Royal Victory
Petroleum companies await decision on judge's ruling
Petroleum companies await decision on judge's ruling

By Chris Casteel

Published: November 25, 2007

WASHINGTON — It was a $60 billion decision, delivered the day before Halloween.

For oil and gas companies with certain-win deepwater leases in the Gulf of Mexico, it was definitely a treat. For the U.S. government — not so much.

A federal judge in Louisiana ruled in a case filed by Kerr-McGee Corp. that the company — which was purchased by Anadarko Petroleum last year — didn't have to pay federal royalties on production from eight of its deepwater leases until it had pumped amounts specified in a 1995 law.

The decision, by U.S. District Judge Patricia Minaldi, could affect 2,370 leases signed between 1996 and 2000 and cost the government an estimated $60 billion over the life of the leases.

It has reverberated on Capitol Hill, raising the ire of some lawmakers who already wereangry about royalties lost due to errors made by the Interior Department in deepwater leases issued in 1998 and 1999.

Several members of Congress have asked the Justice Department to appeal the ruling. A department spokesman said last week that a decision hasn't been made about that. Lawmakers also are urging President Bush to do something to address the matter.

Sen. Jeff Bingaman, D-N.M., the chairman of the Senate Energy Committee, said the decision "will result in the oil and gas industry being able to tap billions of dollars of the public's natural resources for free, with none of their resulting income shared with the American public. ... It will not increase supply or lower the price that Americans pay for their energy. It will simply create a huge hole in our treasury at a time when royalty revenues are needed to pay for important priorities, including national security.”

Energy companies affected by the decision have been mostly quiet in its wake. Anadarko Petroleum issued a statement saying the judge had correctly interpreted Congress' intent when it passed a 1995 law to spur deepwater drilling in the Gulf of Mexico.

Aaron Bernstein, a spokesman for the Independent Petroleum Association of America, a trade group for independent oil and gas companies, said the group would withhold comment as the case makes its way through the legal system.

J. Larry Nichols, chairman and chief executive of Devon Energy of Oklahoma City, which has leases that would be affected by the ruling, recently told analysts on a conference call that he wasn't surprised by the decision.

But Nichols declined to be specific about the potential impact for Devon's bottom line.

"We'll wait and see what happens — whether it's appealed,” Nichols said. "And if so, what the appellate court rulings are.”

But Congress, which is expected to consider a comprehensive energy bill in the next few weeks, might not wait to see what the Justice Department or any other courts might do.

Because of bureaucratic mistakes on some leases from 1998 and 1999, the House energy bill already includes a provision that would require energy companies to renegotiate those leases to include "price thresholds” — requirements that royalties be paid after market prices reach certain targets — or be barred from getting more leases.

President Bush vowed to veto the House bill, in part because of that provision.

Rep. Nick Rahall, D-W.Va., the chairman of the Natural Resources Committee, wrote Bush a letter last week urging him to support the provision in light of the judge's decision in the Kerr-McGee case. Rahall said the provision could be extended to all leases issued under the 1995 law.

"Companies that refuse to pay a fair royalty for the oil and gas they extract from public lands are failing to fulfill the expectations of the government, and the government is not required to continue to do business with such companies,” Rahall told the president.

The Kerr-McGee case stemmed from a 1995 law that — all sides agree — was meant to create incentives for drilling in the Gulf of Mexico in waters deeper than 200 meters.

At the time, oil prices were low, and companies had little interest in investing heavily in deepwater drilling.

The question was about how much of an incentive Congress was creating.

On Gulf of Mexico production, companies generally paid royalties to the federal government ranging from 12.5 percent, in deep water, to 16.5 percent for shallower production.

The 1995 bill gave "royalty relief” for deepwater production up to certain amounts: 17.5 million barrels of oil equivalent in waters of 200 to 400 meters; 52.5 million barrels of oil equivalent in waters of 400 to 800 meters; and 87.5 million barrels of oil equivalent in waters deeper than 800 meters.

The bill also had royalty relief thresholds for natural gas production.

The U.S. Interior Department, which oversees the leasing of public lands for drilling, interpreted the law to mean that the royalty relief only applied when oil or natural gas prices were below certain levels.

And in January 2006, the Interior Department told Kerr-McGee that it owed the government royalties on eight leases signed under the 1995 law because the prices for oil and natural gas had exceeded the price thresholds.

Kerr-McGee filed suit against the Interior Department two months later, contending that the law allowed it to produce oil and natural gas up to the volume limits in the bill, regardless of the market prices.

Last month, the federal judge in Louisiana agreed with Kerr-McGee that the company was being "unlawfully” charged royalties.

"Because the Interior (Department) imposed price threshold requirements on Kerr-McGee's eight deepwater leases that would require Kerr-McGee to pay millions of dollars in royalties before it had produced even the minimum volume of royalty-free production, the Interior exceeded its Congressional authority,” the judge wrote. "Thus ... the Interior's action is unlawful because it contradicts the plain, unambiguous text of the statute.”

The judge granted Kerr-McGee's request for a quick judgment in the case, a stinging defeat for the U.S. government.

Andrew Ames, a Justice Department spokesman, told The Oklahoman in an e-mail last week, "In the litigation before the district court, the United States argued vigorously that the Department of the Interior acted lawfully when it included royalty price threshold provisions in the leases signed by Kerr-McGee.

"We are reviewing the district court's decision, and no determination has been made as to our next step.”

The Kerr-McGee decision added to the controversy on Capitol Hill over leases granted under the 1995 law.

Lawmakers were already angry over the fact that leases written in 1998 and 1999 contained no price thresholds, thereby allowing oil and natural gas to be produced without royalty payments despite high market prices.

According to the Interior Department, the lack of price thresholds in those leases was simply a bureaucratic mistake.

It was that situation that led the House to pass legislation requiring that the leases be renegotiated or the companies be barred from getting more leases.

But the judge's decision in the Kerr-McGee case means, in effect, that the price thresholds are insignificant until the production volumes set in the 1995 law are met.

The Government Accountability Office, Congress' auditing arm, said in a report earlier this year that a total of 3,401 leases had been granted under authority of the 1995 law.

The Minerals Management Service, part of the Interior Department, included price thresholds in 2,370 leases issued in 1996, 1997, and 2000 but did not include price thresholds in 1,031 leases issued in 1998 and 1999, the GAO said.

The potential loss in revenue from the leases that didn't include price thresholds was estimated by the MMS at $10 billion.

Referring to the Kerr-McGee lawsuit, the GAO said, "In addition, a recent lawsuit questions whether MMS has the authority to set price thresholds for the leases issued from 1996 through 2000. Depending on the outcome of this litigation, MMS preliminary estimates indicate that this could result in up to $60 billion in additional forgone royalty revenue.”

The GAO said it is difficult to pinpoint the actual losses, since production and prices are uncertain. And, the GAO said, losses in royalties to the government can be offset by the benefits of increased production of oil and natural gas and the receipt of lease fees.

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