WARNING FLAGS HOISTED OVER GULF OF MEXICO LONGEVITY

Oil and gas development in the Gulf of Mexico is headed for trouble unless operators substantially increase drilling there.

A prime oil and gas province since U.S. offshore production began ramping up more than 30 years ago, the gulf has accounted for more than 20% of U.S. gas production since 1978. Gulf oil and condensate flow since 1970 has averaged about 10% of U.S. production.

By global standards, the gulf is mature. Minerals Management Service estimated cumulative gulf production at yearend 1991 at 8.41 billion bbl of oil and 98.5 tcf of gas. Remaining recoverable reserves were 2.33 billion bbl of oil and condensate in 143 fields and 32 tcf of gas in 676 gas fields.

While still adequate to attract the interest of smaller operators, at current rates of production gulf oil reserves in producing fields have a productive life of 8 years and gas reserves 6.8 years.

As development has progressed in the gulf, operators steadily have pursued exploratory targets farther from shore in deeper water. At the same time, the size of discoveries has decreased and greater exploratory effort has been required to add reserves. MMS data list 1980-89 gulf discoveries at an average 14.3 million barrels of oil equivalent (BOE).

As the size of the prize has decreased, interest in the gulf among major companies has waned. Declining major company interest allows independent operators more chances to take farmouts or bid at MMS lease sales on offshore acreage.

CHANGING OF THE GUARD

According to some indicators of activity, independents have replaced majors as the gulf's predominant players.

Jim Dodson, president of James Dodson Co., Fort Worth, says independents own 52% of 1,825 leases in the gulf held by production. Of leases in primary terms, independents hold 1,612, including 72% on which wells have been drilled, and 45% of undrilled tracts.

Gary Hall, chairman of Hall-Houston Oil Co., Houston, adds that independents since 1987 have acquired more leases in the gulf than major companies and have drilled about 64% of all wells in shallow water on the federal OCS.

In 1990, Hall said, 81% of all exploratory wells in the gulf in 261 ft of water or less were drilled by independents. Last year, independents installed more than 70% of new platforms on the shelf.

Dodson says 1985 was the last year major companies accounted for more than half of all wells in the Gulf of Mexico. As recently as 1987 major companies drilled 246 development wells in the gulf to independents' 147, for respective shares of about 63% and 37%.

But even in 1987, independents accounted for 56% of all wells in the gulf. By 1990, independents' share of gulf wells had increased to more than 80%.

This year through November, by Dodson's count, independents had drilled 103 development wells in the gulf to majors' 96. On the exploration side, independent dominance in the gulf during the first 11 months of 1992 is nearly complete, with 145 of 166 total exploratory wells.

Based on drilling trends after 1986, Dodson said, if oil and gas activity in the Gulf of Mexico is to be revived, the recovery will be driven by independent companies.

"And I don't think we can expect them to do any more than what they're doing now-if they can keep that up," he said.

SIGNS OF TROUBLE

Some industry observers doubt the U.S. oil and gas industry can thrive in the gulf if it relies excessively on independent companies to maintain production and reserves.

They say many independent companies don't have enough money to carry out the breadth of roles being given up by major companies. Rather, new found independent dominance is more a result of majors' retrenchment than of ramped up independent activity.

As major company drilling has ebbed, too few independents have increased activity to pick up the slack. As a result, gulf well completions are lagging, and Dodson estimates net gulf reserves in 1991-92 have been reduced by volumes about equal to the gulf's yearly production.

Active drilling rigs in the gulf as counted by Baker Hughes Inc., Houston, dropped substantially after 1985. For the 6 years during 1980-85, Baker Hughes's annual active rig counts combined to average more than 198 rigs. Annual counts for 1986-90 averaged less than 95 rigs.

The American Petroleum Institute reported Gulf of Mexico operators during 1980-85 completed about 990 wells/year on the OCS. That level of activity by 1986 increased gulf gas reserves to 45.8 tcf from less than 40.2 tcf in 1980. Similarly, oil reserves by 1985 increased to more than 4.05 billion bbl from 3.05 billion bbl in 1980.

By comparison, well completions during 1986-90 averaged less than 800/year, with a predictable effect on reserves. Gas reserves in producing fields by 1990 had dropped to less than 36.9 tcf and oil reserves to about 2.53 billion bbl.

The unusually low level of drilling and completions is troubling to gulf operators because-as the gulf's maturity has spread-more wells have been needed to maintain reserves.

MMS figures show companies in the gulf in the 1980s drilled 4,356 exploratory wells to find 291 fields with combined oil and gas reserves of 4.17 billion barrels of oil equivalent (BOE) for an average discovery size of 14.3 million BOE. By comparison, an average gulf held 138.94 million BOE during 1947-59, 76.95 million BOE in 1960-69, and 42.3 million BOE in 1970-79.

DECLINE ACCELERATING

To make matter worse, the Gulf of Mexico's drilling slump in the past 2 years has accelerated.

Baker Hughes in 1991 reported its count of active drilling rigs in the gulf averaged 72 units, including 57 in the central gulf and 15 in the western gulf. Through October of this year, drilling in the gulf was on pace to average 44 active rigs-38 in the central gulf and only six in the western gulf.

API in 1991 counted 516 well completions in the gulf, and Dodson says gulf operators this year are on pace to complete about 450 wells.

Gulf oil and gas production for the past decade has held relatively steady at about 300 million bbl/year and 4.4 tcf/year. But because of decreased drilling activity and fewer well completions, gulf oil reserves in 1991 decreased more than 200 million bbl to 2.33 billion bbl and gas reserves dropped 4.87 tcf to 32 tcf, Gulf production in 1991 totaled about 290 million bbl of oil and 4.7 tcf of gas, the latter supporting Dodson's notion of gulf production equaling reserve declines.

Gulf operators have maintained oil flow despite steadily declining production among major companies.

Dodson said, "Major companies' oil output has faded badly, and their production is going to be even lower when we annualize 1992 based on the first half of the year. A lot of folks might lay some of this year's decline on Hurricane Andrew, but I think gulf operators are producing wide open right now.

"No more incremental productive capacity is left. There is no gas bubble. "

ENVIRONMENTAL BURDEN

So long as 600 or fewer wells/year are drilled in the gulf, annual shrinkage of reserves and production likely will continue.

Still, Dodson defends major companies for reducing activity in the gulf until financial liabilities resulting from increasing environmental exposure now a retroactive ad hoc issue-is settled.

Dodson contends U.S. regulators have raised environmental issues to an ecumenical level that is obstructing oil and gas development throughout the U.S. OCS.

Dodson said federal policies protecting small producers discriminate against large companies and "suggest we want to reduce the domestic oil industry to a bunch of two man drilling outfits."

"It's almost as if we're either going to have to reinvent the oil industry or just let environmentlalists take full responsibility for our energy policies-and that's not far from happening."

REVERSING THE DECLINE

Dodson is skeptical of relying on independent companies to reverse the decline of gulf activity.

"Wildcatting is not something to do in the gulf with independents," many of whom "are struggling just to keep themselves whole," he said. Most independents would be hard pressed to drill even a single wildcat in the gulf, let alone carry the burden of exploring, drilling, and developing discoveries or building and setting platforms in 200 ft of water. But at current rates of production, he warns, gulf operators need to complete about 1,000 wells/year-half exploratory and half development and about 65% gas wells-just to maintain reserves. The gulf's reserves decline won't be halted with 600 wells/year or less.

If something isn't done to lift activity to the 1,000 wells/year plateau, Dodson predicts, the Gulf of Mexico will lose another 1 tcf of gas deliverability by 1994-95, and oil capacity of more than 200 million bbl/year is doubtful.

Without action, he said, the gulf after 1995 could reach a point of no return as a significant U.S. oil and gas province, beyond which the cost of revitalizing activity would become magnitudes greater than if gulf operators begin stepping up activity next year.

"We're not downsizing anymore. We're in a process of amputation," he said. "In about 2 more years we'll be at failsafe. If that doesn't alarm people, nothing will. We either turn it around or we're done for."

Hall agrees that if oil and gas exploration and development in the gulf falls below an unspecified threshold, U.S. operators likely will be hard pressed to restore production and reserves to significant levels.

CALL FOR CHANGE

Late last October, MMS proposed a list of regulatory and administrative changes intended to spark operator interest in the federal OCS (OGJ, Nov. 2, p. 38).

Among its proposals, MMS suggested:

• Lowering federal royalties to 12.5% from 16% on fields in water 200-400 m deep to make more reserves economical to recover.

• Clarifying regulations outlining procedures for applying for royalty rate reductions.

• Streamlining the appeal filing process by eliminating the need for payors to file a separate request to stay an order while an appeal is pending.

• Consolidating royalty information reporting forms to simplify reporting for payors and to improve Efficiency of governmental collections.

But Dodson said the changes MMS proposed won't be enough to halt or reverse the gulf's decline.

If independents are to be the mainstays of exploration in the gulf, prospects must be attractive enough to prompt investors from outside the petroleum industry to take greater risks. Operators should be allowed to expense all exploration costs so they will be able to recover those costs within 1 year whether or not they drill a dry hole.

"I'd say tax concessions are going to have a lot more to do with the ability of independents offshore and onshore to raise money to drill," Dodson said. "Or else the Energy or Interior departments will have to start a state owned oil company and a state owned gas company to take over exploration on offshore federal acreage,"

IN FAVOR OF INDEPENDENTS

Hall proposes changing leasing rules on the OCS to encourage more independent activity. For starters, he would reduce royalties more than MMS has proposed but would design the reductions as incentives for speedy development.

On existing producing leases, Hall says MMS should:

• Reduce royalties by 50% on producing wells to 8.33%.

• Allow producers to deduct operating expenses of $20,000/well/month prior to calculating MMS royalty.

• Grant a royalty holiday for 3 years for production from any new field discovery or a well drilled into a new fault block, followed by institution of a 4.167% royalty in the fourth year and an 8.33% royalty in the fifth year.

On an active lease with two wells producing a combined 120 MMcf/month of gas and generating gross revenue of $180,000/month, Hall's plan would net an extra $18,334/month to divide among working interest owners.

On existing nonproducing leases, Hall would grant a royalty holiday for the greater of either 3 years or the remaining primary lease term. In the first year after the holiday, MMS could require a 4.167% royalty and an 8.33% royalty in subsequent years.

On new leases, Hall proposes changing primary lease terms to 3 years from 5. He would allow a royalty holiday during the 3 year primary term, extendable by 1 year if discovery occurs during the first year of a lease and by another year if production begins within 18 months. At the end of the royalty holiday, MMS could impose a royalty rate of 8.33%.

REDUCING OFFSHORE COSTS

Hall suggests other measures MMS could take to slant offshore activity toward rapid development.

He said MMS should divide offshore blocks in half if they are in water less than 600 ft deep to lower leasing costs and accomodate the smaller areal extent of recently delineated reservoirs.

"For most of our prospects," he said, "a 5,000 acre tract is way too much acreage. Since we pay minimum bonus bids of $25/acre, smaller tracts would cut leasing costs and allow us to target shoot these prospects a little more."

Hall also says annual rentals could be redefined to reward rapid drilling and early production and penalize companies for failure to promptly develop reserves. MMS could waive rentals-presently $3/acre/year-if a well is drilled in the first year of a new lease but increase rentals to as much as $20/acre/year on leases where no drilling occurs during the first year.

"The current rental rate is so small, it is not a factor to most operators," Hall said. "But it would hurt an independent to write a $50,000 or $100,000 rental check if a well were not drilled in the first year of a lease. That would stimulate drilling activity."

Operators also would be less likely to bid on federal offshore acreage unless they had specific development plans.

Hall said reducing MMS royalties or declaring royalty holidays would do more than help assure that an adequate infrastructure will survive to support future development and production of finite gulf resources that otherwise might be left in the ground. It would reverberate through the U.S. economy, creating millions of dollars of new investment capital, protecting existing jobs and creating new ones, and helping reduce the U.S. trade deficit, among other things.

However such incentives might affect the U.S. as a whole, the maturity of the Gulf of Mexico as an oil and gas province suggests new rules are needed to fit the new reality.

"Since 1977," Hall said, "we have been producing more oil and more gas than we have discovered. Without adequate revisions of the rules of the game, this trend is not going to turn around."

Copyright 1992 Oil & Gas Journal. All Rights Reserved.