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Democrats Move to End Royalty Relief; Republicans Launch Inquiry

House Democrats last week introduced legislation that would, at current prices, put an end to much of the royalty relief for oil and natural gas production on federal lands. Republicans began an inquiry into the Interior Department's implementation of the royalty relief program. Industry urged lawmakers to look at the "full picture," saying the federal government would lose more than it would gain by eliminating royalty relief.

The legislation, sponsored by Rep. Edward Markey (D-MA) and six other House lawmakers, calls on the Interior secretary to renegotiate existing oil and gas leases to ensure that producers are paying the required amount of royalties for energy development on public lands. The House members urged the head of the House Resources Committee to hold a hearing and markup on the bill (HR 4749).

Specifically, the legislation directs Interior to suspend royalty relief on crude oil production when the price of crude in the United States is greater than $34.71/bbl over the most recent four consecutive weeks, and to end royalty relief for natural gas production when the price of gas in the United States is greater than $4.34/Mcf over a four-week period. These were the price thresholds set by Interior in 2005 to determine the royalties owed for production on deepwater oil and gas leases, excluding leases issued in 1998 and 1999.

Producers who refuse to renegotiate by the one-year anniversary of the enactment of the bill will be barred from entering into any new lease that authorizes production of oil or gas on federal lands, and will not be eligible to obtain by sale or other transfer any lease issued before the end of the period, according to the House legislation.

Sen. Dianne Feinstein (D-CA) also signaled she plans to introduce legislation that would eliminate royalty relief for energy producers. "That way oil companies will not benefit twice -- they won't be able to [report] record profits and get federal handouts."

House Resources Committee Chairman Richard Pombo (R-CA) and Rep. Jim Gibbons (R-NV), chairman of the Energy and Minerals Subcommittee, sent a letter to Interior Secretary Gale Norton last Wednesday questioning the agency's implementation of the Deep Water Royalty Relief Act of 1995, which was the first congressional action to provide royalty relief to deepwater producers. The bill was signed into law by President Clinton.

"The incentives Congress passed to increase domestic energy production in the Gulf worked, but oil and gas companies do not need any carrots during periods of record-high prices," said Pombo. He noted that the royalty incentives approved by Congress in the subsequent Energy Policy Act of 2005 would be available to producers only when oil and gas prices fall significantly below their current level of $59/barrel and $7.13/Mcf, respectively.

"We are taking steps to determine why the 1995 act was not implemented consistently," Pombo said in a statement. A spokeswoman for Sen. Pete Domenici (R-NM), chairman of the Senate Energy and Natural Resources Committee, said he also planned to pose similar questions to Norton.

The House legislation and inquiry comes in the wake of a report in the New York Times, which said the federal government plans to give more than $7 billion in royalty relief to producers between now and 2011 even though oil and gas prices have risen to lofty levels, with crude exceeding $50/bbl and natural gas rising to as high as $15/Mcf at year-end 2005 before falling to its current level of about $7-8/Mcf.

Based on figures in Interior's just-released budget proposal for fiscal year 2007, NGI has calculated that royalty-free production in the Gulf of Mexico over the six-year period will be significantly higher -- approximately $9.2 billion. This includes a $2 billion royalty holiday for 298 million barrels of crude production in the Gulf between 2006 and 2011, and a $7.2 billion royalty holiday for 7 Tcf of gas production in the Gulf over the same period.

During the same time frame, producers' royalty payments to the federal government will be more than five times the royalty-free benefit. They are expected to pay about $50 billion in royalties for oil and gas production on the federal Outer Continental Shelf (OCS) area of the Gulf over the six-year period -- $29 billion on 4.25 billion barrels of crude production and $19.3 billion on 18.95 Tcf of natural gas production, according to Interior's budget figures.

Congress approved the Deep Water Royalty Relief Act a decade ago as a carrot to entice producers to drill in the deep waters of the Gulf, where large reserves of oil and gas were believed to be located but where few producers ventured due to the high costs of drilling there. It's estimated that drilling in the deepwater Gulf costs producers anywhere from $80-100 million per project, while drilling wells in shallower water costs an average of $1-3 million. The law was designed initially to help offset some of these costs for deepwater producers, many of whom are independents such as Kerr-McGee, Anadarko and Devon.

The royalty-relief law placed limits on the amount of production that would be eligible for royalty relief, but it did not establish price limits for eligibility, according to Gary Strasburg, a spokesman for Interior's Minerals Management Service (MMS). As a result, producers who purchased leases in 1998 and 1999 are still eligible for royalty relief, even though prices for oil and natural gas have escalated over the past years, he said. And that's where the controversy is. Leases purchased from the federal government after 2001, however, are subject to price thresholds and are not eligible for suspension of royalties, Strasburg noted.

Most of the oil and gas leases in the Gulf are not eligible for royalty relief and have been notified by the MMS of this, said Kim Farb, director of policy and government affairs for the National Ocean Industries Association (NOIA), which represents the offshore industry.

Farb and NOIA spokesman Michael Kearns urged lawmakers to look at the whole picture before deciding whether to end royalty relief. "Overall, they're [the government] gaining. They're getting more revenues. They're getting more energy production. They're helping to spur that. If you took away the royalty relief, none of that might be happening," Kearns told NGI.

Since the enactment of the Deep Water Royalty Relief Act, oil and gas production in the deep waters of the Gulf has risen fourfold, according to NOIA. There are now about 150 deepwater discoveries, of which 107 are producing, it said. Deepwater leases accounted for only 288 Bcf of gas production prior to the royalty relief act, but production volumes in the deepwater Gulf jumped to 1.33 Tcf in 2002 as a result of the congressional action, accounting for about one-third of the Gulf's dry gas production that year, according to the MMS. The agency estimates that 42% (10 Tcf) of proved natural gas reserves in the Gulf as of 2002 were in the deepwater area.

While some producers aren't paying royalties, "they [are paying] bonus bids, which are a lot of money to the federal government. They pay a huge amount of different kinds of fees, such as rentals...Eventually, they'll also be paying royalties...because you're only suspending the royalties for a certain period and then the royalties will kick in. The government is going to be collecting a lot of money if there is a find [in the deepwater] and they're able to produce," Farb said.

A typical well might have a production lifecycle of 25 years, with the producer receiving a royalty holiday during the first five years, but then paying royalties during the last 20 years, Kearns said. "If there's no government support to help them go out there in the first place, the government would be foregoing 20 years of royalties and 25 years of production."

Through royalty relief, he noted that the federal government is sharing the risk of exploring for new production in the deepwater Gulf. "If you look at the full picture and you look at its whole life cycle, it's always a win for the government even with royalty relief."

NOIA called for the continuation of royalty relief for producers. "Without it, simple economics will make it more likely that companies will shift their investment to overseas fields where production costs are lower."

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