Oil and gas producers should expect a political fight after a US appeals court ruled in their favor about royalties from deepwater leases. They also should prepare for wild claims about associated “costs.”
Deepwater royalty relief, one of the most effective energy programs in US history, elicited outrage in 2006 when the New York Times reported that the federal budget lacked estimates of royalty income for deepwater Gulf of Mexico leases issued in 1998 and 1999. The leases didn’t reinstate royalty, as did those issued in similarly administered years, when oil and gas prices exceeded statutory “thresholds.”
Courts, meanwhile, have been addressing the question whether the Department of the Interior’s Minerals Management Service had authority to limit royalty relief on the basis of price for leases issued in the five years from 1996 through 2000. So far, the consistent answer is no.
In a case filed in 2006 by the former Kerr-McGee Oil & Gas Corp., now part of Anadarko Petroleum Corp., a federal appeals court on Jan. 12 unanimously upheld a lower-court ruling that Congress did not empower Interior to impose price thresholds during the years in question (OGJ, Jan. 19, 2009, p. 39). The Deep Water Royalty Relief Act of 1995, according to the courts, stipulated volume but not price limits for leases issued in 1996-2000.
Now, therefore, the federal government might receive no royalty payments, until volume thresholds are met, from deepwater leases of that vintage. It also might have to repay $1.5 billion collected from leases in which MMS improperly inserted price thresholds. To a heavily indebted government thinking it must spend feverishly to stimulate economic activity, both prospects will seem unbearable.
Economic perspective
If nothing else, this issue illuminates the power of economic perspective. In the 1995 law, Congress yielded future royalty revenue in order to start a business promising national benefits. At the time, oil and gas prices were depressed. Royalty relief looked like a promising investment in domestic energy supply, technology, jobs, and nonroyalty government revenue. By 2006, oil and gas prices were high and rising, and the forgone royalty came to be viewed solely as cost.
About that, politicians soon will have much to say. In 2006, the government was said to be facing a $60 billion “loss” if it lost the Kerr-McGee-Anadarko case. That number came from a 2004 MMS estimate subsequently found to have been based on overestimated production.
Since then, the Government Accountability Office has made two estimates of the value of forgone royalty on future production from deepwater leases. These estimates naturally vary with oil and gas prices. In fact, GAO published its second estimate last June to accommodate its forecasts to the unprecedented prices prevailing at the time. Since then, off course, crude has lost two thirds of its value.
The GAO estimates provide a framework against which to gauge “cost” complaints likely soon to emanate from Congress. For the threshold-free 1998 and 1999 leases, GAO estimates the total value of forgone future royalty at $4.3-14.7 billion, depending on commodity prices and production. The price ranges assumed for these years are $50-100/bbl for oil and $6.50-8/Mcf for natural gas. To project forgone future royalty for leases issued in 1996-97 and 2000, GAO uses a different price range: $70-100/bbl for oil and $6.50-8/Mcf for gas. It estimates forgone royalty from these leases at $15.1-38.3 billion.
Royalties in flux
Depending on future prices and production, then, the value of royalty relief for future production from deepwater leases issued in 1996-2000 could be as low as $19.4 billion or as high as $53 billion. These are totals spread over production lives assumed by GAO to be about 25 years. Over a quarter-century, these “costs” aren’t extreme.
Against the 1 million b/d of oil and nearly 3.5 bcfd of gas now produced in deep water by an industry that would be nowhere close to its current level of development without past royalty relief, the cost, which involves no real expenditure of public money, looks a lot like investment. Some might even call it stimulus.
