Deep Gas Royalty Relief Proposed Rule

1. Deep Gas Royalty ReliefProposed Rule Al Durr Minerals Management Service January 22, 2004

2. General Information • Proposed Rule published March 26, 2003 • Federal Register: Vol. 68, No. 58, Pages 14868-14886 • Amends 30 CFR 203 (adds 203.40-48) • Notifications to drill deep wells: 28 Drilling has not started: 4 Currently drilling: 12 Plugged and abandoned: 7 Temporarily abandoned: 2 On production: 3 2

3. Program Design • Meaningful incentive; minimizes unnecessary relief • Immediate effect • Applies to deep depths • Categorical relief • Uses a familiar royalty incentive format • Not limited to new reservoirs

4. Eligible Leases • Issued before January I, 2001, or issued after January 1, 2001 and exercised option to switch to deep gas royalty relief regulation. • Wholly located in the GOM west of 87° 30’ west longitude • In water depths less than 200 meters • Has not produced gas or oil from a completion 15,000 feet or deeper in a well that commenced drilling before March 26, 2003.

5. Types of Royalty Relief • Royalty Suspension Volume • Royalty Suspension Supplement

6. Royalty Suspension Volumes Successful Deep Well Well Depth (TVD SS) From 15,000 to less than 18,000 feet 15 BCF 18,000 feet or deeper 25 BCF

7. Royalty Suspension Volume Provisions • Successful well with top of perforated interval 15,000’ TVD SS or deeper that commenced drilling after March 26, 2003. • New wellbore (bypasses eligible; sidetracks not eligible) • Gas production from a deep well before 5 years after effective date of final rule • Not limited to new reservoir

8. Royalty Suspension Volume Provisions • First deep well to produce establishes the lease royalty suspension volume. • RSV will be monitored using OGOR-A • Production volumes reported by well • Slightly reduces royalty relief

9. Royalty Suspension Volume Provisions • Gas Measurement Requirements • Semimonthly testing of all producing wells • Monthly calibration of each test separator gas meter • MMS Notification • Intent to drill deep well • Commencement of deep production

10. Royalty Suspension Volume Provisions • Letter to Regional Supervisor for Production and Development • Intent to drill well • Lease number • Area/Block • Anticipated spud date • Target depth • Commence production • Within 30 days • Lease number, Area/Block • Well number • Perforated interval • Reservoir name • Date production commenced • Request confirmation of size of size of RSV 10

11. Royalty Suspension Supplement Unsuccessful Deep Well Well Depth (TVD SS) From 15,000 to less than 18,000 feet 0 BCF 18,000 feet or deeper 5 BCFE

12. Royalty Suspension Supplement Provisions • Unsuccessful well targets a reservoir at least 18,000 feet TVD SS • Drilling commenced on or after March 26, 2003 • Well (no sidetrack) commenced drilling before deep production begins on the lease

13. Royalty Suspension Supplement Provisions • Applicable to oil and gas volumes produced from or allocated to the lease, regardless of depth, as reported on OGOR-A (5.62 MCF=1BO). • Lease is eligible for two royalty suspension supplements, but only one per wellbore. • Maximum relief 2 RSS 10 BCF 1 RSV 25 BCF Total 35 BCF

14. Royalty Suspension Supplement Provisions • Letter to Regional Supervisor for Production and Development • Within 60 days after reaching total depth • Well log data, if well does not meet the producibility requirements of 30 CFR 250, subpart A • Well log, well test, seismic, and economic data, if well does meet the above producibility requirements 14

15. Royalty Suspension Supplement Provisions • Well meets producibility requirements but is not commercially producible • G&G Data • Digital well logs showing target • Structure and amplitude map • Reserve estimate • Seismic volume used for evaluation • Well test data • Economic Data • Point estimate (production profile, costs, etc.) • Prospective costs only • No P&A costs • Before tax analysis • Oil and gas prices published by MMS • <15% ROR is uneconomic • Assume royalty suspension volume 15

16. Unitization Options considered by MMS for deep gas royalty relief in federal units prior to the proposed rule: • Unit Based Approach • One RSV per unit • Entire unit ineligible • RSV allocated to unit leases • Lease Based Approach • Each eligible unit lease can earn an RSV • Only individual leases are ineligible • RSV is not allocated

17. Unitization • Hybrid Approach • Each eligible lease can earn an RSV • Only individual leases are ineligible • RSV allocated to unit leases • In the proposed rule, MMS chose the lease-based approach including no allocation of the RSV to the unit leases.

18. Unitization • Primary Reason: Some unit leases are allocated production, but can not be allocated an RSV, e. g., state leases and ineligible federal leases. • ineligible federal leases include those in water depths deeper than 200 meters or with deep production from wells drilled prior to March 26, 2003 • approximately 50% of existing shallow water units have either state leases or federal leases that are ineligible for relief • other units may contain leases issued after January 1, 2001, which have no provision in the lease instrument requiring lessees to share their deep gas RSV

19. Unitization Allocation of Production • Separate Participating (Productive) Areas will be used to allocate royalty-bearing and royalty-free gas production • Shallow PA (shallow reservoirs and ineligible deep reservoirs) • Deep PA (reservoirs with successful qualified wells) • Each PA has its own allocation percentages adding up to 100%

20. Price Threshold • Royalties are due in a calendar year when NYMEX average price exceeds gas price threshold. • Gas price threshold equals $5.00/MMBTU, adjusted annually for inflation from year 2000. • Royalties plus interest are due within 90 days after end of the year. • Production volumes count as part of the royalty suspension volume and royalty suspension supplement.

21. Miscellaneous Provisions • Minimum royalties are due during royalty-free production • RSV and RSS can be transferred to successor lessees • Unused RSV and RSS terminate when lease expires

22. Sharing RSV on Lease • If C1 produces first, lease gets 25 BCF - C2 can share up to 15 BCF of 25 BCF • If C2 produces first, lease gets 15 BCF - C1 can share up to 15 BCF 15,000 ft C2 18,000 ft C1

23. Sharing RSV, RSS on Lease • If C1 is unsuccessful, lease gets 5 BCFE RSS. • If C2then produces, lease also gets 15 BCF RSV for total of 20 BCF. 15,000 ft C2 18,000 ft C1

24. Sharing RSV, RSS in Well • If C1 is unsuccessful and RSS used up, then C2earns 10 BCF (15 BCF – 5 BCFE) 15,000 ft C2 18,000 ft C1

25. Substitution Option • Lessees may replace deep gas royalty relief provisions in lease terms with provisions in final rule. • Available to shallow water leases in sales after January 1, 2001. • Exercising the option is irrevocable.

26. Substitution Option • Letter to the Regional Supervisor for Production and Development • Within 180 days after effective date of final rule • Specify decision to exercise option • Provide Lease Number and Area/Block

27. Substitution ComparisonLease instrument vs. Proposed Rule RSS None RSS Certified unsuccessful well (up to 2) RSS = 5 BCFE Price Threshold $5.00/MMBTU $3.50/MMBTU (Sale 178) Price Threshold $5.00/MMBTU

28. Substitution ComparisonLease instrument vs. Proposed Rule 28

29. Pending Issues • Lease/Well Eligibility • Sidetracks • Unitization • Price Threshold • Ultra Deep Drilling • Production Start-Up

30. Industry Comments on Pending Issues Lease/Well Eligibility • Grant RSV to each successful deep well • Grant additional RSV to a successful well drilled to a deeper depth interval • Grant deep gas relief to deepwater leases

31. Industry Comments on Pending Issues Sidetracks • Include sidetracks in deepgas relief program • Provides opportunities to drill and produce small resource accumulations • Maximum use of existing facilities

32. Industry Comments on Pending Issues Unitization • Allocate royalty suspension volume same as production • Not allocating RSV could • Reduce value of relief • Promote drilling of unnecessary wells

33. Unitization Lease A Lease B 15,000’ Qualified Well x1 18,000’ 50% 50% • Lease B earns an RSV of 15 BCF and is allocated 50% of production from X1 • Lease A has no royalty relief but is allocated 50% of production from X1 • With no allocation of RSV, X1 will have to produce 30 BCF to receive the • full royalty- free incentive of 15 BCF

34. Unitization • Lease-based approach promotes drilling of unnecessary wells if X1 alone can efficiently drain the reservoir. • Comments also suggested allowing an RSV for Leases B,C, and D without the drilling of a deep well, if MMS concurs that X1 alone can efficiently drain the reservoir. A B X1 C D

35. Industry Comments on Pending Issues Price Threshold Eliminate or modify $5.00/MMBTU gas price threshold • Creates uncertainty about availability of relief • Reduces value of relief • Imposes unnecessary barrier to deep gas exploration and development

36. Industry Comments on Pending Issues Ultra Deep Drilling Category Add a third tierof relief (35 to 45 BCF) for wells below 20,000 feet • Costs and risks are disproportionately greater at 20,000’ vs. 18,000’ • Real targets of opportunity lie below 20,000’ • Greater incentive for greater cost and risk seems appropriate

37. Industry Comments on Pending Issues Production Start-Up Requirement • Five years is too short a time to explore and commence production of deep gas reserves given the technological challenges. • Provide an extension on a case-by-case basis when additional time is justified • Allow for unavoidable delays, such as weather, that are beyond the control of the operator

38. Royalty Relief Information MMS GOMR Web Site Homepage: www.gomr.mms.gov (click on “offshore information” and then on “royalty relief”; for additional information click on “deep gas”) MMS Contacts Al Durr at (504) 736-2659; alvin.durr@mms.gov Kevin Karl at (504) 736-2632; kevin.karl@mms.gov