Mineral Revenues
Cost and Revenue Information Needed to Compare Different Approaches for Collecting Federal Oil and Gas Royalties Gao ID: GAO-04-448 April 16, 2004In fiscal year 2003, the federal government collected $5.6 billion in royalties from oil and gas production on federal lands. Although most oil and gas companies pay royalties in cash, the Department of the Interior's Minerals Management Service (MMS) has the option to take a percentage of the oil and gas produced and sell this product-- known as "taking royalties in kind (RIK)." MMS has taken royalties in kind continuously since 1998 with the goal of achieving administrative savings while maintaining revenue. GAO attempted to (1) quantify the administrative savings that may be attributable to the RIK sales and (2) compare the sales revenues from RIK sales to what would have been collected in cash royalty payments.
Although data on administrative savings are limited, there are substantial audit savings attributable to RIK sales, but there are no quantified savings in the overall administration of royalty collections. MMS has anticipated savings in auditing and litigation expenses. While MMS data showed that auditing costs for RIK sales were less than auditing costs for cash sales on a per lease basis, MMS redirected the resources it saved to auditing additional leases. At this time, MMS cannot quantify the benefit from additional auditing. The costs of litigation, which the Solicitor's Office in the Department of the Interior performs for MMS, are not tracked. However, officials with the Solicitor's Office were unable to attribute any savings in litigation to the increased use of RIK and said that future litigation costs are difficult to predict. Finally, MMS must weigh these benefits against additional costs required to conduct RIK sales. Despite limitations in MMS's analyses and revenue data that prevented a more comprehensive assessment of all RIK sales, our estimate of the revenue impacts from RIK sales in three areas indicates a mixed performance. Specifically, RIK oil sales in Wyoming increased revenues by 2.6 percent, for a gain of $967,000 on sales of $37 million. RIK oil sales in the Gulf of Mexico decreased revenues by $7.2 million, for a loss of 5.5 percent on sales of $131 million. RIK gas sales in the Gulf increased revenues by $4 million, for a gain of 2 percent on revenues of $210 million. However, these sales only represent 11 percent of the gas and 57 percent of the oil that MMS took in kind from inception of the pilots through November 2003. MMS does not analyze all sales because there is no requirement to do so, staff considers existing information on sales sufficient, few staff are assigned to analyzing sales, and MMS management has a lengthy review process for finalizing sales analyses.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-04-448, Mineral Revenues: Cost and Revenue Information Needed to Compare Different Approaches for Collecting Federal Oil and Gas Royalties
This is the accessible text file for GAO report number GAO-04-448
entitled 'Mineral Revenues: Cost and Revenue Information Needed to
Compare Different Approaches for Collecting Federal Oil and Gas
Royalties' which was released on May 11, 2004.
This text file was formatted by the U.S. General Accounting Office
(GAO) to be accessible to users with visual impairments, as part of a
longer term project to improve GAO products' accessibility. Every
attempt has been made to maintain the structural and data integrity of
the original printed product. Accessibility features, such as text
descriptions of tables, consecutively numbered footnotes placed at the
end of the file, and the text of agency comment letters, are provided
but may not exactly duplicate the presentation or format of the printed
version. The portable document format (PDF) file is an exact electronic
replica of the printed version. We welcome your feedback. Please E-mail
your comments regarding the contents or accessibility features of this
document to Webmaster@gao.gov.
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed
in its entirety without further permission from GAO. Because this work
may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this
material separately.
Report to Congressional Requesters:
April 2004:
MINERAL REVENUES:
Cost and Revenue Information Needed to Compare Different Approaches for
Collecting Federal Oil and Gas Royalties:
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-448]:
GAO Highlights:
Highlights of GAO-04-448, a report to Representative Nick J. Rahall,
Ranking Minority Member, House Committee on Resources, and
Representative Carolyn B. Maloney
Why GAO Did This Study:
In fiscal year 2003, the federal government collected $5.6 billion in
royalties from oil and gas production on federal lands. Although most
oil and gas companies pay royalties in cash, the Department of the
Interior‘s Minerals Management Service (MMS) has the option to take a
percentage of the oil and gas produced and sell this product”known as
’taking royalties in kind (RIK).“ MMS has taken royalties in kind
continuously since 1998 with the goal of achieving administrative
savings while maintaining revenue. GAO attempted to (1) quantify the
administrative savings that may be attributable to the RIK sales and
(2) compare the sales revenues from RIK sales to what would have been
collected in cash royalty payments.
What GAO Found:
Although data on administrative savings are limited, there are
substantial audit savings attributable to RIK sales, but there are no
quantified savings in the overall administration of royalty
collections. MMS has anticipated savings in auditing and litigation
expenses. While MMS data showed that auditing costs for RIK sales were
less than auditing costs for cash sales on a per lease basis, MMS
redirected the resources it saved to auditing additional leases. At
this time, MMS cannot quantify the benefit from additional auditing.
The costs of litigation, which the Solicitor‘s Office in the Department
of the Interior performs for MMS, are not tracked. However, officials
with the Solicitor‘s Office were unable to attribute any savings in
litigation to the increased use of RIK and said that future litigation
costs are difficult to predict. Finally, MMS must weigh these benefits
against additional costs required to conduct RIK sales.
Despite limitations in MMS‘s analyses and revenue data that prevented a
more comprehensive assessment of all RIK sales, our estimate of the
revenue impacts from RIK sales in three areas indicates a mixed
performance. Specifically, RIK oil sales in Wyoming increased revenues
by 2.6 percent, for a gain of $967,000 on sales of $37 million. RIK oil
sales in the Gulf of Mexico decreased revenues by $7.2 million, for a
loss of 5.5 percent on sales of $131 million. RIK gas sales in the Gulf
increased revenues by $4 million, for a gain of 2 percent on revenues
of $210 million. However, these sales only represent 11 percent of the
gas and 57 percent of the oil that MMS took in kind from inception of
the pilots through November 2003. MMS does not analyze all sales
because there is no requirement to do so, staff considers existing
information on sales sufficient, few staff are assigned to analyzing
sales, and MMS management has a lengthy review process for finalizing
sales analyses.
Actual and Projected RIK Gas Sales in the Gulf of Mexico:
[See PDF for image]
[End of figure]
What GAO Recommends:
GAO reported on MMS‘s RIK Program in 2003 and recommended that MMS
identify and acquire key information to monitor and evaluate the RIK
Program prior to expanding the program further. While MMS has made some
progress, it has yet to implement these recommendations. Should the
Congress seek more assurance of the level of success of the RIK
Program, it might consider directing MMS to establish a systematic
evaluation of the revenue impacts of all future sales and to quantify
overall changes in the administration of royalty collections. In
commenting on the draft report, Interior generally agreed with GAO‘s
observations.
www.gao.gov/cgi-bin/getrpt?GAO-04-448.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Jim Wells at (202)
512-3841 or wellsj@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Savings in Auditing RIK Occur, but Overall Impact on Royalty
Administration Costs Cannot Be Completely Quantified:
The Revenue Impact of RIK Sales Is Mixed:
Conclusions:
Matters for Congressional Consideration:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
Wyoming Oil:
Gulf of Mexico Oil:
Gulf of Mexico Gas:
Other Factors May Affect Revenue Analysis:
Appendix II: Comments from the Department of the Interior:
GAO Comments:
Appendix III: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Acknowledgments:
Figures:
Figure 1: Comparison of Weighted Average Monthly Sales Prices Obtained
from Wyoming Severance Tax Database and MMS's Financial System for
Selected Asphaltic Properties Subsequently Included in RIK Sales:
Figure 2: Comparison of Weighted Average Monthly Sales Prices Obtained
from Wyoming Severance Tax Database and MMS's Financial System for
Selected General Sour Properties Subsequently Included in RIK Sales:
Figure 3: Comparison of Weighted Average Monthly Sales Prices Obtained
from Wyoming Severance Tax Database and MMS's Financial System for
Selected Sweet Properties Subsequently Included in RIK Sales:
Abbreviations:
ABC: activity-based cost:
DOE: Department of Energy:
GAO: General Accounting Office:
MMBtu: one million British thermal units:
MMS: Minerals Management Service:
MOPS: Matagorda Offshore Pipeline System:
MRM: Minerals Revenue Management:
NYMEX: New York Mercantile Exchange:
RIK: royalty in kind:
SPR: Strategic Petroleum Reserve:
Letter April 16, 2004:
The Honorable Nick J. Rahall:
Ranking Minority Member:
Committee on Resources:
House of Representatives:
The Honorable Carolyn B. Maloney:
House of Representatives:
In fiscal year 2003, the Department of the Interior's Minerals
Management Service (MMS) collected about $5.6 billion in royalties from
oil and gas production on federal lands. MMS traditionally accepts the
federal government's oil and gas royalties in cash. Under the Mineral
Leasing Act of 1920 and the Outer Continental Shelf Lands Act, MMS also
has the authority to take a portion of the actual oil and gas produced,
referred to as "taking royalties in kind." MMS then sells this oil and
gas to the highest bidders at competitive auctions. MMS established
Royalty-in-Kind (RIK) pilot sales with the intent of testing whether
MMS can (1) decrease the cost of administering royalties and (2)
maintain or increase royalty revenues. MMS began to evaluate the use of
federal royalty oil as an alternative to cash royalty payments through
a series of pilot sales in Wyoming beginning in 1998. In addition, MMS
has conducted pilot sales for gas and oil in the Gulf of Mexico. We
estimate that revenue from RIK pilot sales was about $682 million in
fiscal year 2003. Based on MMS estimates for further expansion of RIK
sales, MMS could be collecting between $1.5 billion and $2.5 billion
per year in revenue from RIK pilot sales by 2008.
To address MMS progress toward a more systematic evaluation of MMS's
RIK efforts, you asked us to (1) quantify any savings in administering
royalty collections that are attributable to the RIK pilots and (2)
compare sales revenues from RIK pilots to what would have been
collected under cash royalty payments.
In responding to the objectives, we discussed the RIK sales program
with MMS officials and oil and gas marketers who are active in Wyoming
and the Gulf of Mexico, where MMS has conducted almost all of its RIK
pilot sales. We initially reviewed documents analyzing RIK sales and
the costs to administer these sales. However, we found at the start of
our review that MMS had only released two draft reports that analyzed
the impact of RIK sales, and these reports and other informal studies
only addressed the revenue impacts associated with 9 percent of the
royalty oil sold through July 2002 and about 44 percent of the royalty
gas sold through March 2002. The reports remained in draft until
approved by management in March 2004. While the two studies asserted
that RIK sales produce administrative savings, the studies did not
conclusively quantify any savings. Given the nature of MMS's limited
analysis of administrative cost and revenue impacts, we attempted to
address the objectives by acquiring and analyzing additional MMS data.
However, in the course of our analysis, we found that sufficiently
detailed administrative cost information necessary to compare RIK to
cash royalties does not exist, leaving us unable to completely assess
the administrative impacts.
In evaluating the revenue impact of RIK sales, we obtained royalty data
from MMS's financial data system. However, this system was designed to
collect and disburse revenues and not to specifically analyze the
revenue impacts of RIK sales; therefore it was not suitable for doing a
comprehensive evaluation of the RIK sales. In addition, some erroneous
and missing data required time-consuming inspections of the royalty
data to ensure their reliability and integrity. As a result, we were
only able to assess the revenue impacts in case studies representing
parts of three RIK pilot sales areas: Wyoming oil, Gulf of Mexico oil,
and Gulf of Mexico natural gas. The sales we analyzed represented about
57 percent of the royalty oil and 11 percent of the royalty gas MMS
took in kind from inception of these pilots through November 2003. We
performed significance tests on the results of our case studies and
found them to be statistically significant at the 5 percent level.
However, it was not possible to project the total revenue impact of all
the RIK pilot sales from these case studies because the difference
between RIK revenues and cash royalty revenues can vary greatly over
time and because the case studies are not representative samples of all
RIK sales. In addition, we were unable to obtain data that would have
enabled us to measure the effects of audits on revenues from RIK and
cash sales, which adds uncertainty to our estimates in the case
studies. Therefore, we are unable to determine conclusively how well
the RIK pilot sales have done compared to what would have been expected
from cash sales over the long term.
We conducted our work from February 2003 through March 2004 in
accordance with generally accepted government auditing standards. For a
more detailed discussion of the scope and methodology of our review,
see appendix I.
Results in Brief:
There are substantial administrative savings in auditing royalty
collections that are attributable to the RIK pilots, but there are no
quantified savings in the overall administration of royalty
collections. MMS has stated that the RIK pilots should create savings
primarily by reducing the costs of auditing royalty payments and by
decreasing overall litigation. RIK royalty auditing costs are
substantially less than cash royalty auditing costs on a per-lease
basis, but MMS simply redirected any resources it saved to auditing
more cash payments. Although more audits of these cash payments could
result in higher revenue collections if the audits identified royalty
underpayments, MMS is not currently able to determine this benefit
because the auditing of cash payments takes several years to complete.
Similarly, the Department of the Interior's Solicitor's Office could
not identify any change in the amount of litigation attributable to the
RIK pilots or predict the extent to which RIK would affect its future
litigation workload. MMS did incur other administrative costs under RIK
that it would not have incurred by accepting cash royalty payments. For
example, it incurred $1.7 million in direct costs to conduct the RIK
pilot sales during fiscal year 2003 and one-time costs of $13 million
to purchase information systems that, among other things, were intended
to bill, collect, and report revenues from the RIK pilots.
Our analysis of the revenue impacts from three case studies of RIK
pilots indicated a mixed performance when compared to cash royalty
payments. Specifically, we estimated that (1) RIK sales in Wyoming
increased revenues by about 2.6 percent, for a gain of $967,000 on
sales of about $37 million; (2) a 6-month oil sale in the Gulf of
Mexico decreased revenues by 5.5 percent, for a loss of $7.2 million on
sales of about $131 million; and (3) natural gas sales in the Gulf of
Mexico increased revenues by about 2 percent, for an estimated gain of
about $4 million on sales of about $210 million. These sales
represented about 11 percent of the gas and 57 percent of the oil that
MMS took in kind from inception of the pilots through November 2003.
Limitations in MMS's data and a lack of MMS analyses of RIK sales
precluded us from comprehensively analyzing the revenue impact of more
RIK sales in a timely manner. Currently, MMS is not required to analyze
sales or document them, the staff responsible for conducting sales
considers the information on sales results sufficient, few staff are
assigned to analyzing sales, and MMS management has not placed a
priority on the time-consuming review of sales results.
In January 2003, we reported to the Congress that MMS had not developed
sufficient management control over its RIK sales, including the
collection of the data necessary to quantify the revenue impacts and
the administrative savings attributable to the RIK program.[Footnote 1]
In our report, we recommended that the Secretary of the Interior
instruct the appropriate managers in MMS to identify and acquire key
information to monitor and evaluate the RIK program prior to expanding
the program. We recommended that such information include the revenue
impacts of all RIK sales and the administrative costs and savings
attributable to RIK. MMS generally agreed with our recommendations and
emphasized their current efforts and future plans to improve the
evaluation of RIK. We recognized MMS's progress in establishing
management control and documenting the results of its RIK sales.
However, as RIK sales have continued to grow, it is still difficult to
completely quantify the administrative cost and revenue impact of the
RIK program. As MMS looks to continue to expand the use of RIK, we are
suggesting that if the Congress wants to ensure a systematic and timely
evaluation of RIK efforts, the Congress may want to consider directing
MMS to conduct an evaluation of all future RIK sales and to quantify
any changes in the administrative cost and revenue impact on royalty
collections as a result of RIK.
Background:
In general, royalty rates for onshore federal oil and gas leases are
12-1/2 percent of the value of the oil and the gas produced, whereas
royalty rates for offshore leases are generally 16-2/3 percent. MMS
also administers programs under which royalties are reduced or
suspended to encourage exploration and production. The administration
of cash royalty payments has been challenging for MMS. MMS relies upon
royalty payors to self-report the amount of oil and gas they produce,
the value of this oil and gas, and the cost of transportation and
processing that they deduct from cash royalty payments. With 22,000
producing leases and often several companies paying royalties on each
lease each month, the auditing of these cash royalty payments has
become a formidable task. In addition, payors and MMS often disagree
over the value of the oil and gas and the transportation and processing
deductions, leading to time-consuming and costly appeals and litigation
for those disagreements that they cannot resolve. MMS claims that
compared to cash royalty payments, RIK can substantially simplify the
administration of royalties because it reduces these disagreements and
the time that MMS must spend resolving them. While RIK offers the
promise of simplified administration, MMS must also consider the
revenue impact of RIK. The Mineral Leasing Act of 1920 and the Outer
Continental Shelf Lands Act authorize taking royalties in kind. These
two acts directed the Secretary of the Interior to obtain fair market
value for the oil and gas taken in kind.[Footnote 2] The Outer
Continental Shelf Lands Act defined "fair market value" as the average
unit price for the mineral sold either from the same lease or, if such
sales did not occur, in the same geographic area. Moreover, the fiscal
years 2001 through 2004 Appropriation Acts for Interior and related
agencies directed MMS to collect at least as much revenue from RIK
sales as MMS would have collected from traditional cash royalty
payments.
In recent years, MMS conducted three major RIK pilots involving (1) oil
in Wyoming, (2) oil in the Gulf of Mexico, and (3) natural gas in the
Gulf of Mexico. For oil in Wyoming, MMS has taken royalties in kind
since October 1998. Although the amount of royalty oil that MMS takes
in kind in Wyoming is less than 1 percent of all federal royalty oil,
MMS has gained valuable experience during these sales. MMS has also
taken royalty oil in kind in the Gulf of Mexico in two 6-month sales
between November 2000 and March 2002. Unlike in Wyoming, the amount of
royalty oil that MMS took in the Gulf approached 20 percent of all
federal royalty oil during the second 6-month sale from October 2001
through March 2002. MMS's RIK oil pilot in the Gulf was put on hold
when the president directed that MMS use royalty oil to fill the nearby
Strategic Petroleum Reserve (SPR). Finally, for natural gas in the Gulf
of Mexico, MMS has consistently taken natural gas in kind since
December 1998. MMS currently takes about 19 percent of total federal
royalty gas in pilots conducted in the Gulf of Mexico, and this program
continues to grow.
Savings in Auditing RIK Occur, but Overall Impact on Royalty
Administration Costs Cannot Be Completely Quantified:
While there are substantial administrative savings in auditing royalty
collections that are attributable to the RIK pilots, there are no
quantified savings in the overall administration of royalty
collections. MMS's overall budget to administer royalties has declined
slightly as MMS increased the use of RIK, but the development of many
other changes in royalty administration during the same time makes it
difficult to assess the relative impact of RIK. MMS only began
collecting detailed administrative cost information starting in fiscal
year 2003, so it is not possible to attribute costs to the different
royalty administration activities before then. MMS's development of a
more specific cost information system in 2003 may help with future
impact assessments, but will not allow any comparison to the past. MMS
claims that the administrative cost savings from using RIK comes
primarily from a reduction in audit and litigation activities that
would have occurred under cash royalty collections. Information
collected by MMS starting in 2003 has supported MMS's assertion that
RIK pilots can create savings by reducing the costs of auditing royalty
payments. While MMS has redirected auditing resources it saved to
auditing more cash payments, it is not yet able to determine the
benefit of this increased audit effort on overall royalty collection.
Regarding litigation savings, no litigation cost information has been
collected nor have any savings been identified. Finally, these
potential savings must be weighed against additional specific costs
that would otherwise not be incurred under cash royalties, such as
operating costs in fiscal year 2003 of $1.7 million to conduct the RIK
sales. MMS also incurred a capital investment of $13 million to
purchase information systems.
MMS's Budget to Administer Royalty Collections Has Declined Slightly,
but the Impact of RIK Is Not Clear:
In October 2001, MMS reorganized and created the Minerals Revenue
Management organization (MRM) within MMS to collect, disburse, and
audit royalty revenues. Since its creation, MRM's budget has declined
by about 7 percent, from $86.5 million in fiscal year 2002 to $80.4
million in fiscal year 2004. Approximately 41 percent of MRM's budget
over this period supported financial management, including the
collection and disbursement of royalty revenues. Nearly all of the
remaining 59 percent of the budget supported compliance asset
management, a major function of which is the auditing of oil and gas
royalty revenues. Budget documents indicate that MRM has maintained
about 572 full-time personnel from fiscal years 2002 through 2004, of
which 184 were assigned to financial management and 388 were assigned
to compliance asset management. An official within the Department of
the Interior added that the actual number of employees on board was 558
in 2004, with some of this difference due to a decrease in the number
of personnel assigned to compliance asset management. Within compliance
asset management is the RIK Office that oversees RIK pilot sales, the
Small Refiners Program, and the filling of the SPR.
Other developments in the administration of royalty collection have
made it difficult to attribute changes in the MRM budget to RIK
activities. Whereas RIK sales significantly change the processes for
collecting royalty revenues, other developments, including the
substantial change in the duties of the personnel responsible for
auditing oil and gas revenues and for ensuring compliance with
applicable rules and regulations, have ultimately affected the way MMS
deploys its personnel--a major component of MRM's budget. For example,
in June 2000 MMS implemented new oil valuation regulations that provide
more specific guidance on what prices companies must report to MMS on
the sales of oil to their affiliates, and this should decrease
discrepancies between MMS auditors and royalty payors. Similarly, MMS's
increased willingness to write formal agreements on these prices is
also expected to decrease such disagreements. The change in the way MMS
audits oil and gas revenues since its reorganization is also expected
to decrease its workload. For example, MMS auditors no longer routinely
compare all production volumes reported by the operators of oil and gas
leases against all sales volumes reported by royalty payors to search
for possible underpayments. Instead, MMS auditors now perform this
activity on a case-by-case basis as needed. MMS auditors are also
increasingly selecting the property as the entity to audit rather than
selecting an individual company. Finally, when MMS does select a
company to audit, there are fewer companies to select because of the
recent mergers of the large oil and gas companies.
Prior to fiscal year 2003, MMS lacked the necessary data to
conclusively quantify the difference in administrative costs under
different royalty collection methods. Under Interior's agencywide
initiative, MMS implemented an activity-based cost (ABC) management
system in fiscal year 2003. The system identifies specific work
activities in order to measure their costs, monitor and evaluate
program performance and results, and improve the way MMS does its work.
In essence, MMS personnel record the hours spent on specific work
activities, such as RIK audits, and convert these hours into labor
costs. These labor costs are then added to nonlabor costs, such as
travel and materials costs, to produce total direct costs for the
identified work activities. MMS has captured the costs of the work
activities included in the collection and auditing of royalty revenues
during fiscal year 2003. Such information may help MMS compare the
costs of administering the RIK sales to the costs of administering cash
royalty collections; however, there is no way to make this comparison
prior to fiscal year 2003.
RIK Reduces Audit Costs, But Overall Impact on Royalty Collection Is
Not Quantified:
According to MMS, the auditing and compliance effort is significantly
reduced under RIK because MMS and the RIK purchaser agree to a
contractual price before the sale and because transportation deductions
are no longer an issue when MMS sells the oil or gas at the lease. MMS
further explained that auditing RIK leases can be done within as little
as 120 days after the sale because it has all the necessary price
information at that time, while up to 3 years transpire before MMS
initiates an audit of cash royalty payments. During such cash royalty
audits, MMS personnel must physically collect and inspect collaborative
pricing and transportation documents, often at the payors' offices,
while similar pricing information for RIK sales is instantly available
in MMS's information systems.
The data from MMS's newly implemented ABC management system does
support MMS's assertion that the auditing of certain RIK sales revenues
is less costly on a per-lease basis than the auditing of comparable
cash royalty payments. A review of the auditing and compliance costs
for oil and gas leases in the Gulf of Mexico and Wyoming--two locations
in which MMS received both cash and in-kind royalty payments during
fiscal year 2003--showed that the costs to audit cash sales per lease
were substantially higher than the costs to audit in-kind royalties in
both areas. In the Gulf of Mexico, MMS reported spending $6,765,000 to
audit cash sales from 242 oil and gas leases, or $27,956 per lease,
while spending $458,000 to audit all 297 gas leases included in the RIK
pilot sales, or $1,542 per lease. Similarly, MMS reported spending
$820,000 to audit cash royalties from 912 oil and gas leases in
Wyoming, or $899 per lease, while spending $38,000 to audit all 580 RIK
oil leases in Wyoming, or $66 per lease.
While the ABC data suggest that the auditing costs for RIK sales
revenues are less than the auditing costs for cash royalty payments,
this difference does not necessarily mean that MMS is spending less
money as it moves more leases into its RIK sales. MMS explained that
instead of decreasing its audit budget, it has used these freed-up
resources to audit additional cash royalty payments that it would not
have otherwise audited. In addition, MMS has stated that auditing
additional cash royalty payments could result in the collection of
additional revenues. For fiscal year 2000, the latest year for which
audit data are available, MMS reported that its audit activities,
together with state and tribal audits of federal royalty revenues,
generated about $219 million (or 5 percent) on royalty revenues of
about $4.6 billion. However, MMS will not know the results of auditing
additional cash royalty payments for several years because it takes
time to select leases for audit, conduct the audits, and resolve
related appeals and litigation. In the future, it is possible that MMS
may experience different rates of revenue increase, either upwards or
downwards, as it expands its audit coverage because of the different
leases it selects for audit.
Litigation Costs Are Not Tracked:
MMS's new ABC system provided costs associated with taking royalties in
kind during fiscal year 2003, but it did not capture the costs
associated with specific types of litigation performed by others for
MMS. Litigation sometimes arises after MMS or state and tribal auditing
efforts identify a discrepancy that cannot be resolved by MMS and the
payors. Such discrepancies commonly involve the value of oil and gas or
the costs of transporting this oil and gas to market. MMS has
maintained that the taking of royalties in kind reduces litigation.
However, the savings that could result from avoiding litigation cannot
be quantified by MMS because MMS does not conduct the litigation.
Instead MMS relies primarily upon the Department of the Interior's
Solicitor's Office, which does not track specific types of litigation
costs for MMS. Officials in the Solicitor's Office reported that since
fiscal year 1999, between two and four of their attorneys worked full-
time on MMS royalty issues. In addition, these officials said that
attorneys within the Department of Justice represent MMS in court.
Officials in the Solicitor's Office could not attribute any decrease in
litigation to an increase in the use of RIK. They also stated that the
nature of the royalty litigation could change as a result of RIK; while
litigation over valuation and transportation deductions may decrease,
litigation over RIK contracts and discrepancies over volumes sold may
increase. They also cautioned that future litigation over
administrative decisions and rule making is impossible to predict.
Finally, regardless of the volume of RIK sales, they cautioned that as
long as MMS receives some cash royalty payments, there would always be
the potential for litigation on valuation issues and transportation
allowances.
RIK Sales Require Additional Costs Not Incurred When Collecting Cash
Royalties:
The administration of the RIK pilot sales includes additional
activities that are not necessary when accepting cash royalty payments
and therefore add to the cost of collecting royalties in kind. Such
activities include identifying properties from which to sell oil and
gas, calculating minimum acceptable bids, awarding and monitoring
contracts, billing purchasers, negotiating transportation rates, and
reconciling discrepancies in volumes. In fiscal year 2003, MMS's
preliminary ABC data showed direct costs of $1.7 million to conduct
activities for the RIK pilot sales that it would not have incurred had
it accepted cash royalty payments.[Footnote 3] Of this $1.7 million,
MMS reportedly spent $475,000 to identify properties, calculate minimum
acceptable bids, and conduct sales; $464,000 to market the royalty oil
and gas; $176,000 to monitor the credit worthiness of purchasers;
$496,000 for auditing leases and reconciling volumes; and $127,000 for
policy compliance and legal support.
MMS also incurred one-time costs of more than $13 million to acquire
three information systems, part of whose functions are to bill,
collect, and report on revenues from the RIK pilots. When fully
implemented, these systems may help address the management control
weakness that we previously identified involving the manual entry of
data into unlinked computer spreadsheets.[Footnote 4] The first of
these systems, the gas information system, is wholly dedicated to the
administration of the RIK gas pilot sales and cost $7.3 million.
Implemented in January 2003, the system automates the billing,
collecting, and reporting functions. MMS's second system, the liquids
information system, cost almost $5 million and was implemented in June
2003. Like the gas system, it is designed to automate the billing,
collecting, and reporting functions, but unlike the gas system it is
not wholly dedicated to the RIK pilot sales, but also supports the
Small Refiners Program and the filling of the SPR. MMS's third system,
the Risk and Performance Management System, cost about $0.9 million and
is designed to measure the results of the RIK gas sales and the Small
Refiners Program for periods during 2003. In addition, MMS's
preliminary ABC data shows that MMS incurred direct costs of $682,000
in fiscal year 2003 to develop and maintain these information systems.
MMS will also incur additional costs in future years to operate and
maintain these systems.
The Revenue Impact of RIK Sales Is Mixed:
Our analysis of sales in three RIK pilots indicates a mixed performance
when comparing RIK sales revenue to what might have been collected
under cash royalty payments. Specifically, (1) RIK sales in Wyoming
increased revenues by about 2.6 percent, for an estimated gain of
$967,000 on sales of about $37 million; (2) a 6-month oil sale in the
Gulf of Mexico decreased revenues by 5.5 percent, for an estimated loss
of $7.2 million on sales of about $131 million; and (3) natural gas
sales in the Gulf of Mexico produced more revenues than would have been
collected from cash royalty payments--an increase of about 2 percent,
for an estimated gain of $4 million on revenues of $210 million. These
sales represented about 11 percent of the gas and 57 percent of the oil
that MMS took in kind from inception of the pilots through November
2003. Our attempts to review the revenue impact of more RIK sales were
precluded by specific limitations in MMS financial data and the
availability of only two independent MMS draft reports.[Footnote 5] As
we observed in our January 2003 report, MMS continues to expand its RIK
pilots without analyzing and documenting the revenue impacts of all its
RIK sales. MMS is making some progress in this area, but still has not
demonstrated that it has received fair market value, or at least as
much as it would have received in cash royalty payments.
RIK Oil Sales in Wyoming Increased Revenues by About 2.6 Percent:
MMS chose to conduct its first RIK oil sales in Wyoming because of the
state's active oil markets and the cooperative spirit of state
officials. MMS offered for sale the federal government's royalty share
of oil together with the state of Wyoming's royalty oil that was for 6-
month periods beginning in October 1998.[Footnote 6] Bidders offered a
fixed amount of money either more or less than published market prices,
such as Wyoming posted prices, Canadian posted prices, and the oil
futures contract on the New York Mercantile Exchange (NYMEX).[Footnote
7] The winning bidders, which included companies that market, refine,
transport and/or produce oil in Wyoming and adjacent states, accepted
delivery of the oil at the lease. Although MMS's RIK sales in Wyoming
accounted for only about 1 percent of total federal royalty oil, MMS
acquired significant knowledge on how to conduct sales and market oil
onshore. For example, MMS determined that companies more commonly bid
on royalty oil from properties that are connected to pipelines and
prefer flexibility in choosing a specific price upon which to base
their bid. In addition, MMS learned in 2002 that it was not profitable
to transport the volumes from many scattered leases to one central
location for sale.
In a draft report issued in March 2001, updated in June 2002, and
finalized in March 2004, MMS estimated that it received slightly more
revenue in its first three RIK sales than it would have received in
cash royalty payments. Specifically, MMS reported that it collected
$810,000 more from RIK sales than it would have received in cash
royalty payments, or an increase of about 2.9 percent on sales of
$27.66 million from October 1998 through March 2000. MMS based its
conclusion on a comparison of winning RIK bids to severance taxes that
producers reported and paid to the state of Wyoming. State severance
taxes are calculated as a percentage of the value of all oil that
companies sell, regardless of whether the oil is produced from federal,
state, or private lands. Because the state of Wyoming's oil valuation
statutes are similar to how the federal government values oil, MMS
assumed that the price that companies reported for state severance
taxes on RIK properties was equal to the price that the government
would have received in cash royalty payments. However, MMS did not
demonstrate that the average sales prices for cash royalty payments
were equal to the average sales prices used to calculate Wyoming
severance taxes, initially creating some uncertainty about MMS's
revenue calculations.
To address the uncertainty in MMS's assumption about the relationship
between cash royalty payments and severance tax prices, we analyzed the
relationship. For nine federal properties[Footnote 8] that accounted
for about 47 percent of the oil that MMS sold in Wyoming during the
first seven RIK sales, we compared Wyoming severance tax data with
MMS's financial data for the 33-month period prior to the RIK sales and
concluded that Wyoming severance tax prices are a reasonable proxy for
cash royalty payments. Therefore, based on Wyoming severance tax data,
we estimated that MMS collected $967,000 more from the RIK sales from
October 1998 through March 2002 than it would have collected in cash
royalty payments--an increase of about 2.6 percent on sales of about
$37 million. The results of our analysis of selected Wyoming RIK sales
are consistent with MMS's conclusion that the RIK sales that it
analyzed resulted in slightly more revenue that it would have realized
if it had accepted cash royalty payments. A more detailed discussion of
our analysis appears in appendix I.
Six Months of RIK Oil Sales in the Gulf of Mexico Decreased Revenues by
About 5.5 Percent, But Long Term Impacts Could Differ:
Although MMS has a long-standing history of selling royalty oil through
the Small Refiners Program, MMS did not sell offshore royalty oil
directly to other qualified purchasers until November 2000. MMS sold,
through two separate 6-month sales, up to 20 percent of the federal
government's royalty share of oil in the offshore Gulf of Mexico to all
purchasers meeting predetermined financial qualifications, whether
they were small refiners, large refiners, producers, or
marketers.[Footnote 9] Winning bidders offered a fixed amount of money
that was more than or less than a formula based on one of two widely
published oil prices--Koch's published price for West Texas
Intermediate oil in the first sale and the NYMEX futures contract in
the second sale. During the first sale, MMS offered about 39,000
barrels of oil per day, but awarded contracts for only about 7,600
barrels per day. Only two companies submitted bids. MMS attributed the
lack of interest to the delivery points for the oil being at market
centers onshore rather than offshore near the lease. During the second
sale, which commenced in October 2001, MMS offered and awarded
approximately 48,000 barrels of oil from six major pipeline systems.
Nearly all of the oil consisted of two types, referred to as the Mars
and Eugene grades, produced in water depths up to about 4,000 feet. The
delivery point for the oil was offshore near the lease, and competition
was robust. MMS terminated the Gulf RIK oil pilots after the second
sale when ordered by a Presidential directive to transfer oil from
these properties to the SPR.
As of July 2003, MMS had not evaluated the revenue impacts of either
sale. Because of the larger amount of oil sold during the second sale,
we chose to analyze this sale and estimated that MMS received about
$7.2 million less in revenues than it would have received had it
accepted cash royalty payments--a 5.5 percent loss on sales of about
$131 million. We selected 13 of the 26 leases included in the second
sale that collectively accounted for about 89 percent of the oil
offered and sold. For the 16-month period prior to the start of the
second oil sale, we compared the average monthly sales price for oil
from each lease to the price as prescribed by MMS's oil valuation
regulations for sales between affiliated parties (transactions not at
arm's-length).[Footnote 10] We then computed a weighted average
difference in the monthly prices for the entire 16-month period and
assumed that this weighted average difference would have persisted over
the 6-month RIK sales period had royalties been paid in cash. A
detailed explanation of our analysis appears in appendix I.
Because revenue from RIK sales and from cash sales can differ
considerably in any given month, a longer period of evaluation is
needed to determine whether a specific type of RIK sales can generate
at least as much royalty revenue as cash sales. The reason that RIK and
cash sales revenues differ month to month is that they are generally
based on different sets of market prices. For example, the formula that
MMS used to award RIK bids in the second Gulf of Mexico sale differs
from the formula prescribed in the oil valuation regulations primarily
in two ways: (1) the bidding formula relies on prices from a period
that is almost a month earlier than that prescribed by the oil
valuation regulations, thereby creating a timing difference and (2) the
bidding formula relied on an adjustment to NYMEX futures price,
referred to as "the roll." The roll is an adjustment that compensates
for differences in oil futures prices for subsequent months. If futures
prices for the next three trade months trend downward, the roll is a
positive adjustment. If futures prices trend upward for the next three
trade months, the roll is a negative number. Rising oil futures prices
that accompanied uncertainty in the financial markets after the
September 11 terrorist attacks resulted in generally lower-than-
anticipated RIK royalties caused by the timing differential and a
negative roll, thereby contributing significantly to the negative
performance of the second sale.
MMS officials agree that a 6-month term is an insufficient period of
time during which to evaluate a sales methodology. Specifically, MMS
added that it had intended to continue the oil sales in the Gulf of
Mexico but that the President directed that royalty oil be used to fill
the SPR, and royalty oil from the leases included in the pilot sales
was the only feasible source. Although MMS generally agrees with the
magnitude of the revenue impact that we identified during the 6-month
period of the second sale, MMS believes that we should have examined a
longer period of time, even though the oil that was sold during this
sale was thereafter transferred to the SPR. After learning of our
analysis, MMS conducted its own evaluation of many of the same leases.
MMS combined the results of the 6-month second sale with the following
12 months during which oil from these same leases was transferred to
the SPR. MMS estimated that during this combined 18-month period, its
sales methodology increased revenues by $4.9 million. This estimate,
however, does not mean that MMS collected $4.9 million more than it
would have collected in cash royalty payments. MMS's estimate is based
on combining cash collections from RIK sales in the first 6 months with
market index prices at the time that MMS transferred the oil to the
Department of Energy (DOE) for filling of the SPR. MMS estimated that
it lost $6 million in cash during the first six months and that the
value of the oil transferred to DOE was $10.9 million more than it
would have received in cash royalties had the RIK pilot sales continued
for the next 12 months.
We do not believe that MMS's evaluation of the SPR program is
necessarily indicative of how the RIK program would have performed had
it been allowed to continue. The SPR program does not generate royalty
income for the federal government in the same way as the RIK program
does. In the SPR program, the royalty oil, or an equivalent amount from
another source, is pumped into the reserve, and revenues will only be
generated upon its removal and sale at some unspecified period in the
future. In addition, the data that MMS used in estimating the revenue
impacts of its Gulf of Mexico oil sales was problematic in several
ways. First and most important, MMS did not adjust its revenue estimate
by quality bank adjustments. Quality bank adjustments are either
positive or negative adjustments to sales revenues that pipeline
companies compute because the royalty oil is of either better or worse
quality than the average quality of oil in the pipeline. Payors either
add or subtract these adjustments from both their cash and in-kind
royalty payments to MMS. Quality bank adjustments can be substantial--
during the second RIK sale, they lowered MMS's revenues on the leases
we examined by $2.5 million. Second, MMS did not use the actual
transfer volumes to the SPR in its financial database, opting instead
to use volumes recorded in its production database or to use estimates
of these volumes, adding uncertainty to the accuracy of its revenue
calculations. For example, we examined the production volumes for 8 of
the 13 leases we reviewed during the 6-month sale and found significant
discrepancies between these volumes and the volumes in its financial
database. Similarly, independent auditors performing an audit of MMS's
fiscal year 2002 financial statements noted that MMS's use of estimated
volumes did not ensure an accurate calculation of the SPR amounts
transferred to DOE. Third, we identified some minor discrepancies in
the prices MMS used to calculate the value of the SPR transfers, such
as using an index other than that used during the 6-month sale and
assuming that companies bid exactly the same on the SPR transfers as
they did in the 6-month sale, but it is unclear as to whether these
discrepancies would significantly alter MMS's calculations.
Sales of Royalty Gas from Two Pipelines in the Gulf of Mexico Generated
Higher Revenues Than Would Have Been Expected from Cash Royalties:
After initial experimentation with selling royalty gas in 1995 and
simultaneously with the contracting of gas marketers in 1999, MMS
established sales procedures for offshore royalty gas similar to those
in 2003. Beginning in June 1999, MMS tested the sale of offshore
royalty gas from 11 federal offshore leases. Production from these
leases flowed through the Matagorda Offshore Pipeline System or through
the Blessing Pipeline System.[Footnote 11] MMS entered a cooperative
agreement with the Texas General Land Office to conduct the RIK sales
because under section 8(g) of the Outer Continental Shelf Lands Act,
royalty revenues for federal leases located in coastal waters are to be
shared with the state. MMS sold the royalty gas for 1-month periods at
competitive auctions, during which purchasers who met minimum financial
qualifications bid an increment or decrement relative to applicable
published gas indexes. Several months into the pilot, MMS started
dividing the gas into two separate packages--a larger package (base
volume), for which MMS guaranteed that it would deliver the specified
volume at a fixed first-of-the-month price, and a smaller package
(swing volume), for which MMS did not guarantee the volume delivered
and which MMS offered at published prices that varied daily. Beginning
in 2000, MMS began combining its monthly gas sales into two sales
periods for administrative reasons. MMS now conducts gas sales for
delivery from April through October, corresponding to the period during
which natural gas is used extensively for air conditioning, and for
delivery from November through March, corresponding to the period
during which natural gas is used extensively for heating.
In accordance with its cooperative agreement with the Texas General
Land Office, MMS issued a draft report in March 2002 on the analysis of
its gas sales from the Blessing and the Matagorda Offshore Pipeline
Systems from June 1999 through December 2000. The report stated that
the RIK sales increased revenues by nearly $1 million over what it
would have collected in cash royalties--an increase of about 1 percent
on sales of almost $100 million. MMS obtained this estimate by
comparing RIK sales revenues to cash royalty sales from 18 other leases
located in the same geographic area. However, because of limitations
with its financial data, MMS did not subtract the costs of transporting
the gas to its sales points onshore, comparing gross unit prices rather
than prices net of transportation allowances.
After reviewing MMS's study and conducting our own analysis, we reached
conclusions similar to those of MMS--that revenues from the sale of RIK
gas from the Blessing and Matagorda Offshore Pipeline Systems were
higher than MMS would have received in cash royalty payments. We
included additional RIK leases in our analysis, excluded some cash
royalty payments that MMS later identified as not coming from leases on
the same pipeline systems, and extended the time frame of our study to
December 2001. We estimated that, including the cost to transport the
RIK gas to its onshore sales points, revenues were increased by about 2
percent. Hence, we estimate that MMS realized about $4 million more
than it would have collected in cash royalties, or a gain of about 2
percent on sales of about $210 million. A more detailed description of
our analysis appears in appendix I.
Data Limitations Prevent a More Comprehensive Analysis of RIK Sales:
In analyzing RIK sales, we identified specific limitations in MMS's
financial data that inhibited our analysis and precluded us from
conducting a comprehensive computer-based assessment of all RIK sales.
A small amount of erroneous, missing, and improperly coded financial
data, together with other anomalous but legitimate financial data,
required time-consuming inspections of these data and complex edit
checks to ensure data reliability and integrity. For example, in our
analysis of the three RIK pilot sales, we analyzed almost 60,000
financial transactions, followed at times by a line-by-line inspection
of some of these data, discussions with MMS personnel, and manual
checks of source documents. MMS staff confirmed that the financial data
in their raw form were unreliable in assessing program performance; in
some instances, MMS staff chose to use contract prices or production
volumes in lieu of the financial data because they lacked confidence in
the available financial data. In addition, the lack of a systematic
method to electronically combine data in its financial database with
well, pipeline, product quality, and market center data also prevented
us from analyzing the revenue impacts of all offshore RIK sales.
Although MMS obtains and records these data for individual properties
included in its RIK sales, MMS personnel must manually obtain these
data for each property through time-consuming phone calls and searches
of industry databases. According to its procedures, MMS performs these
data collection efforts each time it expands the RIK program into new
areas. However, MMS's unsystematic collection and recording of these
data may slow the development of benchmarks against which to compare
RIK sales in the future.
In 2001, MMS took steps to improve its collection and management of
royalty data and to develop the means to identify and correct erroneous
financial data. For example, MMS began to develop a more consistent
coding of RIK transactions, and MMS personnel in the RIK Office began
to take a more active role in entering RIK transactions for the purpose
of ensuring data reliability. In October 2001, MMS revised its
electronic form for collecting royalty data in an attempt to correct
erroneous data. More recently, MMS sought external assistance in
developing software to identify erroneous data that can then be
corrected or eliminated. While some of the data problems may have been
resolved by MMS, other problems continue to be evident. Specifically,
the misallocation of SPR volumes to some individual leases and the
aggregating of sales from multiple gas leases will continue to
complicate future analyses unless these problems are corrected. MMS
says that it plans to correct these deficiencies as it further refines
its newly acquired oil and gas information systems. See appendix I for
more detailed information on data problems.
Lacking Formal Requirements, Many RIK Sales Remain Unanalyzed:
Our ability to assess the revenue impact of RIK sales was further
limited by the failure of MMS to analyze and document the results of
its sales. We reported in January 2003 that MMS quantified the revenue
impacts of only 9 percent of the 15.8 million barrels of federal
royalty oil that it sold from October 1998 through July 2002 and about
44 percent of the 241 billion cubic feet of federal royalty gas that it
sold from December 1998 through March 2002. MMS has since sold an
additional 201 billion cubic feet of gas in the Gulf of Mexico and an
additional 1.4 million barrels of oil in Wyoming through November 2003,
but has not published an analysis of the revenue impacts of these
sales. In total, we estimate that MMS has analyzed only 8 percent of
the 17.2 million barrels of royalty oil and 24 percent of the 442
billion cubic feet of royalty gas sold during RIK pilot sales through
November 2003. This limited analysis of revenue impacts could be a
significant issue as RIK sales expand in the future. Based on MMS's
estimates for further expansion of the program, we estimate that MMS
could be collecting between $1.5 billion and $2.5 billion per year in
revenue from the RIK pilot sales by 2008.
MMS has not systematically analyzed and documented the results of all
its RIK sales for four main reasons. The first and most significant
reason is that MMS has no requirement that all sales results be
analyzed and documented. Although the Congress directs MMS to (1)
obtain fair market value and (2) collect at least as much revenue from
the RIK sales as MMS would have collected from traditional cash royalty
payments, MMS is not required to document how this directive is met.
While MMS does analyze factors that will affect the revenues of
upcoming sales, MMS lacks a systematic process for analyzing the final
results of each of its sales. Second, staff responsible for conducting
sales already believe that they have enough information on sales
results. For example, MMS staff cited the second 6-month oil sale in
the Gulf of Mexico in which market conditions unexpectedly moved in a
manner that resulted in revenue collections that were less for this
period than what would have been expected from cash royalty
collections. MMS stated that they had enough information on the market
conditions that drove the sales results even before completion of the
6-month sale. Third, insufficient staff is available for analyzing
sales. We observed that staff who conduct sales are busy with
identifying properties for inclusion in sales, establishing minimum
acceptable bids, evaluating bids, and expanding the program. MMS has
only one staff member independent of the RIK Program whose duties
involve selectively analyzing RIK sales results at the direction of MMS
management. To ensure proper management control and to remove the
appearance of a conflict of interest, it is best to segregate the
responsibility of a program's operation from the responsibility of
reviewing the program, which MMS correctly did when it reviewed the
Wyoming oil and the Gulf of Mexico gas sales. Fourth, a lengthy
management review process limits the usefulness of analyses that are
conducted. For example, MMS's report on the Wyoming pilot sales dated
March 2001 and its report on gas sales in the Gulf of Mexico dated
March 2002 remained in draft form pending final management approval
until March 2004. In addition, a study of subsequent gas sales in the
Gulf of Mexico, completed in April 2003, is still being reviewed and
modified under the direction of MMS management.
MMS Has Recently Taken Steps to Address Deficiencies in Analyzing Sales
Results and Quantifying Administrative Efficiency:
Since our last report, MMS has hired an industry consulting group to
develop a strategic plan to guide the transition of the RIK pilots
through the end of 2008. MMS intends to develop a 5-year business plan
based largely upon the consulting group's plan. The consulting group,
among other things, has proposed that MMS (1) develop benchmarks that
are indicative of fair market value; (2) develop a consistent process
for monitoring RIK sales at regular time periods against these
benchmarks; (3) develop a consistent process for deciding whether to
accept cash royalty payments or to take RIK; (4) track administrative
efficiency expressed as the cost per unit of royalty oil and gas sold;
and (5) measure the amount of time it takes to collect, report, audit,
and reconcile RIK revenue collections. The consulting group intends
that the benchmarks satisfy MMS's congressional mandates that RIK sales
achieve fair market value and generate at least what would have been
collected in cash royalty payments. The consulting group has developed
a timetable for MMS to develop benchmarks for fair market value by
March 2004 and benchmarks for administrative efficiency by March 2005.
While much of the data collection for developing benchmarks will remain
a manual process, MMS anticipates that overall calculation of RIK
Program performance will be facilitated by MMS's newly acquired RIK
information systems. MMS stated that while data on RIK sales are
available in less than 30 days after the sales month, RIK purchasers
continue to submit data on quality adjustments and volume imbalances
after these sales, and MMS must enter these data into its financial
systems and audit the final figures. MMS believes that 120 days after
an RIK sale, it will have completed these audits and has set this 120-
day period as a formal objective. Within 180 days, MMS stated that it
would be able to report on the results of these sales. However, many
RIK sales only have a length of about 180 days or less, so obtaining
performance results 180 days after a sale is not timely enough to use
these results to modify the next sale. Recognizing this limitation, the
consulting group recommended that performance be measured on a monthly
or quarterly basis, and MMS believes this will be possible with its
newly acquired RIK information systems.
Conclusions:
RIK can be an important tool for managing the collection of royalty
revenues from federal oil and gas leases. In light of the possibility
of revenue collections from RIK sales approaching $1.5 billion to $2.5
billion by 2008, it is important that MMS measure and document the
revenue impact and costs of administering RIK relative to cash royalty
payments, to ensure itself and the public that royalties are collected
in the most efficient manner. In doing so, MMS may be able to
conclusively show that it has reduced overall administrative costs or
collected more than traditional cash royalty payments. MMS has made
some progress in analyzing the revenue impacts of some of its sales,
but many sales remain unanalyzed, and MMS has yet to implement a more
systematic and timely approach to analyzing these sales. Also,
completely quantifying the administrative efficiency of these RIK sales
continues to be a challenge. While key data from MMS's new activity-
based cost management system have shed some light on the difference in
costs to administer RIK and cash royalties, MMS has been unable to
quantify any overall benefit that may arise from shifting resources to
auditing more cash royalty payments and from changes in litigation due
to RIK. Unless steps are taken to quantify the impacts of these
changes, MMS and the Congress will be unable to determine the
efficiency of RIK. Because MMS has not systematically assessed and
documented the overall administrative cost and revenue impacts of many
RIK sales, knowledge of MMS's RIK Program is insufficient to determine
whether MMS should expand or contract the use of RIK.
Matters for Congressional Consideration:
Should the Congress seek a more systematic and timely evaluation of RIK
efforts, the Congress may want to consider directing MMS to implement a
systematic process for evaluating all future RIK sales in a timely
manner and to quantify any changes in the administrative cost and
revenue impact on royalty collections as a result of RIK.
Agency Comments and Our Evaluation:
We provided the Department of the Interior with a draft of this report
for review and comment. Interior generally agreed with our observations
and emphasized the steps that they are taking to improve their
measurement of RIK sales performance. Interior said that the insights
and conclusions contained in the report are timely and will be valuable
in their efforts to improve the RIK Program. Their comments and our
response to these comments are reproduced in appendix II.
As agreed with your offices, and unless you publicly announce its
contents earlier, we plan no further distribution of this report until
30 days from the date of this letter. At that time, we will send copies
of this report to the Secretary of the Interior; the Director of the
Office of Management and Budget; and other interested parties. We will
also make copies available to others upon request. This report will be
available at no charge on GAO's Web site at [Hyperlink,
http://www.gao.gov].
If you have any questions about this report, please call Mark Gaffigan
or me at (202) 512-3841. Key contributors to this report are listed in
appendix III.
Signed by:
Jim Wells:
Director, Natural Resources and Environment:
[End of section]
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
To determine the administrative cost savings associated with RIK, we
first examined MMS's two draft studies on RIK sales--Wyoming Oil
Royalty In Kind Pilot, Evaluation Report (June 1, 2002) and Texas
General Land Office/Minerals Management Service 8(g) Gas Royalty In-
Kind Pilot, A Report (March 27, 2002). We reviewed MMS's logic and
assumptions in these reports concerning the quantification of
administrative savings and benefits attributable to RIK. We used the
data in these reports, MMS's budgetary data, and testimonial evidence
from MMS officials to identify which aspects of administrative savings
and benefits to investigate. We then obtained data from the activity-
based cost (ABC) management system for the entire fiscal year 2003 and
solicited MMS's assistance in understanding the individual activities
and in identifying which direct costs were attributable to RIK sales
and which were attributable to cash royalty collections. We also
obtained one-time expenditures for MMS's new information systems from
MMS officials and supporting documentation since not all of these costs
were reflected in the fiscal year 2003 ABC data. To calculate costs for
auditing cash royalty payments and RIK sales revenue on a per-lease
basis, we used ABC data, together with the numbers of the different
types of leases that MMS audited in fiscal year 2003, as supplied by
MMS. We obtained data on additional royalty revenue obtained through
auditing and compliance activities from MMS's report entitled Report of
Royalty Management and Delinquent Account Collection Activities, Fiscal
Year 2000. We interviewed MMS personnel on the costs of appeals, and we
interviewed attorneys in the Department of the Interior's Solicitor's
Office to obtain information on the impact of RIK sales on litigation.
Finally, we audited revenue from all RIK sales during fiscal year 2002
to determine the benefit of early collections.
To evaluate all of MMS's RIK pilot sales, we planned to compare RIK
sales revenues with cash royalties from comparable federal leases. We
started with sales in the Gulf of Mexico by attempting to identify
comparable leases through the electronic matching of attributes, such
as type of oil, sulfur content, market center, well location, pipeline
available for shipment, and distance to the nearest market center. To
do so necessitated combining data on these attributes in MMS's offshore
geographic information system with data on sales values, sales volumes,
royalty values, royalty volumes, transportation deductions, and quality
bank adjustments in MMS's financial system. We examined data from
January 1997 through July 2003, but we did not independently verify the
integrity of MMS's financial database. Unfortunately, we could not
perform the intended analysis because of two reasons: (1) we were
unable to link the data in the financial system with data in the
offshore geographic information system, and (2) we identified many data
anomalies in MMS's financial database. We were unable to link the
financial data with data in the offshore geographic information system
because the common link--the lease number--had been compromised during
some RIK gas sales. Specifically, MMS personnel who entered these data
had combined RIK sales revenue from multiple leases and entered these
data under a new lease number referred to as a "dummy lease number." We
also found that some data that would be helpful in identifying
comparable oil leases, such as the quality of oil and the sulfur
content, were not present in MMS's geographic information system. Upon
examination of the financial data, we discovered many data anomalies
that prevented us from reliably and easily aggregating the monthly
transactions to the same lease and payor. Within the data aggregated to
the month-lease-payor level, anomalies included negative sales volumes,
missing sales values, negative sales values, and missing quality
measures for gas prior to fiscal year 2002. Some of these anomalies
were obvious errors, but many more appeared to be correct and
legitimate data entries. With no explanations in the financial data
documentation to indicate which anomalies were accurate and which were
not, resolving the anomalies required line-by-line inspection of the
data and, in some cases, manual checks with other documentation. As a
result of the large number of data anomalies and the time-consuming
process required to correct and verify the royalty data, we undertook
case studies of MMS's RIK pilots in three sales areas: (1) RIK oil
sales in Wyoming, (2) RIK oil sales in the Gulf of Mexico, and (3) RIK
gas sales on two pipelines in the Gulf of Mexico.
Wyoming Oil:
In analyzing the integrity and reliability of MMS's financial data that
we used to evaluate RIK oil sales in Wyoming, we selected nine
properties that provided about 47 percent of the oil sold during the
RIK sales we analyzed. We selected properties that produced the three
different types of crude oil that MMS sold in its RIK sales--asphaltic,
general sour, and Wyoming sweet oils. We obtained MMS's financial data
for all nine properties from January 1996 through March 2002 and
aggregated these 32,823 financial transactions to the property-month
level rather than the lease level because we anticipated that the
financial impact of the smaller leases would not be as significant. We
found that 3.3 percent of property months contained erroneous or
missing data, but we were able to correct or obtain these data.
To estimate the revenue impact of Wyoming RIK oil sales, we attempted
to determine if Wyoming severance tax[Footnote 12] prices were a good
proxy for what MMS would have received in cash royalty payments. We
first obtained the state of Wyoming's severance tax data for the same
nine properties. We then proceeded to examine the average sales price
per barrel and the number of barrels produced from each property during
each of the 33 months immediately preceding the first RIK sale. The
Bureau of Land Management, which leased the nine federal properties in
Wyoming, grouped federal leases into these properties based on the
geological boundaries of the oil fields. Personnel with the state of
Wyoming, however, group producing leases into clusters for tax
purposes. At our request, a Wyoming state official attempted to match
these clusters as closely as possible to the federal properties.
However, some clusters included additional state or private leases that
they could not segregate, and in some instances, the state official
could not precisely match the properties. We then graphed the volumes
reported to the state of Wyoming for severance taxes and the volumes
reported to MMS for cash sales for each of the nine properties. The
graphs suggested that seven state properties contained many of the same
federal leases. We then graphed the state severance tax prices and
MMS's cash royalty prices for each property. We determined that the
severance tax prices and MMS's cash royalty prices are essentially the
same for eight properties. The severance tax prices for the ninth
property were on average about 50 cents higher than MMS's cash royalty
prices. See figures 1, 2, and 3 for graphs of these prices that
aggregate properties according to type of oil.
Figure 1: Comparison of Weighted Average Monthly Sales Prices Obtained
from Wyoming Severance Tax Database and MMS's Financial System for
Selected Asphaltic Properties Subsequently Included in RIK Sales:
[See PDF for image]
[End of figure]
Figure 2: Comparison of Weighted Average Monthly Sales Prices Obtained
from Wyoming Severance Tax Database and MMS's Financial System for
Selected General Sour Properties Subsequently Included in RIK Sales:
[See PDF for image]
[End of figure]
Figure 3: Comparison of Weighted Average Monthly Sales Prices Obtained
from Wyoming Severance Tax Database and MMS's Financial System for
Selected Sweet Properties Subsequently Included in RIK Sales:
[See PDF for image]
[End of figure]
Gulf of Mexico Oil:
To evaluate the integrity and reliability of MMS's financial data that
we used to evaluate the second RIK oil sale in the Gulf of Mexico, we
examined MMS's financial data from January 1997 through March 2002 for
16 of the 26 leases in the sale. We removed all transactions involving
the SPR and small refiners so that we could compare sales from the
second RIK sale to cash royalty payments only. We found this initial
task difficult because MMS inconsistently used transaction codes for
sales to small refiners and for transfers to the SPR during the time
frame of our study. We aggregated 7,725 transactions to the payor-
lease-month level and found that 1.9 percent of the payor-lease-months
contained erroneous or missing data, and about 9 percent of the
aggregated data was compromised by payors using multiple payor codes.
Payors also inconsistently reported or did not report royalty volumes
when reporting transportation deductions prior to October 2001 and
inconsistently reported or did not report sales values when reporting
quality bank adjustments. We subsequently reduced the period of our
analysis to June 2000 through March 2002, reduced our leases to the 13
that accounted for about 89 percent of the oil sold during the sale,
and corrected the single significant error that we found in this data
set.
To estimate the revenue impact of the October 2001 through March 2002
RIK oil sale in the Gulf of Mexico, we first chose a sample of leases
included in the RIK sale and determined the relationship of their cash
sales prices before the RIK sale to the prices as prescribed by MMS's
royalty valuation regulations for sales to affiliated companies (also
known as transactions not at arm's length). We analyzed only those
leases that produced Mars and Eugene Island sweet oil because these two
oil grades collectively accounted for 96 percent of the production. We
then selected only the Mars and Eugene Island leases that had cash
royalty sales during at least 8 of the 16 months between June 2000--the
first month that the current oil valuation regulations became
effective, and September 2001--the month immediately preceding the RIK
sale. These selection criteria produced the 13 leases for our detailed
analysis. Eleven of the 13 leases had cash royalty sales during all 16
months. For each of the 13 leases, we then calculated the average
monthly cash sales price (net of any transportation allowances and
quality bank adjustments) from data in MMS's financial database for
each of the 16 months preceding the RIK sale. Next, we obtained the
average monthly price from MMS for Mars and Eugene Island sweet oils as
prescribed in MMS's oil valuation regulations for sales not at arm'
length at the market center for the same time period. We then
subtracted these monthly prices from the average monthly cash prices
and multiplied this difference by the barrels of oil sold each month to
yield monthly revenue for each lease relative to MMS's regulations.
Next, we summed these monthly revenues and divided the sum by the total
barrels of oil sold to obtain a weighted average difference per barrel
for the entire 16-month period. This value, -$1.36, indicates that MMS
received on average $1.36 less than the market center price for each
barrel of royalty oil produced from these 13 leases from June 2000
through September 2001. We attribute most of this difference to the
payors' costs of transporting the oil to market. Finally, for the 6-
month term of the RIK sale, we calculated a weighted average difference
per barrel between the RIK sales price and the price as prescribed by
MMS's valuation regulations for transactions not at arm's length. This
value, -$2.24, indicates that MMS received on average $2.24 less than
the average market center price for each barrel of oil that MMS sold
during its RIK sale from October 2001 through March 2002. We then
assumed that if MMS had not conducted this RIK sale, it would have
received cash royalty payments that on average would have been $1.36
less than the market center price as we previously computed. We
subtracted $2.24 from $1.36 to estimate that MMS lost on average $0.88
on every barrel that MMS sold during this RIK sale. Since MMS sold 8.2
million barrels during this sale, MMS lost approximately $7.2 million.
Gulf of Mexico Gas:
In analyzing MMS's financial data on gas sales in the Gulf of Mexico,
we discussed with MMS officials the financial data limitations that
they identified while conducting their analysis of RIK gas sales--
limitations that prompted MMS personnel to use invoice prices rather
than the sales data in MMS's financial database. We then obtained
19,211 financial transactions for all the cash and RIK sales on the
Blessing and Matagorda Offshore Pipeline Systems (MOPS) from January
1997 through December 2001. Upon aggregating these data to the payor-
lease-month level and researching anomalous data, we found that 6
percent of the RIK summary data remained anomalous. Consequently, we
decided to use the RIK invoice data, adjusted for transportation costs,
to compute net unit prices for the RIK transactions.
To estimate the revenue impacts of RIK gas sales in the Gulf of Mexico,
we relied on financial data aggregated to the lease-month for all cash
sales on the Blessing Pipeline System and on MOPS from January 1997
through December 2001.[Footnote 13] On each of the pipeline systems,
MMS determined that the leases from which it received cash royalty
payments were comparable to the leases from which it collected RIK. For
each lease connected to the Blessing Pipeline System, we calculated the
average cash sales price net of all reported transportation costs per
MMBtu for each month and subtracted it from the average RIK sales price
net of all transportation costs per MMBtu for each month.[Footnote 14]
We then multiplied these figures by the quantity of royalty gas (in
MMBtu) sold in kind each month to obtain the monthly revenue impacts,
and we then summed the monthly revenue impacts to yield total revenue
impacts of the RIK sales on the Blessing Pipeline System. To determine
the revenue impacts of RIK sales on MOPS, we followed the same
procedure as that on the Blessing Pipeline System, using data specific
to sales on that pipeline. We then summed the revenue impacts from RIK
sales on both systems to yield the total estimated revenue gain of
about $4 million on sales of about $210 million.
Other Factors May Affect Revenue Analysis:
Our case studies did not include other overall factors that may affect
revenues from RIK sales. First, differences in the timing of royalty
collections can affect total revenue collections because an earlier
collection of these revenues allows the Treasury to earn interest on
the funds collected. Revenues from the sale of royalty oil are due 10
days earlier than cash royalties, while revenues from the sale of gas
are due 5 days earlier than cash royalties. We reviewed MMS's revenue
collections from all RIK pilot sales during fiscal year 2002 and
determined that 98 percent of the oil and 92 percent of the gas
revenues were collected according to this early schedule. For fiscal
year 2002, we calculated the combined benefit to be about $128,500, or
about 0.03 percent on a total of $454 million collected in RIK pilot
sales.[Footnote 15] MMS may have also realized relatively small amounts
of money from interest on those revenues that were late. Future
benefits will depend upon the amount of oil and gas sold in kind,
interest rates, and the sales prices of oil and gas. Secondly, during
the time frame of our revenue analysis, data were not available on a
lease-by-lease basis that would enable us to estimate how much
additional revenue had accrued to MMS as the result of the audit
process. Hence, we could not determine whether any additional funds
collected as a result of auditing were included in MMS's financial
data. For example, Wyoming state auditors who audit the federal leases
in Wyoming that we included in our revenue analysis stated that they
audited some of these leases for some of the time frame. While any
additional audit collections would be expected to affect unit prices in
both MMS's financial database and the state's severance tax database,
additional collections were not necessarily recorded for every lease.
We did not examine how any additional collections resulting from audits
were recorded for oil and gas leases in the Gulf of Mexico because of
the difficulty in accessing individual leases in the information system
that tracks auditing efforts. In addition, some of the time frame that
we included in our revenue analyses had not yet been audited by MMS
when we initiated our work.
[End of section]
Appendix II: Comments from the Department of the Interior:
United States Department of the Interior:
OFFICE OF THE SECRETARY
Washington, DC 20240:
TAKE PRIDE IN AMERICA:
APR - 5 2004:
Mr. Jim Wells:
Director, Natural Resources and Environment
U.S. General Accounting Office:
441 G Street, N.W. - Room 2T23A
Washington, D.C. 20548:
Dear Mr. Wells:
We appreciate the opportunity to review the U.S. General Accounting
Office (GAO) Draft Audit Report, MINERAL REVENUES: "Cost and Revenue
Information Needed to Compare Different Approaches for Collecting
Federal Oil and Gas Royalties." Our general and specific comments are
enclosed for you to consider for incorporation into the final report.
The insights and conclusions contained in the draft report are timely
and will be valuable in our efforts to improve the Federal Royalty-In-
Kind Program. We generally agree with your observations as more fully
described in the enclosed response.
The Department of the Interior's Minerals Management Service (MMS) has
been implementing an asset management approach for the collection and
verification of the Nation's oil and gas mineral royalties. In this
effort, MMS has implemented a strategic plan to make the royalty-in-
kind (RIK) approach a permanent component of the asset management
strategy to be used in tandem with the royalty-in-value (RIV) approach.
We appreciate GAO's acknowledgment of the progress made in advancing
the RIK approach in the March 2004 draft report.
Again, thank you for the opportunity to review and comment on this
report. If you have any questions, please contact Ms. Denise Johnson,
Minerals Management Service's Audit Liaison Officer, at (202) 208-3976.
Sincerely,
Signed for:
Rebecca W. Watson:
Assistant Secretary Land and Minerals Management:
Enclosure:
Response to March 2004 General Accounting Office (GAO) Draft Report
Titled "Cost and Revenue Information Needed to Compare Different
Approaches for Collecting Federal Oil and Gas Royalties":
Summary Comments:
The March 2004 draft GAO report primarily addresses the administrative
costs and revenues associated with the MMS royalty-in-kind (RIK) pilot
projects. The report offers insights and conclusions on the importance
of performance measures and information needed to comparatively
evaluate the RIK and royalty-in-value (RIV) approaches. The MMS agrees
with GAO and has already taken steps to improve RIK performance
documentation and measurement. As discussed below, we have been
implementing and will continue to refine implementation of new systems
and procedures necessary to ensure effective RIK program operations and
contemporaneous evaluation of program performance.
Since issuance of the January 2003 GAO report, MMS has successfully
designed and implemented three RIK information systems. All three
systems, a gas management system, liquids management system, and a Risk
and Performance Management (RPM) System, were implemented on time and
within budget. They are the operational backbone of the RIK program,
housing all transactions and most of the data. As a result, the RIK
management control process is now functioning on a par with commercial
industry standards.
The draft report states that limitations in MMS's access to and
analysis of revenue data prevented a comprehensive GAO assessment of
RIK sales. The MMS's program experience, combined with initial results
from new measurement tools, indicates that revenues are generally
higher and that administrative costs are reduced under the RIK
approach. The MMS has been awaiting completion of its new automated RIK
support systems to more fully address the limitations observed by GAO.
These systems are now implemented and MMS is able to better evaluate
both revenues and costs to document RIK program performance.
The GAO draft report correctly acknowledges implementation and use of
an Activity-Based Cost (ABC) Management System to capture cost data and
allocate to various minerals revenue management functions. The draft
report also notes that the ABC system has identified substantial audit
savings in FY 2003. These efficiencies have already freed-up resources
to conduct additional audits and assist on RIK functions.
GAO's analyses of the revenue impacts of two of the three RIK pilot
projects assessed in the draft report show revenue gains totaling some
$5 million. These assessments are consistent with MMS's internal
analyses of the same pilot projects. The MMS agrees with the GAO
conclusion that the time period covered in their assessment of the Gulf
of Mexico crude oil sale is too short for any meaningfully assessment
of economic results.
The draft report emphasizes the importance of systems and processes for
measuring both the administrative costs and revenue impacts of the RIK
program. MMS fully recognizes this responsibility. MMS's monitoring and
evaluation of the RIK pilot projects has always included in-depth pre-
sale, concurrent, and post-sale analyses of RIK value received. These
assessments document and assure that the MMS RIK program is complying
with the underlying statutory obligations authorizing the program.
The MMS agrees with the GAO conclusion that more systematic and timely
measurement of program performance is needed for the future. The
recently implemented information systems position MMS to
contemporaneously and systematically assess the revenue impacts of the
RIK program. In February 2004, MMS measured revenue impacts for the
natural gas RIK program and the non-SPR crude oil program in the Gulf
of Mexico for recent periods. Results are being evaluated and appear to
be slightly revenue positive. We are now able to measure revenue
performance of the RIK program in a systematic, timely, and continuing
manner. The Administration supports the RIK language in the Energy Bill
which would substantially address the GAO recommendation to institute
systematic and timely measurement of the RIK program.
The MMS believes that a Federal RIK Program is essential to the
effective management of the Nation's oil and gas royalty assets. In
January 2003, MMS competitively awarded a contract to the Lukens Energy
Group of Houston, Texas, to commercially assess the RIK program,
recommend improvements (focusing in major part on performance
measurement tools and metrics), and make recommendations relative to a
five-year RIK strategic planning initiative. Based on recommendations
of the Lukens Energy Group and GAO observations, MMS will publish a
Five-Year RIK Business Plan in May 2004. The Plan will include
strategic direction, clear goals and objectives linked to statutory
authorities, and specific management action items to advance RIK
business activity for 2004-2008.
Detailed Comments:
GAO Highlights Page and Page 1:
The GAO states that MMS collected $4.7 billion in FY 2003. While this
number is accurate as reflecting a 5-year average annual distribution
of mineral royalties, the correct number for mineral royalty
collections for FY 2003 is $5.6 billion.
Pages 2, 3, 4, 8, 23:
The draft report states that neither GAO nor MMS could quantify revenue
or cost impacts "conclusively," "completely," or "comprehensively." The
MMS agrees with this assessment, and notes that, due to inherent
uncertainties, comparisons of "actual" minerals revenue program results
to "projected" results of mineral revenue programs, whether under the
RIK or RIV approaches, are unlikely to ever conclusively, completely,
or comprehensively quantify revenue or cost impacts. On the revenue
side, estimates of what would have been received in RIV are just that -
estimates. On the cost side, as GAO points out in the draft report,
both the RIK and RIV programs are evolving and present moving targets
for comparative analysis.
Page 3:
The draft report states that MMS would not have incurred an FY 2003
direct cost of $1.7 million by accepting cash royalty payments. This
number incorrectly includes $496,000 for auditing and reconciling
volumes, a function that MMS incurs whether in RIK or RIV status. Thus,
the correct direct cost incurred by MMS in FY 2003 for RIK is $1.2
million.
Page 6:
GAO reports on expenditures for RIK systems development and operation,
but does not mention expenditure of significant funds for systems that
support financial and compliance activities. We believe that a balanced
treatment of comparative costs requires mention of system costs for
both RIK and RIV or neither.
Page 7:
The GAO states that 572 FTE were maintained by MMS from FY 2002 through
FY 2004. While this number is accurately sourced from MMS budget
documents, actual employees on board decreased from 602 in FY 2000 to
558 in FY 2004. While there are several variables accounting for the
decrease, the administrative ease of RIK is certainly one of the
primary factors. We recommend that GAO include these numbers in the
final report.
Also, with regard to administrative savings, we recommend that GAO
include data on the FTE trends in the compliance and asset management
(CAM) workforce (primarily an RIV-dedicated activity). Specifically,
the CAM offices have shown an FTE decrease of 44 from 2002 to 2004,
with some of this decrease contributing to the RIK FTE increase of 27
for the same period.
Page 11:
The GAO incorrectly describes the function of the Risk and Performance
Management (RPM) System (referred to by GAO as the risk management
information system) as the performance of credit monitoring. The RPM
actually is the system that supports measurement of revenue performance
of the RIK program. It was implemented in August 2003, and, in February
2004, was populated with data and utilized to begin measurement of RIK
revenue results for the natural gas and small refiner RIK programs for
periods during 2003. Credit monitoring is supported by MRM's gas and
liquids management systems.
Page 21:
The GAO incorrectly states that only one staff employee is assigned to
assessments of RIK revenue performance. In reality, six MRM staff and
one MRM senior manager, independent of the marketers, have spent major
portions of their time in the past year dedicated to these assessments.
In addition, the marketers located in the RIK Front Office have always
routinely and continually assessed performance results. Further,
substantial efforts from two contractors have been expended on
performance assessments and methodology for the past several years:
* In the past year, Lukens Energy Group submitted three reports to MMS
dedicated to this topic and another two deliverables addressing
performance metrics. Two contractor staff and one senior manager spent
the majority of their time on this effort, and:
For more than 2 years, MRM's systems contractor has been designing,
developing, implementing, and refining a Risk and Performance
Management System to measure the revenue performance of the RIK
program.
The GAO has spent a considerable amount of effort in conducting a
credible analysis of the revenue results of an MMS crude oil RIK sale
occurring from October 2001 through March 2002. We appreciate the
effort and believe that the results are parallel with our analysis. We
have several technical comments on the GAO analysis which we will
transmit to GAO field staff.
The following are GAO's comments on the Department of the Interior's
letter dated April 5, 2004.
GAO Comments:
1. We clarified our report to reflect these comments.
2. We included the costs of $496,000 for auditing leases and
reconciling volumes because MMS reported it as a direct cost of the RIK
pilot sales, and because it is unknown how many of these leases would
have been selected for auditing if they had not been in the RIK
Program.
3. We acknowledge that there are considerable costs for systems that
support financial and compliance activities. However, the financial
system supports both the collection of cash royalty payments and RIK
payments, so its costs are incurred regardless of whether royalties are
collected in cash or in kind. We acknowledge MMS's observation that the
compliance system has associated costs and that these costs are
incurred predominantly with the collection of cash royalties. However,
it was not our intent to compare systems costs under different methods
of collecting royalties. We intended only to mention the incremental
costs associated with collecting royalties in kind because MMS will
continue to incur costs associated with collecting cash royalty
payments.
4. We clarified the report by stating that there is only one staff
independent of the RIK Program whose duties involve analyzing RIK sales
results. We acknowledge that additional RIK Program staff and managers
analyze sales results. However, we believe that proper management
controls require that staff independent of the RIK Program should
analyze sales results for MMS management. We also acknowledge and state
in this report that an independent contractor has assisted with
developing a strategy for analyzing sales. We believe that this is a
significant step towards comprehensively and systematically analyzing
RIK sales results.
5. MMS's technical comments on its Gulf oil sale related to two issues:
(1) removing the effect of quality bank adjustments and (2) the
validity of extending its analysis for an additional 12 months. Because
of the variability of quality bank adjustments, MMS stated that it is
necessary to remove these adjustments before conducting an analysis,
and MMS believes that it has done so. We acknowledge the variability of
quality bank adjustments and also note that transportation allowances
associated with the leases that we reviewed are also variable, albeit
to a lesser degree. However, when we conducted our analysis, there was
insufficient data on quality bank adjustments for the time period prior
to the second RIK sale to effectively remove their effect from our
analysis. To compensate for the variability of both quality bank
adjustments and transportation allowances among the 13 leases we
examined, we chose to establish our relationship between cash royalty
payments and MMS's royalty valuation regulations for a relatively long
time period prior to the 6-month RIK sale. We assumed that the effects
of variability would be minimized over the 16-month period for which we
established our relationship. Concerning the validity of extending the
time period of analyzing the Gulf of Mexico oil sale, MMS restated its
belief that analyzing the transfer of oil to the SPR during the
subsequent 12 months is a valid technique. We already discussed the
limitations of using this technique in the report.
[End of section]
Appendix III: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Jim Wells (202) 512-3841 Mark Gaffigan (202) 512-3168:
Acknowledgments:
In addition to those named above, Ron Belak, Robert Crystal, Art James,
Lisa Knight, Jonathan McMurray, Franklin Rusco, Dawn Shorey, and Maria
Vargas made key contributions to this report.
(360304):
FOOTNOTES
[1] U.S. General Accounting Office, Mineral Revenues: A More Systematic
Evaluation of the Royalty-in-Kind Pilots Is Needed, GAO-03-296
(Washington, D.C.: Jan. 9, 2003).
[2] The Mineral Leasing Act uses the term "market price" not "fair
market value." The requirement to obtain market price does not cover
competitive sales, which by their very nature, provide some protection
to the federal government.
[3] We relied upon the direct costs identified by MMS--costs that MMS
defines as directly supporting its mission. We regarded the RIK direct
costs as being most indicative of the incremental costs to administer
the RIK pilots. We did not analyze indirect costs--those costs that MMS
defines as sustaining the organization, normally referred to as
overhead, including information technology support, general
management, and general administrative support. Indirect costs are
allocated back to the mission-supporting activities based on the ratio
of the labor cost contained in each direct work activity to the total
labor cost in all direct work activities.
[4] U.S. General Accounting Office, Mineral Revenues: A More Systematic
Evaluation of the Royalty-in-Kind Pilots is Needed, GAO-03-296
(Washington, D. C.: Jan. 9, 2003).
[5] Staff independent of the MMS RIK sales staff conducted draft
studies for 18 months of the Wyoming oil sales and 19 months of the
Gulf of Mexico gas sales. See Wyoming Oil Royalty In Kind Pilot,
Evaluation Report (June 1, 2002) and Texas General Land Office/Minerals
Management Service 8(g) Gas Royalty In Kind Pilot, A Report (March 27,
2002).
[6] Wyoming participated in all but the first 6-month sale.
[7] A NYMEX futures contract is an agreement through the New York
Mercantile Exchange for a future purchase or sale of 1,000 barrels of
sweet crude oil, similar in quality to West Texas Intermediate oil.
While most NYMEX contracts result in a financial gain or loss, rather
than the delivery and receipt of oil, parties to the agreement can
exchange oil at Cushing, Oklahoma, where several oil pipelines
intersect and where storage facilities exist.
[8] Properties consist of one or more leases. In Wyoming, producing
properties often contain more than one contiguous lease.
[9] The first sale was automatically extended for another 5 months.
[10] We chose MMS's valuation regulations for transactions not at
arm's-length for comparison because these regulations rely upon readily
available published oil prices at market centers through which the oil
must flow.
[11] Although not technically named the Blessing Pipeline System, GAO
and MMS refer to it by this name because the pipelines terminate at a
gas plant in Blessing County, Texas.
[12] Severance taxes are levied by the state as a percentage of the
value of the oil or gas that is produced, regardless of whether the
lease is for federal, state, or private lands.
[13] Unlike RIK transactions, data from cash sales could be manually
reviewed and adjusted to achieve an anomalous financial data rate of
less than 1 percent.
[14] MMBtu (one million British thermal units) is a measure of the
heating quality of the gas equal to 1,000 cubic feet of gas at a Btu
quality of 1,000.
[15] To make this calculation, we used the federal funds rate, which is
the rate that banks charge each other for short-term loans during the
Federal Reserve Bank check clearing process.
GAO's Mission:
The General Accounting Office, the investigative arm of Congress,
exists to support Congress in meeting its constitutional
responsibilities and to help improve the performance and accountability
of the federal government for the American people. GAO examines the use
of public funds; evaluates federal programs and policies; and provides
analyses, recommendations, and other assistance to help Congress make
informed oversight, policy, and funding decisions. GAO's commitment to
good government is reflected in its core values of accountability,
integrity, and reliability.
Obtaining Copies of GAO Reports and Testimony:
The fastest and easiest way to obtain copies of GAO documents at no
cost is through the Internet. GAO's Web site ( www.gao.gov ) contains
abstracts and full-text files of current reports and testimony and an
expanding archive of older products. The Web site features a search
engine to help you locate documents using key words and phrases. You
can print these documents in their entirety, including charts and other
graphics.
Each day, GAO issues a list of newly released reports, testimony, and
correspondence. GAO posts this list, known as "Today's Reports," on its
Web site daily. The list contains links to the full-text document
files. To have GAO e-mail this list to you every afternoon, go to
www.gao.gov and select "Subscribe to e-mail alerts" under the "Order
GAO Products" heading.
Order by Mail or Phone:
The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or
more copies mailed to a single address are discounted 25 percent.
Orders should be sent to:
U.S. General Accounting Office
441 G Street NW,
Room LM Washington,
D.C. 20548:
To order by Phone:
Voice: (202) 512-6000:
TDD: (202) 512-2537:
Fax: (202) 512-6061:
To Report Fraud, Waste, and Abuse in Federal Programs:
Contact:
Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail: fraudnet@gao.gov
Automated answering system: (800) 424-5454 or (202) 512-7470:
Public Affairs:
Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800 U.S.
General Accounting Office, 441 G Street NW, Room 7149 Washington, D.C.
20548:
