Comment

Leonard Le Blanc

The 18% issue

Coastal states in the US make their own decisions about whether to oppose drilling offshore, and most have decided against it. Only 18% of US OCS water bottom is available for leasing. If it were not for Gulf of Mexico deepwater prospectivity and a convenient natural gas transportation infrastructure, many offshore producers would have fled US waters long ago.

US states fight expansion of offshore E&P operations for two reasons: residential or tourist aesthetics, and environmental impact. Two elements on the horizon may provide a way of tackling both concerns.

Revenue sharing: Unless states with tourist economies have a standing revenue stream from oil and gas leasing, there is no incentive to allow drilling. Employment and business opportunities are not sufficient in themselves. In recognition of this shortfall, a bill sponsored by a Louisiana senator in the US Congress proposes a greater share of US government royalties for locally impacted states and coastlines.
Technology: Floating production, storage, and offloading systems and gas-to-liquids conversion technologies can eliminate near-shore and shoreline impacts for coastal states. Pipelines and shore support services would not necessarily accompany oil and gas development. Oil spills that far offshore would not pose any greater risk than from a tanker passing in international waters.

In the future, exploration programs can be designed to begin as far offshore as prospectivity and technology will allow, in order to alleviate coastal concerns. Demo programs could be set up in lieu of full blown area leasing to prove up technologies and risks.

When drilling moves beyond the 200-mile offshore boundary into international waters, coastal states will lose their influence on drilling decisions. There, the mechanism for administering leasing, drilling, and producing remains largely unresolved, and the US is assured only of having a voice in a leasing program.

Over the long run, it would be in the US states' best interest to reach accommodation with limited offshore exploration and development. First of all, the need for cheap oil and gas energy is not going away soon. Secondly, when deepwater technologies make available oil and gas reserves in international waters - the remaining three-fifths of the planet - the 78% of US water bottom presently not available to drilling will become much less significant. The loss will be the US states', not industry's.

Royalty impacts

Drilling contractors have invested $12 billion in new and refurbished drilling units for deepwater operations, principally for the US Gulf of Mexico. Producers have even more tied up in deepwater leases and installations. Service, supply, and other contractors also have invested billions in supporting this expansion.

This is a deep commitment, and - more significantly - a long term one. Return-on-investment models for field development factor in increases in contracting and supply costs and decreases in oil and gas prices. However, in order to remain within the model's acceptable financial return range, the other factors must remain fixed. Royalty rates are one of these.

The US Department of Interior apparently has decided that deepwater royalty rates should be boosted from one-eighth to one-sixth - a 4% increase in government's share of field production. In addition, lease rentals would shift from $25/acre to $37.50/acre.

Only four years ago, revenue from the Gulf of Mexico was heading downhill fast. Deepwater reserves were attractive, but too costly. The midwater depths - 600-2,000 ft - were no longer attractive. Gas production on the shelf was keeping the US Gulf alive. In order to lessen deepwater risks, an attractive royalty and rental structure was offered, including limited royalty postponement. What is emerging today from the US government is a classical "bait and switch" campaign.

Certainly, the US public has every right to maximize revenue from federal water bottoms. But, employing a tactic that will destabilize deepwater operations is not very productive. If the US Department of Interior is compelled to move on this issue, there are alternatives that would allow producers to work through high sunk costs in deepwater:

Stretch out the royalty and lease rental increases over a 6-8 year period.
Apply the lease royalty and rental increases only to future leases.
Diminish the leasing period for future leases to six years, instead of eight.

The US government should take notice that deepwater is a global phenomena. Huge plays are developing off West Africa. Brazil will soon open up leasing. Those long-term contracts for deepwater rigs do not mean that drilling is confined to US waters. US leasing terms must remain competitive, or the rush to the deepwater US Gulf can end as quickly as it started.