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Royal Dutch Shell Plc .com: Negotiating Royalties

From Bangor Daily News
Wednesday, July 05, 2006 –

The U.S. Department of the Interior made mistakes in contracts for deep-sea oil and gas drilling by exempting companies from royalty payments to the federal government. To correct the problem, lawmakers are pressuring companies to renegotiate the contracts. While encouraging these negotiations is appropriate, blackmailing companies – by banning their participation in future drilling opportunities, for example – isn’t the best solution.

When it negotiated the 1998-99 lease contracts for deep-water drilling in the Gulf of Mexico, the Interior Department failed to include an addendum, typical in such leases, requiring that companies pay royalties to the federal government when oil and gas prices surpass set levels. The price triggers in other contracts at the time were $28 a barrel for oil and $3.50 per thousand cubic feet for natural gas. Both now are trading at prices far above such triggers, and the Government Accountability Office found that the federal government would lose $10 billion in royalty payments over the life of the leases.

A former Interior attorney who reviewed the leases, Milo Mason, told The Associated Press that he was surprised by the absence of the addendum, but said he thought it was no big deal because the department figured oil prices wouldn’t rise.

Prices did rise, substantially, and now Congress wants to do something about the problem. The Senate Appropriations Committee last week approved a provision prohibiting companies from being granted future offshore leases by the Interior Department unless they renegotiate the faulty leases. This was a re-write of a calmer provision introduced by Sen. Susan Collins that aimed to end the practice of royalty relief by barring exemptions from royalties in future leases when oil averages more than $55 a barrel and natural gas average $10 per thousand cubic feet. Exceptions were allowed to avoid supply disruptions in the Collins measure.

Many large companies, which own the vast majority of leases, such as Shell Oil and Chevron Corp., say they are ready to discuss changes in the lease agreements to resolve the issue. Others disagree, and one company, Kerr-McGee Corp., has sued the government over royalty price triggers in lease contracts. The company’s general counsel, Gregory Pilcher, said relief from royalty payments was intentionally included in the contracts to encourage costly deep-sea exploration and drilling.

Oil and gas companies are rightly concerned about the retroactive, punitive nature of the measure approved by the Appropriations Committee. Pushing companies to the negotiating table is a good goal. It shouldn’t be undermined by bullying companies so hard that they balk at doing so.

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