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Interior Reforming Royalty Rates to Eliminate Producer Subsidies

Interior Secretary Ken Salazar Friday said the department is taking a broad look at royalty rates for oil and natural gas produced on public lands, saying he "[does] not believe that we should be subsidizing the oil and gas industry."

The Department of Interior is "taking a comprehensive look at royalty rates both onshore as well as offshore. We'll be putting forward a royalty reform package to Congress for their consideration," he told reporters during a briefing in Washington, DC.

"As part of it...we will be looking at organizational issues relating to the department, including the MMS [Minerals Management Service] and Bureau of Land Management and their respective roles concerning the management of oil and gas resources and the collection of royalties. It is a process that we currently have underway and we're probably several months away from making any decisions," Salazar said.

Asked if Interior was considering any kind of royalty relief for producers to spur development, Salazar said, "the driver for us will be to make sure the American public and the nation's taxpayers are getting their just return for these assets that belong to all of the American people...I do not believe that we should be subsidizing the oil and gas industry. We should get [a] fair value market return."

As part of the broad review, he said Interior was comparing the royalty rates for production on state and private lands to the royalty rates for oil and gas produced on public lands.

Salazar further said there was a "good chance" that the federal government will appeal to the U.S. Supreme Court, although he noted "we have not yet reached [a final] decision." In January the appeals court in New Orleans upheld a lower court ruling, which found that the company did not have to pay the federal government millions of dollars in royalties on eight oil and natural gas leases in the Gulf of Mexico (see NGI, Jan. 19).

The case focused on a 1995 law that gave producers royalty relief in order to promote increased oil and gas drilling in the GOM. The Deep Water Royalty Relief Act of 1995 authorized Interior to suspend the collection of oil and gas royalties from all new and preexisting federal deepwater leases and to impose price or volume thresholds in order to determine when royalty payments should recommence.

Between 1996 and 2000 Kerr-McGee Oil and Gas, which is now owned by Anadarko Petroleum Corp., purchased the eight GOM leases that were subject to royalty relief. While the price threshold was subsequently triggered for royalty payments to begin, "not one of the leases" triggered the volume threshold -- production level of 87.5 MMboe per lease, effective for wells drilled in water deeper than 800 meters, the appeals court found. Interior claimed that breaking the price threshold was enough and ordered Kerr-McGee to pay royalties, but the producer challenged the order in district court and won based on the volume threshold argument (see NGI, Nov. 5, 2007). The appeals court followed suit, citing the same reason.

The stakes in the case are high for the government, with the ruling potentially affecting royalties owed by other producers. Interior noted that if the district court decision was upheld, the federal government could lose as much as $30 billion in royalties on production from offshore leases issued between 1996 and 2000.

"We will continue to litigate our position" with respect to Kerr-McGee, Salazar said. He further indicated that the agency is no longer negotiating with producers over back royalties owed on the faulty 1998-1999 deepwater leases, which did not include the royalty-triggering price thresholds due to an omission by the department.

"We are having conversations with the oil and gas industry as a whole...[But] in the context of some of those meetings, I don't believe that this is an issue that will be raised in large part because of the fact that it's still a matter [that] is very much in litigation."

Salazar further said the the "181 South" oil and gas lease sale in the Central Gulf of Mexico, which is scheduled for March 18, would proceed as planned, laying to rest the concerns of House Republicans that the sale would be delayed.

"We do not [plan to delay it]. In fact, we intend to personally be in New Orleans to announce that lease sale and actually to participate in the auction itself," he said. Salazar also noted that he will "look at some of the development of the oil and gas resources in the Gulf Coast" while he's there.

A coalition of 15 House Republicans led by Rep. Doc Hastings of Washington sent a letter to Salazar last Thursday urging him to move forward with the planned lease sale later this month. "The secretary's recent actions...revoking leases in Utah, reinstating the moratoria on the OCS [Outer Continental Shelf] by delaying the five-year plan and stopping the oil shale research in its tracks in the Mountain West...[show] a clear trend against oil and gas development," Hastings said (see NGI, Feb. 16; Feb. 9).

The Central Gulf sale is the largest annual oil and gas lease sale held by the United States. For the first time since 1988, the sale will offer the "181 South" area consisting of more than 4.2 million. The MMS estimates that the sale could result in production of about 0.8 to 1.3 billion bbl of oil and 3.3-5.4 Tcf of natural gas.

On the other side of Capitol Hill, a coalition of 35 Republican senators led by Kay Bailey Hutchison of Texas, Kit Bond of Missouri and Lisa Murkowski of Alaska last week called on the White House to tap new domestic oil and natural gas resources and to expeditiously complete the administration's five-year plan for developing resources on the OCS.

"An affirmative decision by you not to reinstate the presidential moratorium on U.S. offshore...production, along with your leadership in delivering a new offshore drilling plan in an expeditious manner, will benefit all Americans. We also encourage you to continue the practice of revenue-sharing with producing states in order to return a fair share of royalties to them," the coalition wrote in a letter to President Obama last Monday.

"I urge the Administration to take the steps necessary to develop our domestic and abundant OCS resources, which have been off-limits since 1982...We must begin with the swift development of offshore oil and gas, as well as leveraging renewable resources and increasing energy efficiency," said Hutchison.

Dr. Howard K. Gruenspecht, acting administrator of the Energy Information Administration (EIA), told a subpanel of the House Natural Resources Committee last Thursday that the "OCS is expected to remain a substantial contributor to domestic crude oil and natural gas supply" over the next several decades.

By 2030, he said offshore crude oil production in the Lower 48 region is expected to double to 2.7 million b/d, while total offshore natural gas production in the Lower 48 region is projected to rise by nearly two-thirds to 4.9 Tcf. Oil output in the OCS was 1.3 million b/d in 2007, and gas production was estimated at 2.8 Tcf down from 5.1 Tcf in 1997, Gruenspecht said. He expects offshore output to begin rising in the near-term as new projects begin operations.

If either Congress or the president should restore the moratorium in the federal OCS, he said oil production in the OCS would be 560,000 bbl/d less than what the EIA has projected for 2030, and the projected offshore gas output would drop 800 Bcf but onshore production would increase 230 Bcf in 2030.

The EIA estimated that the unproduced, technically recoverable gas reserves in the OCS are approximately 456 Tcf, of which 76 Tcf lies in areas that had been covered by the moratorium.

The agency expects domestic production on federal lands to increase over the next couple of decades. In 2007, 32% of U.S. oil produced came from federal lands, while 29% of gas production was on federal lands, Gruenspecht said. The total amount of U.S. oil and gas produced on federal lands is expected to grow to 47% and 36%, respectively, by 2030.

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