DOI agencies could press leaseholders to produce, acting IG says

Federal oil and gas leasing programs could do more to encourage leaseholders to move more aggressively toward production, the US Department of the Interior's acting inspector general told a congressional subcommittee.

Mar 20th, 2009

Federal oil and gas leasing programs could do more to encourage leaseholders to move more aggressively toward production, the US Department of the Interior's acting inspector general told a congressional subcommittee on Mar. 17.

Mary L. Kendall told the House Natural Resources Committee's Energy and Minerals Subcommittee that the DOI inspector general's office recently completed an evaluation of non-producing federal oil and gas leases for US Rep. Norman D. Dicks (D-Wash.), who chairs the House Appropriations Committee's Interior and Environment Subcommittee.

"In addition to some very challenging data integrity and lease oversight issues, we found that the [US] Bureau of Land Management and the [US] Minerals Management Service need to develop much clearer policy concerning the expectations of production of oil and gas on federal lands. We recommended that [DOI] consult with Congress in this regard," she said.

Kendall said that investigators from her office found that producers who hold federal leases have little obligation to actually produce oil and gas, and that DOI has no formal policy to compel them to bring the leases into production.

"While current statutes, regulations and policies do promote exploration, production activities are not required to commence within the primary lease term. The bureaus do not inquire about the production strategies of companies and have not attempted to enforce the performance clause included in lease agreements," she said in her written testimony.

"Both industry and bureau officials cautioned, however, that mandating production activities may not necessarily have positive outcomes and could, in fact, be counter-productive by reducing industry interest in federal leases," Kendall said.

Dispenses with rhetoric

She made her observations at the House Natural Resources subcommittee's hearing examining oil and gas production on the US Outer Continental Shelf. Rep. Jim Costa (D-Calif.), the subcommittee's chairman, said that he was determined to examine the lease diligence question without the rhetoric which characterized congressional debate on the matter last summer.

"Perhaps no single statistic was used more last year than the number 68 million, as in 'there are 68 million acres of non-producing federal oil and gas leases in the United States.' While an accurate number, by itself it told us very little," Costa said in his opening statement.

"One side argued that oil companies were just sitting on these leases and they should 'use it or lose it.' The other side argued that these leases had no oil and gas beneath them, and we needed to provide new acreage to the industry so they could 'drill, baby, drill.' To me, both of these positions are nonsensical," he maintained.

Costa said that witnesses at the Mar. 17 hearing also included a representative from the Government Accountability Office, which also has been examining whether federal leaseholders are aggressively trying to produce oil and gas from their tracts.

"From their reports, this much is clear: The answers here are not solely on one side or the other. Companies are not just sitting on their leases and refusing to drill, but they are also not being blocked by lawsuits at every turn or are stuck with land that has no resources," he said.

Many reasons

He noted that many factors can explain why a lease does not produce oil and gas, including regulatory delays, workforce shortages, equipment shortages and many other complexities. "Understanding these reasons in a more thoughtful manner will allow us to move forward more intelligently and ultimately help us figure out how domestic oil and gas production will fit into our short-term, medium-term and long-term energy strategies," Costa said.

Rep. Doug Lamborn (R-Colo.), the subcommittee's ranking minority member, noted that Congress extensively debated the non-producing leases issue last year after the Natural Resources Committee's majority staff issued a report on the subject. "Unfortunately, that debate was held on the House floor and not in this subcommittee. The result was the dissemination of a tremendous amount of misinformation about the process and status of oil and gas development on our federal lands and the OCS," he said.

"Now we all know that there are no domestic companies sitting on vast reserves of oil. There are, however, many state run companies that are part of the [Organization of Petroleum Exporting Countries] cartel who are committed to hoarding oil to drive up prices. That isn't an option for American companies who only make money by bringing the oil out of the ground," Lamborn said.

New policies proposed by US President Barack H. Obama are more disturbing than statements about domestic producers not aggressively developing their leases because Obama clearly relied on information from the committee majority staff's report, he continued. "Last year, it was the 'use it or lose it' legislation. This year, it's the president's budget, which includes a billion dollars in new taxes just on operations in the Gulf of Mexico," he said.

"These new 'non-producing' fees will charge companies while they wait for federal permits, evaluate seismic data or spend billions to build the infrastructure needed to produce oil from deep beneath the sea floor. These fees will not make companies develop any faster. In fact, they constitute a purely punitive proposal designed for what appears to be cheap political gain. They will, however, harm domestic development by discouraging companies from investing in marginal leases, thus reducing investments in new development and ultimately leaving us more dependent on foreign sources of oil," Lamborn maintained.

'Litany of obstacles'

Kendall said that investigators from her office found that data integrity issues within the MMS and BLM systems, "a litany of obstacles cited by oil and gas companies," and limited statutory requirements on either DOI or the oil and gas industry to promote production were the three primary reasons why many federal leases were not in active production.

"We believe that improved and more comprehensive data would assist in instituting a monitoring program for non-producing leases and paint a much more accurate picture of the production status of DOI leases. Similarly, a better understanding of the processes and problems leading to production would lead to a more accurate perception by the public of the production status of DOI leases. Further, more explicit statutory and/or regulatory mandates would contribute to clearer expectations on the parts of both DOI and the oil and gas industry," she said in her written testimony.

Frank Rusco, GAO's natural resources and environment director, told the committee that the congressional watchdog service has found many material weaknesses in the numerous evaluations of federal oil and gas management it has conducted in recent years. These include DOI's doing less to encourage development of federal leases than some state and private landowners, MMS and BLM employing different practices for deciding which properties to lease and when, not doing more to encourage development of leases which appear more likely to have significant resources, and BLM's persistent problems in hiring and retaining enough well-trained employees to keep up with its rapidly increasing workload.

"The federal government receives one of the lowest shares of revenue for oil and gas resources compared with other countries, and [DOI] has not systematically re-examined how the federal government is compensated for extraction of oil and gas for over 25 years," Rusco said in his written testimony.

Kendall said that her office's investigators found that incompatible data in MMS and BLM's tracking systems put DOI at risk of losing millions of dollars in royalties. "In one case, a breakdown in communications between MMS and BLM could have resulted in a loss of nearly $6 million in royalties over a five-year period had the company holding the leases not sent its first production report to both bureaus, not just BLM. The existing process is heavily reliant upon companies doing the right thing," she said.

Little guidance

She said that while several federal leasing laws and regulations contain general "due diligence" provisions requiring lessees to act affirmatively in developing tracts, DOI has done little to give leaseholders specific guidance. "For 99% of the leases, the department does not monitor to ensure that due diligence is exercised. Accordingly, none of these leases is terminated for failure to produce. Rather, [DOI] allows these leases to expire naturally," Kendall said.

Another witness confirmed that MMS has some statutory authority to enforce due diligence, which could be used to seek additional data from leaseholders. "Until a company comes to us with an exploration plan, we don't know whether it has been conducting seismic tests," said Chris Oynes, the associate MMS director in charge of the DOI agency's offshore energy and minerals management program.

MMS employs a detailed evaluation process to determine whether bids are adequate, he said in his written testimony. "It considers the potential income stream to the lessee associated with the lease and all potential royalties and rental payments to be paid to the federal government to ensure that the bonus received adequately reflects the value of the potential resources associated with the lease," he indicated. Nearly $10 million of high bids in four 2008 OCS lease sales were rejected because this evaluation process showed that they did not meet fair market value criteria, Oynes said.

Rusco suggested that DOI might adopt leasing rates and durations which could be adjusted to reflect a property's relative hydrocarbon prospects. Oynes questioned whether this would be effective. "Some leases have more prospectivity in terms of whether hydrocarbons are there, but this can't be determined until they are actually drilled," he said.

Another witness warned that changing US offshore leasing terms could dampen producers' interest in the OCS. "Fluctuations in prices and costs are something we in the industry have come to expect and have learned to manage. What has taken us by surprise, however, is the change in fiscal terms in the United States," said James W. Farnsworth, president and chief exploration officer at Cobalt International Energy LP, a privately-held Houston independent.

'Even more burden'

"For us, the high cost and technical complexity of the Gulf of Mexico was offset by a stable tax and royalty system. Since 2005, when Cobalt was founded and we began investing over $1 billion, federal royalty rates in the offshore have increased by 50% and lease rental costs have increased by 47%. This increase has occurred despite the fact that oil prices have reverted back to 2005 levels. Additional taxes and fees are now being considered to add even more burden to companies that are trying to find new oil and gas fields here in the US," he told the subcommittee.

The United States moved into a world without OCS moratoriums or withdrawals for the first time in more than 20 years last fall, "a world we haven't known for some time. Is there more oil and gas out there? Most likely," observed still another witness, National Ocean Industries Association President Tom Fry. New evaluations of areas which have been off-limits for two decades clearly are needed, but they should be conducted by the oil and gas industry and not the federal government, he said.

"When you consider how much oil is coming from a comparatively small amount of land offshore, it becomes increasingly clear just how much potential resource may exist in areas in which we haven't looked. As decision-makers, Congress doesn't have all of this information. The information we do have is often over 30 years old and reliant on outdated technology," said Fry, who also testified on behalf of the American Petroleum Institute, Independent Petroleum Association of America, International Association of Drilling Contractors, Natural Gas Supply Association, American Exploration and Production Council and the US Oil & Gas Association.

"We know there are plenty of areas where oil and gas exploration may not be compatible with the landscape. We also know there will be parts of the ocean where resources will not be present or will not be economic. With talk of opening up areas or closing some down, shouldn't we increase our knowledge base so we can have an informed discussion about the consequences?" he said in his written testimony.

Oynes said that if the federal government conducted a full inventory of the OCS, it would take 3-5 years, depending on the type of seismic survey used and several other variables. He said that MMS would close the public comment period soon on gathering information for an environmental impact statement of the Atlantic OCS but does not have funding for the actual EIS. Other funding options are being considered, but Oynes said that he does not expect much activity before 2010.

Contact Nick Snow at nicks@pennwell.com

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