DOI should define non-producing lease before assessing fee, Salazar told

US Interior Secretary Ken Salazar could not provide an answer when House Interior Appropriations Subcommittee leaders asked him what constitutes a non-producing federal oil and gas lease.

US House Interior Appropriations Subcommittee leaders asked Interior Secretary Ken Salazar a basic question when he presented his department's fiscal 2010 budget request on May 13: How does the US Department of the Interior define a non-producing lease?

Salazar couldn't supply an answer, but promised to develop one soon and consult with subcommittee members about it. He's already under pressure because the Obama administration's proposed federal budget includes $122 million of revenue annually from fees on non-producing leases starting Oct 1.

He doesn't question the idea behind the assessment. "I've practiced water law in the West. States' water laws have a similar use-it-or-lose-it feature. Oil and gas are similarly precious commodities," he told the subcommittee.

But Salazar also couldn't answer the question when Rep. Michael K. Simpson (R-Ida.), the subcommittee's ranking minority member, asked what DOI considers a non-producing lease eligible for collection of the proposed $4/acre fee.

"I think this is important, particularly if someone could be penalized for bureaucratic or legal delays which aren't his fault," Simpson said. Officials from one of DOI's major agencies, the US Bureau of Land Management, told the subcommittee last year that it can take up to four years for a federal oil and gas lessee to simply get a drilling permit, he added.

'Would be unfair'

The subcommittee's chairman, Rep. Norman D. Dicks (D-Wash.), broke in. "I have to agree with my colleague. It does take time to go through the permitting process. I think it would be unfair to penalize someone starting the day they acquire the lease. You need to give them some time," he told Salazar.

Independent producers have been asking federal policymakers what would constitute a non-producing lease since the US House Natural Resources Committee proposed instituting the charge last year in addition to bonus bids and rentals which the US Minerals Management Service and BLM already receive.

"We asked the committee's staff if their definition included leases where development was delayed by litigation. They said yes," said Daniel T. Naatz, vice president of federal resources and political affairs at the Independent Petroleum Association of America.

The idea that a producer would lease a tract and not develop it doesn't make sense, he continued. "There isn't any company which will pay bonuses and bids and then sit on a lease. If they get a sense that a lease isn't working, they're going to relinquish it," he told OGJ Washington Pulse following the subcommittee's hearing.

"What we've always said is that even if they know what leases are not producing, they give lessees no credit for bureaucratic delays, environmental challenges, and other obstructions," said Kathleen Sgamma, government affairs director for the Independent Petroleum Association of Mountain States, who also was in Washington on May 13.

She said that IPAMS members normally take 5-6 years to complete a comprehensive analysis for a federal environmental impact statement before drilling their first well on a federal onshore lease. Small projects of less than 10 wells which qualify for the less complicated environmental assessment take 2-3 years, she said.

'The only way'

"We've proposed working with Secretary Salazar to help him understand all the work that's done to comply with a lease's terms and requirements. That's the only way he can accurately determine if or why a lease isn't producing," Sgamma told OGJ Washington Pulse.

She noted that Mary L. Kendall, DOI's acting inspector general, said in a Feb. 27 report to Salazar that BLM and MMS use different definitions for non-producing properties. "There are so many data inconsistencies and incompatibilities between the two agencies that it's not surprising DOI can't tell what leases are producing or not producing," she said.

In the report, which is posted online at the DOI IG's website, Kendall said in a cover letter to the secretary that investigators "found numerous data integrity issues and confirmed that [DOI] cannot compel companies to develop their federal leases."

The examination, which the DOI IG's office begin in July 2008 at Dicks's request, found that the department has no formal policy to compel companies to bring leases into production, and that BLM and MMS risk losing millions of dollars in royalties because their tracking systems are not compatible. In one case, a communications breakdown between the two agencies could have resulted in nearly $6 million of royalties being lost over five years if the lessee had not sent its first production report to both bureaus and not just BLM. "The existing process is heavily reliant on companies doing the right thing," the report said.

In one inconsistency example, investigators found that BLM considers every lease contained in a unit producing, even though a well may not have been drilled on every lease and every lease within the unit is not paying royalties. Leases in a unit which are not required to pay royalties are categorized as "held by location in a producing unit," according to the report. It noted that MMS reports leases which are not paying royalties as non-producing both onshore and offshore in areas it administers, regardless of whether they are part of a producing unit.

Definitions differ

"Consequently, leases that are identified as producing by BLM may be reported as non-producing by MMS," it said, adding that BLM defines onshore leases determined to be capable of producing paying quantities as commercial as producing while MMS considers them non-producing.

Investigators also learned during their examination that the lease development process has many variables which are not immediately apparent, it continued. "For example, due to inherent geologic uncertainties, there is no guarantee that any given lease contains oil and gas in commercial quantities. Also, because each lease property is unique, data from currently producing leases cannot be used to predict the volume of oil and gas that might be extracted from other leases," it said.

"Overall, DOI could do much more to track the status of non-producing leases, but it may not be able to do much to promote production. Absent new policy or legislative direction, both industry and bureau officials cautioned that mandating production on all federal leases or increasing lease fees would not necessarily enhance production and could, in fact, reduce industry interest in federal leases," the report indicated.

Naatz said that the assessment would also be collected on offshore tracts, which could generate significant revenue because they are much larger than onshore tracts. But the impact would be greater on smaller independent producers who primarily work onshore, and who face a possible increase in fees for processing each drilling permit application to $6,500 from $4,000 and other expenses, he pointed out.

"It's the proverbial death-by-a-thousand-cuts for smaller operators who are facing hard economic times because of depressed commodity prices," he explained.

Contact Nick Snow at nicks@pennwell.com

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