Oil and Gas Royalties
The Federal System for Collecting Oil and Gas Revenues Needs Comprehensive Reassessment Gao ID: GAO-08-691 September 3, 2008In fiscal year 2007, domestic and foreign companies received over $75 billion from the sale of oil and gas produced from federal lands and waters, according to the Department of the Interior (Interior), and these companies paid the federal government about $9 billion in royalties for this oil and gas production. The government also collects other revenues in rents, taxes, and other fees, and the sum of all revenues received is referred to as the "government take." The terms and conditions under which the government collects these revenues are referred to as the "oil and gas fiscal system." This report (1) evaluates government take and the attractiveness for investors of the federal oil and gas fiscal system, (2) evaluates how the absence of flexibility in this system has led to large foregone revenues from oil and gas production on federal lands and waters, and (3) assesses what Interior has done to monitor the performance and appropriateness of the federal oil and gas fiscal system. To address these issues, we reviewed expert studies and interviewed government and industry officials.
In addition to having a low government take, the deep water Gulf of Mexico and other U.S. regions are attractive targets for investment because they have large remaining oil and gas reserves and the U.S. is generally a good place to do business compared to many other countries with comparable oil and gas resources. Multiple studies completed as early as 1994 and as recently as June 2007 indicate that the U.S. government take in the Gulf of Mexico is lower than that of most other fiscal systems. For example, data GAO evaluated from a June 2007 industry consulting firm report indicated that the government take in the deep water U.S. Gulf of Mexico ranked 93rd lowest of 104 oil and gas fiscal systems evaluated. Generally, other measures indicate that the United States is an attractive target for oil and gas investment. The lack of price flexibility in royalty rates--automatic adjustment of these rates to changes in oil and gas prices or other market conditions--and the inability to change fiscal terms on existing leases have put pressure on Interior and the Congress to change royalty rates in the past on an ad hoc basis with consequences that could amount to billions of dollars of foregone revenue. For example, royalty relief granted on leases issued in the deep water areas of the Gulf of Mexico between 1996 and 2000--a period when oil and gas prices and industry profits were much lower than they are today--could cost the federal government between $21 billion and $53 billion, depending on the outcome of ongoing litigation challenging the authority of Interior to place price thresholds that would remove the royalty relief offered on certain leases. Further, royalty rate increases in 2007 are expected to generate modest increases in federal revenues from future leases offered in the Gulf of Mexico. However, in choosing to increase royalty rates, Interior did not evaluate the entire oil and gas fiscal system to determine whether or not these increases strike the proper balance between the attractiveness of federal leases for investment and appropriate returns to the federal government for oil and gas resources. Interior does not routinely evaluate the federal oil and gas fiscal system, monitor what other governments or resource owners are receiving for their energy resources, or evaluate and compare the attractiveness of federal lands and waters for oil and gas investment with that of other oil and gas regions. As a result, Interior cannot assess whether or not there is a proper balance between the attractiveness of federal leases for investment and appropriate returns to the federal government for oil and gas resources. Specifically, Interior does not have procedures in place for evaluating the ranking of (1) the federal oil and gas fiscal system or (2) industry rates of return on federal leases against other resource owners. Interior also does not have the authority to alter tax components of the oil and gas fiscal system. All these factors are essential to inform decisions about whether or how to alter the federal oil and gas fiscal system in response to changing market conditions.
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-08-691, Oil and Gas Royalties: The Federal System for Collecting Oil and Gas Revenues Needs Comprehensive Reassessment
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Report to Congressional Requesters:
United States Government Accountability Office:
GAO:
September 2008:
Oil And Gas Royalties:
The Federal System for Collecting Oil and Gas Revenues Needs
Comprehensive Reassessment:
GAO-08-691:
GAO Highlights:
Highlights of GAO-08-691, a report to congressional requesters.
Why GAO Did This Study:
In fiscal year 2007, domestic and foreign companies received over $75
billion from the sale of oil and gas produced from federal lands and
waters, according to the Department of the Interior (Interior), and
these companies paid the federal government about $9 billion in
royalties for this oil and gas development. The government also
collects other revenues in rents, taxes, and other fees, and the sum of
all revenues received is referred to as the ’government take.“ The
terms and conditions under which the government collects these revenues
are referred to as the ’oil and gas fiscal system.“ This report (1)
evaluates government take and the attractiveness for investors of the
federal oil and gas fiscal system, (2) evaluates how the absence of
flexibility in this system has led to large foregone revenues from oil
and gas production on federal lands and waters, and (3) assesses what
Interior has done to monitor the performance and appropriateness of the
federal oil and gas fiscal system. To address these issues, we reviewed
expert studies and interviewed government and industry officials.
What GAO Found:
In addition to having a low government take, the deep water Gulf of
Mexico and other U.S. regions are attractive targets for investment
because they have large remaining oil and gas reserves and the U.S. is
generally a good place to do business compared to many other countries
with comparable oil and gas resources. Multiple studies completed as
early as 1994 and as recently as June 2007 indicate that the U.S.
government take in the Gulf of Mexico is lower than that of most other
fiscal systems. For example, data GAO evaluated from a June 2007
industry consulting firm report indicated that the government take in
the deep water U.S. Gulf of Mexico ranked 93rd lowest of 104 oil and
gas fiscal systems evaluated. Generally, other measures indicate that
the United States is an attractive target for oil and gas investment.
The lack of price flexibility in royalty rates”automatic adjustment of
these rates to changes in oil and gas prices or other market
conditions”and the inability to change fiscal terms on existing leases
have put pressure on Interior and the Congress to change royalty rates
in the past on an ad hoc basis with consequences that could amount to
billions of dollars of foregone revenue. For example, royalty relief
granted on leases issued in the deep water areas of the Gulf of Mexico
between 1996 and 2000”a period when oil and gas prices and industry
profits were much lower than they are today”could cost the federal
government between $21 billion and $53 billion, depending on the
outcome of ongoing litigation challenging the authority of Interior to
place price thresholds that would remove the royalty relief offered on
certain leases. Further, royalty rate increases in 2007 are expected to
generate modest increases in federal revenues from future leases
offered in the Gulf of Mexico. However, in choosing to increase royalty
rates, Interior did not evaluate the entire oil and gas fiscal system
to determine whether or not these increases strike the proper balance
between the attractiveness of federal leases for investment and
appropriate returns to the federal government for oil and gas
resources.
Interior does not routinely evaluate the federal oil and gas fiscal
system, monitor what other governments or resource owners are receiving
for their energy resources, or evaluate and compare the attractiveness
of federal lands and waters for oil and gas investment with that of
other oil and gas regions. As a result, Interior cannot assess whether
or not there is a proper balance between the attractiveness of federal
leases for investment and appropriate returns to the federal government
for oil and gas resources. Specifically, Interior does not have
procedures in place for evaluating the ranking of (1) the federal oil
and gas fiscal system or (2) industry rates of return on federal leases
against other resource owners. Interior also does not have the
authority to alter tax components of the oil and gas fiscal system. All
these factors are essential to inform decisions about whether or how to
alter the federal oil and gas fiscal system in response to changing
market conditions.
What GAO Recommends:
Interior did not fully agree with the recommendations in our draft
report, stating that an ongoing Interior study covered many of the
issues we recommended they study. GAO maintains that a more
comprehensive review is necessary and suggest that Congress consider
directing Interior to (1) convene an independent panel to conduct such
a review of the federal oil and gas fiscal system, and (2) establish
procedures to periodically evaluate the state of the fiscal system.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-691]. For more
information, contact Frank Rusco at (202) 512-3841 or ruscof@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
The Gulf of Mexico Has a Relatively Low U.S. Government Take and the
United States Is an Attractive Place to Invest in Oil and Gas
Development:
The Inflexibility of Royalty Rates to Changing Oil and Gas Prices Has
Cost the Federal Government Billions of Dollars in Foregone Revenues:
Interior Does Not Have a System in Place to Evaluate Whether the
Federal Fiscal System Is in Need of Reassessment:
Conclusions:
Matter for Congressional Consideration:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Companies Receiving Royalty Relief In The Gulf Of Mexico:
Appendix III: Comments from Department of Interior:
GAO Comments:
Appendix IV: GAO Contact and Staff Acknowledgments40:
Tables:
Table 1: Summary of Four 2007 Studies Comparing Government Take
Percentages:
Table 2: Amounts of Royalty Relief Received by Companies:
Abbreviations:
BLM: Bureau of Land Management:
DWRRA: Deep Water Royalty Relief Act of 1995:
EIA: Energy Information Administration:
FLPMA: Federal Land Policy and Management Act:
FRS: Financial Reporting System:
Interior: Department of the Interior:
MMS: Minerals and Management Service:
OCSLA: Outer Continental Shelf Lands Act:
S&P: Standard & Poor's:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
September 3, 2008:
The Honorable Jeff Bingaman:
Chairman, Committee on Energy and Natural Resources:
United States Senate:
The Honorable Nick J. Rahall II:
Chairman, Committee on Natural Resources:
House of Representatives:
The Honorable Steven Pearce:
Ranking Member, Subcommittee on Energy and Mineral Resources:
Committee on Natural Resources:
House of Representatives:
The Honorable Mary L. Landrieu:
United States Senate:
In fiscal year 2007, domestic and foreign companies received over $75
billion from the sale of oil and gas produced from federal lands and
waters, according to the Department of the Interior's (Interior)
Minerals Management Service (MMS). The agency further reported that
these companies paid the federal government about $9 billion in
royalties for such oil and gas development. Clearly, such large and
financially significant resources must be carefully developed and
managed so that the nation's rising energy needs are met while at the
same time the American people are assured of receiving a fair return on
publicly owned resources. In May 2007, we reported that, based on
studies by industry experts, the amount of money that the U.S.
government receives from production of oil and gas on federal lands and
waters--the so-called "government take"--was among the lowest in the
world. The government take that accrues to any government resource
owner is largely determined by the government's oil and gas fiscal
system--the precise mix and total amount of payments made to the
government for the rights to explore, develop, and sell oil and gas
resources. We also noted that several factors needed to be considered
to determine whether adjustments to an oil and gas fiscal system are
warranted, including the size and availability of the oil and gas
resources in place; the costs of finding and developing these
resources, including labor costs and the costs of complying with
environmental regulations; and the stability of both the oil and gas
fiscal system and the country in general.[Footnote 1] Conceptually, a
fair government take would strike a balance between encouraging private
companies to invest in the development of oil and gas resources on
federal lands and waters while maintaining the public's interest in
collecting the appropriate level of revenues from the sale of the
public's resources.
Governments and companies negotiate the exploration and development of
oil and gas resources under terms of leases or contracts granted by
governments. The terms and conditions of such arrangements are
established by law and policy, or are negotiated on a case-by-case
basis. An important aspect of these arrangements is the oil and gas
fiscal system, which defines all applicable payments from the companies
to the government resource owners.[Footnote 2] Oil and gas fiscal
systems vary widely across different resource owners, reflecting
differences in the mix and weight of the various payments. U.S. federal
oil and gas leases operate under a system in which the government
transfers title to the oil and gas produced to a company for a period
of time, generally in exchange for a lump-sum payment called a bonus
bid. The company is then typically subject to the payment of rental
rates, royalties, and taxes for any oil and gas that is eventually
produced on the lease. In other oil and gas fiscal systems, such as
"production sharing" or "profit sharing" systems, the host country and
production company enter into a contract to apportion the production or
profits between them rather than or in addition to royalty payments.
In recent years, and in response to increasing industry profits and
other changing market conditions, many countries have re-evaluated or
are re-evaluating their oil and gas fiscal systems. A number of
countries have significantly increased their overall government take
while others--typically those with marginal or less certain levels of
oil and gas resources--have reduced their government take. According to
Wood Mackenzie, an energy consulting firm that recently performed a
comprehensive study of government take and other measures that
determine the attractiveness of different countries to oil and gas
investors, the most prominent trend in changing oil and gas fiscal
systems has been the imposition of windfall profits taxes or other
mechanisms to increase the resource owners' shares of oil and gas
revenues from existing projects. Wood Mackenzie estimates that these
changes will ultimately result in these countries' collecting
additional oil and gas revenues of between $118 billion and $400
billion, depending on future oil and gas prices.[Footnote 3] For
example, the state of Alaska recently increased its government take and
changed the terms of contracts to give Alaska larger shares of revenues
as oil and gas prices increase. A second trend in changing oil and gas
fiscal systems has been an increase in governmental control of
resources. For example, Algeria, Russia, and Venezuela have rich
resource reserves and have increased the state control over these
resources, while increasing their government takes. Other trends
include increasing variation of fiscal terms across and within
countries to reflect differences in the value of the resources and
other factors that affect the attractiveness of these resources to
investors. For example, Papua New Guinea and Vietnam are offering terms
to encourage production that reflect these countries' status as
frontier areas for exploration, while Norway has provided incentives
for exploration and continued production on fields with declining
production.
A considerable body of legislation governs Interior's authority and
obligations to manage resources on federal lands and within federal
waters. For example, the Outer Continental Shelf Lands Act (OCSLA) and
the Federal Land Policy and Management Act (FLPMA) direct Interior to
ensure the United States receives fair market value on the development
of its oil and gas resources. In 1976, an Interior report concluded
that the government receives "fair market value" when lessees receive
no more than a "normal" rate of return. In 1982--the last time Interior
convened a task force to comprehensively review its "fair market value"
procedures, the task force indicated that fair market value was not the
value of the oil and gas eventually discovered or produced; instead it
is the value of "the right" to explore and, if there is a discovery, to
develop and produce the energy resource. In general, for offshore,
Interior has the authority to change most components of the federal oil
and gas fiscal system so long as no more than one component is set on
automatically adjusting or "flexible" terms, and so long as the
Congress does not disapprove the change--pass a resolution of
disapproval--within 30 days of receiving notice of Interior's bidding
system. However, only the Congress may change the tax components of the
oil and gas fiscal system.
To provide more information to the Congress about the nature of the
federal oil and gas fiscal system and the attractiveness of the United
States as a place in which to invest in oil and gas development, we
agreed to build on the information in our May 1, 2007, report, which
compared the U.S. government's take with the government takes of other
resource owners throughout the world, by reviewing new studies on the
subject and adding and updating other information. Specifically, this
report (1) evaluates the government take and the attractiveness for
investors in the federal oil and gas fiscal system for the Gulf of
Mexico and the United States in general, (2) evaluates how the absence
of flexibility in this system has led to large foregone revenues from
oil and gas production on federal lands and waters as oil and gas
prices have risen, and (3) assesses what Interior has done to monitor
the performance and appropriateness of the federal oil and gas fiscal
system in light of changing market conditions.
To evaluate the attractiveness of the United States for oil and gas
investment, we reviewed the results of a study we procured from Wood
Mackenzie, a leading industry consultant. In using this study, we
reviewed the methodology and controls used by Wood Mackenzie to ensure
the accuracy of the data used and the study results. We found the study
results and the data that accompanied the study to be sufficiently
reliable to meet the objectives of this report.[Footnote 4] We also
evaluated the results of various studies conducted by other industry
experts and by MMS, the agency responsible for collecting oil and gas
royalties from federal lands and waters. To evaluate the study results,
we interviewed study authors and other industry experts to determine
the studies' methodologies and the appropriate interpretation of the
results. Based on these interviews and our review of the results of the
studies, we believe the general approaches taken by the authors of the
studies was reasonable and that results of the studies are credible.
However, with the exception of the Wood Mackenzie study, we did not
fully evaluate each study's methodology or the underlying data used to
make the government take estimates. We also purchased and evaluated
data from a leading financial firm and evaluated data and information
published by the Department of Energy's Energy Information
Administration (EIA), the American Petroleum Institute, and other
sources. We assessed these data for reliability and deemed them
reliable for the purposes of this report. We reviewed academic and
government studies that investigated the costs and benefits of various
oil and gas fiscal systems, and we interviewed and gathered information
from officials from MMS, other governments, and the oil and gas
industry. To evaluate how the absence of flexibility in the federal oil
and gas fiscal system has led to large foregone revenues from oil and
gas production on federal lands and waters as oil and gas prices have
risen, we relied on past work evaluating changes in federal oil and gas
fiscal terms in the deep water regions of the U.S. Gulf of Mexico. We
also evaluated Interior analyses that accompanied recent increases in
royalty rates in the U.S. Gulf of Mexico. In addition, we reviewed the
Wood Mackenzie study and accompanying data. We also interviewed company
officials and industry experts to obtain information on their
preferences regarding oil and gas fiscal system characteristics. To
assess what Interior has done to monitor the performance and
appropriateness of the federal oil and gas fiscal system in light of
changing market conditions, we evaluated the extent to which Interior
had collected the types of information and done the analysis needed to
determine whether or not the oil and gas fiscal system should be
changed in light of the recent changes in oil and gas market
conditions. To do this, we reviewed Interior studies, policies, and
guidance and interviewed officials from MMS; interviewed and collected
views from oil and gas companies and industry groups; and evaluated
analyses of oil and gas fiscal systems. We neither assessed Interior's
overall management of the federal system, both on and offshore, nor did
we attempt to evaluate the costs and benefits of any of Interior's
specific changes to the system over time. We conducted this performance
audit from May 2007 to September 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.
Results in Brief:
In addition to having a low government take, the U.S. Gulf of Mexico
and other U.S. regions are attractive targets for investment because
they have large remaining oil and gas reserves and the United States is
generally a good place to do business compared to many other countries
with comparable oil and gas resources. Multiple studies completed as
early as 1994 and as recently as June 2007 indicate that the U.S.
government take in the Gulf of Mexico is lower than that of most other
oil and gas fiscal systems. For example, data we evaluated from a June
2007 Wood Mackenzie report indicate that the government take in the
deep water U.S. Gulf of Mexico ranked as 93rd lowest of 104 oil and gas
fiscal systems evaluated. More broadly, other measures indicate that
the United States as a whole is an attractive target for oil and gas
investment. First, the deep water U.S. Gulf of Mexico and other U.S.
oil and gas regions rank high in terms of remaining oil and gas
reserves among countries that allow private oil and gas companies to
operate on their lands and waters. Second, since 2002 as oil prices
have risen and gas prices have remained high by historical standards,
the number of oil and gas drilling rigs operating in U.S. lands and
waters has increased much faster than in the rest of the world.
Specifically, the number of rigs in use globally outside the United
States increased by about 18 percent from an annual average of 998 in
2002 to 1,180 through the first 4 months of 2008, while the number of
rigs operating in the United States increased by about 113 percent,
from an annual average of 831 in 2002 to 1,829 rigs in April 2008.
Finally, the United States ranks high among almost all other
governments in terms of its general attractiveness for doing business.
For example, the World Bank ranked the United States as the third most
favorable place to conduct business of 178 countries analyzed in a 2007
study.
The lack of price flexibility in royalty rates and the inability to
change fiscal terms for existing leases have put pressure on Interior
and the Congress to change royalty rates on future leases in an ad hoc
basis with consequences that could amount to billions of dollars of
foregone revenue. For example, 1995 legislation granted royalty relief
on certain leases issued in the deep water areas of the U.S. Gulf of
Mexico between 1996 and 2000--a period when oil and gas prices and
industry profits were much lower than they are today--could cost the
federal government between $21 billion and $53 billion, depending on
the outcome of ongoing litigation concerning the authority of Interior
to place price thresholds that would remove the royalty relief offered
on certain leases. A royalty relief provision also was included in the
Energy Policy Act of 2005 on leases issued during the 5-year period
beginning on the date of enactment of this act. Further, two royalty
rate increases affecting future U.S. Gulf of Mexico leases were
announced by Interior in 2007. These royalty rate increases are
expected to generate modest increases in federal revenues from future
leases offered in the U.S. Gulf of Mexico. However, in choosing to
increase royalty rates Interior did not evaluate the entire oil and gas
fiscal system to determine whether or not these increases strike the
proper balance between the attractiveness of federal leases for
investment and appropriate returns to the federal government for oil
and gas resources. As a result, and because the new royalty rates are
not flexible with respect to oil and gas prices, Interior and the
Congress may again be under pressure from industry or the public to
further change royalty rates if and when oil and gas prices either fall
or continue rising. Finally, these royalty changes only affect U.S.
Gulf of Mexico leases and do not address onshore leases at all, which
should also be considered in light of the increases in oil and gas
prices. Wood Mackenzie reports that the deep water U.S. Gulf of Mexico
ranked in the bottom half of oil and gas fiscal systems in terms of
stability based on recent changes to fiscal terms and on the relative
lack of built-in flexibility that would allow the fiscal terms to
adjust to market conditions. Oil and gas companies we communicated with
stated a clear preference for stable fiscal terms, other things being
equal. In general, while companies prefer lower government take, it is
reasonable to expect that these companies would be willing to pay a
higher share of revenues in return for greater assurance that the
fiscal terms will not induce balancing changes when market conditions
change, such as the windfall profits charges that a number of countries
have recently imposed.
Interior does not routinely evaluate the federal oil and gas fiscal
system as a whole, monitor what other governments or resource owners
worldwide are receiving for their energy resources, or evaluate and
compare the attractiveness of the United States for oil and gas
investment with that of other oil and gas regions. As a result,
Interior cannot assess whether or not there is a proper balance between
the attractiveness of federal lands and waters for oil and gas
investment and a reasonable assurance that the public is getting an
appropriate share of revenues from this investment. Specifically,
Interior does not have procedures in place for routinely evaluating the
ranking of (1) the federal oil and gas fiscal system or (2) industry
rates of return on federal leases against other resource owners.
Further, Interior does not have the authority to alter the tax
components of the oil and gas fiscal system. All these factors should
inform any decisions about whether or how to alter the federal oil and
gas fiscal system in response to changing market conditions. While
Interior has made many specific changes to components of the oil and
gas fiscal system over the years to adjust to changing market
conditions, these changes were generally not done as part of a
comprehensive review of the system that took into account the relative
ranking of the U.S. government take or other comparisons with other
countries or regions. In fact, the last time Interior conducted a
comprehensive evaluation of the federal oil and gas fiscal system was
over 25 years ago. Finally, the lack of a comprehensive re-evaluation
of the federal oil and gas fiscal system stands in contrast to the
actions of many other governments that have recently re-evaluated or
are currently re-evaluating their systems in light of rising oil and
gas prices and higher industry profits and rates of return.
Recent large increases in oil and gas prices and industry profits raise
obvious questions about whether the public share of oil and gas
revenues is appropriate. The fact that the recent studies show that the
government take in the deep water U.S. Gulf of Mexico is relatively low
and U.S. federal oil and gas regions are attractive places to invest
also indicates that the federal oil and gas fiscal system may not
strike a proper balance between maintaining competitive investment
conditions and providing an appropriate share of revenues to the public
from oil and gas sold on public lands and waters. Finally, because
Interior has not comprehensively re-evaluated the federal oil and gas
fiscal systems for over 25 years, such a comprehensive evaluation of
the systems, both on-and offshore, is overdue. Comparing oil and gas
fiscal systems and attractiveness for investment is inherently complex
and Interior has not collected information needed to perform such a
comprehensive review. In the draft report we sent to Interior for
comment, we made recommendations to address these issues. In its
response, Interior stated that it did not fully concur with our
recommendations because it had already contracted for a study that will
address many of the issues we raise. However, because Interior's
ongoing study is limited in scope and is limited to a specific region
in the Gulf of Mexico, rather than a review of the entire federal oil
and gas fiscal system as we recommended, we do not find the agency's
stated rationale for not agreeing fully with our recommendations to be
convincing. Therefore, we believe that Congress may wish to consider
directing the Secretary of the Interior to to convene an independent
panel to perform a comprehensive review of the federal oil and gas
fiscal system. Further, in order to keep abreast of potentially
changing market conditions going forward, the Congress may wish to
consider directing the Secretary of the Interior to direct the Minerals
Management Service and other relevant agencies within Interior to
establish procedures for periodically collecting data and information
and conducting analyses to determine how the federal government take
and the attractiveness for oil and gas investors in each federal oil
and gas region compare to those of other resource owners and report
this information to the Congress.
Background:
Interior, created by the Congress in 1849, oversees and manages the
nation's publicly owned natural resources, including parks, wildlife
habitats, and minerals, including crude oil and natural gas resources,
on over 260 million surface acres and 700 million subsurface acres
onshore and in the waters of the Outer Continental Shelf. In this
capacity, Interior is authorized to lease federal oil and gas resources
and to collect the royalties associated with their production,
Interior's Bureau of Land Management (BLM) is responsible for leasing
federal oil and natural gas resources on land, whereas offshore--
including the U.S. Gulf of Mexico--Minerals Management Service (MMS)
has the leasing authority. To lease U.S. Gulf of Mexico waters for oil
and gas exploration, companies generally must first pay the federal
government a sum of money that is determined through a competitive
auction and evaluated by Interior against departmental economic and
geologic models. This money is called a bonus bid. Companies are
required to submit one-fifth of any bid for a lease tract up front at
time of bid, and pay the remaining four-fifths balance of their bonus
payment and their first year rental payment after acquiring a lease.
After the lease is awarded and production begins, the companies must
also pay royalties to MMS based on a percentage of the cash value of
the oil and gas produced and sold or "in kind," as a percentage of the
actual oil or gas produced. Royalty rates for onshore leases are
generally 12.5 percent. Royalty rates for leases in the U.S. Gulf of
Mexico, prior to 2007, ranged from 12.5 percent for water depths of 400
meters or deeper (referred to as deepwater) to 16-2/3 percent for water
depths less than 400 meters (referred to as shallow). In 2007, the
Secretary of Interior twice increased the royalty rate for future U.S.
Gulf of Mexico leases--in January, the rate for deep water leases was
raised to 16-2/3 percent and in October, the rate for all future
leases, included those issued in 2008, was raised to 18-3/4 percent.
A considerable body of legislation has been enacted pertaining to the
management of resources on federal and Indian trust lands and within
federal waters. This legislation includes the Mining Law of 1872,
Mineral Lands Leasing Act of 1920, 1947 Mineral Leasing Act for
Acquired Lands, Outer Continental Shelf Lands Act of 1953, Federal Land
Policy and Management Act of 1976, the Outer Continental Shelf Lands
Act Amendments of 1978, Federal Oil and Gas Royalty Management Act of
1982, as well as the Federal Onshore Oil and Gas Leasing Reform Act of
1987, the Outer Continental Shelf Deep Water Royalty Relief Act of
1995, and the Energy Policy Act of 2005. The Outer Continental Shelf
Lands Act, as amended (OCSLA) is, among other things, intended to
ensure the public "a fair and equitable return" on the resources of the
shelf. The law directs the Secretary of Interior to conduct leasing
activities to assure receipt of fair market value for the lands leased
and the rights conveyed by the federal government. In addition, the
Federal Land Policy and Management Act indicated that, unless otherwise
provided by statute, it is the policy of the United States to receive
"fair market value" for the use of the public lands and their
resources. In 1982, Interior's MMS convened a task force to review its
fair market value procedures. Upon completion of the task force's work,
the Secretary of Interior informed the Congress by letter in March 1983
that the Department had completed its analysis and validation of the
process by which it will assure a fair return to the American people.
The Secretary indicated in that letter that the process in place will
assure the American people a full and fair return as it pertains to
bonuses, rentals, royalties, and taxes. The 1983 Interior task force
report also provided some clarity regarding a fair return, or fair
market value. The report indicated that the market value of a lease is
not the market value of the oil and gas eventually discovered or
produced. Instead, it is the value of the right to explore and, if
there is a discovery, develop and produce the energy resource.
Currently Interior has the legal authority to change most aspects of
the oil and gas fiscal system. Specifically, Interior is allowed by
statute to change bid terms for offshore leases including the royalty
rate, the bonus bid structure, rental terms, and even the minimum 12.5
percent royalty rate, so long as there is only one variable or
"flexible" term--such as a royalty rate that adjusts upwards or
downwards with oil and gas prices--in the resulting system, and so long
as Congress does not pass a resolution of disapproval within 30 days of
Interior's changes to the system.[Footnote 5] With regard to onshore
leases, Interior is generally allowed by statute to change bid terms
including the royalty rate, the bonus bid structure, rental terms, and
the minimum royalty rate so long as the bid structure meets certain bid
terms,[Footnote 6] but with certain additional limits on flexibility
than the offshore leases. Over the past 25 years, Interior has
implemented several programs that adjusted royalty rates or other
system components. Such programs included the net profit share leases,
which were for offshore leases that based royalties on a percentage of
net profits derived from production; sliding scale royalty rates, which
was an onshore royalty rate system based on changing production levels;
and royalty rate reduction for stripper wells and lower-grade, more
viscous crude oil, where onshore oil wells producing less than 15
barrels of oil per day were eligible for royalty rate reductions.
Interior officials told us they also "experimented" with a variety of
flexible royalty rate and profit sharing systems in the early 1980s,
but found them difficult to administer and validate the amount of
payments due to MMS, which in Interior's estimation more than offset
any enhanced flexibility associated with a variable royalty rate.
The Gulf of Mexico Has a Relatively Low U.S. Government Take and the
United States Is an Attractive Place to Invest in Oil and Gas
Development:
Multiple studies completed as early as 1994 and as recently as June
2007 all indicate that the U.S. government take in the Gulf of Mexico
is lower than most other oil and gas fiscal systems. Four recent
studies by private consultants or resource owners indicate that the
U.S. government take in the Gulf of Mexico is relatively low. For
example, data we evaluated from a June 2007 report by Wood Mackenzie
reported that the government take in the deep water U.S. Gulf of Mexico
ranked as the 93rd lowest out of 104 oil and gas fiscal systems
evaluated in the study. Other U.S. oil and gas regions are also listed
in the Wood Mackenzie study and some but not all other studies.
However, these regions are not uniquely under federal jurisdiction, so
a direct comparison of the government take in these other regions
cannot be used to isolate the federal oil and gas fiscal system. The
results of the four studies are summarized below in table 1.
Table 1: Summary of Four 2007 Studies Comparing Government Take
Percentages:
Study: Our Fair Share: Report of the Alberta Royalty Review Panel,
Sept. 18, 2007 (analysis done by the Alberta Department of Energy);
Rank (from highest to lowest) of Gulf of Mexico U.S. government take
among oil and gas fiscal systems reviewed in each study: 16/19;
Government take percentages: Highest: 77.00;
Government take percentages: Lowest: 39.00;
Government take percentages: Gulf of Mexico: 47.50.
Study: Cambridge Energy Research Associates: 2002 vs. 2007;
Rank (from highest to lowest) of Gulf of Mexico U.S. government take
among oil and gas fiscal systems reviewed in each study: 17/17;
Government take percentages: Highest: 95.00;
Government take percentages: Lowest: 49.00;
Government take percentages: Gulf of Mexico: 49.00.
Study: Van Meurs Corporation: Comparative Analysis of Fiscal Terms for
Alberta Oil Sands and International Heavy and Conventional Oils, May
17, 2007;
Rank (from highest to lowest) of Gulf of Mexico U.S. government take
among oil and gas fiscal systems reviewed in each study: 25/28;
Government take percentages: Highest: 92.00;
Government take percentages: Lowest: 25.00;
Government take percentages: Gulf of Mexico: 47.00.
Study: Wood Mackenzie: Government Take: Comparing the Attractiveness
and Stability of Global Fiscal Systems, Wood Mackenzie, June 2007;
Rank (from highest to lowest) of Gulf of Mexico U.S. government take
among oil and gas fiscal systems reviewed in each study: 93/104;
Government take percentages: Highest: 98.04;
Government take percentages: Lowest: 18.05;
Government take percentages: Gulf of Mexico: 44.09.
Source: GAO analysis of four calendar year 2007 government take
studies.
[End of table]
As we reported in May 2007, the results of five other studies completed
between 1994 and 2006 had similar findings. The information reported by
Wood Mackenzie and other such expert studies are used by resource
owners and oil and gas companies alike to aid in making investment or
policy decisions and these studies represent the best data on
government take available. However, we recognize there are limitations
with the government take studies and the relative ranking of government
take alone is not sufficient to determine whether the federal
government is receiving its fair share of oil and gas revenues. A
number of other factors that are not part of the government take
determine company decisions of where and how much to invest and how
much to pay for access to oil and gas resources. These factors include
the relative size of oil and gas resource bases in different regions
and the relative costs of developing these resources. Thus government
take is a major, but not sole factor in determining the attractiveness
of a fiscal system for oil and gas development.
When other factors are taken into consideration, the U.S. Gulf of
Mexico is an attractive target for investment because it has large
remaining oil and gas reserves and the United States is generally a
good place to do business compared to many other countries with
comparable oil and gas resources. For example, once reserves that are
entirely owned by governments are removed from the analysis, of the 104
remaining fiscal regimes ranked by Wood Mackenzie that allow some
participation by international oil companies and that have remaining
oil and gas reserves, the deep water U.S. Gulf of Mexico ranked 18th
highest in terms of remaining oil and gas reserves. Three other U.S.
regions were ranked in the top 18 in terms of reserves. These were the
U.S. Rocky Mountains (8th), Alaska (14th), and U.S. Gulf Coast (15th),
but these regions are not uniquely covered by the federal fiscal
regimes, as state and private resource owners may also exist.
Wood Mackenzie also ranked oil and gas fiscal regimes in terms of their
attractiveness for investment. Wood Mackenzie's measure of oil and gas
fiscal attractiveness took into account both reward associated with
factors such as resource size; and risk, including the extent to which
government take includes bonuses. With respect to reward, Wood
Mackenzie compared the levels of government take with the size of oil
and gas fields governed by the various oil and gas fiscal systems. The
risk ranking reflected whether or not the system included bonus
payments, which increase the risk to investors because they must be
paid whether or not economic volumes of oil and gas are eventually
found on an oil and gas tract.[Footnote 7] Risk also included a measure
of the extent to which and the way in which the resource owner held an
equity share in the resources being developed. The impact of the fiscal
terms on the rewards and risks associated with a wide range of
hypothetical new investments were assessed under the terms of each of
the 103 oil and gas fiscal systems included in this section of the
study. Based on these assessments, Wood Mackenzie ranked the deep water
U.S. Gulf of Mexico fiscal system as more attractive for investment
than 60 (about 58 percent) of the 103 fiscal systems ranked.
More broadly, other measures indicate that the United States is an
attractive place to invest in oil and gas production. For example,
since 2002 as oil prices have risen and gas prices have remained high
by historical standards, the number of oil and gas drilling rigs
operating in the United States has increased much faster than in the
rest of the world, which indicates companies in recent years have
continued to find the United States a conducive place to invest in oil
and gas production. Specifically, according to data on crude oil rig
counts from Baker Hughes, the number of rigs in use globally excluding
the United States increased by about 18 percent from an annual average
in 2002 of 998 to 1,180 through the first 4 months of 2008, while the
number of rigs operating in the United States increased about 113
percent, from 831 rigs in 2002 to 1,768 rigs in 2007 and 1,829 rigs in
April 2008. These increases coincided with the increase in oil and gas
prices over the same period and indicate that the United States has
remained an attractive place to invest in oil and gas as prices have
risen.
While rig counts can reasonably be associated with the attractiveness
of a region for development and production, they do not tell the whole
story. For example, according to Baker Hughes, the Gulf of Mexico rig
count fluctuated over the longer term and has decreased in recent
years. Specifically, from 1973 to 1981, rig counts in the Gulf of
Mexico increased, from 80 to 231, before generally decreasing to 45 in
1992. They then generally rose again until 2001. From 2001 to April
2008, the annual rig count in the Gulf of Mexico decreased from 148 to
58. This decline has occurred despite the Gulf of Mexico being
generally considered an attractive target for investment, both from the
perspective of the government take and because of the potential for
significant oil and gas resources.
Other analyses report the oil and gas industry appears to have
performed favorably in recent years compared with other industries.
* The Energy Information Administration reported in December 2007 that
from 2000 through 2006, the return on equity, which compares a
company's profit with the value of the shares held by the company's
owners, for the major energy producers, referred to as Financial
Reporting System (FRS) companies, averaged 7 percentage points higher
than that of the U.S. Census Bureau's "All Manufacturing Companies."
[Footnote 8] According to the report, this reversed a trend where the
return on equity for the major energy producers averaged 2 percentage
points lower than All Manufacturing Companies from 1985 to 1999.
* The American Petroleum Institute, in a 2007 study, showed that from
2000 to 2005, the average return on investment for oil and gas
production was about 61 percent higher than for the Standard & Poor's
(S&P) industries.[Footnote 9] However, the average return on investment
for the industry has matched or exceeded the returns for the S&P
industrials only in recent years; over the 25-year period from 1980 to
2005, the average return on investment for oil and gas production was
about 18 percent lower than for the S&P industries.
* A GAO analysis found that the "upstream," or exploration and
production segments, of the domestic oil and gas production companies
also received higher rates of return than companies operating in other
U.S. manufacturing industries from 2002 through 2006. We analyzed
financial data from S&P's Compustat and EIA's FRS. From 2002 through
2006, the upstream segments of the domestic oil and gas production
companies have averaged a 17.4 percent return on investment,[Footnote
10] compared with 15.2 percent for all other manufacturing companies.
[Footnote 11] When both upstream and "downstream" the refining and
marketing segments are included in the analysis, the oil and gas
industry return on investment averaged over 20 percent during this
period. This short term picture, however, contrasts with a longer-term
analysis, which shows the oil and gas industry receiving a return on
investment that is comparable, or slightly lower, than that received by
other manufacturing industries over the past 30 years. Our analysis
found that during this period, upstream oil and gas production has
averaged 11.2 percent return on investment with the entire oil and gas
industry receiving an average 13.7 percent return on investment. All
other manufacturing companies have averaged 12.3 percent return on
investment during this period. This recent improvement in financial
performance from 2000 through 2006 coincided with rising oil and gas
prices. Further, since 2006, oil and gas prices have risen even higher,
while EIA's most recent projections to 2030 are for oil and gas prices
to remain much higher than they were for most of the period 1985
through 1999.
In addition, the United States is also generally ranked favorably as a
place to conduct business by the World Bank and by business media
sources, including The Economist, and AM Best. For example, the World
Bank ranked the United States as the third most favorable place to
conduct business of 178 countries analyzed in a 2007 study.[Footnote
12] The Economist in October 2007 ranked the United States as the ninth
highest of 82 countries analyzed for projected favorability of business
environment from 2008 to 2012. Finally, as of February 2008, the United
States remained in the top tier--of five possible tiers--on AM Best's
countries for business risk index, meaning the United States generally
posed the least risk for investors of the five possible levels
assigned.
The Inflexibility of Royalty Rates to Changing Oil and Gas Prices Has
Cost the Federal Government Billions of Dollars in Foregone Revenues:
The lack of price flexibility in royalty rates and the inability to
change fiscal terms for existing leases have put pressure on Interior
and the Congress to change royalty rates in the past on future leases
on an ad hoc basis. For example, in 1980, a time when oil prices were
comparable in inflation-adjusted terms to today's prices, Congress
passed a windfall profit tax, which amounted to an excise tax per
barrel of oil produced in the United States. Congress repealed that tax
in 1988 at time when oil prices had fallen significantly from their
1980 level. The tax attempted to recoup for the federal government much
of the revenue that would have otherwise gone to the oil industry as a
result of the decontrol of oil prices.
Further, in 1995--a period with relatively low oil and gas prices--the
federal government enacted the Outer Continental Shelf Deep Water
Royalty Relief Act (DWRRA). In implementing the DWRRA for leases sold
in 1996, 1997, and 2000, MMS specified that royalty relief would be
applicable only if oil and gas prices were below certain levels, known
as "price thresholds," with the intention of protecting the
government's royalty interests if oil and gas prices increased
significantly. MMS did not include these same price thresholds for
leases it issued in 1998 and 1999. In addition, the Kerr-McGee
Corporation--which was active in the Gulf of Mexico and is now owned by
Anadarko Petroleum Corporation--filed suit challenging Interior's
authority to include price thresholds in DWRRA leases issued from 1996
through 2000. Recently, the U.S. District Court for the Western
District of Louisiana granted summary judgment in favor of Kerr-McGee
concerning the application of price thresholds to those leases and this
ruling is currently under appeal.[Footnote 13] In our June 2008 report
on the potential foregone revenues at stake in the Kerr-McGee
litigation, we found that the value of future forgone royalties is
highly dependent upon oil and gas prices, and on production levels.
[Footnote 14] Assuming that the District Court's ruling is upheld,
future foregone royalties from all the DWRRA leases issued from 1996
through 2000 could range widely--from a low of about $21 billion to a
high of $53 billion,[Footnote 15] depending on the outcome of ongoing
litigation concerning the authority of Interior to place price
thresholds that would remove the royalty relief offered on certain
leases. The $21 billion figure assumes relatively low production levels
and oil and gas prices that average $70 per barrel and $6.50 per
thousand cubic feet over the lives of the leases. The $53 billion
figure assumes relatively high production levels and oil and gas prices
that average $100 per barrel and $8 per thousand cubic feet over the
lives of the leases. A royalty relief provision was also included in
the Energy Policy Act of 2005 on leases issued during the 5-year period
beginning on August 8, 2005.
In 2007, the Secretary of the Interior twice increased the royalty rate
for future Gulf of Mexico leases--in January, the rate for deep water
leases was raised to 16-2/3 percent and in October, the rate for all
future leases in the Gulf, including those issued in 2008, was raised
to 18-3/4 percent. Interior estimated these actions will increase
federal oil and gas revenues by $8.8 billion over the next 30 years.
The January 2007 increase applied only to deep water Gulf of Mexico
leases; the October 2007 increase applied to all water depths in the
Gulf of Mexico. These royalty rate increases appear to be a response by
Interior to the high prices of oil and gas that have led to record
industry profits and raised questions about whether the existing
federal oil and gas fiscal system gives the public an appropriate share
of revenues from oil and gas produced on federal lands and waters.
However, the royalty rate increases do not address these record
industry profits from existing leases at all and high profits will
likely remain as long as the existing leases produce oil and gas or
until oil and gas prices fall. In addition, in choosing to increase
royalty rates, Interior did not evaluate the entire oil and gas fiscal
system to determine whether or not these increases were sufficient to
balance investment attractiveness and appropriate returns to the
federal government for oil and gas resources. On the other hand,
according to Interior, it did consider factors such as industry costs
for outer continental shelf exploration and development, tax rates,
rental rates, and expected bonus bids. Further, because the new royalty
rates are not flexible with respect to oil and gas prices, Interior and
the Congress may again be under pressure from industry or the public to
further change the royalty rates if and when oil and gas prices either
fall or continue rising. Finally, these royalty changes only affect
Gulf of Mexico leases and do not address onshore leases at all, which
should also be considered in light of the increases in oil and gas
prices.
In addition, Wood Mackenzie reports that the deep water U.S. Gulf of
Mexico ranked in the bottom half of countries in terms of oil and gas
fiscal system stability based on repeated changes to fiscal terms for
future leases and on the relative lack of built-in flexibility that
would allow the fiscal terms to adjust to market conditions.
Specifically, the Wood Mackenzie study ranked the deep water U.S. Gulf
of Mexico fiscal terms as lower than 71 (about 72 percent) of the 103
oil and gas fiscal systems. In contrast, among the key trends among
governments in recent years has been to make fiscal terms more
responsive to market conditions. By adding such progressive features to
oil and gas fiscal systems including royalty rates that increase with
oil and gas prices, these other entities are making their systems more
stable over time by reducing incentives for industry or the public to
push for ad hoc changes in fiscal terms as future prices change. Wood
Mackenzie's measure of fiscal stability combines two criteria: recent
history of changes to fiscal terms and built-in flexibility. As
discussed previously in this report, changes to royalty rates occurred
in the Gulf of Mexico three times since 1995, with the royalty relief
in the mid 1990s and the two increases in royalty rates in 2007.
However, as noted above, the study was conducted before the second 2007
increase in royalty rates, so the government take would likely have
increased but the U.S. stability rating could have fallen in the
intervening period. Built-in flexibility reflects the relative degree
to which a fiscal system is regressive or progressive, with more
progressive systems being more flexible. A flexible system does not
mean changing the fiscal terms of existing contracts but having a
system in place that automatically adjusts to changing economic and
market conditions.
Oil and gas companies we communicated with stated a clear preference
for stable fiscal terms, other things being equal. Overall, oil and gas
companies may be more willing to invest in flexible systems, given that
they tend to be inherently more stable and therefore are less likely to
be arbitrarily changed on a recurring basis. Oil and gas companies and
industry trade associations we contacted provided us a range of views
on the advantages and disadvantages of various oil and gas fiscal
systems, and generally indicated that one of the most important
features of any system is its stability and predictability. Stability
of fiscal terms is important because oil and gas companies are making
very long-term investments and uncertainty about whether or not the
resource owner will change the fiscal terms during the lifetime of the
investment adds to the investment risk. The respondents also said that
the terms of the oil and gas fiscal system should consider industry
exploration and development costs, the likelihood of discovery, and
political and economic risks. While companies surely prefer lower
government take, all else constant, to the extent that stability is
also preferred, a more stable system may be able to remain competitive
for investment while resulting in a higher government take than a less
stable system. In particular, companies may be willing to pay a larger
average share of oil and gas revenues if they believe that oil and gas
fiscal systems will not change when market conditions change, such as
the windfall profits charges that a number of countries have recently
imposed. Such willingness to accept lower expected profits in exchange
for lower risk is a common feature of investment markets.
In addition to the potential trade-off between oil and gas fiscal
system stability and government take, companies may be willing to pay
higher average shares of revenues if governments bear some of the risk
that companies take on when they purchase the rights to explore for oil
and gas. For example, in the United States as well as for a number of
other governments, leases are awarded through a bidding process that
requires companies to pay bonus bids for the rights to explore and
develop leases. With regard to bonus bids, there are advantages to
requiring such bids. First, when companies have to compete with one
another to win a lease, the lease is more likely to be awarded to a
company with the expertise and resources to properly explore and
develop the resources on the lease than if leases are awarded using
some other rationing mechanism that does not take into account how much
companies are willing to pay for the lease. In addition, it guarantees
the public some revenue early on in the exploration and development
process, which can take a number of years to complete. However, the use
of bonus bids pushes a great deal of risk onto oil and gas companies
and requires them to estimate many uncertain factors, including the
amounts of oil and gas that will ultimately be produced on the lease,
the costs of that production, and the prices of gas and oil over the
entire working life of the lease. In general, by increasing the risk
that companies bear, these companies will have to expect to receive a
higher rate of return to be willing to take on the project. In fiscal
systems requiring bonus bids or other up-front payments, the companies
bear the risk that leases will not generate economically significant
oil and gas production. In fact, in the United States, a large
proportion of leases that companies have paid for do not generate
economic levels of production and the companies, after purchasing the
lease, and paying rent for the duration of the initial term of the
lease and whatever resources they spent on exploring for oil and gas,
simply let the lease revert back to the government when the initial
term expires.
Some oil and gas fiscal systems mitigate the risk associated with up-
front company expenditures by allowing the companies to recover
exploration and development costs prior to starting higher royalty
payments. For example, Alberta, Canada, has used such fiscal terms.
Other fiscal systems share risk with companies by more strongly linking
government take to company profits. In such oil and gas fiscal systems,
government take is low in early years of a lease, when exploration and
early development are being undertaken, but increases if production
increases or if oil and gas prices increase once production begins. The
state of Alaska has recently changed its fiscal terms to increase its
government take and to increase the linkage between government take and
company profits. Both Alberta and the state of Alaska have higher
government takes than the U.S. Gulf of Mexico according to the Wood
Mackenzie study.
Interior Does Not Have a System in Place to Evaluate Whether the
Federal Fiscal System Is in Need of Reassessment:
Interior does not routinely evaluate the federal oil and gas fiscal
system as a whole, monitor what other resource owners worldwide are
receiving for their energy resources, or evaluate and compare the
attractiveness of the United States for oil and gas investment with
that of other oil and gas regions. As a result, Interior cannot assess
whether or not there is a proper balance between the attractiveness of
federal lands and waters for oil and gas investment and a reasonable
assurance that the public is getting an appropriate share of revenues
from this investment. This is true of the U.S. Gulf of Mexico as well
as other federal oil and gas producing regions. Interior does not have
procedures in place for routinely evaluating the ranking of (1) the
federal oil and gas fiscal system against other resource owners or (2)
industry rates of return on federal leases compared to other U.S.
industries which could factor into any decisions about whether or how
to alter the fiscal systems in response to changing market conditions.
Interior officials told us that they have a "bid adequacy review
process" for offshore leases that determines whether the bonus bid
meets criteria designed to ensure fair market value of the leased tract
but that onshore leases do not have a similar bid adequacy provision.
Moreover, Interior maintains it has been responsive to changes in
market conditions through revisions to lease terms, including changes
in minimum bonus bid levels, fluctuating royalty rates, and price
thresholds. However, as we have discussed previously in this report,
bonus bids have both positive and negative sides with respect to their
likely impact on overall government take. Further, frequent adjustments
to fiscal terms are not looked on favorably by industry, especially
when they involve increases in royalty rates or other charges. Interior
indicated, in commenting on the report draft, that it is in the process
of evaluating other fiscal approaches such as sliding scale royalties
for some oil and gas leases.
We did not evaluate the effectiveness of the bid adequacy review
process in terms of its intended goal of ensuring bonus bids on
offshore federal leases are competitive. However, even assuming that
these bids are competitive, we do not think that this is sufficient to
ensure that the other elements of the system are appropriately
balancing the interests of taxpayers and oil and gas companies. In
light of the complexity of oil and gas fiscal systems, the great deal
of uncertainty surrounding the volumes and future prices of oil and
gas, and the costs of producing it, oil and gas companies cannot be
expected to accurately forecast all the factors that will ultimately
determine the value of a lease at the time that lease is sold. As a
result, oil and gas company profits have tended to rise and fall over
time with oil and gas prices, putting pressure on Interior to alter
fiscal terms in a reactive rather than a strategic way. Further, the
fact that Interior does not apply the same or a similar bid adequacy
process for onshore leases raises questions about how Interior,
overall, is providing reasonable assurance that even the bonus bids it
receives are competitively determined in all publicly owned oil and gas
producing regions.
While Interior has made many specific changes to components of the
federal oil and gas fiscal system over the years to adjust to changing
market conditions, these changes were generally not done as part of a
comprehensive review of the fiscal system that took into account the
relative ranking of the U.S. government take or other comparisons with
other countries or regions. The last time Interior conducted a
comprehensive evaluation of the oil and gas fiscal system was over 25
years ago. The lack of a recent comprehensive re-evaluation of the U.S.
federal fiscal system stands in contrast to the actions of many other
governments that have recently reevaluated or are currently re-
evaluating their fiscal systems in light of rising oil and gas prices
and higher industry profits and rates of return. For example, as
previously discussed in this report, a number of countries have
recently imposed windfall profits taxes or other mechanisms to increase
the resource owners' shares of oil and gas revenues from existing
projects. Wood Mackenzie estimates that these changes will ultimately
result in these countries' collecting additional oil and gas revenues
of between $118 billion and $400 billion, depending on future oil and
gas prices.
In evaluating an oil and gas fiscal system, all components of the
system, including bonus bids, land rental rates, royalties, and oil and
gas company taxes, must be considered. However, while Interior has a
great deal of expertise and data from years of administering and
collecting revenues from oil and gas leases on federal lands and waters
that would be essential for any review of the federal oil and gas
fiscal system, they do not have the authority to change taxes and,
therefore, cannot fully revise the system without legislative action by
the Congress. Further, it is essential to keep federal leases
competitive with other potential investments governed by different
fiscal systems. Therefore, in addition to input from Interior, oil and
gas industry experts must also be consulted in any comprehensive review
of the federal oil and gas fiscal system. For example, when Alberta
recently reviewed its oil and gas fiscal system, it convened a panel
that included experts from academia, energy research and consulting
firms, and the energy industry and also hired a consultant to evaluate
the system and make specific recommendations. Following this review,
Alberta increased some elements of the oil and gas fiscal system.
However, prior to this review, Canadian government corporate taxes were
reduced, which made Alberta more attractive for investors. In any
comprehensive review of the U.S. oil and gas fiscal system, taxes may
need to be part of the discussion. Therefore, congressional action may
be needed to change the federal oil and gas fiscal system, if changes
are ultimately determined to be appropriate.
Conclusions:
Oil prices have increased in recent years to levels not seen since the
late 1970s and early 1980s when adjusted for inflation. Natural gas
prices have also been high by historical standards in recent years.
These high prices have coincided with rising oil company profits.
Moreover, the EIA's long-term outlook projects these prices to remain
much higher than what they had been for much of the past 25 years. Our
work indicates that federal oil and gas leases in the deep water U.S.
Gulf of Mexico and other U.S. regions are attractive investments and
that the government take in the U.S. Gulf of Mexico ranks among the
lowest across a large number of other oil and gas fiscal systems. Our
work further indicates that other measures, including fiscal
attractiveness and rates of return, indicate the U.S. Gulf of Mexico
and other U.S. oil and gas producing regions are attractive places to
invest. However, the regressive nature of the U.S. federal fiscal
systems and other factors have caused these fiscal systems to be
unstable over time and this adds risk to oil and gas investments and
may reduce the amount oil and gas companies are willing to pay in total
for the rights to explore and develop federal leases. Because of these
facts and because Interior has not re-evaluated its oil and gas fiscal
system in over 25 years, a comprehensive re-evaluation is called for.
While Interior could collect data and commission studies to re-evaluate
the federal fiscal system, the agency does not currently have the
information to fully compare the federal fiscal system with those of
other governments, including states or foreign countries. In addition,
Interior does not have the authority to make changes to all elements of
federal fiscal system if such changes were found to be desirable.
Finally, because of the complexity of evaluating oil and gas fiscal
systems and the importance of striking a balance between remaining an
attractive place for investment and providing revenue to the federal
government, it is important that independent experts also be consulted
as well as representatives from the oil and gas industry.
Matter for Congressional Consideration:
In the draft report we sent to Interior for comment, we made
recommendations to address these issues. In its response, Interior
stated that it did not fully concur with our recommendations because it
had already contracted for a study that will address many of the issues
we raise. However, because Interior's ongoing study is limited in scope
and is limited to a specific region in the Gulf of Mexico, rather than
a review of the entire federal oil and gas fiscal system as we
recommended, we do not find the agency's stated rationale for not
agreeing fully with our recommendations to be convincing. Therefore, we
believe that Congress may wish to consider directing the Secretary of
the Interior to convene an independent panel to perform a comprehensive
review of the federal oil and gas fiscal system.
Further, in order to keep abreast of potentially changing market
conditions going forward, the Congress may wish to consider directing
the Secretary of the Interior to direct the Minerals Management Service
and other relevant agencies within Interior to establish procedures for
periodically collecting data and information and conducting analyses to
determine how the federal government take and the attractiveness for
oil and gas investors in each federal oil and gas region compare to
those of other resource owners and report this information to the
Congress.
Agency Comments and Our Evaluation:
The Department of the Interior provided us comments on a draft of the
report. Overall, the department agreed that it is important to reassess
the federal oil and gas fiscal system but did not fully concur with
either of our two recommendations to (1) perform a comprehensive review
of the system using an independent panel and (2) adopt policies and
procedures to keep abreast of important changes in the oil and gas
market and in other countries' efforts to adjust their oil and gas
management practices in light of these changes. We disagree with
Interior's rationale for its lack of full concurrence with our
recommendations and have, therefore, elected to reframe the
recommendations into Matters for Congressional Consideration in the
final report.
In response to our first recommendation, Interior indicated that it
would be premature and duplicative for the department to undertake such
a review because it had recently contracted with an outside party to
conduct a 2-year study of the policies affecting the pace of area-wide
leasing and revenues in the Central and Western Gulf of Mexico. We
disagree that our recommended review is either premature or duplicative
with this Interior study effort. First, a comprehensive review is
overdue, given that Interior has not performed a comprehensive
evaluation of the oil and gas fiscal system in over 25 years and in
light of the dramatic increases in oil and gas prices and industry
profits in recent years. Further, as documented in this report, many
other oil and gas owners have been re-evaluating and changing their oil
and gas fiscal systems in response to these recent market conditions.
The Congress and the public are justifiably concerned about whether the
federal government is getting a fair return for its energy resources as
oil and gas company profits have reached record levels. In addition,
our recommended review would not be duplicative with Interior's ongoing
study, which is geographically limited to only two sections of the Gulf
of Mexico. In contrast, we recommended that Interior review all its oil
and gas fiscal systems, both onshore and offshore. Nor does Interior's
ongoing study cover the full scope of review that we recommended,
including looking at how other resource owners are managing their oil
and gas fiscal systems. Further, Interior's ongoing study does not
explicitly look at the stability of the system as we recommended and
this appears to be a critical factor influencing changes to oil and gas
fiscal systems globally. Finally, Interior's ongoing effort does not
utilize an independent panel. We believe it is essential to empanel an
independent body, representative of major stakeholders, including those
representing the interests of industry and the public, in order to
develop recommendations that strike an appropriate balance between
remaining and attractive place for investment and providing revenue to
the federal government.
In response to our second recommendation, Interior implied that such an
effort was unnecessary because Interior agencies that lease federal
minerals already keep abreast of current literature on fiscal systems
of other resource owners. During our work, we identified only one
Interior study done over the past 25 years that provided information on
the U.S. government take compared to other fiscal systems. While that
one Interior study issued in 2006 showed, similar to our work, that the
U.S. government take was low compared to other fiscal systems, it is
also worth noting that the study itself relied on dated 1994 government-
take information. Therefore, we do not believe that Interior has
adequately kept abreast of important trends in oil and gas management,
especially as it relates to how other resource owners are managing
these resources. In addition, our recommendation went further than
simply keeping abreast of current literature. In particular, our
recommendation sought to have Interior monitor and report on how the
federal government's fiscal terms for oil and gas development compare
with the terms of other resource owners worldwide.
Interior's full letter commenting on the draft report is printed as
appendix III, and our detailed response follows. In addition, Interior
made technical comments that we have addressed as appropriate.
As agreed with your offices, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the date of this report. At that time, we will send copies to
appropriate congressional committees, the Secretary of the Interior,
the Director of MMS, the Director of the Office of Management and
Budget, and other interested parties. We will also make copies
available to others upon request. In addition, the report will be
available at no charge on GAO's Web site at [hyperlink,
http://www.gao.gov].
If you or your staff have any questions about this report, please
contact me at (202) 512-3841 on ruscof@gao.gov. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this report. GAO staff who made major contributions to
this report are listed in appendix IV.
Signed by:
Frank W. Rusco:
Acting Director, Natural Resources and Environment:
[End of section]
Appendix I: Scope and Methodology:
We performed our work at the Department of Interior's (Interior),
Bureau of Land Management's (BLM), and Minerals Management Service's
(MMS) offices and in Washington, D.C. from May 2007 to September 2008
in accordance with generally accepted government auditing standards. We
focused our analysis of government take and industry rates of return on
the U.S. Gulf of Mexico because it represents approximately 79 percent
of oil and 50 percent of gas production on federal leases, and because
there are complicating factors for onshore oil and gas leases, such as
state and local taxes or fees that may differ by locality, which the
available studies do not fully address. We did evaluate information
that applied more broadly to the United States, specifically with
respect to overall measures of the attractiveness of the United States
for oil and gas investment. However, we cannot infer from our review of
the Gulf of Mexico federal oil and gas leases how the data on federal
government take or industry returns to investment are applicable to
federal onshore leases. In general, the results of this review can
compare the federal system associated with the U.S. Gulf of Mexico to
that of other oil and gas fiscal systems but cannot provide specific
prescriptive recommendations for how to change the federal fiscal
system to achieve a fair return for the public from sale of oil and gas
on public lands and waters. We also compared the federal oil and gas
fiscal system to all types of fiscal systems around the world to
encompass the range of choices that oil and gas companies are faced
with when deciding where to invest.
To determine the degree to which the federal government is receiving a
fair return, our work included reviewing various pieces of energy
resource management legislation enacted over the last several decades.
This included, among others, the Outer Continental Shelf Lands Act of
1953 (OCSLA) and its amendments and the Federal Land Policy and
Management Act of 1976 (FLPMA) and its amendments. We also collected
and analyzed various pieces of Interior energy resource policy and
management information. To evaluate how the U.S. government take
compares to those in other countries, we reviewed the results of a
study procured from Wood Mackenzie, a leading industry consultant, and
recent studies conducted by other private consultants or resource
owners. We also collected and analyzed various studies generated by
MMS, the agency responsible for collecting oil and gas royalties from
federal lands and waters and interviewed private consulting firm
officials. In evaluating the study results, we conducted interviews
with study authors and an industry expert to discuss the study
methodologies and the appropriate interpretation of the results. Based
on these interviews and our review of study results, we believe the
general approach that these study authors took was reasonable and that
the results of the studies are credible. However, we did not fully
evaluate each study's methodology or the underlying data used to make
the government take estimates. Overall, because all the studies came to
similar conclusions with regard to the relative ranking of the U.S.
federal government, and because such studies are used by oil and gas
industry companies and governments alike for the purposes of evaluating
the relative competitiveness of specific oil and gas fiscal systems, we
are confident that the broad conclusions of the studies are valid. To
assess the extent to which the United States' oil and gas fiscal system
is able to remain stable as market conditions change, we relied heavily
on the study and data we obtained from Wood Mackenzie. We interviewed
industry experts and gathered information regarding the types of fiscal
systems and the relative stability offered with each. We interviewed
company officials and industry experts to obtain information on their
preferences regarding fiscal system characteristics.
We also purchased data from Compustat and analyzed that data and data
published by the Energy Information Administration. The financial data
we procured are widely used by private companies and governments for
purposes of comparing company and industry rate of return over time,
because Interior in the past used rate of return as a credible measure
to evaluate the profitability of the Gulf of Mexico for firms
conducting oil and gas exploration there versus the relative
profitability of other manufacturing firms operating in the United
States. We also evaluated data reported by the American Petroleum
Institute and other sources. Further, we reviewed various reports
prepared over the last 2 years by private sources on the profitability
of oil and gas companies operating in the U.S. versus operating
elsewhere in the world. We also spoke to industry officials regarding
aspects of the various fiscal systems in which they operate. Finally,
we discussed the issue of a "fair return" with various Interior, BLM,
and MMS officials, as well as members of the oil and gas industry. To
determine what steps Interior takes to get reasonable assurance that
the federal government take provides a fair return to the public, we
reviewed Interior studies and procedures, and interviewed officials
from MMS.
We conducted this performance audit from May 2007 to September 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.
[End of section]
Appendix II: Companies Receiving Royalty Relief in the U.S. Gulf of
Mexico:
According to Interior, companies operating in the U.S. Gulf of Mexico
had received more than $1.3 billion in royalty relief through September
30, 2007. Table 2 lists the companies that have received royalty relief
under DWWRA and the amounts of that relief. Six companies had signed
agreements with Interior, allowing thresholds to be placed for
royalties to be paid in the future. Those companies are BP Exploration
and Production; ConocoPhillips & Burlington Resources Offshore, Inc.;
Marathon; Shell; Walter Hydrocarbons; and Walter Oil and Gas. According
to Interior information dated February 4, 2008, ConocoPhillips &
Burlington Resources Offshore, Inc., had not received royalty relief.
Table 2: Amounts of Royalty Relief Received by Companies:
Company: ATP Oil & Gas Corporation;
Ownership: Public - United States;
Royalty Relief Received to Date: 7,080,958;
Signed agreement with Interior to include price thresholds: No.
Company: BHPBilliton;
Ownership: Public - Australia;
Royalty Relief Received to Date: 6,480,679;
Signed agreement with Interior to include price thresholds: No.
Company: BP Exploration & Production;
Ownership: Public - United Kingdom;
Royalty Relief Received to Date: 172,508,633;
Signed agreement with Interior to include price thresholds: Yes.
Company: Chevron USA/Texaco/Union Oil;
Ownership: Public - United States;
Royalty Relief Received to Date: 4,003,495;
Signed agreement with Interior to include price thresholds: No.
Company: Devon Energy Corporation/Ocean/Santa Fe;
Ownership: Public - United States;
Royalty Relief Received to Date: 143,808,801;
Signed agreement with Interior to include price thresholds: No.
Company: Dominion Exploration;
Ownership: Public - Italy;
Royalty Relief Received to Date: 126,504,055;
Signed agreement with Interior to include price thresholds: No.
Company: EnCana Gulf of Mexico;
Ownership: Public - Canada;
Royalty Relief Received to Date: 43,908;
Signed agreement with Interior to include price thresholds: No.
Company: ENI Deepwater;
Ownership: Public - Italy;
Royalty Relief Received to Date: 27,176,887;
Signed agreement with Interior to include price thresholds: No.
Company: Howell Group;
Ownership: Public - United States;
Royalty Relief Received to Date: 46,867;
Signed agreement with Interior to include price thresholds: No.
Company: Anadarko Petroleum Corporation/Kerr McGee/Offshore Shelf/
Westport;
Ownership: Public - United States;
Royalty Relief Received to Date: 142,406,788;
Signed agreement with Interior to include price thresholds: No.
Company: Marathon Oil Corporation;
Ownership: Public - United States;
Royalty Relief Received to Date: 1,393,586;
Signed agreement with Interior to include price thresholds: Yes.
Company: Mariner Energy, Inc.;
Ownership: Public - United States;
Royalty Relief Received to Date: 44,050,427;
Signed agreement with Interior to include price thresholds: No.
Company: Marubeni;
Ownership: Public - Japan;
Royalty Relief Received to Date: 26,477,247;
Signed agreement with Interior to include price thresholds: No.
Company: Newfield Exploration Corp.;
Ownership: Public - United States;
Royalty Relief Received to Date: 10,338,890;
Signed agreement with Interior to include price thresholds: No.
Company: Nexen Inc.;
Ownership: Public - Canada;
Royalty Relief Received to Date: 129,518,866;
Signed agreement with Interior to include price thresholds: No.
Company: NI Energy Venture;
Ownership: Public - Japan;
Royalty Relief Received to Date: 406,747;
Signed agreement with Interior to include price thresholds: No.
Company: Nippon Oil Exploration;
Ownership: Public - Japan;
Royalty Relief Received to Date: 22,897,836;
Signed agreement with Interior to include price thresholds: No.
Company: Noble Corp.;
Ownership: Public - Cayman Islands;
Royalty Relief Received to Date: 1,137,105;
Signed agreement with Interior to include price thresholds: No.
Company: Occidental Petroleum Corp.;
Ownership: Public - United States;
Royalty Relief Received to Date: 109,653,662;
Signed agreement with Interior to include price thresholds: No.
Company: Petrobras America;
Ownership: Semipublic - Brazil;
Royalty Relief Received to Date: 13,354,061;
Signed agreement with Interior to include price thresholds: No.
Company: Pioneer Natural Resources Co.;
Ownership: Public - United States;
Royalty Relief Received to Date: 128,068,000;
Signed agreement with Interior to include price thresholds: No.
Company: Pogo Producing Co.;
Ownership: Public - United States;
Royalty Relief Received to Date: 7,414,106;
Signed agreement with Interior to include price thresholds: No.
Company: Royal Dutch Shell;
Ownership: Public - Netherlands;
Royalty Relief Received to Date: 27,399,688;
Signed agreement with Interior to include price thresholds: Yes.
Company: Total E&P;
Ownership: Public - France;
Royalty Relief Received to Date: 171,648,800;
Signed agreement with Interior to include price thresholds: No.
Company: Walter Oil & Gas Corp./Walter Hydrocarbons;
Ownership: Private - United States;
Royalty Relief Received to Date: 1,286,768;
Signed agreement with Interior to include price thresholds: Yes.
Total:
Royalty Relief Received to Date: 1,325,106,861.
Source: GAO analysis of Interior data dated February 4, 2008.
Note: Numbers do not add exactly due to rounding.
[End of table]
Appendix III: Comments from Department of the Interior:
Note: GAO comments supplementing those in the report text appear at the
end of this appendix.
United States Department of the Interior:
Office Of The Secretary:
Washington, D.C. 20240:
August 8, 2008:
The Honorable Frank Rusco:
Director, Government Accountability Office:
441 G Street, NW:
Washington, D.C. 20548:
Dear Mr. Rusco:
Thank you for the opportunity to review and comment on the Government
Accountability Office draft report "Oil and Gas Royalties: The Federal
System for Collecting Oil and Gas Revenues Needs Comprehensive
Reassessment" (GAO-08-691). We appreciate the efforts of the GAO and
have consistently worked closely with the GAO on this and previous
reports over the years. We agree that it is important to review the
Federal oil and gas fiscal system, but we do not fully concur with the
recommendations in your draft report. The GAO's recommendations to
conduct more reviews attest to the complexity of evaluating the Federal
oil and gas fiscal system.
Background:
In June 2006, Congress asked the GAO to review royalties on Federal oil
and gas production and provide advice on what changes if any should be
made to ensure that the public is receiving fair value. The GAO lists
three objectives in its draft report: 1) evaluate the attractiveness
for oil and gas investors of the Federal oil and gas fiscal system; 2)
evaluate how the absence of flexibility in this system has led to large
forgone revenues from oil and gas production on Federal lands and
waters; and 3) assess what the Department of the Interior (Interior)
has done to monitor the performance and appropriateness of the Federal
oil and gas fiscal system. As noted in the draft report, comparing
fiscal systems for oil and gas is inherently complex. The Minerals
Management Service agrees with the implications of the GAO report that
we should evaluate fiscal system designs that are responsive to market
conditions and keep informed of what other countries are doing in their
fiscal systems; however, we have concerns with other findings and
statements in the GAO draft report, which are discussed below.
Areas of Concern:
In addressing the first objective noted above, the GAO draft report
relies heavily on measures of Government take, but does not clarify the
link between Government take and investment attractiveness to
investors, nor does the draft report relate the significance of
Government take to the purposes of the Outer Continental Shelf Lands
Act and the Federal Land Policy and Management Act. [See comment 1]
The second objective of the GAO study appears to lead to a
predetermined conclusion. The report's conclusion that inflexibility in
the system is responsible for significant reductions in Federal
receipts is not supported by the GAO's analysis presented in the draft
report. The example cited by the GAO concerns the deep water leases
issued in 1998 and 1999. At the time, the MMS was implementing the
special requirements of the Deep Water Royalty Relief Act. The MMS
acted in a flexible and creative way to set the elements of the fiscal
terms of its leases in a manner consistent with anticipated technical,
as well as market, conditions at time of sale. The GAO also states that
the MMS did not evaluate the entire oil and gas fiscal system to
determine whether or not the two royalty increases provided the proper
balance between the attractiveness of Federal leases for investment and
appropriate returns to the Federal Government. Interior did evaluate
components of the Federal leasing system, including tax and production
losses from imposing the resulting royalty increases that, in large
part, were a prudent and incremental response to emerging market
conditions. [See comment 2]
The GAO does not credit the MMS for efforts related to the third
objective, which is monitoring the performance of the Federal fiscal
system. Even though Interior may not have conducted a "comprehensive
evaluation" of the Federal oil and gas fiscal system as defined by the
GAO, the MMS evaluates the expected OCS resources and market conditions
in light of our organic statutes and tax laws when setting the fiscal
terms for each lease sale and analyzing the results following each
sale. [See comment 3]
Onshore Federal royalty issues, while not directly addressed by the GAO
in this report, differ from offshore due to the intermingling of
Federal, State, Indian, and private lands. The Federal take is severely
limited by the revenue split with States. Bonus money paid for onshore
leasing is, by law, the result of competitive bidding with a minimum
acceptable bid set by Congress of not less than $2.00 per acre.
Multiple bids received at onshore lease auctions are an indication of
market value, with the high bidder generally being awarded the lease.
The price of natural gas is set by the domestic market, and, generally,
higher royalty rates will be passed on to consumers as higher gas
prices. [See comment 4]
Senior Departmental officials have consistently interpreted the
mandates of the OCSLA as receipt of fair market value, expeditious
exploration and development, encouragement of competition, protection
of human health and the environment, resource conservation, etc.-not
maximization of Government receipts as the GAO implies. We believe
Interior bureaus have succeeded in achieving the purposes of the OCSLA
and FLPMA. In its oversight role, Congress should hold Interior to the
standards encompassed in existing statutes. Maximizing Federal mineral
revenues or achieving some worldwide ranking of government take are not
purposes in the existing laws guiding Federal oil and gas programs.
[See comment 5]
The MMS analyzes fiscal terms before each lease sale and reviews the
results of each sale. The analysis includes the level and extent of
bidding activity to determine if fiscal terms are operating as
intended. Studies and literature are reviewed related to fiscal terms
and potential economic, fiscal, and geologic outcomes in different
countries and regions operating under different fiscal terms. The two
recent Gulf of Mexico royalty rate increases were made by the MMS
incrementally in response to expected oil and gas prices. These royalty
rate increases are consistent with the statutory objective to achieve
fair market value. Additionally, both the MMS and the Bureau of Land
Management are investigating sliding royalty options for future oil and
gas leasing. The BLM is focusing on a variable royalty structure for
onshore oil shale and the MMS is analyzing additional variable royalty
and rental structures for the Federal OCS. [See comment 6]
The MMS recently contracted with a panel of academic oil and gas
industry experts to conduct a 2-year study on issues that, to a large
extent, overlap those being recommended by the GAO for a comprehensive
study and independent panel. Entitled "Policies to Affect the Pace of
Leasing and Revenues in the Gulf of Mexico," the study is analyzing a
variety of fiscal arrangements, including fixed and sliding royalty
terms much like those discussed or implied in the GAO report. A
considerable part of this study is designed to cover important fiscal
issues now being raised by the GAO. Interior believes it is premature
and duplicative to conduct another comprehensive study of fiscal terms
and convene another panel of experts until the recommendations of this
panel are reviewed and evaluated. [See comment 7]
We agree that total revenue allocated to the Government (Government
take) varies greatly among countries and resource owners. In many of
the fiscal systems that rank higher in Government take in the studies
cited in the GAO report, governments own and produce the resource. It
is important to point out that global companies have choices where they
make capital investments. Their investment choices are affected by many
variables, including the fiscal system of rents, royalties, and bonus
bids, as well as the cost of capital, risk, and the attractiveness of
alternative investments. An increase in Government take through higher
royalties, taxes, or other aspects of the fiscal system may result in
less domestic oil and gas production than would occur at more favorable
economic terms. Thus any increases in Federal revenues through higher
fiscal terms must be carefully weighed. The public receives significant
direct, indirect, and induced economic benefits from domestic oil and
gas leasing and development in the form of jobs and economic growth, as
well as less dependency on foreign energy sources. [See comment 8]
We disagree with the GAO assertion that Interior cannot properly and
effectively conduct the mineral leasing programs without explicitly
ranking Federal mineral leasing systems and assessing industry rates of
return compared to leasing systems employed worldwide. While Government
take rankings may be a comparison measure, Interior operates under a
management and leasing policy defined by Congress in the OCSLA and
FLPMA. Through the evaluation of varied fiscal terms, the MMS has made
changes within the authority granted to the Secretary under the OCSLA
and in response to subsequent legislative requirements. The OCSLA in
particular describes the purposes of the offshore oil and gas program,
which include expeditious exploration and development, encouraging
competition, receipt of fair market value, etc. [See comment 9]
Interior notes that the report does not mention the deep water royalty
relief mandated by Congress in the Energy Policy Act of 2005. The
Administration has actively sought repeal of this provision. Since the
GAO's findings for leasing in the OCS focus almost entirely on deep
water leases in the Gulf of Mexico, the impact of the law should have
been taken into consideration. [See comment 10]
Conclusion:
The Department of the Interior does not fully concur with the two
recommendations made to the Secretary of the Interior. While we agree
that it is important to review the Department's oil and gas lease
terms, Interior's existing procedures are adequate to evaluate
alternative fiscal terms and systems in the context of the stated
purposes, goals, and objectives of the statutory requirements. Many of
the fiscal systems used by other countries are not allowed in the
United States. [See comment 11]
The first recommendation, with which we do not fully concur, is that
the Secretary of the Interior direct the MMS, the BLM, and other
relevant agencies within Interior to conduct a comprehensive review of
the Federal oil and gas fiscal system using an independent panel that
includes private sector experts and oil and gas industry
representatives to collect and evaluate the necessary information to
make informed conclusions. Recently the MMS commissioned an outside,
independent group of energy industry experts from the University of
Rhode Island to conduct a related 2-year study entitled, "Policies to
Affect the Pace of Leasing and Revenues in the Gulf of Mexico."
Accordingly, it would be premature and duplicative for the MMS to
undertake another comprehensive study, and convene another group of
experts prior to completion of the current study. On any study, the
Secretary will involve partners, as appropriate. The MMS and the BLM
will continue to evaluate program requirements and analyze options for
determining the most appropriate mineral leasing fiscal systems subject
to the authorizing legislation. [See comment 12]
The second recommendation, with which we do not fully concur, is for
the Secretary of the Interior to direct the MMS, the BLM, and other
relevant agencies within Interior to establish procedures to
periodically evaluate the Federal oil and gas fiscal system in relation
to those of other resource owners and report the findings to Congress.
Interior would respond to any Congressional request. The MMS and the
BLM have conducted internal control reviews of key components of their
fluid minerals management programs. The MMS evaluates the fiscal terms
before each OCS lease sale and will continue to balance the
requirements of the OCSLA and continues to respond to emerging market
conditions. Interior agencies that lease Federal minerals already keep
abreast of current literature on fiscal systems of other resource
owners. Therefore, we believe that what other resource owners may do is
useful to know, but what they do is not the most important factor to
consider in designing appropriate fiscal terms for mineral leases
issued by the Department of the Interior. [See comment 13]
Through our leasing program, we continually update, evaluate, and
review the fiscal terms of leases. We are always open to suggestions to
clarify procedures in order to assure their effectiveness. We will
closely examine those procedures internally.
Technical comments are enclosed. If you have any questions, please
contact Andrea Nygren, MMS Audit Liaison Officer, at (202) 208-4343.
Sincerely:
Signed by:
C. Stephen Allred:
Assistant Secretary:
Enclosure:
The following are GAO's comments on the Department of the Interior's
letter dated August 8, 2008.
GAO Comments:
1. Regarding Interior's statements that (1) the draft report relies
heavily on measures of government take but does not clarify the link
between government take and investment attractiveness, and (2) the
draft report does not relate the significance of the OCSLA and FLPMA
laws, we disagree. The report on page 1 states that several factors
need to be considered, including the size of availability of the oil
and gas resources in place; the cost of finding and developing these
resources, and the stability of other the oil and gas fiscal systems
and the country in general. Also on page 2, we note that a fair
government take would strike a balance between encouraging private
companies to invest in the development of oil and as resources on
federal lands and waters while maintaining the public's interest in
collecting the appropriate level of revenues from the sale of the
public's resources. Further, we devote a significant portion of our
discussion of objective one to how the attractiveness of the U.S. oil
and gas fiscal system compares with those of other resource owners, and
concludes that U.S Gulf of Mexico and other U.S. places are attractive
places to invest. With regard to the significance of the OCSLA and
FLPMA laws, on page 3 of the report we discuss the provisions of the
OCSLA and FLPMA laws and how they relate to the management of the
federal oil and gas fiscal system.
2. Interior commented that the report's conclusion that inflexibility
in the federal oil and gas fiscal system is responsible for significant
reductions in the federal fiscal take is not supported. We maintain
that the inherent inflexibility of the federal fiscal system means that
government receipts from the production of oil and gas on federal lands
and waters have not tracked with the prices of oil and gas. This lack
of flexibility explains, in part, why the Congress enacted the Deep
Water Royalty Relief Act in 1995, a time when oil and gas prices were
much lower than they are today. The lack of flexibility of the royalty
rates for some of the leases issued under this Act, as implemented by
Interior, will end up costing the public billions of dollars in
foregone revenues. Further, the recent increases to royalty rates that
Interior references in its comments do nothing to address the bulk of
leases already held and for which industry profits have increased as
high as they have precisely because neither the royalty rates, nor
other components of the oil and gas fiscal system were sufficiently
flexible to allow federal revenues to increase automatically when oil
and gas prices and industry profits increased. Overall, Interior should
strive to achieve fair market value over time, not simply evaluate
market conditions at the time leases are issued.
3. With regard to Interior's comments that although it has not
conducted a comprehensive evaluation of the federal oil and gas fiscal
system, it has evaluated expected resources and conditions on the Outer
Continental Shelf (offshore) tracts, we agree that Interior takes some
steps to evaluate offshore leases but the objective addresses a broader
evaluation of how Interior monitors the performance and appropriateness
of the entire federal oil and gas fiscal system, including offshore and
onshore, and also including assessing performance over time rather than
at the time a lease is sold. Interior officials told us they evaluate
offshore tracts before the issuance of a lease for prospectivity of the
lease and use such measures to determine an adequate minimum bid for
the lease. However, as Interior makes note in its own comments,
Interior officials have not systematically reviewed the bid outcomes of
offshore tracts.
4. We agree that onshore and offshore leases can be very different and
for the reasons stated in Interior's comments. That is why we
recommended a comprehensive review of the entire federal oil and gas
fiscal system, including onshore and offshore. We also recommended that
the results of this comprehensive review be presented to the Congress
so that it can act appropriately in the event any existing laws or
regulations that govern the leasing and collection of revenues from
federal oil and gas leases could be improved in light of the
recommendations of the independent panel.
5. Interior states that the report implies that Interior maximizes
government receipts from oil and gas leases. We disagree that the
report implies this and can find no place in the report where we
believe a reader would make such an inference.
6. We disagree with Interior's statement that it "analyzes fiscal terms
before each lease sale and reviews the results of each sale."
Interior's analysis of prospective leases is for offshore leases only
and, according to Interior officials, is an analysis of the
prospectivity of the offshore tract, designed to set minimum adequate
bids. It is not a review of "fiscal terms," as Interior states in its
comments. With regard to the two recent royalty rate increases for
future oil and gas leases in the Gulf of Mexico, these increases do not
resolve fair market value for past leases issued with inflexible fiscal
terms and are themselves inflexible. Therefore, if future oil and gas
prices turn out to be different than what Interior expected when they
made the changes, the resulting outcome will again not reflect a fair
return and could be too high or too low, depending on what happens in
the oil and gas markets.
7. With regard to Interior's comment that it recently contracted with a
panel of academic oil and gas industry experts to conduct a study of
fiscal arrangements including fixed and sliding royalty terms, please
see our general response to Interior's comments on page 24.
8. We agree with the statements Interior makes in this paragraph, and
note that these concepts are also well represented in our report. For
example, we note that investment choices are affected by many
variables, including the fiscal system of rents, royalties, and bonus
bids, as well as the cost of capital, risk, and the attractiveness of
investments; indeed, we designed the job to discuss the first range of
issues in our first objective, and the second range of issues in the
second objective. We conclude, and Interior agrees, that any increases
in federal revenues through higher fiscal terms must be carefully
weighed; however, Interior has not done this "careful weighing" in
making its royalty rate increases. That is why we recommended a
comprehensive review of the federal oil and gas fiscal system.
9. With regard to Interior's comment that it operates under a
management and leasing policy defined by the Congress in the OCSLA and
FLPMA, we agree and this is reflected on page 3 of the draft report.
However, Interior cannot effectively conduct the mineral leasing
programs without evaluating federal mineral leasing systems and
assessing industry rates of return and other factors discussed in this
report. Interior must keep abreast of these issues and developments in
fiscal regimes elsewhere, and advise Congress on developments in the
competitiveness of the federal oil and gas fiscal system versus those
employed by other resource owners. Further, our audit work shows that
Interior has responded to oil and gas market changes in a reactive,
rather than strategic and forward-looking manner, and we believe the
Congress needs to be kept abreast of changes affecting federal oil and
gas leasing and revenue generation.
10. Interior comments that the draft report does not mention the
royalty relief mandated by the Congress in the Energy Policy Act of
2005, and its decision to seek repeal of this provision, and that the
impact of the law should have been taken into consideration. We agree
that the draft report did not discuss the 2005 law explicitly but note
that the results we report do implicitly take this law into
consideration. Our results on the government take and attractiveness of
investment in the deep water Gulf of Mexico derive largely from a 2007
study done by Wood Mackenzie that took into account the impact of the
existing laws at the time of the study. We have added language to make
explicit acknowledgement of the Energy Policy Act of 2005:
11. See our general response to Interior's comments on page 24-25 of
this report.
12. See our general response to Interior's comments on page 24-25 of
this report.
13. See our general response to Interior's comments on page 24-25 of
this report.
[End of section]
Appendix IV: GAO Contact and Staff Acknowledgments:
GAO Contact:
Frank Rusco, (202) 512-3841 or Ruscof@gao.gov:
Staff Acknowledgments:
In additional to the individual named above, Jon Ludwigson (Assistant
Director), Robert Baney, Ron Belak, Nancy Crothers, Glenn Fischer,
Michael Kendix, Carol Kolarik, Michelle Munn, Daniel Novillo, Ellery
Scott, Rebecca Shea, Dawn Shorey, Barbara Timmerman, and Maria Vargas
made key contributions to this report.
[End of section]
Footnotes:
[1] GAO, Oil and Gas Royalties: A Comparison of the Share of Revenue
Received from Oil and Gas Production by the Federal Government and
Other Resource Owners, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-07-676R] (Washington, D.C.: May 1, 2007).
[2] In general, each country has at least one oil and gas fiscal
system. Certain countries--for example, Canada and the United States--
have a number of different oil and gas fiscal systems: a federal system
that governs resource development on federal lands and other systems
that govern resource development on provincial lands in Canada and
state lands in the United States.
[3] The estimated additional revenues are the estimated reduction in
the companies' share of remaining value of existing assets, when
comparing fiscal systems in place at the start of 2002 and those in
place in mid-2007, under a high-price scenario of $75 per barrel of
crude oil.
[4] In the Wood Mackenzie study, "Gulf of Mexico" results refer only to
deep water areas of 400 meters or greater depth; Wood Mackenzie
currently does not have a comparable database for shallower Gulf
waters.
[5] 43 U.S.C. § 1337.
[6] With regard to onshore leasing, there are both competitive and
noncompetitive leases. For competitive leases, 30 U.S.C. Section 226
stipulates that a national minimum acceptable bid of $2 an acre be met
and a royalty payment of not less than 12.5 percent be met, although
Section 209 of the law allows the Secretary to waive or reduce rental
rates or minimum royalty rates when he deems this is necessary to
promote development or if the leases cannot be successfully operated
under the terms provided; Section 226 of the law allows the Secretary
to increase the $2 an acre minimum bid, so long as he notifies the
House and Senate Committees on Natural Resources 90 days before doing
so. For noncompetitive leases, if there are no bonus bids made at an
auction, or if all bids are less than the national minimum, the land is
offered noncompetitively, with some exceptions.
[7] Wood Mackenzie's evaluation of risk did not compare the likely
resource risk from future drilling activities or include a risk
comparison of technical and/or resource risks; it evaluated the risk to
companies for conducting business under the specific fiscal system
being evaluated.
[8] Energy Information Administration, Performance Profiles of Major
Energy Producers: 2006, December 2007. A return of equity is another
measure of company and industry profitability. A return on equity is
net income divided by shareholders' equity.
[9] American Petroleum Institute, America's Oil and Gas Industry:
Putting Earnings into Perspective, 2007.
[10] Return on investment is calculated by dividing net income by net
investment in place.
[11] Our analysis differs from the other studies cited in this report
because we examined return on investment for exploration and production
only, instead of oil and gas industry-wide return on investment or
return on equity. Additionally, our analysis of the manufacturing
industry includes the universe of companies identified as manufacturers
by Standard Industrial Classification code (excluding oil and gas
companies) instead of an industry index as was used by the American
Petroleum Institute and EIA studies. As a result, our return on
investment differs from the other studies.
[12] World Bank, Doing Business 2008: Comparing Regulation in 178
Economies, Washington, D.C., 2007.
[13] Six of the 25 companies that have received royalty relief to date
have signed agreements with Interior to allow the inclusion of price
thresholds for leases signed in 1998 and 1999. A list of U.S. and
international companies that currently receive royalty relief, and who
may be affected by the outcome of the legal challenge, is presented in
app. II.
[14] GAO, Oil and Gas Royalties: Litigation over Royalty Relief Could
Cost the Federal Government Billions of Dollars, [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-08-792R] (Washington, D.C., June
5, 2008).
[15] By foregone revenue, we mean the royalty revenue that would have
accrued to the federal government had there been no royalty relief
under the DWRRA.
[End of section]
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