Robust lease revenues expected despite higher royalty rates

Feb. 5, 2007
Federal officials recognized the possibility that increasing royalty rates could reduce future initial deepwater oil and gas bonus bids, a Department of the Interior official told the Senate Energy and Natural Resources Committee Jan. 25.

Federal officials recognized the possibility that increasing royalty rates could reduce future initial deepwater oil and gas bonus bids, a Department of the Interior official told the Senate Energy and Natural Resources Committee Jan. 25.

“We try to determine what will be attractive and produce the most revenue for the US. The first is the bonus bid, which produces immediate income. The second is the royalty rate. If you raise that, you probably will get less on the bonus bid. That was what we were looking at when the president decided to increase the royalty rate to 16 2/3%,” said C. Stephen Allred, deputy secretary for land and minerals at DOI.

Nevertheless, the federal government anticipates that it will receive significant leasing income in coming years because it expects oil and gas to account for the bulk of US energy through 2030, he said. “Much of the new energy growth will have to be met from the Outer Continental Shelf, especially new areas in the Gulf of Mexico and areas off Alaska,” Allred said.

His observations came as the committee examined potential US OCS oil and gas development and issues surrounding it. Other witnesses included Marjorie A. McKeithen, Louisiana Dept. of Natural Resources assistant secretary in charge of mineral resources; Lisa P. Jackson, commissioner of New Jersey’s Dept. of Environmental Protection; J. Larry Nichols, chairman, president, and chief executive of Devon Energy Corp.; Paul K. Siegele, vice-president of deepwater exploration and projects for Chevron North America Exploration & Production Co., and Athan Manuel, director of lands protection programs at the Sierra Club.

Estimated potential

Allred said that after DOI assessed potentially recoverable quantities of oil and gas on the OCS as required under the 2005 Energy Policy Act (EPACT), it determined a mean level of 86 billion bbl of oil and 420 tcf of gas.

The estimates represent about 65% for oil and 40% for gas within the total estimated US inventory of remaining economically recoverable oil and gas resources, he said. They do not include areas in the Gulf of Mexico and off Alaska’s coast that were opened for leasing in late 2006, Allred added.

“There is great uncertainty regarding the resource potential in areas where leasing has been prohibited and where the last geophysical surveys and drilling exploration occurred more than 25 years ago. Using the information available to us, we estimate that nearly 17.8 billion bbl of oil and 76.5 tcf of technically recoverable gas remain unavailable for leasing consideration,” he said.

Nichols said more-current resource estimates are needed to make OCS policy decisions. “As more information is gained, resource estimates can grow substantially. In the 1970s, the original estimate of natural gas in [the central and western Gulf of Mexico] was 50 tcf. We already have produced 150 tcf.”

Nichols said that if a hearing had been held 5-7 years ago, people opposed to developing [deepwater] offshore resources would have said there was no evidence of oil and gas resources in these waters. “If you look at it today, however, we do have drilling rigs that can work in 10,000 ft of water, seismic that can determine if the resources are there, and wells that are producing.”

Siegele said the deepwater gulf is critical to a diverse energy portfolio because it can produce large volumes of oil and gas. “However, it is a high-cost area that requires new technology and major investments,” he noted.

Projects, costs

Siegele said Chevron Corp. is participating in three new offshore projects involving investments of more than $1 billion each, but they are expected to yield about 300,000 b/d of oil within the next 4 years. Two of these projects-Tahiti and Blind Faith, which Chevron operates-represent more than $4.5 billion in capital outlays and are designed to produce 165,000 b/d. The third, the ultradeep Perdido regional development project, is expected to be producing 130,000 b/d of oil near the end of the decade.

“Deepwater exploration and production is risky, and success cannot be guaranteed. Exploratory wells can cost $100 million each and may result in dry holes,” Siegele said. “The process of bringing new energy supplies to the marketplace-from leasing through exploration, development, and construction-can take a decade or more. Companies invest billions of dollars before there is any income from production, and assume all this risk. The Deepwater Royalty Relief Act was successful. Production from the gulf will dramatically increase in the next decade,” he said.

McKeithen said Louisiana is looking forward to royalty increases because the state now will receive a share of federal OCS leasing revenues to help it absorb the impact. About 34% of the nation’s total gas supply and almost 30% of its crude oil supply is either produced in or off Louisiana or moves through the state, she pointed out.

“We believe oil and gas production and environmental protection can coexist, but we know we can’t continue doing it without learning some hard lessons,” McKeithen told the committee. “The good news is scientists know how to restore our wetlands and protect our barrier islands. What has been lacking in the past hasn’t been the will, but the resources. We have those resources now and look forward to using them.”

Garden State goals

Jackson expressed a different view. “Our coast helps drive our tourism economy, which brings in more than $36 billion/year.” She said $4.5 billion comes from commercial fishing and aquaculture alone and that coastal revenues represent the state’s largest economic sector.

Instead of supporting offshore oil and gas activity, Jackson said, the administration of New Jersey Gov. Jon S. Corzine is proceeding with a commitment to have 22.5% of the electricity consumed within the state come from renewable resources and to reduce total projected electricity demand by 20% by 2020 through conservation, improved building standards, and alternatives.

Virginia officials have expressed some interest in allowing offshore oil and gas development, but Jackson said: “I would prefer to avoid potential environmental impacts rather than learn how to mitigate them.” She said Virginia may seem distant from New Jersey but its potential lease area is only 75 miles away.

Virginia has been included in the 5-year OCS plan currently being developed by MMS, and discussions are continuing, but Allred noted that no leasing would occur unless Congress lifts a moratorium currently in place.

Potential spills discussed

Manuel said the Sierra Club continues to oppose additional US offshore oil and gas activity despite new technology because it still can pollute the environment. “Current cleanup methods are incapable of removing all the oil from spills and only a small fraction can be recovered,” he said.

“The eastern Gulf of Mexico and America’s East Coast, the two areas most coveted by the oil and gas industry, are no strangers to hurricanes and other strong storms. Several pipelines and platforms were severely damaged by hurricanes Katrina and Rita in 2005. We simply think putting more oil and gas rigs in hurricane-prone areas is not a smart policy,” Manuel continued.

Allred said that, within federal areas of the OCS in the hurricanes’ paths, there were 124 spills totaling a little more than 7,000 bbl of oil from pipelines and 10,000 bbl from rigs.

“As we look at the results, it’s amazing. All of the shut-in valves performed as intended. There were no reports of spills from them, although there were spills that reached the ocean from onshore facilities,” Allred said.

Uncultivated reserves

Committee chairman Jeff Bingaman (D-NM) asked how to change the fact that 33 million acres on the OCS are leased but not producing. Allred said MMS offshore leases are for 5-10 years, depending on the water depth, with the break point occurring at 400 ft. After companies are awarded leases, they must make decisions based on information they gain about where the most productive resource may be.

“There are payments with regard to rental rates on these leases going forward,” he said. “Some may decide to turn the leases back, and they will go back on the market in the area’s next lease sale,” he explained.

Just before committee members were called to the floor for a vote, Sen. Mary L. Landrieu (D-La.) said there’s no reason for an oil company to drill a well if there’s no way to get the oil and gas to market. “This is something our colleagues from nonproducing states may not understand.”