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GAO Says Royalty Relief to Cost At Least $20B, and Much More if Producer Wins Lawsuit

Federal measures exempting oil and natural gas producers active in the prodigious Gulf of Mexico from royalties could deprive the U.S. Treasury of a minimum of $20 billion in lost revenues over the next two decades or more, according to information contained in a preliminary government report that was leaked to the press last week.

Half of those lost revenues would stem from the omission of price thresholds in leases that were issued by the Interior Department's Minerals Management Service (MMS) in 1998 and 1999, according to the preliminary estimates in a Government Accountability Office (GAO) report that is being prepared at the request of Sen. Jeff Bingaman of New Mexico, the ranking Democrat on the Senate Energy and Natural Resources Committee, and a number of other senators. Price caps were included in leases issued in 1996, 1997 and 2000, but were inadvertently omitted in the 1998 and 1999 leases, which MMS estimates could involve more than 1,100 leases.

As a result of the omissions, "these leases [continue] to be royalty free despite record high market prices for oil and gas," Bingaman wrote last Tuesday in a letter to then-Interior Secretary Gale Norton, who stepped down last week.

The GAO's estimate of $10 billion in losses due to the exclusion of price thresholds in the 1998 and 1999 leases is significantly higher than the projection of a House Government Reform subcommittee last month -- $7 billion (see NGI, March 6).

The draft GAO report further predicts that the federal Treasury could lose an additional $60 billion in royalty revenues if Kerr-McGee Oil & Gas Corp. wins its lawsuit disputing Interior's authority to impose price thresholds on leases acquired between 1996 and 2000, Bingaman told Norton. "It is my belief that Congress intended for the price thresholds to apply to all leases under the...Deep Water Royalty Relief Act," he said. Under the price thresholds, royalty relief for producers expires once oil and gas prices exceed a certain level.

The Kerr-McGee lawsuit, filed in federal court in Louisiana on March 17, challenges Interior's right to suspend royalty relief to producers when oil and gas prices reach certain price thresholds (see NGI, March 27). Royalty relief -- an exemption from paying royalties -- was offered under the Deep Water Royalty Relief Act of 1995, which was designed to encourage producers to explore for energy in the high-cost, high-risk deepwater areas of the Gulf at a time when energy prices were much lower than they are now.

The Kerr-McGee suit is being viewed as a test case. If the Oklahoma City, OK-based producer is victorious, it could lead to in a number of other lawsuits by producers.

"The final figure is going to be big" in terms of loss of royalties to the federal government, said William Wicker, a spokesman for Bingaman. "It's clear from the preliminary figures" from the GAO, he told NGI. Wicker noted that GAO last Monday briefed the Senate energy panel staff on the results of its investigation so far. A final report is expected to be released in a couple of weeks.

In his letter to Norton, Bingaman said he was "extremely concerned" about the preliminary revenue-loss estimates from the GAO. "While I understand that these are preliminary numbers based on assumptions regarding future prices and production, the magnitude of these estimates gives rise to serious concerns. I write to inquire as to what you plan to do to address this situation and these significant potential losses to the taxpayers of our nation."

The GAO draft report and Bingaman's letter come amid heightened concern on Capitol Hill about the royalty relief that is being provided to producers, even as oil and gas prices have reached record levels and producers report stunning profits. Lawmakers in the Senate and House have responded by proposing legislation to abolish royalty relief for producers.

The Congressional Budget Office reported last month that Senate legislation (S. 2314) seeking to scale back royalty relief for oil and gas producers in the Outer Continental Shelf would trigger an increase in the amount of oil and gas royalties paid to the federal government, but it also would result in a drop-off in bonus bid revenues flowing in the Treasury. Consequently, net receipts to the federal government from offshore leasing might not rise in the long run and could even fall over the next five years if royalty relief was abolished, it said (see NGI, March 27).

In a related development, Rep. Edward Markey (D-MA), a senior member of the House Resources Committee, last Monday asked the head of MMS to explain why producers are being given greater royalty relief for natural gas produced from deep wells in shallow water than for wells drilled in the deep waters of the Outer Continental Shelf (OCS).

While the recent controversy on Capitol Hill over whether to end royalty relief has focused on producers who are active in the deep waters of the OCS, Markey said that royalty relief is even greater for production of natural gas from deep wells located in shallow waters -- which are defined as wells that are drilled to depths of more than 15,000 feet below the ocean's surface in water depths of 400 meters or less. The industry's growing interest in shallow-water gas production was borne out in the results of the March 15 Central Gulf of Mexico lease sale, which generated nearly $1 billion in total bonus bids, a 38% hike over the previous year's sale in the Central Gulf, he noted.

MMS estimates the price cap above which royalty relief will be suspended for deep gas from shallow wells will be $9.91/Mcf this year, or 44% higher than the price cap for gas production in the deepwater OCS ($6.90/Mcf). Markey estimated that current gas prices (slightly above $7/Mcf for April delivery) would still have to rise by roughly 40% before MMS would suspend royalty relief on deep gas produced from any of the leases that were offered in the recent Central Gulf Mexico sale (Lease Sale 198).

Proponents have argued that royalty relief was approved by Congress to encourage producers to drill in the high-risk deep waters of the Gulf. For Markey, this begs the question of why royalty relief is being provided to producers to drill for deep gas in the shallow waters of the Gulf.

"With high natural gas prices and oil and gas companies showing an increased interest in deep gas production, the high price cap could lead to the loss of significant revenue for the federal treasury and the American taxpayer," said Markey in a letter to MMS Director Johnnie Burton. "The American people deserve to know why the Department of Interior's Minerals Management Service has decided to set such a high price cap for natural gas produced from deep wells in shallow water," he noted in a separate statement.

"The recent lease sale in the Gulf of Mexico shows us that the oil and gas companies have apparently discovered this latest loophole that could lead to the loss of billions of dollars for American taxpayers over the life of these leases."

Markey called on Burton to provide further information on deep gas production and the royalty relief cap, including:

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