R-Squared Energy Blog

Pure Energy

The Oil Industry for Dummies

Because apparently, this is a business that any dummy could run. Take Ed Markey’s new bill, for instance:

America’s untapped oil

“Big Oil is more interested in pumping up prices and pumping up their own profits rather than pumping more oil,” said Rep. Edward Markey (D-Mass), who has co-sponsored a bill to charge oil companies a fee for land they hold that’s not producing oil. “We should not even begin discussing handing over more public land to the oil companies until they first use [the land] they already hold.”

You would think it would occur to oil companies to develop the land currently under lease. They must be even dumber than the likes of Markey, who should have obviously been an oil company CEO.

The oil industry says it pays millions of dollars for these leases, and not producing oil on them is something they would not intentionally do.

“No one is sitting on leases these days,” said Rayola Dougher, senior economic advisor for the American Petroleum Institute. “Those making those assertions don’t understand the bidding and leasing process.”

Now, now. That’s what we would expect the oil industry to say.

So who’s right?

The oil industry is correct about not hoarding oil, said Oppenheimer analyst Fadel Gheit. With prices at $135 dollars a barrel, everyone is trying to pump as much as they can, he said.

But fearing oil prices will eventually fall, the industry is leery about making too many investments in the fields it has – many of which are in deepwater areas that can be pricey to develop.

Personally, I think Markey should just set up a hotline, so oil companies could call him up and ask which areas should be developed. Of course this is the same guy who screams that 1). Gas prices are too high; and 2). Carbon emissions are too high. Apparently, the irony of his positions has been lost on him.

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June 23, 2008 - Posted by | energy policy, gas prices, global warming

18 Comments

  1. “Rather, years of exploration is required before drilling can even begin. In some cases, no oil is found on leases they hold. In others, drilling the wells and building the pipelines takes years, and is especially hard now that a worldwide boom in oil exploration has pushed up the prices – and timelines – for skilled workers and specialized equipment.” – From the CNN article you referenced.

    So, if there’s a worker/equipment shortage, why would oil companies expect new off-shore drilling rights to be helpful? Unless, like politicians, they view the pretense of action as equally valuable or moreso than the real thing?

    Comment by Anonymous | June 23, 2008

  2. anonymous,

    So why not just give them the rights to drill? It won’t hurt anything to give them all the tools they request.

    Comment by Paul | June 23, 2008

  3. The other thing is, the government wants to extract more money out of the oil companies. By auctioning off the leases, they do just that. If the oil companies don’t develop them, the government still collects the lease payments.

    RR

    Comment by Robert Rapier | June 23, 2008

  4. The lack of leadership is just terrible. McCain, at least, has two things right: He wants more nukes, and he wants a $300 million X-prize for the first great car battery (today’s news). I say $300 m. is chump change, and why not $5 billion, but at least it is not a stupid idea.
    Is it too late to mount a write-in campaign for Mr. R-Squared?

    Comment by benny "peak demand" cole | June 23, 2008

  5. I haven’t seen it mentioned, but don’t oil companies sometimes buy leases to prevent competitors from getting the lease? In other words, company X wants a monopoly on some play, but doesn’t have the resources to fully develop that play right now. But to keep from having to share the play with company Y, X goes ahead and ties up the leases now. This seems like a perfect legitimate business practice, but since this is a sellers market for leaseholders (whether private or governmental), it would make sense to have some kind of elevator clause in the lease–i.e., the lease gets more expensive every year the oil company doesn’t develop it. It’s what I would do if a landman came a-knocking (and I had land with oil or gas potential, which I don’t, alas).

    Comment by Robert Boyd | June 23, 2008

  6. The $300MM prize is an interesting idea…but really, a major breakthrough in battery technology would be worth a lot more that $300MM, and I doubt that very many people would be motivated to work on it by the prize who weren’t *already* motivated by scientific interest and the commercial potential.

    Comment by David | June 23, 2008

  7. I think you meant “The Oil Industry for *@@^&%$^” but you were just too polite to title it that.

    Funny how his name sounds like “malarkey”.

    Comment by Anonymous | June 24, 2008

  8. “But fearing oil prices will eventually fall, the industry is leery about making too many investments in the fields it has – many of which are in deepwater areas that can be pricey to develop.”

    Oh oh, this argument, in this context, is a clunker … as is:

    “If the oil companies don’t develop them, the government still collects the lease payments.”

    The first “defense” undermines the idea that selling leases will bring an immediate commitment to production.

    The second quote reinforces that but also identifies a useful corporate strategy: acquire leases at public auction while oil is say $40/bbl, and then produce it later when oil is $80/bbl. Heck, I would do that if I could.

    I actually think we should delay coastal and arctic drilling for what are essentially strategic reasons (PO will come at some point), but I think even without that we should want taxpayers to drive a good deal for public lands.

    If they want immediate production they should make that part of the contract … or they work future market price into the lease agreements.

    (taxpayers should drive as hard a bargain as private property owners do)

    Comment by odograph | June 24, 2008

  9. Not that it will make any difference, but you have to give credit to Governor Sarah Palin for at least trying. I can imagine Harry Reid going all “Lou Grant” when he gets

    this letter : “She’s got spunk. I hate spunk.”

    Comment by KingofKaty | June 24, 2008

  10. Robert Boyd has a good point. There are a lot of analogies to the granting of precious water rights.

    If there is a limited and precious commodity whose development is regulated, there is usually no shortage of those willing to buy up the rights and sit on them, for investment purposes, with no intent to develop. That’s why the granting of water rights in the west is usually contingent on proof of beneficial use. I’m not saying that oil leasing should be handled in the same way, but it’s a valid point.

    Comment by iftheshoefits | June 24, 2008

  11. Oil leases should be practically free upfront to encourage exploration, with royalties on a sliding scale so both oil companies and the people win when prices spike. That’s the only sane way to do it, but neither politicians (who want predictable revenues to spend on pet projects) or oil companies (who want to keep all the price appreciation to themselves) want it. So instead we get silliness.

    Comment by doggydogworld | June 24, 2008

  12. Odograph – as with most things, the Democrat Party is oversimplifying the oil and gas leasing business.

    Think of it like manufacturing tables and chairs from raw wood. Oil and gas leases are the input that goes into the front end of the manufacturing process and oil comes out the back. Unused leases are like “scrap” not every piece of raw wood can be turned into furniture. Nobody would say to a furniture manufacturer “you can’t have any more wood until you have used all the wood you have in inventory”.

    Companies pay for the rigts to explore on federal land. They shoot additional seismic data, maybe drill a test well on the lease itself or in other blocks in the formation. The most prospective areas get developed first, the remaining leases get developed later or never. In my experience nobody spends millions of dollars acquiring a lease to keep it from being developed. There are primary terms on a lease, depending on the particular sale. The term is generally 5 to 10 years. You can usually extend that term by another period. If by the end of the second term it goes back up for auction.

    I am the record holder of an offshore lease that had previously been leased by Coastal back in the late 1980s and came up in the 2004 Western Gulf sale. We purchased the offshore lease not for oil and gas but to put an offshore natural gas pipeline hub on it. We wanted to hold the mineral rights so we could locate the hub anywhere within the 100 sq miles of the lease, without having to work out the location with the mineral holder. We did it to save time and hassle.

    So I suppose in Harry Reid’s world I shouldn’t get another lease until I drill on this one or until it expires in 2009.

    Comment by KingofKaty | June 24, 2008

  13. BTW – my lease is one of the LEAST prospective areas. When looking for a site for the natural gas hub we deliberately picked something unlikely to be developed. It had been offered for leasing for 3 or 4 times. We put down the minimum plus $1,000 to acquire the rights.

    Comment by KingofKaty | June 24, 2008

  14. That’s a better argument King, than the one from the original article:

    With prices at $135 dollars a barrel, everyone is trying to pump as much as they can, he said. But fearing oil prices will eventually fall, the industry is leery about making too many investments in the fields it has – many of which are in deepwater areas that can be pricey to develop.

    The bit “the industry is leery about making too many investments in the fields it has” was not conductive to the point the guy was trying to make, and I thought it was worth pulling out … especially if the new leases are “in deepwater areas that can be pricey to develop”

    That was the defender, not the “Democrat Party” talking.

    Comment by odograph | June 24, 2008

  15. Odograph – I was responding to the Democrat Party talking point last week about not opening up additional OCS acreage because not all the current leases are in use.

    I’ll give you another reason that OCS leases are sometimes not developed. We lay offshore pipelines out to the oil and gas fields. Particularly for natural gas, the pipelines have lives of 50 years or more, but the fields they serve produce from 3-5 years of natural gas and 10-20 years for crude. The pipelines and other infrastructure can cost as much or more as the field development. Amortizing a 5 year pipeline sized to drain a field quickly would be very uneconomic, so fields are developed in stages. I buy a lease now for a field that I bring on in 5-10 years as my current production peaks and falls.

    Another issue not spoken about at all in this debate is the flow of capital. Opening onshore and OCS areas would mean that US companies would divert capital to domestic production.

    Comment by KingofKaty | June 24, 2008

  16. As I said, my objection is long term and strategic. I want the US to be among the last nations with domestic oil reserves.

    Frankly, political arguments that support that don’t bother me too much.

    Just curious … on that front how would you like the “end game” to play out. Should Saudi Arabia, or Iran or Columbia be the last country with substantial reserves?

    Comment by odograph | June 24, 2008

  17. I don’t know too much about alternative energy, but I know a thing or two about exploration. Here are a few comments related to recent posts.

    “So, if there’s a worker/equipment shortage, why would oil companies expect new off-shore drilling rights to be helpful?”

    Well, you best prospect has 10 million barrels upside potential. Suddenly offshore California opens up; you buy data; you bid on and win a few leases with 500 million barrel potential. As exploration manager, where do you think you’ll focus your staff’s efforts?

    Staffing was also a critical issue in the early 1980’s. I didn’t notice many companies slowing down. I saw lots of leases being acquired.

    What you don’t understand is that 1) the exploration agenda can be prioritized, and 2) companies are constantly churning through leases, drilling some, selling others, buying new ones. Some work and some don’t.

    If you rest on your current lease inventory because of staff issues, then it’s going to cost you future production. Some, in fact probably most, of your exploration leases are going to be unsuccessful.

    “I haven’t seen it mentioned, but don’t oil companies sometimes buy leases to prevent competitors from getting the lease?….. but since this is a sellers market for leaseholders (whether private or governmental), it would make sense to have some kind of elevator clause in the lease–i.e., the lease gets more expensive every year the oil company doesn’t develop it”

    Yes, companies will often buy large lease positions to lock up a new play concept, or, they’ll buy lots of leases, i.e. lots of prospects, at one time in an OCS lease sale (for example). They don’t drill them up all at once. Usually they’ll put together a well thought out drilling program… lease a rig, drill a well, evaluate the results, and then decide. Depending on results of well #1, they may sell some interest, drop the leases, or lease several rigs and go full speed ahead. There are lots of ways the program could turn out, and one of the consequences of this is that some leases may not be drilled for a few years.

    Besides an upfront bonus bid, leases will almost always have a delay rental, wherein the lessee pays a fee to the lessor for each specified period during which the lease remains undrilled. Also, leases typically expire in 3-5 years, or longer in the case of difficult environments such as deepwater Gulf of Mexico.

    “…acquire leases at public auction while oil is say $40/bbl, and then produce it later when oil is $80/bbl. Heck, I would do that if I could.”

    Can I borrow your crystal ball? Companies paid billions for leases in Alaska’s Beaufort, Bering, and Chukchi Seas when oil was very high in the early 1980’s. Then oil crashed in the mid 1980’s and they were left holding the bag.

    “If they want immediate production they should make that part of the contract … or they work future market price into the lease agreements.”

    You can’t dictate a date for first production. The first wells on the North Slope were drilled in the 1940’s. Prudhoe Bay wasn’t discovered until 1968. You never know where the oil is until you start drilling, and your initial assumptions going into the drilling program can often be wrong.

    Some countries do try to work market prices into contracts. Would you want to invest billions if the host government denied you any price upside, but left you exposed to downside price risk?

    “Oil leases should be practically free upfront to encourage exploration, with royalties on a sliding scale so both oil companies and the people win when prices spike”

    I’d guess that lease costs have only rarely impeded exploration. They sure aren’t now, as drilling rig utilization is at a 20 year high. Companies will pay what it takes to secure a lease of they think they can make money on it. Period.

    The government usually specifies a minimum bid, and this minimum is not particularly high. It’s then left to competitive bidding. I don’t understand what alternative method you’d propose to this. If you want “cheap” leases, do you mean you want the government or private mineral rights owners to dole them out by ration or lottery? Good luck with that!

    Royalties are often fixed, or have a sliding scale with higher royalties toward the end of the lease term to encourage rapid drilling. Why let them slide according to price? If you as lessor are getting a 25% royalty on $50 oil, you will also get 25% of $135 oil. It comes straight off the revenue stream.

    Comment by armchair261 | June 25, 2008

  18. I simply do not understand where this inane idea that oil companies buy leases and sit on them originates, but I am hearing it all the time now, especially with this offshore drilling proposal on the table.

    Apart from the obvious, that no one wants to have idle investments, look at the data:

    Active 3D seismic crew count, 2003: 252
    Active 3D seismic crew count, 2007: 667

    Wells drilled, 2003: 30,675
    Wells drilled, 2007: 53,558

    It’s so obvious. How can we have such stupid and/or lazy elected officials? Do they not have staffs to look this stuff up? Jeez, a 19 year old intern should be able to tell him he’s an oaf.

    Comment by armchair261 | June 25, 2008


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