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

“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.

Allred said only six producers — including BP Exploration, ConocoPhillips, Burlington Resources and Shell Offshore — have renegotiated to pay royalties on future production from their 1998-1999 leases, 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 (see Daily GPI, Nov. 2, 2007). The court essentially ruled that Interior-imposed price thresholds, 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 decision is not overturned, 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. This includes an estimated $9.1 billion that would be at risk if the 1998-1999 leases are not renegotiated to include price thresholds.

Under the 1995 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.

However, Interior’s Minerals Management Service failed to include price thresholds in the 1998-1999 leases, which has allowed producers to escape payment of royalties on certain volumes of production in the Gulf. Allred said the 1998-1999 leases are a “subset” of the broader Kerr-McGee case, which challenges the right of Interior to include price thresholds in any of the leases that were issued between 1996 and 2000 under the deepwater royalty act.

“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 Congresses passes legislation to force producers to renegotiate their contracts or be 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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