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Bloomberg: Congress, Oil Drillers Set to Clash Over Royalties (Update1)

By Jim Efstathiou Jr.

(Bloomberg) — The U.S. Congress and oil and natural- gas producers are set to clash over proposals to resolve a mistake which exempts some companies from more than $10 billion in government royalties on Gulf of Mexico drilling leases.

Leases issued in 1998 and 1998 by the U.S. Minerals Management Service omitted price thresholds that would require royalty payments when oil and gas prices rise. The House of Representatives in January passed a bill that would force producers to fix the leases or bar them from future drilling contracts, a solution oil companies say violates the sanctity of valid contracts.

Senator Dianne Feinstein, a Democrat from California, in March proposed giving producers more time to develop their leases if they agreed to pay drilling fees. That idea has split the drillers, and Feinstein now says she will move forward with a version of the House bill.

“What you’re seeing now is Congress saying `no, we’re not going to give these guys anything’,” said David Pursell, a principal with Pickering Energy Partners, a consulting firm in Houston. “Gasoline prices are higher and I think its tough to give the industry anything, regardless of whether it’s right or wrong.”

Another proposal would establish a fee or tax on future production to make up for royalties lost on the 1998 and 1999 leases. Higher fees on drillers would result in higher energy prices for consumers, according to the American Petroleum Institute, which lobbies on behalf of the largest U.S. oil companies.

Mistake

The Interior Department’s inspector general found that the thresholds were left out of over 1,000 leases by mistake. About 570 of the leases are active and about 21 have produced commercial quantities of oil or gas, the Minerals Management Service, a division of the Interior Department, said in September.

The error has cast a shadow over current Minerals Management Service Director Johnnie Burton, who told Congress in September she first learned about the mistake in early 2006. Confronted with evidence that her employees told her in 2004, Burton failed to take action, the inspector general said in a report. President George W. Bush appointed Burton in 2002.

Once the mistake became public last year, Burton tried to persuade companies to voluntarily agree to pay fees under the botched leases. In December, six companies including Royal Dutch Shell Plc, BP Plc, ConocoPhillips and Marathon Oil Corp. said they would pay royalties for production from Oct. 1, 2006, forward.

Chevron Talks

The terms for royalty payments are set when leases are signed and affect fees paid out over decades. Years can pass from the signing of a lease to actual drilling and production.

The agreements exclude about 45 companies, including Chevron Corp. The idea of offering three-year extensions to prod more companies to accept a deal on the fees originated in talks with Chevron, said John Northington, a lobbyist with the consulting firm Thomas Advisors Inc.

Deepwater leases in the Gulf of Mexico typically give companies 10 years to begin commercial production, and are returned to the government if no action is taken in that time. Once turned back, the government can offer the leases to the highest bidder.

“It’s my understanding that the genesis of an overall lease extension came in discussions that Chevron had early on with the Minerals Management Service,” Northington, a former senior adviser at the Interior Department, said in an interview.

Rewards for Inaction

Of the 570 active leases, 406 will expire in 2008 and the remainder in 2009, Stephen Allred, head of the Interior Department’s land and minerals division, told reporters May 1. Allred couldn’t say how many companies would benefit from the proposed three-year extension.

“One of the reasons I think Chevron was interested in the extensions was that they would have to get extensions approved, which means they had not developed them,” Allred said.

Regardless of the number of leases at issue, offering extensions rewards companies for inaction, according to Marvin Odum, Shell’s executive vice president of exploration and production in the Americas.

Shell and others will invest money and technology anticipating “that these leases turn over every 10 years,” Odum said in an interview yesterday. “My biggest concern is that Congress somehow tries to correct a mistake by, if I just be fairly bold here, by legislating what I think would be another mistake.

“Should Come Forward”

Forcing producers to rework existing contracts will discourage production of domestic oil and gas reserves, the American Petroleum Institute said. In an e-mail yesterday, Feinstein said there may be no way to avoid litigation under any universal solution forged by Congress.

“Companies that have not signed should come forward and sign up, but we can’t force them to,” Allred said. “The consequences of not solving this problem on their own could well subject them to not only an image issue, but the potential of Congressional action that they won’t like.”

To contact the reporters on this story: Jim Efstathiou Jr. in Washington at [email protected]

Last Updated: May 4, 2007 15:45 EDT

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