Saturday, September 6, 2008

Drill, Baby, Drill

I wound up having a fairly extensive blogument over here about outer continental shelf (OCS) drilling, which forced me to do a little research and sharpen up my thinking. This post is my book report.

First, we have the old chestnut about oil companies sitting on productive leases, so there's no need to lease new OCS tracts. I went off researching this and found... nothing on point. Turns out this is a hard topic to quantify. Tracts available for lease can be in various states, very few of which are actually tracked by the Department of the Interior's Minerals Management Service (MMS):
  1. They can be unleased or abandoned.
  2. They can be unexplored.
  3. They can be explored and found to have no detectable hydrocarbons.
  4. They can have hydrocarbons, but not in quantities that are currently economical to extract.
  5. They can have extractable hydrocarbons but be "shut-in" because there's some economic or (more likely) logistical reason they can't be extracted immediately.
  6. They can be producing.
As far as I can tell, MMS only knows whether a tract is leased, unleased, producing, or abandoned (i.e. the lessee has turned the lease back in). So it's pretty difficult to determine the veracity of claims about oil companies sitting on leases. Here's a nice piece of industry propaganda that makes the oil companies' case.

Next, the upside of drilling on the OCS is huge. The EIA puts US proven reserves at between 20 and 29 billion bbl, while the MMS estimates the "undiscovered, technically recoverable" oil resources on the OCS at about 66 billion bbl. (I'm not counting gas, which is actually much larger, just to get an apples-to-apples comparison.) So there may be as much as 3 times as much undiscovered OCS oil as our current proven reserves.

But there's a problem with how leases are managed. When a company takes out a lease, they're given a fixed time period (the "primary term") to explore it and make it productive. If they make it productive, they can renew the lease. If it's not productive at the end of the primary term, the MMS can, at its discretion, extend the lease with the current lessee or put it back up for sale. The carrying costs of an unproductive lease are what they are, but it's entirely likely that those costs are lower than the future value of the oil. This can lead to a situation where, if the MMS arbitrarily extends leases, it's good to gobble up as many leases as you can and sit on them, waiting for the oil to appreciate. So, to properly utilize all these new OCS resources, there are two problems, one legislative and one executive:
  • We need to Congress to lift the moratorium on additional OCS leases.

  • We need the administration (or a future administration) to instruct MMS to be rigorous in putting unproductive leases (i.e., leases that aren't producing oil, for whatever reason) back up for sale, instead of doing perfunctory renewals with the current lessee.
I have no doubt that a McCain administration will be less inclined to take the appropriate executive steps than an Obama administration would. But that won't matter either way unless and until Congress becomes less recto-cranially inverted and lifts the moratorium.

The key to getting the right executive action is, as always, transparency. I'm sure that the status of leases is public record. It just takes a couple of negative press reports for the MMS and its attendant administration to feel the heat and adopt proper lease management rules.

Finally, what does all this buy us? Well, because the current supply of oil is strongly influenced by the expected future price of oil (which, incidentally, can be derived efficiently from the far-futures market for oil), opening up the OCS will result in a significant drop in the price of oil. (See the Feldstein op-ed, to which I have linked multiple times .) As indirect proof of this thesis, consider the price of oil when the "drill more" meme surfaced and the price of oil now. Certainly some of that 30% reduction was the result of normal over-buying but I'd bet that a hefty chunk was the result of estimates of future available supply going up.

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