Oil and Gas Royalties:

The Federal System for Collecting Oil and Gas Revenues Needs Comprehensive Reassessment

GAO-08-691: Published: Sep 3, 2008. Publicly Released: Sep 12, 2008.

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Franklin W. Rusco
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In fiscal year 2007, domestic and foreign companies received over $75 billion from the sale of oil and gas produced from federal lands and waters, according to the Department of the Interior (Interior), and these companies paid the federal government about $9 billion in royalties for this oil and gas production. The government also collects other revenues in rents, taxes, and other fees, and the sum of all revenues received is referred to as the "government take." The terms and conditions under which the government collects these revenues are referred to as the "oil and gas fiscal system." This report (1) evaluates government take and the attractiveness for investors of the federal oil and gas fiscal system, (2) evaluates how the absence of flexibility in this system has led to large foregone revenues from oil and gas production on federal lands and waters, and (3) assesses what Interior has done to monitor the performance and appropriateness of the federal oil and gas fiscal system. To address these issues, we reviewed expert studies and interviewed government and industry officials.

In addition to having a low government take, the deep water Gulf of Mexico and other U.S. regions are attractive targets for investment because they have large remaining oil and gas reserves and the U.S. is generally a good place to do business compared to many other countries with comparable oil and gas resources. Multiple studies completed as early as 1994 and as recently as June 2007 indicate that the U.S. government take in the Gulf of Mexico is lower than that of most other fiscal systems. For example, data GAO evaluated from a June 2007 industry consulting firm report indicated that the government take in the deep water U.S. Gulf of Mexico ranked 93rd lowest of 104 oil and gas fiscal systems evaluated. Generally, other measures indicate that the United States is an attractive target for oil and gas investment. The lack of price flexibility in royalty rates--automatic adjustment of these rates to changes in oil and gas prices or other market conditions--and the inability to change fiscal terms on existing leases have put pressure on Interior and the Congress to change royalty rates in the past on an ad hoc basis with consequences that could amount to billions of dollars of foregone revenue. For example, royalty relief granted on leases issued in the deep water areas of the Gulf of Mexico between 1996 and 2000--a period when oil and gas prices and industry profits were much lower than they are today--could cost the federal government between $21 billion and $53 billion, depending on the outcome of ongoing litigation challenging the authority of Interior to place price thresholds that would remove the royalty relief offered on certain leases. Further, royalty rate increases in 2007 are expected to generate modest increases in federal revenues from future leases offered in the Gulf of Mexico. However, in choosing to increase royalty rates, Interior did not evaluate the entire oil and gas fiscal system to determine whether or not these increases strike the proper balance between the attractiveness of federal leases for investment and appropriate returns to the federal government for oil and gas resources. Interior does not routinely evaluate the federal oil and gas fiscal system, monitor what other governments or resource owners are receiving for their energy resources, or evaluate and compare the attractiveness of federal lands and waters for oil and gas investment with that of other oil and gas regions. As a result, Interior cannot assess whether or not there is a proper balance between the attractiveness of federal leases for investment and appropriate returns to the federal government for oil and gas resources. Specifically, Interior does not have procedures in place for evaluating the ranking of (1) the federal oil and gas fiscal system or (2) industry rates of return on federal leases against other resource owners. Interior also does not have the authority to alter tax components of the oil and gas fiscal system. All these factors are essential to inform decisions about whether or how to alter the federal oil and gas fiscal system in response to changing market conditions.

Matter for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: Interior disagreed with our recommendation during the Bush administration, which led us to change the recommendation to a Matter for Congressional Consideration. However, with the change in administration and the change in the Secretary of the Interior, Interior announced a study consistent with our recommendation. Interior stated in its fiscal year 2011 budget justification that it would complete a comprehensive study of oil and gas fiscal systems and adjust its royalty rates on the basis of the report's findings, in accordance with our 2008 recommendation. In 2010, Interior contracted out a study called "Comparative Assessment of the Federal Oil and Gas Fiscal System" with the goal to inform decisions about federal lease terms, such as royalties, by consistently comparing the federal oil and gas fiscal systems with those of other countries. Interior completed this study in October 2011. Among other things, the report compared the oil and gas federal fiscal systems against a selected peer group of jurisdictions that compete for investment in the upstream oil and gas industry.

    Matter: Congress may wish to consider directing the Secretary of the Interior to convene an independent panel to perform a comprehensive review of the federal oil and gas fiscal system. Further, in order to keep abreast of potentially changing market conditions going forward, the Congress may wish to consider directing the Secretary of the Interior to direct the Minerals Management Service and other relevant agencies within Interior to establish procedures for periodically collecting data and information and conducting analyses to determine how the federal government take and the attractiveness for oil and gas investors in each federal oil and gas region compare to those of other resource owners and report this information to the Congress.


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