Make U.S. Gulf Leasing More Competitive
Posted May 10, 2019
Headlines announcing big oil discoveries in the U.S. Gulf of Mexico (GOM) – such as the Blacktip deepwater find last month – are something we’ve come to expect. Gulf production long has been strategically important to the United States, accounting for 17 percent of total U.S. crude oil production, and it’s easy to take for granted that the basin will just keep producing and producing.
Yet, two recent analyses, IHS Markit’s report for the U.S. Bureau of Ocean Energy Management and a Crystol Energy report, caution that the Central and Western Gulf, currently open to oil and natural gas development, are maturing, having been developed for several decades, and production could begin to decline before long. GOM development must compete globally with other offshore and onshore prospects or face declining interest in exploration, falling investment and decommissioning of critical infrastructure.
The Crystol report suggests U.S. Gulf production could reach a crisis point with serious impacts:
In the longer term, if recent trends continue, the maturity of the U.S. GOM will become increasingly more pronounced leading to negative consequences for the economies of the states bordering the GOM and the overall US energy scene.
In that context both reports analyzed whether the government’s current leasing/licensing and fiscal policies are sufficient for a maturing basin, where development is increasingly marginal economically and/or technologically challenging.
These are critical questions, because future Gulf development depends on its ability to attract new private investment in exploration and production – recognizing that other basins around the world also are competing for those investment dollars.
Our take is that the federal government should consider enhancements to its leasing and fiscal frameworks to ensure that finding and producing Gulf reserves can continue to be competitive with other global reserves.
The chart below from Crystol Energy shows increasing Gulf production (blue line) – but declining proven reserves (orange bars):
The recent increase in US GOM oil production has been largely driven by the development of fields that were discovered many years ago and brought on stream during the preceding period of high oil prices. Also, the magnitude of proven oil reserves has gone in the opposite direction, suggesting that the reserves’ replacement is not being maintained. …
Oil demand is facing many uncertainties, and for oil producers in increasingly competitive markets, history shows that the low-cost producer has always had the edge. Given the global nature of the industry, competition for domestic and international capital is also expected to intensify. This dictates a real sense of urgency for US policy makers to put in place policies that will ensure that the valuable GOM oil and gas resources are not to become economically stranded.
- Current leasing policy, which is more rigid than elsewhere in the world, should be made more flexible – in line with the maturing nature of the Central and Western Gulf – to increase those areas’ attractiveness to investors.
- Reduce the complexity of the leasing system, align lease duration with that of competing offshore areas and foster greater predictability – by broadening the instances that qualify for lease suspensions to include advanced technology needs and the need for additional seismic data.
- Align rental fees with global norms.
- A sliding scale royalty rate, based on post-tax rate of return, with a top rate of 18.75 percent.
Crystol, on the current Gulf fiscal system:
The current US GOM fiscal regime is essentially a legacy regime shaped for the environment several decades ago when exploration programs could deliver a large number of highly profitable and volumetrically large discoveries. Competitor basins, both domestically and internationally, were not perceived as challenging the attractiveness of the US GOM as the leading destination for upstream investment. The fiscal regime has been amended frequently to preserve the high rates of Royalty when the economic evidence suggests that terms should have been improved to encourage the development of marginal fields.
IHS Markit on fiscal systems for shallow water development:
For projects with a higher per-unit cost structure, the government has a disproportionate share in terms of the before-tax cashflow. This is attributed to the regressive nature of levies, such as royalties and bonuses, which do not consider profitability. The investor cashflow for the 10 MMboe [million barrels of oil equivalent] oil field is negative in the base case as is the case for the majority of the countries in the peer group. This reflects the marginal nature of such discoveries. On a stand-alone basis, such fields are not economic …
In the case of deepwater oil, the IHS report notes that the U.S. Gulf provides the second-lowest internal rate of return (16 percent) for companies compared to the analyzed peer groups.
Again, the big point of these analyses is that government should consider smart revisions to current policies that could enhance the attractiveness of production zones that may be marginal for economic and/or technological reasons. This is particularly important considering current access to Gulf reserves, shown in the map below:
The Central and Western Gulf are much more developed than the Eastern Gulf, where a moratorium on oil and natural gas development has been in place since 2006.
You also can see the leasing activity in Mexican waters of the Gulf since Mexico allowed foreign companies to invest and operate there, which bears on the competitiveness of the Central and Western U.S. Gulf. Since 2015, Mexico has leased approximately 17 million acres in its Gulf waters compared to 14.7 million acres leased in the U.S. Gulf, resulting in greater dollar investments. Opening the Eastern Gulf to leasing and development also would support more investment in the U.S. Gulf.
Short of that, the government should work to make existing fiscal and lease terms more favorable for investment to sustain development from this mainstay of U.S. energy.
About The Author
Mark Green joined API after a career in newspaper journalism, including 16 years as national editorial writer for The Oklahoman in the paper’s Washington bureau. Previously, Mark was a reporter, copy editor and sports editor at an assortment of newspapers. He earned his journalism degree from the University of Oklahoma and master’s in journalism and public affairs from American University. He and his wife Pamela have two grown children and four grandchildren.
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