Oil and Gas and Sulphur Operations in the Outer Continental Shelf (OCS)-Royalty Relief-Ultra-Deep Gas Wells and Deep Gas Wells on OCS Oil and Gas Leases; Extension of Royalty Relief Provisions to OCS Leases Offshore of Alaska, 28396-28423 [E7-9294]

Agencies

• DEPARTMENT OF THE INTERIOR
• Minerals Management Service

[Federal Register Volume 72, Number 96 (Friday, May 18, 2007)]
[Proposed Rules]
[Pages 28396-28423]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-9294]



[[Page 28395]]

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Part III





Department of the Interior





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Minerals Management Service



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30 CFR Parts 203 and 260



Oil and Gas and Sulphur Operations in the Outer Continental Shelf 
(OCS)--Royalty Relief--Ultra-Deep Gas Wells and Deep Gas Wells on OCS 
Oil and Gas Leases; Extension of Royalty Relief Provisions to OCS 
Leases Offshore of Alaska; Proposed Rule

Federal Register / Vol. 72, No. 96 / Friday, May 18, 2007 / Proposed 
Rules

[[Page 28396]]


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DEPARTMENT OF THE INTERIOR

Minerals Management Service

30 CFR Parts 203 and 260

RIN 1010-AD33


Oil and Gas and Sulphur Operations in the Outer Continental Shelf 
(OCS)--Royalty Relief--Ultra-Deep Gas Wells and Deep Gas Wells on OCS 
Oil and Gas Leases; Extension of Royalty Relief Provisions to OCS 
Leases Offshore of Alaska

AGENCY: Minerals Management Service (MMS), Interior

ACTION: Proposed rule.

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SUMMARY: MMS is proposing to amend its deep gas royalty relief 
regulations to incorporate statutory changes enacted in the Energy 
Policy Act of 2005. This proposed rule would provide additional royalty 
relief for certain wells on the Outer Continental Shelf (OCS) leases in 
the Gulf of Mexico (GOM). It would also extend the applicability of 
existing deep gas royalty relief regulatory provisions to more OCS 
leases. MMS is also proposing amendments to discretionary royalty 
relief provisions and associated definitions to extend the 
applicability of certain royalty relief to leases offshore of Alaska.

DATES: Submit comments by July 17, 2007. MMS may not consider comments 
received after this date. Submit comments to the Office of Management 
and Budget on the information collection burden in this rule by June 
18, 2007.

FOR FURTHER INFORMATION CONTACT: Marshall Rose, Chief, Economics 
Division, at (703) 787-1536 or marshall.rose@mms.gov.

ADDRESSES: You may submit comments on the proposed rulemaking by any of 
the following methods. Please use the Regulation Identifier Number 
(RIN) 1010-AD33 as an identifier in your message. See also Public 
Availability of Comments under Procedural Matters.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions on the Web site for submitting comments.
     E-mail MMS at rules.comments@mms.gov. Use the RIN 1010-
AD33 in the subject line.
     Fax: 703-787-1546. Identify with the RIN, 1010-AD33.
     Mail or hand-carry comments to the Department of the 
Interior; Minerals Management Service; Attention: Regulations and 
Standards Branch (RSB); 381 Elden Street, MS-4024; Herndon, Virginia 
20170-4817. Please reference ``Royalty Relief--Ultra-Deep Gas Wells on 
OCS Oil and Gas Leases; Extension of Royalty Relief Provisions to OCS 
Leases Offshore of Alaska, 1010-AD33'' in your comments and include 
your name and return address.
     Send comments on the information collection in this rule 
to: Interior Desk Officer 1010-AD33, Office of Management and Budget; 
202-395-6566 (fax); e-mail: oira_docket@omb.eop.gov. Please also send 
a copy to MMS.

SUPPLEMENTARY INFORMATION: 

A. Background and Summary of the Proposed Rule

    Section 344 of the Energy Policy Act of 2005, Pub. L. 109-58, 119 
Stat. 594, 702 (codified at 42 U.S.C. 15904) (referred to hereinafter 
as ``section 344''), enacted on August 8, 2005, provides incentives to 
producers in the form of royalty relief for production of certain deep 
gas from offshore federal oil and gas leases in the shallow waters of 
the GOM wholly west of 87 degrees, 30 minutes West longitude. This 
statutorily-mandated relief supplements royalty relief MMS previously 
provided by regulation.
    On January 26, 2004 (69 FR 3510), MMS adopted regulations at 30 CFR 
Sec. Sec.  203.40-203.48 to provide royalty relief incentives for deep 
gas production from GOM leases in less than 200 meters of water that 
lie wholly west of 87 degrees, 30 minutes West longitude (the rule was 
effective for wells spudded on or after the date of the proposed rule, 
March 26, 2003). These rules, subject to certain limitations, provide a 
royalty suspension volume (RSV) for two basic categories of deep gas 
production: 15 billion cubic feet (BCF) of RSV is provided for 
qualifying wells with a perforated interval the top of which is between 
15,000 and 18,000 feet true vertical depth subsea (TVD SS); and 25 BCF 
of RSV is provided for qualifying wells completed at least 18,000 feet 
TVD SS. The rules also provide lesser amounts of royalty relief for 
deep sidetracks and for drilling certain unsuccessful deep wells.
    Section 344 requires MMS to adopt regulations providing for 
additional categories of deep gas royalty relief for GOM leases wholly 
west of 87 degrees, 30 minutes West longitude. First, section 344(a) 
provides that for certain ultra-deep wells in less than 400 meters of 
water (defined in section 344(a)(3)(A) as wells with a perforated 
interval the top of which is at least 20,000 feet TVD SS), the agency 
shall issue regulations granting an RSV of not less than 35 BCF. This 
requires adding a new well depth category and new RSV amount to the 
existing deep gas royalty relief rule.
    Second, section 344(b) requires MMS to promulgate regulations 
granting royalty relief suspension volumes for gas produced from deep 
wells on leases in waters more than 200 meters but less than 400 meters 
deep. In calculating the suspension volumes, section 344(b) requires 
MMS to use the same methodology used to calculate suspension volumes 
for deep wells in shallower waters. This requires adding a new water 
depth category to the existing deep gas royalty relief rule. These 
proposed regulations implement these two statutory directives.
    In addition, section 346 of the Energy Policy Act, 119 Stat. 704, 
amended section 8(a)(3)(B) of the OCS Lands Act (OCSLA), 43 U.S.C. 
1337(a)(3)(B), to extend the Secretary's discretionary authority to 
grant royalty relief to leases offshore of Alaska. This proposed rule 
also implements this provision. However, neither the existing deep gas 
royalty relief rule nor the additional deep gas royalty relief granted 
in section 344 applies to leases offshore of Alaska.
    Both subsections (a) and (b) of section 344 provide that any final 
rule that the Secretary adopts will be retroactive to the date of this 
proposed rule. Therefore, production from any wells that earn royalty 
relief under section 344 drilled on or after the publication date of 
the proposed rule would qualify for the relief provided for in the 
final rule, if the well meets the requirements of the final rule. Of 
course, MMS may modify the rule between this proposed rule and the 
final rule, so lessees should not assume that the proposed rules would 
apply.
    With respect to ultra-deep wells on leases located wholly west of 
87 degrees, 30 minutes West longitude in the GOM in shallow waters less 
than 400 meters deep, section 344(a)(1) provides:

    [T]he Secretary shall issue regulations granting royalty relief 
suspension volumes of not less than 35 BCF with respect to the 
production of natural gas from ultra deep wells on leases issued in 
shallow waters less than 400 meters deep located in the Gulf of 
Mexico wholly west of 87 degrees, 30 minutes west longitude.

    While this statutory language does not specify how the rulemaking 
should allocate or grant the 35 or greater BCF ``with respect to the 
production of natural gas from ultra deep wells on leases,'' Congress 
certainly intended an incentive to drill and produce ultra-deep wells 
beyond what MMS rules currently provide. Section 344(a)(2) further 
grants the Secretary considerable discretion when an ultra-deep well is 
not an original well or if there has been

[[Page 28397]]

previous deep gas production on the lease. Section 344(a)(2) provides:

    (2) Suspension Volumes.--The Secretary may grant suspension 
volumes of not less than 35 billion cubic feet in any case in 
which--
    (A) The ultra deep well is a sidetrack; or
    (B) The lease has previously produced from wells with a 
perforated interval the top of which is at least 15,000 feet true 
vertical depth below the datum at mean sea level. (Emphasis added.)

Therefore, section 344 requires that an ultra-deep well drilled on a 
lease receive an RSV of at least 35 BCF except for (1) an ultra-deep 
well that is a sidetrack, or (2) an ultra-deep well on a lease that has 
previously produced from a well with a perforated interval the top of 
which is at least 15,000 feet TVD SS. The combined effect of these 
provisions is that only the first ultra-deep original well on a lease 
with no prior production from a deep well is entitled to the 35 BCF 
RSV. Thus, while Congress directed generally that the first ultra-deep 
well on a lease drilled after the date of the proposed rule receive 35 
BCF or more of RSV, Congress' use of the term ``may'' in section 
344(a)(2) gives the Secretary discretion to decide whether any 
sidetracks completed to depths below 20,000 feet TVD SS or the first 
ultra-deep well completed after production from any deep well 
(including a second ultra-deep well on a lease) should be granted an 
additional 35 BCF or more of royalty relief. One objective of this 
proposed rulemaking is to determine whether MMS should grant RSVs of 
not less than 35 BCF for ultra-deep sidetracks and subsequent ultra-
deep wells. Because of the statutory language, MMS cannot use section 
344's authority to grant an RSV of between 0 and 35 BCF.
    Since the royalty relief is available only upon the ``production of 
natural gas from ultra-deep wells on leases,'' Congress intended to 
supplement the existing rules that were promulgated with the objective 
of reducing the cost of producing domestic natural gas from deep 
formations in the shallow waters of the GOM. MMS intends to adopt an 
approach that is consistent with the statute. In general, with only 
limited exceptions, MMS is proposing to give no more relief than 
section 344 compels. Therefore, MMS seeks comments on its proposal to 
grant royalty relief only for the first ultra-deep well.
    Subject to the receipt and analysis of requested comments regarding 
those discretionary provisions, for any lease that has never produced 
from any deep well, MMS is proposing to grant 35 BCF of RSV for the 
first producing ultra-deep original well or sidetrack with a sidetrack 
measured depth (i.e., length) of at least 20,000 feet drilled after the 
date of this proposed rule. (One exception is discussed below.) MMS is 
not proposing to grant an RSV for subsequent ultra-deep wells or 
shorter sidetracks on a lease.
    Because section 344 is not retroactive, it does not provide for 
additional royalty relief for ultra-deep wells drilled before the 
publication date of this proposed rule. However, an ultra-deep well 
drilled before the publication date of this proposed rule would, if it 
met the other requirements of the existing rule, earn the same royalty 
relief as a deep well with a perforated interval the top of which is 
18,000 feet TVD SS or deeper. Thus, MMS is proposing to treat ultra-
deep wells drilled before the publication date of this proposed rule in 
the same manner as any other deep well in the 18,000-feet-or-deeper 
depth range.
    MMS is not proposing to grant an RSV of 35 BCF under section 344 
for an ultra-deep well that is a sidetrack that has a measured depth of 
less than 20,000 feet. Treatment of such a well for purposes of royalty 
relief under this proposed rule, as explained further below, depends on 
when the well begins producing.
    For purposes of clarity, MMS proposes to revise the definitions in 
the existing rule to segregate a ``deep well'' (a well with a 
perforated interval the top of which is at least 15,000 feet and less 
than 20,000 feet TVD SS) from an ``ultra-deep well'' (a well with a 
perforated interval the top of which is at or below 20,000 feet TVD SS) 
for all purposes. This is also consistent with section 344(a)(3)(A)'s 
definition of ``ultra-deep well.'' Trying to use the term ``deep well'' 
to include an ultra-deep well in some contexts but not in others 
carries a high potential for confusion. The changes in definitions 
necessitate revisions to several provisions of the existing rule to 
accommodate the change in terminology. These changes do not change the 
substance of the existing rule with regard to deep wells or ultra-deep 
wells drilled before the publication date of this proposed rule.
    Section 344(a) provides no time limit on the relief it grants for 
ultra-deep wells (a ``sunset'' provision). MMS therefore is not 
proposing one in this rulemaking.
    The sunset provision in the existing deep gas rule is contained in 
the definition of ``qualifying well'' in the current Sec.  203.0, which 
limits qualifying deep wells to those that produce gas before May 3, 
2009. That date is 5 years after the effective date of the final rule 
currently in force and 6 years (plus a few weeks) after the publication 
date of the original proposed deep gas rule (March 26, 2003). Because 
section 344(b) requires that MMS use the same methodology in 
calculating RSVs for deep wells in 200-400 meters of water that is used 
to calculate RSVs for deep wells in shallower water, MMS is proposing a 
sunset provision for deep wells in 200-400 meters of water of May 3, 
2013, which is exactly 4 years after the sunset date for relief for gas 
produced from deep wells in 200 meters of water or less, and about 6 
years from the publication date of this proposed rule.
    Section 344(c) provides that ``[t]he Secretary may place 
limitations on the royalty relief granted under this section based on 
market price.'' Therefore, as explained more fully below, MMS is 
proposing price thresholds that, if exceeded, would require the lessee 
to pay royalty on production that otherwise would be royalty-free. The 
concept underlying the price threshold terms proposed here is that to 
the extent ultra-deep gas and deep gas royalty relief granted under the 
proposed provisions would have been granted under the existing rule for 
existing leases, the existing rule's price threshold ($9.88 per MMBtu, 
adjusted annually for inflation after 2006) would apply. For all deep 
gas and ultra-deep gas royalty relief that results from section 344's 
new provisions, and for deep gas royalty relief for leases issued after 
the effective date of the final rule that are located partly or 
entirely in less than 200 meters of water, a different price threshold 
of $4.47 per MMBtu, adjusted annually for inflation after 2006, would 
apply. MMS is requesting comment, data, information, and other input on 
this proposed threshold or why a threshold other than $4.47 per MMBtu 
might be more appropriate for section 344 royalty relief.
    Section 344(c) also provides that ``The royalty relief granted 
under this section shall not apply to a lease for which deep water 
royalty relief is available.'' The proposed rule reflects this 
limitation.
    The existing regulations at Sec.  203.44 provide royalty relief in 
the form of a royalty suspension supplement (RSS) of up to 5 BCF for 
certain unsuccessful wells drilled to a depth below 18,000 feet TVD SS. 
MMS is not proposing any additional relief for unsuccessful wells 
simply because an unsuccessful well or sidetrack was drilled to a depth 
below 20,000 feet TVD SS. Unsuccessful wells drilled to a depth below 
20,000 feet TVD SS would continue to be treated the same as 
unsuccessful wells drilled

[[Page 28398]]

to a depth between 18,000-20,000 feet TVD SS.
    The fact that section 344 is not retroactive also means that the 
extension of deep gas royalty relief to leases in the 200-400 meter 
water depth range does not apply to deep or ultra-deep wells drilled on 
such leases before the publication date of this proposed rule.

B. Section-by-Section Analysis

    The discussion in part A of this preamble summarized the principal 
concepts of this proposed rule. This section-by-section analysis will 
describe the more significant proposed changes in additional detail.

What definitions apply to this part? (Sec.  203.0)

    MMS proposes changes to some definitions in the existing rule and 
some new definitions to implement section 344's requirements.
    MMS proposes to revise the definition of ``deep well'' to mean a 
well with a perforated interval the top of which is at least 15,000 
feet and less than 20,000 feet TVD SS, and to add a definition of 
``ultra-deep well'' to mean a well with a perforated interval the top 
of which is 20,000 feet TVD SS or deeper. Under the existing rule, the 
term ``deep well'' includes all wells deeper than 15,000 feet TVD SS.
    Because section 344 adds a new water depth category (leases located 
in more than 200 meters and less than 400 meters of water) to deep gas 
royalty relief, the coverage of these definitions extends beyond the 
existing rule, which applies only to leases in 200 meters of water or 
less.
    Further, the existing rule does not cover all leases located in 
water entirely or partly less than 200 meters deep. At the end of 
October 2006, about 70 leases in that water depth range are subject to 
deep gas RSV's, conditions, and requirements specified in the lease 
instruments because their lessees did not opt to convert to the deep 
gas royalty relief terms in the existing regulations. To accommodate 
section 344 requirements for these leases, MMS proposes to add a 
definition of ``non-converted lease'' in Sec.  203.0. This category of 
leases must be separated from leases in the 0-200 meter water depth 
category that are covered by the existing rule because their deep gas 
wells have different timing and reservoir conditions for qualification, 
earn different RSV's, and are subject to different price thresholds.
    In addition to distinguishing between deep wells and ultra-deep 
wells, MMS further proposes to add definitions for the terms ``phase 1 
ultra-deep well,'' ``phase 2 ultra-deep well,'' and ``phase 3 ultra-
deep well.'' The proposed royalty relief treatment of ultra-deep wells 
depends first on whether an ultra-deep well was drilled before or after 
the date of publication of this proposed rule. Wells drilled before the 
date of publication of the proposed rule are phase 1 ultra-deep wells.
    A phase 1 ultra-deep well would be an ultra-deep well on a lease 
that is located in water entirely or partly less than 200 meters deep 
for which drilling began before the date of publication of this 
proposed rule. In other words, these are wells that would continue to 
be treated the same as they are under the provisions of the existing 
rule for deep wells of more than 18,000 feet TVD SS. Phase 1 ultra-deep 
wells would not be eligible for the higher RSVs prescribed in section 
344.
    A phase 2 ultra-deep well would be an ultra-deep well for which 
drilling began on or after the publication date of this proposed rule 
and that falls into one of the three following categories: (1) The 
ultra-deep well begins gas production before May 3, 2009, on a lease 
that is located in water partly or entirely less than 200 meters deep 
that is not a non-converted lease; (2) the ultra-deep well begins gas 
production within the primary term of a non-converted lease; or (3) the 
ultra-deep well begins production before May 3, 2013, on a lease that 
is located in water entirely more than 200 meters and entirely less 
than 400 meters deep.
    A phase 3 ultra-deep well would be an ultra-deep well for which 
drilling began on or after the publication date of this proposed rule 
and that begins gas production on or after the dates prescribed for 
production from a phase 2 ultra-deep well. Only phase 2 ultra-deep 
wells and phase 3 ultra-deep wells would be eligible to earn the higher 
35 BCF RSV prescribed in section 344.
    Because MMS also proposes to differentiate the treatment of ultra-
deep wells that are sidetracks with a sidetrack measured depth of 
20,000 feet or more from sidetracks with a sidetrack measured depth of 
less than 20,000 feet, MMS also proposes to add a definition of 
``ultra-deep short sidetrack'' to mean ultra-deep wells that are 
sidetracks with a sidetrack measured depth of less than 20,000 feet.
    The reasons for distinguishing between phase 2 and phase 3 ultra-
deep wells relate to both the proposed royalty relief treatment of 
ultra-deep short sidetracks and the proposed price threshold 
provisions. Both of these matters are addressed in detail below.
    Under the existing rule, the term ``qualified well'' means a deep 
well for which drilling begins on or after March 26, 2003, the date the 
original deep gas proposed rule was published, and which meets other 
applicable requirements. Qualified wells are wells to whose gas 
production an RSV may be applied. The fact that a well is a qualified 
well does not mean that it earns an RSV. A well must be a qualified 
well to earn an RSV, but it also must meet other requirements. Wells 
that earn an RSV are a subset of qualified wells. But RSVs also are 
applied to gas production from qualified wells that do not themselves 
earn an RSV. MMS proposes to amend the definition of ``qualified well'' 
and add definitions for ``qualified deep well'' and ``qualified ultra-
deep well,'' to address all four categories of deep gas royalty relief 
that exist after enactment of section 344--namely, deep gas wells on 
leases located in less than 200 meters of water that are covered by the 
existing rule, deep gas wells on non-converted leases (all of which are 
in less than 200 meters of water), deep gas wells on leases located in 
200-400 meters of water, and ultra-deep gas wells on leases in all 
water depths less than 400 meters.
    MMS also proposes to revise the definition of ``certified 
unsuccessful well'' in Sec.  203.0, used in the royalty suspension 
supplement provisions in re-designated Sec. Sec.  203.45 and 203.46 
(Sec. Sec.  203.44 and 203.45 in the existing rule), to add the new 
200-400 meter water depth category.
    In the definition of ``expansion project,'' MMS proposes to specify 
that reservoirs to whose production an RSV would be applied under 
Sec. Sec.  203.30 through 203.36 and 203.40 through 203.48 cannot be 
included as part of an expansion project.
    MMS also proposes amendments to certain of the part 203 provisions 
to include leases offshore of Alaska under section 346 of the Energy 
Policy Act. These amendments would involve modifying the definitions of 
``development project'' and ``expansion project'' and the royalty 
relief provisions for development projects and expansion projects in 
Sec.  203.2. In addition, references to a lease location or water depth 
in Sec. Sec.  203.60, 203.69, and 203.78, mention of a specific MMS 
Regional office in Sec. Sec.  203.62, 203.70, 203.77, 203.81, and 
203.90, and the associated price threshold provisions in Sec.  203.78 
would be revised to accommodate leases offshore of Alaska.

[[Page 28399]]

Royalty Relief for Drilling Ultra-Deep Gas Wells on Leases Not Subject 
to Deep Water Royalty Relief (Sec. Sec.  203.30 through 203.36)

    For the most part, the new proposed ultra-deep gas provisions in 
Sec. Sec.  203.30 through 203.36 follow the structure of the existing 
deep gas rule at Sec. Sec.  203.40 through 203.48, and many of the 
provisions are similar. MMS is also proposing changes in Sec. Sec.  
203.40 through 203.48 to accommodate the new ultra-deep gas provisions 
in Sec. Sec.  203.30 through 203.36.

Which leases are eligible for royalty relief as a result of drilling an 
ultra-deep well? (Sec.  203.30)

    Proposed Sec.  203.30 prescribes the basic criteria for a lease to 
be eligible for deep gas royalty relief. Paragraph (a) of this proposed 
section follows the statutory requirement in section 344(a) and (b) 
that the lease must be located in the GOM wholly west of 87 degrees, 30 
minutes West longitude.
    Paragraph (c) of this proposed section implements the requirement 
of section 344(c) that deep gas royalty relief shall not apply to a 
lease for which deep water royalty relief is available. (In this 
context, ``available'' means either provided for in the lease terms or 
granted in response to an application.) This issue arises because 
section 344(b) requires the Secretary to extend deep gas royalty relief 
to leases located in more than 200 but less than 400 meters of water. 
Deep water royalty relief applied to leases in that water depth range 
under the Outer Continental Shelf Deep Water Royalty Relief Act of 
1995, Pub. L. No. 104-58, Title III, 109 Stat. 563 (DWRRA). Thus, to be 
eligible for deep gas royalty relief, a lease located in more than 200 
but less than 400 meters of water had to have been issued either before 
November 28, 1995 (the date of enactment of the DWRRA), or after 
November 28, 2000. Leases issued between those dates (i.e., in the 
first 5 years after the DWRRA's enactment) were issued under the 
mandatory deep water royalty relief provisions of DWRRA section 304. 
All the leases issued under section 304 provide for deep water royalty 
relief and therefore are not eligible for deep gas royalty relief.
    A lease issued before November 28, 1995, would not be eligible for 
deep gas royalty relief if MMS had granted deep water royalty relief 
under section 302 of the DWRRA (adding 43 U.S.C. 1337(a)(3)(C)).
    A lease issued after November 28, 2000, would not be eligible for 
deep gas royalty relief if MMS had granted deep water royalty relief 
under 30 CFR 203.60 through 203.79. The royalty suspension (RS) 
provisions in 30 CFR 260.120 through 260.124 that apply to post-
November 2000 leases do not themselves grant deep water royalty relief 
and refer back to the specific lease terms. There are no RS leases in 
the 200-400 meter water depth interval--in other words, there is no 
lease issued in a lease sale held after November 28, 2000, in the 200-
400 meter water depth interval that provides for any royalty relief in 
the lease terms. Therefore, the only leases issued in lease sales held 
after November 28, 2000, that are excluded from deep gas royalty relief 
are those that have applied for and been granted deep water relief 
under Sec. Sec.  203.60 through 203.79.
    Paragraph (b) of this proposed section reflects MMS' general 
proposal, under section 344(a)(2)(B), not to grant deep gas royalty 
relief if the lease has previously produced gas or oil from a deep well 
or an ultra-deep well. Proposed section 203.31(b) contains an 
exception.

If I have a qualified phase 2 or phase 3 ultra-deep well, what royalty 
relief would my lease earn? (Sec.  203.31)

    In proposed Sec.  230.31(a), the text preceding the table and the 
table reflect the interpretation of the statute described above that 
the first qualifying original phase 2 or phase 3 ultra-deep well on a 
lease that meets the requirements of proposed Sec.  203.30 would earn 
an RSV of 35 BCF.
    The table in Sec.  230.31(a) shows that if a sidetrack drilled 
after the publication date of this proposed rule is completed to a 
depth below 20,000 feet TVD SS and has a length (measured depth) of at 
least 20,000 feet, i.e., a length equivalent to that of an original 
ultra-deep well, the sidetrack would earn an RSV of 35 BCF if there has 
been no gas production from a deep well or an ultra-deep well on the 
lease. As a practical matter, MMS believes that the only sidetracks 
that are likely to have a sidetrack measured depth of 20,000 feet or 
more are sidetracks drilled from a platform slot reclaimed from a 
previously drilled well. (See the inclusion in the definition of 
``sidetrack'' in section 344(a)(3)(B)(ii)(I).) These wells are new 
wells and are the functional equivalent of original wells. (MMS does 
not believe that a 20,000-foot-long sidetrack drilled to a new 
objective bottom-hole location by leaving a previously drilled well--
see section 344(a)(3)(B)(i)--is a practical likelihood.)
    As stated above, in light of the fact that section 344 requires MMS 
to grant either a 35 BCF RSV or 0 BCF RSV, MMS does not believe it is 
appropriate or consistent with statutory objectives or congressional 
intent to grant a 35 BCF RSV for a relatively short sidetrack simply 
because it was completed at a depth below 20,000 feet TVD SS. (An 
example would be a 6,000-foot-long sidetrack that left the main 
wellbore at 14,700 feet and was completed at 20,100 feet TVD SS.) It 
would appear that under such a circumstance, granting a 35 BCF RSV 
would be disproportionate to the costs and risks of drilling the 
sidetrack and to the degree of relief that would encourage ultra-deep 
production.
    At the same time, in view of the general congressional policy 
underlying section 344, it is difficult to believe that Congress 
intended to compel MMS to grant either a disproportionate RSV or no RSV 
at all for a sidetrack drilled to an ultra-deep depth from an existing 
wellbore (if there has been no production from any deep or ultra-deep 
well) simply because the sidetrack was completed to a depth below 
20,000 feet TVD SS, even though the statutory phraseology could be read 
to permit no other result. Therefore, MMS proposes to treat sidetracks 
of lengths less than an original ultra-deep well but completed to 
ultra-deep depths (i.e., ultra-deep short sidetracks) in the same 
manner as they are treated under the existing rule, to more fully 
effectuate what appears to be the overall intent of Congress. Under the 
proposed Sec.  203.31(a), such a sidetrack would earn an RSV of 4 BCF 
plus 600 MCF times the sidetrack measured depth. Likewise, the same 
sunset dates would apply to these sidetracks that apply to sidetracks 
under the existing rule (and as the existing rule is proposed to be 
amended to add leases in the 200-400 meter water depth range under 
section 344(b)). In other words, the ultra-deep short sidetrack would 
have to be a phase 2 ultra-deep well. If an ultra-deep short sidetrack 
would not have earned an RSV under the existing rule (as it is proposed 
to be amended to add leases in the 200-400 meter water depth range), 
MMS proposes to grant no RSV to it here.
    MMS specifically requests comments regarding the adequacy of its 
authority to prescribe this RSV. If MMS concludes that the proposed 
provision is not supported by adequate statutory authority, MMS' 
alternative proposal would be to grant no RSV to an ultra-deep short 
sidetrack, and not to grant an RSV of 35 BCF.
    Proposed Sec.  203.31(b) contains an exception from the requirement 
that the lease not have produced previously from any deep well or 
ultra-deep well. Some background explanation is necessary to explain 
the reasons for the

[[Page 28400]]

proposed exception. Under the existing rule, in cases where a deep well 
completed at a depth between 15,000 feet and 18,000 feet TVD SS has 
produced and earned an RSV of 15 BCF, a subsequent well completed at a 
depth greater than 18,000 feet TVD SS may earn an additional RSV of 10 
BCF. But under the proposed rule, if the subsequent well is an ultra-
deep well (completed at a depth greater than 20,000 feet TVD SS), it 
would earn no additional RSV. Thus, if a lessee has produced from a 
deep well that earned an RSV of 15 BCF and then drills an ultra-deep 
well, the lease would get less royalty relief than under the existing 
rule and less royalty relief than if the lessee had drilled a deep well 
to a depth between 18,000 and 20,000 feet TVD SS. Section 344, however, 
allows that result. (MMS anticipates that the number of cases in which 
this scenario might occur before deep gas royalty relief under the 
existing rule expires in May 2009 would be very small.)
    Similarly, consistent with the proposed policy explained above, MMS 
proposes to grant no RSV for a sidetrack completed at a depth of 20,000 
feet or more if there has been production from any deep well, 
regardless of the length of the sidetrack. This proposal would result 
in the possibility of a similar scenario arising in which a lessee 
drills a sidetrack to an ultra-deep depth after the lease has earned an 
RSV of 15 BCF from a well completed at a depth between 15,000 feet and 
18,000 feet TVD SS. Under the proposed rule, the sidetrack would earn 
no additional RSV, while under the existing rule it would earn an RSV 
of 4 BCF plus 600 MCF times the sidetrack measured depth, up to a 
maximum of an additional 10 BCF. Under such a scenario, the lease would 
receive less royalty relief than under the existing rule and less than 
if the lessee had completed the sidetrack at a depth between 18,000 
feet and 20,000 feet TVD SS.
    The exception proposed in Sec.  203.31(b) arises because all leases 
issued in water depths of 200 meters or less during 2004 and 2005, that 
is in lease sales 190, 192, 194, and 196, specifically cite the 
existing deep gas rule in the lease terms--unlike leases issued before 
2004 or after 2005. Although deep gas royalty relief under the existing 
rule was effective for wells drilled after publication of the proposed 
rule (March 26, 2003), that relief did not become effective until the 
final rule. The final rule initially had an effective date of March 1, 
2004, but an administrative oversight led to the effective date of the 
final rule being delayed until May 3, 2004. The lease sales held in 
2004 were all after the initial effective date, and the terms of the 
leases issued in those sales referred to royalty relief terms in the 
existing rule. While MMS does not believe that a reference to the 
citation of the existing rule makes the terms of the rule as they 
existed on that date a fixed property right, MMS also doubts that 
Congress would have intended to reduce potential royalty relief that 
existing leases already had under the rules on the date of enactment of 
the Energy Policy Act if the lease instrument itself referred to the 
rule.
    Leases issued before 2004, which preceded the effective date of the 
existing rule, do not refer to the rule in their terms. For these 
leases, the existing rule, including the opportunity for a deep well to 
earn relief after the lease already has production from a deep well, 
was a benefit that MMS granted on its own initiative after the lease 
was already in force. MMS may change, or even entirely eliminate, that 
benefit prospectively through a subsequent rulemaking should it choose 
to do so. In this rulemaking, MMS proposes to do just that--eliminate 
the additional relief these pre-2004 leases could have earned for 
drilling a well deeper than 20,000 feet TVS SS after producing from a 
well completed between 15,000 and 18,000 feet TVD SS.
    However, to avoid potential future conflict regarding the terms of 
leases issued in the four Gulf of Mexico sales held in 2004 and 2005, 
i.e., Sales 190, 192, 194, and 196, MMS proposes to allow the 
additional relief associated with drilling an ultra-deep well after 
producing from a well completed between 15,000 and 18,000 feet TVD SS 
provided for in the existing rule for these leases. MMS specifically 
requests comments on this proposed exception.
    MMS further notes that the issue discussed in the preceding 
paragraph does not arise in the context of leases issued between 
January 1, 2001 and January 1, 2004, that contain deep gas royalty 
relief in their lease terms and for which the lessee exercised the 
option in Sec.  203.48, re-designated Sec.  203.49 in this proposed 
rule, to convert to the rule. The lessees filed a form with an election 
to go under the rule. The intent was to treat these leases identically 
to pre-2001 leases. Nor does the issue discussed above arise in the 
context of leases issued after January 1, 2001, that are located partly 
in water less than 200 meters deep (and, therefore, partly in water 
more than 200 meters deep) that are covered by the existing rule 
because no deep water royalty relief terms in statutes or lease terms 
apply (see the existing Sec.  203.40(a)(2) and (3)). These leases also 
are in a situation that is functionally identical to pre-2001 leases, 
and for which there is no question that MMS may change the rule 
prospectively. Therefore, MMS does not propose to include leases in 
these two categories within the exception proposed in Sec.  203.31(b).
    Proposed Sec.  203.31(c) specifies that all gas production from 
qualified wells (i.e., qualified deep and qualified ultra-deep wells) 
on the lease, including gas production that is not subject to royalty, 
counts toward the RSV earned by a qualified deep well or qualified 
ultra-deep well on the lease, in the manner required under proposed 
Sec. Sec.  203.32 and 203.36. For example, assume that the lessee 
drills and produces from a qualified 22,000-foot phase 2 ultra-deep 
well that earns an RSV of 35 BCF. Further assume that the lessee then 
drills and produces from two qualified deep wells (completed at 16,500 
feet TVD SS and 17,200 feet TVD SS, respectively), neither of which 
earns an RSV. In this circumstance, the 35 BCF RSV earned by the first 
well applies to the earliest production from all 3 wells until the 35 
BCF of RSV is used.
    Proposed Sec.  203.31(d) would provide that lessees may recoup any 
royalties paid on production from a qualified phase 2 or phase 3 ultra-
deep well that occurs before 30 days after the date of publication of 
the final rule. This provision is necessary because of the provisions 
in subsections (a) and (b) of section 344 that ``[r]egulations issued 
under this subsection shall be retroactive to the date that the notice 
of proposed rulemaking is published in the Federal Register.'' Those 
provisions make royalty relief applicable to gas produced after the 
date of the proposed rule and before the final rule. A lessee may begin 
producing gas from a qualified phase 2 or phase 3 ultra-deep well after 
the date of this proposed rule, but would not be able to claim royalty 
relief under this proposed rule for any of that production unless and 
until a final rule is promulgated and becomes effective. (However, 
royalty relief may be available under existing regulations.) The lessee 
therefore might have to pay royalty on production occurring before a 
final rule becomes effective. Because the royalty relief provided for 
under section 344 would then be retroactive to the proposed rule's 
publication date, the lessee would have to recoup or seek a refund of 
the royalties paid in the meantime. Proposed paragraph (d) would 
clarify that the lessee could do so.
    Proposed Sec.  203.31(e) includes several examples of how the 
proposed provisions would work in various circumstances. Example 1 
illustrates a

[[Page 28401]]

situation in which a lessee drills and produces from a qualified ultra-
deep well after the date of this proposed rule (in this example, a 
phase 2 ultra-deep well), and earns a 35 BCF RSV. The lessee then 
drills a second qualified ultra-deep well on the lease. Under the 
proposed rule, the second ultra-deep well would not earn any additional 
RSV. (The 35 BCF RSV would be applied to gas production from both 
wells.)
    MMS bases this proposal on section 344(a)(2), which expressly 
grants the Secretary discretion whether to provide royalty relief for 
ultra-deep wells if the lease has previously produced from a well with 
a perforated interval the top of which is at least 15,000 feet TVD SS 
(i.e., any deep well under the existing rule). As discussed previously, 
section 344 does not command the Secretary to grant 35 BCF of royalty 
relief for each and every ultra-deep well drilled and produced on a 
lease simply because a well is an ultra-deep well. To accomplish the 
statutory objective of encouraging exploration for and production from 
ultra-deep wells, and at the same time to avoid excessive reductions in 
royalty payments that would not further that objective, MMS proposes to 
limit the 35 BCF in royalty relief to the first producing ultra-deep 
well on the lease that was drilled after the publication date of the 
proposed rule, with the condition that there has been no production 
from any other deep wells or ultra-deep wells on the lease.
    The same rationale would apply to situations where more than one 
ultra-deep well is drilled after the date of this proposed rule. MMS 
proposes that the first ultra-deep well drilled after the publication 
date of this proposed rule that produces from a lease that has not 
previously produced from a deep well or an ultra-deep well would earn a 
35 BCF RSV, but subsequent ultra-deep wells on the same lease would not 
earn additional RSVs. MMS believes that this is clearly within the 
discretion granted to the Secretary in section 344(a)(2), which permits 
the Secretary to disallow royalty relief if there has been prior 
production from any deep well.
    Example 2 illustrates a situation in which a lessee has produced 
gas from an ultra-deep well drilled on the lease before the effective 
date of the ultra-deep provisions as specified in section 344(a), i.e., 
the date of publication of this proposed rule. Under the proposed 
definitions, this would be a phase 1 ultra-deep well. In Example 2, the 
ultra-deep well was drilled before the publication date of this 
proposed rule but after March 26, 2003. In this circumstance, any 
ultra-deep well drilled after the publication date of this proposed 
rule (the second ultra-deep well on the lease) would not earn an RSV. 
However, in Example 2 the ultra-deep well drilled after March 26, 2003, 
is also a qualified deep well under the existing rule and may qualify 
for an RSV of 25 BCF under its provisions. If the first ultra-deep well 
had earned 25 BCF under the current rule, the lease would keep that 
relief. However, drilling an additional ultra-deep well after the 
publication of this proposed rule would not earn the lease any 
additional royalty relief.
    Example 3 illustrates a situation in which a deep well was drilled 
and produced before the existing deep gas rule became effective. The 
deep well therefore did not earn an RSV for the lease. The lessee then 
drilled a phase 2 ultra-deep well after the publication date of the 
proposed rule. Under the proposed rule, the ultra-deep well would not 
earn an RSV.
    In Example 4, a lessee drills and produces gas from a qualified 
phase 2 ultra-deep well and earns an RSV of 35 BCF on a lease located 
in water 300 meters deep. Subsequently, the lessee drills a deep well 
that is not an ultra-deep well. Under the existing regulations at Sec.  
203.41(e), the later well would not earn any RSV because the lease has 
already produced from a deep well with a perforated interval the top of 
which is 18,000 feet TVD SS or deeper. However, any remaining RSV 
earned by the ultra-deep well would be applied to production from the 
new deep well, as well as production from the ultra-deep well that 
earned the RSV, because the new deep well is also a qualified well 
under the hypothetical facts stated. In contrast, if the new deep well 
hypothesized in this example (for which drilling begins in 2010) begins 
production on or after May 3, 2013 (or if the new deep well were on a 
lease located in water less than 200 meters deep), the new deep well 
would not be a qualified well. In that event, the lessee would have to 
pay royalty on all production from that well notwithstanding the RSV 
earned by the phase 2 ultra-deep well.
    In Example 5, a lessee drills and produces from a qualified deep 
well completed at a depth between 15,000 and 18,000 feet TVD SS that 
earns an RSV of 15 BCF for the lease under the existing Sec.  203.41. 
The lessee then later drills and produces from a qualified phase 2 or 
phase 3 ultra-deep well (depending on the water depth of the lease) on 
the same lease. The ultra-deep well would earn no additional RSV under 
the proposed rule, but the 15 BCF RSV earned by the deep well would be 
applied to production from both the deep well and the ultra-deep well. 
Example 7 illustrates an exception to this case.
    Example 6 illustrates the proposed difference in consequences 
between drilling sidetracks of different lengths to ultra-deep depths. 
Section 344(a)(2) provides discretion whether to grant royalty relief 
if the ultra-deep well is a sidetrack. To be consistent with the 
statutory objectives, and to avoid granting excessive amounts of 
royalty relief for sidetracks that are shorter than the length 
necessary for an original well from the surface to earn royalty relief 
as an ultra-deep well, MMS proposes to grant a 35 BCF RSV if the 
sidetrack measured depth (i.e., the length of the sidetrack) is at 
least 20,000 feet and the sidetrack has a perforated interval the top 
of which is at least 20,000 feet TVD SS (and otherwise is a qualified 
phase 2 or phase 3 ultra-deep well). However, MMS would not grant 
additional royalty relief under the section 344 ultra-deep provisions 
if the sidetrack measured depth is less than 20,000 feet. A sidetrack 
of less than 20,000 feet measured depth may qualify for a lesser RSV 
that is equivalent to the relief granted under the deep well provisions 
if it is a phase 2 ultra-deep well, i.e, one that begins production 
before the applicable sunset date for royalty relief for deep wells.
    Example 7 illustrates the exception proposed in Sec.  203.31(b). In 
this example, the lease was issued after the initial effective date of 
the existing rule and before the enactment of the Energy Policy Act, 
and its terms specifically referred to the existing rule. In this 
example, the lessee completed a deep well in the 15,000-18,000 feet TVD 
SS water depth range that earned a 15 BCF RSV before enactment of the 
Energy Policy Act. The lessee then drilled and completed a phase 2 
ultra-deep well. Under the proposed Sec.  203.31(b) exception, the 
ultra-deep well would earn an additional 10 BCF RSV.

What other requirements or restrictions apply to royalty relief for a 
qualified phase 2 or phase 3 ultra-deep well? (Sec.  203.32)

    This section addresses various further requirements and some 
restrictions that would apply to RSVs earned by ultra-deep wells. These 
are self-explanatory.

To which production do I apply the RSV earned by qualified phase 2 and 
phase 3 ultra-deep wells on my lease? (Sec.  203.33)

    Proposed Sec.  203.33(a), which applies to leases that are not 
within an MMS-approved unit, has a structure similar to

[[Page 28402]]

the existing deep well provision at Sec.  203.42(a), re-designated 
Sec.  203.43(a) in this proposed rule. This paragraph specifies that an 
RSV earned by a qualified phase 2 or phase 3 ultra-deep well applies to 
all gas produced from all qualified wells (i.e., all qualified deep and 
qualified ultra-deep wells) on the lease. Proposed Sec.  203.32(f) also 
reflects this principle.
    Proposed Sec.  203.33(b), which applies to leases within a unit, 
follows the same structure for ultra-deep wells that the existing Sec.  
203.42(b), re-designated Sec.  203.43(b) in this proposed rule, has for 
deep wells. An RSV earned by a qualified phase 2 or phase 3 ultra-deep 
well would be applied to production from all qualified wells on non-
unitized areas of the lease on which the ultra-deep well is located and 
to production allocated to the lease, under the approved unit 
agreement, from qualified wells on unitized areas of the lease and on 
other leases in the unit. The allocation of production from qualified 
wells on other leases in the unit would not increase the RSV for your 
lease.
    Proposed paragraph (c) of this section is similar to Sec.  
203.42(e) of the existing rule, re-designated Sec.  203.43(c) in this 
proposed rule and specifies that the lessee would have to pay royalties 
on all production when the cumulative production from all qualified 
wells on the lease reaches the applicable RSV.

To which production may an RSV earned by qualified phase 2 and phase 3 
ultra-deep wells on my lease not be applied? (Sec.  203.34)

    This proposed provision is analogous to the existing Sec.  
203.42(d) for deep wells, re-designated Sec.  203.43(d) in this 
proposed rule, with changes to reflect section 344's addition of leases 
in the 200-400 meter water depth range.

What administrative steps must I take to use the RSV earned by a 
qualified phase 2 or phase 3 ultra-deep well? (Sec.  203.35)

    This proposed section is analogous, with one exception, to the 
existing Sec.  203.43 that applies to deep wells, re-designated Sec.  
203.44 in this proposed rule. That exception deals with the temporary 
extension of the deadline by which production must start to qualify a 
well for relief. There is no deadline by which production must start 
for most ultra-deep wells to qualify for relief, so no such extension 
is needed. The analogous temporary extension is provided for ultra-deep 
short sidetracks which do face a deadline.

Do I keep royalty relief if prices rise significantly? (Sec.  203.36)

    As explained above, the concept underlying the proposed price 
threshold terms is that to the extent ultra-deep gas and deep gas 
royalty relief granted under the proposed provisions would have been 
granted under the existing rule for existing leases (as of the date the 
final rule becomes effective), the existing rule's price threshold 
($9.88 per MMBtu, adjusted annually for inflation after calendar year 
2006) would apply. The value $9.88 per MMBtu in 2006 dollars is 
equivalent to the value $9.34 per MMBtu in 2004 dollars as stated in 
the existing rule. The inflation adjustment is described in the 
existing Sec.  203.47 (redesignated Sec.  203.48 in this proposed 
rule). The MMS webpage at https://www.mms.gov/econ/DWRRAPrice1.htm shows 
results from applying that adjustment. Excepted where noted, all price 
threshold values discussed in this proposed rule are stated in 2006 
dollars. Hence, those values are adjusted for inflation after 2006.
    For all deep gas and ultra-deep gas royalty relief that results 
from section 344's new provisions, and for deep gas and ultra-deep gas 
royalty relief for leases issued after the effective date of the final 
rule, a different price threshold of $4.47 per MMBtu, adjusted annually 
for inflation after calendar year 2006, would apply. Lessees would have 
to pay royalty on all gas production to which an RSV otherwise would be 
applied under the proposed ultra-deep well provisions for any calendar 
year in which the average daily closing New York Mercantile Exchange 
(NYMEX) natural gas price exceeds $4.47 per MMBtu (adjusted for 
inflation after 2006).
    The RSVs specified for ultra-deep wells in proposed Sec.  203.31 
for existing leases (and any future leases issued before the effective 
date of the final rule) are a consequence of section 344, with three 
exceptions. The first exception is the first 25 BCF of RSV earned under 
proposed Sec.  203.31(a) by a phase 2 ultra-deep well on a lease 
located in water partly or entirely less than 200 meters deep (i.e., a 
well drilled after the publication of this proposed rule that begins 
production before May 3, 2009). Such a well would also earn a 25 BCF 
RSV under the existing rule, so this RSV would be subject to the same 
price threshold as in the existing rule--$9.88 per MMBtu, adjusted 
annually after calendar year 2006 for inflation.
    The second exception is an RSV of up to 10 BCF earned by a phase 2 
ultra-deep well under proposed Sec.  203.31(b)'s exception for leases 
issued after the initial effective date of the existing rule and before 
enactment of the Energy Policy Act that specifically refer to the 
existing rule in the lease terms. Such a well would earn the RSV 
specified in proposed Sec.  203.31(b) under the existing rule. 
Therefore, paragraph (a) of this proposed provision would apply the 
same price threshold as in the existing rule to this RSV of 10 BCF, 
i.e., $9.88 per MMBtu, adjusted annually after calendar year 2006 for 
inflation.
    The third exception is the first 20 BCF of the 35 BCF RSV earned by 
a phase 2 ultra-deep well on a non-converted lease that begins 
production before 5 years after the date the lease was issued. Parallel 
to the situation with the RSV under proposed Sec.  203.31(a), paragraph 
(b) of proposed Sec.  203.36 would apply the price threshold specified 
in the lease terms to this RSV. For non-converted leases issued in the 
central GOM lease sale in 2001 (Sale 178), that price threshold 
originally was $3.50 per MMBtu, adjusted annually after calendar year 
2000 for inflation. For non-converted leases issued in the western GOM 
sale in 2001 and the central and western GOM sales in 2002 and 2003 
(Sales 180, 182, 182, 185, and 187), that price threshold originally 
was $5.00 per MMBtu, adjusted annually after calendar year 2000 for 
inflation. Inflation between 2000 and 2006 raised these price 
thresholds to $4.00 and $5.72 per MMBtu, respectively, as of 2006. The 
proposed Sec.  203.36(a)(3) and (4) therefore express the price 
thresholds at those levels, and they would be adjusted annually after 
calendar year 2006 for inflation in the same manner as all the other 
price thresholds.
    Paragraph (a)(2) of this proposed section addresses the RSVs earned 
by ultra deep wells that result from section 344 or that are earned by 
wells on leases issued after the effective date of the final rule that 
are located party or entirely in less than 200 meters of water. These 
RSVs include (1) the last 10 BCF (in the case of a non-converted lease, 
the last 15 BCF) of the 35 BCF of RSV earned under Sec.  203.31(a) by a 
phase 2 ultra-deep well on a lease that is located in water partly or 
entirely less than 200 meters deep issued before the effective date of 
the final rule; (2) any RSV earned under Sec.  203.31(a) by a phase 2 
ultra-deep well on a lease that is located in water partly or entirely 
less than 200 meters deep issued after the effective date of the final 
rule; (3) any RSV earned under Sec.  203.31(a) by a phase 2 ultra-deep 
well on a lease that is located in water entirely more than 200 meters 
and entirely less than 400 meters deep; and

[[Page 28403]]

(4) any RSV earned under Sec.  203.31(a) by a phase 3 ultra-deep well.
    MMS proposes to apply a lower price threshold to the RSV that 
results from section 344 than the $9.88 per MMBtu (adjusted for 
inflation after 2006) level in the existing rule. Three factors drive 
this decision. First, the absence of a sunset date for ultra-deep well 
relief risks generating in perpetuity a fiscally expensive program that 
may prove unnecessary or ineffective. A lower price threshold will 
mitigate the likelihood of such an outcome when the program is least 
necessary, that is, when prices are higher than expected. Second, 
results to date show a weaker than expected lessee reaction to the deep 
drilling incentive in the existing rule. This experience demonstrates 
the prudence of imposing tighter fiscal controls on the statutorily 
mandated expansion of that program. Third, this price threshold would 
apply when the deep drilling incentive would likely be less important, 
e.g., when other sources of natural gas have become more available and 
when current long range forecasts indicate natural gas prices will have 
retreated significantly from current levels.
    MMS analyzed several different price thresholds taking into 
consideration predicted gas prices, volatility of gas prices, and 
expected economics for deep and ultra-deep wells covered by the Energy 
Policy Act. The economic analysis that accompanies this rulemaking 
provides estimates of the effects of each option on measures of social 
welfare such as consumer and producer surplus, production and royalty 
revenues.
    MMS has chosen to propose $4.47 per MMBtu, adjusted annually for 
inflation after calendar year 2006, for incentives covered by the 
Energy Policy Act for several reasons. First, it simplifies the gas 
price threshold structure across royalty relief programs, because $4.47 
per MMBtu (adjusted for inflation after 2006) is the same gas price 
threshold that applies to all leases covered by the DWRRA. That means 
both congressionally mandated royalty relief programs provide the same 
balance between the incentive to explore and produce in a frontier area 
and the fiscal risk of offering that categorical incentive. Second, 
this choice recognizes that gas produced from deepwater leases and gas 
produced from deep wells on leases in shallower waters sells in the 
same market. The RSV in each program is the policy variable tailored to 
the costs and risks specific to the different frontier areas that 
produce that product. Third, though recent gas market conditions led 
MMS to use price thresholds above $4.47 per MMBtu (adjusted for 
inflation after 2006), those higher price thresholds are used where 
bonus bids or sunset provisions provide added controls against 
incurring unnecessary fiscal costs. Finally, given the typical time 
frame between the decision to drill and the potential emergence of deep 
gas production, the ever-present risk exists that future events will 
prove the assumptions and forecasts used to justify the proposed 
additional RSV incentives inaccurate. This observation suggests the 
need for a conservative policy for selecting the appropriate deep gas 
price threshold level.
    Also, Sec.  203.36(a) includes a default price threshold of $4.47 
per MMBtu (adjusted for inflation after 2006) for ultra-deep wells on 
future leases should their lease terms fail to provide for a different 
price threshold.
    Proposed Sec.  203.36(c) sets out several examples that clarify how 
the price thresholds would work. Example 1 assumes that a lessee drills 
and begins producing from a qualified phase 2 ultra-deep well in 2008 
on a lease issued in 2004 in less than 200 meters of water. The ultra-
deep well earns the lease an RSV of 35 BCF. The well produces a total 
of 18 BCF by the end of 2009. In both 2008 and 2009, the average daily 
NYMEX closing natural gas price is less than $9.88 per MMBtu (adjusted 
for inflation after 2006). In 2010, the well produces another 13 BCF. 
In that year, the average daily closing NYMEX natural gas price is 
greater than $4.47 per MMBtu (adjusted for inflation after 2006), but 
less than $9.88 per MMBtu (adjusted for inflation after 2006). Under 
these circumstances, the first 7 BCF produced in 2010 will exhaust the 
first 25 BCF of the 35 BCF RSV that the well earned that is subject to 
the $9.88 per MMBtu (adjusted for inflation after 2006) threshold. The 
lessee must pay royalty on the remaining 6 BCF produced in 2010, which 
is subject to the $4.47 per MMBtu threshold (adjusted for inflation 
after 2006) that was exceeded.
    Example 2 addresses a situation in which a lessee in 2008 drills 
and produces from Well No.1, a qualified deep well, to a depth of 
15,500 feet TVD SS that earns a 15 BCF RSV for the lease under Sec.  
203.41, which would be subject to a price threshold of $9.88 per MMBtu 
(adjusted for inflation after 2006). Later in 2008, the lessee drills 
and produces from Well No. 2, a second qualified deep well to a depth 
of 17,000 feet TVD SS that earns no additional RSV. Then in 2013, the 
lessee drills and produces from Well No. 3, a qualified phase 3 ultra-
deep well that earns no additional RSV. Further assume that in 2013, 
the average daily closing NYMEX natural gas price exceeds the $4.47 per 
MMBtu (adjusted for inflation after 2006) but does not exceed $9.88 per 
MMBtu (adjusted for inflation after 2006). In 2013, any remaining RSV 
earned by Well No. 1 (which would have been applied to production from 
Well Nos. 1 and 2 in the intervening years), would be applied to 
production from all three qualified wells. Because the price threshold 
applicable to that RSV was not exceeded, the production from all three 
qualified wells would be royalty-free until the 15 BCF RSV earned by 
Well No. 1 is exhausted.
    Example 3 assumes the same initial facts regarding the 3 wells as 
in Example 2. Further assume that Well No. 1 stopped producing in 2011 
after it had produced 8 BCF, and that Well No. 2 stopped producing in 
2012 after it had produced 5 BCF. Two BCF of the RSV earned by Well No. 
1 remain. That RSV would be applied to production from Well No. 3 until 
it is exhausted, and the lessee therefore would not pay royalty, 
because the $9.88 per MMBtu (adjusted for inflation after 2006) price 
threshold is not exceeded.
    In example 4, assume that in February 2010 a lessee completes and 
begins producing from an ultra-deep well (at a depth of 21,500 feet TVD 
SS) on a lease located in 325 meters of water with no prior production 
from any deep well and no deep water royalty relief. The ultra-deep 
well would be a phase 2 ultra-deep well, and would earn the lease an 
RSV of 35 BCF. Further assume that during 2010, the average daily 
closing NYMEX natural gas price exceeds $4.47 per MMBtu (adjusted for 
inflation after 2006) but does not exceed $9.88 per MMBtu (adjusted for 
inflation after 2006). Because the lease is located in more than 200 
but less than 400 meters of water, the price threshold of $4.47 per 
MMBtu (adjusted for inflation after 2006) applies to all of the RSV, 
and the lessee will owe royalty on all gas produced from the ultra-deep 
well in 2010. The volume of gas produced from the ultra-deep well in 
2010 counts against the RSV, as provided in proposed paragraph (e).
    The same principles would apply when a lessee applies RSVs to 
production allocated to a lease from qualified wells on other leases 
under an MMS-approved unit agreement. The price threshold associated 
with the RSV determines whether royalty is suspended on the production 
volume allocated to the lease.
    Proposed Sec.  203.36(d) provides that in the event the price 
threshold is exceeded in any calendar year, royalties

[[Page 28404]]

on production would be due by March 31 of the following year. The 
purpose of this proposed provision would be to allow the lessee a 
reasonable time to compute and pay royalties for the year for which 
they were due. If royalties were not paid by that date, late payment 
interest would accrue beginning April 1 until paid. MMS is also 
proposing a corresponding change to the late payment interest provision 
in the existing deep gas rule at Sec.  203.47 (proposed to be 
redesignated as Sec.  203.48).
    Finally, paragraph (e) of this proposed section specifies that 
production volumes on which a lessee must pay royalty as a result of 
the applicable price threshold being exceeded would count against the 
RSV.

Which leases are eligible for royalty relief as a result of drilling a 
deep well or a phase 1 ultra-deep well? (Sec.  203.40)

    MMS is proposing to expand the existing deep well eligibility 
provision at Sec.  203.40(b) to require that the lease be located in 
the GOM wholly west of 87 degrees, 30 minutes West longitude in water 
depths entirely less than 400 meters deep to implement section 344(b). 
MMS also proposes other amendments to reflect the addition of leases in 
the 200-400 meter water depth range, and proposes to change the wording 
of the section heading to reflect the change in the definition of 
``deep well'' and the addition of the definition of ``phase 1 ultra-
deep well.''

If I have a qualified deep well or a qualified phase 1 ultra-deep well, 
what royalty relief would my lease earn? (Sec.  203.41)

    MMS proposes to modify the tables at existing Sec.  203.41(a) and 
(c), other parts of the text of the section, and the wording of the 
section heading to reflect the new ultra-deep well category of royalty 
relief and the changes in the definition of terms. The proposed 
revision adds a new paragraph (a) to emphasize the pivotal role that 
prior deep production plays in the incentive. Also, the proposal 
changes the existing paragraph (a) to paragraph (b), and combines the 
content of the existing paragraphs (b) and (d) into a new paragraph 
(d), and divides that content into numbered subparagraphs.
    The expanded coverage of this section and the proposed new 
paragraph (e) result from section 344's extension of royalty relief for 
deep wells to leases located in the