WHY PADDIE MAC? BUT WHY NOT?

Merits of the U.S. Department of Energy's proposed Petroleum Development Investment Management Corp. will be easy to assess. If the proposal is approved by Congress and implemented, and if there is demand for a secondary market in hedged production loans, then the program, called Paddie Mac, will find its niche in the financial marketplace and endure. If there is indeed demand for a secondary market in hedged production loans, however, is it the government's responsibility to start one?

DETERMINED TO HELP

That question aside, DOE seems determined to help U.S. oil and gas producers (which it calls gas and oil producers), especially small ones. Benevolent intent from government should never go unnoticed or unappreciated. But there are better ways to help.

Paddie Mac would be a private corporation chartered by government to help the "gas and oil industry" raise capital. It would, DOE says, assist in the establishment of price hedges, provide production rate sureties, and create a secondary market for hedged, surety-covered loans. It would cost government nothing more than a loan of $5-10 million for start-up expenses and be self-financing through fees, premiums, and interest rate spreads.

The advantages to producers, according to DOE, are new access to risk-reducing financial tools such as hedging and production surety, risk diversification through the pooling of loans, and reduced costs of capital. An advantage to the government, DOE perceptively notes, is increased revenues to the degree that it raises production.

It sounds good. A few of DOE's assumptions deserve attention, however.

One assumption is that few oil and gas banks offer hedging. In fact, few banks make oil and gas loans unless the production is hedged to minimize price risk-and most gladly offer the hedging services themselves.

Another assumption is that hedging is somehow beyond the reach of small and medium-sized producers. To the contrary, access to hedging instruments has nothing to do with size of the prospective hedger. There are indeed producers that opt not to hedge. They are the biggest risk takers left in the upstream petroleum business, which explains why some of them have problems borrowing money.

DOE further seems to believe there's a shortage of capital for upstream projects. That's not the word in the producing regions of the country. If there's a shortage, it's of quality projects. There used to be a capital shortage, but that was before hedging came on the scene. Since there's no capital shortage, Paddie Mac's main contribution might be to raise the number of times capital changes hands. To the questionable extent such a liquidity increase would cut capital costs, program fees might well offset the benefit.

GROWING LIMIT

While production loans are available, however, they can be difficult to close. The problem is a risk no one has yet found a good way to hedge-legal liability for past environmental lapses. Lenders become very demanding-if not outright unapproachable-about producing properties with questionable environmental histories. Paddie Mac does not address this growing limit to the flow of oil field capital.

If Paddie Mac promises producers any help at all, however, it's worth supporting. There must be no mistake, however: As a production benefit, Paddie Mac is no substitute for a healthy leasing policy for federal land or tax relief for producers in times of price distress. Yet some help is better than no help. Beyond that, the market will decide if Paddie Mac is a good idea.