U.S. Justice Department joins suit alleging royalty fraud

The U.S. Department of Justice (DOJ) has joined in a private lawsuit that alleges four oil companies knowingly undervalued oil production in order to lower the royalties they paid the U.S. and other landowners.

U.S. Atty. Mike Bradford of Beaumont, Tex., said private parties originally filed the suit in U.S. District Court at Lufkin, Tex., under the False Claims Act, which allows citizens to sue on behalf of the U.S. and receive part of the damages recovered.

The court sealed the case while DOJ investigated the allegations to determine whether to intervene and prosecute the case.

Bradford said the original complaint alleged 14 companies violated the False Claims Act by knowingly underpaying royalties on oil taken from federal and Indian lands.

DOJ's involvment

The U.S. action was against Amoco Corp., Burlington Resources Inc., Conoco Inc., Shell Oil Co., and the four companies' subsidiaries and affiliates. DOJ said that, from 1988 to the present, the four companies undervalued hundreds of millions of barrels of production.

Justice did not estimate the value of the alleged underpayments. The False Claims Act allows the U.S. to recover three times the amount of its losses, plus civil penalties.

Rayford Etherton, one of the attorneys for the plaintiffs, said royalty underpayments could total several hundred million dollars, and the damages and statutory civil penalties could exceed $5 billion. That would make the case the largest recovery yet under the False Claims Act.

The plaintiffs are asking for 15-25% of the recovery for themselves.

The DOJ is continuing to investigate whether to intervene in the allegations against the other 10 defendants in the lawsuit. They are: Exxon Corp., Chevron Corp., Unocal Corp., BP America Inc., Phillips Petroleum Co., Pennzoil Co., Kerr-McGee Corp., Oryx Energy Co., Oxy USA Inc., and Union Pacific Corp.

Plaintiffs

The case, which was consolidated from four separate suits, alleges the 14 companies and their subsidiaries engaged in "a nationwide conspiracy" to defraud the U.S. and Indian tribes of royalties due on crude and condensate production from more than 27 million acres of leases in or off 21 states.

The parties bringing the suit said they knew of the unlawful conduct "through their positions in the oil industry and/or their unique access to information."

The plaintiffs are:

J. Benjamin Johnson Jr. of Plano, Tex., ARCO's eastern U.S. manager of crude oil marketing from January 1991 until November 1993.
John Martineck of Carrollton, Tex., a manager in ARCO's crude oil marketing group from April 1986 until December 1993.
Harold "Gene" Wright of Tyler, Tex., an independent oil operator and a former member of the Independent Petroleum Association of America's executive committee.
Leonard Brock of Palm Desert, Calif., a former director of oil properties for the City of Long Beach.
Danielle Brian, executive director of the Project on Government Oversight (POGO), which has been critical of companies' royalty payments (OGJ, Oct. 28, 1996, p. 19).

Allegations

The suit claimed the companies misrepresented that the first sale of oil under buy/sell agreements between themselves and/or third parties is the actual value they received for the oil.

It said they bought and sold crude at the wellhead, with one another and with other producers, "at values less than otherwise available to the defendants, with the implicit understanding that, as long as approximately equal volumes are bought and sold, the net financial impact upon any defendant is neutral."

They claimed the oil companies sold crude to affiliate firms to mask the actual market value of the oil and used an artificially low price for valuing oil when the defendants refined it.

The suit said the firms falsely classified oil as lower priced sour crude, or as oil subject to quality penalties, when it actually was higher quality crude.

It also said they paid royalties on the basis of lower priced sour crude and then commingled the oil with higher priced sweet crude and sold the commingled oil entirely as sweet crude "commanding a higher price not shared with the U.S. as a royalty owner."

And, similarly, the suit said the companies paid royalties on the basis of low-gravity penalties, after they commingled the oil with higher gravity crude to obtain a mixture not subject to penalties.

Reactions

The Interior Department's Minerals Management Service collects royalties for the federal government and has a rule pending to revise the method for collecting oil royalties (OGJ, Feb. 16, 1998, p. 36).

Interior Sec. Bruce Babbitt said, "We have been working to ensure that the correct royalty is paid for oil produced on federal and Indian lands.

"In light of these (latest) allegations, the administration recommends that everyone move very, very cautiously before considering any new legislation, such as mandatory royalty in-kind, that could decrease the amount of money rightfully due the American people."

James Stafford, president of the National Association of Royalty Owners, Ada, Okla., said the Justice Department action could be seen as "a declaration of war" against the nation's oil and gas producers.

"The industry must adopt practices above and beyond the slightest hint of abuse. Until now, the subject of fair royalty payment has been treated as a nuisance, rather than a sleeping giant."

Rep. Carolyn Maloney (D-N.Y.), has held congressional hearings on alleged oil company royalty underpayments.

She said, "Justice's action is further evidence that the oil companies have and are continuing to shortchange the American people by underpaying their federal oil royalties. This action also provides new urgency for a more accurate federal rule on oil royalty valuation."

Oil firms reply

Tom DeCola, a Conoco spokesman, said the suit was "an awfully inappropriate way to address a commercial issue. We will defend our royalty valuation method."

He added that in 1996 MMS auditors gave Conoco an award for the efficiency of its federal royalty payments. "The people responsible for collecting the money said we were doing great."

Shell said it has paid royalties in accordance with lease terms and federal rules.

"We have written confirmation from the MMS that validates our method of valuing crude oil. If the government has some dispute with Shell concerning its contracts, we are dismayed that the Justice Department would attempt to resolve the matter through the inappropriate vehicle of the False Claims Act. We regard any such claim as meritless and will fight it vigorously."

Jim Fair, an Amoco spokesman, said, "We clearly believe that we have properly paid our royalties on federal production. We've been cooperating with the government on this matter and will continue to do that. We think we'll be able to resolve what's really a royalty accounting issue."