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MMS, the 800 MMcf/d Gorilla, Swings into Gas Market

July 19, 1999
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MMS, the 800 MMcf/d Gorilla, Swings into Gas Market

With at least 800 MMcf/d and potentially more than 1 Bcf/d of gas supply to sell, the Minerals Management Service (MMS) will be a major force in the gas market come October when its Gulf of Mexico Royalty In-Kind (RIK) pilot program begins. MMS' total royalty share of Gulf production is about 2.5 Bcf/d, and by next spring it expects at least a third of that will be taken in kind in lieu of cash payments.

MMS' Bonn Macy, special assistant to the director of the MMS and formerly employed by British Petroleum, said buyers already are scrambling to do deals with the government agency.

"There's a new source of gas supply on the market. I've talked with some big utilities that currently have some large contracts with marketers and just in a minute they would take 100 MMcf/d in one shot," said Macy. "They would rather deal with MMS because they feel they would get a better deal from us, and they probably would. There are a number of cost efficiencies. We have very little overhead doing this. We don't have the costs associated with an Enron for instance, and we don't have the risks.

"I don't think a lot of people realize we are going to be a major competitor," he said. "The industry has really been pushing us to do this, but we could take a lot of business away from people.

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

The industry has been pressuring MMS for years to take a portion of production as its royalty share rather than taking cash because of questions about the accuracy of MMS' methodology used in valuing royalties. Legislation mandating that MMS give producers the option of paying royalties in kind rather than in cash was introduced last year and backed by the industry. But MMS put up a strong fight, claiming mandatory RIK would increase administrative costs and lead to a net loss of as much as $400 million in revenue for the federal government. The legislation died in the House (see NGI March 9, 1998; May 4, 1998; May 25, 1998; Jan. 18, 1999).

MMS lost money compared to traditional royalty collection in its first RIK test in 1995. The first pilot covered 79 leases in the Gulf. MMS took about 125 MMcf/d (a total of 45.6 Bcf) of gas in kind in that pilot.

But political and industry pressure has forced the MMS to continue evaluating its methods of royalty collection. Two RIK pilots currently are underway: one for crude oil in Wyoming and a small gas pilot offshore Texas. The October Gulf RIK pilot is going to be significantly larger than the others, however. The four-year program is expected to be the definitive test determining whether MMS will continue taking gas royalties as a portion of production going forward.

"Certainly MMS has learned lessons," said Macy. "I think we lost a little money in the pilot in 1995 but I think it was a successful pilot because it did what a pilot is supposed to do: teach us," he said. "We learned about contracting. We learned about pipelines. One of the issues we certainly learned from was dealing with nonjurisdictional pipelines. Various people who bought the production got screwed. We now have the ability to direct the operator to deliver their production to us onshore. We're going to examine the economics of that.

"I'm pretty optimistic. I think we've gone a pretty good distance in the last couple years, and I think we know what to expect. We just need to get market value," he said. "There are a lot of advantages that we have that I think will be attractive to [the market] and will provide us with a respectable return."

Macy said MMS doesn't expect to be selling the full 800 MMcf/d right off the bat in October. "We have our toe in now. We have an alliance with [Texas in the 8(g) production area offshore Texas] and we're moving some gas volumes (about 50 MMcf/d) there (see NGI, April 26). By October we'll probably have the whole foot in. By November we'll probably at least be up to our waist. And by the spring, we'll at least be at the full 800 MMcf/d. It all depends on how things are working and what our needs are."

He said MMS will focus the pilot on leases and areas of the Gulf that have the best economics for the program. "I think we'll probably focus on bringing gas onshore in Louisiana, because of the concentration there. But we have a number of federal uses in Texas so we might take some from the western Gulf. Everything is going to be driven based on operational aspects and what makes economic sense. [Where we take gas in kind] will be influenced by where the end-users might be, where we have contracts with pipelines and what makes the best deal for us."

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

Another royalty portion probably will be sold by alliances between MMS and gas marketers. Although MMS has not had any negotiations with marketers yet, Macy said he probably will bring up the issue at MMS' scheduled meeting on the OCS RIK pilot next week in Houston.

"We would be working together with [marketers] rather than turning over the gas for them to sell because there are other issues with that-one, of course, is then having to audit, which basically 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 gas to buyers. "While contracting with buyers would be an extremely attractive option for us, we can't use that option the same way other businesses can because of the competitive bidding requirement in the OCS Lands Act. We're looking at trying to be able to negotiate arrangements with end-users while being consistent with the whole competitive bidding aspect of this. We're beating our heads against the wall trying to come up with some interesting way of doing that," he said.

Natural Gas Supply Association's John Sharp, director of congressional affairs and counsel, said the MMS is being very "creative" this time around. "Their heart's in the right place. Hopefully they're going to start thinking like producers and understand a little more about royalty valuation. We're looking forward to that part of it." Sharp questioned, however, whether MMS or an allied marketer would be the "new force" in the Gulf Coast gas market. He said last time MMS tried gas marketing it realized it was not prepared to handle the task.

Macy noted the MMS is "not a business" and will operate a lot differently from other producers and marketers. For example, it does not intend to hedge any of its royalty gas because it has no downside price risk. If it did use the futures market, it might be considered speculation, something which probably would trigger a great deal of criticism. In addition, it will not be selling a wide variety of special contracts and services so it will have very few costs and little overhead.

MMS outlined some of the details and procedures of the OCS RIK and its other RIK pilots in a Federal Register notice last week (see an MMS web site at http://www.rmp.mms.gov/library/leglroom/notices/Notices.htm#37809pd f). On the upstream end, MMS intends to give lease operators 30-day prior written notice that it intends to take its royalty share of production in kind. The operator will then be required to deliver the royalty production in marketable form, including paying the costs of gathering, dehydration, compression and possibly other processes required to provide gas to a typical purchaser. MMS may ask for delivery to a market point and would then reimburse the producer for the cost of transportation.

The RIK provisions require the MMS to sell its royalty share for not less than "fair market value." MMS intends to accomplish that in a number of ways. "We need to know what price gas at the lease has sold for so we can go back and check and say 'yes we made fair market value,'" said Macy. As a result MMS still will require some price data from leasees. "We don't need the data concurrently. We don't even need it months later. We can go every six months. While we're trying to diminish the reporting aspects of this, to show that it can work we do need some price checks to know how we're doing, to know if this is a viable option for the federal government going forward. There won't be any additional price information required. It will be basically the same prices [producers] report now only on a less frequent basis, and those prices aren't going to be used for auditing down the road."

MMS intends to judge its performance based on prices of gas sold from the lease by the leaseholder, prices for gas sold at other nearby leases and based on some economic modeling using published index prices, such as those reported by NGI.

MMS has scheduled a meeting on the OCS RIK pilot for 10 a.m. on July 20 at the MMS Houston Compliance Division Office RM 104, 4141 Sam Houston Parkway East. It is open to the public without reservation. Lessees, operators and potential purchasers are encouraged to attend.

Rocco Canonica

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