Associations, government help U.S. independents grapple with low oil prices

Patrick Crow
Energy Policies Editor

• U.S. CRUDE PRICES SLIDE [56,681 bytes]

The U.S. Department of Energy and oil associations are scrambling to help smaller U.S. producers survive a deep oil price depression that has no end in sight.

They are examining short and long-term measures to help independents, reeling from the 5-month-old oil price slump. But most of the actions will take time, and independents are being told they must remain patient and optimistic.

The American Petroleum Institute recently said U.S. wellhead prices last November averaged less than $10/bbl, the lowest level in more than 50 years, when adjusted for inflation.

It said the prices were down more than 40% from the previous year, forcing oil companies to cut exploration and development budgets. As of last Dec. 11, Baker-Hughes Inc. reported only 169 rigs were drilling for oil onshore in the U.S., vs. 361 at the same time a year earlier. Rigs drilling for gas totaled 498 vs. 647 a year earlier.

Last November, U.S. oil production slipped 3.2% to 6.252 million b/d, compared with November 1997. Crude and products imports rose 8.4% to 10.787 million b/d.

Gil Thurm, president of the Independent Petroleum Association of America (IPAA), said, "Our members have been through a lot over the years, ups and downs, good times and bad. But nobody we've spoken to can remember it being worse. It's the extended nature of it, with no prospects for relief anytime soon."

Thurm said small producers are under pressure from banks and are cutting salaries and laying off workers.

He said one independent has laid off 64 workers with a total of 1,000 years of oil industry experience. "You can't ever get that back," he added.

DOE efforts

Energy Sec. Bill Richardson plans to propose initiatives this month to help the industry.

DOE's highest priorities apparently will be to take some crude off the saturated market by storing it in the Strategic Petroleum Reserve (SPR), and to ask Congress to enact tax credits to keep marginally economic wells on line.

Richardson has been on the job only 4 months, but he represented a New Mexico oil and gas district in Congress for many years.

He told oil producers at a recent National Petroleum Council meeting, "I know the seriousness of the state of the oil industry. We at the Department of Energy are on your side."

He said a DOE task force has been "scouring the country, speaking in depth to industry to gauge what solutions might best work. "We're examining...energy policies that cut costs and reduce red tape. We're looking at economic relief initiatives such as tax credits, other tax relief, and perhaps emergency loans for producers literally on the brink of economic collapse.

"We're examining regulatory relief approaches that can lower exploration and production costs without compromising health or environmental protection. And we're looking at activities that are already under way in the department that can be accelerated to provide short-term support for oil production. We've made progress on several of these actions."

Tax, environment

Richardson said he has had several discussions with Treasury Sec. Robert Rubin on possible tax incentives for marginal oil and gas production. More meetings are planned.

"DOE has been closely working with the IPAA to examine all sides of such a plan. We looked into options like credits at specific prices, and we think that, possibly-if we all work together-sometime next year, a proposal might be fashioned.

"Let me make it clear there is no administration policy yet on this issue, until we flesh out many of the areas we are discussing. I can't guarantee anything, exceptellipsethat, if the proposal is right, it's going to be on the table, and I will be fighting for it vigorously."

Richardson said he has met with Carol Browner, the Environmental Protection Agency administrator, and discussed what could be done for the oil industry.

"We will continue to work with EPA and the states to reduce the cost of environmental regulation and compliance. I believe that, increasingly, energy policy is going to go hand in hand with environmental policy."

Richardson said, "For over a year, DOE has been researching the environmental benefits resulting from advances in E&P technology. We expect to publish our findings in early January. And when we do, I think that any objective reader will be very impressed." For example, he said, the industry requires a much smaller "footprint" now to drill a well. And he said worker safety has improved more than 30% since just 1997.

SPR fill

Adding oil to the SPR is a top priority for DOE. It would not only replenish the SPR with low-cost crude (OGJ, Dec. 28, 1998, p. 24) but also send the market a signal that the crude surplus is shrinking.

Richardson said, "One of the items under discussion is to find ways to take excess oil off the market and place it in the SPR, helping the domestic industry in the short term while bolstering our energy security over the long term.

"We're looking for ways to be creative with the SPR, but there has to be administration support. We're working on it, but we have not finalized a proposal to the Office of Management and Budget (OMB)."

DOE was considering three options. One would be just to buy $100-420 million worth of crude on the open market. Funding could be included in an emergency supplemental spending bill that is anticipated early in the congressional session.

Another would be to purchase oil only from marginal U.S. wells. That would help stripper well operators but could present administrative and accounting problems.

And DOE was considering stocking the SPR with federal offshore royalty oil. Under that plan, the administration would direct the Minerals Management Service to take some of its offshore Gulf of Mexico royalty oil in-kind and store the crude in the SPR sites along the Gulf Coast.

DOE officials say that could be done quickly, without congressional approval.

But getting MMS approval will be hard. The agency has been wary of taking oil in-kind and has not yet launched its own pilot program to take Gulf of Mexico crude in-kind.

Royalty relief

When DOE talks about administrative relief, industry has a quick suggestion.

For more than a year, it has been battling a proposed-and often revised-MMS rule to revamp the way royalties are calculated on federal royalty oil.

Oil companies say the proposed rule is so complex it would be unworkable and would unfairly raise their royalty rates (OGJ, June 22, 1998, p. 23).

In a law enacted last fall, Congress blocked MMS from issuing the rule until June 1 and encouraged MMS to negotiate further with industry. No talks have taken place yet.

Personnel turnover at the Interior Department has added more uncertainty to negotiations. Bob Armstrong, assistant secretary for land and minerals, has resigned. And MMS Director Cynthia Quarterman plans to quit about Feb. 1.

American Petroleum Institute Pres. Red Cavaney said no relief from oil prices is in sight through 1999, and companies will continue to seek economies through mergers and acquisitions. He said that, if the U.S. government wants to help the oil industry survive the depression, an obvious step would be to shelve the MMS rule.

William Whitsitt, Domestic Petroleum Council president, agreed: "It is important that the government not do anything to harm or add burdens on the industry. We are losing productive capacity and shouldn't do something that would accelerate that."

Independent push

IPAA's Thurm said, "IPAA is doing everything we can think of to bring attention to the problem in the oil patch. This has gone on for too long. The industry is in a crisis mode."

He said IPAA officials and members "are helping DOE look at all conceivable options, whether regulatory or administrative, state or local. But any solution has to have a realistic chance of being done quickly.

"We've been very pleased with what we hear coming out of DOE. Richardson has focused on the problem. We applaud him for that. "We'd also like to see this elevated to the presidential level. It would be helpful for President Bill Clinton and Vice-President Albert Gore to seriously focus on the seriousness of this situation."

Thurm said, "The emphasis should be on short-term solutions-things that will take us through the next 30 days-or a series of short-term solutions until we can get long-term legislation through." He warned that buying oil for the SPR "will not turn the situation around by itself," and that relaxed rules at MMS and the Bureau of Land Management should be "part of the puzzle."

Independents were unsuccessful in getting the last Congress to approve SPR oil purchases or marginal well tax credits. Thurm said both issues became mired in larger appropriations debates.

"We feel like we made progress on those. We spent a lot of time and effort last year moving the ball downfield, although we didn't score."

Crude awakening

IPAA sent a notice titled "Crude Awakening" to members of Congress in December, warning them of the crisis.

It said, "America's true strategic petroleum reserve of oil-America's proven oil reserves produced through its 500,000 marginal oil wells-is in jeopardy of being lost one small piece at a time, lost to future generations.

"Congress has acted to underpin America's farmers. Congress has reacted to threats to America's steel producers. Congress has demonstrated its commitment to American education. Now is the time for Congress to show this same action (for the oil industry)."

It said the typical independent is a small business with 10-13 employees and average production of 221 b/d of oil and 2.5 MMcfd of gas. Independents drill 85% of U.S. wells and produce 45% of crude and 88% of gas.

IPAA said that, since October 1997, low oil prices have reduced state severance taxes and federal royalties by more than $1.4 billion. Much of those funds go to support school systems.

Ipams survey

The Independent Petroleum Association of Mountain States is surveying independent producers in the Rockies on the effect of low oil prices. Results will be released this month.

Karyn Grass, Ipams executive director, said, "Virtually every independent oil company is now in an hour-by-hour struggle to stay afloat.

"Unless prices rise or Washington gives us immediate and substantial legislative relief, the U.S. will lose these small businesses. America needs to pay attention to this crisis because independent producers provide more than 40% of the oil this country uses every day."

In a similar Ipams survey last June, respondents reported a 50% loss in revenue. Then, layoffs were just beginning, and companies were starting to curtail exploration.

Grass said, "Even though the oil price crisis was certainly serious in June, the results of this new survey will be frightening. The first few survey responses we've already received report more than 4,000 layoffs and multi-million-dollar revenue losses."

She said, "The major companies are staying in business by merging and then slashing their work force. Unfortunately, that strategy won't work for (most) small independent producers. It's hard to cut employees when your work force only amounts to a few people. The choice often comes down to going out of business."

Solutions

Carla Wilson, Ipams tax and royalty director, said the association is pleased with Richardson's involvement.

"We haven't had an advocate in the administration for at least 5 years. It doesn't sound like they're paying lip service to the industry. They're making a serious effort to do all they can." She said, first of all, DOE should try to bolster oil prices: "We need price stability to keep wells in production. The tax credits won't do any good if the wells are shut in."

Ipams has suggested that the government buy marginal production for the SPR, possibly taking federal royalty oil in-kind for the SPR, and that the State Department be authorized to use grants and commodity bartering programs to encourage other nations to cut production.

Ipams proposed tax incentives such as marginal well production credits, an "emergency" depletion allowance, and expensing of geological and geophysical costs.

It suggested royalty incentives such as a royalty reduction for marginal properties, allowance of royalty prepayment, and other accounting relief.

Wilson said the U.S. still needs a comprehensive national energy policy that would stress the benefits of the U.S. oil and gas industry to the economy and promote access to federal lands.

Survival training

The Petroleum Technology Transfer Council is redirecting its efforts to help small producers through the price slump.

The nonprofit PTTC was formed in 1994 to disseminate technology to independent producers and communicate industry's needs to the R&D community.

It recently drafted an "Industry Crisis Action Plan" to redirect its efforts this year to educating independents on "survival methods." The effort will be focused, as much as possible, on the specific technical needs of producers in PTTC's ten regions.

Subjects might include reducing electrical costs, improving pump efficiencies, developing inexpensive casing leak repairs, and using gel polymers to reduce water-lifting costs.

Robert Nance, president and CEO of Nance Petroleum Co., Billings, Mont., is PTTC chairman. He said, "Many believe this is the most severe depression this industry has seen in decades. We will dedicate the organization's resources and activities to helping individual producers and companies survive."

PTTC plans to issue a report early this year about the oil price decline.

Iogcc study

The Interstate Oil & Gas Compact Commission (Iogcc) recently urged the immediate purchase of $420 million of crude for the SPR to help stabilize prices.

The 29-state organization also said the U.S. should identify the hidden costs of imported oil and gas, consider exploration and production incentives, and create a state-federal commission to study the impact of oil imports on the nation's trade imbalance. Iogcc issued a study that said most oil-producing states have seen their taxes from oil production halved as prices have fallen and operators have shut in wells. Nearly 11,000 jobs have been lost as oil field service companies and producers cut back.

Christine Hansen, Iogcc executive director, recently visited congressional offices in Washington, D.C.

She said both small oil producers and farmers suffered last year from low commodity prices and a glutted market. She asked congressional aides why farmers got relief and the oil industry didn't.

"They told me, simply, that the farmers had been in their faces all year and the oil people hadn't. Well, producers ought to be, if they still have the price of bus fare to Washington, D.C." Hansen said, "There's no turnaround in sight. Oil companies have been trying to keep their people employed so they don't lose their resource base, but now it's going. Not only that, but the service and supply industry is going away, too."

Oklahoma summit

The Oklahoma legislature will meet in a special Jan. 20 session to consider relief for oil producers. It had been due to convene Feb. 1 for the regular session.

Legislators will consider proposals that a task force, created by Gov. Frank Keating and the legislature, have drafted to shift the state's gross production tax on a sliding scale.

The tax would be 1% when the price of oil is under $14/bbl, 4% at $14-17, and the normal 7% above $17. The average price of Oklahoma crude is now about $9/bbl.

The governor's office said the measure would cost the state $30-70 million/year in revenue, but would save thousands of oil industry jobs. Keating said the special session should "reduce our gross production tax and take other appropriate measures to provide some kind of solace, some kind of support, some kind of hope, some kind of opportunity, for the energy industry."

Oklahoma Corporate Commission says low oil prices have put about 10,000 oil-related jobs and hundreds of businesses in jeopardy. It said 80% of the 90,000 oil-producing wells in Oklahoma make less than 2 b/d and many have been losing money at $9/bbl.

Gov. Keating also was trying to call a summit of oil state governors. He said, "The domestic oil industry is facing its greatest crisis in our history. Crude oil prices at the wellhead are at an all-time low, with inflation factors considered. There must be a coordinated effort on behalf of the energy-producing states to approach this continuing problem on a more national level. The governors of the energy-producing states can address the deterioration of our national oil infrastructure through special sessions of state legislatures and by meeting jointly to draft proposals for further federal action."

Texas relief

The Texas Independent Producers & Royalty Owners Association (Tipro) will be asking the state legislature for relief.

The Texas Railroad Commission (TRC) said that, last November, producers applied for 561 well permits, compared with 1,010 for the same month in 1997. For the first 11 months of 1998, they sought 8,820 permits vs. 12,824 for the same period in 1997. Lindsey Dingmore, Tipro public affairs vice-president, said the legislature will convene Jan. 12: "We are working on a package of tax relief, not to necessarily answer the oil price collapse problem but to get the state to provide producers some relief for the duration of the collapse."

Dingmore said Tipro is drafting a package that would include sales tax relief on items that the oil industry uses, severance tax relief, and franchise (corporate) tax relief. He said Tipro also will ask TRC for regulatory relief, such as a reduction in filing fees.

"The commission seems to be receptive to suggestions (as long as) they do not compromise environmental safety. Nothing has been firmed up yet."

Dingmore said, "This is a price collapse that rivals 1986 and goes beyond that. We're at a place now where we're truly going to lose production, and it will go off the tax rolls for good if we don't answer this problem. Some people today are producing oil at a loss just to keep those wells pumping.

"I have talked to Tipro members who are laying off people. I've talked to Tipro members who are digging into cash reserves to keep key people. I've talked to Tipro members who are both optimistic and pessimistic about the future.

"Independents will be independents, and they all have their own opinions."

Tax credit

Rep. Wes Watkins (R-Okla.) plans to reintroduce a bill to maintain marginal well production when the 106th Congress convenes this month.

IPAA said marginal wells account for about 1.3 million b/d of U.S. production.

Watkins said, "This bill provides a long-term safety net for our country's small oil and gas producers when prices fall quickly. "The drop in world oil prices has left Oklahoma's 120,000 oil and gas wells at great risk and jeopardized the 54,000 Oklahoma jobs that are directly related to oil and gas production. It is unthinkable to remain silent and thereby drive our small producers out of business, potentially lose thousands of Oklahoma jobs, and place this country at a further security risk."

The credit would begin when the price of crude drops to $15/bbl and would be fully implemented when prices dip to $12/bbl. It would have a 5-year carry-back and a 10-year carry-over, allowing producers to offset losses this tax year against previous or future profits.

Watkins said, "Our state's oil production has dipped to its lowest level since 1914, with less than 90 drilling rigs working in Oklahoma. This legislation would help keep those wells open and operating during hard times."

Domino effect

If the U.S. lost most of its stripper production, there could be a domino effect of problems.

William Sydow, director of the Nebraska Oil & Gas Conservation Commission, said, "If prices continue to remain low or decline further, our nation could lose all stripper oil production, amounting to nearly 1 million b/d, and potentially another 500,000-750,000 b/d with further price erosion. The loss could amount to 25% of our nation's daily oil production."

He said, if the losses were replaced with oil imports, there may not be enough excess tanker capacity in the world to move another 1.5 million b/d.

At any rate, he said, U.S. terminals and coastal storage capacity are insufficient to accommodate the added volume. Coastal refineries could not handle the additional volumes, nor could pipelines move products inland.

Sydow said, "Refineries located in the heartland of the U.S. would lose their feedstock as oil production from interior basins evaporates due to economics."

He said Venezuela, Canada, and Mexico, which collectively are the source of 44% of U.S. oil imports, also would be impacted by low prices.

"If the world price erodes further, significant amounts of these countries' daily oil production will become uneconomic, and wells will be shut in. An unknown volume of oil will cease to be produced and exported. The financial stability of Venezuela and Mexico could be jeopardized."

Sydow recommended a federal floor price for oil and a tariff system to preserve domestic production.

"The independent producer cannot raise money in the public marketplace, and funds from individual investors cannot be raised for new drilling and other projects.

"The low oil prices existing since 1985 have effectively stifled the growth and survival of the independent companies. These individuals and companies are the backbone of our domestic oil industry."

Budget cuts

Eight senators from oil states recently protested to President Bill Clinton about a potential cut in oil research and development.

DOE's oil and gas production R&D programs were funded at $75 million in fiscal year 1999, but OMB proposed a substantial cut for fiscal 2000.

Sen. Jeff Bingaman (D-N.M.) said, "DOE has historically played an important role in the development and transfer of technology to small oil and gas operators, who are unable to conduct their own R&D. We are therefore disturbed by reports that, in the midst of the current crisis facing the industry, OMB unilaterally has decided to cut funding for petroleum R&D.

' "Events in the Persian Gulf (recently) only underscore the importance of maintaining a healthy domestic oil and gas industry and reducing our dependence on foreign oil. Taking away research dollars that help our producers boost their performance is the last move we should be contemplating at this stage."

Signing the letter with Bingaman were Senate Energy Committee Chairman Frank Murkowski (R-Alas.), Bryan Dorgan (D-N.D.), Kent Conrad (D-N.D.), Mary Landrieu (D-La.), John Breaux (D-La.), Craig Thomas (R-Wyo.), and Kay Bailey Hutchison (R-Tex.).

Gas prices

Fortunately for some independents, natural gas prices are not down as much as oil.

Michael Cha, of J.P. Morgan Securities Inc., said, "The bright spot has been natural gas prices." He said they were strongly above $2/MMBTU for most of the year "until early December, when the worst Indian summer in history brought 70° F. temperatures to the Northeast and spot gas below the $1 level. "While gas prices have rebounded to better levels in the $2 range for spot, they still should be higher at this time of year."

A Petrie Parkman & Co. report suggested producers should continue to emphasize gas production, because "oil producers will become increasingly vulnerable to lower-cost oil production in other parts of the world, as well as global political machinations." Lee Fuller, IPAA's government relations vice-president, said, "Most of the focus so far has been on the depression in the oil side of the business. But that has implications for developing gas reserves as well. If you strip away the service and supply infrastructure for oil, it's also not going to be there for gas either."

Nebraska's Sydow agreed that gas revenues have been keeping many oil producers in business. "If the gas market goes south, Katie bar the door."

Retrenchment

Raymond Plank, chairman of Apache Corp., Houston, said "Lower prices of crude and some decline in natural gas means some of the Gulf of Mexico's deepwater projects will be put on hold. We (the industry) won't be doing as much drilling in the Gulf of Mexico as we would otherwise."

J.P. Morgan's Cha said, "We would characterize these days as the gloomiest ever in the oil market, the corollary to early 1995, which we characterized as the gloomiest ever in the gas market. "Back in 1995, many industry experts said that natural gas would never reach $2/MMTBU again. But then, as soon as the (stock) market had just about written off natural gas, it has spent most of the time since early 1996 above $2/MMBTU, despite two of the warmer winters in history.

"Similarly, today we have many industry experts saying that oil may never approach $20/bbl for the foreseeable future.

"Admittedly, today there are meaningful worldwide fundamental factors that are causing structural weakness in the oil market, namely weak global demand and overproduction. Maybe the experts are right this time on oil; on the other hand, maybe the oil market will turn back up again as it did for natural gas 4 years ago."

Petrie Parkman said, "There is little doubt that we have entered a new era of retrenchment and consolidation within the E&P sector. In the Darwinian environment now unfolding, we believe those independents that are best able to hone a core competency or competitive advantage-whether it be acquisitions, operations/exploitation expertise, prospect generation, or some combination thereof-will be the most successful.

"The ability to identify and dominate a given niche, rather than sheer size, will be rewarded, as companies continually seek to prune their portfolios of underperforming assets."

Optimism

DOE's Richardson has urged oil producers to remain optimistic in the face of adversity.

"I know you're hurting. I know the industry is in trouble. I know there is pessimism. However, because of your resilience and some policies we will pursue, I see things getting better. Give us some time to develop these policies.

"In times like these, we must constantly remind ourselves, and the public, that oil is a cyclical business. We have to let the market do its work and allow the current cycle to run its course.

"This is a resilient industry, and it remains a prime mover in our nation's and the world's fiscal growth. For the health of the industry, we must recommit ourselves to a long-term view. We know that oil demand will rise and the current overhang will dissolve."