Can royalty reform kickstart the offshore industry?

May 1, 2019

The painfully slow recovery of the offshore oil and gas market – which has been glacial for service companies – is still trudging stubbornly along. The impact of the market crash was massive, and much work has gone into getting the industry back to where it is today with companies regaining profitability in a new and more competitive seascape. However, the US must continue to find new ways of remaining the premier destination for offshore energy investment and development. Deepwater royalty reform could kick start further recovery in the market and for offshore energy companies.

The devastating impact of the commodity price slide to the energy industry operating in the Gulf of Mexico cannot be overstated. Between 2014 and 2018, offshore development investment dropped by 30%, offshore exploration investment dropped by 80% and the offshore rig count fell by 50%. In the face of the lingering market downturn, offshore energy companies determined to survive cut costs and improved efficiency, and remarkably, the industry pushed offshore oil production to record highs.

Today, with oil prices hovering between $50-60/bbl, the offshore industry is showing renewed signs of life around the world. More than 100 offshore projects are expected to come online in 2019 – more than double the number of new projects from 2016. An additional $127 billion in new offshore projects globally could also be sanctioned in 2019. However, the location of these projects will not be the same as had been planned prior to the price collapse.

Countries like Mexico, Brazil and Guyana, hungry for economic growth and new energy production, have adopted competitive royalty policies to attract investment dollars. Billions of dollars are flowing to their offshore projects. The days of the US being the premier offshore player at the table, even in the Gulf of Mexico, are over.

The US Department of the Interior is slowly adapting to the changing offshore world. In July 2017, intending to attract investors to a mature segment of Gulf of Mexico production, Interior lowered the shallow-water royalty rate from 18.75% to 12.5%, bringing it on par with onshore royalty rates. The initial results are encouraging, with the number of bids for shallow-water blocks increasing in subsequent lease sales.

However, Interior’s attitude toward deepwater has been cooler. Interior has not acted upon recommendations from the Royalty Policy Committee to bring deepwater royalty rates in line with the royalty rates for shallow-water and onshore projects, even though the 18.75% deepwater royalty rate is anachronistically uncompetitive.

Yet, there is room for optimism. Interior’s Royalty Policy Committee (RPC) commissioned an update of the 2011 Comparative Assessment of the Federal Oil and Gas Fiscal System, a comprehensive report that examined the global competiveness of US royalty rates. Since the release of the original report in 2011, there have been several seismic shifts affecting the competitiveness of global offshore energy markets. Three major changes reflected in the updated study are Mexico’s constitutional amendment allowing foreign companies to develop its oil and gas resources; massive oil and natural gas finds offshore Guyana and Brazil; and changes to the US corporate tax rate. Each of these changes dramatically changed the offshore market, which US royalty policy should accurately reflect.

In March 2019, BOEM released the first part of the updated study, which looks at both shallow water and deepwater royalty rates in the US Gulf of Mexico. The study shows that the deepwater plays in the Gulf of Mexico currently offer lower rates of returns than other producing margins throughout the world. High deepwater royalty rates are causing producers to turn away from the capital-intensive high-pressure/ high-temperature (HP/HT) plays in the deepwater US Gulf of Mexico and instead focus their investments in areas offshore Guyana, Brazil, Angola, the United Kingdom, and Mexico.

It appears that current federal deepwater royalty rates are drying up US offshore investments.

NOIA, through its work on the Royalty Policy Committee, is a strong advocate for deepwater royalty rates that are competitive with shallow water and onshore royalty rates. Unfortunately, Interior’s current royalty framework is arbitrarily picking winners and losers. Part II of the royalty report, expected to be published later this year, should underscore the need for royalty reform and give the Department of the Interior the impetus to adopt smarter royalty rates.

The challenges facing the offshore industry have not lessened the need for offshore production; in fact, the US needs access to more areas for offshore exploration and development. The US Energy Information Administration (EIA) predicts that even by 2050, nearly 70% of US energy demand will still be met by oil and natural gas. New deepwater technologies and new efficient practices, combined with onshore shale production expected to plateau by the mid-2020s, are bringing investment dollars back to the US Gulf of Mexico.

The pendulum is swinging back toward offshore, and the US must seize this opportunity by incentivizing investments in new offshore oil and gas projects.

As long as the US, and the world, need affordable and reliable energy, oil and natural gas will be vital components of a responsible and balanced “all of the above” American energy portfolio. Deepwater royalty reform can help the US reclaim its competitive edge in the offshore world and drive new job creation, economic growth, and increased energy security at home. Wise decisions by policy makers can ensure that U.S. producers are able to answer the call. •

The author

Richard Clark is President of the Gulf of Mexico Business Unit for Kosmos Energy and Chairman of the National Ocean Industries Association (NOIA). He was previously the President of Deep Gulf Energy, which he formed in 2004. Kosmos Energy purchased Deep Gulf Energy in August 2018. Prior to forming Deep Gulf Energy, he served in a variety of engineering and operational positions including Chief Engineer, Operations Manager, Production Manager, Vice President–Production, and Executive Vice President of Mariner Energy, Inc. and its predecessor companies from 1984 to 2002. Clark was one of the four founders of Mariner Energy, Inc., and a member of the Board of Directors from 1988 until leaving the company in 2002. Clark began his career as Production Engineer for Shell Offshore from 1979 to 1984. He graduated with a Mechanical Engineering Degree from the University of Tennessee at Chattanooga in 1979.