The US Department of the Interior's Minerals Management Service July 12 released a 5 year royalty management plan that expands federal royalty-in-kind (RIK) programs but does not replace traditional cash royalty collection.
Industry officials endorsed the proposal. An American Petroleum Institute spokesperson called the MMS policy document "a conservative business plan" that expands RIK only when it makes economic sense.
API said MMS's policy would mean that the government gets its money faster while industry spends less time and effort on litigation and administrative costs. API also stressed it fully expects MMS to continue to audit royalty accounts but if the lease in question is an RIK property, reviews will cover recent production over several months at the most. Conversely, cash royalty audits can focus on production drilled 5 years ago.
Replacement system sought
For years, producers that operate federal leases have called on MMS to replace its cash royalty system with RIK because of long-running disputes with the agency over market values of oil and natural gas. Under RIK, MMS accepts a percentage of the actual oil and gas produced and sells the production itself.
In its latest action, MMS resisted industry's wishes for a total RIK collection system. But the agency did recently make industry-supported changes to the way it values oil-for-cash royalty obligations; a new gas valuation proposal is imminent.
For oil cash payments, the agency switched from an index spot price benchmark to a valuation based on the New York Mercantile Exchange for oil sold between two related parties (nonarm's length contracts). The oil rule went into effect July 6.
Past RIK programs ran into criticism from some producing states as well as the General Accountability Office (formerly General Accounting Office) because in some cases MMS staff were poorly trained to sell the production. Moreover, the government lost money when RIK was used instead of the cash system in thinly traded markets.
GAO as recently as last year said that for RIK to succeed, the agency must install more checks and balances and train more staff (OGJ Online, Jan. 16, 2003).
Improvements made
MMS responded to those GAO and congressional concerns by hiring the Houston-based consulting firm Lukens Energy Group to independently evaluate its existing RIK program and offer advice on how it could be expanded on a larger scale. MMS agreed with Lukens's finding that RIK works in some markets but not across the board. As a result, MMS officials said they would rely on traditional "in value" programs in tandem with "in kind" programs to collect royalties.
Lukens also recommended MMS improve its level of commercial expertise, especially regarding marketing and sales, before expanding RIK. To that end, MMS said it plans to hire personnel with significant commercial experience in oil and gas marketing.
But legal experts that represent state royalty interests said they remain skeptical about MMS's ability to find and retain experienced oil and gas marketers because government salary levels typically aren't as competitive as in the private sector.
"MMS would have to transform itself into an oil company for this to work," said Lee Helfrich, an attorney with Washington, DC-based law firm Lobel, Novins & Lamont who represents the state of California's controller.
Interior officials said they have proof RIK already works; according to MMS, royalty revenue generally increases 1-3% when the agency uses RIK instead of demanding cash. MMS's 5 year plan will boost revenue by a total of $50 million, the agency said. Some state auditors, including California, have disputed those figures.
Guidelines
The MMS report said it will continue to focus on the Gulf of Mexico as a strategic core area but will work with producing states to develop onshore RIK opportunities.
The agency predicted that RIK gas levels could reach 1.3 bcfd in fiscal year 2009. The oil program will be more modest, with volumes of less than 190,000 b/d through the same period. MMS said it wants to increase gas RIK sales to utilities and industrial customers so that customer base would represent 20% of all RIK gas sales.
Currently about 500 MMcfd of gas is taken in kind from the gulf, representing about 25% of the gulf's royalty volumes. No onshore gas is currently taken in kind. Meanwhile, some 180,000 b/d of federal RIK crude is transacted, either through competitive sales to small refiners and commercial crude purchasers or delivery to the Strategic Petroleum Reserve.