An Interior Department official last Tuesday said the agency didn't expect any more producers to renegotiate the faulty 1998-1999 offshore oil and natural gas leases until the controversial court case involving Kerr-McGee Oil and Gas is decided on appeal.

"I think there's little chance of any additional movement until the Kerr-McGee case is resolved," said C. Stephen Allred, assistant secretary for Lands and Minerals Management, during a hearing before the Senate Appropriations Subcommittee on Interior, Environmental and Related Agencies. Pending the outcome of an appeal of the Kerr-McGee ruling, "we have little ability to enforce" producers who hold the 1998-1999 leases to renegotiate their contracts. The leases in those two years are defective because Interior failed to include price thresholds in the contracts, which are critical for the government to collect royalties from producers.

Allred said only six producers -- including BP Exploration, ConocoPhillips, Burlington Resources and Shell Offshore -- have renegotiated to include the price thresholds in their 1998-1999 leases and pay royalties on future production from them, but not on past production.

Last October a district court in western Louisiana ruled in favor of Kerr-McGee in its dispute with Interior over the payment of royalties on leases issued in the late 1990s pursuant to the Deepwater Royalty Relief Act of 1995 (DWRRA). The company challenged the right of Interior to place price thresholds in leases issued between 1996 and 2000 under the DWRRA (see NGI, Nov. 5, 2007).

The court essentially ruled that Interior-imposed price thresholds in lease contracts, which were intended to cut off royalty relief to producers when the market prices for oil and gas exceeded certain levels, were unlawful because they "contradict[ed] the plain, unambiguous text of the [DWRRA] statute." The Department of Justice has filed a notice to appeal the lower court decision in the U.S. Court of Appeals for the Fifth Circuit.

If the district court Kerr-McGee decision is upheld on appeal, the issue of whether producers owe back royalties on the faulty 1998-1999 leases would then become "moot," Allred said. Interior estimates that the federal government could lose as much as $30 billion in royalties on production from offshore leases issued between 1996 and 2000 if the Kerr-McGee ruling is not overturned. This includes an estimated $9.1 billion that is at risk with the 1998-1999 leases.

Under the 1995 royalty-relief law, Congress waived royalty payments for producers to encourage exploration of the deepwater Gulf of Mexico. At the time prices for oil and gas were significantly below what they are today. Interior contends that the royalty relief did not apply when oil and gas prices climbed above the price threshold benchmarks in the lease contracts Kerr-McGee argued otherwise.

The Kerr-McGee case addresses the broader issue of whether Interior can, when commodity prices are high, cut off royalty relief to holders of leases that were issued between 1996 and 2000 under the DWRRA. The 1998-1999 leases are a "subset" of the Kerr-McGee case. There, producers are arguing that they are not required to pay royalties on certain volumes due to the failure of Interior to include price thresholds in the lease contracts for those two years.

"I believe we have to appeal" the district court's decision in Kerr-McGee, Allred said. He noted, however, that the final decision would be made by Justice and the Solicitor General. "I would not expect the [appeals] court to be black or white" on the issue, but rather it would give guidance about what can be done and what can't be done, he said.

"We're not opposed to congressional action at all" to get the holders of the 1998-1999 Gulf leases to the bargaining table with the federal government, he told the subcommittee. But he cautioned lawmakers to be careful of "unintended consequences."

If Congress passes legislation to force producers to either renegotiate their contracts or face being barred from future leasing, the loss of royalties and bonus payments to the federal government could be significant, Allred said. "It would be a large amount of money" that the government would lose if the producers are embargoed from future leasing activities.

Subcommittee Chairman Dianne Feinstein (D-CA) said she plans to reintroduce such legislation this year. Her bill was defeated in the Senate Appropriations Committee last year by one vote. "I intend to persevere...And if I don't win this year, there will be next year."

Sen. Wayne Allard of Colorado, the ranking Republican on the panel, said he would oppose any legislation that would force the holders of the 1998-1999 leases to renegotiate their contracts. "I believe in the sanctity of contracts." He further noted that if the federal government reneged on the contracts, it could jeopardize the entire offshore program.

"It is my hope that the lower court's decision is reversed," Allard said. If the ruling is overturned, he noted that he still believes that the 1998-1999 leases pose a separate question about the sanctity of contracts and whether the federal government honors its agreements.

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