenue.
Cloud Peak, Peabody Energy and Arch Coal all declined to explain how they book their Asia business, but a large share of Powder River Basin sales passes through traders.
Sales to brokers and traders are allowed, but royalty rules assume that those buyers' economic interest is opposite to miners'. Sales to in-house or affiliated traders are due more scrutiny under the law.
"We are familiar with the rules around both arms-length and non-arms-length transaction and fully comply with both," said Vic Svec, a Peabody Energy spokesman, referring to the principle that is supposed to guide such sales.
Arch Coal declined to comment on its trading business, and Cloud Peak said it faces frequent audits from state and federal officials to make sure it follows the rules.
"In my neighborhood, I don't stop at every block. I could. But that's not where the stop signs are," said Cloud Peak's Kimrey. "You can say you don't like the regulations, but we play by the rules."
Former and current officials said the government has been slow to understand the power of foreign markets or protect the taxpayer's stake in those lucrative sales.
"Exports were simply not on the radar," said Bob Abbey, who in May stepped down as head of the Bureau of Land Management, the agency that grants federal coal leases. [ID: nL1E8L5GU0]
While the industry says it is acting aboveboard, outside lawyers point to a natural gas precedent that they say further indicates the issue is far from settled.
In the late 1970s, Marathon Oil Corp used a similar accounting system to settle royalties on natural gas that was produced in Alaska but sold to Japan.
A federal court eventually told Marathon to pay out royalties based on the overseas value. Officials leveled a $10 million fine against Marathon.
Peter Appel, a former Justice Department attorney, said the case showed that officials expect taxpayers to get a taste of the true gains on exported fuel.
"This ruling should give officials confidence to give a hard look at coal sales," said Appel, who prosecuted cases for the DOJ's Environment and Natural Resources Division and teaches at the University of Georgia School of Law.
And lax royalties oversight is not simply a matter for federal officials since third parties can sue the government for failing to collect, said Erika Kelton of Phillips & Cohen LLP who represents whistleblowers in federal fraud cases.
"Energy companies have been called to task for missing these payments," she said, noting that major oil and gas companies have paid out hundreds of millions of dollars to settle false claim charges on royalty reports.
Whistleblower statutes are tools environmental advocates can use to shine a light on issues like coal royalties, said Theo Spencer who works on coal and climate change issues at the Natural Resources Defense Council.
"We're considering several promising legal angles to address what is clearly a flawed process," he said on Tuesday.