Shell confirmed last week that it reached a preliminary agreement with the Interior Department’s Minerals Management Service (MMS) to add price thresholds and pay royalties on oil and natural gas production stemming from the flawed 1998 and 1999 Gulf of Mexico deepwater leases when the price ceilings are exceeded.

Shell signaled Friday 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 company said.

It declined to disclose any of the terms of the deal, saying that “details on the actual agreements are still being worked out” by the parties.

“The talks are partially completed,” David Sexton, president of Shell Oil Products, told Reuters Friday. “Shell has agreed an adjustment needs to be made, and we believe this is the right thing to do,” he said.

“Shell is concerned any time there is an effort to retroactively change the terms of an existing contract,” the producer noted. While the company favors price thresholds for all deepwater royalty-relief leases, it does not believe deepwater royalty relief is necessary in the current commodity price environment. But this could change if prices fall back significantly, the company said.

Shell said it currently holds 73 deepwater leases that were acquired in 1998 and 1999, four of which are producing in the Gulf. It’s estimated that more than 1,000 royalty-free leases were issued by the MMS during the two-year period.

The company said it has been negotiating with MMS Director Johnnie Burton since June on the issue of adding price thresholds to the defective 1998-1999 leases. The lease price thresholds 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.

Burton last month said the agency planned to forgo efforts to try to collect royalties on past production from 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 (GAO) pegged the lost revenues from the 1998-1999 leases at $2 billion so far. The GAO believes the losses could climb to as much as $10 billion over the life of the leases. Burton said it “would be very hard to recoup” royalties on production that has already occurred from the 1998-1999 leases.

House Government Reform Committee officials let Interior know in no uncertain terms that the agency’s decision not to recoup billions of dollars in royalties on past production from the flawed 1998 and 1999 leases was unacceptable (see NGI, Oct. 2).

In a letter to Interior Secretary Dirk 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 producers to avoid paying royalties despite high-flying energy prices.

An eight-month investigation by the 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 by MMS employees 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 that up to 20 of the 59 producers with interests in royalty-free deepwater leases in the Gulf have contacted the MMS about potentially renegotiating their 1998 and 1999 leases.

But she noted that only 10 lease holders, including Shell and BP, “have come in the building” to talk about correcting the lease oversight that is costing the federal government billions of dollars. Burton declined to identify the other eight producers, saying that they had not given the MMS the authority to disclose their names.

About 19 oil and gas leases that lack price thresholds currently are producing in the Gulf of Mexico, and roughly 25 leases have indicated discoveries, but the MMS doesn’t know whether they will be producible or not, Burton said.

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