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As noted in this prior post, I recently participated in a bloggers’ conference call with oil and gas industry experts from the American Petroleum Institute (API). While I highly recommend listening to the entire podcast or reading the entire transcript here, I thought I’d post the section with the discussion about the existing oil company leases for ‘Grok readers who wish to know the real facts behind the false rhetoric being dished out by many Democrats, including our own from NH.
The discussion included 10 or so bloggers and featured three speakers: Red Cavaney, President ad CEO, American Petroleum Institute; John Felmy, Chief Economist, American Petroleum Institute; and Jim Hoskins, Group President, Government and Financial Services, Harris Interactive.
What I’m learning from these discussions is how much I didn’t (and still don’t) know about the machinations and complexities of the many parts that make up the whole of the energy industry here in the US…
MR. LAMBERT (GraniteGrok): Okay. Earlier this week, I had a chance to ask a question of one of our senatorial candidates who’s been really kind of lacing Senator Sununu, our present senator, hard for his ties to big oil, et cetera. And so, I asked her – I told her that I’ve just bought a new vehicle. It’s traditional in engine and all of that. I’ll be paying for it for five years; I need it for business. So I said to her, if you’re opposed to drilling, what does that do for me with my vehicle? I can’t put a windmill on my car. I can’t put pinecones in the tank or water or anything. I’m stuck with the traditional gasoline.
And she gave me the standard answer – there’s another politician up here, Congressman Paul Hodes, who has filed legislation, and both of them are on the same track. And they’re saying that we have a 14-year supply just waiting on 68 million acres of land that they have present leases that, quote, "big oil just won’t drill on." Could you provide some kind of a talking-point-type answer that I can come back with when somebody tells me that because that seems to be – to a person, anybody who’s opposed to expanded drilling or exploration – is that it seems like that they are all singing from the same playbook now. And that’s – the oil companies have leases; they’re just not using them.
RED CAVANEY: I think we can help you here. First of all, these are arguments that are put forth by people who don’t understand how the industry operates. First of all, and I think this is sort of commonsensical, the Creator or evolution, whichever you want to tag, didn’t put hydrocarbons – oil and natural gas, specifically – every place on the globe. History would show you, if you went back and looked at the leases that the federal government has let over a period of time, that, far and away, the large, large majority of leases have proven not to contain hydrocarbons in sufficient commodities that you could commercialize it.
So it is a – very specific examples. We’re just getting data out right now. If you go back to the ’96, ’97 time period – and I choose that because that’s a 10-year spread and we’ll be talking about the OCS – if you look at the leases that were granted during that period, there were – the lease payments, in other words, the companies bid $2.3 billion to obtain about 3,200 leases. The lease term is typically 10 years, which means, at the end of 10 years, if a lease is not producing, then the company is obligated to turn it back to the federal government, forfeiting not only its original lease bid, but the annual lease payment it makes plus all of the expenditures it incurred in the exploratory phase to determine that there wasn’t sufficient oil and gas available in commercial commodities to go ahead and extend the funds to put a production facility in place and to ultimately produce.
Ninety-three to 95 percent of the leases from those two years were expired, terminated, or they were relinquished, in other words, given back to the government even before the 10-year term ran. That gives you a bit of a sense that most of the leases don’t end up being commercially producible oil or natural gas facilities.
Now, the other point that I would make is that companies have an idea, whether it’s onshore or offshore, that there’s the potential for oil and gas in certain areas. And so they make bids, but there’s about a 10-step process, which I would be glad to bore you with if you wanted, that starts with the bid being accepted, and then after it’s been accepted, you start with geological exploration, in other words surface work and before you go through all the other steps that lead up to the point as to whether or not you’re going to produce. Probably 80 to 90 percent of the work on a lease is in this pre-production determination phase. That period of time has been euphemistically tagged by our critics as an idle lease, but I would submit to you, the lease in most cases is anything but idle.
When you get to–
MR. LAMBERT (GraniteGrok): So, now, let me just if you would let me interrupt for a second, so in order to even begin to determine more exactly whether the supply, before you can study, you have to actually lease?
MR. CAVANEY: Yes, we – the federal government puts out a notice of a public lease process and companies submit bids. And the government is required, as long as they can satisfy the minimum operating requirements, they’re required to take the highest bid. That money is then paid before the company can do anything to go forward. A contract is signed with all the terms; it’s a government contract, the companies have no input on it. It determines the length of the lease.
It determines the amount they’re going to pay. It determines the royalty rate that they’re going to pay if they do get to a production basis. So that’s the very first step, and so a company, every company, has expended a fair amount of money to hold what in another business would be called inventory. In other words, this is their inventory. And it’s a long, extended process to work through these, and so it should not surprise anyone that they come into a certain area and they may go pretty far on one of these particular lease tracks and determine that the geology here doesn’t look like it has any oil or natural gas. And then they may look at a bunch of the surrounding tracks that are also leases and figure they’re so much the identical that I’m going to now move to the next place where I think I have a chance of making a commercial discovery of oil or natural gas.
And so companies are constantly trying to upgrade the quality of their portfolio at these each individual bid rounds that occur. And then as leases expire for things that clearly don’t have oil or gas, they give those back to the government and somebody else may bid on them or not. So this is a constant iterative process and the quality of their inventory, in other words, the things that they’re working on to determine whether they can get to commercial production, is a very important part in their competitiveness with one another. John?
MR. FELMY: When you buy a lease, you effectively could be buying what can be termed a pig in a poke. You don’t know if there’s oil there, but you’re going to pay the federal government just for the ability to be able to look. But what’s interesting about this argument that there’s all this oil out there, it’s being made by the same people who, if you go back and check their records, will probably have said, no, there isn’t enough oil to justify going forward. So that’s a delightful opportunity for somebody to contrast what is mixed messages and trying to have it both ways by some folks.
MR. CAVANEY: And the last point we would want to make on this is if you’ll go back and look at the language that’s actually in statute, this "use it or lose it" is already in current law. And a number of the people who are our leading critics actually signed or voted for that particular piece of legislation. Let me read you the actual language itself because this is kind of interesting in this big "use it or lose it" debate. It says, "no bid for a lease may be submitted if the Secretary" – and they’re referring to the Secretary of the Interior – "finds after notice and hearing that the bidder is not meeting due diligence requirements on other leases." And by due diligence, they’re referring to this period of time when 90 percent of the effort of the work is going on.
I might remind you also that during that period, before they can do any seismic exploration, they have to go and get through the government permitting process, approval, and that’s one of the stages where oftentimes, there is objections are raised. That’s oftentimes when suits are raised by certain people and the like, which delays the process. Well, let’s assume they go through, shoot the seismic; they spend the analysis, they look at it, they get to the point where they think, all right, this is worth me putting some more of my capital at risk to actually drill an exploratory well because regardless of what seismic says, you never know what you’ve got until you drill at least one exploratory well.
Well, now you’ve got to go and go to the government permitting process again to get a permit to be able to drill. So this long process that’s being considered idle is anything but idle. And it involves a lot of interaction with the public over which the company has no control. It’s governed by the due process, if you will.
MR. LAMBERT (GraniteGrok): Now, I’m intrigued by the "pig in the poke" statement because that’s my understanding as well. And I really think that for you guys to get the message out, that it’s a tremendous gamble, it seems, for the company to even get involved because you’re basically guessing on a tract of land, until you actually lease it, whether it’s going to be viable. Is that a good sound bite to describe your present situation?
MR. CAVANEY: Yes, it is, absolutely.
MR. HAGENS: This is Nate Hagens. I think most people, or many people including myself, don’t know what a pig and a poke is, so you might want to explain that if you write that up.
MR. CAVANEY: (Laughter.) Wait, that’s an economist talking so this can be fairly sophisticated. I’ll have John speak slowly on this.
MR. FELMY: It’s the old, actually medieval, expression that when you were buying animals at a farm, you never knew what was in that burlap sack. It could be a pig or it could be nothing. So it’s just an ancient expression that I love using at times.
[Thanks to API’s New Media Advisor Jane Van Ryan for inviting us to participate]