Commentary: Marginal wells could remain active with royalty reductions

Daniel Fine
The Daily Times

There are 15,000 such producing wells in the state yielding an average of less than three barrels per day. Over 400,000 are working in the country. Combined, some 15 percent of total oil production is from stripper wells. Stripper wells include natural gas wells with marginal production.

Since the shale oil extraction breakthrough beginning in 2009, service costs have increased. Most stripper owners require a $70 price per barrel of oil (West Texas Intermediate) to avoid shut-in. The decision to shut-in is not taken lightly. In New Mexico if there is no production reported for 60 days, the lease is lost. Once shut-in or abandoned, stripper wells’ oil production and reserves are lost to the state and the country.

It is uneconomic to drill a well from shut-in or abandoned status for three barrels per day. Stripper production is a strategic privately held oil reserve and has provided, since 1973, an offset against supply disruption. It is recognized by the Organization of Petroleum Exporting Countries, which is in a price war against American shale producers and stripper well production, that both operators are high-cost producers. The organization’s objective is more OPEC oil and less American — Southwest and North Dakota — in the market.

The stripper producer must decide whether to lose money and hold his lease or shut-in as abandonment which surrenders the lease. It was this circumstance that New Mexico considered in 1994 when the state Legislature passed a bill into law that provided royalty rate reduction. Lowering the royalty rates paid by stripper well owners to state and the federal governments provides an economic incentive to avoid shut-in.

Over a million barrels a day production could be lost without royalty rate reduction.

Royalty rate reduction from 12.5 to 5 percent in New Mexico would keep the stripper well operators in business at $40 per barrel of oil.

Debate would open in Washington with the federal government possibly following the lead of the states.

It is unlikely that oil will go to back to $100 in the next five years as the Saudi/OPEC market share strategy is designed to reduce American production by maintaining output levels that do not reflect falling prices.

New Mexico strippers require a $70 price to prevent shut-ins. In New Mexico, there are oil industry cycles of boom and bust. Oil is a commodity and the oil industry is cyclic. We are in a down-cycle since last October.

Royalty rate reduction is the government tool created to deal with previous down-cycles. OPEC is now focused on how much of “our” oil is being sold on the world market. Non-OPEC shale and stripper oil production and sales from the U.S. are at the center of the storm. Merrion Oil & Gas and Dugan Production Corp. in Farmington have maintained stripper production for more than 25 years — these wells keep going — and this translates into jobs that remain even as capital spending by the large operators declines. The New Mexico state program would protect both companies against abandonment at current prices if the royalty rate reduction qualification was increased to six and 10 barrels per day.

Daniel Fine is the associate director of the Center For New Energy Policy at New Mexico Tech, and the project leader for the state of New Mexico Energy Policy.