A House Government Reform subcommittee is probing why oil and natural gas leases negotiated between the Interior Department and producers in 1998 and 1999 did not include price thresholds — a move that the panel estimates could cost the federal government as much as $7 billion in royalties on production from the Outer Continental Shelf.

“We want to know why price thresholds were not included in those two years,” said Larry Brady, staff director for the House Energy and Resources Subcommittee. “Someone is going to explain why there is no directive or memo explaining why these thresholds were not in the leases” in 1998 and 1999, he told NGI. He said up to 1,100 leases could be involved.

“This is certainly a subject that will require further investigation by the subcommittee. The amount of the revenue lost to the U.S. government — up to $7 billion — is staggering,” said Subcommittee Chairman Darrell Issa (R-CA) during a hearing Wednesday.

The sole witness, Dr. Walter Cruickshank, deputy director of Interior’s Minerals Management Service (MMS), was unable to explain why the leases executed in 1998 and 1999 did not contain price thresholds, while the leases negotiated in 1996, 1997 and 2000 did include price caps as authorized by the Deep Water Royalty Relief Act of 1995.

The price threshold provision “was inadvertently dropped” from an addendum attached to more than 1,100 leases issued by MMS in 1998 and 1999, allowing the companies to avoid payments for years to come, Cruickshank was quoted by the Associated Press as saying.

The royalty-relief law offered incentives to producers to drill for energy in the deep-water regions of the Gulf of Mexico, where reserves of natural gas were believed to be significant but where few ventured due to the high costs and risks. Interior offered the royalty relief to offset these costs and risks. However, the law called for price thresholds to be included in the leases to prevent producers from benefiting twice when oil and gas prices escalated — once from the royalty relief, and again from the higher energy prices.

Issa wanted to know who ordered the price thresholds to be removed. “Was there written guidance from anyone in the [Interior] department to omit price thresholds in 1998 and 1999? Was there any written guidance from the White House? Has there been any investigation of the electronic trail in the drafting of the leases by your agency [MMS] of by the Department of Justice?”

Cruickshank said he could not say why, how or at whose direction the language was removed, and he added that there had been no forensic investigation of the electronic trail, according to the subcommittee. Bruce Babbitt was Interior secretary during that period, and Cynthia Quarterman was director of MMS.

Issa noted that the failure to include the price-threshold provision in the 1998 and 1999 leases was enough to affect the federal government’s bottom line. He said the subcommittee planned to hold more hearings on the issue.

In a related development that could have implications for many producers, Kerr-McGee Exploration and Development is considering a challenge of the legality of the imposed price thresholds, saying that the royalty-relief law did not grant Interior the authority to impose price thresholds between 1996 and 2000. As a result, it claims it does not have to pay royalties for production on federal lands during that period.

A favorable ruling for Kerr-McGee could set in motion a series of lawsuits challenging Interior’s interpretation and implementation of the royalty-relief law, which could bar the federal government from collecting an estimated $28 billion over the next five years, according to Issa’s subcommittee. Moreover, the MMS reports that this could also force the government to refund approximately $525 million in royalties that have already been collected and invoiced.

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