MMS proposes new offshore royalty relief for deep gas in shallow waters

March 27, 2003
US Interior Sec. Gale Norton Wednesday said the Minerals Management Service wants to expand offshore royalty relief to increase deep natural gas production in the Gulf of Mexico.

By the OGJ Editors

WASHINGTON, DC, Mar. 26 -- US Interior Sec. Gale Norton Wednesday said the Minerals Management Service wants to expand offshore royalty relief to increase deep natural gas production in the Gulf of Mexico.
Under the proposal, MMS plans royalty-suspension incentives when companies take the risk of exploring and developing deep gas deposits in shallow-water areas they have already leased.

"American families have felt the pinch of higher natural gas prices in recent months because demand is outpacing supply," Norton said. "We need to respond by encouraging production of deep gas resources that otherwise are financially risky for companies to explore and develop."

Under the rule, lessees would be eligible for royalty relief on their existing leases if they are willing to drill for new and deeper prospects more than 15,000 ft below sea level. MMS estimates that undiscovered gas resources of up to 20 tcf may underlie this "frontier" area. About 2,400 existing leases are expected to qualify for royalty relief under the proposed rule, MMS said.

Industry reaction
The National Ocean Industries Association praised the proposal, saying royalty relief will alleviate some of the enormous front-end costs and help to make marginal prospects economically viable.
"Although MMS was offering deep-gas relief on new shallow-water leases, this incentive will spur a great deal of new exploration on the 2,400 leases that are currently held," NOIA said. "At a time when natural gas supplies are tight and prices are high, this kind of exploration incentive is a significant step in the right direction."

MMS cited statistics from the Energy Information Administration forecasting natural gas demand will increase 30% over the next 15 years, with domestic supplies available to meet only 70% of this need.
"Production from deep wells on existing leases in the shallow-water gulf is one of the most attractive sources of additional natural gas to help meet the near and midterm energy needs of the nation," MMS said.

Outer Continental Shelf natural gas currently provides about 25% of domestic production, although the contribution from the shallow-water area has declined precipitously over the past 5 years. While the shallow waters of the gulf have been actively explored, relatively few wells have penetrated depths below 15,000 ft due to the high cost and risks associated with such wells, MMS said. Because a drilling infrastructure is already in place, MMS anticipates that production could come on line relatively quickly with new incentives.

Incentive details
The proposed incentive program provides the following:

-- A royalty suspension on the first 15 bcf of gas produced from a well drilled and completed at 15,000-18,000 ft below sea level or on the first 25 bcf from a well drilled and completed 18,000 ft or deeper below sea level. To encourage companies to drill early, authorized drilling could commence immediately. Deep production must start before 5 years after the effective date of the final rule. One royalty suspension volume is available per lease.

-- A royalty suspension supplement of 5 bcf, applied to future production of gas or oil from any drilling depth on that lease, is allowed for an unsuccessful well drilled to a target reservoir 18,000 ft or deeper. This dry hole incentive is aimed at helping to offset the high risk associated with drilling that deep. Two royalty suspension supplements per lease are available prior to production from a deep well.

-- A well drilled after the date of the proposed rule and before 5 years from the effective date of the final rule may qualify for either incentive, if the lease has not had any deep gas production from wells drilled prior to the proposed rule. Any royalty suspension volume or supplement earned must be applied only to production occurring after the effective date of the final rule, even if this production actually started between the proposed and final rule.

MMS has included a deep-gas royalty incentive for new leases since March 2001. MMS proposes to allow lessees to exercise an option to replace their existing deep-gas royalty terms on leases acquired from sales held after Jan. 1, 2001, with the terms in the final rule on this initiative. The rule provides for a 60 day comment period. MMS plans to hold a workshop during the comment period, the date of which will be announced shortly.