Calling the proposal “all sizzle and no steak,” Raymond James Energy Group echoed other analysts in criticizing the new royalty relief program unveiled recently by the Minerals Management Service (MMS). Analysts believe the proposed plan will not result in enough meaningful economic incentives and will do little to boost drilling or production.

Raymond James’ conclusions mirror those of analysts at Friedman Billings Ramsey, who reviewed the plan last week with guarded enthusiasm as well (see Daily GPI, April 7). The MMS program is designed to decrease the amount of royalties paid by producers on initial production from new deep natural gas wells drilled in about 2,400 blocks on the shallow-water shelf in the Gulf of Mexico (see Daily GPI, March 27).

“On the surface,it appears that the royalty relief program could help lower costs and improve returns to producers and compensate for the higher risks involved with deeper drilling,” said Jeffrey L. Mobley, a Raymond James analyst. However, he said, “if it sounds too good to be true, it usually is. As you would expect with a government program, the devil is in the details. All of the industry’s leading deep shelf explorers…viewed the incentives as nice to have, but didn’t expect the program to change their drilling plans at all.”

Producers noted that not every well will qualify. Relief is only available on the first deep or ultra deep well drilled on a lease and is not available if a well has been previously drilled on the lease below 15,000 feet. It also is not available each year that natural gas prices average above $5/MMcf. “The MMS views higher prices as incentive enough to drill and the program effectively only serves as a downside price hedge.”

Also, producers noted that the “modest” royalty relief is not likely to change their decision processes to initiate a deep or ultra deep well, which can average $10-$15 million to drill. More challenging wells may be double or triple that amount. They also told Raymond James that “similar programs have not materially changed activity levels.”

As Mobley noted, “even if the new program did increase drilling, it is not likely to have a meaningful impact on domestic supply of gas. The federal waters of the Gulf of Mexico account for about 25% of domestic gas production and about 80% comes from shallow waters on the shelf. If the MMS estimates of 2.4 Tcf in production could be generated by the proposal over 15 years, Mobley noted that it would only equate to “about 0.2 to 0.4 Bcf/d of additional gas production, or about 0.4% to 0.8% of current domestic gas production.”

Raymond James analysts believe that domestic gas production has probably peaked and long term, liquefied natural gas imports “are the only real avenue to meaningfully increase the supply of natural gas to the U.S. market.” Although the MMS proposal is “appealing on the surface…the program will not provide meaningful enough incentives to producers to offset the greater costs and risks of deep shelf drilling.”

Instead, Raymond James analysts suggested that “improved access to federal lands in the Rockies and offshore, as well as a return of Section 29 tax credits, would have a much greater impact in addressing domestic supply problems.”

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