Design and Rationale of the Final Rule on the Deep Water Royalty Relief Act

Abstract

Abstract Following passage of the Deep Water Royalty Relief Act in November 1995, the Minerals Management Service (MMS) implemented its deep water royalty relief program for existing leases (any in most areas of the Gulf of Mexico that were issued before the act and are located in water deeper than 200 meters) with publication of an interim rule in May 1996. Comments subsequently received from the oil and gas industry focused on six core issues: categorical qualification, application timing, certification, complexity, treatment of historic costs, and criteria for material changes and redeterminations. The first half of this paper reviews the basic relief qualification process and summarizes the changes MMS made in the program in response to industry comments as well as the reasons for making these changes. The final rule was published in January 1998. Inquiries and initial applications submitted under the Act identified some oversights and omissions in the evaluation and implementation procedures. These included possible changes to the field composition after an application, poor representation of the geologic data, the effect of ownership changes on sunk cost, justifying the development option chosen over alternatives, unanticipated cost arrangements and structures, wide and skewed cost distributions, contingency and excessive overhead cost factors, and evaluating fields that mix pre- and post-Act leases. These issues prompted MMS to reexamine policy on field assessment, certain costing issues, potential alternative development systems, and field configurations. The second half of this paper reviews the lessons learned so far from experience with eight implementation issues. This paper should afford those who seek deep water royalty relief in the future a better understanding of the process. The Act directs that MMS grant royalty relief only where it is economically necessary. However, forecasting the economics of a deep water oil and gas project is complex and subject to substantial uncertainty. Among other things, current economic assessments can be overtaken by rapid technological advances, by dramatic price or cost changes, or by increased experience and understanding of deep water oil and gas development. The MMS will balance this uncertainty with industry needs because royalty relief may well be a necessary condition for development of some significantly sized deep water fields. Introduction In the 10 years preceding passage of the Outer Continental Shelf Deep Water Royalty Relief Act (DWRRA) in 1995, production of oil from the Gulf of Mexico Outer Continental Shelf (OCS) was remarkably steady. For the years 1985 through 1994, annual oil production in the Gulf of Mexico Federal OCS (as measured by published crude oil and condensate sales volume) varied from a low of 272 to a high of 312 million barrels. The stability of these results was somewhat surprising, given the small proportion of production that emerged from newly discovered fields in this period. Over 90 percent of the total production for the period was from shallow water leases (i.e., those in less than 200 meters of water). Thus, based on trends existing in the early to mid-1990's, a decline in Gulf of Mexico Federal OCS oil production by the turn of the century appeared inevitable.