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

In fiscal year 2007, the Department of the Interior's (Interior) Minerals Management Service (MMS) collected over $9 billion in oil and natural gas (hereafter referred to as oil and gas) royalties and disbursed these funds to federal, state, and tribal accounts. The federal portion of these royalties, which totaled $6.7 billion, represents one of the country's largest non-tax sources of revenue. In addition to this substantial financial value to the government, oil and gas production on federal lands and waters represents a critical component of the nation's energy portfolio, supplying roughly 35 percent of all the oil and 30 percent of all the gas produced in the United States in 2006. Companies that develop and produce oil and gas resources from federal lands and waters do so under leases obtained from and administered by agencies of Interior--the Bureau of Land Management (BLM) for onshore leases and MMS's Offshore Energy and Minerals Management (OEMM) for offshore leases. Together, these agencies are responsible for overseeing oil and gas operations on more than 28,000 producing leases to help ensure that oil and gas companies comply with applicable laws, regulations, and agency policies. Companies, or lessees, compensate the government for producing oil and gas resources on federal lands either "in value" (royalty payments made in cash) or "in kind" (royalty payments made in oil or gas). In fiscal year 2006, about 58 percent of the $9.74 billion in oil and gas royalty payments were made in value or in cash, while about 42 percent were made in kind. 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.