CHAPTER 11 FEDERAL OFFSHORE ROYALTY RELIEF PRACTICAL APPLICATIONS

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management
(Feb 2007)
CHAPTER 11
FEDERAL OFFSHORE ROYALTY RELIEF PRACTICAL APPLICATIONS
Kevin J. Karl
Regional Supervisor
Office of Production and Development
MMS - Gulf of Mexico Region
Minerals Management Service
U.S. Department of the Interior
New Orleans, Louisiana
J. Keith Couvillion
Deepwater Land Manager
Chevron Exploration and Production Company, a division of Chevron U.S.A. Inc.
Houston, Texas

KEVIN J. KARL

Kevin J. Karl is the Regional Supervisor for the Office of Production and Development and has been employed with the Minerals Management Service (MMS), Department of Interior, for approximately 25 years. The MMS manages the mineral resources on the outer continental shelf to assure a sound and safe environment and collects, verifies, and distributes mineral revenues from Federal and Indian lands. Mr. Karl works in the Gulf of Mexico Region located in the New Orleans area. This office regulates oil and gas operations in the Federal waters of the Gulf of Mexico. Mr. Karl has been promoted through several petroleum engineering and supervisory positions before reaching the current position as Regional Supervisor for the Office of Production and Development. His prior position was as Deputy Regional Supervisor for the Office of Production and Development. Mr. Karl oversees approximately 72 employees including supervisors, engineers, geologists, and geophysicists whose main function is related to the conservation of the natural resources, the prevention of waste, and the proper measurement of oil and gas. Mr. Karl also works closely with the oil and gas companies operating in the Gulf of Mexico in order to make sure all applicable laws and regulations are being followed. Mr. Karl received a Bachelor's degree in Petroleum Engineering from Louisiana State University in 1984.

J. KEITH COUVILLION

J. Keith Couvillion is the Deepwater Land Manager supporting Chevron's Deepwater Gulf of Mexico Exploration and Projects Business Unit located in Houston, Texas. Mr. Couvillion joined Texaco in late 1979 and has worked either onshore or offshore for the past 27 years in many capacities supporting Texaco's, and now Chevron's, exploration and production operations in the Gulf of Mexico region. He has held the positions of Landman, District Landman, Offshore Land Manager, New Orleans Production Operations Land Manager, Land Consultant and Deepwater Land Manager. Mr. Couvillion has been involved in the offshore portion of the land profession since late 1985. In 1997, Mr. Couvillion assumed the responsibility of Offshore Land Manager for Texaco's New Orleans based business unit. In November of 2001, he accepted a position with the newly formed ChevronTexaco organization (now Chevron) as an in-house Land Consultant and now serves as Chevron's Deepwater Land Manager in its Deepwater Exploration & Projects Business Unit located in Houston. Mr. Couvillion is active in many industry trade and professional associations supporting Gulf of Mexico OCS activities and currently serves as co-Chairman of the API led Marine Wildlife Issues Group. Mr. Couvillion is a frequent presenter in industry forums addressing offshore issues.

Table of Contents

I. INTRODUCTION

II. OUTER CONTINENTAL SHELF LANDS ACT

III. DEEPWATER ROYALTY RELIEF ACT

A. Pre-Act Lease Royalty Relief

B. Eligible Leases

C. Post Act Deepwater Royalty Relief

IV. SHALLOW WATER - DEEP GAS ROYALTY RELIEF

A. OCS Lease Sale 178 (March 2001)-OCS Lease Sale 184 (August 2002)

B. Leases issued after January 1, 2003

1. Qualifying Shallow Water Leases

2. Royalty Relief Suspension Type Definitions

3. RSV Qualifications

4. RSS Qualifications

5. Deep Gas Price Thresholds

C. Post Energy Policy Act of 2005

V. ENERGY POLICY ACT OF 2005

A. Shallow Water Deep Gas Royalty Relief

B. Intermediate Water Deep Gas Royalty Relief

C. Deep water Royalty Relief

VI. END-OF-LIFE ROYALTY RELIEF

VII. SPECIAL CASE ROYALTY RELIEF

VIII. PRICE THRESHOLDS

IX. UNITIZATION

A. Deep Water Units

B. Shallow Water Units with Deep Gas Wells

X. ROYALTY REPORTING IMPLICATIONS

XI. CONCLUSION

I. INTRODUCTION

Offshore oil and gas exploration and development in the United States began off the coast of Summerland, California in 1896. From that point in time government entities claiming jurisdiction to offshore subsoil mineral resources have been sharing in some form a portion of the value generated as a result of oil and gas being produced from successful energy developments. This share of the benefits from production is known as royalty and is the subject of many lectures, debates, books, periodicals, media reports, newspaper articles and litigation. Relieving an entity from the obligation to provide a portion of the resources discovered to the owner of the minerals is known as royalty relief. Royalty relief has also been used as an incentive to stimulate activity in geographic areas where the risk and cost to explore for and develop minerals are significant. In the United States, the federal government for many years has used the concept of royalty relief to stimulate exploration and development in offshore frontier areas.

The Outer Continental Shelf (OCS) Lands Act, 43 U.S.C. 1337, as amended by the OCS Deep Water Royalty Relief Act (DWRRA), Public Law 104-58, authorizes the Secretary of the Interior ("Secretary") to grant royalty relief in three situations:

(a) Under 43 U.S.C. 1337(a)(3)(A), the Secretary may reduce or eliminate any royalty or a net profit share specified for an OCS lease to promote increased production.

(b) Under 43 U.S.C. 1337(a)(3)(B), the Secretary may reduce, modify, or eliminate any royalty or net profit share to promote development, increase production, or encourage production of marginal resources on certain leases or categories of leases. This authority is restricted to leases in the Gulf of Mexico (GOM) that are west of 87 degrees, 30 minutes West longitude.

(c) Under 43 U.S.C. 1337(a)(3)(C), the Secretary may suspend royalties for designated volumes of new production from any lease if:

(1) The lease is in deep water (water at least 200 meters deep);

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(2) The lease is in designated areas of the GOM (west of 87 degrees, 30 minutes West longitude);

(3) The lease was acquired in a lease sale held before the DWRRA (before November 28, 1995);

(4) The Secretary finds that new offshore production would not be economic without royalty relief. ¹

This paper will provide an overview of the royalty relief programs currently used by the Department of the Interiors Minerals Management Service ("MMS") to stimulate production in the United States. The four major categories of royalty relief will be discussed (Deep Water, Shallow Water Deep Gas, End-of-Life and Special Case). This paper will also discuss some of the practical applications of the royalty relief program as administered by the MMS. Throughout the paper "Notes" have been inserted to emphasis these practical applications.

II. OUTER CONTINENTAL SHELF LANDS ACT

The Outer Continental Shelf Lands Act ("OCS Lands Act")² was signed into law on August 7, 1953. This particular statute is considered to be the foundation of the federal offshore mineral development program and provides the framework for regulating the exploration, development, and production of oil, gas and other minerals on and under the seabed in U.S. waters beyond the jurisdiction of coastal States. Through the implementing regulations of the OCS Lands Act, mineral resources on the continental shelf are leased "to the highest responsible qualified bidder or bidders by competitive bidding."³ Nine (9) bidding systems are available at the discretion of the Secretary of the Interior to be used in leasing offshore resources. All bidding systems found in the OCS Lands Act contain a component of royalty which is either fixed or variable. Of the approximately 8,000 active leases issued by the MMS offshore, most have a fixed royalty of either 12½ per centum or 16½ per centum of all oil or gas saved, removed or sold from the lease.

III. DEEPWATER ROYALTY RELIEF ACT

In an effort to promote the exploration and production of natural gas and crude oil in deep water the DWRRA⁴ was signed into law on November 28, 1995. The DWRRA implemented and provided authority for royalty relief programs for leases located in the Gulf of Mexico in water depths of 200 meters or greater wholly west of 87 degrees and 30 minutes West longitude. Basically the area located in the Western and Central Gulf Planning Areas and a small portion of the Eastern Planning Area. Deep water royalty relief is the most common form of royalty relief and consists of both discretionary relief and relief that does not require an economic evaluation. Discretionary relief requires an application demonstrating economic need whereas there is no application process for the relief that does not require an economic evaluation. The four main parts of the DWRRA are as follows: (1) allows lessees to

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petition MMS for economic need based royalty relief for non-producing deep water leases issued prior to November 28, 1995 ("Pre-Act Leases"); (2) provides lessees holding deepwater leases acquired in OCS lease sales held in 1996 through 2000 with automatic royalty relief up to certain volumetric limitations without the submittal of an application demonstrating economic need; (3) gave MMS the authority to issue leases after the year 2000 with royalty relief provisions determined by the Secretary of the Interior ("Secretary") on a sale-by-sale basis; and (4) gave the Secretary the authority to establish royalty relief programs regardless of water depth and producing status (e.g., shallow water deep gas).

A. Pre-Act Lease Royalty Relief⁵

The DWWRA stipulates that leases issued prior to November 28, 1995 that qualify for royalty relief will receive relief up to the volume...