# Presentation: 916953

## A Low Oil Price Environment

- <date/time>

- _A Low Oil Price Environment_

- Tom Kitsos, Deputy Director
- Minerals Management Service
- U.S. Department of the Interior

*Effects on the Federal OCS Program in the Gulf of Mexico*

**Adams and Reese Annual Energy Conference- November 20, 1998**

**Notes:**
I appreciate being invited to this gathering, both to hear others’ perspectives as well as to share some thoughts about MMS’s view on oil and gas prices.
This title differs from the one shown in the Agenda.
While I will have a lot to say about the Deep Water Royalty Relief Act, it will not be only thing I will discuss in the context of low prices.
Low energy prices benefit consumers and large parts of our economy.
However, they complicate things for those of us whose organizations deal with  revenues resulting from oil & gas production.

## MMS Perspective on Low Prices

- What does MMS do?
- How are MMS policies affected by oil & gas prices?
- How can MMS leasing policies respond to price swings?

**Notes:**
I want to explain how key MMS activities react to and are affected by low oil prices.
My remarks are arranged around the questions shown.
The main points I will make are:
We have a range of legal mandates.
We have some flexibility to change focus as the market changes.
Long term(not short term) price expectations are most important to our policies.

## What does MMS do?

**Manage leasing & regulate mineral extraction on OCS**
- 1.5 billion acres
- 20% of U.S. oil
- 27% of U.S. natural gas
- Gulf of Mexico
- 85% of OCS oil
- 99% of OCS natural gas

**Collect payments for the right to produce minerals on all Federal land**
- Since 1954, $118 billion from OCS leases
- Over last 10 years, 75% royalties - 20% bonuses - 3% rentals

**Notes:**
MMS has 2 main functions -- manage mineral extraction on the OCS and collect mineral revenues for all Federal lands.
The GOM has all but about 200 of the 8500 active leases on the OCS.
Of the $6.2 Billion collected by MMS in FY 1997, $5.2 Billion  was from OCS leases. 
Nearly $700 million of these funds was disbursed to States of which over a $100 million are OCS Section 8(g) funds distributed to coastal states.
$1.7 Billion went  to:
the Land & Water Conservation Fund ($900 million)
the Reclamation Fund ($450 million)
Indian tribes and allottees ($200 million)
the National Historic Preservation Fund ($150 million)
The remaining  $3.9 billion went to the Federal Treasury.

## MMS Mandate

- Expedite exploration & development of the OCS
- Protect human, marine, & coastal environments
- Obtain fair & equitable return for public on OCS resources
- Preserve & maintain competition
- _Balance range of priorities under ALL market conditions_

**Notes:**
The OCSLA assigns MMS several responsibilities.
To carry out its mandates, MMS:
Develops & maintains a 5-year schedule of lease sales,
Sets lease terms & holds approved lease sales,
Evaluates the adequacy of bids & awards the right to explore for and  produce minerals,
Regulates OCS oil & gas industry to ensure safety and environmental protection,
Responds to requests for royalty relief or suspension of operations or production.
MAIN POINT -- we’re obliged to honor full range of mandates under all market conditions.

## Effect of Price Changes on MMS Policies

- 4 Program Activities for  illustration
- 5-year oil and natural gas leasing program
- Bid adequacy procedures
- Royalty relief
- Leasing policies

**Notes:**
How are MMS policies affected by oil & gas prices?
Flexibility in OCSLA  & associated Regs allow MMS to respond to market conditions, including low or falling prices.
I will briefly go through 4 of our major activities to show how oil & gas prices play a role.

## 5-Year Leasing Program

- Programs included sales dropped later for lack of industry interest because of low prices
- No Central or Western GOM sales have been threatened
- Planning lead-times require use of long-term (10+year) price expectations

**Notes:**
We develop 5-yr programs to schedule potential lease sales to meet US energy needs under a variety of possible conditions.
Proposed sales in some areas have been cancelled because conditions conducive to holding them did not materialize.
Low energy prices can be one such condition since they signal abundance rather than scarcity of supplies that often corresponds with lower industry interest in more leasing.
Low prices haven’t affected the scheduling of  annual sales in Central and Western GOM because abundant existing infrastructure on the Shelf and the DWRRA in deep water improve project economics. 
Long-term price expectations, rather than current realizations or short-term price expectations, are what count.
The analysis for 5-yr programs is done 3 to 7 years before sales and 20 to 40 years before exploration, development, and production plays out.

## Bid Adequacy Procedures

- Price expectations play an important role in MMS bid adequacy determinations
- Low prices
- Tend to compress the range of bids
- Make it more likely that MMS will accept high bids for lower-valued tracts

**Notes:**
Following each lease sale, we examine all bids to determine if the highest bid for each tract represents fair market value.
Market conditions, which are largely reflected by oil & gas price expectations, play several roles.
For certain tracts, we use information provided by selected other bids as well as the high bid.
When multiple bids are in close agreement with each other, we accept the high bid.
This bid acceptance criteria gets more use when prices are low.
As price expectations decline bid levels follow, hence the bid range tightens around the minimum bid.
In other situations, MMS compares the high bid to its own estimate of tract value which is based in part on expected prices.
The oil and gas price expectations we use in our estimates of tract values are responsive to changing market perceptions.
Even if our tract value exceeds the high bid, we may still accept it.  We average our value with other bids in close agreement with the high bid, and accept the high bid if it exceeds this average.
The MAIN POINT of this slide is that price expectations play an important role in our bid adequacy determinations and low prices sometimes even increase the likelihood that we will accept a high bid.

## Changes in Royalty Relief Authority

- Prior MMS authority
- MMS granted new discretionary authority by Deep Water Royalty Relief Act
- New requirement under the OCS DWRRA

**Notes:**
Various forms of royalty relief are available to lessees to cushion the effects of low prices on exploration, development and production efforts.
Since the OCSLA amendments of 1978, MMS has offered reduced royalties to increase production by extending the lives of producing leases.  17 applications have been received, 8 from the GOM, only 2 applications were received prior to 1990.  
The DWRRA expanded MMS’s royalty relief arsenal by adding discretionary  authority to grant royalty relief for non-producing leases of all water depths in the Central and Western GOM areas.
The DWRRA also provided potential relief in the form of royalty suspensions for new  fields and existing fields in leases in water depths greater than 200 meters.

## Royalty Relief for Existing Leases

_**Deep Water**_
- Royalty suspension based on forecast of economic need
- Price assumptions
- Use 3-year average of GOM-specific prices for starting prices
- Coupled with long-term EIA outlook projections
- Since 1996, 4 applications

_**End-of-Life**_
- Royalty rates reduced by half (demonstrated economic need)
- Weak prices tend to ease qualification as revenues decrease relative to costs
- Since 1990, 12 requests approved (2 in GOM)

**Notes:**
The deep water royalty relief program offers royalty suspensions on an economic-need basis to non-producing fields & capital expansion projects in the Central and Western GOM under lease prior to enactment.
In deep water we look at a number of factors, including price expectations, to determine whether economic-need exists.
Given the long-term nature of deep water OCS investments, the appropriate price expectations reflect more than current price levels.
We generally adjust our price expectations for royalty relief  annually, but because of the large continuing drop in prices this year, we have just reduced prices from the ones we issued in the spring.
The end-of-life program offers to cut royalty rates in half for leases that need it to extend their economic life.
 In end-of-life relief requests, actual data, which reflect last years’ prices, costs & production , are used to assess need. 
IN GENERAL, royalty obligations reduce automatically with prices.
 We offer  royalty relief to further mitigate price effects.
However,  minimal participation in these programs tends to suggest that other things like cost reductions have largely forestalled the need for relief from royalties.

## Tracts Leased

- Oil Price

**Notes:**
This graph helps to show that policy changes can temporairily counter the effects of lower of falling prices.  Superimposed on this graph are major MMS leasing policy events.
The move to area-wide leasing in 1983.
The reduction of the minimum bid in 1987.
The implementation of the 1995 DWRRA in 1996.
The number of tracts leased increased along with oil prices in the early 1970’s in reaction to the Arab oil embargo.  In 1983, MMS replaced offerings based on tract selection with area-wide leasing  to attempt to boost domestic production.  The number of tracts leased in 1983  6 times the previous level This increase was in the face of declining prices.
In 1987, MMS reduced  minimum bids from $150/acre to $25/acre in an attempt to revive leasing in spite a sustained oil price collapse.  The number of tracts leased increased 7 times the number leased in 1986. This increase occurred despite little change in prices.
Both of these policy changes effectively unlinked  prices from leasing, though only temporarily.
As one can clearly see the DWRRA has made an even more dramatic impression on leasing since the mid 1990’s.

## Slide 11

**Notes:**
You can see from this table the boom in deep-water leasing--due in part to the DWRRA--that has occurred over the past few years. 
The reason for this is that the DWRRA directs MMS to suspend royalties on all new leases in deep water issued between 1996 and 2000.
As was demonstrated when we went to area-wide leasing and reduced the minimum bid the number of GOM tracts leased increased dramatically.  This increase has been even more impressive as a result of the DWRRA, especially, as you might imagine, in deep water.
Overall, the number of tracts leased was 2 1/2 times the 1800 leased in 1993-96.  In water over 400 meters deep the increase was even greater from 418 tracts leased to 2,955 tracts an increase of over 600 percent.
The increase in the magnitude of high bids is even more impressive.  Overall, the total of high bids over last 3 years is 3 times greater than the previous 3 
However in water over 400 meters deep high bids increased 20 times from $100 million in 1993-95 to $2.6 billion in 1996-98.
All of these increases occurred despite relatively modest oil prices.   As before with with earlier policy stimulants to leasing, the numbers of tracts have begun to revert, falling towards more typical levels.from 1,778 tracts leased in 1997 to 1,160 tracts leased  in 1998.
The point that I want to be sure to leave you with from these last two slides is that MMS leasing policies have responded to market conditions.   The three examples of the policies I have present to you have demonstrated that these policies have been at once potent if only temporary offsets to price effects.

## What Happens Next?

- What are the fiscal effects of a prolonged low price period?
- What possible options does MMS have to respond to continued low prices?
- How will continued low prices influence other MMS responsibilities?

**Notes:**
Enough about the past, let’s move on to what everyone is interested in — the future?
To wind down my presentation, I want to offer a few observations and maybe a couple predictions.
I want to show you some potential effects of low prices on mineral receipts, and how the MMS may respond in a prolonged low-price environment.
But first a word of caution, we all acknowledge that price forecasts can be notoriously unreliable.  For example, short-term forecasts we made in April of average prices for FY98 were well off the mark.
OMB price estimates had us overestimating royalty receipts by 15% for FY 1998.  Longer-term price forecasts and their effects are even more uncertain.
Industry has its own way of surviving in times of low prices.  For example, at price forecasts prevailing 5-6 years ago, who among us would have predicted the recent boom in the deep water GOM.. 
Through advances in technology, high flow rates, reduced costs, and royalty suspensions this area has become the hottest ticket on the planet.
My point is that we need to be careful not to concede too much influence to price expectations.

## Revenue Estimates to 2008

- OCS Revenue

**Notes:**
How much could prolonged low prices affect lease bonuses, rentals, and royalties that comprise OCS revenues?
Our current estimate of Federal receipts over next 10 years is based on expected prices set by OMB.
Under this price scenario $41 billion in OCS revenues will be collected over the next decade.
However under a sustained low price scenario, these revenues could decline by 40 percent to $26 billion over the same time period. 
Yesterday, Senator Landrieu mentioned the Reinvestment & Environmental Restoration Act of 1998.  This bill would provides additional shares of Federal OCS receipts to coastal States and Parishes (Counties).
The MMS has provided economic analysis in support of this bill.
Should the this low price scenario prevail the impact could be a reduction of $400 million per year to States.

## Slide 14

**Notes:**
This is a map of the Central and Western Gulf of Mexico Planning Areas.  
The scale of the map makes it impossible for you to see anything specific, but I can still use it to make an important point.
The colored areas of these planning areas represent tracts that are currently under lease.  
The many green tracts and the fewer gold tracts represent tracts leased since 1995 when the DWRRA was signed.
Why is this important?
The MMS has, in the past, modified its policies to promote leasing in times of low prices.
As you can see the huge success of DWRRA  has created a new situation, a scarcity of leasable tracts.
Therefore, encouraging more leasing seems unlikely to add to future development and production if only marginal tracts are left.
Further, we have observed that the policy changes that affect leasing do not have an equal effect on production. 
This is why we have been  more aggressively promoting development and production activity through post-sale royalty relief.

## Conclusions

**Aware of the effects of low prices**
**Modified policy in the past to effectively mitigate the effects of low prices**
**Future policies target converting yesterday’s successes in leasing into tomorrow’s achievements in development and production**

**Notes:**
In summary, I have shown you some of the ways in which flexibility under the OCSLA has allowed MMS to respond to low prices:
by changing lease sale terms,
modifying bid adequacy criteria, or 
adjusting royalty relief criteria.
I have reviewed for you how MMS responsibilities and the current circumstances in GOM dictate how we can exercise this flexibility in the future:
MMS has an interest in stable, predictable policies involving long-term price forecasts and a mandate to receive fair market value;
MMS has more leverage on tract availability than on production and;
There is an abundance of exploration targets already in private hands diminishing the number of attractive tracts that remain available for lease.
I also have offered some predictions on what a low price scenario could do to OCS revenue collections.  Thank you, I’d be glad to take questions.