A group of 14 US Representatives, on Mar. 20, 2020, sent Department of the Interior Secretary David Bernhardt a letter requesting a temporary reduction in royalty payments associated with the production of offshore Gulf of Mexico oil and gas. The legislators explained that doing so would “help mitigate a price war that is sinking prices and decreasing production.”
Hailing predominantly from the US oil patch—in this case Texas, Louisiana, and southwestern Arkansas—the political appeal of such a reduction for those who proposed it is clear. Less clear is the degree to which it would help mitigate the price collapse sparked by simultaneous large-scale demand destruction (COVID-19) and pending supply expansion (Saudi Arabia and Russia).
Offshore leaseholders pay the US government annual rent for leases on the Outer Continental Shelf until paying production starts, at which point payments switch to royalties. Royalty rates are 12.5% for production from water depths less than 200 m and 18.75% for production from deeper water. Offshore production royalties in 2019 totaled $3.8 billion.
A sample of earnings reported by Gulf of Mexico operators reveals hard times for companies both large and small, even before the forces buffeting the market today were in place. Royal Dutch Shell’s full-year 2019 earnings were off 23% to $16.5 billion. BP PLC’s fell 57% to $4 billion and Occidental Petroleum’s net was 124% softer than 2018, coming in at a loss of $985 million.
Smaller companies’ reports were similar. W&T Offshore and Talos Energy experienced earnings drops of 70% and 73%, respectively, to $74.1 million and $58.7 million.
An outlier in the earnings landscape was Murphy Oil, which reported a 168% jump in its net to $1.1 billion. Murphy benefited from its April 2019 acquisition of assets from LLOG Exploration Offshore and LLOG Bluewater Holdings, supported by increased oil production and positive differentials to West Texas Intermediate oil pricing. Proceeds from the sale of its Malaysian assets also boosted the bottom line. Occidental’s loss, similarly, was largely the result of its 2019 purchase of Anadarko Petroleum.
But 2019 earnings also reveal an industry that was still making good money; enough money to keep making royalty payments to the US.
Scale
Acknowledging that the global oversupply of oil and gas has only expanded since end-2019, the question remains regarding the ability of royalty relief to achieve the goals laid out by those supporting it: addressing the combination of sinking prices and decreasing production. The scale of potential relief offered by reduced royalties isn’t up to the task.
Even fully eliminating the 18.75% rate applied to deeper-water production, with oil prices near $20/bbl, royalties saved would be on the order of $3.75/bbl. Given that WTI crude prices fell more than $26/bbl Mar. 2-Mar. 30 (and offshore Mars US nearly $32/bbl), it is unlikely that royalty relief would be the catalyst that prompts US producers to boost volumes, especially in light of the millions of barrels of extra Saudi and Russian production poised to enter the market.
It is possible that an extra $3.75/bbl would be enough to keep incremental production in the black for some offshore operators. But others will be fine without it and still others will sink either way.
Given this, any relief should be limited to the companies that need it. And when they’re back on their feet, should be repaid.
Changes to offshore royalty rates have been considered as recently as 2018 to entice companies to make long-term investments they might otherwise shy away from. And over the producing life of a field the money saved could be substantial. But such changes will not address the immediate problems at hand.
