Interior Secretary Dirk Kempthorne last Monday said the department will take a “fresh look” at the flawed 1998 and 1999 deepwater Gulf of Mexico leases that are costing the federal government billions of dollars in lost royalties.

Speaking at the annual meeting of the American Petroleum Institute in Washington, DC, Kempthorne said that he has directed Steve Allred, Interior’s new assistant secretary of land and minerals, to “take a fresh look at the issue, to review these negotiations [with producers], to consult with Congress and to reach a fair and equitable resolution” on the issue of royalties owed.

“When I worked with [Allred] in Idaho, I saw first hand his ability to successfully conclude complex negotiations with all parties,” Kempthorne told oil and natural gas producers.

The Bush administration “believes the U.S. government must always remain a reliable business partner [with producers]. At the same time, we must assure that we are delivering value to the American public for the resources we manage,” he said.

Johnnie Burton, director of Interior’s Minerals Management Service (MMS), last month said the agency would forego efforts to try to collect royalties that have been lost so far due to the failure of the agency to include price thresholds in 1998 and 1999 leases, but rather would concentrate on recovering revenues on future production from the flawed leases (see NGI, Sept. 25). Burton estimated the lost revenues at $1.3 billion, while the Government Accountability Office pegged the lost revenues from the 1998-1999 leases at $2 billion so far.

This evoked anger from Capitol Hill. House Government Reform Committee officials said the agency’s decision not to recoup billions of dollars in back royalties on oil and natural gas production from the defective leases was unacceptable.

In a letter to Kempthorne, Committee Chairman Tom Davis (R-VA) and Rep. Darrell Issa (R-CA), chairman of the Energy and Resources Subcommittee, directed the agency to formulate a new plan to retrieve the back royalties from the 1998 and 1999 Gulf leases, which — due to the omission of the price thresholds — allowed companies to produce oil and gas without paying royalties despite high-flying energy prices (see NGI, Oct. 2).

The lease price ceilings cut off royalty relief to producers when oil and gas prices are too high. Without this cut-off point in the 1998 and 1999 leases, producers who negotiated leases in those two years have escaped paying royalties on production up to a specific volume limit. The price caps that trigger royalties were included in leases that were issued in 1996, 1997 and 2000, but were not in the 1998 and 1999 leases due to a mistake on the part of the MMS. Congress has put pressure on producers to renegotiate these leases with the MMS.

An eight-month investigation by the House Energy and Resources Subcommittee found that the flawed leases were the result of gross mismanagement and a failure of accountability on the part of Interior and the MMS. A review of the matter by Interior Inspector General Earl Devaney confirmed that the omission of the lease price thresholds was first detected in 2000 but then was covered up (see NGI, Sept. 18). The discovery of the mistake and subsequent cover-up occurred before production on the 1998-1999 leases had begun and royalties were owed, according to the subcommittee. If the missing price thresholds had been properly reported to MMS superiors in 2000, the whole incident could have been avoided, Issa said.

Burton said up to 20 of the 59 producers with interests in royalty-free deepwater leases in the Gulf had contacted the MMS about potentially renegotiating their 1998 and 1999 leases. But she noted that only 10 lease holders “have come in the building” to talk about correcting the lease oversight that is costing the federal government billions of dollars.

Shell earlier this month said it had reached a preliminary agreement with the MMS to add price thresholds and pay royalties on oil and natural gas production stemming from the 1998 and 1999 leases when the price ceilings are exceeded.

Shell signaled that its agreement focused solely on recovering royalties on future production from the 1998-1999 leases, rather than on retrieving royalties from past production under the leases. “We believe royalty payments should be made prospectively in order to honor the sanctity of the contracts and are negotiating that with MMS now,” the Houston-based producer said.

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