Royalty Revenues:

Total Revenues Have Not Increased at the Same Pace as Rising Oil and Natural Gas Prices due to Decreasing Production Sold

GAO-06-786R: Published: Jun 21, 2006. Publicly Released: Jul 21, 2006.

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James E. Wells, Jr
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In fiscal year 2005, federal and Native American lands supplied about 35 percent of the oil and 26 percent of the natural gas produced in the United States. Companies that lease these lands to produce oil and natural gas pay royalties to the Department of the Interior's Minerals Management Service (MMS) based on a percentage (the royalty rate) of the cash value of the oil and natural gas produced and sold. As an alternative to collecting cash royalty payments, MMS has the option to take a percentage of the actual oil and natural gas produced (referred to as "taking royalties in kind") and selling it themselves or using it for other purposes, such as filling the nation's Strategic Petroleum Reserve (SPR). MMS reported collecting $7.4 billion in fiscal year 2001 and $8 billion in fiscal year 2005 in cash royalty payments and in revenue from its own royalty-in-kind sales of oil and natural gas. While these total royalty revenues increased by about 8 percent from 2001 to 2005, oil and natural gas prices rose substantially more--about 90 percent for oil and 30 percent for natural gas. Consequently, Congress asked us why oil and natural gas royalty revenues did not increase at the same pace as the increase in oil and natural gas prices.

Federal and Native American royalty revenues did not increase at the same pace as oil and natural gas prices between 2001 and 2005 principally because the volumes upon which royalties are based declined substantially during this time. In assessing changes in royalty revenues, it is important to understand the three key variables of volume, price, and royalty rate that make up total royalty revenues. When reporting and paying royalties to MMS, companies must collect and report various data, including the volume of oil or natural gas sold, the sales price received less allowable deductions--such as transportation--to get the resource to market, and the royalty rate to be paid as specified in the oil and natural gas lease. Companies can calculate the royalty revenue they owe to the federal government using the three key variables illustrated in the following equation: Royalty revenue = volume sold x sales price less deductions x royalty rate. In conducting our work, it was not possible with the available data to precisely determine how much of the change in total royalty revenues was due to a change in any one variable, as all three variables were changing over time at varying rates. For example, during any given month in which royalties are collected, each of the variables may either rise or fall compared to the previous month. For our analysis, however, we estimated a variable's contribution to the total dollar change in royalty revenues for oil and natural gas by assuming that the other two variables changed at a constant rate. Under this assumption, the total change in that variable from 2001 to 2005 closely approximated the actual change over the period. We also examined the effects of specific factors, such as hurricanes, on total volumes sold and average royalty rates. We obtained oil and natural gas data from MMS's financial system for fiscal years 2001 and 2005 to conduct our independent analysis to more fully explain the change in both natural gas and oil royalty revenues. We also interviewed MMS officials at their Lakewood, Colorado, office to solicit their views on why oil and natural gas royalty revenues did not increase at the same rate as prices between 2001 and 2005. The comparison of royalty revenues between 2001 and 2005 does not include natural gas or oil production that is subject to royalty relief. Legislation and regulations exempt some production from certain leases in the Gulf of Mexico from royalties, and therefore these production volumes do not appear in the royalty revenue statistics. Although the volumes subject to royalty relief were small, they are expected to grow in the future. We have ongoing work and plan a future report on royalty-relief policies and MMS efforts to estimate the impact of royalty relief on future royalty revenues.

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