Royalty Relief Plan Would 'Outsource' Leases to Foreign Firms

Oil industry officials say congressional plans to limit royalty waivers for Gulf of Mexico producers could prevent experienced U.S. companies from buying future federal offshore leases and provide an opening for foreign firms from China and elsewhere.

The House approved an Interior Department spending bill this month aimed at forcing renegotiation of 1990s lease contracts that allow "royalty relief" but lack "price thresholds" that end the incentive when prices reach certain limits. The royalty relief program stems from a 1995 law designed to encourage higher-risk, higher-cost deepwater gulf production when energy prices were much lower.

Interior mistakenly drafted 1998 and 1999 lease contracts without the thresholds, an omission that could cost the government billions in coming years. The House measure -- sponsored by Rep. Maurice Hinchey (D-N.Y.) -- would prevent companies holding these leases from receiving new leases in fiscal year 2007. The intent is to convince producers to agree to price thresholds, and lawmakers approved the language as an amendment to the spending measure on May 18.

Initial complaints about the House legislation centered around the idea that reopening old contracts is bad precedent, a signal that the government does not honor its agreements. "This could be Bolivia," said John Felmy, chief economist at the American Petroleum Institute, referring to the South American country that is seeking greater state control over foreign natural gas producers.

But industry officials also said in interviews the provision would apply to so many companies, it would effectively block those most qualified to conduct offshore operations from participating in lease sales.

"The effect of the Hinchey amendment could be very severe in terms of preventing energy supplies from being provided by the companies that can best provide them, the U.S. companies," said Bill Whitsitt, president of the Domestic Petroleum Council, which represents larger independent companies.

Fifty-six companies have leases issued in years affected by the provision. Companies include major oil companies like Exxon Mobil Corp. and Shell, and major independents such as Kerr-McGee and Dominion. The list of companies holding 1998 and 1999 leases overlaps largely with the list of companies that submitted successful bids in the most recent Gulf of Mexico lease sale, which drew nearly $600 million in high bids for the central Gulf Coast blocks.

Felmy, in an interview last week, said the list of companies that have 1998 and 1999 contracts includes "virtually all the operators that are knowledgeable about the gulf." As a result, he said that lease sales would draw less experienced companies, and other nations. He said the policy is tantamount to "outsourcing to foreign oil firms." The Minerals Management Service plans to hold two gulf lease sales in fiscal 2007.

To operate in the Gulf of Mexico, foreign companies must have a U.S. subsidiary or partner with a domestic company, MMS spokesman Gary Strasburg said.

A "dear colleague" letter circulated by two House lawmakers opposing Hinchey's plan says two thirds of the companies that placed bids in the March 2006 lease sale would be precluded from participating in fiscal 2007 sales.

"If companies holding 1998 and 1999 leases are, in effect, precluded from participating in the FY '07 there will be significant impacts," says the letter by Reps. Charlie Melancon (D-La.) and Dan Boren (R-Okla.). It says "fewer players will be bidding on leases in these sales and lower bids will result due to the exclusion of certain players" and adds the government will receive less bidding revenues.

The letter failed to sway enough lawmakers. Hinchey's amendment passed 252-165 on May 18.

The House language would have to be approved in the Senate. Sen. Dianne Feinstein (D-Calif.), a member of the Appropriations Committee, said recently she hopes to offer similar language in the Senate appropriations process, which is proceeding more slowly than the House spending bills.

'They could renegotiate the leases'

Morgan Gray, an aide to Rep. Ed Markey (D-Mass.) -- who leads House Democrats on the issue -- dismissed claims that the language could hinder Gulf Coast production efforts. Energy companies, he said, have a simple way to deal with it: "They could renegotiate the leases."

"The purpose of this was to provide a strong economic incentive to renegotiate these leases," Gray said. "Exxon is still free to drill in the future as long as they renegotiate these leases that were given in error." Both Markey and Feinstein have sponsored legislation that similarly seeks to pressure companies into renegotiating.

MMS, which oversees outer continental shelf leasing, did not comment on the effect of the Hinchey plan. "We typically wait until it becomes a law before comment on whether it is of concern to us or not," MMS spokesman Strasburg said yesterday. "It is hard to comment because we don't know what will happen with it for sure."

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