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entitled 'Oil and Gas Royalties: MMSís 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' which was released on October 29, 2008. 

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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, ß 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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