Court Action Puts MMS 'In Holding Pattern' on Royalty Disputes

Interior Department efforts to address flawed late 1990s Gulf of Mexico oil and gas leases are on hold pending the outcome of litigation over the government's power to compel royalty payments from deepwater producers, the director of the Minerals Management Service said in a recent interview.

MMS Director Randall Luthi also defended the agency's plans to sell new leases off the coast of Alaska and expressed frustration that the agency has not moved faster to draft its offshore renewable energy leasing rules.

Gulf oil and gas leases issued in 1998 and 1999 that allow royalty waivers lack clauses that suspend the incentives when energy prices surpass certain limits, an omission that jeopardizes billions of dollars in royalty collections.

But Luthi said resolution of the issue will likely await the outcome of a court case brought in 2006 by Kerr-McGee Oil and Gas Corp. The company, which was later purchased by Anadarko Petroleum Corp., disputes MMS authority to condition royalty incentives on energy prices.

The company is challenging price-based limits on royalty incentives for leases it was issued in 1996, 1997 and 2000. But the case more broadly raises questions about the legality of including "price thresholds" in leases issued to many oil companies under the 1995 Deep Water Royalty Relief Act.

A federal district court in Louisiana sided with the company last October. The Department of Justice is considering whether to appeal the case, a step that Interior officials are urging. MMS, a branch of Interior, has estimated that tens of billions of dollars in eventual royalty payments from various gulf producers are at stake.

Luthi in September said talks with industry over the 1998-1999 contracts were "in abeyance" while the agency waited to see whether Congress could address the issue before the end of 2007. Congress did not act on the issue.

But in last week's interview at Interior headquarters, Luthi said the court decision and appeals process mean the issue is still on hold, calling the federal court decision a "major change."

"We are now back in a holding pattern to see what the eventual court decision is on that," he said. MMS in late 2006 had reached agreements with a handful of companies to apply the so-called price thresholds to future production from their leases, but the issue remains unresolved for many more companies.

He said there are no negotiations ongoing with industry. However, Luthi also said he is continuing to mull how the agency might resolve the issue.

"I have not come up with any firm new options yet," he said. "I also know that, until Kerr-McGee is decided, we are pretty limited in what we can do."

He reiterated the agency's view that MMS should have the right to base royalty waivers on energy prices. "It is difficult to believe that Congress really intended us not to be able to collect royalties," he said.

Defending Alaska plans

MMS on Feb. 6 is planning to auction leases in the Chukchi Sea in a region covering 29.7 million acres of federal waters off Alaska's northern coast. The Chukchi Sea area may contain up to 15 billion barrels of oil, according to the agency.

But the upcoming sale has come under criticism from environmental groups, who says oil and gas development could harm species including the polar bear.

The sale comes as the Fish and Wildlife Service is expected to make a decision within weeks about whether to extend Endangered Species Act protections to the bear. Environmentalists have petitioned for the listing of the bear under ESA on the grounds that melting sea ice caused by global warming is degrading the bear's habitat. There have also been calls to delay the sale, which Luthi rejects.

"We are confident that we have got the environmental work done to support this sale," he said.

Luthi said that regardless of the FWS decision on the polar bear, the agency already works closely with FWS and other agencies to address species protection in Alaska. For instance, he highlighted that the sale will not include waters within 25 miles of shore in order to address whale migration routes.

Also, he said that oil and gas exploration activities are conducted in the "open water" season and that production -- which takes place year round -- would be years away in the Chukchi. "Before they go into production there is going be coordination with FWS on how best to minimize any impact [to the bear], if any is to occur," he said.

Luthi also said that MMS has informed oil and gas producers that listing the polar bear could trigger additional environmental controls. MMS has informed industry that if the bear is listed under ESA, it "may be required to apply additional mitigation measures on OCS activities to ensure appropriate protection."

More broadly, he said MMS has spent $300 million over the last three decades on various environmental studies in Alaska, with dozens ongoing.

Alt-energy leasing

Elsewhere, Luthi said the agency is getting closer to completing a proposed rule on offshore renewable energy leasing and sending it to the White House for review. Sweeping energy policy legislation enacted in 2005 put MMS in charge of renewable energy development in federal waters.

But the agency has not yet proposed regulations for managing the sector, despite growing interest in offshore wind and wave energy. "It has been personally frustrating to me, the pace at which we have done this," Luthi said. "Unfortunately, we don't have an unlimited team of people to do all this, so it has come down to somewhat of a workload issue."

Luthi did not provide a specific timeline but said the agency wants to ensure a final rule is completed during the Bush administration.

"It is one of my top priorities," he said. "It would be very important for MMS to complete that, and it does not matter who wins the next election. This is setting the national policy, the national program, and I think any administration would want see that up and going when they take over, and that is our goal."

The agency has taken some preliminary steps, recently issuing a formal "record of decision" that confirms the broad parameters of the program.

Also, the agency is continuing work on the Cape Wind project off the Massachusetts coast that has long been in the planning stages, and work is proceeding even in the absence of the offshore rules mandated by the 2005 energy law.

The agency today announced that it had filed a draft environmental impact statement for the project and announced a series of public hearings in March. (See related story.)

Royalty management

Luthi said the agency is already working on some of the recommendations that were contained in a recent outside report on improving the agency's royalty collections and management procedures.

Two former senators led a study issued last month that contained dozens of recommendations for managing collection of what is a major source of federal revenue (Greenwire, Dec. 18, 2007).

Luthi said the agency is aiming to improve coordination with the Bureau of Land Management and increase ethics training for staff involved with the royalty-in-kind program.

"We have done that. We have gone even ... a step further," he said of the RIK program. He said the oil and gas industry is accustomed to conducting business in places including the golf course, something he said cannot fly.

He said MMS has informed industry, "We are going to deal with you professionally, we are going to deal with you on a very commercial basis, but we have got to do it differently than what you are used to and we have already started that kind of outreach."

The recent report also recommended creation of a "trust fund" within the federal government that would help fund royalty management. It would require congressional approval.

"We think it is a great idea. But the reality is that is going to take quite a bit of selling to Congress," he said. "But it is worth pursuing, talking to them."

Looking forward, and back

Interior Secretary Dirk Kempthorne appointed Luthi, who is from Wyoming, roughly six months ago to lead MMS. His appointment came at a time when the agency was under scrutiny from Congress, the press and Interior's inspector general about its royalty management programs.

The rancher and lawyer had been deputy director of FWS since early 2007 when appointed to MMS and also served a decade in the Wyoming Legislature, including a stint as speaker in 2005 and 2006.

"I continue to be impressed with how important the agency's mission is to our nation, both in terms of our energy supply picture and in terms of our economy," Luthi said. He praised the "dedication" of the agency's staff. "It is just an absolutely wonderful bunch," he said.

The MMS director said he was concerned about the economic effects of sustained high energy prices, noting a recent Energy Information Administration forecast of record gasoline prices this spring. He said it is vital that MMS do everything it can to boost domestic oil and gas production, while also working to boost alternatives.

"No matter what we do in terms of conservation, alternative fuels, alternative energy, it is still going to be for the next generation, the next 30 years or so, coal, oil and gas that are still going to be used to supply our vast energy needs," he said.

"I think we should do everything we can to increase production of those traditional forms of energy as well as move as fast as we possibly can on alternative forms of energy," he added. "It is going to take both of those."

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