Oil and Gas Royalties
MMS's Oversight of Its Royalty-in-Kind Program Can Be Improved through Additional Use of Production Verification Data and Enhanced Reporting of Financial Benefits and Costs Gao ID: GAO-08-942R September 26, 2008In fiscal year 2007, the Department of the Interior's (Interior) Minerals Management Service (MMS) collected over $9 billion in oil and natural gas (hereafter referred to as oil and gas) royalties and disbursed these funds to federal, state, and tribal accounts. The federal portion of these royalties, which totaled $6.7 billion, represents one of the country's largest non-tax sources of revenue. In addition to this substantial financial value to the government, oil and gas production on federal lands and waters represents a critical component of the nation's energy portfolio, supplying roughly 35 percent of all the oil and 30 percent of all the gas produced in the United States in 2006. Companies that develop and produce oil and gas resources from federal lands and waters do so under leases obtained from and administered by agencies of Interior--the Bureau of Land Management (BLM) for onshore leases and MMS's Offshore Energy and Minerals Management (OEMM) for offshore leases. Together, these agencies are responsible for overseeing oil and gas operations on more than 28,000 producing leases to help ensure that oil and gas companies comply with applicable laws, regulations, and agency policies. Companies, or lessees, compensate the government for producing oil and gas resources on federal lands either "in value" (royalty payments made in cash) or "in kind" (royalty payments made in oil or gas). In fiscal year 2006, about 58 percent of the $9.74 billion in oil and gas royalty payments were made in value or in cash, while about 42 percent were made in kind. To ensure that the government obtains the fair value of royalty-in-kind sales, MMS must make sure that it receives the volumes to which it is entitled. Because prices of these commodities fluctuate over time, it is also important that MMS receive the oil and gas at the time it is entitled to them. MMS sells the oil and gas it receives through the royalty-in-kind program and disburses the revenues received from the sales to federal and state recipients. Revenues from oil and gas received in kind in 2006 were about $4.12 billion. MMS may also transfer royalty oil or gas to federal agencies for them to use. Prior to the mid-1990s, MMS's in kind efforts were generally limited to its Small Refiners Program--under which MMS sold oil that it took in kind to small refiners that did not have an adequate supply of their own. In 1995, MMS began to study whether there were additional circumstances under which taking oil and gas in kind were in the best interest of the federal government. In 1998, MMS began a series of pilot sales of royalty oil and gas and, based on the results of these pilot sales, expanded its royalty-in-kind program. In 2003, we recommended that MMS develop a more systematic approach to assess its royalty-in-kind program, and MMS has since made progress in developing metrics for measuring the performance of the program. MMS estimated that from fiscal years 2004 through 2006 the royalty-in-kind program generated about $87 million more in net value to the government than MMS would have collected had it received royalties in cash. In March 2008, we provided congressional testimony on Interior's oversight of the collection of royalties paid both in value and in kind on the production of oil and gas from federal lands and waters. This report highlights oversight issues related to MMS's royalty-in-kind program raised in that testimony and assesses (1) the extent to which MMS has reasonable assurance that it is collecting the correct amounts of royalty-in-kind oil and gas and (2) the reliability of the information on the performance of the royalty-in-kind program contained in MMS's annual report to the Congress.
Under the royalty-in-kind program, MMS's oversight of its natural gas production volumes is less robust than its oversight of oil production volumes. As a result, MMS does not have the same level of assurance that it is collecting the gas royalties it is owed. For instance, for oil, MMS compares companies' self-reported oil production data with third-party pipeline meter data from OEMM's liquid verification system, which records oil volumes flowing through pipeline metering points. Using these third-party pipeline statements to verify production volumes reported by companies provides a check against companies' self-reported statement of royalty payments owed to the federal government. While analogous data are available from OEMM's gas verification system, MMS does not use these third-party data to verify the company-reported production numbers. In December 2007, the Subcommittee on Royalty Management, a panel appointed by the Secretary of the Interior to examine MMS's royalty program, reported that OEMM was not adequately staffed to conduct sufficient review of data from the gas verification system. MMS's annual reports to the Congress do not fully describe the performance of the royalty-in-kind program and, in some instances, may overstate the benefits of the program. For example, MMS's calculation that from fiscal years 2004 to 2006 MMS sold royalty oil and gas for $74 million more than it would have received in cash was based on assumptions, not actual sales data, about the prices at which royalty payors would have sold their oil or gas had they sold it on the open market. MMS did not report to the Congress that even small changes in these assumptions could result in very different estimates. Also, MMS's calculation that the royalty-in-kind program cost about $8 million less to administer than the royalty-in-value program over the same period did not include certain costs, such as information technology costs shared with the royalty-in-value program, that would likely have changed the results of MMS's administrative cost analysis. In addition, these annual reports lack important information on the financial results of individual oil sales that the Congress could use to more broadly assess the performance of the royalty-in-kind program. From the examples cited above, we believe opportunities exist to enhance the oversight of MMS's royalty-in-kind program. We are recommending that MMS improve its verification of gas volumes owed to the government and, therefore, gas royalties owed, by using third-party production information, such as data from OEMM's gas verification system. We are also recommending that MMS take several actions to improve its calculations of the benefits and costs of the royalty-in-kind program and the information it presents annually to the Congress on the program. We provided the Department of the Interior with a draft of this report for comment.
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-08-942R, Oil and Gas Royalties: MMS's Oversight of Its Royalty-in-Kind Program Can Be Improved through Additional Use of Production Verification Data and Enhanced Reporting of Financial Benefits and Costs
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September 26, 2008:
Congressional Requesters:
Subject: Oil and Gas Royalties: MMS's Oversight of Its Royalty-in-Kind
Program Can Be Improved through Additional Use of Production
Verification Data and Enhanced Reporting of Financial Benefits and
Costs:
In fiscal year 2007, the Department of the Interior's (Interior)
Minerals Management Service (MMS) collected over $9 billion in oil and
natural gas (hereafter referred to as oil and gas) royalties and
disbursed these funds to federal, state, and tribal accounts. The
federal portion of these royalties, which totaled $6.7 billion,
represents one of the country's largest non-tax sources of revenue. In
addition to this substantial financial value to the government, oil and
gas production on federal lands and waters represents a critical
component of the nation's energy portfolio, supplying roughly 35
percent of all the oil and 30 percent of all the gas produced in the
United States in 2006.
Companies that develop and produce oil and gas resources from federal
lands and waters do so under leases obtained from and administered by
agencies of Interior--the Bureau of Land Management (BLM) for onshore
leases and MMS's Offshore Energy and Minerals Management (OEMM) for
offshore leases. Together, these agencies are responsible for
overseeing oil and gas operations on more than 28,000 producing leases
to help ensure that oil and gas companies comply with applicable laws,
regulations, and agency policies. Companies, or lessees, compensate the
government for producing oil and gas resources on federal lands either
"in value" (royalty payments made in cash) or "in kind" (royalty
payments made in oil or gas). In fiscal year 2006, about 58 percent of
the $9.74 billion in oil and gas royalty payments were made in value or
in cash, while about 42 percent were made in kind.
When paying royalties in kind, a company owes to MMS a volume of oil or
gas as determined by the following equation:
Royalty volume = total production volume x royalty rate[Footnote 1]
To ensure that the government obtains the fair value of royalty-in-kind
sales, MMS must make sure that it receives the volumes to which it is
entitled. Because prices of these commodities fluctuate over time, it
is also important that MMS receive the oil and gas at the time it is
entitled to them. As part of its royalty-in-kind oversight effort, MMS
identifies imbalances between the volume companies report they owe the
federal government in royalties and the volume delivered and resolves
these imbalances by adjusting future delivery requirements or cash
payments.
MMS sells the oil and gas it receives through the royalty-in-kind
program and disburses the revenues received from the sales to federal
and state recipients. Revenues from oil and gas received in kind in
2006 were about $4.12 billion. MMS may also transfer royalty oil or gas
to federal agencies for them to use. For example, since 1999, MMS has
transferred oil to the Department of Energy (DOE), which DOE has traded
for other oil of specific quality to fill the nation's Strategic
Petroleum Reserve (SPR). In fiscal year 2007, MMS transferred $306
million worth of oil to DOE as part of its efforts to fill the SPR. In
May 2008, DOE announced that it would suspend transfers of royalty oil
to the SPR through the end of the year.[Footnote 2] The SPR currently
holds roughly 700 million barrels--equivalent to about 58 days of net
oil imports--which can be released at the discretion of the President
in the event of an oil supply disruption.
Prior to the mid-1990s, MMS's in kind efforts were generally limited to
its Small Refiners Program--under which MMS sold oil that it took in
kind to small refiners that did not have an adequate supply of their
own. In 1995, MMS began to study whether there were additional
circumstances under which taking oil and gas in kind were in the best
interest of the federal government. In 1998, MMS began a series of
pilot sales of royalty oil and gas and, based on the results of these
pilot sales, expanded its royalty-in-kind program. In 2003, we
recommended that MMS develop a more systematic approach to assess its
royalty-in-kind program, and MMS has since made progress in developing
metrics for measuring the performance of the program.[Footnote 3] The
Energy Policy Act of 2005[Footnote 4] requires the Secretary of the
Interior to submit an annual report to the Congress that describes the
performance, benefits, and savings associated with MMS's royalty-in-
kind program. Under the act, MMS is charged with ensuring that oil and
gas taken in kind are not sold for less than market value and that
revenues it receives are at least as great as the revenues it would
have received had it taken the royalties in cash. According to MMS, it
can often achieve greater revenues when it sells gas taken in kind
because it is able to negotiate favorable transportation and processing
arrangements. To meet the requirement that MMS receive at least as much
revenue as it would have had it taken the royalties in value, MMS
compares the estimated benefits of the in kind program with the
estimated benefits MMS would have received if the royalties had been
taken in cash and includes this information in its annual reports to
the Congress. MMS estimated that from fiscal years 2004 through 2006
the royalty-in-kind program generated about $87 million more in net
value to the government than MMS would have collected had it received
royalties in cash. This $87 million estimated net value amounts to
about 1 percent of total royalty-in-kind revenues of $8.15 billion for
this period. Of this $87 million, MMS estimated that (1) $74 million
came from selling royalty-in-kind oil and gas for more than MMS would
have received in cash royalty payments, (2) $5 million came from
interest from receiving revenues from in kind sales earlier than cash
payments are due, and (3) $8 million came from savings accrued because
the royalty-in-kind program costs less to administer than the in value
program.
In March 2008, we provided congressional testimony on Interior's
oversight of the collection of royalties paid both in value and in kind
on the production of oil and gas from federal lands and
waters.[Footnote 5]
This report highlights oversight issues related to MMS's royalty-in-
kind program raised in that testimony and assesses (1) the extent to
which MMS has reasonable assurance that it is collecting the correct
amounts of royalty-in-kind oil and gas and (2) the reliability of the
information on the performance of the royalty-in-kind program contained
in MMS's annual report to the Congress.
To assess the extent to which MMS has reasonable assurance that it is
collecting the correct amounts of royalty-in-kind oil and gas, we
interviewed officials at OEMM and MMS's royalty-in-kind program about
MMS's production verification processes for oil and gas. In addition,
we reviewed documentation on MMS policies and procedures for collecting
royalties. To assess the reliability of the information on the
performance of the royalty-in-kind program in MMS's annual report to
the Congress, we interviewed officials in MMS's Economic Analysis
Office who are responsible for preparing the annual report. We also
collected and assessed information on the sales of royalty oil and gas
and reviewed MMS procedures for preparing the administrative cost
comparison between the benefits derived from the royalty-in-kind and
royalty-in-value programs. Here, we assessed the reliability of the in
kind sales and performance data by (1) reviewing the systems that MMS
has in place to help ensure that the data are entered and calculated
correctly and (2) comparing the data with aggregate performance results
that MMS reported to the Congress for fiscal years 2004 through 2006.
We determined that the data were sufficiently reliable for the purposes
of this report. We conducted this performance audit from April 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:
Under the royalty-in-kind program, MMS's oversight of its natural gas
production volumes is less robust than its oversight of oil production
volumes. As a result, MMS does not have the same level of assurance
that it is collecting the gas royalties it is owed. For instance, for
oil, MMS compares companies' self-reported oil production data with
third-party pipeline meter data from OEMM's liquid verification system,
which records oil volumes flowing through pipeline metering points.
Using these third-party pipeline statements to verify production
volumes reported by companies provides a check against companies' self-
reported statement of royalty payments owed to the federal government.
While analogous data are available from OEMM's gas verification system,
MMS does not use these third-party data to verify the company-reported
production numbers. In December 2007, the Subcommittee on Royalty
Management, a panel appointed by the Secretary of the Interior to
examine MMS's royalty program, reported that OEMM was not adequately
staffed to conduct sufficient review of data from the gas verification
system.
MMS's annual reports to the Congress do not fully describe the
performance of the royalty-in-kind program and, in some instances, may
overstate the benefits of the program. For example, MMS's calculation
that from fiscal years 2004 to 2006 MMS sold royalty oil and gas for
$74 million more than it would have received in cash was based on
assumptions, not actual sales data, about the prices at which royalty
payors would have sold their oil or gas had they sold it on the open
market. MMS did not report to the Congress that even small changes in
these assumptions could result in very different estimates. Also, MMS's
calculation that the royalty-in-kind program cost about $8 million less
to administer than the royalty-in-value program over the same period
did not include certain costs, such as information technology costs
shared with the royalty-in-value program, that would likely have
changed the results of MMS's administrative cost analysis. In addition,
these annual reports lack important information on the financial
results of individual oil sales that the Congress could use to more
broadly assess the performance of the royalty-in-kind program.
From the examples cited above, we believe opportunities exist to
enhance the oversight of MMS's royalty-in-kind program. We are
recommending that MMS improve its verification of gas volumes owed to
the government and, therefore, gas royalties owed, by using third-party
production information, such as data from OEMM's gas verification
system. We are also recommending that MMS take several actions to
improve its calculations of the benefits and costs of the royalty-in-
kind program and the information it presents annually to the Congress
on the program. We provided the Department of the Interior with a draft
of this report for comment.
MMS's Royalty-in-Kind Production Verification Is Not as Robust for Gas
as It Is for Oil:
MMS's royalty-in-kind program does not extend the same production
verification processes used by its oil program to its gas program, and,
as a result, MMS does not have the same level of assurance that it is
collecting the gas royalties it is owed. For instance, for gas, MMS
relies on information contained in two gas operator-provided documents-
-monthly production reports and "imbalance statements"[Footnote 6]--to
determine the federal government's correct share of gas from federal
off-shore gas leases. Production reports contain a large number of data
elements, including production volumes for each gas well. Imbalance
statements include the operator's total gas production for the month,
the share of that production that the government is entitled to, and
any differences between what the operator delivered and the
government's royalty share.
For oil, on the other hand, MMS collects monthly production reports and
imbalance statements from oil companies but also uses additional third-
party pipeline meter data from OEMM's liquid verification system, which
records oil volumes flowing through numerous pipeline metering points
in the Gulf of Mexico region. MMS calculates its royalty share of oil
by multiplying the total production volumes provided in these pipeline
statements by the royalty rates for a given lease. MMS compares this
calculation with the volume of royalty oil that the operators
delivered. Using pipeline statements to verify production volumes
provides an additional check against companies' self-reporting of
royalties due the federal government because companies have an
incentive not to underreport their share of oil going into the pipeline
as that is the same amount they will have to sell at the other end of
the pipeline.
Importantly, since 2004, OEMM has collected data from gas pipeline
companies through its gas verification system, which is similar to its
liquid verification system in that it records information from pipeline
company-provided source documents. Our review of data from this program
shows that these data could be a useful tool in verifying offshore gas
production volumes at some pipeline meters. Our analysis of these
pipeline data showed that for the months of January 2004, May 2005,
July 2005, and June 2006, 25 percent of the pipeline metering points
had an outstanding discrepancy between self-reported and pipeline data.
These discrepancies are both positive and negative--that is, production
volumes submitted to MMS by operators are at times either under-or over-
reported. MMS has recognized that it needs to improve the data in the
gas verification system. In December 2007, the Subcommittee on Royalty
Management, a panel appointed by the Secretary of the Interior to
examine MMS's royalty program, reported that OEMM was not adequately
staffed to conduct sufficient review of data from the gas verification
system.[Footnote 7] Interior is currently implementing a recommendation
action plan to address this concern and other recommendations made by
the Subcommittee.
MMS's Annual Reports to the Congress on the Royalty-in-Kind Program May
Overstate Its Benefits:
The methods and underlying assumptions MMS uses to compare the revenues
it collects in kind with what it would have collected in cash do not
sufficiently deal with uncertainties and do not account for all costs,
making the financial benefits of the royalty-in-kind program unclear.
For example, MMS's calculation that early royalty-in-kind payments
yielded $5 million in additional interest from fiscal years 2004 to
2006 was based on assumptions about payment dates and interest rates
that could misstate the estimated interest benefit. In addition, these
annual reports lack important information on the financial results of
individual oil sales that the Congress could use to more broadly assess
the performance of the royalty-in-kind program.
Reported Revenues from Royalty-in-Kind Sales Do Not Account for
Uncertainties:
MMS sold the oil and gas it collected as royalties during fiscal years
2004 through 2006 for $8.15 billion and estimated that this amount
exceeded what it would have received in cash royalties by about $74
million--a net benefit of approximately 0.9 percent. However, according
to MMS's Economic Analysis Office, these estimates are subject to
uncertainty because MMS makes assumptions about how much royalty payors
would have sold their oil or gas for had they paid royalties in cash.
Office of Management and Budget Circular A-94, which describes how
agencies should determine the costs and benefits of federal programs,
instructs agencies to identify key assumptions behind net benefit
calculations and determine how sensitive the calculations are to
changes in those assumptions. MMS has not conducted such a sensitivity
analysis.[Footnote 8] As a result, MMS has not calculated, or reported
to the Congress, the uncertainties surrounding the benefits of taking
royalties in kind, which can be significant. For example, a 1 percent
error in the estimate of cash payments can lead to a change in the $74
million estimated benefit of the royalty-in-kind program to anywhere
from a loss of $6 million to a benefit of $155 million. MMS has
recognized that its estimates of what it would have received in cash
payments are subject to some degree of uncertainty but has not
evaluated or reported how sensitive the net benefit calculations are to
this uncertainty.
Reported Interest Rate Savings Do Not Account for Range of Possible
Outcomes:
In addition, MMS calculated that the government earned about $5 million
in interest from fiscal years 2004 through 2006 from the royalty-in-
kind program. This interest benefit may have accrued because revenues
from the sale of in kind oil are due 10 days earlier than cash
payments, and revenues from the sale of in kind gas are due 5 days
earlier.[Footnote 9] However, we found two weaknesses in the way MMS
calculated this interest benefit. First, the payment dates used to
calculate the interest revenue have the potential to over-or
underestimate its value. That is, MMS calculated the interest on the
basis of the time between the actual date that the Department of the
Treasury (Treasury) received a royalty-in-kind payment and the
theoretical latest date that Treasury would have received a cash
payment under the royalty-in-value program. However, MMS officials told
us that cash payments can, and sometimes do, arrive before their due
date. As a result, MMS might be overstating the value of the early
royalty-in-kind payments. Second, the interest rate used to calculate
the interest revenue may either over-or understate its value because
the rate is not linked to any market rate. From fiscal year 2004
through 2007, MMS used a 3 percent interest rate to calculate the time
value of these early payments. However, during this time, actual market
interest rates at which the federal government borrowed fluctuated. For
example, 4-week Treasury bill rates ranged from a low of 0.72 percent
to a high of 5.18 percent during this period. Therefore, during some
fiscal years, MMS is likely to have over-or understated the value of
these early payments.
Reported Administrative Cost Savings Exclude Certain Fixed Costs:
MMS calculated that the royalty-in-kind program cost about $8 million
less to administer than the royalty-in-value program during fiscal
years 2004 through 2006. However, MMS's calculation of the
administrative cost savings did not include some fixed costs that were
not incurred on a regular or predictable basis. If these costs had been
included, they could have changed MMS's administrative cost analysis.
For example, in fiscal year 2006, royalty-in-kind information
technology costs of $3.4 million were excluded from the administrative
cost analysis. Moreover, additional information technology costs of
approximately $29.4 million--some of which may have been incurred under
either the in kind or in value program--were also excluded. Including
and assigning these information technology costs to the programs they
supported would have provided a more complete accounting of the
respective costs of the in kind and in value programs.
Important Information about Individual Oil Sales Is Excluded:
Interior's annual reports to the Congress on its royalty-in-kind
program do not include important information that could be useful to
the Congress in its evaluation of the program. In particular, the
annual reports do not provide information on individual oil sales. Such
information would show that relatively few sales have accounted for
most of the estimated benefits of the program. For example, during
fiscal years 2004 through 2006, the top 15 percent of oil sales
accounted for almost 80 percent of the benefits of taking royalty oil
in kind.[Footnote 10] Information displayed by subgroupings of
individual sales would also show that MMS has sold some of its oil
assets for less than it estimates it would have received in cash
payments. In fiscal years 2004 and 2005, MMS sold 1.2 percent and 12.4
percent, respectively, of oil collected in kind for less than it
estimated it would have collected in cash. In fiscal year 2006, MMS
sold 28 million barrels, or 64 percent of all oil it collected in kind,
for less than it estimated it would have received in cash. MMS
officials told us that the oil in kind program's performance in 2006
was an anomaly caused by hurricane activity in the Gulf late in fiscal
year 2005. However, because MMS presents oil sales performance in
aggregate it is difficult to monitor the program's performance between
years. In contrast to its reporting for oil sales, MMS has presented
individual sales data for its natural gas sales in its annual report to
the Congress.
Conclusions:
Interior's royalty management programs have faced increased scrutiny in
the last few years, and the agency is in the process of implementing
many recommendations made by GAO, its own Inspector General, and its
Subcommittee on Royalty Management. While the outcome of Interior's
implementation of these recommendations will not be known for some
time, we believe additional opportunities exist to enhance the
oversight of MMS's royalty-in-kind program. Our findings show that MMS
risks not collecting accurate volumes of gas and, therefore, accurate
gas royalties, because the agency relies on operator-reported data.
Data from the gas verification system could be useful in validating
production volumes and reducing discrepancies in some instances. In
addition, our review of MMS's annual reports to the Congress on the
performance of its royalty-in-kind program shows that these reports may
overstate the program's benefit and do not provide the Congress with
all the information it could use to assess the performance of the
program.
Recommendations for Executive Action:
We recommend that the Director of MMS improve verification of natural
gas volumes owed to the government by using third-party production
information, such as data from OEMM's gas verification system, to
verify reported production and royalties owed.
We also recommend that the Director of MMS improve calculations of the
benefits and costs of the royalty-in-kind program and the information
presented to the Congress by (1) calculating and presenting a range of
the possible performances of the royalty-in-kind sales in accordance
with Office of Management and Budget guidelines; (2) reevaluating the
process by which it calculates the early payment savings; (3)
disclosing the costs to acquire, develop, operate, and maintain royalty-
in-kind-specific information technology systems; and (4) disaggregating
the oil sales data to show the variation in the performances of
individual sales.
Agency Comments:
We provided a draft of this report to Interior for review and comment.
Interior provided written comments, which are presented in enclosure I.
In general, Interior concurred with our findings and recommendations.
While generally agreeing with our recommendations, Interior raised
concerns about specific methods to implement two of our recommendations
related to the calculation of benefits and costs of the royalty-in-kind
program. In particular;
* Regarding our recommendation for MMS to calculate and present a range
of the possible performances of the royalty-in-kind program in
accordance with Office of Management and Budget guidelines, MMS agreed
with the need to provide better information to the Congress, but
expressed concern about how to do so. In its comments, MMS
misinterpreted an illustrative example in our draft report of how
uncertainty can be explained--that a 1 percent error in the estimate of
cash payments can lead to a significant change in the estimated benefit
of the program was simply to illustrate how sensitive the reported
program benefits were to even small changes in assumptions--to be a
definitive methodology of how to implement our recommendation. We
believe that there are a variety of ways to convey the inherent
uncertainty in the estimates MMS provides to the Congress. We support
Interior's efforts to develop language and/or graphics that will better
explain that the Revenue Performance Metrics are estimates.
* Regarding our recommendation for MMS to disaggregate oil sales data
to show the variation in the performance of individual sales, MMS
expressed concerns regarding disclosing confidential information. We
believe this information could be presented without disclosing the
revenue performance by individual oil properties. Rather, as we pointed
out in the report, RIK sales data could be disaggregated to show the
number of oil properties that were sold for less that what MMS
estimated it would have received in cash payments or to show that
relatively few oil properties accounted for most of the estimated
benefits of the program. We believe that such information could be
useful to the Congress in its evaluation of the royalty-in-kind
program.
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 report date. At that time, we will send copies of this report
to appropriate congressional committees, the Secretary of the Interior,
the Director of MMS, 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 staffs have any questions or comments about this report,
please contact Frank Rusco at (202) 512-3841 or ruscof@gao.gov, or
Jeanette Franzel at (202) 512-9406 or franzelj@gao.gov. Contact points
for our Offices of Congressional Relations and Public Affairs may be
found on the last page of this report. GAO staff who made contributions
to this report include Assistant Director Paul Kinney, Assistant
Director Jon Ludwigson, Ron Belak, Ben Bolitzer, Lisa Brownson, Melinda
Corderro, Nancy Crothers, Glenn C. Fischer, Cindy Gilbert, Tom Hackney,
Heather Hill, Chase Huntley, Jennifer Leone, Tim Minelli, Michelle
Munn, G. Greg Peterson, and Barbara Timmerman.
Signed by:
Frank Rusco:
Acting Director, Natural Resources and Environment:
Jeanette Franzel:
Director, Financial Management and Assurance:
Enclosure:
List of Congressional Requesters:
The Honorable Jeff Bingaman:
Chairman:
Committee on Energy and Natural Resources:
United States Senate:
The Honorable Ron Wyden:
Chairman:
Subcommittee on Public Lands and Forests:
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 Darrell E. Issa:
Ranking Member:
Subcommittee on Domestic Policy:
Committee on Oversight and Government Reform:
House of Representatives:
[End of section]
Enclosure I: Comments from the Department of the Interior:
United States Department of the Interior:
Office Of The Secretary:
Washington, DC 20240:
Take Pride In America:
September 18, 2008:
Mr. Frank Rusco:
Acting Director, Natural Resources and Environment:
Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Mr. Rusco:
Thank you for the opportunity to review and comment on the Government
Accountability Office (GAO) draft report entitled, "Oil and Gas
Royalties: MMS's Oversight of its Royalty-in-Kind (RIK) Program Can Be
Improved Through Additional Use of Production Verification Data and
Enhanced Reporting of Financial Benefits and Costs" (GAO-08-942R).
The GAO's usual protocol of providing a complete draft report,
following an in-person exit conference to discuss the statement of
facts. facilitates a full and comprehensive review by the agency being
evaluated. Please note that, in this case, GAO restricted access to the
draft report, which required the Minerals Management Service (MMS)
staff to visit GAO offices in Denver, CO, and Washington, D.C., to
review the statement of facts, conclusions, and recommendations. The
MMS made every effort to work with GAO given the constraints created by
restricted document access and appreciates your staff's providing
meeting space for MMS staff to review the draft document. We believe
our response addresses GAO's conclusion and recommendations as
discussed below.
We concur with the GAO's findings and recommendations. Comments on the
recommendations are provided below:
Recommendation 1. We recommend M ,IS improve its verification of
natural gas volumes owed to the Government by using third-party
production information, such as data from the OEMM [Offshore Energy and
Minerals Management] gas verification system (GVS) to verify reported
production and royalties owed.
We concur with Recommendation 1. The MMS believes that with adequate
functionality, the GVS data could be a useful tool in verifying
offshore gas production taken in kind. The MMS has been using similar
data from the liquids verification system to verify crude oil
production taken in kind. As GAO acknowledged in its draft report, MMS
has recognized the need to improve the data in the GVS and is
evaluating and implementing recommendations to that end.
Recommendation 2. We recommend MS improve its calculations of the
benefits and costs of the RIK Program and the information presented to
Congress by:
a. Calculating and presenting a range of possible performances of the
RIK sales in accordance with OMB guidelines.
b. Reevaluating the process by which it calculates the early payment
savings.
c. Disclosing the cost to acquire, develop, operate, and maintain RIK
specific IT [Information Technology] systems.
d. Disaggregating the oil sales data to show the variation in the
performance of individual sales.
We concur with the concepts in Recommendation 2. However, we disagree
with GAO's suggested methods to implement the Recommendation in 2a and
2d. We address the four parts of Recommendation 2 below:
2. a.: Footnote 7 of the GAO draft report states, "MMS has calculated
ranges for its estimates of cash payment, but these ranges are based on
variation in their estimates over time, not on the inherent
uncertainties of underlying assumptions. Therefore, the methods used to
calculate these ranges do not meet OMB's [Office of Management and
Budget] guidelines. The Royalty Policy Committee (RPC) has recommended
that MMS report to the Congress the ranges that MMS currently
calculates internally. However, we believe that adopting this
recommendation would not contribute to accurately portraying the
uncertainty of the benefits of the royalty-in-kind program."
The MMS disagrees with the GAO. The GAO suggested that the MMS present
uncertainty about a statistical estimate as a band of plus or minus one
percent. The OMB guidance recommends that uncertainty be characterized
to the extent possible by probability distributions. The OMB guidance
is to use sensitivity analysis for assumptions. Fair Market Value (FMV)
is not an assumption, it is an estimate. The MMS believes the RPC
recommendation more closely follows OMB guidance than the GAO
recommendation, but we also have doubts it would contribute to
portraying the uncertainty of the benefits to the nontechnical reader.
The performance metric that MMS uses to evaluate the performance of the
RIK Program begins with a FMV benchmark based on the major liquid
market pricing point(s) located close to RIK properties. The MMS then
determines other benchmarks based on where the oil or gas could be sold
and from this sample, calculates a normalized mean and a variance. This
calculation gives MMS some parameters from which a range of prices can
be calculated for the FMV benchmark. The MMS compares this range to
what was actually received for the product taken in kind. This range
concept has statistical validity in presenting uncertainty and is not
based on variation in MMS's estimates over time. The range is based on
estimates of what market participants did sell or could have sold oil
or gas at markets located close to RIK properties.
In the draft report, the GAO suggests calculating a sensitivity
analysis around the aggregate FMV benchmark. The value of the
benchmark, however, is not an assumption; it is a calculated value of
what market participants could sell oil or gas at markets located close
to RIK properties.
In the $74 million estimated benefit of the royalty-in-kind program to
anywhere from a loss of $6 million to a benefit of $155 million." This
statement does not inform a nontechnical reader about the uncertainty
of the estimated benefit and has no statistical validity. The MMS is
currently evaluating reporting RIK revenue performance as a range for
Fiscal Year (FY) 2008. We will develop language and/or graphics that
will better explain that the Revenue Performance Metrics are estimates.
2. b.: The MMS is in the process of reevaluating the process by which
we calculate the time value of money benefit or early payment savings,
including the interest rates used and the methodology for comparison to
in-value payments. We anticipate completion of the review of this
process and resulting changes to be reported in the FY 2008 Annual
Report to Congress as required by Section 342 of the Energy Policy Act
of 2005 (EPAct).
2. c.: The MMS will disclose the costs associated with RIK-specific IT
systems beginning with the FY 2008 Annual Report to Congress as
required by Section 342 of the EPAct. The IT operations and support
(O&S) costs for RIK are aggregated with other MMS O&S costs and
included in the Exhibit 300. We cannot add the RIK-specific IT costs to
the administrative cost calculation due to the complexities of
allocating MMS's overall systems costs between the RIK program and the
Royalty-in-Value program. Allocating the costs of various system
upgrades that occur every few years would render the administrative
cost comparison data meaningless. Development costs for RIK projects
are not included in the Exhibit 300.
2. d.: While MMS calculates revenue performance metrics by individual
property for oil and by pipeline for gas, the results are rolled up
into reporting categories in order to protect proprietary information
regarding RIK sales, particularly contractual arrangements with service
providers. The MMS believes reporting revenue performance by individual
oil property or gas pipeline has the potential to compromise the actual
bid prices that MMS receives for the sale of oil or gas and could
affect the competitive nature of the sales.
Proprietary information includes pricing and sales data. The RIK sales
contracts include confidentiality clauses that neither party will
disclose prices received under the contract. Many RIK service
agreements for transportation and/or processing also have
confidentiality clauses that neither party will disclose the rates
charged or the terms of the agreement. Maintaining the confidentiality
of proprietary data is essential to continue to contract for royalty-in-
kind. Because the MMS uses a portfolio approach in its RIK sales,
losses may occur in individual sales packages due to diversification in
purchasers, pricing, and other contract terms as a means to mitigate
risk. The FY 2007 Annual Report to Congress does not show revenue
performance metrics by gas pipeline, as did prior reports, in order to
protect the proprietary nature of the information. However, the FY 2007
Report does include a footnote stating that this information can be
made available upon request by Congress.
We appreciate the opportunity to comment on the draft report and look
forward to working with the GAO and implementing the GAO's
recommendations. Please contact Andrea Nygren, MMS Audit Liaison
Officer, at (202) 208-4343, if you have any questions regarding this
response.
Sincerely,
Signed by:
C. Stephen Allred:
Assistant Secretary and and Minerals Management:
[End of section]
Footnotes:
[1] In some cases, there may be deductions to the royalty oil and gas
given MMS as a result of costs incurred by the company or payor to
transport the oil or gas to the point at which MMS takes possession. In
addition, there may also be credits or deductions that adjust for
different qualities of oil transported on a pipeline.
[2] In May 2008, the Congress passed legislation suspending transfers
of royalty oil to fill the SPR. See Strategic Petroleum Reserve Fill
Suspension and Consumer Protection Act of 2008, Pub. L. No. 110-232.
[3] GAO, Mineral Revenues: A More Systematic Evaluation of the Royalty-
in-Kind Pilots Is Needed, GAO-03-296 (Washington, D.C.: Jan. 9, 2003).
[4] Energy Policy Act of 2005, Pub. L. No. 109-58, § 342 (2005).
[5] GAO, Mineral Revenues: Data Management Problems and Reliance on
Self-Reported Data for Compliance Efforts Put MMS Royalty Collections
at Risk, GAO-08-560T (Washington, D.C.: Mar. 11, 2008).
[6] Production reports refer to form MMS-4054, also referred to as the
Oil and Gas Operations Report (OGOR). The OGOR is an operator-submitted
form that identifies all oil and gas lease production and dispositions.
The form is used for all production reporting for offshore Outer
Continental Shelf and onshore federal and Indian lands. Operator
imbalance statements are required by entities that transfer gas to MMS
in lieu of cash and are required, if requested, for oil. The imbalance
statement must specify total production, MMS's entitled share, volumes
delivered, the monthly imbalance, and the cumulative imbalance.
[7] Subcommittee on Royalty Management, Royalty Policy Committee,
Report to the Royalty Policy Committee: Mineral Revenue Collection from
Federal and Indian Lands and the Outer Continental Shelf (2007).
[8] In commenting on a draft of this report, Interior noted that the
Royalty Policy Committee has recommended that MMS report to the
Congress the ranges that MMS currently calculates internally.
[9] While MMS calls this value "interest," it is not interest per se
because the money does not go into an interest-bearing account. Rather,
MMS argues that the government uses the early payments to cover
expenses that it would otherwise need to borrow money to pay for. The
interest, then, is the cost that the government avoids by deferring the
need to borrow.
[10] The top 15 percent of oil sales by volume were determined by
ranking sales volumes by the percentage by which they exceeded the
royalty-in-kind program's calculation for cash payments.
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