Order Code RS22567
Updated September 18, 2008
Royalty Relief for U.S. Deepwater Oil
and Gas Leases
Marc Humphries
Analyst in Energy Policy
Resources, Science, and Industry Division
Summary
The most common incentives for offshore oil and gas development include various
forms of royalty relief. The Outer Continental Shelf Lands Act (OCSLA) authorizes the
Secretary of the Interior to grant royalty relief to promote increased oil and gas
production (43 U.S.C. 1337). The Deep Water Royalty Relief Act of 1995 (DWRRA)
expanded the Secretary’s royalty relief authority in the Gulf of Mexico outer continental
shelf (OCS).
Controversy over royalty relief currently focuses on the lack of price thresholds in
Minerals Management Service (MMS) OCS lease sales held in 1998 and 1999. Without
the price thresholds, deepwater producers continued to benefit from royalty relief, even
as oil prices hit record levels. In an unresolved issue over the Secretary of the Interior’s
authority and discretion to impose price thresholds, the Department of the Interior
asserts that the Secretary of the Interior is not required to impose price thresholds in each
lease (but has the discretion to do so). All lease sales held since the enactment of
DWRRA included price thresholds, except those held in 1998 and 1999. According to
the MMS and the Government Accountability Office (GAO), omitting price thresholds
for those two years could cost the federal government as much as $10 billion. This
situation has prompted efforts to amend the 1998 and 1999 leases to include price
thresholds. A recent court decision, however, ruled that the Secretary of the Interior does
not have authority to impose price thresholds in those DWRRA leases. On September
16, 2008, the House passed H.R. 6899. Under Title I, this bill would, among other
things, deny new Gulf of Mexico oil and gas leases to lessees holding leases without
price thresholds or payment of or agreement to pay the proposed “conservation of
resources” fees. An earlier bill (H.R. 6) with similar language passed the House in
January 2007 by a vote of 264-123. However, on December 6, 2007, the House
approved the Senate-passed version of energy policy legislation (H.R. 6) without the
royalty relief provisions discussed above. The royalty relief provisions were not enacted
into law.

---

CRS-2
Introduction
As oil and gas prices hit record levels during 2006, allegations arose about missteps
at the Minerals Management Service (MMS) regarding the collection of royalties for oil
and gas production on the outer continental shelf (OCS). Of particular concern to
Congress is that price thresholds for royalty relief in deepwater leases were omitted from
deepwater lease sales held in 1998 and 1999. Such thresholds establish a maximum price
per barrel of oil or million Btu of natural gas where producers may receive royalty relief;
above the threshold price, royalties must be paid. Except for the 1998 and 1999 lease
sales, the thresholds are included in all leases eligible for automatic royalty relief under
the Deepwater Royalty Relief Act of 1995 (DWRRA, P.L. 104-58). Without the price
thresholds, oil and gas can be produced from a lease up to a specified volume without
being subject to royalties, no matter how high the price goes.
OCS Leasing System
The Outer Continental Shelf Lands Act of 1953 (OCSLA), as amended, provides for
the leasing of OCS lands in a manner that protects the environment and returns to the
federal government revenues in the way of bonus bids, rents, and royalties. Lease sales
are conducted through a competitive, sealed bonus-bidding process, and leases are
awarded to the highest bidder. Successful bidders make an up-front cash payment, called
a bonus bid, to secure a lease. A minimum bonus bid is determined for each tract offered.
Bidding on deepwater tracts in the mid-1990s led to a surge in bonus revenue (e.g.,
$1.4 billion in FY1997).1 Bonus bids totaled $902.6 million in FY2007. In addition to
the cash bonus bid, a royalty rate of 12.5% or 16.66%, has been imposed on the value of
production, with royalties sometimes paid “in-kind.”2 More recently, the MMS imposed
an 18.75% royalty rate on its offshore leases. Annual rents range from $5 to $9.50, with
lease sizes generally ranging from 2,500 to 5,760 acres. Initial lease terms of 5-10 years
are standard, and leases are continued as long as commercial quantities are being
produced. The MMS, in the Department of the Interior, administers the offshore leasing
program.
Royalty Relief
OCSLA authorizes the Secretary of the Interior to grant royalty relief to promote
increased oil and gas production. There are generally four royalty relief categories in the
Gulf of Mexico (GOM): Deepwater (more than 200 meters), Shallow Water Deep Gas,
End-of-Life, and Special Case. Royalty relief under the End-of-Life and Special Case
categories was already in place under OCSLA before the Deep Water Royalty Relief Act
of 1995 (DWRRA) and is not involved in the current controversy. DWRRA expanded
the Secretary’s authority to grant royalty relief to deepwater leases in the Gulf of Mexico
1 Department of the Interior, FY2002 Budget Justifications, p. 63.
2 A royalty-in-kind payment would be in the form of barrels of oil or cubic feet of natural gas.

---

CRS-3
OCS. Under DWRRA, the Secretary may reduce royalties if production would otherwise
be uneconomic.3
In an unresolved matter over price thresholds, the Department of the Interior
interprets the DWRRA (P.L. 104-58) to provide the Secretary of the Interior with the
authority and discretion to establish thresholds, above which the relief is discontinued.
Another interpretation of the law concludes that thresholds are mandatory, not
discretionary.4 In addition, the authority of the Secretary to impose price thresholds has
come into question in a lawsuit filed by Kerr-McGee.5 The U.S. District Court, Western
District of Louisiana issued a ruling on October 18, 2007, in favor of Kerr-McGee,6
meaning that the Secretary of the Interior did not have authority to impose price threshold
levels in leases issued under DWRRA (1996-2000). The ruling could apply to potentially
$23-$31 billion in future OCS royalties according to the MMS, but may not affect
congressional efforts to impose new fees or establish new lease eligibility criteria
discussed below.7 Threshold levels were established in 1995 for eligible deepwater leases
and are adjusted annually for inflation.8 The market price for oil in late 2006 was above
the threshold, so leases with thresholds were paying royalties on oil production. Some gas
lease thresholds were below the late-2006 market price and others slightly above.9
DWRRA provides for “fields”10 with eligible leases to receive royalty suspensions
for specific volumes of production at specified depths (Table 1). The royalty relief was
contingent on the lease being part of a non-producing field before DWRRA was enacted.11
3 A description of MMS royalty relief programs is available at [http://www.gomr.mms.gov/
homepg/offshore/royrelef.html]. A more detailed analysis of the royalty relief programs is
contained in a Department of the Interior, MMS, report: Guidelines for the Application, Review,
Approval, and Administration of the Deepwater Royalty Relief Program for Pre-Act Leases and
Post-2000 Leases, Appendix 1 to NTL No. 2002-No. 2, February 2002.
4 Letter to House Committee on Government Reform, by Stephen Lowey of Lowey Dannenberg
Bemporad & Selinger, P.C., Re: Gulf of Mexico defective deep water drilling leases, October 31,
2006.
5 For more details on this case, see CRS Report RL33404, Offshore Oil and Gas Development:
Legal Framework, by Adam Vann.
6 Kerr-McGee Oil & Gas Corp. v. Allred, No. 2:06-CV-0439 (W.D. La. October 30, 2007).
7 See CRS Report RL33974, Legal Issues Raised by Provision in House Energy Bill (H.R. 6)
Creating Incentives for Certain OCS Leaseholders to Accept Price Thresholds, by Robert Meltz
and Adam Vann and CRS General Distribution Memorandum: Impact of the Kerr-McGee Oil and
Gas Corp. v. Allred Ruling on the Proposed Royalty Relief for America Consumers Act of 2007,
by Adam Vann.
8 Price threshold levels for deepwater oil and gas can be found on the MMS website at
[http://www.gomr.mms.gov/homepg/offshore/royrelef.html].
9 See the MMS website at [http://www.mms.gov/econ/PDFs/currentkick-outsNOV-2006.pdf].
10 A field is defined as an area consisting of a single reservoir or multiple reservoirs with the same
geological structure or stratigraphic trapping condition and may contain more than one lease.
11 The MMS rule pertaining to royalty relief for each field as opposed to each lease was
challenged in district court in Louisiana in 2003. The court ruled in favor of the lessees (and was
(continued...)

---

CRS-4
Eligible leases are those issued in the GOM between 1996 and 2000 at depths greater than
200 meters located wholly west of 87 degrees, 30 minutes West longitude. The lease is
offered subject to a lease suspension volume — the amount of oil and gas that can be
produced royalty-free. Eligible leases do not require an economic evaluation to be
granted royalty relief. Also within the Deepwater category are “Pre-Act” leases (lease
sales held before November 1995), Post-2000 leases (lease sales held after November
2000), and leases classified as Expansion Projects, all of which can qualify for royalty
relief under DWRRA with an application demonstrating economic need. In addition,
“Post 2000” leases or “royalty suspension leases” may be offered with an automatic
royalty suspension volume on a “lease,” rather than field, basis. The Energy Policy Act
of 2005 (EPACT-05, P.L. 109-58) expanded the “post-Act” royalty relief program by
providing automatic minimum suspension volumes at specified depths in each lease.
A shallow-water, deep-gas incentive became effective March 1, 2004.12 The rule
suspends the royalty on gas from wells with at least 15,000 feet “true vertical depth”
located in waters less than 200 meters deep in the central and western GOM. It also
provides a royalty suspension supplement for drilling “certain” unsuccessful deep wells
in that region. The gas price threshold for discontinuing this royalty relief was $9.91 per
million Btu in late 2006 for 2004-2005 lease sales.13 The shallow-water, deep-gas
incentive was expanded by EPACT-05 to require royalty suspension volumes of at least
35 billion cubic feet of natural gas produced in waters less than 400 meters deep from
ultra-deep wells (20,000 feet true vertical depth), leases that have previously produced
from wells at 15,000 feet deep, or “sidetrack wells.”
Table 1. Minimum Royalty Suspension Volumes Per Lease
DWRRA 1995 (P.L. 104-58)
Energy Policy Act 2005 (P.L. 109-58)
Barrels of Oil Equivalent
Barrels of Oil Equivalent
Depth
Depth
(in millions)
(in millions)
200-400 meters
17.5
—
—
400-800 meters
52.5
400-800 meters
5.0
> 800 meters
87.5
800-1,600 meters
9.0
—
—
1,600-2,000 meters
12.0
> 2,000 meters
16.0
Source: P.L.104-58 and P.L.109-58.
Proponents of these royalty relief measures contend that without incentives, little
GOM deepwater or shallow-water, deep-gas drilling would have taken place, because
these areas would not have been competitive with foreign offshore prospects (e.g., Brazil
and West Africa). Increased GOM drilling enhances U.S. energy security, proponents
contend. Critics, during the debate on royalty relief that preceded passage of EPACT-05,
charged that the government would forfeit millions of dollars through the subsidy and that
11 (...continued)
upheld by the Court of Appeals), allowing royalty relief to apply to individual leases rather than
fields (reported at 385 F. 3rd 884, 5th Circuit Court).
12 69 Federal Register 3492, January 26, 2004.
13 See the MMS website at [http://www.mms.gov/econ/PDFs/currentkick-outsNOV-2006.pdf].

---

CRS-5
drilling costs were already coming down as a result of advances in technology, thus
making many deepwater lease tracts economical. According to MMS, deepwater drilling
in the Gulf of Mexico has benefitted from a combination of improved technology, higher
prices, and royalty reductions.14
Deepwater Development
A significant amount of activity is taking place in deepwater GOM. Out of 8,221
active offshore oil and gas leases, 54% are in deep water. Interest surged after enactment
of DWRRA, with 3,000 deepwater leases bid between 1996 and 1999.15 Deepwater oil
production rose from 42 million barrels in 1994 to 348 million barrels in 2004. Natural
gas production increased from 159 billion cubic feet in 1994 to 1.4 trillion cubic feet in
2004. Within the past two years, there was a 37% increase in the number of producing
projects. Deepwater development, however, is facing major challenges. Currently, about
8% of the DWRRA-eligible leases issued between 1996 and 2000 have been drilled, and
only a few are in production (because of rig constraints and large lease inventories). In
2004, of the 1,667 leases producing in the GOM, 30 qualified as eligible leases under
DWRRA. Since 2004, oil and gas prices rose above the price thresholds, and full
payment of royalties became due on 10 of those leases that were issued in 1996, 1997, and
2000. The other 20 were issued in 1998 and 1999 without price thresholds.
MMS maintains that the future of deepwater production looks bright. Proved oil and
gas reserve and resource estimates have more than doubled since 2000 (Table 2),
discoveries are taking place in much deeper waters since 2000, and development time
decreased from 10 years in the mid-1990s to 7 years in 2006. Although DWRRA spurred
a surge of interest in deepwater oil and gas development, major production directly related
to the act’s incentives has yet to be realized. For leases containing price thresholds,
relatively little royalty relief has been granted.
Table 2. Deepwater Proved Reserves and Resources
(in million barrels of oil equivalent)
Proved
Proved and Unproved Resources
Year
Reserves
and Industry Discoveries
2000
4,015
8,622
2002
4,385
12,871
2004
6,702
15,573
2006
9,435
18,531
Source: DOI, MMS, OCS Report MMS 2006-02.
Congressional Concerns
Controversy over royalty relief currently focuses on the lack of price thresholds in
OCS lease sales held in 1998 and 1999. Without the price thresholds, deepwater
14 Deepwater Gulf of Mexico 2006: America’s Expanding Frontier, OCS Report MMS 2006-022,
U.S. Department of the Interior, May 2006.
15 Ibid., Fig. 52.

---

CRS-6
producers continued to benefit from royalty relief even as oil prices hit record levels.
How these price thresholds were omitted is the subject of ongoing congressional and
administrative investigations. According to the Minerals Management Service, although
the Secretary of the Interior is not required to impose price thresholds in each lease (but
has the discretion to do so), all lease sales held since the enactment of DWRRA included
price thresholds except those held in 1998 and 1999. The MMS and the Government
Accountability Office (GAO), estimate that this error could cost the federal government
as much as $10 billion. The MMS estimated that about $956 million in royalty revenue
was foregone through FY2006. Annually, the MMS collects about $10 billion in
revenues from oil and gas leases on federal lands.
The policy concern for some is whether, and if so how, to amend the 1998 and 1999
leases to include price thresholds. Some argue that modifications to the leases should be
retroactive to capture past as well as future revenues from deepwater oil and gas
production. Others in Congress argue that any mandatory modification of the leases
might be a breach of contract or unconstitutional, and would be contested in court.
Another legislative possibility is to enact incentives, such as prohibiting lessees from
bidding on future leases to induce holders of 1998-1999 leases to accept price thresholds.
MMS has initiated efforts to have lessees voluntarily modify their leases to include price
thresholds going forward from October 2006. In December 2006, five companies holding
about 25% of the leases have agreed to the MMS initiative.16 Of the 1,032 deepwater
leases issued in 1998 and 1999, 526 are active (under exploration or development) and
19 are currently producing. While prices remain at the current level, the only volumes
subject to royalty relief will come from deepwater leases that were awarded in 1998 and
1999 without price thresholds and from shallow-water, deep-gas leases.
Legislative Actions
On September 16, 2008, the House passed H.R. 6899, the Comprehensive American
Energy Security and Consumer Protection Act. Under Title I, this legislation would,
among other things, require the Secretary of the Interior accept a lessee’s request to
modify those leases without price thresholds (“covered leases”) to include price
thresholds. The bill would not made available to lessees holding “covered leases” new
oil and gas leases in the Gulf of Mexico unless current leases include price thresholds or
the lessee agree to pay the proposed “conservation of resources fee”17 or an agreement to
pay such fees. The bill would also reaffirm the Secretary’s authority to impose a price
threshold in certain leases. Earlier in the 110th Congress, on January 18, 2007, the House
passed H.R. 6, with similar language on royalty relief, by a vote of 264-123. However,
the provisions discussed above were not included in the House-passed version (December
6, 2007) of the Senate-passed energy policy bill (H.R. 6, P.L. 110-140). The royalty relief
provisions were not enacted into law.
16 Companies include BP Plc, ConocoPhillips, Marathon Oil, Royal Dutch Shell, and Walter Oil
and Gas Corp.
17 The fee would be $9/barrel oil and $1.25/million Btu natural gas on covered producing leases
and$3.75/acre annually on non-producing leases.

---