By LOUISE S. DURHAM
EXPLORER Correspondent

U.S. Needs the Gas

Royalties Sweeten Deep Gas Pot

Help appears to be on the way, thanks to a new roalty relief initiative being proposed by the MMS.

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There's buzz aplenty over the potential to tap into huge gas finds deep on the shallow water (<200 meters) shelf of the Gulf of Mexico.

Of the 5,000 exploration wells drilled in shallow water in the past 10 years, only 7 percent bottomed out between 15,000 and 18,000 feet true vertical depth subsea (TVD SS), and a mere 2 percent went below 18,000 feet, according to the Mineral Management Service (MMS).

This is not surprising given that drilling into this essentially unknown environment requires deep pockets and a huge tolerance for risk - meaning operators can use all the help (aka economic incentive) they can get.

Help appears to be on the way, thanks to a new royalty relief initiative being proposed by the MMS.

The agency has an established track record of coming to the rescue where Gulf drilling is concerned. It has provided several royalty relief programs in the deep water, along with deep drilling incentives for shallow water leases issued after 2000, which addresses only a small part of the deep gas potential.

There's an urgency to do more because natural gas production from Alaska and Canada and the deepwater GOM are not anticipated to add enough to the domestic supply to meet U.S. demand until after 2006.

Recognizing the need to find new production that could be brought on line near-term, the MMS took a hard look at the more than 2,400 active leases on the shelf issued prior to 2001. With platforms, production facilities and pipelines already in place, these holdings represent the best opportunity to bring any newly discovered deep gas production to market quickly.

As a result, the MMS decided to propose some significant royalty relief provisions for drilling deep on these properties:

• A successful qualified well drilled from 15,000 to 18,000 feet (Depths are true vertical depth subsea TVD SS) receives a royalty suspension volume (RSV) of 15 BCF.
• An unsuccessful certified well between 15,000 and 18,000 feet garners zero relief.
• Successful qualified wells drilled to 18,000 feet or more qualify a lease for 25 BCF RSV.
• An unsuccessful certified well to 18,000 feet or deeper qualifies for 5 BCF royalty suspension supplement (RSS).

A lease must meet certain criteria to be eligible for royalty relief:

• Located entirely in water less than 200 meters (656 feet) deep.
• Located on blocks wholly west of 87 degrees, 30 minutes west longitude.
• No prior production from a well spudded before March 26, 2003, with completion depth of 15,000 feet or more.
• Issued in a lease sale held prior to January 2001.

It is noteworthy that an unsuccessful certified well below 18,000 feet qualifies a lease to snag a RSS of 5 BCF. In fact, a lease can acquire up to two RSS plus the RSV associated with the initial qualified deep well that started production. Significantly, this means a lease could earn the right to produce as much as 35 BCF royalty free, i.e., 10 BCF from two unsuccessful wells and 25 BCF from one success.

The proposed royalty relief provisions for active leases will be subject to a natural gas price threshold of $5 per million Btu, adjusted from year 2000 for inflation, with royalty payments due for product that exceeds this price. Deep gas production must begin within five years after the effective date of the final rule for the program.

To accommodate shallow water leases issued in a sale after January 1, 2001, but prior to the effective date of the final rule for the proposed package, the MMS is offering the option to substitute the new incentives for the deep gas incentive terms in the lease.

The perceived urgency to bring new natural gas supplies to market is underscored by the retroactive feature of the proposed initiative.

The MMS is offering to make the royalty relief program effective as of the date of the proposed rule (March 26, 2003) to encourage deep gas drilling to begin ASAP rather than waiting for the final ruling, which is anticipated to be near the end of the summer.

A caveat: Royalty relief will apply only to production that comes on line after the effective date of any final rule.

Because interest already has been expressed for drilling into areas 30,000 feet or more, the agency said it will look at whether added measures are justified for these extreme conditions.