Mineral Revenues
Data Management Problems and Reliance on Self-Reported Data for Compliance Efforts Put MMS Royalty Collections at Risk Gao ID: GAO-08-560T March 11, 2008Companies that develop and produce federal oil and gas resources do so under leases administered by the Department of the Interior (Interior). Interior's Bureau of Land Management (BLM) and Offshore Minerals Management (OMM) are responsible for overseeing oil and gas operations on federal leases. Companies are required to self- report their production volumes and other data to Interior's Minerals Management Service (MMS) and to pay royalties either "in value" (payments made in cash), or "in kind" (payments made in oil or gas). GAO's testimony will focus on whether (1) Interior has adequate assurance that it is receiving full compensation for oil and gas produced from federal lands and waters, (2) MMS's compliance efforts provide a check on industry's self-reported data, (3) MMS has reasonable assurance that it is collecting the right amounts of royalty-in-kind oil and gas, and (4) the benefits of the royalty-in-kind program that MMS has reported are reliable. This testimony is based on ongoing work. When this work is complete, we expect to make recommendations to address these and other findings. To address these issues GAO analyzed MMS data, reviewed MMS, and other agency policies and procedures, and interviewed officials at Interior. In commenting on a draft of this testimony, Interior provided GAO technical comments which were incorporated where appropriate.
Interior lacks adequate assurance that it is receiving full compensation for oil and gas produced from federal lands and waters because Interior's Bureau of Land Management (BLM) and Offshore Minerals Management (OMM) are not fully conducting production inspections as required by law and agency policies and because MMS's financial management systems are inadequate and lack key internal controls. Officials at BLM told us that only 8 of the 23 field offices in five key states we sampled completed their required production inspections in fiscal year 2007. Similarly, officials at OMM told us that they completed about half of the required production inspections in calendar year 2007 in the Gulf of Mexico. In addition, MMS's financial management system lacks an automated process for routinely and systematically reconciling production data with royalty payments. MMS's compliance efforts do not consistently examine third-party source documents to verify whether self-reported industry royalty-in-value payment data are complete and accurate, putting full collection of royalties at risk. In 2001, to help meet its annual performance goals, MMS moved from conducting audits, which compare self-reported data against source documents, toward compliance reviews, which provide a more limited check of a company's self-reported data and do not include systematic comparison to source documentation. MMS could not tell us what percentage of its annual performance goal was achieved through audits as opposed to compliance reviews. Because the production verification processes MMS uses for royalty-in-kind gas are not as rigorous as those applied to royalty-in-kind oil, MMS cannot be certain it is collecting the gas royalties it is due. MMS compares companies' self-reported oil production data with pipeline meter data from OMM's oil verification system, which records oil volumes flowing through metering points. While analogous data are available from OMM's gas verification system, MMS has not chosen to use these third-party data to verify the company-reported production numbers. The financial benefits of the royalty-in-kind program are uncertain due to questions and uncertainties surrounding the underlying assumptions and methods MMS used to compare the revenues it collected in kind with what it would have collected in cash. Specifically, questions and uncertainties exist regarding MMS's methods to calculate the net revenues from in-kind oil and gas sales, interest payments, and administrative cost savings.
GAO-08-560T, Mineral Revenues: Data Management Problems and Reliance on Self-Reported Data for Compliance Efforts Put MMS Royalty Collections at Risk
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Testimony:
Before the Subcommittee on Energy and Mineral Resources, Committee on
Natural Resources, House of Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery:
Expected at 10:00 a.m. EST:
Tuesday, March 11, 2008:
Mineral Revenues:
Data Management Problems and Reliance on Self-Reported Data for
Compliance Efforts Put MMS Royalty Collections at Risk:
Statement of Frank Rusco, Acting Director:
Natural Resources and Environment:
Accompanied by:
Jeanette Franzel, Director:
Financial Management and Assurance:
GAO-08-560T:
GAO Highlights:
Highlights of GAO-08-560T, a testimony before the Subcommittee on
Energy and Mineral Resources, Committee on Natural Resources, House of
Representatives.
Why GAO Did This Study:
Companies that develop and produce federal oil and gas resources do so
under leases administered by the Department of the Interior (Interior).
Interior‘s Bureau of Land Management (BLM) and Offshore Minerals
Management (OMM) are responsible for overseeing oil and gas operations
on federal leases. Companies are required to self-report their
production volumes and other data to Interior‘s Minerals Management
Service (MMS) and to pay royalties either ’in value“ (payments made in
cash), or ’in kind“ (payments made in oil or gas).
GAO‘s testimony will focus on whether (1) Interior has adequate
assurance that it is receiving full compensation for oil and gas
produced from federal lands and waters, (2) MMS's compliance efforts
provide a check on industry‘s self-reported data, (3) MMS has
reasonable assurance that it is collecting the right amounts of royalty-
in-kind oil and gas, and (4) the benefits of the royalty-in-kind
program that MMS has reported are reliable. This testimony is based on
ongoing work. When this work is complete, we expect to make
recommendations to address these and other findings.
To address these issues GAO analyzed MMS data, reviewed MMS, and other
agency policies and procedures, and interviewed officials at Interior.
In commenting on a draft of this testimony, Interior provided GAO
technical comments which were incorporated where appropriate.
What GAO Found:
Interior lacks adequate assurance that it is receiving full
compensation for oil and gas produced from federal lands and waters
because Interior‘s Bureau of Land Management (BLM) and Offshore
Minerals Management (OMM) are not fully conducting production
inspections as required by law and agency policies and because MMS‘s
financial management systems are inadequate and lack key internal
controls. Officials at BLM told us that only 8 of the 23 field offices
in five key states we sampled completed their required production
inspections in fiscal year 2007. Similarly, officials at OMM told us
that they completed about half of the required production inspections
in calendar year 2007 in the Gulf of Mexico. In addition, MMS‘s
financial management system lacks an automated process for routinely
and systematically reconciling production data with royalty payments.
MMS‘s compliance efforts do not consistently examine third-party source
documents to verify whether self-reported industry royalty-in-value
payment data are complete and accurate, putting full collection of
royalties at risk. In 2001, to help meet its annual performance goals,
MMS moved from conducting audits, which compare self-reported data
against source documents, toward compliance reviews, which provide a
more limited check of a company‘s self-reported data and do not include
systematic comparison to source documentation. MMS could not tell us
what percentage of its annual performance goal was achieved through
audits as opposed to compliance reviews.
Because the production verification processes MMS uses for royalty-in-
kind gas are not as rigorous as those applied to royalty-in-kind oil,
MMS cannot be certain it is collecting the gas royalties it is due. MMS
compares companies‘ self-reported oil production data with pipeline
meter data from OMM‘s oil verification system, which records oil
volumes flowing through metering points. While analogous data are
available from OMM‘s gas verification system, MMS has not chosen to use
these third-party data to verify the company-reported production
numbers.
The financial benefits of the royalty-in-kind program are uncertain due
to questions and uncertainties surrounding the underlying assumptions
and methods MMS used to compare the revenues it collected in kind with
what it would have collected in cash. Specifically, questions and
uncertainties exist regarding MMS‘s methods to calculate the net
revenues from in-kind oil and gas sales, interest payments, and
administrative cost savings.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.GAO-08-560T]. For more information, contact
Frank Rusco at (202) 512-3841 or ruscof@gao.gov.
[End of section]
Mr. Chairman and Members of the Subcommittee:
We are pleased to participate in the subcommittee's hearing to discuss
the Department of the Interior's (Interior) oversight of the collection
of royalties paid on the production of oil and natural gas (hereafter
oil and gas) from federal lands and waters. In fiscal year 2007,
Interior's Minerals Management Service (MMS) collected over $9 billion
in oil and gas royalties and disbursed these funds to federal, state,
and tribal accounts. The federal portion of these royalties, which
totaled $6.7 billion in fiscal year 2007, represents one of the
country's largest nontax sources of revenue. At the same time, oil and
gas production on federal lands and waters represents a critical
component of the nation's energy portfolio, supplying roughly 35
percent of all the oil and 30 percent of all the gas produced in the
United States in 2006. The Department of Energy's (DOE) Energy
Information Administration projects that over the next 10 years the
portion of U.S. production from federal lands and waters will increase
to 47 percent for oil and 37 percent for gas. In fiscal year 2007, MMS
also transferred $322 million worth of oil to DOE as part of its
efforts to fill the nation's Strategic Petroleum Reserve (SPR). The SPR
currently holds nearly 700 million barrels of oil--equivalent to about
58 days of net oil imports--that can be released at the discretion of
the President in the event of an oil supply disruption. Recently, both
oil prices and the demand to drill for oil and gas on federal lands
have increased dramatically. For example, the price of West Texas
Intermediate--a commonly used benchmark crude oil--now exceeds $100 per
barrel, a price that, when adjusted for inflation, is the highest price
since 1980. Moreover, Interior's Bureau of Land Management (BLM) is
projecting substantially increased numbers of drilling permit
applications. It received 8,351 in 2005 and anticipates receiving
12,500 in 2008.
Companies that develop and produce federal oil and gas resources from
federal lands and waters do so under leases obtained and administered
by Interior--BLM for onshore leases and MMS's Offshore Minerals
Management (OMM) for offshore leases. Together, BLM and OMM are
responsible for overseeing oil and gas operations on more than 28,000
producing leases to help ensure that oil and gas companies comply with
applicable laws, regulations, and agency policies. Among other things,
BLM and OMM staff inspect producing leases to verify whether oil and
gas are accounted for as required by both the Federal Oil and Gas
Royalty Management Act of 1982[Footnote 1] and agency policies. As a
condition of producing oil and gas under federal leases, companies are
required to self-report monthly production volumes to MMS (as part of
their monthly production reports).[Footnote 2] In some situations,
several companies may be jointly involved in developing oil and gas
from a lease or a number of adjacent leases, in which case the
companies designate one of the companies to be the "operator." The
operator has sole responsibility for submitting production reports for
all oil and gas produced from the leases.
Companies, or lessees, compensate the government for producing federal
oil and gas resources either "in value" (royalty payments made in
cash), or "in kind" (royalty payments made in oil or gas). In fiscal
year 2006, 58 percent of the $9.74 billion in oil and gas royalty
payments were made in value, while 42 percent were made in kind. Under
the royalty-in-value program, lessees responsible for paying cash
royalties, also called "payors," calculate the royalty payment they owe
to the federal government using the key variables illustrated in the
following equation:
Royalty payment = (sales volume x sales price - deductions) x royalty
rate[Footnote 3]
Cash royalty payors are required to submit monthly royalty reports to
MMS specifying the royalty amount they owe the federal government for
the production and sale of oil and gas, and generally make the cash
payment via an electronic fund transfer to an account at the Department
of the Treasury (Treasury).[Footnote 4] In many instances, because
leases are co-owned by multiple companies, multiple payors submit
individual royalty reports for a single lease. However, in these
situations a single company is designated the "operator" and is
responsible for submitting the production report for that entire lease.
As a result, MMS will often receive multiple royalty reports
corresponding to a single production report. Royalty reports include
the sales volume (amount sold), the sales revenue (the amount of
revenue received from the sale), and the royalty payment due to MMS
(royalty value less allowances taken for transportation and processing
the gas into a marketable condition), prorated based on the share owned
by each payor. Some of these data, as well as some of the deductible
transportation costs, are also available from third-party sources. For
example, individual royalty payor data on production and some
transportation costs can be acquired from pipeline statements, which
are essentially receipts from pipeline companies for shipping oil and
gas. In contrast, documentation of sales revenue data, as well as data
supporting allowable deductions, are generally available only from oil
and gas company records. Royalty payors submit their monthly royalty
reports through a Web-based portal. Once MMS reconciles the self-
reported royalty payment data from the monthly royalty reports with the
payments submitted to Treasury, MMS disburses the royalties from the
Treasury account to the appropriate federal, state, and tribal
accounts. The transaction information is recorded in MMS's financial
management system.[Footnote 5]
As a check on the accuracy of the self-reported data the payors use
when determining cash royalty payments, among MMS's internal controls
are audits and compliance reviews.[Footnote 6] Audits are an assessment
of the accuracy and completeness of the self-reported production and
royalty data compared against source documents, such as sales contracts
and oil and gas sales receipts from pipeline companies. By contrast,
compliance reviews deal with reasonableness--a quicker, more limited
check of the accuracy and completeness of a company's self-reported
data--and they do not include systematic examination of underlying
source documentation. In addition, some states and tribes that receive
a share of royalties collected by MMS have agreements with MMS
authorizing them to conduct both audits and compliance reviews on
federal and Indian producing leases within their
jurisdictions.[Footnote 7] MMS has an annual performance goal whereby
it evaluates the compliance group's performance on the basis of whether
the group has conducted compliance activities--either full audits or
compliance reviews--on a predetermined percentage of royalty payments.
In contrast to royalties in value, when paying royalties in kind, a
payor delivers a volume of oil or gas to MMS as determined by the
following equation:
Royalty volume = total production volume x royalty rate[Footnote 8]
Once it receives the oil or gas, MMS may either sell it and disburse
the revenues received from the sales, or transfer it to federal
agencies for them to use. For example, MMS can transfer oil to DOE and
DOE, in turn, can trade this oil for other oil of specific quality to
fill the SPR. Under the Energy Policy Act of 2005,[Footnote 9] MMS is
charged with ensuring that the revenues it receives when it sells oil
and gas taken in-kind are at least as great as the revenues it would
have received had it taken the royalties in value. Furthermore, MMS
cannot sell oil and gas it takes in-kind for less than market value. As
required, MMS routinely compares the estimated benefits of the in-kind
program to the estimated benefits MMS would have received if the
royalties had been taken in cash and annually reports these benefits to
the Congress.
MMS estimates that from fiscal years 2004 through 2006 the royalty-in-
kind program generated about $87 million more in net value to the
government than MMS would have collected had it received royalties in
cash. Of this $87 million, MMS estimates that (1) $74 million came from
selling royalty-in-kind oil and gas for more than it would have
received in cash royalty payments, (2) $5 million came from interest
from receiving revenues from in-kind sales earlier than cash payments
are due, and (3) $8 million came from savings because the royalty-in-
kind program costs less to administer than the in-value program.
Our testimony today is based on two ongoing efforts. The first focuses
on MMS's royalty-in-value program and addresses (1) whether Interior
has adequate assurance that it is receiving full compensation for oil
and gas produced from federal lands and waters and (2) the extent to
which MMS's compliance efforts provide an adequate check on industry's
self-reported data.[Footnote 10] The second, relating to MMS's royalty-
in-kind program, addresses (1) the extent to which MMS has reasonable
assurance that it is collecting the right amounts of royalty-in-kind
oil and gas and (2) the reliability of the benefits of the royalty-in-
kind program that MMS has reported.[Footnote 11]
In addressing these issues, we reviewed documentation on MMS policies
and procedures for collecting royalties; collected and assessed
information on the sales of royalty oil and gas; and reviewed MMS
procedures for preparing the administrative cost comparison between the
royalty-in-value and royalty-in-kind programs. We also interviewed
officials at offices selected from a nonprobability sample of five BLM
field offices and the associated BLM state offices--the offices were
selected based on the numbers of violations, oil and gas volume errors
identified, and geographic location. In addition, we interviewed
officials at MMS; toured oil and gas production facilities in Wyoming,
Colorado, and the Gulf of Mexico; sent questionnaires addressing
production and royalty data issues to the 11 state and 7 tribal members
of the State and Tribal Royalty Audit Committee, of which 9 states and
5 tribes responded. We assessed the reliability of the royalty-in-kind
sales and performance data by (1) reviewing the systems that MMS has in
place to help ensure that the data were entered and calculated
correctly, and (2) comparing the data to aggregate performance results
that MMS reported to the Congress for fiscal years 2004 through 2006.
We determined that the data were sufficiently reliable for the purposes
of this testimony. Our work is ongoing and we are continuing to assess
information related to the objectives and findings presented in this
testimony. We conducted this work from April 2007 to February 2008 in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.
In summary, regarding the royalty-in-value program, our work to date
has revealed the following:
* Interior lacks adequate assurance that it is receiving full
compensation for oil and gas produced from federal lands and waters.
For example, neither BLM nor OMM is meeting statutory obligations or
agency targets for conducting inspections of meters and other equipment
used to measure oil and gas production, which raises questions about
the accuracy of oil and gas measurement. Further, MMS's systems and
processes for collecting and verifying royalty data are inadequate and
lack key internal controls. Specifically, MMS lacks an automated
process to routinely and systematically reconcile all production data
filed by payors (those responsible for paying the royalties) with
production data filed by operators (those responsible for reporting
production volumes).
* MMS's compliance efforts do not consistently examine data from third
parties to verify whether self-reported industry payment data are
complete and accurate. Combined with the inadequacy of MMS's systems
and processes for collecting and verifying royalty data and the lack of
key internal controls, the absence of a consistent check on self-
reported data using third-party data raises further questions about the
accuracy of royalty payments.
Regarding the royalty-in-kind program, our work to date has revealed
the following:
* MMS does not consistently check the accuracy of self-reported gas
collection data against available third-party data, putting the
accuracy of gas royalty collections at risk. MMS's ability to detect
gas production discrepancies is weaker than for oil because, unlike in
the case of oil, MMS does not use third-party gas metering data to
verify the operator-reported production numbers.
* The methods and assumptions MMS uses to compare the revenues it
collects in kind with what it would have collected in cash do not
account for all costs and do not sufficiently deal with uncertainties,
raising significant questions about the reported financial benefits of
the in-kind program.
Interior's Oversight Does Not Provide Adequate Assurance That the
Government Is Being Fully Compensated for Oil and Gas Production on
Federal Lands and Waters:
Interior lacks adequate assurance that it is receiving the full
royalties it is owed because (1) neither BLM nor OMM is fully
inspecting leases and meters as required by law and agency policies,
and (2) MMS lacks adequate management systems and sufficient internal
controls for verifying that royalty payment data are accurate and
complete. With regard to inspecting oil and gas production, BLM is
charged with inspecting approximately 20,000 producing onshore leases
annually to ensure that oil and gas volumes are accurately measured.
However, BLM's state Inspection and Enforcement Coordinators from
Colorado, Montana, New Mexico, Utah, and Wyoming told us that only 8 of
the 23 field offices in the 5 states completed both their (1) required
annual inspections of wells and leases that are high-producing and
those that have a history of violations and (2) inspections every third
year on all remaining leases.[Footnote 12] According to the BLM state
Inspection and Enforcement Coordinators, the number of completed
production inspections varied greatly by field office. For example,
while BLM inspectors were able to complete all of the production
inspections in the Kemmerer, Wyoming, field office, inspectors in the
Glenwood Springs, Colorado, field office were able to complete only
about one-quarter of the required inspections. Officials in 3 of the 5
field offices in which we held detailed discussions with inspection
staff told us that they had not been able to complete the production
inspections because of competing priorities,[Footnote 13] including
their focus on completing a growing number of drilling inspections for
new oil and gas wells, and high inspection staff turnover. However, BLM
officials from all 5 field offices told us that when they have
conducted production inspections they have identified a number of
violations. For example, BLM staff in 4 of the 5 field offices
identified errors in the amounts of oil and gas production volumes
reported by operators to MMS by comparing production reports with third-
party source documents. Additionally, BLM staff from 1 field office we
visited showed us a bypass built around a gas meter, allowing gas to
flow around the meter without being measured. BLM staff ordered the
company to remove the bypass. Staff from another field office told us
of a case in which individuals illegally tapped into a gas line and
routed gas to private residences. Finally, in one of the field offices
we visited, BLM officials told us of an instance in which a company
maintained two sets of conflicting production data--one used by the
company and another reported to MMS.
Moreover, OMM, which is responsible for inspecting offshore production
facilities that include oil and gas meters, did not inspect all oil and
gas royalty meters, as required by its policy, in 2007. For example,
OMM officials responsible for meter inspections in the Gulf of Mexico
told us that they completed about half of the required 2,700
inspections, but that they met OMM's goal for witnessing oil and gas
meter calibrations. OMM officials told us that one reason they were
unable to complete all the meter inspections was their focus on the
remaining cleanup work from hurricanes Katrina and Rita. Meter
inspections are an important aspect of the offshore production
verification process because, according to officials, one of the most
common violations identified during inspections is missing or broken
meter seals. Meter seals are meant to prevent tampering with
measurement equipment. When seals are missing or broken, it is not
possible without closer inspection to determine whether the meter is
correctly measuring oil or gas production.
With regard to MMS's assurance that royalty data are being accurately
reported by companies, MMS's systems and processes for collecting and
verifying these data lack both capabilities and key internal controls,
including those focused on data accuracy, integrity, and completeness.
For example, MMS lacks an automated process to routinely and
systematically reconcile all production data filed by payors (those
responsible for paying the royalties) with production data filed by
operators (those responsible for reporting production volumes). MMS
officials told us that before they transitioned to the current
financial management system in 2001, their system included an automated
process that reconciled the production and royalty data on all
transactions within approximately 6 months of the initial entry date.
However, MMS's new system does not have that capability. As a result,
such comparisons are not performed on all properties. Comparisons are
made, if at all, 3 years or more after the initial entry date by the
MMS compliance group for those properties selected for a compliance
review or audit.
In addition, MMS lacks a process to routinely and systematically
reconcile production data included by payors on their royalty reports
or by operators on their production reports with production data
available from third-party sources. OMM does compare a large part of
the offshore operator-reported production data with third-party data
from pipeline operators through both its oil and gas verification
programs, but BLM compares only a relatively small percentage of
reported onshore oil and gas production data with third-party pipeline
data. When BLM and OMM do make comparisons and find discrepancies, they
forward the information to MMS, which then takes steps to reconcile and
correct these discrepancies by talking to operators. However, even when
discrepancies are corrected and the operator-reported data and pipeline
data have been reconciled, these newly reconciled data are not
automatically and systematically compared with the reported sales
volume in the royalty report, previously entered into the financial
management database, to ensure the accuracy of the royalty payment.
Such comparisons occur only if a royalty payor's property has been
selected for an audit or compliance review.
Furthermore, MMS's financial management system lacks internal controls
over the integrity and accuracy of production and royalty-in-value data
entered by companies. Companies may legally make changes to both
royalty and production data in MMS's financial management system for up
to 6 years after the reporting month, and these changes may necessitate
changes in the royalty payment.[Footnote 14] However, when companies
retroactively change the data they previously entered, these changes do
not require prior approval by, or notification of, MMS. As a result of
the companies' ability to unilaterally make these retroactive changes,
the production data and required royalty payments can change over time,
further complicating efforts by agency officials to reconcile
production data and ensure that the proper amount of royalties was
paid. Compounding this data reliability concern, changes made to the
data do not necessarily trigger a review to determine their
reasonableness or whether additional royalties are due. According to
agency officials, these changes are not subject to review at the time a
change is made and would be evaluated only if selected for an audit or
compliance review. This is also problematic because companies may
change production and royalty data after an audit or compliance review
has been done, making it unclear whether these audited royalty payments
remain accurate after they have been reviewed. Further, MMS officials
recently examined data from September 2002 through July 2007 and
identified over 81,000 adjustments made to data outside the allowable 6-
year time frame. MMS is working to modify the system to automatically
identify adjustments that have been made to data outside of the
allowable 6-year time frame, but this effort does not address the need
to identify adjustments made within the allowable time that might
necessitate further adjustments to production data and royalty payments
due.
Finally, MMS's financial management system could not reliably detect
when production data reports were missing until late 2004, and the
system continues to lack the ability to automatically detect missing
royalty reports. In 2004, MMS modified its financial management system
to automatically detect missing production reports. As a result, MMS
has identified a backlog of approximately 300,000 missing production
reports that must be investigated and resolved. It is important that
MMS have a complete set of accurate production reports so that BLM can
prioritize production inspections, and its compliance group can easily
reconcile royalty payments with production information. Importantly,
MMS's financial management system continues to lack the ability to
automatically detect cases in which an expected royalty report has not
been filed. While not filing a royalty report may be justifiable under
certain circumstances, such as when a company sells its lease, MMS's
inability to detect missing royalty reports presents the risk that MMS
will not identify instances in which it is owed royalties that are
simply not being paid. Officials told us they are currently able to
identify missing royalty reports in instances when they have no royalty
report to match with funds deposited to Treasury. However, cases in
which a company stops filing royalty reports and stops paying royalties
would not be detected unless the payor or lease was selected for an
audit or compliance review.
MMS's Compliance Efforts Do Not Consistently Use Third-Party Data to
Check Self-Reported Royalty-in-Value Payment Data:
MMS's increasing use of compliance reviews, which are more limited in
scope than audits, has led to an inconsistent use of third-party data
to verify that self-reported royalty data are correct, thereby placing
accurate royalty collections at risk. Since 2001, MMS has increasingly
used compliance reviews to achieve its performance goals of completing
compliance activities--either full audits or compliance reviews--on a
predetermined percentage of royalty payments. According to MMS,
compliance reviews can be conducted much more quickly and require fewer
resources than audits, largely because they represent a quicker, more
limited reasonableness check of the accuracy and completeness of a
company's self-reported data, and do not include a systematic
examination of underlying source documentation. Audits, on the other
hand, are more time-and resource-intensive, and they include the review
of original source documents, such as sales revenue data,
transportation and gas processing costs, and production volumes, to
verify whether company-reported data are accurate and complete. When
third-party data are readily available from OMM, MMS may use them when
conducting a compliance review. For example, MMS may use available
third-party data on oil and gas production volumes collected by OMM in
its compliance reviews for offshore properties. In contrast, because
BLM collects only a limited amount of third-party data for onshore
production, and MMS does not request these data from the companies, MMS
does not systematically use third-party data when conducting onshore
compliance reviews. Despite conducting thousands of compliance reviews
since 2001, MMS has only recently evaluated their effectiveness. For
calendar year 2002, MMS compared the results of 100 of about 700
compliance reviews of offshore leases and companies with the results of
audits conducted on those same leases or companies. However, while the
compliance reviews covered, among other things, 12 months of production
volumes on all products--oil, gas, and retrograde, a liquid product
that condenses out of gas under certain conditions--the audits covered
only 1 month and one product. As a result of this evaluation comparing
the results of compliance reviews with those of audits, MMS now plans
to improve its compliance review process by, for example, ensuring that
it includes a step to check that royalties are paid on all royalty-
bearing products, including retrograde.
To achieve its annual performance goals, MMS began using the compliance
reviews along with audits. One of MMS's performance goals is to
complete compliance activities--either audits or compliance reviews--
on a specified percentage of royalty payments within 3 years of the
initial royalty payment. For example, in 2006 MMS reported that it had
achieved this goal by confirming reasonable compliance on 72.5 percent
of all calendar year 2003 royalties. To help meet this goal, MMS
continues to rely heavily on compliance reviews, yet it is unable to
state the extent to which this performance goal is accomplished through
audits as opposed to compliance reviews. As a result, MMS does not have
information available to determine the percentage of the goal that was
achieved using third-party data and the percentage that did not
systematically rely on third-party data. Moreover, to help meet its
performance goal, MMS has historically conducted compliance reviews or
audits on leases and companies that have generated the most royalties,
with the result that the same leases and companies are reviewed year
after year. Accordingly, many leases and companies have gone for years
without ever having been reviewed or audited.
In 2006, Interior's Inspector General (IG) reviewed MMS's compliance
process and made a number of recommendations aimed at strengthening it.
The IG recommended, among other things, that MMS examine 1 month of
third-party source documentation as part of each compliance review to
provide greater assurance that both the production and allowance data
are accurate. The IG also recommended that MMS track the percentage of
the annual performance goal that was accomplished through audits versus
through compliance reviews, and that MMS move toward a risk-based
compliance program and away from reviewing or auditing the same leases
and companies each year. To address the IG's recommendations, MMS has
recently revised its compliance review guidance to include suggested
steps for reviewing third-party source production data when available
for both offshore and onshore oil and gas, though the guidance falls
short of making these steps a requirement. MMS has also agreed to start
tracking compliance activity data in 2007 that will allow it to report
the percentage of the performance goal that was achieved through audits
versus through compliance reviews. Finally, MMS has initiated a risk-
based compliance pilot project, whereby leases and companies are
selected for compliance work according to MMS-defined risk criteria
that include factors other than whether the leases or companies
generate high royalty payments. According to MMS, during fiscal year
2008 it will further evaluate and refine the pilot as it moves toward
fuller implementation.
Finally, representatives from the states and tribes who are responsible
for conducting compliance work under agreements with MMS have expressed
concerns about the quality of self-reported production and royalty data
they use in their reviews. As part our work, we sent questionnaires to
all 11 states and seven tribes that conducted compliance work for MMS
in fiscal year 2007. Of the nine state and five tribal representatives
who responded, seven reported that they lack confidence in the accuracy
of the royalty data. For example, several representatives reported that
because of concerns with MMS's production and royalty data, they
routinely look to other sources of corroborating data, such as
production data from state oil and gas agencies and tax agencies.
Finally, several respondents noted that companies frequently report
production volumes to the wrong leases and that they must then devote
their limited resources to correcting these reporting problems before
beginning their compliance reviews and audits.
The MMS Royalty-in-Kind Program Is at Risk of Inaccurate Collection of
Natural Gas Royalties because of Inconsistent Oversight:
Because MMS's royalty-in-kind program does not extend the same
production verification processes used by its oil program to its gas
program, it does not have adequate assurance that it is collecting the
gas royalties it is owed. As noted, under the royalty-in-kind program,
MMS collects royalties in the form of oil and gas and then sells these
commodities in competitive sales. To ensure that the government obtains
the fair value of these sales, MMS must make sure that it receives the
volumes to which it is entitled. Because prices of these commodities
fluctuate over time, it is also important that MMS receive the oil and
gas at the time it is entitled to them. As part of its royalty-in-kind
oversight effort, MMS identifies imbalances between the volume
operators owe the federal government in royalties and the volume
delivered and resolves these imbalances by adjusting future delivery
requirements or cash payments. The methods that MMS uses to identify
these imbalances differ for oil and gas.
* For oil, MMS obtains pipeline meter data from OMM's liquid
verification system, which records oil volumes flowing through numerous
metering points in the Gulf of Mexico region. MMS calculates its
royalty share of oil by multiplying the total production volumes
provided in these pipeline statements by the royalty rates for a given
lease. MMS compares this calculation with the volume of royalty oil
that the operators delivered as reported by pipeline operators. When
the value of an imbalance cumulatively reaches $100,000, MMS conducts
further research to resolve the discrepancy. Using pipeline statements
to verify production volumes is a good check against companies' self-
reporting of royalties due the federal government because companies
have an incentive to not underreport their share of oil going into the
pipeline because that is the amount they will have to sell at the other
end of the pipeline.
* For gas, MMS relies on information contained in two operator-provided
documents--monthly imbalance statements and production reports.
Imbalance statements include the operator's total gas production for
the month, the share of that production that the government is entitled
to, and any differences between what the operator delivered and the
government's royalty share. Production reports contain a large number
of data elements, including production volumes for each gas well. MMS
compares the production volumes contained in the imbalance statements
with those in the production reports to verify production levels. MMS
then calculates its royalty share based on these production figures and
compares its royalty share with gas volumes the operators delivered as
reported by pipeline operators. When the value of an imbalance
cumulatively reaches $100,000, MMS conducts further research to resolve
the discrepancy.
MMS's ability to detect gas imbalances is weaker than for oil because
it does not use third-party metering data to verify the operator-
reported production numbers. Since 2004, OMM has collected data from
gas pipeline companies through its gas verification system, which is
similar to its liquid verification system in that the system records
information from pipeline company-provided source documents. Our review
of data from this program shows that these data could be a useful tool
in verifying offshore gas production volumes.[Footnote 15]
Specifically, our analysis of these pipeline data showed that for the
months of January 2004, May 2005, July 2005, and June 2006, 25 percent
of the pipeline metering points had an outstanding discrepancy between
self-reported and pipeline data.[Footnote 16] These discrepancies are
both positive and negative--that is, production volumes submitted to
MMS by operators are at times either under-or overreported.
Data from the gas verification system could be useful in validating
production volumes and reducing discrepancies. However, to fully
benefit from this opportunity, MMS needs to improve the timeliness and
reliability of these data. After examining this issue, in December
2007, the Subcommittee on Royalty Management, a panel appointed by the
Secretary of the Interior to examine MMS's royalty program, reported
that OMM is not adequately staffed to conduct sufficient review of data
from the gas verification system.[Footnote 17] We have not yet, nor has
MMS, determined the net impact of these discrepancies on royalties owed
the federal government.
Significant Questions and Uncertainties Exist Regarding the Reported
Financial Benefits of the Royalty-in-Kind Program:
The methods and underlying assumptions MMS uses to compare the revenues
it collects in kind with what it would have collected in cash do not
account for all costs and do not sufficiently deal with uncertainties,
raising doubts about the claimed financial benefits of the royalty-in-
kind program. Specifically, MMS's calculation showing that MMS sold the
royalty oil and gas for $74 million more than MMS would have received
in cash payments did not appropriately account for uncertainty in
estimates of cash payments. In addition, MMS's calculation that early
royalty-in-kind payments yielded $5 million in interest was based on
assumptions about payment dates and interest rates that could misstate
the estimated interest benefit. Finally, MMS's calculation that the
royalty-in-kind program cost about $8 million less to administer than
an in-value program did not include significant costs that, if
included, could change MMS's conclusions.
Sales Revenue:
MMS sold the oil and gas it collected during the 3 fiscal years 2004
through 2006 for $8.15 billion and calculated that this amount exceeded
what MMS would have received in cash royalties by about $74 million--a
net benefit of approximately 0.9 percent. MMS has recognized that its
estimates of what it would have received in cash payments are subject
to some degree of error but has not appropriately evaluated or reported
how sensitive the net benefit calculations are to this error.[Footnote
18] This is important because even a 1 percent error in the estimates
of cash payments would change the estimated benefit of the royalty-in-
kind program from $74 million to anywhere from a loss of $6 million to
a benefit of $155 million.
Moreover, MMS's annual reports to the Congress present oil sales data
in aggregate and therefore do not reflect the fact that, in many
individual sales, MMS sold the oil it collected in kind for less than
it estimates it would have collected in cash. Specifically, MMS
estimates that, in fiscal year 2006, it sold 28 million barrels of oil,
or 64 percent of all the oil it collected in kind, for less than it
would have collected in cash. The government would have received an
additional $6 million in revenue if it had taken these royalties in
cash instead. These sales indicate that MMS has not always been able to
achieve one of its central goals: to select, based on systematic
economic analysis, which royalties to take in cash and which to take in
kind in a way that maximizes revenues to the government.
According to a senior MMS official, the federal government has several
advantages when selling gas that it does not have when selling oil, a
fact that helps to explain why MMS's gas sales have performed better
than its oil sales. For example, MMS can bundle the natural gas
production in the Gulf of Mexico from many different leases into large
volumes that MMS can use to negotiate discounts for transporting gas
from production sites to market centers. Because purchasers receive
these discounts when they buy gas from MMS, they may be willing to pay
more for gas from MMS than from the original owners. Opportunities for
bundling are less prevalent in the oil market. Because MMS generally
does not have this, or other, advantages when selling oil, purchasers
often pay MMS about what they would pay other producers for oil, and
sometimes less. Indeed, MMS's policies allow it to sell oil for up to
7.7 cents less per barrel than MMS estimates it would collect if it
took the royalties in cash. MMS told us that the other financial
benefits of the royalty-in-kind program, including interest payments
and reduced administrative costs, justify selling oil for less than the
estimated cash payments because once these additional revenues are
factored in, the net benefit to the government is still positive.
However, as discussed below, we have found that there are significant
questions and uncertainties about the other financial benefits as well.
Interest:
Revenues from the sale of royalty-in-kind oil are due 10 days earlier
than cash payments, and revenues from the sale of in-kind gas are due 5
days earlier. MMS calculates that the government earned about $5
million in interest from fiscal years 2004 through 2006 from these
early payments that it would not have received had it taken royalties
in cash.[Footnote 19] We found two weaknesses in the way MMS calculates
this interest. First, the payment dates used to calculate the interest
revenue have the potential to over-or underestimate its value. MMS
calculates the interest on the basis of the time between the actual
date that Treasury received a royalty-in-kind payment and the
theoretical latest date that Treasury would have received a cash
payment under the royalty-in-value program. However, MMS officials told
us that cash payments can, and sometimes do, arrive before their due
date. As a result, MMS might be overstating the value of the early
royalty-in-kind payments. Second, the interest rate used to calculate
the interest revenue may either over-or understate its value because
the rate is not linked to any market rate. From fiscal year 2004
through 2007, MMS used a 3 percent interest rate to calculate the time
value of these early payments. However, during this time, actual market
interest rates at which the federal government borrowed fluctuated. For
example, 4-week Treasury bill rates ranged from a low of 0.72 percent
to a high of 5.18 percent during this same period. Therefore, during
some fiscal years, MMS likely overstated or understated the value of
these early payments.
Administrative Cost Savings:
MMS has developed procedures to capture the administrative costs of the
royalty-in-kind and cash royalty programs and includes in its
administrative cost comparison primarily the variable costs for the
federal offshore oil and gas activities--that is, costs that fluctuate
based on the volume of oil or gas received by MMS, such as labor costs.
Although MMS also includes some department-level fixed costs, it
excludes some fixed costs that it does not incur on a predictable basis
(largely information technology [IT] costs). According to MMS, if it
included these IT and other such costs, there would be a high potential
of skewing the unit price used to determine the administrative cost
savings. However, by excluding such fixed costs from the administrative
cost comparison, MMS is not including all the necessary cost
information to evaluate the efficacy of the royalty-in-kind program.
MMS's administrative cost analysis compares a bundle of royalty-in-kind
program administrative costs divided by the number of barrels of oil
equivalent realized by the royalty-in-kind program during a
year,[Footnote 20] with a bundle of cash royalty program administrative
costs divided by the number of barrels of oil equivalent realized by
that program. The difference between these amounts represents the
difference in cost to administer a barrel of oil equivalent under each
program.
MMS then multiplies the difference in cost to administer a barrel of
oil equivalent under the two programs by the number of barrels of oil
equivalent realized by the royalty-in-kind program to determine the
administrative cost savings. However, MMS's calculations excluded some
fixed costs that are not incurred on a regular or predictable basis
from the analysis. For example, in fiscal year 2006, royalty-in-kind IT
costs of $3.4 million were excluded from the comparison. Moreover,
additional IT costs of approximately $29.4 million--some of which may
have been incurred for either the royalty-in-kind or the cash royalty
program--were also excluded. Including and assigning these IT costs to
the programs supported by those costs would provide a more complete
accounting of the respective costs of the royalty-in-kind and royalty-
in-value programs, and would likely impact the results of MMS's
administrative cost analysis.
Conclusions:
Ultimately the system used by Interior to ensure taxpayers receive
appropriate value for oil and gas produced from federal lands and
waters is more of an honor system than we are comfortable with. Despite
the heavy scrutiny that Interior has faced in its oversight of royalty
management, we and others continue to identify persistent weaknesses in
royalty collections. Given both the long-term fiscal challenges the
government faces and the increased demand for the nation's oil and gas
resources, it is imperative that we have a royalty collection system
going forward that can assure the American public that the government
is receiving proper royalty payments. Our work on this issue is
continuing along several avenues, including comparing the royalties
taken in kind with the value of royalties taken in cash, assessing the
rate of oil and gas development on federal lands, comparing the amount
of money the U.S. government receives with what foreign countries
receive for allowing companies to develop and produce oil and gas, and
examining further the accuracy of MMS's production and royalty data. We
plan to make recommendations to address the weaknesses we identified in
our final reports on these issues.
We look forward to further work and to helping this subcommittee and
the Congress as a whole to exercise oversight on this important issue.
Mr. Chairman, this concludes our prepared statement. We would be
pleased to respond to any questions that you or other members of the
subcommittee may have at this time.
GAO Contact and Staff Acknowledgments:
For further information about this testimony, please contact either
Frank Rusco, at 202-512-3841, or ruscof@gao.gov, or Jeanette Franzel,
at 202-512-9406, or franzelj@gao.gov. Contact points for our
Congressional Relations and Public Affairs may be found on the last
page of this statement. Contributors to this testimony include Ron
Belak, Ben Bolitzer, Lisa Brownson, Melinda Cordero, Nancy Crothers,
Glenn C. Fischer, Cindy Gilbert, Tom Hackney, Chase Huntley, Heather
Hill, Barbara Kelly, Sandra Kerr, Paul Kinney, Jennifer Leone, Jon
Ludwigson, Tim Minelli, Michelle Munn, G. Greg Peterson, Barbara
Timmerman, and Mary Welch.
[End of section]
Footnotes:
[1] Federal Oil and Gas Royalty Management Act, Pub. L. No. 97-451, §
101(a) (1983).
[2] Companies are required to self-report monthly production volumes to
MMS on an Oil and Gas Operations Report (OGOR) form.
[3] The royalty rate varies somewhat but is typically in the range of
12.5 to 18.75 percent. In other words, the federal government typically
receives between 12.5 and 18.75 percent of revenues less allowable
deductions for oil and gas produced on federal lands and waters.
Allowable deductions include payments to pipeline companies and other
shipping costs required to transport the commodity to a market center,
as well as adjustments made for the costs of processing natural gas.
[4] Companies are required to self-report monthly royalty payments to
MMS on the Report of Sales and Royalty Remittance Form, Form 2014.
[5] This system, also known as the Minerals Revenue Management Support
System, is designed to store and support the collection, verification,
and disbursement of royalty revenues from federal and Indian mineral
leases.
[6] Internal controls are a series of management actions and activities
that occur throughout an entity's operations and include the procedures
used to meet agency objectives.
[7] Eleven states--Alaska, California, Colorado, Louisiana, Montana,
New Mexico, North Dakota, Oklahoma, Texas, Utah, and Wyoming--and seven
tribes--Blackfeet Nation, Jicarilla Apache Tribe, Navajo Nation,
Shoshone and Arapaho Tribes, Southern Ute Indian Tribe, Ute Mountain
Ute Tribe, and the Ute Indian Tribe--conducted compliance work under
cooperative agreements with MMS in fiscal year 2007.
[8] In some cases, there may be deductions to the royalty oil given MMS
as a result of costs incurred by the payor to transport the oil to the
point at which MMS takes possession. In addition, there may be credits
or deductions that adjust for different qualities of oil transported on
a pipeline.
[9] Energy Policy Act of 2005, Pub. L. No. 109-58, § 342 (2005).
[10] This work is being done at the request of Senator Bingaman and Mr.
Davis, Mr. Issa, Ms. Maloney, and Mr. Rahall, House of Representatives.
[11] This work is being done at the request of Senator Bingaman and
Senator Wyden, and Mr. Issa and Mr. Rahall, House of Representatives.
[12] We excluded production inspection results from three BLM field
offices where BLM state Inspection and Enforcement Coordinators could
not validate production inspection numbers because they felt the data
in BLM's Automated Fluid Minerals Support System (AFMSS), the database
used to track production inspections, were unreliable. We excluded one
additional BLM field office because it is implementing a pilot project
inspection program using different selection and prioritization
criteria; therefore it is not comparable with the other BLM field
offices.
[13] To gain a balance of perspectives of how BLM field offices conduct
production inspections, we chose a nonprobability sample of five field
office locations--Meeker, Colorado; Vernal, Utah; Farmington, New
Mexico; Buffalo, Wyoming; and Pinedale, Wyoming. We selected the field
offices in each of these states through consideration of a number of
criteria, ensuring that we visited BLM field offices that represented a
range of BLM state office jurisdictional policies. While this
nonprobability sample allowed us to learn about many important aspects
of production inspections, it was not designed to be representative of
all the BLM field offices production inspection activities. As such,
the findings cannot be generalized to sites we did not visit.
[14] The Royalty Simplification and Fairness Act of 1996, Pub. L. No.
104-185, § 5(a) (1996), provides a 6 year adjustment window.
[15] Onshore gas properties accounted for less than 1 percent of the
revenue managed by the royalty-in-kind program from fiscal year 2004
through fiscal year 2006, but this area is expected to grow in the
future.
[16] For purpose of this testimony, we used 4 months of data from the
gas verification system. We chose these months (January 2004, May 2005,
July 2005, and June 2006) because these are the months for which MMS
has started to work to resolve the discrepancies identified between the
production reports and pipeline data.
[17] Subcommittee on Royalty Management, Royalty Policy Committee,
Report to the Royalty Policy Committee: Mineral Revenue Collection from
Federal and Indian Lands and the Outer Continental Shelf (2007).
[18] OMB Circular A-94, "Guidelines and Discount Rates for Benefit-Cost
Analysis of Federal Programs," suggests that such sensitivity analysis
be done and reported.
[19] While MMS calls this value "interest," it is not interest per se
because the money does not go into an interest-bearing account. Rather,
MMS argues that the government uses the early payments to cover
expenses that it would otherwise need to borrow money to pay for. The
interest, then, is the cost that the government avoids by deferring the
need to borrow.
[20] A barrel of oil equivalent is an amount of natural gas or natural
gas liquid that contains the same heating value as a barrel of oil.
[End of section]
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