Big oil wields ultra deep influence

Introduction

In the spring of 2001, at a cocktail party on Capitol Hill, a staff member of the House Committee on Science brought up a subject of great interest to a lobbyist for the Gas Technology Institute, a Chicago-area organization that provides research and development for the natural gas industry: Rep. Ralph Hall, an 11-term Texas Democrat who sat on both the science committee and the Committee on Energy and Commerce, was interested in ultra-deepwater drilling and research collaborations between industry and government. In fact, the staffer let on, the science committee was drafting a bill proposing that the government subsidize technology for extracting natural gas and oil from hard-to-reach sources such as sand, rock and the deepest waters of the Gulf of Mexico.

This no doubt came as welcome news to the GTI lobbyist, as the organization was already working on developing deepwater drilling technology. And the news would only get better: GTI eventually contributed language to the legislation, which was later incorporated in the 2003 comprehensive energy bill as a program that would allocate more than $2 billion for research into “ultra deepwater and unconventional natural gas technology.”

But if GTI’s constituents stood to gain from the measure, many lawmakers saw it as yet another gift to an industry with plenty of market incentive to go after valuable hydrocarbons itself. Now, as Congress places a new energy bill atop its list of priorities for the upcoming session, Gulf-state legislators are shrugging off the skeptics and again promoting the program as beneficial for American energy independence, not to mention hometown jobs.

Dry Land

Opinions may differ on exactly when the Earth will pass its peak in oil production, but there is consensus that the day is unnervingly near: the U.S. Department of Energy and the International Energy Agency date it sometime after 2030 , while controversial “peak oil” theorists place it at 2008. In even the most optimistic scenario, humans will have extracted more than half the earth’s oil within the next three decades, after which oil production will begin its inevitable decline. Yet the world’s energy needs will be almost 60 percent higher at that time, according to the IEA.

That peak will arrive even faster in the United States, the Energy Department says. U.S. petroleum production will reach its apex at 9.8 million barrels per day in 2009, falling to 8.8 million barrels per day by 2025. Yet domestic demand will increase by almost 40 percent in that period. Similarly, demand for natural gas is projected to increase by 40 percent, while domestic production will only increase by 14 percent.

This double whammy of declining production and increasing demand is creating an even greater dependence on imported energy: Net oil imports, which rose from 37 percent of total U.S. petroleum consumption in 1980 to 56 percent in 2003, are projected to account for 68 percent of consumption in 2025. Twenty-one percent of America’s gas will be imported by that year as well.

U.S. leaders call this dependence on foreign energy a major national security concern, because of the vulnerability to supply disruptions. Insurgency campaigns in Iraq, pipeline sabotage in Colombia and civil unrest in Nigeria are just a few recent examples of supply interruptions that helped push the price of oil to record highs. Reducing U.S. energy dependency has been a chief priority of administrations dating back to the oil shocks of the 1970s.

Reducing dependency on foreign sources of energy means, above all, squeezing every last drop out of domestic ones. But America’s onshore sources are nearly tapped out: oil production from wells on land, for example, fell by 30 percent between 1986 and 1996. Luckily, the United States holds claim to one of the world’s richest oil deposits: the Gulf of Mexico.

Digging Deep

At the ocean’s edge, the earth gently slopes away from shore before dropping off sharply-a shallow undersea plain known as the continental shelf. International maritime law grants nations certain sovereign rights over their continental shelves; these submerged regions generally fall within the “exclusive economic zones” created by the United Nations Law of the Sea, which extend countries’ territory about 230 miles off their shores.

In 1983 President Ronald Reagan established the U.S. exclusive economic zone, in the process creating the world’s largest EEZ: U.S. territorial waters, including those off the Atlantic and Pacific oceans as well as the Gulf of Mexico, constitute an area two-thirds the size of all 50 states combined. Most of that territory is off limits to the energy industry, however: In 1990 President George H. W. Bush placed a moratorium on offshore exploration in 80 percent of the U.S. exclusive economic zone, a ban extended by President Bill Clinton until 2012.

Most offshore wells around the world are drilled on the outer reaches of the continental shelf. Early offshore wells were drilled in just a few hundred feet of water, but by the 1980s prospectors had moved into “deep” waters (defined by the U.S. Department of Energy as beyond 1,300 feet), using 3-D seismic imaging to help find reserves beneath the ocean floor. Current technology permits “ultra-deep” drilling that has bored wells under as much as 10,000 feet of water.

The Federal Oil and Gas Royalty Management Act of 1982 requires companies to pay a royalty on each unit of oil and gas produced on U.S. territory. The Minerals Management Service (MMS), created as a bureau of the Department of the Interior to manage and distribute these royalties, today takes in some $6 billion a year. Much of that comes from the sea: Deepwater drilling accounted for more than 60 percent of the production in the Gulf of Mexico, and offshore drilling provided 30 percent of total U.S. oil production in 2002. What’s more, experts believe that the ultra-deepwater reservoirs of the Gulf, particularly in the western portion, could potentially produce as much oil and natural gas as the North Slope of Alaska.

But the technology taking the industry into ever-deeper waters comes at a price. Drilling in the extreme temperatures and pressures beneath the ocean presents myriad technical challenges. For example, oil hot from the earth’s core can become so cold upon reaching the sea bed that it can’t move through pumps. This makes ultra-deep drilling exorbitantly expensive, with rigs often costing upwards of $1 billion. As a result, only the “supermajor” companies-such as Brazil’s Petrobras, British Petroleum, Royal Dutch/Shell, ExxonMobil and ChevronTexaco-have sufficient resources to invest in ultra-deep research and development. Several smaller companies that provide equipment and other services to the industry also develop technology for ultra-deep drilling, although this is generally through contracts with larger companies.

The Deepwater Royalty Relief Act of 1995, which cut royalties owed to the government for oil and gas drilled on federal lands from depths of 200 meters or more, was signed into law by President Bill Clinton as a way to encourage investment in ultra-deep exploration. The act led to a burst of deepwater exploration, but, according to a 2000 Department of Energy report, development was still “not proceeding fast enough to meet the economy’s growing demand or to slow the increasing reliance on imported supplies of oil.” A 2004 MMS report blamed a recent drop-off in deepwater drilling in the Gulf of Mexico on the relative affordability of foreign ventures and the fact that operators don’t have access to many parts of the Gulf. The DOE’s solution was to lend the industry a helping hand. According to that 2000 report, “Offshore Technology Roadmap for the Ultra Deepwater Gulf of Mexico,” ultra-deepwater reservoirs have “the potential to stabilize energy supplies and reduce U.S. dependence on imported sources,” and required incentives such as “targeted royalty relief, R&D tax credits, and matching research dollars.”

Unconventional Solution

When the White House asked congressional committees to construct a comprehensive energy bill in 2003, Hall and the House science committee submitted H.R. 238, which would provide billions to develop and commercialize DOE energy technologies. The ultra-deep program found a powerful ally in House Majority Leader Tom DeLay (R-Texas), who, staffers say, saw an added benefit in energy industry jobs, which had declined along with oil production. In an April 2004 hearing of a House Energy and Commerce subcommittee, DeLay testified that the program would provide maximum benefits for government in the form of royalties, and industry in the form of research dollars that would allow companies to drill deeper. “Too often, government research programs are limited by size and scope, by the vagaries of the budget cycle, and by the lack of adequate incentives for public/private partnerships,” he said.

The initiative is essentially two separate programs, one for offshore research and development and another for onshore. Under each, the energy department would establish a consortium of industry, government and university representatives to recommend candidates for federal contracts to conduct research and bring it to U.S. energy companies. The consortia are also empowered to disburse funds and manage contracts. Consortia members are required to disclose any financial interests in companies that applied for contracts; however, they (or the companies they worked for) are not barred from applying for contracts.

Proponents say the program would pay off for taxpayers by generating both energy and tax revenue. The Bureau of Economic Geology, a research operation housed at the University of Texas, estimated that royalties from the oil and gas produced from ultra-deep and unconventional methods would pay for the program several times over by 2025, an analysis affirmed by the International Energy Agency.

Critics on the Hill, however, worried that the funds allocated to the consortia might vanish before resulting in taxable oil or gas. The program was drafted as a “direct spending” bill, meaning funds would pass directly from the Minerals Management Service to its own account. Together, the programs would receive up to $150 million a year through 2013 from MMS continental shelf royalties. An additional $500 million would be available to the program through annual appropriations, but the primary funding would not be subject to annual review, raising congressional suspicions that the program could become another unwatched, unregulated money pit.

If so, it would have been in good company: the Energy Security Act of 2003 contained nearly $24 billion in tax incentives for oil and gas production, including nearly $18 billion in new research programs. The bill passed comfortably in the House, but the Senate stripped out the ultra-deep program before killing the bill in November 2004.

In Hill testimony, several members of Congress questioned why the U.S. government should offer help to an industry that saw record receipts and profits in recent years. ExxonMobil, for instance, posted $17.7 billion in income in 2000and recorded profits unmatched by any other U.S. corporation, while the oil giant’s third quarter earnings in 2004 were $5.7 billion, its highest ever. “There are something on the order of 12 rigs in the Gulf today that are drilling to a depth of 5,000 feet or greater,” Rep. Rick Boucher (D-Va.) pointed out at an April 2004 hearing on the program. “Why [should] we be continuing to put research and development funding into an application that has achieved commercial status?”

Industry representatives argue that the high costs-and risks-of ultra-deep exploration put a damper on both production and profits. “The technical challenges facing the large oil and gas producers in ultra-deep water is of such a magnitude today, that they can and will…shift their investment and exploration portfolio towards other opportunities” outside the U.S., Arthur Weglein, director of the Seismic Research Program at the University of Houston, testified at the hearing. U.S. government investment in ultra-deep water R&D would, he added, “help serve the near- and long-term interests of our country.”

Yet studies show the energy industry is still investing a good amount of money into deep and ultra-deep drilling: A report by the U.K.-based industry consultants Douglas-Westwood projects worldwide spending on deepwater wells to increase by 22 percent to $56 billion over the next five years. The Gulf of Mexico and Africa account for 70 percent of this expenditure. In addition, the government itself already spends millions on oil and gas research and development: DOE’s Fossil Energy Research and Development program spent $672 million in 2004, including $43 million on gas programs and $35 million on oil programs.

“I’m not sure we need any more help on perfecting ultra-deep drilling because industry is doing it-they figured it out,” Matt Simmons, an energy consultant and head of a Houston-based investment banking firm specializing in the energy industry, says. “If the government created a new pool of energy research and development funds, could anything good come out of it? Yes, but you need a judicious administrator or it becomes a pork barrel; it gets created, no one pays attention, and the majors say, ‘Let’s cut out our R&D budget and use this.’ That would be a shame.”

In fact, some of the bill’s opponents were super-major oil companies themselves, which stand to lose what they consider proprietary technology. According to documents filed with the House of Representatives, ExxonMobil lobbied on H.R. 238 in 2003, although the documents don’t say whether it lobbied in favor or against it. But Hill staffers say the super-majors were not particularly vocal in their protest, as the energy bill was certainly beneficent for the energy industry overall. In fact, a wide range of industries that would benefit from the program turned out to testify or lobby on its behalf, such as the Independent Petroleum Association of America-a lobbying group representing smaller oil companies-and universities with petroleum engineering programs that stood to win federal research contracts, such as the University of Houston and New Mexico Tech. Overall, parties with a stated interest in energy policy spent $388 million lobbying Congress in 2003, the year of the energy bill’s journey.

The Next Frontier

Staffers for Hall (who has since joined the Republican Party) and DeLay say the legislators will make every effort to keep the program in the next energy bill. They will likely face a steep challenge: Senators named the high cost and profusion of pork the main factors behind the death of the last bill. But the energy industry will doubtlessly reinvigorate its efforts in support of the program. One enterprise in particular is the Hill favorite to score the lucrative contract for managing federal contracts on behalf of the consortium: the Gas Technology Institute.

Whether or not the program makes it into the law that will direct the country’s future energy policy, it demonstrates how anxiety over energy shortfalls is compelling the U.S. government to put itself front and center in the race toward the earth’s final energy frontiers. Despite energy companies’ claims that overwhelming demand doesn’t provide sufficient incentive for investment in technology that will lead to the next great gusher, with this program the U.S. government may be throwing money at a solution rather than a problem.