GAO's errant jab

A new General Accounting Office report takes an errant jab at suggestions that the U.S. government collect oil and gas royalties in kind. In what will likely prove to be its pivotal finding, the GAO report said, "It would not be feasible for the federal government to take its oil and gas royalties in kind except under certain conditions." The conditions: "relatively easy" access to pipelines headed for market centers, "relatively large" production rates, competitive arrangements for processing natural gas, and marketing expertise.

"These conditions do not exist for the federal government or for most federal leases," GAO said. "The federal government does not currently have relatively easy access to pipelines, has thousands of leases that produce relatively low volumes, has many gas leases for which competitive processing arrangements do not exist, and has limited experience in oil or gas marketing."

Crucial paragraph

That paragraph is crucial. It will receive approving notice from the Minerals Management Service, which opposes royalty in kind in favor of its own version of royalty reform. And MMS congressional supporters will no doubt use it to resist legislation that would make a royalty in kind program mandatory.

But the conclusion that flows from it collapses around a fatal omission. Current royalty in kind proposals don't envision the federal government getting into the transportation and processing businesses. They assume the government will sell production to certified marketers who will handle-and pay for-those functions. If GAO had added to its list of conditions access to marketing service, its conclusion about the feasibility of royalty in kind would have been very different.

The crucial paragraph, moreover, explains why MMS ends up on dangerous ground when it complains about not receiving fair market value, yet-except for arm's length transactions-concentrates on prices distant from the lease. GAO's description of what the government doesn't have-pipelines, processing capacity, and marketing expertise-simply defines the difference between the government as royalty owner and the producers and marketers that do have those things. Except to the extent provided by contracts, royalty owners have no claim to value added to oil downstream of the lease.

The longer this conflict drags on, the worse things get for producers beset by slumping oil prices. Few of them dispute the need to change royalty valuation. Too much production is pegged to postings, under which too little oil nowadays flows to be consistently representative. So too much time and money must be spent arguing, often long after the fact, about value.

The problem, though, is obsolescence, not the fraudulence Interior Sec. Bruce Babbitt recently alleged on television. MMS wants to replace the current system with one that is at least as uncertain about value and probably much more costly to administer. Its latest proposal would apply separate valuation systems to three regions of the country and rely heavily on indexes and netbacks.

Cost estimates

And to what end? MMS says the change would raise the government's royalty take by $66 million/year. In a royalty program that generated $4 billion during fiscal 1997, that's peanuts. It's also just plain nuts, according to industry officials who say the estimate accounts inappropriately for several types of cost. Of course, MMS also insists a royalty in kind program would cost $140-367 million/year, even though the administration of which it is part once included such a program in its budget proposal as a revenue booster.

The only Americans who gain from the impasse are government accountants dedicated to retroactive evaluation of hydrocarbons and lawyers eager to litigate discrepancies. Under a royalty in kind program, many of them would have to seek other work. That's beginning to look like the reason MMS won't turn loose of its mistake.