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US Interior leasing reforms to have minor production impact despite higher costs

Highlights

Platts Analytics sees only long-term risk to development

Similar measures in Democrats' reconciliation bill go further

The Biden administration's proposed reforms to federal oil and gas leasing could raise costs to drillers and potentially shrink available acreage, but the expected production impact continues to be minor, analysts said Nov. 29.

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The US Interior Department issued an 18-page report laying out its goals for overhauling the leasing program with the aim of providing a "fair return" to US taxpayers, in line with past recommendations by the Government Accountability Office and Interior's Office of Inspector General.

The report proposed increasing royalties, rental rates, minimum bids, and bonding requirements; while curbing royalty relief and imposing new leasing fees, among other changes.

"There is nothing in this report that would that tangibly impact near or medium-term supply from the US if enacted," said Parker Fawcett, North American supply analyst for S&P Global Platts Analytics. "Further out, a restriction in available acreage for leasing does put lingering risk to the long-term development of federal lands."

About 7% of US oil production and 8% of US gas output is produced on federal onshore lands, while federal offshore acreage accounts for about 16% of US oil output and 3% of gas output, the report said.

Budget bill

Democrats' Build Back Better budget reconciliation bill currently proposes even more aggressive changes to royalty rates, royalty relief, minimum bids, and non-competitive leasing than Interior's report, said Glenn Schwartz, energy policy director of Rapidan Energy Group.

Schwartz added that any regulatory changes on acreage are not "all that necessary." While the Mineral Leasing Act requires quarterly auctions for federal leasing, it gives the Interior Secretary wide discretion under the existing statute to "determine where and how much acreage is offered up."

"While an outright ban was always illegal, this discretion vests [Interior and its Bureau of Land Management] with all the authority it needs to control the flow of leases and permits as it sees fit," Schwartz said. "So, in that way, the changes proposed by this report don't really change our outlook on oil and gas production. Any changes made through regulation or bureaucratic discretion can be undone fairly easily by a future administration that takes a more positive view towards fossil fuel development on federal lands."

Kevin Book, managing director of ClearView Energy Partners, said the timing of the report — the Friday after Thanksgiving — suggests "that the White House may have hoped to minimize criticisms linking current gasoline prices to the administration's federal oil and gas strictures."

Book added that the release of the report could also signal that the White House is making the case to Senate Democrats to retain the reforms in the budget reconciliation package as they make changes to the version the House of Representatives passed.

He said the White House may also be looking to tamp down criticism for tapping the Strategic Petroleum Reserve in an explicit effort to lower oil prices.

"Administration officials may have judged that the federal lands report would provide a way to show environmental stakeholders that Biden remains committed to his green agenda (and perhaps better still if the White House can do so on a quiet news day)," Book said in Nov. 26 note.

Declining production

On royalty rates, Interior determined they were too low at 12.5% and recommended raising rates to be more in line with states such as Texas, where producers pay as much as 25%. The report said that when state royalty rates were increased in Colorado and Texas to 20% and 20-25%, respectively, "there was no significant effect on production from state lands after state royalty rates were raised."

Production in gas plays located on federal land has been in slow, steady rates of decline for years, as most operators have transitioned to state and private lands following the shale revolution. For example, the Piceance Basin, located in western Colorado, averaged more than 2 Bcf/d in 2012, according to S&P Global Platts Analytics data. It has averaged 1.26 Bcf/d year to date in 2021. The Powder River in Wyoming, another play located primarily on federal land, averaged 1.38 Bcf/d in 2011. It is down to 713 MMcf/d so far in 2021.

"As the United States experiences a growing energy crisis, the Biden administration continues to pursue troubling policies for all American households and especially the men and women of our industry who work every day to provide our country with the oil and natural gas needed for daily life," the New Mexico Oil and Gas Association said in a statement. "While the White House has begged OPEC to increase its output, thousands of New Mexicans stand ready and willing to do their jobs right here, right now."

The DOI has the power to increase royalty and bonding rates on its own. However, having the higher rates backed by legislation would better shield the policies from court battles.

Raising the onshore royalty rate to 18.75%, the rate currently charged for drilling in deep waters offshore would generate an additional $1 billion/year between now and 2050, according to research by Resources for the Future. A royalty rate of 25% for both onshore and offshore drilling would double that number to $2 billion/year.

Brian Prest, a researcher with Resources for the Future, determined "raising royalty rates is unlikely to have major effects on oil and gas production or emissions" and would likely lead to "leakage of oil and gas production to non-federal sources."