Interior Should Continue Use of Higher Royalty Rates for Offshore Oil and Gas Leases

In response to a congressional request, GAO reviewed the Department of the Interior's rationale and practices in setting royalty rates for offshore oil and gas production. GAO compared Interior's approach to setting royalty rates with those of various States and foreign countries with offshore leasing programs, addressing the revenue implications of the differing practices.

Historically, over 85 percent of the outer continental shelf tracts have been leased under a cash bonus bid, fixed 16.6 percent royalty rate leasing arrangement. Two studies have shown that this rate fosters competition for leasing and affords the Government an appropriate rate of return on offshore lands. Recently, Interior has used alternative fixed royalty rates and alternative leasing methods in addition to the traditional royalty rate. Higher royalty rates have been used selectively by Interior for tracts estimated to have high resource levels and low development costs. Competition and bonuses were greater for these tracts than for tracts at the traditional rate. States employ different methods of leasing their offshore oil and gas acreage. Although royalty rates charged by States for offshore production are generally higher than the Federal rate, significant differences in leasing methods and leasing environments render a comparison of State and Federal practices inappropriate. States generally do not employ a fixed royalty rate but instead use variable rates and net profit sharing arrangements. Because State leases are generally less costly to develop, industry officials are willing to pay the higher State rates. Further, States rely more heavily than the Federal Government on royalties as an income source. Some foreign governments use fixed royalty rates; however, most foreign countries have or are moving toward the nationalization of oil and gas operations. Agency and industry officials feel that the traditional royalty method should be continued.