GAO says RIK needs more oversight at MMS

Jan. 27, 2003
A new General Accounting Office study recommends that the Minerals Management Service improve its management of the royalty-in-kind program.

A new General Accounting Office study recommends that the Minerals Management Service improve its management of the royalty-in-kind program.

The independent auditing agency also recommends that MMS gather information to monitor and evaluate the program before it is expanded to include all oil and natural gas on federal lands.

"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," GAO said.

Important revenue source

Mineral revenues are an important source of revenue for the federal government. In fiscal year 2001, oil and gas royalties to MMS totaled about $7.5 billion. Over the past 5 years, 32% of oil royalties have been taken in kind instead of in cash.

"From January 1995 through September 2001, MMS took 178 million bbl of oil and 213 bcf of gas in kind, or about 32% of the federal government's royalty share of all oil and 3% of all gas produced on federal lands," GAO said.

The estimated value of the oil and gas taken in kind grew to $1.343 billion in 2000 and $1.121 billion in 2001 from $462 million in 1995, GAO said. Much of the new RIK volume, now about 20% of the federal government's royalty share of all oil produced on federal lands, is devoted to complying with a presidential directive to fill the nation's Strategic Petroleum Reserve with federal royalty oil. Before the directive, MMS selectively took federal oil and gas in kind.

GAO said industry supports the expanded use of RIK because the market value of oil and gas may be disputed. For 5 years, industry opposed MMS's ultimately successful effort to retool oil valuations so cash payments were linked to published prices in market centers.

MMS maintained that the old system relied too much on a company's posted price, leading to royalty underpayments. After a series of lawsuits were brought by the US Department of Justice on the issue, industry agreed the regulation was outdated. However, corporate representatives said the new rule would mean industry would overpay for the oil.

In commenting on the regulations, producers suggested that, instead of collecting cash royalty payments, MMS accept a percentage of the actual oil and gas produced and sell the percentage itself; in other words, take its royalties "in kind." They argued that method would make royalty collection more efficient and save the government some administrative costs.

MMS chose to use RIK on a voluntary basis. A few years later, House lawmakers from oil-producing states sought to make RIK mandatory for all federal leases. But that proposal died after it was included in a comprehensive energy bill that failed to win consensus with the Senate.

Industry support

Industry still strongly supports RIK and claims that expanding its use would avoid costly litigation and streamline royalty payments.

"With RIK, the accounting is simplified. There is no need to estimate the value of production. The auditing is simplified; all that needs to be verified is the volume of production and the volume delivered as royalty. Disputes are fewer," said Poe Leggette, an attorney with Fulbright & Jaworski who spoke on behalf of several trade groups before the Subcommittee on Energy and Mineral Resources, House Committee on Resources on June 12, 2001.

"This simplicity of process is the main reason for the industry's support of the RIK process. Lessees have a business need for certainty in the royalty payment process, but simplicity should be appealing to every stakeholder; the lessee, who produces the oil and gas and pays the royalties; the federal government, who collects the royalties; and the beneficiaries who share in the royalty revenues, states like Wyoming, New Mexico, Colorado, and California," he said.

Skepticism abounds

Public interest groups, however, have been skeptical. They say that MMS does not have the expertise to manage the risk of fluctuating oil and gas prices and that there is a danger that taxpayers and states that share in the royalty revenue will be cheated.

According to the Project on Government Oversight, the new rules collect $72 million more annually for taxpayers.

GAO conducted the RIK study at the request of two Democrats. Responding to the report, Rep. Nick Rahall (D-W. Va) and Rep. Carolyn Maloney (D-NY) who said more "checks and balances" and greater accountability are needed before the Department of Interior expands RIK.

"The quantities owed to the federal government are often subject to dispute, and federal bureaucrats are not readily equipped to market oil and gas. That's a job better left up to the companies," Rahall said.

"The companies support a nationwide royalty-in-kind program because it would provide more of an opportunity to reduce royalty payments to the federal government through suspicious transfers, accounting, and marketing schemes. The traditional cash payment system, on the other hand, requires less administration, isn't as complicated to implement, and keeps the federal government out of the oil and gas business," he said.

More RIK possible

The RIK program is expected to be expanded, but as yet MMS has no clear direction on how to proceed, GAO said.

"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," GAO said.

Interior officials generally agreed with GAO's observations and recommendations, and they pledged to improve management control over the program. In fiscal year 2003, MMS plans to implement an activity-based cost-accounting system to see how RIK compares with traditional cash payments.