MMS rethinks royalty plan

The U.S. Minerals Management Service, heeding strong warnings from the oil and gas industry, has stepped away from a plan to overhaul oil-valuation procedures for federal royalties (see related story, p. 25). The move is proper, and MMS deserves credit for making it.

Sept. 15, 1997

4 min read

MMS this month said it will hold workshops on alternatives to its earlier proposal, which would have linked the royalty value of oil produced from many federal leases to the price of futures contracts for light, sweet crude on the New York Mercantile Exchange. Overwhelmingly, producers and traders see the futures price, handy though it is as a broad market gauge, as an invalid proxy for specific transactions involving specific types of crude. And MMS drew criticism for prescribing system-wide remedies for isolated maladies (OGJ, July 14, 1997, p. 17).

'Additional input'

MMS apparently heard the message. "After thoroughly reviewing more than 2,500 pages of comments submitted on the proposed and supplementary rulemakings," Director Cynthia Quarterman said in a statement, "MMS has decided to request additional input on alternatives arising from those comments before proceeding with the rulemaking."

MMS announced the change 2 days after releasing results of a study on the feasibility of taking the federal royalty in-kind, the general preference of industry. The agency seems receptive to the approach. A subtext of the feasibility study, however, leaves reason for oil and gas companies to worry.

"To be revenue neutral/positive," says a summary statement that echoes others in the study report, "an MMS RIK (royalty in-kind) program must strategically participate in downstream services and value enhancements, most likely through contracting with energy marketers." That sounds like trouble.

MMS doesn't and shouldn't want to get into the oil and gas business. So it should avoid becoming trapped outside the role of royalty owner by commandments that fiscal results of federal activity be no worse than "revenue neutral." Contracts with energy marketers should raise no problems and might even solve some. But officialdom in hot pursuit of "revenue neutrality" can easily lose control.

And the straitjacket of static fiscal analysis might steer MMS away from best available strategies. "Neither the public nor marketing companies provided any evidence that selling crude oil in kind at the lease-either onshore or offshore-would be revenue positive for the U.S." Such lack of evidence shouldn't condemn RIK for oil. Yet it's a reason the study team says it "cannot endorse widespread implementation" of oil RIK. Another reason is that crude oil doesn't provide as many downstream possibilities for "revenue enhancements" as gas does.

In its welcome new look at royalty valuation, MMS needs to keep in mind the impetus for change: the possibility that current valuation procedures fail to accurately reflect the market. There is reason to suspect problems exist. First sales of crude and, especially, gas do tend to occur farther than before from the lease. The changes do raise questions about values at the lease and how to determine them.

High-side errors

Yet it is not beyond reason to suggest that where current valuations miss target some of the error falls on the high side. A true correction thus might produce "revenue negative" results on federal fiscal scorecards. Federal agencies aren't supposed to let that happen, and the words never appear in the RIK feasibility study. If a new royalty valuation program cannot accommodate the possibility, however small, that federal revenues might fall in places or under certain conditions, questions need to be raised about whether effective change can occur.

Against problems that would have arisen under the earlier MMS proposal, however, those are minor concerns. Communication occurred between the oil and gas producing industry and the nation's largest royalty owner. That this is so reflects well on both sides.