Exclusive: U.S. plans to plug coal royalty loophole padding export profits

By Patrick Rucker WASHINGTON (Reuters) - The U.S. government is drafting rules designed to close an accounting loophole that in recent years has helped coal companies boost export profits and likely cost taxpayers tens of millions of dollars, people familiar with the plan said. American taxpayers by law are due a 12.5 percent royalty on the sales of millions of tons of coal pulled each year from federal land that mining companies lease. But a Reuters investigation found in 2012 that coal companies were using affiliated brokers to settle royalty payments on exports to Asia at much lower domestic prices. By clearing royalties based on domestic sales rather than prices fetched overseas, coal companies stood to pocket an additional $40 million on exports from Wyoming and Montana alone in 2011, according to that investigation. The findings prompted Senator Ron Wyden, a Democrat from Oregon, to call on the U.S. Interior Department early last year to investigate the practice. While that review continues, the U.S. Office of Natural Resources Revenue, a unit of the Interior Department that collects energy revenue from federal land, has drafted a plan to close the royalty loophole, said sources familiar with the plan. The fix could make companies pay royalties on sales to the first unaffiliated customer, so-called arm's length sales, in the supply chain. Deborah Gibbs Tschudy, the agency's deputy director, would not comment on specifics and only said the office wanted to collect on the true value of mining companies' coal sales. "That transaction - the arm's length sale - is the value we want," Tschudy told Reuters. Cloud Peak Energy Inc, one of the mining companies most active in the West, has warned investors that a change to arm's-length royalty rules could hurt their bottom line. White House's Office of Management and Budget, which reviews hundreds of federal reforms each year, has been studying the draft proposal for a month, Tschudy said. There is no deadline for finishing that review. A nearly 50 percent slide in benchmark thermal coal prices in Asia from their 2011 levels has made the issue less acute, but government officials want to close the loophole before any market rebound that would reignite U.S. exports to Asia. Royalty savings could balloon into billions of dollars if markets recovered and mining giants were allowed to build loading docks in the Pacific Northwest to ship 150 million tons of coal a year to Asia as planned. "The coal industry is looking to foreign markets - that's the bottom line," Wyden told Reuters. "So how can the government protect taxpayers if they are going to ignore that potential?" STILL A 'BIG OPPORTUNITY' Before the market retreat coal exports were highly lucrative and minimizing royalty payments offered a handsome bonus. In 2011, the ton of coal valued at about $13 at home was fetching roughly 10 times that in China. Back then, less than 5 percent of coal from Cloud Peak Energy was shipped to Asia, but that made up nearly a fifth of its revenue, or about $290 million. However, the recent market slide has hit investors in Cloud Peak, Peabody Energy Corp and Arch Coal Inc whose shares are down roughly 39 percent, 46 percent and 58 percent, respectively, this year. Those companies all have a stake in the western coal-rich Powder River Basin region and hope that a return to higher global prices will again lift their profits. "We still see the exports market (as) the big opportunity for us," Cloud Peak chief executive Colin Marshall told investors in July. Cloud Peak and Arch Coal declined to comment on the royalty reform plan. Vic Svec, a spokesman for Peabody, said the company complied with royalty standards as-written and "they are appropriate". Even as it seeks to close the royalty loophole, the resources revenue office is also checking whether coal companies should have paid more on past sales - a review due to run until the end of next year. Tschudy said officials would seek a return of royalty underpayment if they found abuses. "We're going through old records even as we prepare new rules," Tschudy said. (Editing by Karey Van Hall and Tomasz Janowski)