95115: Outer Continental Shelf Leasing for Oil and Gas Development

Lawrence C. Kumins
Environment and Natural Resources Policy Division

Updated November 1, 1996

CONTENTS

SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS

Disbursement of OCS Revenue

OCS Leasing Moratoria and the Proposed 5-Year (1997- 2002) Leasing Plan

Recent Discovery off the Florida Panhandle

OCS Lease Buybacks

Deep-Water Royalty Holiday Becomes Law

LEGISLATION

SUMMARY

The Outer Continental Shelf (OCS) is the source of 15% of U.S. crude oil production and 25% of natural gas output. Nearly all of this production (95%) comes from the Central and Western Gulf of Mexico, where development encounters little opposition. The Central and Western Gulf is the only area where leases have been auctioned since 1991. Attractive new prospects in these areas--especially in deeper water--as well as a small part of the Eastern Gulf (off Alabama) are the center of current OCS leasing interest.

In 1994 (the latest available data), the Interior Department's Minerals Management Service (MMS) collected $2.5 billion in OCS royalties, lease rentals, and bonus payments for lease acquisition. Of these monies, 57% was retained by the U.S. Treasury in the General Fund. The remainder were used for statutory contributions to the Land and Water Conservation Fund and the National Historic Preservation Fund, as well as the state share of revenue from submerged lands just outside the 3-mile limit. States share mineral rights on the first 3 miles (and in a few cases as much as 6) of the federal OCS adjacent to state lands because hydrocarbon fields can drain across the federal/state boundary.

During the 104th Congress, OCS leasing moratoria and royalty abatement for new deep-water drilling have attracted legislative interest. Legislative moratoria have been part of every Interior Department appropriations bill since the early 1980s. Each year, more acreage has been placed off-limits, with broad bipartisan support. In 1995, the Interior Appropriations Subcommittee reported out a bill with no moratoria, but the full Committee reinstated the moratoria. These annual moratoria are parallelled by a 1990 directive banning leasing and pre-leasing activity in places other than the Texas, Louisiana, and Alabama offshore, and limited areas off Alaska. A Proposed Final Leasing Program for 1997-2002 was released for public comment by the MMS in August 1996. It reflects local input plus the prohibitions delineated on Capitol Hill and at the White House.

Reduction of producer-paid royalties as an incentive to increase OCS production was included in P.L. 104-58 . Royalty relief applies to new production in waters deeper than 200 meters, applicable only to the Central and Western Gulf. At least partially due to the royalty relief, MMS held two very successful lease sales, one of which was the biggest ever, accounting for 902 blocks leased for $512 million.

Some leases in environmentally sensitive locations have been subject to after-sale development bans. Such prohibitions resulted in demands that the Government buy back the tracts involved. Funds to do so were not appropriated, however, and the leaseholders sued. All but one of these cases have been resolved, with payments made from a Department of Justice fund whose purpose is to pay for such settle-ments.

MOST RECENT DEVELOPMENTS

Royalty rate reduction for expensive, new OCS production in deep water was enacted by Congress and signed into law in November 1995 (P.L. 104-58). This law also provided for the sale of the Alaska Power Administration and the export of Alaskan crude. Title III -- Outer Continental Shelf Deep Water Royalty Relief -- provides a holiday for royalty payments on specified amounts of new oil and gas. The amount of production exempt from royalties increases with water depth, beginning at 200 meters.

The initial response to the deep water incentives has been impressive, in part a result of coinciding advances in offshore drilling technology. During FY1996, MMS held two highly successful lease sales. The first, held in May, was the largest ever held, with 1381 bids received. When evaluated, 902 blocks were leased for bonuses totaling $512 million. The second, held in late September, attracted 929 bids on 617 tracts. Those bids are still being evaluated.

In August 1996, MMS issued a Proposed Final 5-Year Oil and Gas Leasing Program for 1997-2002. The Proposed Program steers a course between congressional moratoria and areas where production has proved successful. It also includes local input on areas where exploration is unwelcome. Over the 5-year period, 16 sales in 7 OCS areas are envisioned.

BACKGROUND AND ANALYSIS

As the technology for producing underwater reserves of crude oil and natural gas developed after World War II, interest arose in producing hydrocarbons on the federal Outer Continental Shelf (OCS). The OCS is the federal portion of the continental shelf, extending outward beyond the 3-mile line in most cases. Submerged lands within 3 miles of the coast belong to the states.

Responding to increasing interest in OCS production, Congress enacted the 1953 Outer Continental Shelf Lands Act (OCSLA). OCSLA as amended provides for the orderly leasing of these lands, while ensuring protection of the environment and that the federal government receives fair market values for the lands and mineral production. About 70 million acres of land have been leased under OCSLA; almost all leases have been auctioned to the highest cash bidder. A bidder's up-front cash payment securing a lease is called a bonus bid. Since 1954, bonus bids totalling $57 billion have been paid on oil and gas prospects.

When production results on the federal OCS, a fixed royalty -- typically one-eighth or one-sixth of oil and gas' market value -- is collected by the Interior Department's Minerals Management Service (MMS). Exceptions to the fixed percentage royalty are a handful of net-profit-share leases, where the Government is paid a negotiated share of profits, and a few royalty-in-kind leases, where the federal share is paid in oil or gas. Leaseholders also pay rent on OCS lands as long as they hold a nonproducing lease. Aggregate royalty revenue from hydrocarbon production has reached $50 billion.

Virtually all--$2.4 of $2.5 billion in 1994 -- royalty revenues from OCS oil and gas leases flow from production on the Texas and Louisiana offshore. And the Texas, Louisiana and Mississippi OCS (the Central and Western Gulf of Mexico) are the only areas where OCS leasing has taken place since 1991, and therefore have been the only source of bonus bid revenue.

Table 1 above shows total OCS hydrocarbon revenues from all sources for 5 recent years. These data highlight some noteworthy developments, including:

• a decline in oil royalties, largely stemming from falling oil output on the federal offshore;

• recovering natural gas royalties, a result of steadily increasing production, growing demand, and firmer prices; and

• a decline and subsequent resurgence in bonus revenue. In 1995, the first of two scheduled sales netted $307 million (three times earlier estimates); the second has not yet been held.

OCS hydrocarbon revenues--comprising 80% of the federal government's oil and gas revenues--are nearly four times larger than the revenues resulting from on-shore operations.

Disbursement of OCS Revenue

The OCS has become the source of funds for the Land and Water Conservation Fund (LWCF) and the National Historic Preservation Fund (NHPF). In 1993, about 57% (or $1.7 billion) of OCS revenues went to the U.S. Treasury General Fund; the remainder (approximately $1.0 billion) was apportioned to these special purpose funds and to the states as their revenue share from OCS lands where federal and state interests overlap.

The LWCF Act of 1965 (as amended in 1978) requires the National Park Service to keep at least $900 million in the LWCF at the end of each fiscal year. Monies for this Fund come from surplus government property sales, Treasury motorboat fuel tax collections, and recreation use fees collected by the Departments of Interior and Agriculture. State and federal agencies use the money to buy parks and recreation areas.

In FY1993, all $900 million came from OCS revenues; the majority of these funds have been derived from the OCS since the $900 million figure was established.

The NHPF Act mandates that up to $150 millon of OCS revenues be transferred annually to the Fund, which has been funded at this level since 1980. These monies go to matching grants for the states and to the National Trust for Historic Preservation.

Another claim on OCS revenues comes from a sharing of rights to resources from submerged lands lying outside the 3-mile state zone--up to 10 miles offshore. This was the subject of a state-federal revenue dispute. Among the issues resolved by the 1978 OCSLA amendments was compensation for the drainage of reservoirs on state lands adjacent federal OCS producing areas. Provisions in Section 8(g) of this law call for the payment of 27% of the royalty, rent and bonus revenues from these leases to adjacent states. In FY1994, states received $38 million of that year's OCS revenues, plus an additional $45.5 million in settlement payments on disputed royalties from production during earlier years.

OCS Leasing Moratoria and the Proposed 5-Year (1997-2002) Leasing Plan

State opposition to drilling on the federal OCS has been a factor in OCS leasing for years. Beginning in California--in response to the 1968 Santa Barbara oil spill--local opposition to leasing in areas with valuable environmental amenities has been bipartisan and vociferous. As interest developed and more offshore prospects became candidates for leasing, opposition began to solidify in Florida and off the East Coast, in the Pacific Northwest, and Alaska.

Responding to state opposition, Congress has approved OCS moratoria annually as part of the Interior Appropriations bill since the early 1980s. Each year's moratoria involved increasing acreage as Congress banned the expenditure of appropriated funds for any leasing activity on environmentally sensitive areas of the OCS. In June 1990, President Bush responded to pressure from Florida and California, a number of other states, and those concerned about preserving the ocean and coastal environment and issued a directive ordering the Department of Interior (DOI) not to conduct leasing or preleasing activity in places other than the Texas, Louisiana, Alabama, and limited parts of Alaska offshore until 2000.

In the 104th Congress, the Interior Department Appropriations Bill was reported out of Subcommittee containing no moratoria. This development followed from the changed views of the new Subcommittee members; six of the fourteen are new to the Subcommittee. The much larger full House Appropriations Committee reinstated (by a 33-20 vote) the leasing bans which have--over the past 15 years--been part of this legislation.

If Congress abandoned the moratoria--which now seems unlikely due to broad bipartisan support--the bans put in place by President Bush and continued by the current Administration would remain in place, and environmentally sensitive tracts currently off-limits would not be leased.

Taking the moratoria as a guide, MMS has begun formulating the next 5-year leasing plan. It issued for public comment the Outer Continental Shelf Draft Proposed Oil and Gas Leasing Program 1997 to 2002 in July 1995. In February 1996, the "Proposed" Program was issued, along with a draft EIS. This moves the 1997-2002 leasing program one step further toward finalization. Keeping within the context of the moratoria and Executive order, lease sales have been proposed for the Central and Western Gulf of Mexico. Annual sales offering additional tracts each year were outlined. Strong opposition from the state of Florida to leasing within 100 miles of its coastline has led MMS to propose a range of Eastern Gulf options including no leasing during this 5-year period. Tracts offered for lease would either be more than 100 miles from the Florida coast or off of Alabama, adjacent the eastern boundary of the Central Gulf planning region.

In addition to leasing in Gulf Coast planning areas with a successful leasing history, leasing has been proposed by MMS in five Alaskan planning areas. These are the Beaufort Sea, Chukchi Sea, Hope Basin Cook Inlet/Shelikof Straight and the Gulf of Alaska. Whether leasing will actually take place, as well as how many and which tracts might be leased and the timing of those lease sales, remains open for comment until mid-1996.

In preparing an outline of the next leasing program, MMS has focused on areas where leasing has been the least controversial and the most productive. The long and productive history of the Central Gulf--and the expectation that the Western and Eastern planning areas will follow the Central region's pattern--has made them the focal point of the 1997 to 2002 Program. The 1997-2002 leasing proposal steers clear of controversial prospects and avoids opening serious discussion on leasing in Planning Areas currently off limits to development.

Recent Discovery off the Florida Panhandle

Chevron has made a large natural gas discovery 23 miles off the western edge of the Florida Panhandle. This acreage--in the formation known as the Destin Dome, which was leased prior to moratoria for the area--is within the 100-mile coastal buffer zone claimed by Florida. Chevron may file a development plan with MMS. Were it to seek development, MMS would likely approve the plan as long as it conformed to regional requirements.

Destin Dome development is opposed by the Governor, as well as many in the Florida congressional delegation. The state will likely oppose Chevron's development plan.

OCS Lease Buybacks

The Department of Interior halted the process of developing certain leases in environmentally critical areas. These include 23 tracts in Bristol Bay AK, 53 off the coast of North Carolina and 73 in South Florida, below 26 degrees N. Latitude. The leaseholders initiated litigation, demanding compensation from MMS, contending that the Government's development halt constituted breach of contract, and a taking of leaseholder's (purchased) property rights.

In August 1995, litigation was settled with regard to the Alaska and Florida leases in two agreements covering all remaining claimants. In one suit's settlement, Conoco is to be paid $23 million from the Justice Department's Claims and Judgments Fund. This circumvents the barrier to buybacks posed by a of lack of appropriated funds in DOI's budget.

In the second settlement regarding leases in South Florida, seven other claimants will be paid a total of $175 million from the Fund. A claim by Shell had been settled several years ago as part of a deal involving an offsetting claim on disputed royalty payments owed MMS.

All told, the settlements involved an amount roughly equal to the bonuses paid by the leaseholders. In settling the suits, the plaintiffs gave up their claims to development costs and interest on the bonus monies held by the Government while development was prohibited.

The leases off the North Carolina coast are currently in litigation. In March, 1996, a U.S. Court of Federal Claims ruled that the government illegally barred seven oil companies holding leases from developing their tracts. The court determined that leaseholders should be paid fair market value for the tracts or be reimbursed for lost revenues from the tracts. Interior Department lawyers have asked the Court to rehear the case, and indicated that--absent rehearing--the case would be brought to the Court of Appeals.

Development bans, and the process that ultimately resulted in the buybacks, have introduced a further element of uncertainty in the leasing process. Halting development on leases after they have been bought and paid for reportedly caused a loss of confidence by some prospective bidders in the Government response to the contractual obligations of OCS leasing. The firms involved in the buyback settlements may have recouped their original bonus bids, but they lost any return that might have been earned on their investment because it remained tied up in the buyback dispute for a number of years.

Deep-Water Royalty Holiday Becomes Law

On November 8, 1995, the House agreed to the conference report (H.Rept. 104-312) on S. 395 by a 289 to 134 vote. S. 395 was a three-part bill, containing language facilitating the privatization sale of the Alaska Power Administration, a measure which would end the ban on Alaskan oil exports, and provisions for a royalty holiday on new OCS production from deep water. The royalty holiday had been the subject of lively House floor debate.

Title III contained the schedule for deep-water lease royalty holidays for the Central and Western Gulf. The amounts of crude oil (and other liquid hydrocarbons, or natural gas, measured in oil equivalent terms) exempted from royalty payments on each lease varies with water depth, as follows:

• 17.5 million barrels from depths of 200 to 400 meters;

• 52.5 million barrels from depths of 400-800 meters; and

• 87.5 million barrels from depths greater than 800 meters.

The Senate voted favorably on the conference report on November 14, 1995, passing it by a 69-29 vote. It was signed by the President on November 28 (P. L. 104-58), and MMS is currently in the process of issuing regulations.

The royalty holiday had drawn the support of the Administration. Early House opposition had been based on the belief that the royalty holiday is not justified based on the economics of deep-water drilling. Improvements in technology have reduced deep-water costs and made projects feasible that were not economic a few years ago. The contention made in House debate was that the new technology on its own is sufficient to justify drilling absent any subsidy.

Opponents argued further that any royalty exemptions would mostly benefit foreign firms, since the largest deep-water lease holders in the Central and Western Gulf are BP and Shell.

Deep-water lease holiday proponents held that a substantial number of hydrocarbon prospects extend into deep water. Senate supporters contended that little deep-water drilling has taken place to date, asserting that, if the royalty holiday stimulated drilling and production, it would represent no loss to the Treasury because the production generating the royalties would not take place absent the subsidy.

LEGISLATION

P.L. 104-58, S. 395
The Trans-Alaska Pipeline Amendment Act of 1995 and the Outer Continental Shelf Deep Water Royalty Relief Act. Three-title bill contains the Deep Water Relief Act in Title III. Passed Senate May 16, 1995. House-Senate conference began September 29, 1995. Reported from conference with Outer Continental Shelf Deep Water Royalty Relief language (H.Rept. 104-312) November 6, 1995. House agreed to conference report (289-134) November 8, 1995; Senate voted favorably on November 14, 1995. Signed into law November 28, 1995.