With at least 800 MMcf/d and potentially more than 1 Bcf/d ofgas supply to sell, the Minerals Management Service (MMS) will be amajor force in the gas market come October when its Gulf of MexicoRoyalty In-Kind (RIK) pilot program begins. MMS’ total royaltyshare of Gulf production is 2.5 Bcf/d and it expects at least athird of that will be taken in kind by next spring.

MMS’ Bonn Macy, special assistant to the director of the MMS andformerly employed by British Petroleum, said buyers already arescrambling to sign contracts with the government agency.

“There’s a new source of gas supply on the market. I’ve talkedwith some big utilities that currently have some large contractswith marketers and just in a minute they would take 100 MMBtu/d inone shot,” said Macy. “They would rather deal with MMS because theyfeel they would get a better deal from us, and they probably would.There are a number of cost efficiencies. We have very littleoverhead doing this. We don’t have the costs associated with anEnron for instance, and we don’t have the risks.

“I don’t think a lot of people realize we are going to be amajor competitor,” he said. “The industry has really been pushingus to do this, but we could take a lot of business away frompeople.

“There are a lot of people signing on now because they know theywill get the gas from us and they can completely bypass the market.Word has spread fast and [the Government Services Administration’sgas transfer] program is growing exponentially.”

He said MMS doesn’t expect to be selling the full 800 MMcf/dright off the bat in October. “We have our toe in now. We have analliance with [Texas in the 8(g) production area offshore Texas]and we’re moving some gas volumes (about 50 MMcf/d) there. ByOctober we’ll probably have the whole foot in. By November we’llprobably at least be up to our waist. And by the spring, we’ll atleast be at the full 800 MMcf/d. It all depends on how things areworking and what our needs are.”

Macy said MMS will focus the pilot on leases and areas of theGulf that have the best economics for the program. “I think we’llprobably focus on bringing gas onshore in Louisiana, because of theconcentration there. But we have a number of federal uses in Texasso we might take some from the western Gulf. Everything is going tobe driven based on operational aspects and what makes economicsense. [Where we take gas in kind] will be influenced by where theend-users might be, where we have contracts with pipelines and whatmakes the best deal for us.”

At least a third (up to 300 MMcf/d) of the royalty gas isexpected to be transferred to government facilities through theGSA. MMS intends to hold auctions for another significant portion.The auctions probably will be held during bidweek. Some long-termsupply packages also may be auctioned, probably for the winterheating season during the November bidweek, said Macy.

Another royalty portion probably will be sold by alliancesbetween MMS and gas marketers. Although MMS has not had anynegotiations with marketers yet, Macy said he probably will bringup the issue at MMS’ scheduled meeting on the OCS RIK pilot nextweek in Houston.

“We would be working together with [marketers] rather thanturning over the gas for them to sell because there are otherissues with that — one, of course, is then having to audit, whichbasically is just shifting the audit burden from the [production]company to the marketers and that doesn’t make sense,” he said.

Other restrictions also will limit the way MMS can sell its gasto buyers. “While contracting with buyers would be an extremelyattractive option for us, we can’t use that option the same wayother businesses can because of the competitive bidding requirementin the OCS Lands Act. We’re looking at trying to be able tonegotiate arrangements with end-users while being consistent withthe whole competitive bidding aspect of this. We’re beating ourheads against the wall trying to come up with some interesting wayof doing that,” he said.

Macy noted the MMS is “not a business” and will operate a lotdifferently from other producers and marketers. For example, itdoes not intend to hedge any of its royalty gas because it has nodownside price risk and therefore would be engaging in speculation,something which probably would trigger a great deal of criticism.In addition, it will not be selling a wide variety of specialcontracts and services so it will have very few costs and littleoverhead.

MMS outlined the details of its OCS RIK and its other RIK pilotsin a Federal Register notice this week. On the upstream end, MMSintends to give lease operators 30-day prior written notice that itintends to take its royalty share of production in kind. Theoperator will then be required to deliver the royalty production inmarketable form, including paying the costs of gathering,dehydration, compression and possibly other processes required toprovide gas to a typical purchaser. MMS may ask for delivery to amarket point and would then reimburse the producer for the cost oftransportation.

The RIK provisions require the MMS to sell its royalty share fornot less than “fair market value.” MMS intends to accomplish thatin a number of ways. “We need to know what price gas at the leasehas sold for so we can go back and check and say ‘yes we made fairmarket value,'” said Macy. As a result MMS still will require someprice data from leasees. “We don’t need the data concurrently. Wedon’t even need it months later. We can go every six months. Whilewe’re trying to diminish the reporting aspects of this, to showthat it can work we do need some price checks to know how we’redoing, to know if this is a viable option for the federalgovernment going forward. There won’t be any additional priceinformation required. It will be basically the same prices theyreport now only on a less frequent basis and those prices aren’tgoing to be used for auditing down the road.”

MMS intends to judge its performance based on prices of gas soldfrom the lease by the leaseholder, prices for gas sold at othernearby leases and based on some economic modeling using publishedindex prices, such as those reported by NGI.

MMS’ first experience with a gas RIK in 1995 was not verypositive because the agency actually lost money when compared withthe traditional method of collecting royalties. “Certainly MMS haslearned lessons. I think we lost a little money in the pilot in1995 but I think it was a successful pilot because it did what apilot is supposed to do: teach us. We learned about contracting. Welearned about pipelines. One of the issues we certainly learnedfrom was dealing with nonjurisdictional pipelines. Various peoplethat bought the production got screwed. We now have the ability todirect the operator to deliver their production to us on shore.We’re going to examine the economics of that..

“I’m pretty optimistic. I think we’ve gone a pretty gooddistance in the last couple years, and I think we know what toexpect. We just need to get market value,” said Macy. “There are alot of advantages that we have that I think will be attractive to[the market] and will provide us with a respectable return.”

MMS has scheduled a meeting on the OCS RIK pilot for 10 a.m. onJuly 20 at the MMS Houston Compliance Division Office RM 104, 4141Sam Houston Parkway East. It is open to the public withoutreservation. Lessees, operators, payers and potential purchasersare encouraged to attend.

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