Providing coverage of Alaska and northern Canada's oil and gas industry
May 2007

Vol. 12, No. 19 Week of May 13, 2007

MMS limits incentives for Gulf’s deep-gas drillers

Oil and gas prices drove decision not to offer more incentives; no commercials discoveries yet from ultra-deep zone below shelf

Ray Tyson

For Petroleum News

Deep drillers on the Gulf of Mexico’s natural-gas-prone continental shelf, including those who have failed to penetrate the so-called “ultra-deep” zone far below 25,000 feet, can forget about additional royalty relief on production and other sweet Uncle Sam incentives, due to the rich and lasting nature of the current commodity price environment.

“They have run into some real difficult technical limits in drilling very deep wells on the shelf,” U.S. Minerals Management Service Director Johnnie Burton acknowledged at an April 30 press conference, in Washington, D.C. “But we feel it is less justifiable to offer very big incentives.”

This ultra-deep shelf play is said to encompass the same Miocene-to-Lower Cretaceous geological intervals that have produced huge deepwater discoveries in the hundreds of millions of barrels.

“This is going where no man has gone before. It’s extremely frontier,” Steve Campbell, Newfield Exploration’s head of investor relations, said back in 2002.

“These are very big sedimentary sand systems the size of California,” an MMS geologist added. “If you could find one of these giant structures with good sands ... goodness knows how much you would have.”

However, the big problem with many of these government incentives designed to encourage high-expense, deep-gas drilling on the shelf is that they are subject to price thresholds, meaning they don’t apply when natural gas prices reach a certain higher level.

“The rules that are today in existence for those leases that are still there and, as long as the threshold is not broken, they can have the advantage of these incentives,” Burton said.

However, she added, “the incentive (to drill) is probably not as great because of the market price of the commodity today. So there are still some incentives, but they are not as big as they used to be.”

Incentives launched in 2001

MMS, faced with rapidly declining natural gas production in shallower waters of the Gulf shelf, launched its deep-gas incentive in 2001 by including in lease terms the suspension of federal royalties on the first 20 billion cubic feet of gas produced from discoveries below 15,000 feet, at the time a major challenge for drillers. However, the provision applied only to new leases.

So, in early 2004, the agency greatly expanded the royalty relief program to include some 2,400 existing leases on the shelf and added sliding scale royalty relief based on depth and the number of wells drilled on a lease. Under this program, MMS offered royalty suspension on existing leases for the first 15 bcf of gas produced from depths greater than 15,000 feet and less than 18,000 feet, or on the first 25 bcf of gas produced from 18,000 feet or deeper.

Moreover, a royalty suspension volume of 15 bcf could be increased to 25 bcf from a second successful well to 18,000 feet or deeper. In the event of a dry hole below 18,000 feet, a producer would qualify for a royalty suspension supplement on 5 bcf of gas equivalent that could be applied to future oil or gas production from any depth. Two supplements were available per lease prior to production from a deep well. The maximum relief a lease could earn from either successful or unsuccessful deep wells was 35 bcf. Additionally, sidetrack wells could earn royalty suspensions in amounts based on drilling depth and sidetrack length.

Ultra-deep relief added

Later federal regulators came to the aid of ultra-deep explorers who had long grumbled that more time was needed than allowed under lease terms to prepare for the drilling of tricky and expensive gas wells below the benchmark 25,000-foot level. MMS issued a notice saying the agency would extend current primary terms of five and eight years on a “case-by-case basis,” provided applicants followed a few rules that included submitting “a reasonable schedule of work” that led to drilling.

Thus far attempts to reach the ultra-deep zone below the shelf have been fruitless in terms of commercial discoveries, largely because of the harsh temperatures and immense geological pressures which can slow drilling operations and do serious damage to equipment.

Most notable of these failed ultra-deep wildcats was the ExxonMobil-operated Blackbeard West No. 1 well, located on a huge prospect covering multiple blocks in the South Timbalier and Ship Shoal areas offshore Louisiana. Blackbeard certainly was among the most closely watched exploration ventures on the planet, mainly because of its extreme target depth down as far as 38,000 feet, just a few thousand feet from a new world depth record.

Blackbeard was a bust, falling well short (30,067 feet) of its goal and casting at least some doubt over the future of ultra-deep drilling on the shelf. The well, which cost an estimated $110 million, was spud in February 2005 and was expected to take about a year to complete. E&P independent and Blackbeard partner Newfield announced in August 2006 that drilling operations on Blackbeard had been halted “because of higher-than-expected pressure” downhole.

Shell is another company that has drilled a high-profile, ultra-deep well (Shark) on the shelf. However, the South Timbalier wildcat also came up dry.

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