This is the accessible text file for GAO report number GAO-03-296 
entitled 'Mineral Revenues: A More Systematic Evaluation of the 
Royalty-in-Kind Pilots Is Needed' which was released on January 16, 
2003.



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Report to Congressional Requesters:



United States General Accounting Office:



GAO:



January 2003:



MINERAL REVENUES:



A More Systematic Evaluation of the Royalty-in-Kind Pilots Is 

NeededMineral Revenues:



GAO-03-296:



GAO Highlights:



Highlights of GAO-03-296, a report to Representative Nick J. Rahall, 

Ranking Minority Member, House Committee on Resources, and 

Representative Carolyn B. Maloney:



Why GAO Did This Study:



In fiscal year 2001, the federal government collected $7.5 billion in 

royalties from the sale of oil and gas produced on federal lands.  

Although most oil and gas companies pay royalties in cash, the 

Department of the Interior’s Minerals Management Service (MMS) has the 

option to take a percentage of the oil and gas produced and either 

transfer this percentage to other federal agencies or to sell this 

percentage itself—known as “taking royalties in kind.”  GAO reviewed 

the extent to which MMS has taken royalties in kind since 1995, the 

reasons for taking royalties in kind, and MMS’s progress in 

implementing management control over its Royalty-in-Kind Program.



What GAO Found:



From January 1995 through September 2001, the Minerals Management 

Service (MMS) took, in kind, 178 million barrels of oil and 213 billion 

cubic feet of gas, or 32 percent of the federal government’s royalty 

share of all oil and 3 percent of the federal government’s royalty 

share of all gas produced on federal lands.  MMS sold the majority of 

this oil—143 million barrels—to small refiners in accordance with 

long-standing legislation.  MMS also took 29 million barrels of 

federal royalty oil to fill the Strategic Petroleum Reserve.  MMS took 

the remaining 6 million barrels of oil in kind and all the gas in kind 

under a series of pilot projects to evaluate whether there are 

additional circumstances under which taking royalties in kind is in 

the best interest of the federal government.



MMS personnel have made progress in implementing some components of 

management control for its Royalty-in-Kind Program, such as addressing 

the risks associated with oil and gas sales and developing written 

procedures.  However, MMS does not plan to complete and implement all 

management controls until 2004, when it will consider the 

Royalty-in-Kind pilots to have changed from a pilot stage to a fully 

operational stage and when it will have acquired additional systems 

support.  To date, MMS has not developed clear strategic objectives 

linked to statutory requirements nor collected the necessary 

information to effectively monitor and evaluate the Royalty-in-Kind 

Program.  Without clear objectives linked to statutory requirements 

and the collection of necessary information, MMS cannot systematically 

assess whether Royalty-in-Kind sales are administratively less costly, 

whether they generate fair market value or at least as much revenue as 

traditional cash royalty payments, and thus whether MMS should expand 

or contract the Royalty-in-Kind Program.



Highlights Figure:



[See PDF for image]



[End of figure]



What GAO Recommends:



GAO recommends that MMS clarify its strategic objectives for the 

Royalty-in-Kind Program and link these objectives to statutory 

requirements.  GAO also recommends that MMS gather key information to 

monitor and evaluate the program prior to further expansion of the 

program.  In commenting on the draft report, the Department of the 

Interior generally agreed with GAO’s observations and recommendations 

and emphasized MMS’s future plans to improve management control over 

the Royalty-in-Kind Program.



www.gao.gov/cgi-bin/getrpt?GAO-03-296.



To view the full report, including the scope and methodology, click on 

the link above.For more information, contact Jim Wells at 

(202) 512-6877 or wellsj@gao.gov.



Contents:



Letter:



Results in Brief:



Background:



MMS Has Taken Increasing Amounts of Royalties in Kind Since 1995 to 

Meet Several Objectives:



MMS Takes Oil in Kind and Sells It to Small Refiners:



MMS Takes Oil in Kind to Fill the Strategic Petroleum Reserve:



MMS Is Studying the Increased Use of Royalties in Kind:



MMS Has Established Some Management Control over Its RIK Program, but 

Additional Efforts Are Needed:



Conclusions:



Recommendations for Executive Action:



Agency Comments and Our Evaluation:



Scope and Methodology:



Appendix I: Comments from the Department of the Interior:



Appendix II: Objectives, Scope, and Methodology:



Appendix III: GAO Contacts and Staff Acknowledgments:



Figures:



Figure 1: Estimated Percentage of Federal Royalty Oil Taken in Kind by 

Purpose, Calendar Years 1995 through 2000 and January through September 

2001:



Figure 2: Estimated Value of Federal Royalty Oil Taken in Kind by 

Purpose, Calendar Years 1995 through 2001 and January through July 

2002:



Figure 3: Estimated Percentage of Total Federal Royalty Gas Taken in 

Kind by Purpose, Calendar Years 1995 through 2000 and January through 

September 2001:



Figure 4: Revenues Reportedly Collected from the Sale of Federal 

Royalty Gas Taken in Kind, Calendar Years 1995 through 2001 and January 

through July 2002:



Abbreviations:



DOE: Department of Energy:



GAO: General Accounting Office:



MMS: Minerals Mangement Service:



RIK: Royalty-in-Kind:



SPR: Strategic Petroleum Reserve:



January 9, 2003:



The Honorable Nick J. Rahall

Ranking Minority Member

Committee on Resources

House of Representatives:



The Honorable Carolyn B. Maloney

House of Representatives:



Federal lands supply about one-third of the oil and gas produced in the 

United States. Companies that lease these lands traditionally pay 

royalties to the Department of the Interior’s Minerals Management 

Service (MMS) based on a percentage of the value of the oil and gas 

that the companies produce. In fiscal year 2001, oil and gas royalties 

to MMS totaled about $7.5 billion. Determining proper royalty payments, 

however, has been costly and administratively difficult for both the 

companies that lease federal lands and MMS. The value of the oil and 

gas, in particular, is often a source of dispute. For example, during 

MMS’s recently completed 4-1/2 year process of promulgating new 

regulations for valuing oil, the oil industry strongly opposed these 

regulations primarily because they would increase the industry’s 

royalty payments and increase their administrative burden. In 

commenting on the regulations, industry officials suggested that 

instead of accepting cash royalty payments, MMS should accept a 

percentage of the actual oil and gas produced and sell this percentage 

itself--known as “taking royalties in kind.”:



The Mineral Leasing Act of 1920 and the Outer Continental Shelf Lands 

Act of 1953 authorize taking royalties in kind and require that the 

government obtain at least fair market value for royalty oil and gas it 

sells. Under this authority, MMS has taken federal oil in kind, mainly 

to fulfill congressional and executive directives. Specifically, the 

Congress has directed taking oil in kind for the Small Refiners 

Program, whose objective is to supply crude oil to small refiners that 

do not have an adequate supply of their own. In more recent years, the 

President has directed the taking of oil in kind to fill the Strategic 

Petroleum Reserve as a safeguard against disruptions to the national 

supply of crude oil. However, in 1995, MMS began to study whether there 

are additional circumstances under which taking oil and gas in kind is 

in the best interest of the federal government. MMS’s efforts were 

encouraged by the Congress as a means of avoiding disputes between MMS 

and the oil and gas industry over the value of the oil and gas produced 

as well as a way to simplify royalty administration. To this end, MMS 

established Royalty-in-Kind (RIK) pilots and is developing management 

controls for its RIK Program--a newly created program under which MMS 

manages all its RIK activities. Management control is an integral 

component of an organization’s management that, if effective, can 

provide for the effectiveness and the efficiency of operations, the 

reliability of financial reporting, and compliance with applicable laws 

and regulations. Key management controls include (1) identifying and 

mitigating the risks that could prevent an agency from achieving its 

objectives, (2) developing written procedures, and (3) monitoring and 

evaluating program performance. In the 2001 and 2002 Appropriations 

Acts for Interior and Related Agencies, the Congress provided 

additional direction that MMS collect at least as much revenue from its 

RIK pilots as it would have collected in cash royalty payments.



As a part of your interest in MMS’s stewardship over federal oil and 

gas royalties, you asked us to (1) determine the extent to which MMS 

has taken oil and gas in kind since 1995 and the reasons for doing so 

and (2) report on the status of MMS’s efforts to implement management 

controls for its RIK Program.



Results in Brief:



From January 1995 through September 2001, the Minerals Management 

Service took 178 million barrels of oil and 213 billion cubic feet of 

gas in kind, or about 32 percent of the federal government’s royalty 

share of all oil and 3 percent of the federal government’s royalty 

share of all gas produced on federal lands, and used these quantities 

for various purposes. Of the 178 million barrels, MMS sold about 143 

million barrels to small refiners under the Small Refiners Program. MMS 

also complied with presidential directives to use federal royalty oil 

to fill the nation’s Strategic Petroleum Reserve at various times, 

transferring about 29 million barrels to the Strategic Petroleum 

Reserve from 1999 through 2000. In addition, MMS selectively took 

federal oil and gas in kind with the intent of improving the 

stewardship of federal resources. Specifically, MMS took both oil and 

gas in kind to evaluate whether there are additional circumstances 

under which taking oil and gas in kind is in the best interest of the 

federal government. The amount of oil that MMS took in kind for these 

pilot purposes was small from October 1998 through September 2001. 

However, over the following 6 months, we estimate that the amount may 

have approached 20 percent of the federal government’s royalty share of 

all oil produced on federal lands. Similarly, the amount of gas that 

MMS took in kind beginning in 1998 was small until 2000 and has 

averaged about 10 percent of the federal government’s royalty share of 

all gas produced on federal lands from January 2000 through September 

2001.



MMS personnel have made progress in implementing some components of 

management control, such as mitigating the risks associated with the 

sale of oil and gas and developing written procedures. However, MMS 

does not plan to complete and implement all management controls until 

2004, when it will consider the Royalty-in-Kind pilots to have changed 

from a pilot stage to a fully operational stage and when it will have 

acquired additional systems support. To date, MMS has not developed 

clear strategic objectives linked to statutory requirements or 

collected the necessary information to effectively monitor and evaluate 

the Royalty-in-Kind Program. Without clear objectives linked to 

statutory requirements and the collection of necessary information, MMS 

cannot systematically evaluate to what extent Royalty-in-Kind sales 

should continue.



We are making recommendations to improve the management of the Royalty-

in-Kind Program. These recommendations include clarifying strategic 

objectives and obtaining the necessary information to more effectively 

monitor and evaluate the Royalty-in-Kind Program. We provided the 

Department of the Interior with a draft of this report for comment.



Background:



In fiscal year 2001, the latest period for which data are available, 

the Minerals Management Service reported that it collected about $5.2 

billion in gas royalties and about $2.3 billion in oil royalties. There 

are more than 20,000 producing federal leases located in the 

continental United States and Alaska and more than 2,000 producing 

federal leases in the waters off the shores of the United States. 

Despite the larger number of onshore leases, offshore leases (most of 

which are in the Gulf of Mexico) account for 81 percent of all federal 

oil and gas royalty payments. In general, royalty rates for onshore 

leases are 12-1/2 percent of the value of the oil and gas produced, 

whereas royalty rates for most offshore leases are 16-2/3 percent. The 

government generally distributes about half of the royalty payments 

collected onshore back to the states in which the leases are located. 

The government also shares with the coastal states a smaller portion of 

the royalty payments collected from offshore leases located within 3 

miles of the coast, known as the 8(g) zone. However, the government 

does not share royalties from offshore leases beyond the 8(g) zone, 

where the majority of offshore oil and gas is produced.



The collecting, reporting, and auditing of cash royalty payments have 

been challenging for MMS. MMS relies upon royalty payors to self-report 

the amount of oil and gas they produce, the value of this oil and gas, 

and the cost of transportation and processing that they deduct from 

royalty payments. There are concerns about the accuracy and reliability 

of these data. Although MMS is responsible for auditing these data, 

with more than 22,000 producing leases and often several companies 

paying royalties on each lease each month, the auditing becomes a 

formidable task. In addition, there has been considerable disagreement 

between industry and MMS over the value of the oil and gas produced and 

the cost of transportation and processing deductions, leading to time-

consuming and costly appeals and litigation.



While most companies that lease federal lands pay their royalties in 

cash, the federal government can instead take a portion of the oil and 

gas that these companies produce--known as “taking royalties in kind.” 

The Congress authorized royalties in kind under the Mineral Leasing Act 

of 1920 and under the Outer Continental Shelf Lands Act of 1953. 

Standard leases for the exploration of oil and gas on federal 

properties reserve the right for the federal government to take its 

royalties in kind.



The Federal Managers’ Financial Integrity Act of 1982 directed federal 

agencies to develop management control for safeguarding resources and 

required GAO to prescribe standards for agencies to follow in 

establishing management control.[Footnote 1] Management control plays a 

significant role in helping managers achieve strategic and annual 

performance goals that are required under the Government Performance 

and Results Act of 1993. Management control consists of several 

components: (1) an environment that sets a positive and supportive 

attitude toward management control and conscientious management 

(control environment); (2) an assessment of the risks that an 

organization faces from both external and internal sources (risk 

assessment); (3) procedures, techniques, and mechanisms that enforce 

management’s directives (management control activities); (4) recording 

and communicating information to management and to others that need it 

within the organization (information and communication); and (5) 

monitoring the quality of performance over time (monitoring).



MMS Has Taken Increasing Amounts of Royalties in Kind Since 1995 to 

Meet Several Objectives:



From January 1995 through September 2001, MMS took 178 million barrels 

of oil and 213 billion cubic feet of gas in kind primarily for three 

purposes: (1) to provide small refiners with a stable source of crude 

oil, (2) to fill the Strategic Petroleum Reserve (SPR), and (3) to 

study alternatives to the traditional system of cash royalty 

payments.[Footnote 2] MMS sold the majority of the oil that it took in 

kind to small refineries under the Small Refiners Program--a long-

standing program designed to assist small refiners that are having 

difficulty obtaining an adequate supply of crude oil. MMS also 

transferred substantial quantities of federal royalty oil to the SPR as 

a safeguard against disruptions in the nation’s supply of crude oil. 

MMS takes lesser quantities of oil and gas in kind under a series of 

pilot sales in Wyoming and the Gulf of Mexico to study alternatives to 

the traditional system of cash royalty payments. In doing so, MMS has 

been testing whether it can improve the administrative efficiency of 

royalty collections and whether it can sell the federal royalty oil and 

gas for at least as much as it would have collected from traditional 

cash royalty payments.



MMS Takes Oil in Kind and Sells It to Small Refiners:



From January 1995 through September 2001, MMS sold to small refiners 

about 143 million barrels of oil, or about 25 percent of the federal 

government’s royalty share of all oil produced on federal lands during 

this time period. The amounts of oil taken in kind each year for small 

refiners have ranged from about 10 to 40 percent of the total federal 

royalty oil, as shown in figure 1. These amounts were worth from $138 

million to $588 million, as shown in figure 2.[Footnote 3] The majority 

of federal royalty oil sold to small refiners since 1995 was produced 

in the Gulf of Mexico. Other purposes for which MMS took oil in kind, 

such as for the Wyoming and Gulf pilots and the SPR, are also shown in 

figures 1 and 2.



Figure 1: Estimated Percentage of Federal Royalty Oil Taken in Kind by 

Purpose, Calendar Years 1995 through 2000 and January through September 

2001:



[See PDF for image]



[End of figure]



Figure 2: Estimated Value of Federal Royalty Oil Taken in Kind by 

Purpose, Calendar Years 1995 through 2001 and January through July 

2002:



[See PDF for image]



[End of figure]



Under the Mineral Leasing Act, as amended by P.L. 79-506, if the 

Secretary of the Interior determines that there are insufficient 

supplies of crude oil available on the open market to refiners that do 

not have their own supply, the Secretary is required to give preference 

to these small refiners in selling federal royalty oil. Accordingly, 

the Secretary provides small refiners with a stable source of crude oil 

at equitable prices so that these small refiners can compete in areas 

dominated by integrated oil companies and large refiners. Although the 

Secretary has long held this authority, the Secretary conducted few 

sales prior to 1970 because of little interest from small refiners. The 

Secretary delegated the responsibility to administer small refiner 

sales to MMS shortly after its formation in 1982. After MMS assesses 

small refiners’ needs for crude oil, MMS identifies federal royalty oil 

to meet these needs, and then conducts sales. Often, more than one 

small refiner wanted to purchase the same oil, so MMS in recent years 

conducted a lottery to determine the purchaser.



Prior to 2000, MMS relied upon the producer of the oil to report its 

sales value and subsequently billed the small refiner this amount plus 

an administrative fee to cover the costs of running the program. After 

billing the small refiners, however, MMS determined that the producers 

had understated the value of the oil, so MMS sent additional bills to 

the small refiners. These bills often surprised the small refiners, and 

in some cases, large bills threatened their financial solvency. Because 

small refiners were dropping out of the program owing to the 

uncertainty over the value of the oil, MMS changed its small refiner 

sales in 2000 from lottery-based sales to competitive auction-based 

sales. The bidders and MMS now agree to the price before receiving the 

oil, just as they do in sales of other federal royalty oil.



MMS Takes Oil in Kind to Fill the Strategic Petroleum Reserve:



The Congress established the Strategic Petroleum Reserve to provide 

emergency oil in the event of a disruption in petroleum supplies. The 

SPR consists of a series of underground salt caverns along the 

coastline of the Gulf of Mexico that can store up to 700 million 

barrels of oil. It is managed and maintained by the Department of 

Energy (DOE). Largely to reduce the federal deficit, the federal 

government withdrew and sold oil from the SPR in fiscal years 1996 and 

1997.



To replace the amounts withdrawn from the SPR, MMS assisted with the 

transfer of about 29 million barrels of federal royalty oil from the 

Gulf of Mexico to DOE in 1999 and 2000. This amount represented about 

17 percent of the federal government’s royalty share of all oil 

produced on federal lands in each of these 2 years, as shown in figure 

1. By filling the SPR, the federal government had forgone the receipt 

of royalty revenues that it would have otherwise collected in cash. The 

Office of Management and Budget in February 1999 estimated that the 

total cost of filling the SPR would be $370 million, but oil prices 

rose since then, and the total cost was probably higher. Refilling 

stopped in December 2000 but commenced again in April 2002 under 

presidential directive and is expected to continue into 2005. From 

April through July 2002, MMS assisted in transferring to DOE about 7.5 

million barrels of oil, worth about $169 million. MMS plans to increase 

deliveries to DOE from 63,000 barrels per day in July 2002 to about 

130,000 barrels per day in 2003.



MMS Is Studying the Increased Use of Royalties in Kind:



MMS began studying the use of federal royalty oil as an alternative to 

cash royalty payments through a series of pilot sales in Wyoming. 

Through nine consecutive sales that began in October 1998, MMS and the 

state of Wyoming collectively sold federal and state royalty 

oil.[Footnote 4] In doing so, MMS acquired information on how to group 

properties for sale and how to establish a price basis for bidding. 

Although the federal portion of these volumes far exceeded the state 

portion, we estimate that the federal oil that MMS sold during the 3-

year period from October 1998 through September 2001 accounted for 

about 1 percent of the federal government’s royalty share of all oil 

produced on federal lands. MMS expanded its study of royalty oil to the 

Gulf of Mexico with two competitive sales, the first of which delivered 

oil to purchasers starting in November 2000. Unlike the pilots in 

Wyoming, the amount of federal royalty oil that MMS sold in the Gulf of 

Mexico reached significant quantities during the second pilot sale--

about 32 times the amount of oil sold in Wyoming during the same 6-

month period. We estimate that the federal royalty oil that MMS sold 

during this second sale, which commenced in October 2001 and ended in 

March 2002, might have accounted for about 20 percent of the federal 

government’s royalty share of all oil produced on federal lands during 

the term of the sale.



MMS first began studying the taking of gas in kind by conducting a gas 

pilot in 1995. This pilot assessed the administrative efficiency and 

revenue impacts of taking gas in kind relative to cash royalty 

payments. MMS accepted about 6 percent of the federal royalty gas in 

the Gulf of Mexico and sold it through auctions for about $72.6 

million. Although this pilot showed that MMS could execute the sale of 

royalty gas, MMS estimated that these sales resulted in about 6 percent 

less revenue than MMS would have received in cash royalty payments, or 

more than a $4 million loss. MMS attributed this loss primarily to 

unforeseen problems in securing transportation of the gas through 

pipelines and to industry’s volunteering the royalty gas for sale, 

rather than to MMS’s selecting this gas. MMS continued studying RIK and 

issued a report in 1997 that concluded that RIK sales could be 

administratively more efficient and could generate at least as much 

revenue as traditional cash royalty payments. MMS began testing these 

conclusions with a series of pilot sales in the Gulf of Mexico that 

began in December 1998. The gas that MMS sold during these pilot sales 

averaged about 10 percent of the federal government’s royalty share of 

all gas produced on federal lands from January 2000 through September 

2001, as shown in figure 3. The annual revenues that MMS reported 

collecting from the sale of this federal royalty gas are illustrated in 

figure 4.[Footnote 5] MMS studied various methods of selling this 

royalty gas, including negotiating the sales price, paying gas 

marketers to aggregate smaller volumes of gas into larger volumes, and 

auctioning the gas. As a result of these pilot studies, MMS decided to 

sell federal royalty gas through auctions open to all buyers meeting 

minimum standards of credit worthiness.[Footnote 6]



Figure 3: Estimated Percentage of Total Federal Royalty Gas Taken in 

Kind by Purpose, Calendar Years 1995 through 2000 and January through 

September 2001:



[See PDF for image]



[End of figure]



Figure 4: Revenues Reportedly Collected from the Sale of Federal 

Royalty Gas Taken in Kind, Calendar Years 1995 through 2001 and January 

through July 2002:



[See PDF for image]



[End of figure]



MMS Has Established Some Management Control over Its RIK Program, but 

Additional Efforts Are Needed:



Management control is a necessary safeguard to protect against the 

risks of fraud, waste, abuse, and mismanagement. MMS has made progress 

in establishing some components of management control over its RIK 

Program, such as (1) identifying and mitigating the risks associated 

with oil and gas sales and (2) developing written procedures for these 

sales and for collecting and reporting revenues. However, MMS has yet 

to develop several key management control activities and does not plan 

to develop them until 2004, when it will consider the RIK Program to 

have changed from a pilot status to a fully operational status. 

Specifically, MMS has not clearly defined its strategic objectives, 

linked performance measures to these objectives, and collected the 

necessary information to monitor and evaluate the RIK Program.



Management Control Is a Necessary Safeguard:



The Federal Managers’ Financial Integrity Act of 1982 directs federal 

agencies to develop management control for safeguarding resources 

against the risks of fraud, waste, abuse, and mismanagement. Management 

control is critical to ensure that revenues and expenditures from 

agency operations are recorded and accounted for properly and that 

financial and statistical reports are reliable. The act also directs us 

to issue standards for management control within the federal 

government. These standards provide broad criteria for agencies to use, 

in conjunction with guidance issued by the Office of Management and 

Budget. Management control includes (1) developing strategic 

objectives, (2) linking performance measures to these objectives, (3) 

collecting the necessary information to monitor and evaluate 

performance, (4) identifying and mitigating risks, and (5) developing 

written procedures and documenting compliance with these procedures.



Management control also plays an important role in helping managers 

comply with the Government Performance and Results Act of 1993 (Results 

Act), which requires federal agencies to establish strategic goals, 

measure performance, and report on accomplishments. The Results Act 

shifts the focus of federal agencies away from traditional concerns, 

such as staffing and reporting on activities, toward achieving results. 

There is no more important element in results-oriented management than 

an agency’s strategic-planning process, and establishing formal 

strategic objectives can help clarify what the agency seeks to 

accomplish and can help unify the agency’s staff in achieving its 

goals.



MMS Has Begun to Establish Management Control:



MMS has begun to establish management control over its RIK Program by 

addressing the risk that oil and gas sales will be unsuccessful, 

addressing inherent risks associated with the sale of oil and gas, and 

developing written procedures for various activities within the 

Royalty-in-Kind Program. These activities include conducting RIK sales, 

collecting revenues, and reporting on revenues. MMS also has made 

progress in documenting the results of its RIK sales.



MMS has addressed the risk that RIK sales will be unsuccessful by 

ensuring that prior to these sales, certain conditions exist for the 

properties from which MMS will sell royalty oil and gas. In 1998, we 

identified the conditions necessary for successful oil and gas sales by 

surveying state governments, universities, and the Province of Alberta, 

which, at various times, had programs that took oil and gas in 

kind.[Footnote 7] We identified several conditions that made these 

programs feasible. In particular, these programs seemed successful if 

these entities had (1) relatively easy access to pipelines, (2) 

properties that produce relatively large volumes of oil or gas, (3) 

favorable arrangements for processing gas, and (4) expertise in 

marketing oil and gas. MMS has considered these conditions in 

addressing risk. Specifically, MMS’s practice of negotiating the cost 

of transporting gas through pipelines helps to secure relatively easy 

access to pipelines. Similarly, MMS’s practice of grouping the 

properties that produce royalty oil or gas according to the pipelines 

to which they are connected helps ensure that properties produce 

relatively large volumes of oil or gas. MMS has also arranged for the 

processing of natural gas and has increased its knowledge of oil and 

gas marketing by hiring consultants and interviewing oil and gas 

marketers and representatives of pipeline companies in Wyoming and the 

Gulf Coast.



MMS has also developed procedures to manage the inherent risks, or 

uncertainties, in the selling of oil and gas. Such risks include 

fluctuating oil and gas prices, the varying amount of oil and gas that 

wells produce, and the credit worthiness of purchasers. To manage the 

risk associated with fluctuating prices, for example, MMS does not try 

to maximize revenues by guessing which way the market will move but, 

instead, accepts bids relative to the fluctuating market prices. Thus, 

MMS avoids substantial losses that could result from wrong guesses. MMS 

also manages the risk due to the inability of properties to deliver 

consistent quantities of gas, which could require that MMS purchase or 

supply more costly alternative gas in the event of a shortfall. MMS 

manages this risk by guaranteeing that it will deliver only a portion 

of the gas (base volume) at a stable price and offering the other 

portion (swing volume), without guarantee, at published prices that 

vary daily. MMS has also developed procedures to monitor the credit 

worthiness of oil and gas purchasers and can terminate their sales 

contract or demand additional credit guarantees, if necessary. These 

procedures led MMS to promptly cancel its contract with Enron, thereby 

limiting losses to 1 month’s worth of gas production from the Enron 

contract.



MMS has developed written procedures for conducting RIK sales 

activities, collecting revenues from these sales, and reporting on 

these revenues. Sales activities include identifying properties from 

which to take oil and gas in kind, announcing the oil and gas for sale, 

determining a minimum acceptable bid, analyzing bids, and awarding 

contracts. We examined documents for sales that MMS conducted from 

October 1998 through October 2002 and found documentation of these 

activities in all sales in which they were appropriate. However, we did 

not determine the adequacy of MMS’s procedures for collecting and 

reporting on revenues, nor did we assess the degree to which MMS 

complied with these procedures.[Footnote 8]



MMS Has Not Developed Clear Objectives and Linked Performance Measures 

to These Objectives:



MMS developed the following seven strategic objectives for the RIK 

Program:



* Implement RIK where applicable and when it is an improvement over 

traditional cash royalty payments (royalty in value).



* Leverage MMS’s position as an asset holder.



* Take advantage of potential interagency synergies.



* Minimize the cost of royalty administration.



* Reduce business cycle time (the time to collect, disburse, audit, and 

reconcile revenues).



* Accelerate timing of revenue collections.



* Adopt energy industry business practices and controls wherever 

feasible.



Overall, none of the seven objectives address the revenue impacts of 

the RIK sales. The seven objectives do not address requirements in the 

law that MMS (1) collect at least as much revenue from the RIK pilots 

as it would have from traditional cash royalty payments and (2) obtain 

fair market value. The Congress directed MMS in the fiscal years 2001 

and 2002 Appropriations Acts for Interior and Related Agencies to 

collect at least as much revenue from the sale of royalties in kind as 

MMS would have collected from traditional cash royalty payments. 

Moreover, the Congress had previously directed the Secretary of the 

Interior in the Mineral Leasing Act of 1920 and the Outer Continental 

Shelf Lands Act of 1953 to obtain fair market value for oil and gas 

taken in kind.[Footnote 9] The Congress defined “fair market value” in 

the Outer Continental Shelf Lands Act as the average unit price for the 

mineral sold either from the same lease or, if such sales did not 

occur, in the same geographic area.



Furthermore, the first three objectives are not expressed in either a 

quantitative or measurable form. The last four objectives, although 

being quantitative, address administrative efficiency only. Without 

objectives to guide agency staff in the quantitative evaluation of the 

revenue impacts of RIK sales, MMS will be unable to determine whether 

RIK sales generate more or less revenue than traditional cash royalty 

payments; whether MMS obtains fair market value; and hence, whether it 

should convert the RIK pilots to an operational status.



MMS has also not developed any performance measures that it linked to 

the seven strategic objectives for its RIK Program. However, MMS has 

developed two performance measures--(1) confirm and reconcile, within 

90 days, all production royalties taken in kind and (2) accelerate the 

timing of revenue receipt by 5 days over traditional cash royalty 

payments (royalty in value)--that are linked to the broader agency-wide 

objective of “collecting royalties in the shortest time possible.” In 

addition to supporting the broad agency-wide objective, these two 

performance measures support RIK Program objectives that are designed 

to improve administrative efficiency. MMS officials told us that they 

intend to develop performance measures that are specific to the RIK 

Program in 2004, when the RIK Program changes from the pilot status to 

a fully operational status and they acquire and fully implement new 

information systems that can better measure performance.



MMS Has Not Obtained the Necessary Information to Monitor and Evaluate 

the RIK Program:



After 5 years of conducting pilot programs and completing 24 oil and 

gas pilot sales, MMS’s ability to effectively and efficiently monitor 

and evaluate its RIK Program is limited because it has not obtained the 

necessary information to do so. This information includes the 

administrative costs of the RIK Program, the savings from avoiding 

potential litigation and appeals, the savings in auditing properties, 

and the revenue impacts of all sales. MMS lacks information largely 

because it has not developed an information systems infrastructure to 

rapidly and efficiently collect this information. Without quantitative 

costs, savings, and revenue information, MMS is unable to determine the 

program’s overall cost and effectiveness, whether RIK generates at 

least as much revenue as traditional cash royalty payments, and whether 

the RIK Program should be expanded or contracted.



MMS Has Not Quantified Anticipated Costs and Savings from Implementing 

the RIK Program:



MMS has not quantified the costs of administering the RIK Program. Such 

costs, which MMS incurs when selling RIK but does not incur when 

collecting traditional cash royalty payments, result from identifying 

properties from which to sell oil and gas, calculating minimum 

acceptable bids, analyzing bids, awarding and monitoring contracts, 

billing purchasers, negotiating transportation rates, reconciling 

discrepancies in volume, and comparing RIK revenues with traditional 

cash royalty payments. MMS has not quantified these costs because its 

current personnel, payroll, and budgeting systems do not capture data 

in sufficient detail. Although MMS tracks employees’ time charges with 

these systems, MMS does not distinguish between time charges that 

support only the RIK Program and time charges that support both the RIK 

Program and the traditional system of collecting cash royalties. 

Similarly, MMS has not decided how to assign the cost of MMS’s 

financial system and other significant overhead costs to the RIK 

Program and to the traditional cash royalty system. MMS officials told 

us, however, that they plan to implement an activity-based cost-

accounting system in fiscal year 2003 that will assist in resolving 

these issues.



MMS also has not quantified anticipated savings from avoiding potential 

appeals and litigation by selling oil and gas in kind. MMS officials 

explained that MMS anticipates that it can avoid substantial costs 

associated with appeals and litigation involving primarily the 

valuation of natural gas and the transportation of both oil and gas. 

MMS officials have not estimated the costs of appeals because of 

problems with implementing the information system that tracks these 

costs and because of their uncertainty that these costs are recorded in 

a consistent manner. In addition, the Office of the Solicitor within 

the Department of the Interior, which is responsible for litigation 

concerning MMS’s activities, does not have an automated system to track 

litigation costs.



Although MMS anticipates that the cost of auditing revenues will 

decrease because of taking RIK, MMS has not quantified these savings. 

MMS anticipates substantial savings because verifying the value of oil 

and gas is much easier when taking RIK because the purchaser and MMS 

agree to the sales price before the sale occurs. Similarly, when MMS 

negotiates transportation costs itself, it knows the exact 

transportation rate that companies can charge MMS, unlike when 

companies pay royalties in cash. In addition, MMS does not need to 

audit transportation costs when MMS sells royalty oil or gas at the 

location of the lease because there are no transportation costs, since 

the buyer assumes the responsibility for transportation. Although MMS 

has projected decreases in the number of staff auditors as a result of 

future RIK sales, MMS has not finalized these estimated savings because 

MMS is uncertain of how much oil and gas it will take in kind in the 

future. MMS officials also question the reliability of the time that 

auditors have charged to the RIK Program in the past--information that 

formed the baseline for their projections.



MMS Has Not Fully Determined the Revenue Impacts of RIK Sales:



MMS also has not fully quantified the revenue impacts of all the 

royalty oil and gas that it sold, preventing a comprehensive comparison 

between RIK sales revenues and the revenues that MMS would have 

received under the traditional cash royalty system. MMS does analyze 

factors that affect the revenues of upcoming RIK sales, including 

current oil and gas prices; anticipated market conditions; and 

transportation and processing, if applicable. However, MMS does not 

systematically compare RIK sales revenues with what it would have 

received in traditional cash royalties after these gas sales are 

completed. Of the 15.8 million barrels of federal royalty oil sold in 

pilot sales from October 1998 through July 2002, MMS quantified the 

revenue impacts of about 9 percent. Of the approximately 241 billion 

cubic feet of federal royalty gas that MMS sold from December 1998 

through March 2002, we estimate that MMS quantified, either in whole or 

in part, the revenue impacts resulting from the sale of about 44 

percent of this gas. Although MMS analyzed revenue impacts from 44 

percent of the federal royalty gas it sold, almost none of this 

analysis was done in a timely manner, thereby precluding the use of 

this information to improve or modify subsequent sales. For example, 

MMS did not complete the evaluation of the gas that it sold 

competitively each month over a 19-month period until after it had 

discontinued selling gas in this manner. Similarly, MMS did not 

evaluate the revenue impacts of using a gas marketer to aggregate gas 

volumes until 1 year after it terminated these sales. If MMS had 

evaluated these aggregated sales earlier, it might have discontinued 

this method of selling royalty gas because it would have confirmed 

employees’ suspicions during the initial sale that the manner in which 

gas was being sold was disadvantageous to MMS. Instead, MMS let another 

three contracts with similar terms, resulting in an overpayment of 

almost $3 million on transportation valued at about $13 million.



MMS’s information systems hinder the timely monitoring and evaluation 

of the RIK Program and the evaluation of the revenue impacts from 

individual sales. The RIK Program’s current system for managing RIK 

sales revenues consists of a series of unlinked computer spreadsheets 

into which personnel manually enter RIK data. Such a manual system is 

prone to errors, which could lead to inaccurate information. Prior to 

September 2002, RIK Program personnel did not compile basic monthly 

reports on revenues collected and royalty volumes sold, which could 

have been used to monitor the RIK Program on a periodic basis. Also, 

limitations of MMS’s agency-wide financial system--the system that 

generates agency-wide accounting reports and maintains and manages all 

royalty data--currently hamper the timely comparison of RIK sales 

revenues with cash royalty payments. MMS personnel were unable to use 

the financial system to produce summary data that were more current 

than 1-year old. As of October 2002, for example, MMS personnel were 

unable to use the financial system to determine how much total revenue 

MMS collected and how much oil and gas had been produced from federal 

lands since September 2001. MMS personnel also said that because of 

missing or erroneous data in the agency-wide financial system, data 

extracted from this system cannot be used in revenue comparisons 

without time-consuming checks for accuracy and reasonableness. 

Furthermore, it will be more difficult to use RIK gas data in this 

system to calculate revenue impacts because MMS personnel do not enter 

these data at the lease level.[Footnote 10] Lastly, RIK Program 

personnel said that because they have to manually acquire data to 

evaluate federal properties for prospective sales, the growth of the 

RIK Program has slowed.



MMS officials also said that they have not evaluated the revenue 

impacts from the sales of all royalty oil and gas largely because they 

have delayed the development of performance measures for the RIK 

Program until 2004. These performance measures will incorporate 

benchmarks against which to compare RIK sales revenues. MMS personnel 

said that MMS has generally encountered difficulty in establishing 

benchmarks against which to measure the revenue impacts of RIK oil and 

gas sales because once it takes all federal royalty oil or gas in kind 

in a specific area, it no longer receives any traditional cash royalty 

payments for comparison. However, MMS officials explained that by 2004, 

MMS expects to acquire and fully implement two additional information 

systems dedicated to the RIK Program that will automate the acquisition 

of necessary information for attempting revenue comparisons. MMS 

personnel said that they had not acquired these automated systems 

earlier because they believed that they first needed to process a large 

number of transactions and sell a large volume of oil and gas before 

they could justify the expense of acquiring these systems.



Conclusions:



MMS has begun to establish management control over its RIK Program. It 

has initiated positive steps to address the risks that affect its oil 

and gas sales and has developed written procedures for various 

activities within the RIK Program. MMS has also made progress in 

documenting the results of its RIK sales. However, MMS has not 

established clear objectives for the program that are linked to 

statutory requirements. MMS’s current objectives for its RIK Program 

are not clearly linked to requirements in the law that MMS (1) collect 

at least as much during pilot sales as it would have collected in cash 

royalty payments and (2) obtain fair market value.



In addition to the lack of objectives linked to statutory requirements, 

MMS is not systematically collecting the necessary information to 

monitor and evaluate the RIK program. Such information includes the 

administrative costs of the RIK program, anticipated savings from 

reductions in audit efforts and from avoiding appeals and litigation, 

and the revenue impacts of all sales. Without clear objectives and the 

systematic collection of evaluative information, MMS cannot assess and 

ultimately determine whether it should expand or contract the use of 

royalty in kind sales.



Recommendations for Executive Action:



To continue the further development of management control for the 

Minerals Management Service’s Royalty-in-Kind Program, we recommend 

that the Secretary of the Interior instruct the appropriate managers 

within the Minerals Management Service to do the following:



* Clarify the Royalty-in-Kind Program’s strategic objectives to 

explicitly state that goals of the Royalty-in-Kind pilots include 

obtaining fair market value and collecting at least as much revenue as 

MMS would have collected in cash royalty payments.



* Prior to expanding the Royalty-in-Kind Program, identify and acquire 

key information needed to monitor and evaluate performance. Such 

information, as identified by the Minerals Management Service, should 

include the revenue impacts of all Royalty-in-Kind sales, 

administrative costs of the Royalty-in-Kind Program, estimates of 

savings in avoiding potential litigation, and expected savings in 

auditing revenues.



Agency Comments and Our Evaluation:



We provided the Department of the Interior with a draft of this report 

for review and comment. Interior fundamentally agreed with our 

observations and recommendations and emphasized MMS’s future plans for 

improving management control over the RIK Program. Where appropriate, 

we have included additional references to the activities that Interior 

mentions in its comments. Interior’s comments and our response to these 

comments are reproduced in appendix I.



Scope and Methodology:



In reviewing MMS’s RIK Program, we reviewed congressional directives in 

pertinent legislation; standards for the development of management 

control issued by us and the Office of Management and Budget; and prior 

reports and documentation on the Small Refiners Program, Strategic 

Petroleum Reserve, and RIK pilots. We also obtained statistical 

information from MMS on oil and gas volumes taken in kind and the 

revenue that MMS generated by selling these volumes. In addition, we 

reviewed documentation pertaining to management control and interviewed 

MMS personnel about their efforts to establish management control over 

the RIK Program.



We conducted our work from January to November 2002 in accordance with 

generally accepted government auditing standards. For a more detailed 

discussion of the scope and methodology of our review, see appendix II.



As agreed with your offices, unless you publicly announce its contents 

earlier, we plan no further distribution of this report until 7 days 

from the date of this letter. At that time, we will send copies of this 

report to the Secretary of the Interior; the Director, Office of 

Management and Budget; and other interested parties. We will also make 

copies available to others upon request. This report will be available 

at no charge on GAO’s Web site at http://www.gao.gov.



If you have any questions about this report, please call Mark Gaffigan 

or me at (202) 512-3841. Key contributors to this report are listed in 

appendix III.



Signed by Jim Wells:



Jim Wells

Director, Natural Resources

 and Environment:



[End of section]



Appendix I: Comments from the Department of the Interior:



United States Department of the Interior:



OFFICE OF THE SECRETARY WASHINGTON, D.C. 20240:



Mr. Mark Gaffigan Assistant Director, Natural Resources and Enviromnent 

U.S. General Accounting Office 441 G Street, N.W. Washington D.C. 

20548:



Dear Mr. Gaffigan:



We appreciate the opportunity to review your Draft Audit Report, 

“MINERAL REVENUES: A More Systematic Evaluation of the Royalty-in-Kind 

Pilots Is Needed.” Our general and specific comments are enclosed for 

you to incorporate into the final report (Appendix I).



Since 2001, the Minerals Management Service (MMS) has been advancing 

its Royalty In Kind (RIK) Pilot Program to implement RIK as a permanent 

part of its royalty asset management strategy. In compliance with 

statutes and regulations, MMS has devoted significant attention to 

monitoring and evaluating the RIK pilots. We believe the RIK management 

control process has evolved and is functioning at a level sufficient to 

effectively manage the current scale of the pilot program. We 

appreciate the recognition of this progress in the draft report.



In the draft report, the General Accounting Office (GAO) recommends 

that MMS clarify strategic objectives linked to performance measures 

and gather information to monitor and evaluate performance prior to 

further expansion of the RIK program. We fundamentally agree and, to 

that end, have already taken steps to ensure these and other management 

control enhancements are an integral part of the larger-scale, 

permanent RIK program.



We believe a Federal RIK program is an important vehicle to ensure fair 

market values for large segments of the Nation’s mineral royalty 

assets. With the continuing assistance of the GAO and others, we can 

continue to build and implement a Federal RIK program for which all 

Americans can be proud.



Once again, thank you for the opportunity to review and comment on this 

report. We stand ready to assist GAO in answering further questions or 

providing data that would help in its review of the RIK program. If you 

have any questions, please contact Bettine Montgomery, Minerals 

Management Service’s Audit Liaison Officer, on (202) 208-3976.



Sincerely,



Signed by Rebecca W. Watson:



Rebecca W. Watson 

Assistant Secretary 

Land and Minerals Management:



Enclosure:



Response to December 2002 General Accounting Office (GAO) Draft Report 

Titled “A More Systematic Evaluation of the Royalty-in-Kind Pilots is 

Needed”:



Summary Comments:



The Department of the Interior’s Minerals Management Service (MMS) is 

responsible for the administration of royalty-in-kind (RIK) pilot 

projects and other RIK operational activities. For many years now, MMS 

has been utilizing the RIK approach to manage oil and gas royalty 

assets. Historically, the RIK approach has been used to supply crude 

oil to the small refiner sector of the Nation’s petroleum industry. 

Recently, MMS has been pursuing the development of an operational RIK 

program with the capability to not only manage the Small Refiner 

Program but to also manage the competitive sale of oil and gas and the 

delivery of crude oil production to the Strategic Petroleum Reserve 

(SPR). Since 2001, MMS has been aggressively pursuing an implementation 

plan to make RIK a permanent part of MMS’s royalty asset management 

strategy to be used in tandem with the traditional royalty in value 

(RIV) approach. MMS has made substantial progress in this 

implementation and appreciates GAO’s acknowledgment of this progress in 

the draft report.



We appreciate the insights and suggestions offered by the GAO to assist 

us in implementing a Federal RIK program that operates on sound and 

industry proven business principles with strong management controls. In 

the December draft report, the GAO addresses the importance of 

strategic goals, performance measurements, and information needed for 

consistent and effective monitoring of future RIK program performance. 

MMS fundamentally agrees with these tenets for success and, as 

discussed later in this response, is poised to implement enhancements 

in these areas.



In evolving the RIK program, MMS has implemented a business model and 

operational processes based on industry best practices. This has been 

done in close consultation with state governments, expert consultants, 

and the oil and gas industry. The MMS RIK pilots and other operations 

are premised in significant ways on advice provided by GAO in 1998. 

This early advice set forth conditions and approaches to be used in the 

successful marketing of royalty oil and gas volumes. This advice has 

been extensively applied by MMS in managing the Federal RIK portfolio 

and has proven to be successful in an operational environment. MMS has 

also acquired industry experts to assist in developing automated gas 

and liquids management systems to support RIK asset management 

decisions and operations. These important systems development projects 

are on schedule and in budget with staged implementation of 

functionality beginning next month.



The GAO draft report documents the substantial progress MMS has made to 

implement RIK controls in the areas of risk management and written 

procedures. MMS believes the RIK management control process has evolved 

and is functioning at a level sufficient to effectively manage the 

current scale of the pilot program. At the same time, we agree with the 

GAO that more emphasis will be needed on financial analysis and

performance measurement in the permanent, full-scale RIK program. To 

ensure compliance with statutes and regulations, MMS has devoted 

significant attention to monitoring and evaluating the RIK pilots at 

the pre-sale, concurrent, and post-sale levels. These in-depth 

analytical assessments document that RIK revenues are at least equal to 

RIV revenues and that in several circumstances the revenue stream is 

increased. Although the assessment reports do not quantify 

administrative cost savings of utilizing the RIK approach as compared 

to the RIV approach, such savings are observed in the areas of royalty 

accounting, regulatory reporting and audit. In October 2002, MMS 

implemented an activity-based cost accounting system that provides the 

cost-capture tools and foundation to effectively assess the RIK 

program, particularly in the area of administrative cost savings.



The joint Department of Energy (DOE)/Department of the Interior (DOI) 

initiative to utilize RIK oil to fill the remaining capacity of the 

Nation’s SPR is, far and away, the dominant activity in the current MMS 

RIK program. This presidential initiative was successfully launched 

with first deliveries of RIK crude oil being made in April 2002 and 

will continue through 2005.This significant achievement in crude oil 

logistics is accomplishing a non-monetary transfer of oil volumes to 

the DOE with minimal costs in commodity transportation. The 5-year RIK 

strategic business plan being developed by MMS for the period 2004-2008 

will provide objectives and measures to ensure completion of the SPR 

initiative and the timely collection of proper royalty payments, 

whether they are paid in value or in kind.



In its draft report, GAO provides two recommendations that relate to 

the setting of strategic objectives for the RIK program and acquisition 

of information to support measurement of progress in achieving those 

objectives. The GAO correctly notes that MMS will not fully develop 

certain management controls until 2004 when RIK activities move from 

pilot to operational status. However, GAO’s conclusion that MMS does 

not have clearly defined strategic objectives linked to performance 

measures or information to evaluate performance does not take into 

account the substantial progress MMS has already made in these areas. 

MMS is aware that more controls are needed for an expanded program. In 

partnership with industry experts and other stakeholders, MMS is 

developing and will implement a 5-year strategic business plan to guide 

the continued development and expansion of the Federal RIK program 

through 2008. This new Business Plan for 2004 and Beyond will be the 

vehicle to assure that a full-range of management and internal controls 

are in place to effectively administer the future RIK program at the 

highest levels of integrity.



In 2001, MMS published its first strategic RIK plan (Road Map) to build 

operational RIK processes and for acquisition of supporting technology 

and automated support systems. This Road Map did not address the scale 

of the Federal RIK program nor did it provide strategic direction 

beyond 2003. MMS’s new 5-year RIK plan will translate the political and 

business priorities of the DOI into meaningful strategic business 

objectives to guide future RIK operations and expansion efforts. To 

assist in building and implementing the 5-year plan, MMS plans to award 

a contract in early 2003 to a private-sector company with special 

expertise in oil and gas marketing and strategic business planning for 

the energy industry. These experts will assess current RIK program 

capabilities and provide improvement recommendations. More 

specifically, this initiative will address:



management and internal control processes:



RIK performance measurement tools and metrics Processes and tools to 

optimize RIK revenues Strategies for acquisition of transportation and 

processing services Approaches for aggregating and marketing expanded 

RIK volumes:



In a fully operational status, the Federal RIK program will have 

enhanced business objectives and expansion goals that can be measured. 

The MMS’s stated objective has always been to utilize the RIK asset 

management approach when it is equal to or better than taking royalties 

in value.The permanent RIK program will have the information and means 

needed to comprehensively measure revenue impacts, evaluate overall 

performance, and determine cost savings and other program benefits.



The following sections of this response provide specific comments on 

the findings, conclusions, and recommendations presented in the GAO 

draft report.



GAO Highlights Page:



Under the caption ‘Why GAO Did This Study,” the draft report indicates 

that royalties taken in kind are always sold. The draft report should 

be changed to reflect the fact that royalties taken in kind can also be 

transferred or sold to other Federal agencies. Currently, the majority 

of the hydrocarbon production royalties taken in kind are dedicated to 

the SPR Fill Initiative. In this initiative the DOI takes Gulf of 

Mexico oil royalties in kind and transfers the oil to the DOE at no 

cost, thus there is no sale.



Similarly, the chart titled “Estimated Revenues Collected by the 

Minerals Management Service from Selling Royalties in Kind, January 

1995 to July 2002” incorrectly describes SPR royalty oil as being sold 

and that revenues are being received by MMS. The chart needs to be 

changed to reflect the fact that SPR royalty oil is transferred by MMS 

to the DOE without payment by DOE. This reduction in royalty receipts 

to the Treasury is offset by lower expenditures from the Treasury for 

purchase of oil on commercial markets.



Background:



Page 3:



Offshore royalty payments share with states are limited to those 

associated with leases located in the 8(g) zone, or the 3-mile-wide 

band beyond the Federal/state boundary. States do not share in royalty 

revenues associated with Federal leases located beyond the 8(g) zone 

where the vast majority of offshore oil and gas production occurs. A 

clarification to this effect is recommended.



Page 5:



We recommend that footnote 3 be clarified to provide the reader with 

the reason for data not being available beyond September 2001. In 

December 2001, the MMS, in response to a Court Order issued by the U. 

S. District Court for the District of Columbia, shutdown all of its 

royalty and production accounting systems. The systems remained 

shutdown until March 23, 2002, when approval was received to restore 

the systems and connect them with the Internet. During the shutdown 

period, lessees were unable to report royalty and production data, and 

MMS was unable to process such data. However, during the shutdown, 

royalty revenues continued to be received by MMS from cash royalty 

payors as well as purchasers who continued to be timely billed for 

sales of oil and gas royalty in kind production. With the restoral of 

the systems, MMS proceeded with its recovery plan which will continue 

into 2003.



Page 6:



Figure 2 incorrectly describes SPR royalty oil as being sold and that 

revenues are being received by MMS. The chart needs to be changed to 

reflect the fact that SPR royalty oil is transferred by MMS to the DOE 

at no cost.



Page 8:



The draft report states that MMS plans to increase SPR royalty oil 

deliveries to about 130,000 barrels per day by the end of 2002. The 

established fill schedule does not anticipate the fill rate to increase 

to 130,000 barrels per day until April 2003. This fill rate is expected 

to be sustained for the remainder of the fill initiative, which is 

expected to be completed in the latter part of 2005.



The draft report describes royalty oil and gas sales volumes in 

percentage relationships that are misleading and not reflective of 

actual RIK sales activities. We recommend that instead of using 

percentage relationships, the draft report be augmented with actual 

volumetric deliveries. For example, the state of Wyoming/MMS oil pilot 

has, over the nine consecutive sales, involved the delivery of between 

2,000 barrels and 6,000 barrels of crude oil per day. The variability 

in delivery rates between sales is the result of the rejection of bids 

by MMS and the State as inadequate to assure that RIK revenues were at 

least equal to RIV revenues. In the same respect, the OCS Gulf of 

Mexico competitive RIK oil pilot began in November 2000 with the sale 

of 7,000 barrels per day. For the second sales period beginning in 

October 2001, the RIK oil volume deliveries increased to approximately 

60,000 barrels per day and remained at that level until the end of the 

sale term in March 2002 when the volumes were redirected to the SPR 

Fill Initiative.



Page 9:



The draft report attributes the revenue reductions associated with the 

1995 gas RIK sales to unforeseen problems in securing transportation of 

gas through pipelines. We would note that other factors played a role 

in impacting revenues realized in the 1995 prototype pilot. 
Particularly 

noteworthy was the selection of properties based on the voluntary 

nominations of producers rather than selecting properties based on the 

underlying economics and the physical flow of commercially attractive 

volumes to market centers.



More importantly, the draft report is silent on a major study of 

national scope that was conducted by MMS in 1997. This study assessed 

the feasibility of a truly competitive RIK program that, unlike the 

1995 prototype, would be based on commercial industry standard 

practices. The feasibility study report served as the springboard for 

today’s RIK pilot program.



MMS Has Bequn to Establish Management Control:



Page 13:



The draft report includes the statement “These procedures led MMS to 

cancel its contract with Enron within days after Enron’s bankruptcy, 

thereby limiting losses to 1 month’s worth of gas production from the 

Enron contract.”To more accurately describe the circumstances, this 

statement should read “These procedures led MMS to cancel its contract 

with Enron within days before Enron’s bankruptcy, thereby limiting 

exposure to 1 month’s worth of gas production from the Enron contract.” 

Also, MMS’s claim against Enron is now in a collection action before 

the bankruptcy court. It is worthy of note that MMS also terminated 

four additional contracts thus avoiding exposure to loss with 

purchasers experiencing financial difficulties.



Footnote 8 in the draft report states that “The Department of the 

Interior’s Inspector General recently reported a problem in complying 

with payment procedures.” This statement is incorrect. In fact, the OIG 

identified an issue in the timeliness of reconciliation of natural gas 

volume imbalances. The OIG recommended instituting for natural gas the 

same procedures as used by MMS for oil volume imbalance 

reconciliations. MMS has completed implementation of this and several 

other OIG recommendations. A relevant and noteworthy conclusion made by 

the OIG in the same report comparing the underpayment vulnerability of 

the RIK and RIV approaches, was that ... °RIK is substantially less 

susceptible because valuation is established by fair-market sale, MMS 

receives actual proceeds from sales, MMS negotiates and pays actual 

transportation and processing costs.”:



MMS Has Not Developed Clear Objectives and Linked Performance Measures 

to These Objectives:



Pages 13-14:



The draft report asserts that MMS’s business objectives for the RIK 

program do not (1) address requirements in the leasing statutes that 

MMS collect fair market value, and (2) that they do not address 

requirements of the fiscal years 2001 and 2002 Appropriations Acts for 

Interior and Related Agencies that MMS analyze and document the 

expected return in advance of any royalty-in-kind sales to assure to 

the maximum extent practicable that royalty income under the pilot 

program is equal to or greater than royalty income recognized under a 

comparable royalty-in-value program. We do not believe the facts 

support these assertions.



The first RIK business objective cited in the draft report is clear in 

its statement that the MMS will “Implement RIK where applicable and 

when it is an improvement over traditional cash royalty payments 

(royalty in value).” The Outer Continental Shelf Lands Act and the 

Minerals Leasing Act provide the foundational requirement for the 

royalty value to be collected for production removed from Federal 

lands. For decades, the MMS, and its predecessors, have promulgated 

implementing regulations that define the methodology to be used in 

determining “fair market value” or “market value’ for payment of 

production royalties. The MMS takes very seriously its responsibilities 

under the law in enforcing its regulations to collect proper royalty 

value whether paid in cash or in kind. The codified valuation 

regulations serve as the foundation for determining fair market value 

for oil and gas production and the revenue baseline which the RIK 

option must meet or exceed before lease royalties are converted to the 

RIK option.



Furthermore, regarding the fiscal years 2001 and 2002 Appropriations 

Acts for Interior and Related Agencies, the specific language provides:



“That MMS may under the royalty-in-kind pilot program use a portion of 

the revenues from royalty-in-kind sales, without regard to fiscal year 

limitation, to pay for transportation to wholesale market centers or 

upstream pooling points, and to process or otherwise dispose of royalty 

production taken in kind: Provided further, That MMS shall analyze and 

document the expected return in advance of any royalty-in-kind sales to 

assure to the maximum extent practicable that royalty income under the 

pilot program is equal to or greater than royalty income recognized 

under a comparable royalty-in-value program.”:



While not described in the GAO report, MMS undertakes as a matter of 

standard business practice extensive economic analysis prior to all 

conversions of leases from royalty in value to royalty in kind. This 

economic analysis establishes the baseline revenues from RIV. For crude 

oil competitive sales, minimum acceptable bids (MAB) are established 

prior to each sale based on the revenues expected to be received under 

the effective oil valuation regulations. These MABs must be exceeded 

for an award to be made. MMS rejects bids not meeting MABs and 

consequently does not convert such properties to RIK. Similarly for 

natural gas, prior to the conversion of leases from royalty in value to 

royalty in kind, detailed analyses of commodity sales, transportation 

and processing scenarios are conducted to ascertain the revenue 

impacts. MMS pursues conversion of lease production royalties to in 

kind only when the revenues will equal or exceed what would otherwise 

be expected if paid in value. MMS is confident that it has met and 

continues to meet, in every respect, the subject appropriations law 

requirements related to RIK.



Furthermore, the MMS is conducting ongoing assessments of RIK pilots to 

evaluate performance based on success in meeting the following 

criteria:



*Simplicity, accuracy, certainty for lessees and government.



*Revenue neutral (or better) for the government;



*Reduced administrative burden for lessees and government.



Evaluations of the Wyoming oil pilot and the Texas 8(g) gas pilot have 

been completed and found each pilot to have performed favorably. An 

assessment is currently underway to evaluate the Gulf of Mexico Federal 

natural gas pilot. This assessment is expected to be completed in early 

2003.



The MMS conducts additional ongoing analyses, again as a matter of 

standard business practice, to monitor the status of the RIK sales 

program. These analyses are described on page 9 of these comments.



In Fiscal Year 2002, MMS initiated the development of industry-based 

systems support tools with which to manage the RIK program. These tools 

are critical to the efficient management of a permanent RIK business 

activity as well as for the efficient management of performance 

information related to the business activity. In addition to providing 

the needed support for ongoing logistics and sales activities, the 

installed systems will support the efficient monitoring of RIK sales 

revenues and comparisons against benchmark revenues that would be 

expected with in value collections. This capability will provide more 

current information than the manual processes and pilot assessment 

study approach now being utilized. The first systems implementation 

related to natural gas will occur in January 2003. The second 

implementation for crude oil will occur in September 2003.



In managing the oil and gas royalty asset, the MMS has established 

strategic goals consistent with the Government Performance and Results 

Act. These goals and the associated measures focus on (1) the timely 

collection and verification of the proper amount of royalty whether 

collected in value or in kind, and (2) providing program beneficiaries 

with early access to their revenues. MMS is in the process of 

finalizing its strategic goals for 2004-2008 which will include 

specific focus on the RIK business activity. We are confident that 

these strategic goals and associated measures will capture an ongoing 

comparative monitoring of RIK revenues to RIV benchmark values.



The MMS will also continue to perform its intensive economic analysis 

prior to the conversions of leases from royalty in value to royalty in 

kind to determine revenue neutrality.



While cost data has not been captured for a detailed quantification and 

comparison of the administrative costs of collecting royalties in kind 

versus in value, the RIK pilots have demonstrated that efficiencies and 

cost savings can be realized in the areas of royalty accounting, 

regulatory reporting and audit. This is particularly true for Outer 

Continental Shelf leases involving large volumes of production, 

relatively few leases, and a well-developed and highly competitive 

marketplace far oil and natural gas. As described in the draft report, 

MMS has concluded that the cost of compliance work associated with in 

kind collections for OCS leases is significantly less than for in value 

collections, and is in the pmcess of projecting associated savings.



MMS Has Not Fully Determined the Revenue Impacts of RIK Sales:



Pages 16-18:



The draft report states that the MMS has not fully quantified the 

revenue impacts of all the royalty oil and gas that is sold, preventing 

a comprehensive comparison between RIK sales revenues and the revenues 

that MMS would have received under the traditional cash royalty system. 

The draft report states that this condition exists because MMS’s 

current information systems do not permit timely monitoring and 

evaluation of the RIK program. MMS agrees with GAO that an information 

systems infrastructure is needed to do such comprehensive analysis on 

every commodity sale. Early next year MMS will begin implementation of 

the automated information systems to provide this functionality. As 

previously noted, the MMS RIK Business Plan for 2004 and Beyond will 

implement a full range of management and internal controls to evaluate 

the performance of the permanent full scale RIK program.



While we agree with the draft report’s statement that the RIK Pilot 

Assessments have not addressed and fully quantified the revenue impacts 

on every RIK sale, it is important to note that MMS performs additional 

analyses to quantify and monitor the revenue impacts of RIK sales. 

These analyses address at in-depth levels all of the factors that 

influence and impact revenue receipts. Examples of these analyses 

follow.



The relationship of RIK revenues to commercial benchmarks of fair 

market value used in the industry is known for every RIK sales package 

for every month.



Consistent with statutory requirements, pre-sale analyses and/or 

minimum acceptable bid evaluations compare proceeds to occur for all 

RIK sales to those estimated to occur under RIV, ensuring that sales 

are made only if RIK sales will result in greater estimated revenues.



Transportation and processing costs under RIK and RIV are compared 

comprehensively for all sales packages prior to sale.



Post-sales contract assessments are made for natural gas sales 

examining all aspects of the transactions to determine if changes to 

the sales structure are needed.



These measurements, in addition to routine market intelligence 

gathering on all pipeline systems and markets where RIK sales are 

occurring, are made in a timely manner that supports real-time 

decisions on current and future sales.



The draft report concludes by describing several circumstances in which 

adverse impacts have been experienced by MMS due to its current 

information systems and lack of timeliness in evaluating natural gas 

sales. These issues include transportation costs under gas aggregation 

contracts, access to financial system information for in value 

comparisons, and the compromise of RIK natural gas data. Each issue is 

discussed in the remainder of these comments.



Regarding the draft report’s description of MMS’s natural gas 

aggregation contracts, we are unaware of how the alleged overpayment of 

transportation costs in the draft report was calculated, and thus 

consider it unsubstantiated at this point. Contrary to the draft 

report, MMS was aware of all aspects of the operation of its 

aggregation contracts for gas RIK, including the fact that 

transportation underpayments in times of falling commodity prices 

within such contracts would ultimately offset short-lived 

transportation overpayments during rising markets. Such contracts were 

terminated, not because of untimely assessments as the draft report 

asserts, but because (1) the Federal Energy Regulatory Commission 

opined that they were inconsistent with their regulations, and (2) MMS 

received new authority in appropriations language allowing us to 

arrange for transportation in a less risky manner. The MMS is in the 

process of completing its assessment of the Gulf of Mexico RIK gas 

pilot, including the aggregation contracts, and expects to issue the 

draft report early in 2003.



The draft report describes MMS’s difficulties in gaining access to in 

value royalty data in its financial system and that this has limited 

MMS’s ability to compare in kind and in value receipts. The draft 

report is referring to the adverse impacts of the shutdown of all DOI 

systems in response to a Court Order. While the effects of this order 

were in fact adverse, MMS’s financial systems are now operational and 

relevant data are being timely captured and used.



We do not believe the facts support the GAO conclusion that natural gas 

data in MMS’s systems are compromised due to sales data being entered 

into the MMS financial system under single monthly entries. In fact, 

the sales data are entered into the financial system under multiple 

sales contract entries allocated to single property number(s). Further, 

MMS retains all data necessary to allocate sales volumes and values to 

individual leases where there is a valid reason to do so. There is not 

a routine need to allocate 100 percent Federal revenues to lower levels 

than necessary to ensure contract compliance and distribute such 

revenues.



Note: GAO’s comments supplementing those in the report’s text appear at 

the end of this appendix.



See comment 1.



Note: Page numbers in the draft report may differ from those in the 

report.



See comment 1.



See comment 1.



See comment 1.



See comment 3.



See comment 1.



See comment 1.



See comment 2.



See comment 1.



See comment 1.



See comment 1.



See comment 5.



See comment 4.



See comment 5.



See comment 5.



See comment 7.



See comment 7.



See comment 6.



The following are GAO’s comments on the Department of the Interior’s 

letter dated December 13, 2002.



GAO’s Comments:



1. We clarified our report to reflect these comments.



2. We acknowledge that the Mineral’s Management Service’s (MMS) 

difficulties in obtaining royalty data from its financial system may be 

due, in part, to the court-ordered shutdown of this financial system in 

December 2001. However, 9 months had passed since operation of the 

financial system was restored on March 23, 2002. Additionally, MMS 

personnel said that the statistical subsystem designed to generate 

routine summary data that we requested for October 2001 through July 

2002 had not yet been deployed and was not expected to be deployed 

until April 2003 at the earliest.



3. We expressed Royalty-in-Kind (RIK) volumes as a percentage of total 

federal royalty oil and gas volumes to show the overall significance of 

taking royalties in kind compared with receiving cash royalty payments. 

Using percentages also made it easier to show that large percentages of 

oil were taken in kind for the Strategic Petroleum Reserve (SPR) and 

for the Small Refiners Program relative to the small percentages taken 

for pilot purposes. In expressing RIK volumes as percentages, we used 

actual RIK sales volumes supplied by MMS but had to estimate the total 

federal royalty volumes because MMS does not maintain these data.



4. In this report, we state that MMS’s strategic objectives do not 

address the requirements in the law because nowhere in the seven 

strategic objectives is there reference to the terms “fair market 

value” or “collecting at least as much revenue as would have been 

collected in cash royalty payments.” In its response, Interior states 

that it has intended to accomplish these legislative mandates, and 

Interior apparently believes that these intentions are implied by the 

strategic objective stating that MMS will implement RIK “when it is an 

improvement over traditional cash royalty payments.” In light of 

Interior’s agreeing with us that the objectives for the RIK Program 

should include achieving fair market value and collecting revenues at 

least equal to what MMS would have collected in cash royalty payments, 

we continue to recommend that MMS clarify the language in its strategic 

objectives to reflect these intentions.



5. We acknowledge that MMS performs substantial analysis prior to 

converting leases from traditional cash royalty status to RIK. For oil 

sales, MMS generally calculated a minimum acceptable bid that bidders 

had to exceed before MMS made an award. For gas sales, MMS relied upon 

gas indexes to assess bids. While relying on minimum acceptable bids 

and gas indexes prior to a sale is a first step in ensuring that RIK 

revenues will equal or exceed cash royalty payments, MMS cannot 

determine actual revenue impacts until after the sales are completed. 

To effectively monitor and evaluate the performance of the RIK pilot 

sales, MMS should calculate revenue impacts in a timely manner after 

sales are completed and adjust future sales on the basis of these 

results.



Relying on codified valuation regulations as an indicator of what MMS 

would have collected in cash royalty payments is not as straightforward 

as Interior implies, and the application of valuation regulations is 

often a source of dispute between MMS and industry. For example, MMS 

often does not know which provision of the valuation regulations will 

apply to future royalty collections from a given lease until after the 

sale. Also, MMS’s market analyses suggests that many of the provisions 

for valuing oil and gas sold to affiliated companies may no longer 

reflect the manner in which many companies buy and sell oil and gas 

today. To compensate for these uncertainties, MMS must use considerable 

judgment in estimating revenue impacts prior to RIK sales.



While MMS has evaluated the revenue impacts after some completed sales, 

MMS has not evaluated the revenue impacts of all sales. We point out in 

this report that MMS evaluated the revenue impacts, either in whole or 

in part, of about 9 percent of the oil sold in kind and about 44 

percent of the gas sold in kind. With regards to the Wyoming oil pilots 

and the Texas 8(g) gas pilots that Interior mentions in commenting on 

this report, MMS evaluated and published the results of 3 of the 8 

completed pilot sales in Wyoming and 19 of the 29 monthly Texas 8(g) 

sales. Furthermore, only a few of MMS’s analyses were done in a timely 

manner, precluding MMS from using this information to modify subsequent 

sales. For example, MMS did not analyze the revenue impacts of the 

Texas 8(g) monthly sales or its aggregated gas sales until after it had 

discontinued selling gas by these methods. However, we encourage MMS to 

analyze the revenue impacts of its Gulf of Mexico oil pilots despite 

these sales’ current suspension because the oil from these properties 

is being transferred to the SPR. The results of such a study could be 

useful, should MMS continue the Gulf of Mexico oil pilots in the 

future.



6. MMS supplied us with the estimated loss of about $3 million on the 

aggregation contracts. We calculated that transportation was worth 

about $13 million on the basis of transportation costs and volumes 

supplied by MMS. MMS reported that the total value of royalty payments 

on the aggregated gas was about $363 million.



[End of section]



7. Our assessment that MMS has difficulty obtaining royalty information 

from its financial system is based largely on MMS personnel, who have 

used these data to estimate the revenue impacts of RIK sales and told 

us that they could not use these data without first performing time-

consuming checks for accuracy and reasonableness. At our request, these 

personnel supplied us with royalty data from nine Wyoming oil 

properties that we estimate accounted for about 50 percent of the oil 

sold during the Wyoming pilots. Although we did not find widespread 

systemic problems with this small data set, we confirmed that a small 

amount of missing, incomplete, and inaccurate data, in addition to 

numerous modifications of data entries by payors (adjustments), 

precluded using these data for calculating revenue impacts without 

first inspecting these data for accuracy and reasonableness. We 

confirmed that the manual inspection of these data was time-consuming. 

In addition, MMS personnel told us that RIK gas data are not entered 

into the system at the lease level, and we believe this will complicate 

comparing RIK revenues with cash royalty payments.



[End of section]



Appendix II: Objectives, Scope, and Methodology:



In this report, we discuss (1) the extent to which the Minerals 

Management Service has taken federal royalties in kind since 1995 and 

the reasons for doing so and (2) the status of MMS’s efforts to 

implement management controls for its RIK program.



To determine the extent to which and the purposes for which MMS has 

taken RIK since 1995, we reviewed legislative directives concerning RIK 

in the Mineral Leasing Act of 1920, the Outer Continental Shelf Lands 

Act of 1953, and the Appropriations Acts for the Interior and Related 

Agencies for fiscal years 1995 though 2002. We also reviewed 

presidential directives for using federal royalty oil to fill the SPR. 

We reviewed prior reports and other documentation on the Small Refiners 

Program, the SPR, and the RIK pilots in Wyoming and the Gulf of Mexico. 

We then asked MMS personnel to supply data on the amount and values of 

federal royalty oil and gas taken in kind and of total oil and gas 

royalties from January 1995 through July 2002. Although MMS personnel 

within the RIK Program could supply data on RIK revenues and volumes 

taken in kind during this time period, they could not supply data on 

total royalty revenues and the total amount of oil and gas produced on 

federal lands that were more current than September 2001. We did not 

review the accuracy of these figures.



To review the status of MMS’s efforts to implement management control 

over its RIK Program, we reviewed the Federal Managers’ Financial 

Integrity Act of 1982, the standards for management control that we 

issued entitled Standards for Internal Control in the Federal 

Government (GAO/AIMD-00-21.3.1, November 1999), and the implementation 

guidance issued by the Office of Management and Budget in OMB Circular 

A-123. We also reviewed our tool for assessing an agency’s management 

controls entitled Internal Control Management and Evaluation Tool (GAO-

01-1008G, August 2001) and our guide for assessing an agency’s 

strategic plan entitled Agencies’ Strategic Plans Under GPRA: Key 

Questions to Facilitate Congressional Review (GAO/GGD-10.1.16, May 

1997). Standards for Internal Control in the Federal Government 

establishes the criteria that agencies must meet in developing and 

maintaining management control, which is not one event but a series of 

actions and activities that occur throughout an agency’s operations on 

an ongoing basis. Our review focused on MMS’s efforts to address risks 

that could affect the RIK Program and on some management control 

activities that we identified as being critical to MMS’s implementation 

and management of the program. These management control activities are 

(1) developing strategic objectives, (2) linking performance measures 

to these objectives, (3) obtaining the necessary data for making 

management decisions and for monitoring and evaluating the RIK Program, 

and (4) developing written procedures and documenting compliance with 

these procedures. We assessed MMS’s efforts to establish these 

management control activities by reviewing relevant documentation and 

interviewing MMS personnel.



We reviewed MMS’s efforts to mitigate the risks associated with 

differences in the properties that produce federal oil and gas, 

fluctuating oil and gas prices, disruptions in production, and credit 

worthiness. In assessing strategic objectives and linked performance 

measures, we reviewed these objectives and measures for their results-

orientation, clarity, specificity, ability to be expressed 

quantitatively or in a measurable form, and consistency with 

congressional directives. In reviewing the availability of key data for 

management decisions and monitoring and evaluating the RIK Program, we 

assessed the extent to which MMS had determined the revenue impacts of 

all RIK sales, the administrative cost of operating the RIK Program 

relative to collecting cash royalties, and the expected savings from 

avoiding litigation and appeals and simplifying auditing. We also 

examined whether MMS had compared revenue impacts from each RIK sale 

with expected revenues from traditional cash royalty payments or other 

benchmarks and assessed whether MMS had collected monthly RIK revenues 

and sales volumes for monitoring purposes. In reviewing MMS’s efforts 

to develop written procedures, we determined if written procedures 

existed as of January 1, 2002, for conducting sales activities, 

collecting revenues, and reporting on these revenues. We determined 

major sales activities to be the selection of properties from which to 

sell RIK, the announcement of the sale, the calculation of a minimum 

acceptable bid, the evaluation of bids, and the determination of the 

winning bidders. For each sale completed as of October 2002, we also 

reviewed whether MMS documented these major activities. However, we did 

not assess the adequacy of written procedures to collect and report on 

revenues, nor did we assess MMS’s compliance with these procedures. 

Because at the time of our review, MMS had not implemented an automated 

system to support the RIK Program, we reviewed its current manual 

system and its efforts to acquire automated systems.



[End of section]



Appendix III: GAO Contacts and Staff Acknowledgments:



GAO Contacts:



Jim Wells (202) 512-3841

Mark Gaffigan (202) 512-3168:



Acknowledgments:



In addition to those named above, Letha Angelo, Ronald Belak, Robert 

Crystal, Cynthia Norris, Frank Rusco, Dawn Shorey, Jamelyn Smith, and 

Maria Vargas made key contributions to this report.



FOOTNOTES



[1] Management control is synonymous with internal control, which is 

the term used in the Federal Managers’ Financial Integrity Act of 1982. 

The standards that GAO were required to establish under the act appear 

within the report entitled Standards for Internal Control in the 

Federal Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: November 

1999).



[2] For the purpose of this report, 1 cubic foot of gas has a heating 

value of 1,000 British thermal units. When MMS reported federal royalty 

gas as having a heating value greater than 1,000 British thermal units 

per cubic foot, we adjusted the volume to compensate for this 

difference.



[3] MMS personnel within the RIK Program supplied data on revenues 

collected from the sale of oil taken in kind from January 1995 through 

July 2002. However, MMS personnel were unable to supply data on total 

federal oil royalty revenues (from both RIK sales and cash royalty 

payments) or the total amount of oil produced on federal lands that 

were more current than September 2001. They attributed their inability 

to obtain these data, in part, on a court-ordered shutdown of the 

system that lasted from December 2001 through March 2002.



[4] In these sales, MMS and the state of Wyoming sold oil from 

specified properties for 6-month periods. The buyer would receive the 

federal and state royalty share of oil from those properties for a 

period of 6 months following the sale. Wyoming participated in all but 

the first sale.



[5] MMS personnel within the RIK Program supplied data on revenues 

collected from the sale of gas taken in kind from January 1995 through 

July 2002. However, MMS personnel were unable to supply data on total 

federal gas royalty revenues (from both RIK sales and cash royalty 

payments) or the total amount of gas produced on federal lands that 

were more current than September 2001. They attributed their inability 

to obtain these data, in part, on a court-ordered shutdown of the 

system that lasted from December 2001 through March 2002.



[6] In these auctions, MMS sells gas from selected properties for 

specified periods of time. The buyer receives the federal royalty 

share of gas for a period of 5, 7, or 12 months following the sale.

 MMS initially sold this gas for 1-month periods but discontinued this 

process because it was administratively more efficient to conduct 

sales for greater periods of time.



[7] See Federal Oil Valuation: Efforts to Revise Regulations and an 

Analysis of Royalties in Kind, GAO/RCED-98-242 (Washington, D.C.: Aug. 

19, 1998).



[8] The Department of the Interior’s Inspector General recently 

reported a problem in collecting all revenues due from the sale of 

royalty gas. MMS had not resolved in a reasonable time frame the 

commonly occurring discrepancies between amounts paid and owed due to 

uncertainties in the gas volumes delivered (referred to as “gas 

imbalances”). See Department of the Interior, Office of Inspector 

General, Evaluation of Vulnerabilities to Underreporting: Royalty-in-

Value versus Royalty-in-Kind, Report No. 2002-I-0044 (Washington, D.C.: 

August 2002).



[9] The Mineral Leasing Act uses the term “market price” not “fair 

market value,” and the requirement to obtain market price does not 

cover competitive sales, which, by their very nature, provide some 

protection to the federal government.



[10] When sales involve the federal offshore leases whose royalties 
must 

be shared with adjacent states, MMS officials said that they record the 

transactions for each lease separately. This facilitates the 

disbursement of royalty revenue to the adjacent states.



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