Oil and Gas Royalties:

MMS's Oversight of Its Royalty-in-Kind Program Can Be Improved through Additional Use of Production Verification Data and Enhanced Reporting of Financial Benefits and Costs

GAO-08-942R: Published: Sep 26, 2008. Publicly Released: Oct 28, 2008.

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In fiscal year 2007, the Department of the Interior's (Interior) Minerals Management Service (MMS) collected over $9 billion in oil and natural gas (hereafter referred to as oil and gas) royalties and disbursed these funds to federal, state, and tribal accounts. The federal portion of these royalties, which totaled $6.7 billion, represents one of the country's largest non-tax sources of revenue. In addition to this substantial financial value to the government, oil and gas production on federal lands and waters represents a critical component of the nation's energy portfolio, supplying roughly 35 percent of all the oil and 30 percent of all the gas produced in the United States in 2006. Companies that develop and produce oil and gas resources from federal lands and waters do so under leases obtained from and administered by agencies of Interior--the Bureau of Land Management (BLM) for onshore leases and MMS's Offshore Energy and Minerals Management (OEMM) for offshore leases. Together, these agencies are responsible for overseeing oil and gas operations on more than 28,000 producing leases to help ensure that oil and gas companies comply with applicable laws, regulations, and agency policies. Companies, or lessees, compensate the government for producing oil and gas resources on federal lands either "in value" (royalty payments made in cash) or "in kind" (royalty payments made in oil or gas). In fiscal year 2006, about 58 percent of the $9.74 billion in oil and gas royalty payments were made in value or in cash, while about 42 percent were made in kind. To ensure that the government obtains the fair value of royalty-in-kind sales, MMS must make sure that it receives the volumes to which it is entitled. Because prices of these commodities fluctuate over time, it is also important that MMS receive the oil and gas at the time it is entitled to them. MMS sells the oil and gas it receives through the royalty-in-kind program and disburses the revenues received from the sales to federal and state recipients. Revenues from oil and gas received in kind in 2006 were about $4.12 billion. MMS may also transfer royalty oil or gas to federal agencies for them to use. Prior to the mid-1990s, MMS's in kind efforts were generally limited to its Small Refiners Program--under which MMS sold oil that it took in kind to small refiners that did not have an adequate supply of their own. In 1995, MMS began to study whether there were additional circumstances under which taking oil and gas in kind were in the best interest of the federal government. In 1998, MMS began a series of pilot sales of royalty oil and gas and, based on the results of these pilot sales, expanded its royalty-in-kind program. In 2003, we recommended that MMS develop a more systematic approach to assess its royalty-in-kind program, and MMS has since made progress in developing metrics for measuring the performance of the program. MMS estimated that from fiscal years 2004 through 2006 the royalty-in-kind program generated about $87 million more in net value to the government than MMS would have collected had it received royalties in cash. In March 2008, we provided congressional testimony on Interior's oversight of the collection of royalties paid both in value and in kind on the production of oil and gas from federal lands and waters. This report highlights oversight issues related to MMS's royalty-in-kind program raised in that testimony and assesses (1) the extent to which MMS has reasonable assurance that it is collecting the correct amounts of royalty-in-kind oil and gas and (2) the reliability of the information on the performance of the royalty-in-kind program contained in MMS's annual report to the Congress.

Under the royalty-in-kind program, MMS's oversight of its natural gas production volumes is less robust than its oversight of oil production volumes. As a result, MMS does not have the same level of assurance that it is collecting the gas royalties it is owed. For instance, for oil, MMS compares companies' self-reported oil production data with third-party pipeline meter data from OEMM's liquid verification system, which records oil volumes flowing through pipeline metering points. Using these third-party pipeline statements to verify production volumes reported by companies provides a check against companies' self-reported statement of royalty payments owed to the federal government. While analogous data are available from OEMM's gas verification system, MMS does not use these third-party data to verify the company-reported production numbers. In December 2007, the Subcommittee on Royalty Management, a panel appointed by the Secretary of the Interior to examine MMS's royalty program, reported that OEMM was not adequately staffed to conduct sufficient review of data from the gas verification system. MMS's annual reports to the Congress do not fully describe the performance of the royalty-in-kind program and, in some instances, may overstate the benefits of the program. For example, MMS's calculation that from fiscal years 2004 to 2006 MMS sold royalty oil and gas for $74 million more than it would have received in cash was based on assumptions, not actual sales data, about the prices at which royalty payors would have sold their oil or gas had they sold it on the open market. MMS did not report to the Congress that even small changes in these assumptions could result in very different estimates. Also, MMS's calculation that the royalty-in-kind program cost about $8 million less to administer than the royalty-in-value program over the same period did not include certain costs, such as information technology costs shared with the royalty-in-value program, that would likely have changed the results of MMS's administrative cost analysis. In addition, these annual reports lack important information on the financial results of individual oil sales that the Congress could use to more broadly assess the performance of the royalty-in-kind program. From the examples cited above, we believe opportunities exist to enhance the oversight of MMS's royalty-in-kind program. We are recommending that MMS improve its verification of gas volumes owed to the government and, therefore, gas royalties owed, by using third-party production information, such as data from OEMM's gas verification system. We are also recommending that MMS take several actions to improve its calculations of the benefits and costs of the royalty-in-kind program and the information it presents annually to the Congress on the program. We provided the Department of the Interior with a draft of this report for comment.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In February 2009, MMS began using the third-party data contained in the gas verification system. The Department of the Interior has since discontinued the RIK program.

    Recommendation: The Director of MMS should improve verification of natural gas volumes owed to the government by using third-party production information, such as data from OEMM's gas verification system, to verify reported production and royalties owed.

    Agency Affected: Department of the Interior: Minerals Management Service

  2. Status: Closed - Implemented

    Comments: In August, 2011, Interior submitted a report to Congress on the performance of the royalty-in-kind (RIK)program in fiscal year 2010 which included much of the information GAO recommended Interior include. Specifically, the report included (1) a range of possible performances of the RIK program in accordance with OMB guidelines, (2) additional data on the information technology system used by the RIK program, and (3) disaggregated data on oil sales to show the variation of performance of individual sales. The Department of the Interior has since discontinued the RIK program.

    Recommendation: The Director of MMS should improve calculations of the benefits and costs of the royalty-in-kind program and the information presented to the Congress by (1) calculating and presenting a range of the possible performances of the royalty-in-kind sales in accordance with Office of Management and Budget guidelines; (2) reevaluating the process by which it calculates the early payment savings; (3) disclosing the costs to acquire, develop, operate, and maintain royalty-in-kind-specific information technology systems; and (4) disaggregating the oil sales data to show the variation in the performances of individual sales.

    Agency Affected: Department of the Interior: Minerals Management Service


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