Drilling dilemma: Oil industry leases untapped

@CNNMoney June 8, 2011: 1:20 PM ET
Leases for millions of acres of land that the oil industry could be drilling on lay idle, but experts don't see it as part of a plan to drive up gasoline prices.

Leases for millions of acres of land that the oil industry could be drilling on lay idle, but experts don't see it as part of a plan to drive up gasoline prices.

NEW YORK (CNNMoney) -- The oil industry isn't drilling on leases for millions of acres of land that could be producing energy.

Yet despite claims from several lawmakers, it doesn't appear this is part of a nefarious plan to drive up gas prices or reap huge profits by companies like Exxon Mobil (XOM, Fortune 500), BP (BP), Chevron (CVX, Fortune 500) or Royal Dutch Shell (RDSA).

Experts say oil companies aren't drilling on the land because it doesn't make economic sense to do it.

During recent congressional hearings many Democrats cited a recent report from the Interior Department showing that over 70% of the offshore acres the industry has leased from the federal government are sitting idle.

Onshore, nearly 60%, or 22 million acres in total, aren't producing any oil or gas.

They were responding to calls for more acres of the country to be opened up for oil and gas drilling.

"They have the drilling rights to an area of public land the size of Minnesota where they could and should be drilling," Massachusetts Representative Ed Markey, a Democrat, said in a statement to CNNMoney. "But instead [they] are coming back and asking Congress to allow drill rigs off our beaches up and down the East Coast."

Drill baby drill won't lower gas prices

How the leases work: The oil industry routinely leases blocks of land from the federal government to explore for oil and gas. The leases typically last for 5 to 10 years and cost anywhere from $75,000 to $2 million to get. Then the companies have to pay an additional fee each year for the duration of the lease.

If oil is found, the company get's to keep the lease for the life of the well, which could be 40 years. They would also have to pay the government a royalty on the production, usually ranging from 12% to 18%. If no oil is found, the land reverts to the government.

Markey and other lawmakers say the industry is purposefully idling production so they can book the oil and gas reserves on their balance sheet as an asset -- a move that might drive up their stock price.

Critics also say they might be saving the oil for a future date, when prices might be higher.

The Interior Department, which supports efforts to put more of these leases into production, says over half the nation's 20 billion barrels of recoverable oil reserves lie untapped in the Gulf of Mexico.

To prod the industry into more rapidly exploring and drilling on these acres, the administration and members of Congress have proposed shortening the period for which leases are awarded -- a so-called "use it or lose it" provision.

They have also proposed increasing the amount of money companies have to pay each year for their leases, which can range from $40,000 to $200,000.

Drilling for oil isn't so simple: But the oil industry and independent experts say it's ridiculous to believe that companies wouldn't be trying to produce all they can from the land they have leased if it made financial sense.

The huge amount of untapped land being leased is accurate, said Erik Milito, director of exploration and production at the American Petroleum Institute. But to just look at that number and say the industry is sitting on its hands is too simplistic, "it doesn't explain the oil and gas businesses at all."

One reason the industry isn't producing on these lands, said Milito, is because there's simply no oil there. Only 25 to 30% of the acres the industry leases offshore ends up having large enough oil deposits to bring into production, he said.

Another reason is the time it takes to go from bidding on a lease to producing oil. It can take seven, eight, nine years to do the seismic work, line up the contractors, conduct the exploratory drilling, and then build the infrastructure needed to bring the oil and gas market, he said.

"Companies are in the businesses of developing oil and gas resources, not buying leases," said Milito. "You're not going to make any money if you're sitting on it."

Guy Caruso, former head to the government's Energy Information Administration who's now at the Center For Strategic and International Studies, agreed.

Caruso also cited the long lead time needed to develop an oil lease and the fact that firms want to recoup any money they put into exploration relatively quickly.

Accusations that oil companies aren't drilling in order to book the oil reserves also seem simplistic. An exploration well would be needed for the firm to book the discovery on its balance sheet.

Plus, he said oil at $100 a barrel is a huge incentive for companies to produce oil now. The price in the future, he noted, is anyone's guess.

"This is good politics," said Caruso, "but it's not the way the business works."

By forcing the industry to produce on its idle leases, lawmakers hope to raise domestic oil production, which would tend to increase U.S. jobs and add to federal tax rolls without having to open up additional lands for drilling.

Some hope it would also lower gas prices. But it's questionable if forcing production would have the desired effect.

"Diligent development policies are unlikely to encourage money-losing production today," said Kevin Book, a managing director at ClearView Energy Partners, a research outfit. "If producing were economic, investor-owned oil companies would be doing it."  To top of page

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