[House Hearing, 105 Congress]
[From the U.S. Government Publishing Office]



 
     OVERSIGHT HEARINGS ON ROYALTY-IN-KIND FOR FEDERAL OIL AND GAS 
                               PRODUCTION

=======================================================================

                           OVERSIGHT HEARINGS

                               before the

                         SUBCOMMITTEE ON ENERGY
                         AND MINERAL RESOURCES

                                 of the

                         COMMITTEE ON RESOURCES
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED FIFTH CONGRESS

                             FIRST SESSION

                               __________

             JULY 31 AND SEPTEMBER 18, 1997, WASHINGTON, DC

                               __________

                           Serial No. 105-41

                               __________

           Printed for the use of the Committee on Resources



                                


                      U.S. GOVERNMENT PRINTING OFFICE
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                         COMMITTEE ON RESOURCES

                      DON YOUNG, Alaska, Chairman
W.J. (BILLY) TAUZIN, Louisiana       GEORGE MILLER, California
JAMES V. HANSEN, Utah                EDWARD J. MARKEY, Massachusetts
JIM SAXTON, New Jersey               NICK J. RAHALL II, West Virginia
ELTON GALLEGLY, California           BRUCE F. VENTO, Minnesota
JOHN J. DUNCAN, Jr., Tennessee       DALE E. KILDEE, Michigan
JOEL HEFLEY, Colorado                PETER A. DeFAZIO, Oregon
JOHN T. DOOLITTLE, California        ENI F.H. FALEOMAVAEGA, American 
WAYNE T. GILCHREST, Maryland             Samoa
KEN CALVERT, California              NEIL ABERCROMBIE, Hawaii
RICHARD W. POMBO, California         SOLOMON P. ORTIZ, Texas
BARBARA CUBIN, Wyoming               OWEN B. PICKETT, Virginia
HELEN CHENOWETH, Idaho               FRANK PALLONE, Jr., New Jersey
LINDA SMITH, Washington              CALVIN M. DOOLEY, California
GEORGE P. RADANOVICH, California     CARLOS A. ROMERO-BARCELO, Puerto 
WALTER B. JONES, Jr., North              Rico
    Carolina                         MAURICE D. HINCHEY, New York
WILLIAM M. (MAC) THORNBERRY, Texas   ROBERT A. UNDERWOOD, Guam
JOHN SHADEGG, Arizona                SAM FARR, California
JOHN E. ENSIGN, Nevada               PATRICK J. KENNEDY, Rhode Island
ROBERT F. SMITH, Oregon              ADAM SMITH, Washington
CHRIS CANNON, Utah                   WILLIAM D. DELAHUNT, Massachusetts
KEVIN BRADY, Texas                   CHRIS JOHN, Louisiana
JOHN PETERSON, Pennsylvania          DONNA CHRISTIAN-GREEN, Virgin 
RICK HILL, Montana                       Islands
BOB SCHAFFER, Colorado               RON KIND, Wisconsin
JIM GIBBONS, Nevada                  LLOYD DOGGETT, Texas
MICHAEL D. CRAPO, Idaho

                     Lloyd A. Jones, Chief of Staff
                   Elizabeth Megginson, Chief Counsel
              Christine Kennedy, Chief Clerk/Administrator
                John Lawrence, Democratic Staff Director
                                 ------                                

              Subcommittee on Energy and Mineral Resources

                    BARBARA CUBIN, Wyoming, Chairman
W.J. (BILLY) TAUZIN, Louisiana       CARLOS ROMERO-BARCELO, Puerto Rica
JOHN L. DUNCAN, Jr., Tennessee       NICK J. RAHALL II, West Virginia
KEN CALVERT, California              SOLOMON P. ORTIZ, Texas
WILLIAM M. (MAC) THORNBERRY, Texas   CALVIN M. DOOLEY, California
CHRIS CANNON, Utah                   CHRIS JOHN, Louisiana
KEVIN BRADY, Texas                   DONNA CHRISTIAN-GREEN, Virgin 
JIM GIBBONS, Nevada                      Islands
                                     ------ ------
                    Bill Condit, Professional Staff
                   Sharla Bickley, Professional Staff
                   Deborah Lanzone, Legislative Staff



                            C O N T E N T S

                              ----------                              
                                                                   Page

Hearings:
    July 31, 1997................................................     1
    September 18, 1997...........................................    55

Statements of Members:
    Cubin, Hon. Barbara, a Representative in Congress from the 
      State of Wyoming...........................................     1
        Prepared statement of, September 18, 1997................    55
    Maloney, Hon. Carolyn, a Representative in Congress from the 
      State of New York..........................................     5
        Prepared statement of....................................     8
    Romero-Barcelo, Hon. Carlos, a Delegate in Congress from the 
      Territory of Puerto Rico,..................................     3
        Prepared statement of, July 31, 1997.....................     4
    Romero-Barcelo, Hon. Carlos A., a Delegate in Congress from 
      the Territory of Puerto Rico, July 31, 1997................    57
        Prepared statement of, September 18, 1997................    59
    Thornberry, Hon. William M. ``Mac,'' a Representative in 
      Congress from the State of Texas, July 31, 1997............    55

Statements of witnesses:
    Brian, Danielle, Executive Director, Project on Government 
      Oversight..................................................    62
        Prepared statement of....................................   201
    Brown, Robert E., Associate Director, Minerals Management 
      Service, U.S. Department of the Interior...................    86
        Prepared statement of....................................   264
    Cohelan, Timothy, Esquire, Cohelan & Koury...................    69
        Prepared statement of....................................   249
    Darouse, David, Mineral Revenue Regional Auditor Supervisor, 
      Department of Natural Resources, Baton Rouge, Louisiana....    23
        Prepared statement of....................................   119
    Hagemeyer, Fred, Coordinating Manager, Royalty Affairs, 
      Marathon Oil Company.......................................    33
        Prepared statement of....................................   141
    Hamm, Sue Ann, Vice President, Oil Marketing/Sales, 
      Continental Resources, Incorporated........................    35
        Prepared statement of....................................   154
    Henderson, William, Market Development Representative, Gulf 
      Canada Resources...........................................    60
        Prepared statement of....................................   191
    Magagna, Jim, Director, Office of State Lands and 
      Investments, Office of Federal Land Policy, State of 
      Wyoming....................................................    25
        Prepared statement of....................................   121
    Neufeld, Bob, Vice President, Environment & Government 
      Relations, Wyoming Refining Company........................    71
        Prepared statement of....................................   257
    Nichols, Larry, President, Devon Energy......................    31
        Prepared statement of....................................   130
    Quarterman, Cynthia, Director, Minerals Management Service...    45
        Prepared statement of....................................   181
    Reid, Spencer, Deputy Land Commissioner, Texas General Land 
      Office.....................................................    19
        Prepared statement of....................................    21
    Rorschach, Richard, National Chairman, National Association 
      of Royalty Owners..........................................    63
        Prepared statement of....................................   208
    Rothschild, Edwin S., Public Affairs Director, Citizen Action    65
        Prepared statement of....................................   213
    Segner, Edmund, III, Executive Vice President and Chief of 
      Staff, Enron Corporation...................................    37
        Prepared statement of....................................   172
    Smith, Linden, Managing Director, Barents Group..............    67
        Prepared statement of....................................   224

Additional material supplied:
    Briefing paper...............................................    96
    Congressional Research Service, Library of Congress, 
      Memorandum from Marc Humphries and Lawrence Kumins.........   270
    Crude Oil Royalty Payment Analysis, Report to the State Land 
      Offices of Colorado, New Mexico, and Texas.................   138
    DiBona, Charles, American Petroleum Institute................    94
    Petroleum Marketing Act......................................   162
    Questions from Mrs. Cubin and Mr. Romero-Barcelo and answers 
      from witnesses.............................................   291
    State of Louisiana, prepared statement of, submitted by David 
      Darouse....................................................   119



OVERSIGHT HEARING ON ROYALTY-IN-KIND FOR FEDERAL OIL AND GAS PRODUCTION

                              ----------                              


                        THURSDAY, JULY 31, 1997

        House of Representatives, Subcommittee on Energy 
            and Mineral Resources, Committee on Resources, 
            Washington, DC.
    The Subcommittee met, pursuant to call, at 2:05 p.m., in 
room 1334, Longworth House Office Building, Hon. Barbara Cubin 
[chairman of the Subcommittee] presiding.

 STATEMENT OF HON. BARBARA CUBIN, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF WYOMING

    Mrs. Cubin. The Subcommittee on Energy and Mineral 
Resources will come to order. The Subcommittee is meeting today 
to hear testimony on royalty-in-kind for Federal oil and gas 
production. Under Rule 4[g] of the Committee Rules, any oral 
opening statements at hearings are limited to the Chairman and 
the Ranking Minority Member.
    This will allow us to hear from our witnesses sooner and 
help members keep to their busy schedules. Therefore, if other 
members have statements, they can be included in the hearing 
record under unanimous consent.
    The Subcommittee meets today to review issues concerning 
the collection of production royalties due to the United States 
from Federal oil and gas leases on shore and on the outer 
continental shelf. During the last Congress, Chairman Calvert 
held a hearing to review the initial evaluation by the Minerals 
Management Service of the pilot program the agency had 
conducted in the Gulf of Mexico for natural gas royalty-in-
kind.
    That effort led to inclusion of language in the 
Appropriations Committee report for the 1997 Interior 
Department's spending bill urging consideration of further 
royalty-in-kind initiatives by MMS.
    Many of us in Congress view the idea of a broad based 
royalty-in-kind program as a way to greatly diminish the 
enormous costs associated with audit and enforcement functions 
of collecting royalty-in-value.
    For fiscal year 1998, the House has funded the valuation 
and compliance subactivities within the MMS budget at $68.3 
million, but the true costs are still much higher because the 
Federal Government must expend substantial legal and 
administrative resources to answer protests, appeals, and 
litigation which ensue from differing interpretation of the 
value of oil and gas for royalty purposes.
    Lest anyone forget, let me remind you that I represent the 
State of Wyoming in this body. And my state bears by far the 
largest portion of any state's cost burden under the so-called 
net receipts sharing formula which was codified as permanent 
law in the Omnibus Budget Reconciliation Act of 1993.
    And by my quick arithmetic, the State of Wyoming has had 
over $50 million taken from its half of the Federal mineral 
lease receipts since the inception of the net receipts sharing 
methodology in fiscal year 1991.
    The cumulative burden upon the states with onshore Federal 
leases for fiscal year 1997 alone is $22.1 million representing 
one-fourth of the cost of administering onshore mineral leases 
by the BLM, the U.S. Forest Service, and the MMS.
    Without question, savings in these administrative costs, 
which may be realized through efficiency gains such as 
collecting oil and gas royalties-in-kind rather than in-dispute 
value, will reduce the burden upon the states paying the 
Federal Government's freight, as well as enrich the U.S. 
Treasury to the benefit of taxpayers throughout the nation.
    To my way of thinking, there simply must be a better way to 
more efficiently collect what is owed to the United States in 
return for the right to explore, develop, and produce oil and 
gas from Federal lands; more efficient for the Feds and, 
therefore, by way of the net value sharing formula, less 
burdensome on the states and, yes, more efficient for industry 
which must put their money and capital at risk in the first 
place so there would no income to the Federal Government or the 
states.
    Now, I realize that royalty-in-kind theoretically looks 
good, but putting it into practice is not necessarily cut and 
dry. But should we shy away from pursuing the idea because a 
particular segment of the industry or perhaps a particular 
state or two has certain problems with this method, I say 
absolutely not, nor should we in Congress simply take at face 
value allegation by folks with a vested interest in the status 
quo that R-I-K is a money loser.
    But we must keep in mind the end goal. Increased efficiency 
means greater net revenues to all parties involved. I take 
seriously my job as Chairman of this Subcommittee, and I intend 
to see that that remains our focus. My purpose then in calling 
today's hearing is to attempt to set in motion a consensus-
seeking effort not unlike that of two years ago, which 
ultimately resulted in the passage of a bill which President 
Clinton was eager to sign, the Royalty Fairness Act.
    I understand that there are naysayers within Congress, some 
of whom may believe I have tried to stack the deck in this 
oversight hearing. I disagree strongly with that assertion, but 
this will not be the final hearing on royalty-in-kind. And we 
will hear from other witnesses in September who may perhaps 
have fundamental differences over whether or not R-I-K is an 
idea worthy of pursuit.
    Furthermore, I have agreed to our Minority's request to 
have Representative Carolyn Maloney of New York as our first 
witness today, given the fact that she seems to have an abiding 
interest in royalty collection. And certainly I share that with 
you. I welcome you here today, Mrs. Maloney, and now I 
recognize the Ranking Member, Mr. Carlos Romero-Barcelo for his 
opening statement.
    [Briefing paper may be found at end of hearing.]

STATEMENT OF HON. CARLOS ROMERO-BARCELO, A DELEGATE IN CONGRESS 
               FROM THE TERRITORY OF PUERTO RICO

    Mr. Romero-Barcelo Thank you very much, Madam Chair, and we 
appreciate the opportunity to review the possibilities for a 
royalty-in-kind program in the Federal oil and gas leasing 
program.
    And it is particularly agreeable to have our colleague, 
Carolyn Maloney, Representative of New York, join us here 
today. Representative Maloney has indeed shown a great interest 
in the Federal royalty program for several years now. And her 
insight and her comments will be very welcome on this 
Subcommittee.
    The question of whether the Federal Government should take 
its oil and gas royalties ``in kind'' presents a lot of 
interesting possibilities. Of course, we are interested in any 
option that purports to improve services at a reduced cost.
    We share the Chair's interest in developing more simple, 
certain, and efficient methods of collecting oil and gas 
royalties. We are pleased to learn that a group of the 
independent oil and gas producers, through their trade 
associations, is working together to develop a royalty-in-kind 
proposal; just as we are pleased that the Minerals Management 
Service, under the able leadership of Ms. Cynthia Quarterman, 
is aggressively examining the question. The oil-producing 
states too have a valuable role to play in this discussion.
    However, it is a bit unsettling to hear--after aggressive 
lobbying by the states and oil and gas industry officials, and 
over the initial objections of the Minerals Management 
Service--that the Royalty Fairness and Simplification Act of 
1996 that was signed by President Clinton just one year ago 
should be cast aside along with the improvements made to the 
royalty management program and replaced with an in-kind 
marketing program. This is almost a 180 degree turn from what 
the oil industry and states were clamoring for during the last 
Congress.
    To a certain degree, I am being facetious. However, our 
experience with the Royalty Fairness Act illustrates an 
important factor to bear in mind. We must all be very cautious 
and extremely deliberative in our consideration of the radical 
idea of replacing the traditional in value royalty payment with 
a royalty-in-kind program.
    The Federal Government is the largest single owner of oil 
and gas resources in the United States. What would be the 
consequences of changing the Federal role from royalty 
collector to oil and gas marketer? What safeguards would be 
necessary to assure that the taxpayers will receive their fair 
share from the development of our nation's oil and gas 
resources?
    Have we adequately considered the consequences of enabling 
the Federal Government to dictate market price by virtue of its 
market power? How would the various segments of the oil and gas 
industry respond to having the Federal Government in the oil 
business?
    We must know the answers to these and other critical 
questions before we set about writing and considering 
legislation. Particularly one of the great concerns is we are 
going away from government being involved in many activities, 
and we are now asking the government to get involved being an 
oil marketer. That is a very, very step going away from where 
we are trying to go in many other areas.
    I think our experience in Puerto Rico has been that the 
government's participation in businesses that are most 
appropriately private enterprise is a bad, bad experience. I 
think probably the worst marketer in the world would be the 
government. Because, clearly, if it is not handled correctly, a 
U.S. royalty-in-kind program could seriously disrupt the 
domestic petroleum markets. So we must move slowly and 
carefully to fully examine this idea.
    We have a great deal of research and analysis to do before 
we can say with any degree of certainty that royalty-in-kind is 
better than in-value royalty. And there are others beyond these 
distinguished witnesses here today from whom we should hear, as 
our Chair has already indicated.
    For instance, none of the major oil and gas corporations 
are on the witness list here today. I hope we will gain the 
benefit of their views at the next hearing in September when we 
will also hear from witnesses invited at the minority's 
request.
    Royalty-in-kind does offer interesting possibilities, but 
it is no panacea to problems encountered with the current in-
value royalty program. Suggesting any specific, mandatory 
change to the Federal royalty management program at this point 
in time is premature.
    Only after additional study and experience, which MMS can 
gain through its ongoing efforts and we in Congress can gain 
through additional oversight hearings, can the subcommittee 
begin to consider what, if any, changes are necessary to the 
authorizing statutes. With that message of caution, I join the 
Chair in welcoming our witnesses today.
    [Prepared statement of Mr. Romero-Barcelo follows:]

 Statement of Hon. Carlos Romero-Barcelo, a Delegate in Congress from 
                      the Territory of Puerto Rico

    Madame Chair, we appreciate the opportunity to review the 
possibilities for a royalty-in-kind program in the Federal oil 
and gas leasing program.
    It is particularly agreeable to have our colleague, 
Representative Carolyn Maloney of New York, join us here today. 
Representative Maloney has shown an interest in the Federal 
royalty program for several years now. Her insights and 
comments will undoubtedly be of great value to the 
Subcommittee.
    The question of whether the Federal Government should take 
its oil and gas royalties ``in kind'' presents many interesting 
possibilities. Of course, we are interested in any option that 
purports to improve services at reduced cost.
    We share the Chair's interest in developing more simple, 
certain and efficient methods of collecting oil and gas 
royalties. We are pleased to learn that a group of the 
independent oil and gas producers, through their trade 
associations, is working together to develop a royalty-in-kind 
proposal. Just as we are pleased that the Minerals Management 
Service, under the able leadership of Ms. Cynthia Quarterman, 
is aggressively examining the question. The oil-producing 
States, too, have a valuable role to play in this discussion.
    However, it is a bit unsettling to hear--after aggressive 
lobbying by the States and oil and gas industry officials--and 
over the initial objections of the Minerals Management 
Service--that the Royalty Fairness and Simplification Act of 
1996 that was signed by President Clinton just 1 year ago--
should be cast aside along with the improvements made to the 
royalty management program and replaced with an ``in-kind'' 
marketing program. This is almost a one-hundred and eighty 
degree turn from what the oil industry and states were 
clamoring for during the last Congress.
    To a certain degree, I am being facetious. However, our 
experience with the ``Royalty Fairness'' Act illustrates an 
important factor to bear in mind.
    We must all be very cautious and extremely deliberative in 
our consideration of the radical idea of replacing the 
traditional ``in value'' royalty payment with a ``royalty-in-
kind'' program.
    The Federal Government is the largest single owner of oil 
and gas resources in the U.S. What would be the consequence of 
changing the Federal role from royalty collector to oil and 
marketer?
    What safeguards would be necessary to assure that the 
taxpayers would receive their ``fair share'' from the 
development of our Nation's oil and gas resources?
    Have we adequately considered the consequences of enabling 
the Federal Government to dictate market price by virtue of its 
market power?
    How would the various segments of the oil and gas industry 
respond to having the Federal Government in the oil business?
    We must know the answers to these and other critical 
questions before we set about writing and considering 
legislation.
    Because, clearly, if not handled correctly, a U.S. royalty-
in-kind program could seriously disrupt the domestic petroleum 
market. So, we must move slowly and carefully to fully examine 
this idea.
    We have a great deal of research and analysis to do before 
we can say with any degree of certainty that ``royalty in 
kind'' is better than ``in value royalty.'' And, there are 
others beyond those distinguished witnesses here today from 
whom we should hear. For instance, none of the major oil and 
gas corporations are on the witness list today. I hope we will 
gain the benefit of their views at the next hearing in 
September when we will also hear from witnesses invited at the 
Minority's request.
    ``Royalty in kind'' does offer interesting possibilities, 
but, it is no panacea to problems encountered with the current 
``in-value'' royalty program. Suggesting any specific, 
mandatory change to the Federal royalty management program is 
premature. Only after much additional study and experience--
which MMS can gain through its ongoing efforts--and we in 
Congress can gain through additional oversight hearings--can 
the Subcommittee begin to consider what, if any, changes are 
necessary to the authorizing statutes.
    With that message of caution, I join the Chair in welcoming 
our witnesses today.

    Mrs. Cubin. Thank you. And now for our first witness, Mrs. 
Maloney, the Representative from New York. Welcome.

STATEMENT OF HON. CAROLYN MALONEY, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF NEW YORK

    Mrs. Maloney. Thank you very much, Madam Chairwoman, and 
other members of the Subcommittee. I appreciate very much the 
opportunity to testify today. I would like to request that my 
entire testimony be put in the record as whole, but I have a 
very, very brief synopsis of it.
    The American taxpayer has lost out on nearly $2 billion in 
unpaid oil royalties since 1980. I appreciate very much the 
efforts on the part of the Department of the Interior and the 
Department of Justice toward correcting this debt. However, I 
do not believe that collecting royalties-in-kind will serve 
taxpayers well or the Federal Government.
    Let me bring you up to date very, very briefly on the oil 
royalty situation. Last year, it came to the attention of the 
House Subcommittee on Government Management, Information, and 
Technology, on which I serve, that several oil companies had 
significantly underpaid their Federal oil royalties. The 
information came through the Department of Interior's Task 
Force on California Valuation.
    The task force revealed that the royalties paid were much, 
much lower than they should have been because they were based 
on the posted price of the oil rather than the real economic 
value of the oil. The states who lost out in the undervaluation 
are pursuing their losses. The State of California won a $345 
million settlement from major oil companies. Alaska, Texas, 
Alabama, New Mexico, and Louisiana have also won settlements.
    The Department of Interior and the Department of Justice 
are both investigating the undervaluation reports. The 
Department of Interior has issued bills for $440 million in 
unpaid royalties. And the Department of Interior has proposed 
regulations on Federal oil royalty valuation, which bases the 
price of oil royalties on the New York Mercantile Exchange 
market price and the Alaskan North Slope spot prices, which is 
a standard oil price that the oil companies use.
    This came out in the task force report from the Department 
of Interior, and this is the basis of price for the oil 
companies. If it is the basis of price for the oil companies, 
it should be the basis of price for the Federal Government. 
Here is the key. Those proposed new regulations would bring in 
an additional $100 million annually. It is money that is owed 
to the American people and to the Federal Government.
    As you know, the industry is interested in a substitute 
system. They would prefer to pay the royalties-in-kind. Such a 
deal would force the Federal Government into the oil business, 
and it would cost the citizens, the taxpayers money.
    Here is what would happen under an in-kind system. Oil 
companies hand over oil as payment. The Minerals Management 
Service then contracts out to marketers. The marketers then 
sell to refiners. The profits from the oil are partially eaten 
up in paying the marketing costs, and American citizens and the 
Federal Government get jipped. It simply costs the government 
too much to get rid of the oil.
    Let me give you one example of how this might work. I see 
that Devon Energy is here to testify today as an oil producer. 
But what you all might not know is that Devon Energy is also a 
marketing corporation. The royalty-in-kind proposal gives a 
company like Devon the option of paying the government its 
royalties in oil, then being paid by the government to market 
it.
    I don't mean to single out Devon Energy, which is an 
outstanding company. These practices are quite common in the 
industry, but they seem downright unfair when oil companies are 
making money at the expense of hardworking taxpayers.
    You have heard and will hear today that the MMS, Minerals 
Management Service, has changed. You will hear that it is 
making sincere efforts to change its valuation rules to assure 
the collection of real value. You will hear that it is working 
to correct the flaws in its current royalty-in-kind program and 
to expand and improve that system.
    Despite the progress, I don't believe the Federal 
Government has any business playing J. R. Ewing from the old 
Dallas television series. The Interior Department does not have 
the culture, the incentives, or the equipment to become an 
effective competitor. There are $4 billion in revenues at risk. 
I encourage other reforms of the Royalty Management Program.
    Earlier this year, I introduced the Royalty Collection 
Reform Act, which would move the program from the Department of 
Interior to the Department of Treasury to better ensure the 
collection of money. I believe this is a better solution than 
shortchanging taxpayers to the advantage of the oil industry.
    I would just like to add that last year an important bill 
was passed out of Congressman Horn's Subcommittee on Government 
Management and Technology, and I worked very closely with him 
on this reform. And I just mention it because it is similar in 
a sense. We did a study that showed $55 billion was owed the 
Federal Government in loans, fines, fees--this is how we 
started looking at the royalties--and royalties.
    And one of the things that we did to modernize collection 
is to move collections to a centralized collector whose purpose 
and focus is collecting money, the Department of the Treasury. 
For example, the Education Department had many loans that they 
weren't collecting, but their prime focus and purpose is to 
educate, not to collect money.
    And so if you put it into a collector's hands after a 
certain period of time where the central agency tries to 
collect, then they will focus on collecting it as their prime 
and main mission. So I just mention it. And according to the 
Department of Treasury, our bill has brought in roughly--they 
estimate will bring in $10 billion over the next five years.
    I would like to put three graphs into the record if I could 
that point out simply the proposals. This is the royalty-in-
kind proposal and the new regulations that MMS has put into 
effect. The new regulations that they are calling for would 
have the government royalty based on the market price, which is 
the price that the oil companies pay.
    If it is good enough for private sector, why shouldn't it 
be good enough for government. The royalty-in-kind proposal 
will have the government royalty--the market price could be 
diminished by the marketing expenses and other expenses that 
may be involved.
    This is a graph of how an oil company--many of our large 
oil companies are integrated and formed. They have a production 
affiliate, a marketing affiliate, a transportation affiliate, 
and a refining affiliate. And so there could be built-in costs 
before we would get the real revenue. It is much simpler to 
just get the market price.
    And, again, I give the current system, which is very 
simple. You have the oil. You have the market price. You have 
MMS collecting the market price for the government's oil. Under 
the royalty-in-kind, you would have MMS becoming hugely 
involved in marketing to various contractors, to various oil 
refineries, and there will be a lot of government cost and 
expense.
    And it seems to me as we are working, as we speak on the 
floor jointly in a bipartisan way to balance the budget and to 
invest in values and really run government more efficiently 
that the more efficient way to collect oil royalties is with 
the market price, the market price that, in fact, serves the 
private sector. And I thank you, and I tried to be brief, and 
I----
    Mrs. Cubin. And you did a good job.
    Mrs. Maloney. [continuing] would like to put this in the 
record.
    Mrs. Cubin. Without objection.
    Mrs. Maloney. And if there are any questions, I would love 
to answer them. In any event, I look forward to working with 
you.
    [Prepared statement of Mrs. Maloney follows:]

Statement of Hon. Carolyn B. Maloney, a Representative in Congress from 
                         the State of New York

    Thank you Madam Chairman and Members of the Subcommittee.

Background

    Last year, in a hearing of the House Subcommittee on 
Government Management, Information, and Technology, the 
Subcommittee discussed the findings of the Department of 
Interior's Interagency Task Force on California oil valuation 
at great length. According to the report, major oil companies 
underpaid Federal royalties by posting the price of oil below 
the real economic value of the oil which the companies 
determined to be the Alaskan North Slope (ANS) spot price.
    On September 24, the Committee on Government Reform and 
Oversight released a report entitled, ``Crude Oil 
Undervaluation: The Ineffective Response of the Minerals 
Management Service.'' This report contains three findings that 
pertain to this hearing: 1) the Federal Government has received 
oil royalties below market value, 2) the oil undervaluation 
problem exists nationwide, and 3) the MMS royalty in kind 
program may have left Federal financial interests unprotected.
    Since the release of the Task Force and the Committee 
report, the Department of Interior (DOI) has proposed new 
regulations on Federal oil royalty valuation which bases the 
price of Federal oil royalties the New York Mercantile Exchange 
(NYMEX) market price and the Alaskan North Slope (ANS) spot 
price.

Royalty In Kind

    As you know, MMS' proposed regulations have produced 
voluminous comments, especially from industry. A surprising 
theme repeated throughout the industry comments on Interior's 
proposal is that the Department should cease collecting 
royalties in value and take its production in kind, meaning the 
Federal Government should enter the oil business.
    Compare this to the arguments we heard last year in support 
of the sale of the Elk-Hills Naval Petroleum Reserve. In 
managing that Reserve, the Department of Energy sold Federal 
oil. But last year, many of these same industry advocates were 
arguing that the Department of Energy, as a government entity, 
simply had no place in the oil business. But today, they urge 
us to force the Department of the Interior to enter the market 
on a scale that would eclipse, by several fold, the DOE's Elk 
Hills program.
    It was only last year that this Congress passed into law, 
the Federal Oil and Gas Royalty Simplification and Fairness 
Act. This legislation imposed new requirements on the 
Department of Interior to follow in the collection of 
royalties. As I understand it, the Minerals Management Service 
has yet to fully implement these requirements which has caused 
a flurry of rulemakings, task force groups and other re-
direction of resources. Now industry is advocating even more 
drastic changes--changes, which if implemented in full would 
essentially scrap these recent reforms.
    I believe the real impetus behind industry's royalty in 
kind push is to avoid paying oil royalties based on market 
price as suggested in the new proposed oil valuation 
regulations.
    Forcing the government to take the royalty in kind will 
trap the government in the very posted price system that does 
not reflect value. Industry believes that bidding the 
production out at the lease will safeguard the public's revenue 
interest against posted prices. However, if the real 
independent producers cannot obtain market value, how can the 
Federal Government? The fact is that those that could purchase 
at the lease--the major integrated companies--have an interest 
in getting access to cheap oil. And those others that more 
typically participate--brokers and marketers--would not survive 
if they could not profit from the difference between posted 
price and real value.
    Industry also suggests that MMS use marketing middlemen to 
sell the government's in kind production. This Subcommittee is 
fortunate to have oil marketers before it today, and I would 
urge you to question them closely about how use of marketing 
middlemen would protect the public's revenue interest.
    For example, Devon Energy, which is here to testify in 
support of a government royalty in kind program, is not only a 
producer, but a marketer through its subsidiary, Devon 
Marketing Corporation. Devon's SEC filings indicate that its 
marketing affiliate has purchased over 80 percent of its 
production from third parties over the last few years. 
Logically, it is thus a potential purchaser of the government's 
royalty in kind production. Those same documents indicate that 
Devon Marketing purchases third party oil production at the 
field postings and resells it at a premium over posting.
    I do not mean to single out Devon Energy. As I understand 
it, the practices of its marketing affiliate are common.
    But as potential purchasers of the government's in kind 
production, I would urge the Subcommittee to ask these industry 
marketers the following questions. Would you follow your normal 
practice of purchasing product at the posted price for in kind 
production? And, if not, what percentage of the premium 
received by your marketing affiliate would you share with the 
Federal Government and what would you keep as a ``marketing 
fee''?
    My concern is simple. In the past, MMS operated its royalty 
in kind program as a source of cheap oil for independent 
refiners. The current proposals suggest that the economic 
advantage of cheap government oil will simply be transferred 
from small refiners to marketers. Under either scenario, the 
public's revenue interests are left out of the equation.
    I have also heard repeatedly from industry that MMS simply 
has no understanding of the crude oil market. If it is true 
that MMS' knowledge lags the market, how can we hope to assure 
that MMS will on a timely basis be able to evaluate the 
performance of its marketing agents? And, if it does take five, 
10 years for MMS to catch up, as we have seen in the past, what 
protection will exist that the public will not be short-
changed?
    In referring back to Interior's task force report, our 
Committee found example after example of how oil companies were 
very successful in losing MMS auditors in a maze of oil 
transactions. Let me quote from the report:
    On Page 18, the report states, ``Most oil from Federal oil 
and gas leases is produced by integrated companies that 
transfer production from their production arm to a trading or 
refining arm. After this initial non-arm's-length transfer, oil 
produced from Federal leases loses its identity in companies' 
accounting systems so that its price in subsequent transfers 
cannot usually be determined.
    And on Page 49-50, the report says, ``After transferring 
Federal crude of a specific type to a company's trading 
division, the distinction between Federal and non-Federal crude 
oil was lost. Federal crude oil was not specifically invoiced 
in companies' records after internal transfers, so it is 
unlikely that gross proceeds in excess of posted prices can be 
traced to the production of specific Federal leases.''
    As much as I admire the efforts of the Secretary to make 
improvements to Interior's Royalty Management Program, I 
believe the major oil companies have and can continue to bury 
the Royalty Management Program audit teams in a maze of company 
trading transactions. Furthermore, the oil companies have made 
no secret of their desire to use legal roadblocks and endless 
appeals to prevent the release of their affiliate's records. 
That's why I believe that using spot prices like the ANS and 
NYMEX is by far the most efficient, accurate and least 
bureaucratic method to value royalty on.

Conclusion

    You have heard and will hear today that MMS has changed. It 
is making efforts to change its valuation rules to assure the 
collection of real value, and I applaud those actions.
    But, despite this progress, I simply not believe that the 
Federal Government should enter the oil business. The Interior 
Department does not have the culture, the incentives, or the 
equipment to become an effective competitor. Congress should 
not risk $4 billion in revenues by forcing MMS to try and 
recreate itself into something that in reality it cannot 
effectively become.
    Reform at MMS is possible. I too have called for further 
reforms of the Royalty Management Program. I have introduced 
the Royalty Collection Reform Act, which would move royalty 
collection to the Department of Treasury's Financial Management 
Service (FMS) to better insure that funds owed the government 
are collected. FMS can collect Federal royalties accurately 
without the need for a full blown oil royalty in kind program.
    Thank you.

    [Graphs follow:]
    [GRAPHIC] [TIFF OMITTED] T5026.236
    
    [GRAPHIC] [TIFF OMITTED] T5026.237
    
    [GRAPHIC] [TIFF OMITTED] T5026.238
    
    Mrs. Cubin. Thank you. I do have just a couple questions. 
First of all, I know that you know this, but just for the 
record, when Federal minerals are produced in a state, then the 
state shares in the royalties at 50 percent.
    And so before I came up here today, I think want to say 
this because I want you to understand--not just you but 
everyone to understand--how not only do I think it is the right 
thing to do to collect the appropriate penny of the appropriate 
amount--every single penny that is owed to the government in 
royalties, but it is also for every constituent in my state.
    Because I went back and looked up the data published by MMS 
on all the royalties collected from Federal leases within each 
state since the advent of the Mineral Leasing Act, and it may 
surprise you to learn this that New York has had natural gas 
production from Federal mineral estate totaling $54,327 in 
royalties from 1920 through 1995.
    Now, let us compare that with the total of royalties paid 
into the Treasury from the Federal leases in Wyoming over the 
same period of time. According to MMS, over $6,680,000 of 
royalties were paid from Wyoming, and so, obviously, our 
schools and our communities, our highways--it is very important 
to me that we get every single penny to which we are entitled. 
And we agree very strongly on that.
    There may be some disagreement. I think that is yet to be 
told. But I want to ask you this question. Did your graphs show 
the amount of money that the Federal Government spends on 
litigation, on enforcement, and audits, and all of those kind 
of things--expenses that go into the current collection 
process?
    Mrs. Maloney. Well, we hope the regulations will fix some 
of that. My graphs had no numbers on them at all. And as you 
know, their new regulations greatly simplify their collections 
process, projecting to collect on the Alaskan North Slope 
prices and the New York Mercantile Exchange, as opposed to the 
posted prices.
    I would think that moving to that system would cut out a 
lot of litigation just by common sense, that there is nothing 
to litigate. I mean, it is very clear. Here is the price that 
the private sector pays. Here is the price that the government 
pays. It is the same.
    Mrs. Cubin. Well, unfortunately, it really isn't that 
simple. I live right in the middle of an oil and gas field, and 
the problem that I see at this point in time with the proposed 
rule is that what this rule will do is move the point of 
valuation farther from the wellhead or from the border of the 
lease.
    And so that the price then will include some beneficiation 
rather than the actual price at the wellhead, and that is where 
the tax ought to be assessed, in my opinion. You said that $51 
billion or $55 billion is owed in uncollected royalties. Is 
that correct?
    Mrs. Maloney. That was to illustrate centralizing 
collections in the Treasury. This report that we did was one of 
100 agencies where they reported back what was owed to them, 
and this was not just an oil report. This was all that was owed 
the Federal Government in uncollected----
    Mrs. Cubin. In minerals?
    Mrs. Maloney. No, no, no, in everything.
    Mrs. Cubin. Oh, OK.
    Mrs. Maloney. In everything--education, agricultural loans, 
small business loans, loans, fines, fees, royalties, and other 
areas. This was what was owed to the Federal Government that 
was not collected. And Congressman Horn and I put in a bill to 
improve collections, not just for royalties but across the 
government, that modernized it, simplified it, and, very 
importantly, put collections in one office whose mission it was 
and focus was to bring revenue into the Federal Government.
    Mrs. Cubin. Thank you.
    Mrs. Maloney. And that has helped bring in--in fact, we are 
working on our second report, and I will be glad to share it 
with you with Mr. Horn of what has come in since our bill went 
into effect. But the Treasury projects that having done what we 
did, centralizing collections in Treasury, will improve 
collections across our government by they said $10 billion in 5 
years. That is a lot of schoolteachers. That is a lot of police 
officers. That is a lot of investment in the interior and other 
things in our parks that we need money for.
    I just mentioned that as a way of possibly improving 
collections instead of having the Department of Interior that 
has so many important responsibilities to possibly let the 
Treasury Department, which is collecting now across government, 
likewise collect royalties. Maybe that is another issue maybe 
that is not just in-kind, but I just brought it up since it had 
been successful in bringing in revenue. And that is one of the 
focuses of the in-kind hearing that you are having now, to 
bring in the revenue. In any event, I appreciate your time and 
of all the members here.
    Mrs. Cubin. Thank you. Did you have any questions, Mr. 
Barcelo?
    Mr. Romero-Barcelo. First of all, I would like to thank 
Mrs. Maloney for her testimony and for being here with us----
    Mrs. Maloney. Thank you, Governor.
    Mr. Romero-Barcelo. [continuing] and helping us and 
educating us. She knows more about this problem than I do. I am 
just beginning to learn about it. But, Madam Chair, I would 
like to suggest that we ask for the Administration to give us 
an estimate on the cost of litigation for the collection of 
the----
    Mrs. Cubin. Certainly.
    Mr. Romero-Barcelo. OK. Thank you. Thank you, Madam Chair. 
And I just have a couple of questions for Mrs. Maloney. Do you 
know what has been the experience in those countries like 
Venezuela and Mexico where the government is involved in the 
business of marketing oil?
    Mrs. Maloney. I have not studied those countries. I could 
look at it and get back to you.
    Mr. Romero-Barcelo. Well, the experience is very, very, 
very bad for those countries. I mention that because everywhere 
that the government gets involved in something that is 
capitalistic as marketing, they are never successful.
    So if that is an option, this will be analyzed from all 
angles because it is very--as I said, the experience that we 
have had also in Puerto Rico has been a very bad experience. 
What they had in England and other countries has also been very 
bad when the government gets involved in selling goods or 
services.
    The other thing I would like to ask you, Mrs. Maloney, is 
have you been in touch with the Secretary of the Treasury or 
with anyone in the Federal Management Service about how they 
would go about it and whether they would be interested in 
handling the services of collecting the royalties?
    Mrs. Maloney. Absolutely. I have talked several times with 
Cynthia Quarterman and also with Secretary Babbitt, and I 
applaud the Administration. They really appointed a task force 
that came forward with the first government report that showed 
the undervaluation and took steps to correct it. And I think 
that they have been innovative, and they have worked very hard 
on it, and that they have done something constructively to 
correct a problem. And I applaud them for their efforts.
    Mr. Romero-Barcelo. I am talking about the suggestion that 
you made that the collection of royalties be delegated to the 
Department of Treasury, not the Interior.
    Mrs. Maloney. I have talked to Treasury officials, but I 
have not met with the Secretary, and I will try to meet with 
the Secretary and discuss it with him and see what his 
viewpoints are on it. And I put forward the proposal only with 
the deepest respect of the Department of Interior and the fine 
job that they are doing but in probably helping with the 
management.
    What we are doing across government is each agency will 
have 6 months to collect what is owed to them. Then it moves to 
the Department of Treasury where they then centralize it and 
try to bring it in through a centralized method, which has been 
working very well.
    Mr. Romero-Barcelo. I just asked that question because the 
idea to me seems very good because, obviously, the Treasury 
Department is much more trained to collect any kind of taxes or 
royalties than anybody else in the government. So----
    Mrs. Maloney. I think that a lot of times in government we 
are very shortstaffed, and we don't have enough time or energy 
or personnel to do all the many things that we need to do. And 
a lot of times your main focus is that of your main purpose 
which in the Department of Interior is our resources, our 
parks, our minerals, our oils, and not necessarily the 
management.
    And perhaps that would be a way, but I would, you know, of 
course, want to work with Secretary Babbitt. I think he has 
done an absolutely extraordinary job, and I might add that even 
though there have been published reports about undervaluation 
of oil for many, many years, this was the first time the 
Department of Interior appointed a task force, issued a report, 
then acted on the report's recommendations constructively to 
correct it.
    And I think they have done--I think that I am going to 
recommend them for one of Vice President Gore's--what are 
they--the Hammer Awards for government employees who do a good 
job because I think they have done a wonderful job with those.
    Mr. Romero-Barcelo. Thank you, Mrs. Maloney.
    Mrs. Maloney. Thank you.
    Mrs. Cubin. Mr. Thornberry, did you have--Mr. Brady? Mr. 
Dooley?
    Mr. Dooley. Yes. Mrs. Maloney, before you leave, I just 
wanted to ask one question. I appreciate all the work you have 
done.
    Mrs. Maloney. The last time I saw you you were on the 
floor.
    Mr. Dooley. I know it.
    Mrs. Maloney. Now, you are back up here. I think when I 
left my office you were on the floor giving a good speech.
    Mr. Dooley. That is right. But, you know, a lot of it is 
appreciated--a lot of the work that you have done in terms of 
ensuring that taxpayers are getting their fair share of the 
royalties. I guess I come at this representing a lot of 
independent producers, and we are a little bit concerned with 
some of the proposals in terms of how are we going to ensure 
that the price is going to be reflective of the real price if 
they are being paid for their product.
    And as I was reading your testimony, I was somewhat struck 
because it seems like there is one sentence in your testimony 
that almost expresses a similar concern, and when you were 
talking about how the in-kind will be difficult because you are 
concerned you will not be able to safeguard the public's 
revenue interest against posted prices, you go on to say, 
however, if the real independent producers cannot obtain market 
value, how can the Federal Government.
    And my concern is is you are making a statement there that 
independent producers are not necessarily receiving what will 
be the fair market value, which MMS and I think which you are 
proposing will be reflected by an ANS price if you are from 
California, as I am. And some of us are not convinced that that 
is actually going to occur. In your statement, you state that 
they are not receiving that now.
    Now, I hope that you are sensitive as we try to move 
forward, you know, to make sure that that price of which the 
independents are going to be paid on for their royalties are 
going to be a function of is, in fact, the price that they are 
receiving for the oil. And do you acknowledge--is this a 
problem? I mean, it seems to be as you have stated in your 
testimony.
    Mrs. Maloney. I agree absolutely, completely, Congressman, 
and, in fact, many independent producers have written my office 
and actually have come by personally to see me in support of 
the work of the Subcommittee on the valuation of oil.
    Mr. Dooley. So would that mean that you would then be 
opposed to what MMS is proposing in terms of using a benchmark 
at ANS for independent producers?
    Mrs. Maloney. No. I think that you need to--the independent 
producers want the true value of the oil. Right? And that is 
the value that we want, which is the----
    Mr. Dooley. They want to pay royalties on the price of the 
oil--on what they are being paid for the oil that they are 
selling?
    Mrs. Maloney. Right, exactly, exactly.
    Mr. Dooley. Well, what you are saying in your testimony is 
that sometimes they are not receiving what the fair market 
price is and which we are assuming that what MMS is proposing 
is that the fair market price will either be a New York 
Exchange price or an ANS price?
    Mrs. Maloney. Yes.
    Mr. Dooley. And so, you know, my concern is if you are 
acknowledging they are not getting paid that fair price now, we 
are going to implement a system which is going to ensure that 
they are paying higher royalties than what they should.
    Mrs. Maloney. Well, we should separate the independents 
from the majors in the regulations.
    Mr. Dooley. Thank you.
    Mrs. Maloney. But, you know, what we looked at in our 
committee which was getting the best price for the American 
taxpayer. And the task force showed that the price that the oil 
companies themselves were paying was Alaska North Slope in the 
case of California, or the New York Mercantile Exchange for the 
others. I am not an expert on the oil industry. We were not 
looking at it except for in a management role, which is the 
role of the committee.
    I do know that several independent producers from 
California and other states came to my office in support of 
having a system that was not posted prices but, in fact, Alaska 
North Slope. So they did, you know, support that work. And 
whatever their concerns are, I would like to listen to them 
even more.
    But in terms of the work of the committee and the reports 
coming out of MMS and the proposed system that MMS has 
suggested in the regulations, the ones that came to my office 
were totally supportive of it. Now, if there are other 
independent producers who have a different problem, I am not 
aware of it.
    And as you pointed out, I don't represent an oil state. I 
was not coming at it from a state interest. I was coming at it 
from the purpose of the committee on which I serve, which is 
better management of government resources and reports that come 
forward that oil is greatly undervalued and that California, 
Wyoming, and others--in fact, it was California that the whole 
issue really highlighted out of the collection system of the 
State of California.
    Mr. Dooley. Well, I think most of the independents or 
representatives of their associations have come out in 
opposition and expressing some real concerns about the 
valuation process; at least that is what the associations are 
communicating to me. The other point I would make is----
    Mrs. Maloney. What is their problem with the valuation 
process?
    Mr. Dooley. Well, precisely what you said in your 
testimony. I mean, what you stated in your testimony was, 
however, if the real independent producers cannot obtain market 
value, how can the Federal Government. You have made a 
statement that independent producers are not obtaining fair 
market value. What MMS is proposing is that fair market value 
can be determined by an ANS benchmark. And you have already 
acknowledged that that is not happening.
    And so my concern is that you are stating in your testimony 
that my guys, my independent producers are going to be paying a 
higher royalty than what they should based on what they are 
receiving for the oil that they are producing, and that to me 
is an inequity that we need to be concerned about.
    Mrs. Maloney. We agree some of the independents feel that 
the majors give them an inequity, but, again, we were acting on 
the report of the task force that said the majors--and the task 
force report focused on majors, not the independents--said that 
the major oil companies--10 to be exact--were basing their 
prices internally on Alaskan North Slope and the New York 
Mercantile Exchange, and that the posted prices were much lower 
than those two standards.
    If independents--you know, maybe there should be separate 
regulations for the independents given the specific problems 
that the independent oil companies have. And I would like to go 
back and meet with some independent oil companies and become 
more aware of their particular problems.
    But, as I said, you know, I am not the Department of 
Interior. We were looking at a report that oil was greatly 
undervalued, and we acted on it. But you raised an important 
point, and I agree with the great Congressman from the great 
State of California, which actually brought this attention to 
the national level in the first place.
    Mr. Thornberry. [presiding] Mr. John, you have something?
    Mr. John. Yes. I don't particularly have a question for the 
gentlelady from New York, but with the pleasure and the OK of 
the Chairman, I would like to make just a little observation, a 
little statement about the importance of this issue.
    Being from Louisiana, oil and gas industry is very, very 
important. As I served in the legislature, $1 billion in 
royalties is part of the Louisiana budget for the State of 
Louisiana. So this issue is very, very important.
    And, moreover, than just the State of Louisiana, my 
district, which sits on the Gulf of Mexico and bordered by the 
State of Texas, is what I like to call the heartbeat of the 
offshore oil and gas industry of the Upper Gulf of Mexico. So 
this issue is very important and very vital to my constituency, 
the oil and gas industry, and the taxpayers of the State of 
Louisiana.
    I think we must keep in mind as we go through these 
proceedings that I believe the bottom line, and to make it as 
simple possible, is that we need to look at the cost associated 
with the proposed system and the systems already in place. What 
does it cost MMS now to evaluate the problems that are caused, 
and what is the value? Is it wellhead or is it whatever? Or 
what is it going to cost to revamp a collections agency to go 
toward the in-kind.
    So I think if we keep that in mind, that is the ultimate 
decision that this Committee is going to have to do and decide 
upon. So I just wanted to make a statement that it is very, 
very important to my district in my State of Louisiana. And I 
thank the Chairman of the Committee for holding these hearings. 
Thanks.
    Mrs. Maloney. Well, I thank you. And many of the attorney 
generals of the states that many of you represent that are oil-
producing states have been in contact with our offices and the 
central committee, most of whom are supportive of our efforts 
to revamp the system.
    Mr. John. Well, this issue, like many others, has its 
proponents and opponents, but I am anxious to hear the 
gentlemen from the--or the testimony from the State of Texas 
that actually has an in-kind program in the state on state 
waters and state lands to see how it is working. I think I am 
interested in hearing that testimony. Thanks.
    Mrs. Maloney. Well, I look forward to reading about it too. 
Thank you very much. I appreciate your time.
    Mr. Thornberry. Mrs. Maloney, thank you for your testimony. 
And certainly if your schedule permits, we would certainly 
invite you to stay and sit up on the dais and listen to the 
testimony from the State of Texas where they have had such a 
program since 1973. I think it would be helpful for everyone.
    We would call the next panel now; Jim Magagna, Director, 
Office of State Lands and Investments, Office of Federal Land 
Policy, State of Wyoming; Spencer Reid, Deputy Land 
Commissioner, Texas General Land Office; and David Darouse, 
Mineral Revenue Regional Auditor Supervisor, Department of 
Natural Resources, from Baton Rouge, Louisiana.
    Gentlemen, we appreciate each of you being here today and 
willing to share your perspectives with us on this issue. Mr. 
Reid, we will let you start, and we will just go down the line 
from our right to left.

  STATEMENT OF SPENCER REID, DEPUTY LAND COMMISSIONER, TEXAS 
                      GENERAL LAND OFFICE

    Mr. Reid. Mr. Chairman and members, Texas Land Commissioner 
Garry Mauro appreciates the invitation to appear before the 
Subcommittee today and to discuss the Texas royalty-in-kind 
program and regrets that he is unable to personally attend, and 
he has asked that I speak on his behalf.
    One thing I would like to point out is we were asked to 
bring comments about our experience with our program, and these 
comments are not intended to address any particular proposals 
that are pending. We haven't addressed anything in here like 
that.
    We have been very pleased with the results of our in-kind 
programs and are glad to share this information. While royalty-
in-kind may not cure all of the disputes that arise between 
royalty owners and producers, our experience in Texas has been 
that it does provide a means to substantially reduce royalty 
disputes, valuation disputes particularly, reduce costs to both 
the states and the lessee, and provide the royalty owner with 
an opportunity to obtain an enhanced return.
    For those of you not familiar with the Texas General Land 
Office, it is headed by an elected state official. The 
principal duty he has is to manage 20 million acres of state 
lands of which about 15 million have minerals under them, of 
that about 5 million is offshore of Texas either in the Gulf of 
Mexico or in the various bays of the state.
    And all of the land there is dedicated to the Permanent 
School Fund or one of the Permanent University Funds. The 
Permanent School Fund last year--the General Land Office 
deposited about $155 million, which I know in Federal standards 
isn't a lot of money, but for Texas that has allowed us to 
build on a fund now approaching $14 billion for support of 
public education in Texas.
    There is also the Permanent University Fund in Texas that 
has another--it has got over $5 billion that is operated by the 
University of Texas. It has a lot of land out on Permanent 
Basin. As to the relative size of our production, we have about 
33 billion cubic feet of natural gas, which if Texas were a 
producer in its own right would put us in probably the top 50 
producers in the country.
    The Texas program has been going on for about 14 years. It 
has accelerated in the recent years. Over that time, we have 
enhanced our income to the Permanent School Fund by $11 million 
in gas and $5 million in oil. And another component of the 
state program which is something that really is kind of the 
gist of our program, we save state agencies in Texas over $90 
million over that same period of time in energy costs by 
selling them state gas from state leases directly to state 
consumers.
    Our in-kind program originated in the early 70's. The 
legislature passed the first statutory authorization for the 
program in 1973. From then until the early 80's, we took 
relatively small volumes of gas and sold them in the 
marketplace just like a marketer.
    In 1983, we began marketing gas directly to end-users, and 
by the end of 1985, it was expanded to include state agencies. 
This expanded programs concentrated on sales to agencies, 
universities, and public facilities. The goals of the program 
were twofold: first, to generate more revenue to the Permanent 
School Fund and to save money for the state agencies.
    The Texas legislature has consistently supported the 
program and in recent years has enacted laws that assured the 
smooth operation of the state program. Any state agency 
contract for over 100 Mcf of gas per day must be submitted to 
the General Land Office to see if we can provide state gas and 
get them a better price. And then we are able to transport gas 
and gas utility lines. They are prohibited from--well, they are 
required to carry state gas if they have capacity if it is 
destined for a state agency.
    In addition to the natural gas in-kind program, the Land 
Office takes approximately 2,400 barrels of oil per day and 
sells it in-kind. That is 45 percent of our total production, 
our total royalty share. The oil is sold under 6-month 
contracts at bid sales. Prices are bid at premiums to posted 
prices, and at the last sale in April, the premium was as high 
as $2.08 over the commonly used posting.
    Last fiscal year, the gas program sold approximately 9.1 
Bcf to state agencies and 2.6 Bcf were sold on the spot market. 
Our total gas sales represent about 35 percent of our total 
production--our total royalty share, let us say. Our spot 
market sales assure that adequate supplies have been retained 
to meet our state end-user program. Gas is currently being 
taken in-kind from 105 leases, almost all of them offshore.
    The contracts are in place with 103 state facilities, 28 
state colleges and universities, and six other governmental 
bodies, including school districts, small cities. 
Transportation contracts are currently maintained with 35 
different pipeline companies and local gas distribution 
companies. And we maintain a contract for up to one Bcf of gas 
storage in a facility near Houston.
    Sales of gas on the spot market are sold through monthly 
solicitations of interest from prequalified gas marketers. We 
currently have about seven marketers that bid on this. In order 
to qualify, marketers must show financial stability. But in 
order to encourage small business participation, the Land 
Office maintains a credit risk insurance for those contracts.
    Since 1973, all state oil and gas leases have provided for 
the right of the state to take royalty-in-kind upon 60 days' 
notice of our intent to do so. On some leases, we have been 
able to negotiate in-kind those that were issued prior to 1973.
    Once we have exercised our right to take-in-kind for a 
particular lease, we make every effort to continue to take gas 
from the lease in order not to burden the lessee by alternately 
taking and not taking. We do have the authority to not take. We 
generally take possession at the point in which it has been 
made ready for sale or commercial use through the removal of 
water, natural gas liquids, and impurities.
    Costs of transportation and other direct costs, together 
with the markup or enhancement, which is what the additional 
royalty paid the school funds is termed, and a set 
administrative fee that pays for our operating costs of the 
program are charged to the gas purchasers--the end-user 
purchasers.
    In all but a few cases, prices to the end-user agency are 
below those available from private sources and are lower than 
local utility costs in almost every instance.
    We make a decision at every sale and the local--the agency 
is authorized to not buy from us if it is going to cost them 
money.
    Gas and oil producers on state lands have almost been 
uniformly supportive of both the gas and oil in-kind programs. 
We don't have specific figures on the administrative savings 
and other benefits, but they are undoubtedly there. It is a lot 
easier to account for volumes of oil or gas physically 
delivered than to account for both volumes delivered and the 
market value of those volumes.
    Delivering in-kind relieves the producer of the obligation 
to account for the market value of the gas and relieves the 
Land Office from the burden of conducting the financial audits 
of producers. Once accurate delivery is established, the 
producer no longer needs to be concerned state auditors will 
dispute the value that they received.
    Our programs are so successful we are looking at 
privatization of our programs or bringing in a gas marketing 
firm. We put out a RFP last summer. We have gone through the 
process and got down to the company that we are negotiating 
final contract with.
    The contract provisions provide that we are negotiating for 
an expansion of our end-user program. They will take a three 
cents fee for doing that activity. And then the balance of it, 
if we have overages, essentially works out to a gas sales 
contract indexed to a pipeline.
    I will close by just saying that Texas is very interested 
in a way to obtain its share of Federal royalties that were 
paid in-kind. Volume is the name of the game in this business, 
and we would be very anxious to work with Congress and Interior 
staff to see if a way can be worked out to do that.
    [Prepared statement of Mr. Reid follows:]

Statement of Spencer Reid, Deputy Land Commissioner, Texas General Land 
                                 Office

Ms. Chairman and Members:
    Texas Land Commissioner Garry Mauro appreciates the 
invitation to appear before you to discuss the Texas royalty 
in-kind program, and regrets that he is unable to be here. He 
has asked that I speak on his behalf.
    The Land Office has been pleased with the results of our 
in-kind programs and are glad to share information about them 
with you. While royalty in kind may not cure all of the 
disputes that arise between royalty owners and producers, our 
experi-

ence in Texas is that it does provide a means to substantially 
reduce royalty disputes, reduce costs to both the State and the 
lessee, and provide the royalty owner an opportunity to obtain 
an enhanced return.
    For those of you not familiar with the General Land Office, 
please allow me to briefly explain our role. The Land 
Commissioner, who heads our agency, is an elected official. One 
of his main duties is to manage the more than 20 million acres 
of public lands and minerals owned by the various Texas 
government departments, most prominently, the Permanent School 
Fund, a trust fund that supports public education in Texas. In 
the fiscal year ending August 31, 1996, $155 million were 
deposited in the Permanent School Fund, which, although not 
large by Federal standards, has nonetheless allowed Texas to 
create a school endowment worth over fourteen billion dollars. 
The State's Permanent University Fund, which is similarly 
structured, is valued at over five billion dollars. As to the 
relative size of State production, the approximately 33 billion 
cubic feet of natural gas that represents our annual royalty 
share would rank the School Fund in the top 50 of the largest 
producers of natural gas in the United States.
    Over the past fourteen years, the Texas in-kind program has 
enhanced royalty income for our Permanent School Fund by over 
$11 million in gas royalty and $5.1 million in oil royalty, 
saved State agencies over $90 million in gas utility bills, and 
saved untold thousands of dollars for the General Land Office 
and oil and gas producers by eliminating the need for financial 
accounting for royalty volumes of oil and gas taken in-kind. 
The program's past success has led me to seek to expand the 
program through a new public private alliance that I will 
describe for you in a few minutes.
    The Texas in-kind program originated in the early 1970's. 
The Texas Legislature passed the first statutory authorization 
for the in-kind program in 1973. From then until the early 
1980's, relatively small volumes of gas were sold in the market 
to obtain better prices than were being paid in cash royalties. 
In 1983, the General Land Office began marketing gas directly 
to end-users and by the end of 1985, the program was expanded 
to include State agencies.
    This expanded program has concentrated on sales to State 
agencies, universities, and other public facilities. The goals 
of the program are twofold--first, to enhance income to the 
Permanent School Fund, the principal beneficiary of State 
royalty income. The second goal is to reduce gas costs to State 
facilities by providing State gas at prices below those charged 
by gas utilities.
    The Texas Legislature has consistently supported the 
program and, in recent years, has enacted laws that assure the 
smooth operation of the State program. One such statute 
requires all State agencies that consume at least an average of 
100 Mcf of gas per day to submit all gas acquisition contracts 
to the General Land Office for review. If the Land Office is 
able to provide gas at the same or lower cost, it may require 
the agency to purchase gas from it. Another supportive statute 
requires all regulated gas utilities to provide transportation 
of State gas if capacity is available on their systems and it 
is destined for a state agency. These transportation rates are 
competitive with those provided to private parties.
    In addition to the natural gas in-kind program, the Land 
Office takes in-kind approximately 2400 barrels of oil per day. 
This oil is sold under six-month contracts through a sealed bid 
auction. Prices are bid at premiums to posted prices. At the 
last sale, held in April, these premiums were as high as $2.08 
over one commonly used posting.
    Last fiscal year, the gas program sold approximately 9.1 
Bcf of gas to State agencies and another 2.6 Bcf on the spot 
market which represented 35 percent of our total royalty 
production. Spot market sales assure that adequate supplies 
have been secured to meet State end-user demand. Gas is 
currently being taken in-kind from 105 leases, almost all of 
which are located along the coast. Sales contracts are in place 
with 103 State facilities, twenty-eight State colleges and 
universities, and six other government bodies, including school 
districts and small municipalities. Transportation contracts 
are currently maintained with thirty-five different pipelines 
and local gas distributing companies. We also maintain a 
contract for up to one Bcf of natural gas storage at a facility 
near Houston.
    Sales of gas on the spot market are made through monthly 
solicitations of interest from pre-qualified gas marketers, of 
whom there are currently seven. In order to qualify, marketers 
must show financial stability. In addition, to encourage small 
business participation, the Land Office maintains credit risk 
insurance.
    Since 1973, all State oil and gas leases and statutes have 
provided for the right of the State to take royalty in-kind 
upon sixty days notice of our intent to do so. On some leases 
issued prior to 1973, in-kind takes have been provided for by 
agreement. Once we have exercised our right to take in-kind for 
a particular lease, we make every effort to continue to take 
gas from that lease in order not to burden the lessee by 
alternately taking and not taking. We generally take possession 
of the gas at the point at which it has been made ready for 
sale or commercial use through the removal of water, natural 
gas liquids, and impurities.
    Costs of transportation and other direct costs, together 
with a markup or ``enhancement'' and a set administrative fee 
are charged to the gas purchasers. In all but a few cases, 
prices to the end-user agency are below those available from 
private sources, and are lower than local utility costs in 
almost every instance.
    Gas and oil producers on State lands have been almost 
uniformly supportive of both the gas and oil in-kind programs. 
Although I do not have specific figures, the administrative 
savings and other benefits to both producers and the Land 
Office are clear. It is far easier to account for volumes of 
oil or gas physically delivered than it is to account for both 
the volumes delivered and the market value of those volumes. 
Delivery in-kind relieves the producer of the obligation to 
account for the market value of the gas and relieves the Land 
Office from the burden of conducting financial audits of 
producers. Once accurate delivery is established, the producer 
no longer needs to be concerned that State auditors will 
dispute the prices that the producer received.
    The in-kind programs have been so successful that we are 
now, as I mentioned, starting the process of revising and more 
than doubling the gas program. The changes in the natural gas 
marketplace in the past several years have made it possible, I 
believe, to form a public/private alliance with a gas marketing 
firm that will bring the very specialized expertise of that 
kind of operation together with the gas supply and markets that 
my office can provide, to the benefit of both the State and the 
private company.
    Last year, we invited over 60 gas marketing firms to submit 
initial proposals to the General Land Office for just such a 
public-private alliance. In the invitation, firms were asked to 
propose plans for their management of our end-user program, the 
creation of a natural gas liquids sales program, and to 
purchase the balance of our natural gas supply, approximately 
15 Bcf per year at a price linked to the market price, and 
preferably at a premium. As a result of the responses to that 
invitation, a marketing firm was selected to begin finalizing a 
marketing contract by next fall.
    It is in this context that the State of Texas is interested 
in a way to obtain its OSCLA share of production allocated to 
the States. The name of the game in gas marketing is, of 
course, volume. These 8(g) volumes are approximately 11 to 15 
million cubic feet per day. We would be anxious to work with 
Congressional and interior staff to accomplish this task.
    We believe that in-kind royalty is worth the consideration 
of any royalty owner that has the opportunity to take 
marketable volumes of oil or gas or has the opportunity to join 
with other royalty owners or producers in marketing significant 
volumes.

    Mr. Thornberry. Thank you, Mr. Reid, and I failed to 
mention that without objection each of our full statements will 
be made part of the record. We will have a vote in just a 
moment, but for now we would like to continue, Mr. Darouse. I 
think we have certainly got time to have your statement in, and 
we will see how we get from there. We have got 15 minutes 
before we have to be over there.

 STATEMENT OF DAVID DAROUSE, MINERAL REVENUE REGIONAL AUDITOR 
   SUPERVISOR, DEPARTMENT OF NATURAL RESOURCES, BATON ROUGE, 
                           LOUISIANA

    Mr. Darouse. Thank you, Madam Chairman, and good afternoon. 
My name is David Darouse. I work for Secretary Jack Caldwell at 
the Louisiana Department of Natural Resources. He is unable to 
attend today so I am here at his behest. The purpose of my 
testimony today is to explain and summarize our written 
testimony that we submitted earlier in the week and expound 
upon it and answer questions as time permits.
    It is obvious from our written testimony that we feel that 
in Louisiana, at least, there are certain legislative 
impediments that do not allow the state to take oil and gas in-
kind and receive the max-

imum price that it could, and those are laid out in our written 
testimony.
    But let us assume for discussion purposes that these 
impediments were not in the way and look at how a program would 
operate. There are certain things that we need, to have a 
successful take-in-kind program, and we also need to look at 
how success of such a program would be measured.
    One thing that we need are large volumes of oil and gas 
concentrated geographically in one area so that we can move 
these volumes to an aggregation point at low expense, to where 
we can extract the maximum price possible by selling to third 
parties.
    In the 8[g] area, unfortunately, Louisiana participates in 
about 35 or 40 leases that are spread out from the Louisiana-
Texas border--literally laying on the border--all the way to 
the Louisiana-Mississippi border over in Chandeleur Sound.
    Out of those 35 to 40 leases, we have really only 20 or 25 
that are major-producing leases, and, again, they are spread 
out--not randomly--some are aggregated in certain areas--but 
more or less randomly across that strip of water. So we don't 
really have the concentrated geographic volumes that we can 
easily and inexpensively aggregate and move to a market and 
sell at a premium price.
    But considering that we did have the concentrated volumes, 
which may occur some day, how should we measure the success of 
a potential take-in-kind program? One important criteria would 
be to measure the net revenues from a take-in-kind program 
against the existing royalty-in-value program that we have 
currently.
    Net revenues would be defined as the gross revenues from a 
take-in-kind sale less the additional costs that will occur in 
getting that sale, and we have laid out a number of services: 
experts, forecasters, consultants, that we feel like we would 
have to have. Maybe not all of these but certainly some would 
have to be added to staff, either hired for the state to work 
for us or hired as contractors.
    Let us look at the current oil--not regulations--we don't 
have regulations in Louisiana--but how we are currently 
enforcing our oil leases in Louisiana. The program that we have 
in place is to value oil that is sold nonarm's length, not oil 
that independents or anybody sells to a third party, but oil 
that is sold nonarm's length to an affiliate or marketing arm 
of the producer, for value of that oil at what we call market 
price which we determine as either the Empire Louisiana spot 
price or the St. James Louisiana spot price, depending on 
whether we are looking at heavy oil or light oil.
    Those prices are published by several major publications 
who survey those markets on a daily basis. The publications are 
well-known. Platt's Oilgram is one. Bloomberg's Oil Buyer's 
Guide is another. So in situations where the oil is sold 
nonarm's length, we are currently getting royalty-in-value or 
trying to get royalty-in-value by assessing those values 
against the values currently reported.
    We are getting market value currently. We feel like on 
oil--like we are getting on oil or we are trying to get market 
value on oil. If we went to an in-kind program by taking oil 
in-kind, we feel like in the best situation, a competent 
marketer striking a competent deal on any given day can only 
get the price that we were getting currently at Empire and St. 
James. That doesn't even consider the additional marketing 
cost.
    So we feel like oil take-in-kind would basically be a no-go 
for the state in the 8[g] zone or on state leases. On gas, we 
feel like an opportunity does exist for the state or the MMS to 
make money by marketing gas themselves. There are currently no 
spot prices across the country and specifically across 
Louisiana other than one location at the Henry Hub that gas 
value can be pegged to.
    So in situations where we don't know what the value of 
natural gas is due to interaffiliate transfers, by taking gas 
in-kind and selling it and aggregating it on the open market, 
then that is a possible moneymaker for the state and we feel 
like also for the Federal Government.
    We commend the MMS for the past years of starting a pilot 
program back in 1994 which, although it was not revenue 
neutral, obtained many valuable lessons for the Minerals 
Management Service to apply in future take-in-kind programs.
    We also applaud the MMS for having outreach programs over 
the last year where they have held meetings across the country 
soliciting input from various constituents such as states and 
industry. And we think they are heading in the right direction 
by realistically investigating potential R-I-K programs. And 
with that, I will conclude my comments.
    [Prepared statement of Mr. Darouse may be found at end of 
hearing.]
    Mr. Thornberry. Thank you, sir. I appreciate it. Mr. 
Magagna, we will go ahead and let you. I believe we have time 
to get your statement in if you would like to proceed in that 
way. When we come back, we can start with questions.

 STATEMENT OF JIM MAGAGNA, DIRECTOR, OFFICE OF STATE LANDS AND 
  INVESTMENTS, OFFICE OF FEDERAL LAND POLICY, STATE OF WYOMING

    Mr. Magagna. OK. Thank you, Mr. Chairman. I am Jim Magagna, 
Director of the Office of State Lands and Investments for the 
State of Wyoming. I want to take this opportunity to applaud 
the initiative of Chairman Cubin in providing this important 
dialog for the royalty-in-kind issue.
    The State of Wyoming, under our Governor Jim Geringer, has 
assumed a leadership role, we believe, in seeking development 
and implementation of a cost-effective and efficient royalty-
in-kind program providing an opportunity for full participation 
by affected states. We appreciate this opportunity to share our 
efforts and our expectations with members of the Subcommittee.
    As I have indicated in my written testimony, part of 
Wyoming's initial effort to look at the option of a royalty-in-
kind program certainly and admittedly has been driven by our 
frustrations with the current value based Federal royalty 
program. The Chairman earlier provided figures as to the 
tremendous amount of revenues and level of dependence that the 
State of Wyoming has on this.
    And since the initiation of net receipt sharing in 1991, we 
have been frustrated in our efforts to truly define what are 
the costs of administration that are being borne in part by the 
State of Wyoming through the deduct from our gross royalty 
revenues.
    We were further frustrated when the Minerals Management 
Service announced a devolution proposal nearly 2 years ago and 
then quickly withdrew that proposal. We did work very closely 
with the Administration and with Congress in the development 
and passage of the Federal Oil and Gas Royalty Simplification 
and Fairness Act.
    While we think it represented in many areas an important 
step forward, it was still very limiting from our perspective 
in the delegable functions which were recognized for the 
states. And it provided far greater secretarial discretion in 
delegation than we had hoped for. However, we do continue to 
work with Minerals Management Service in developing standards 
and guidelines for the implementation of this Act.
    To comment only briefly on the valuation issue, we 
recognize and share concern that there are problems with the 
current system with valuation as it applies to non-arm's length 
transactions, and we applaud the Minerals Management Service 
for their efforts to address this. However, we feel that the 
attempt to impose a single index type figure based on the NYMEX 
or some simpler guideline does not apply to the situation that 
exists in Wyoming.
    We have a unique situation here today with the completion 
of the Express Pipeline which will suddenly bring an additional 
140 to 170,000 barrels of oil a day from Canada into Wyoming, 
some of which will stay in the Rocky Mountain region 
refineries.
    What we have seen already in three short months of 
experience with that indicates that the impact of an activity 
like that on the market available to producers operating in 
Wyoming is very diverse from its impact on a national market as 
expressed by an index such as the NYMEX. We have seen some 
significant price declines in Wyoming as a result of this 
increased foreign supply that simply have not been reflected in 
the NYMEX or other standardized measurements to date.
    But Wyoming is driven every bit as much by the 
opportunities for revenue enhancement that we see in the 
royalty-in-kind program, and we recognize that with those 
opportunities comes risk. We as a state are prepared to assume 
those risks that are associated with the private sector in the 
marketplace and that are necessary if you are to achieve the 
rewards that can be associated with that.
    As a first important step in this direction, the 1997 
session of the Wyoming Legislature passed legislation 
authorizing the Governor to take the state's share of Federal 
mineral royalties in-kind should Federal law and policy so 
permit. This was a strong statement by our legislature of their 
desire to have the state move in this direction.
    In followup to this, as a part of the Minerals Management 
Service's effort to look at possible pilot projects, Wyoming 
has offered a pilot project to the Minerals Management Service. 
We are appreciative of their efforts in working with us.
    However, I would offer one note of caution. While we 
believe that there is value in a pilot process in order to test 
a methodology for a royalty-in-kind program. Due to the 
inability to aggregate large volumes and reduce administrative 
costs in a pilot program, we feel it should not be looked upon 
as a test of the net ability to enhance revenues as a result of 
royalty-in-kind.
    I would like to move on and quickly focus on some of the 
key elements that the State of Wyoming believes are critical in 
a Federal royalty-in-kind program in order to allow full 
participation by the states. The first and most important of 
these would be that the state would have an absolute right 
which it could exercise to receive at or near the lease its 50 
percent gross share of Federal royalty oil and gas.
    We would further encourage that the states be given an 
opportunity, or a preference I might say, to also acquire and 
market on the Federal Government's behalf the Federal 50 
percent share provided that the net return to the Federal 
Government would not be reduced thereby.
    Because it has clearly been shown that there are advantages 
to aggregation through the market strength that comes with 
larger volumes, allowing the state to potentially handle 100 
percent of the royalty volume would be a step in the right 
direction.
    We do think it is important in a royalty-in-kind program 
that the state be entitled to the full 50 percent of its gross 
share of Federal mineral royalties, and that the state then 
bear the marketing costs, the state bear the risks associated 
therewith, but not be put in a position of having to bear the 
Federal administrative costs, which we would hope would be 
dramatically reduced as a result of a royalty-in-kind program. 
I am aware of several additional principles that the industry 
has developed, and we would be supportive of these.
    Finally, let me say that a royalty-in-kind program is not a 
simple step forward. I believe it does involve a major 
reengineering of the current approach to royalty receipt. We 
have had the opportunity to personally view the program in 
operation in Alberta, Canada. While their situation is very 
different, we believe that their program as it currently 
operates would provide a good starting point for the 
development of a Federal program in the states.
    But I would emphasize in closing the importance that we see 
in the development of a program that this be done as a joint 
effort involving the Minerals Management Service, the affected 
states, and the industry on an equal footing basis. What comes 
out of this would be something that there is a comfort level 
with that it will work for all of the various interests. Again, 
I want to take this opportunity to thank you for being able to 
appear before the committee today.
    [Prepared statement of Mr. Magagna may be found at end of 
hearing.]
    Mr. Thornberry. Well, thank you and I appreciate all of the 
testimony of each of you gentlemen. We are going to have to go 
vote. We have a few minutes of debate and then the vote on the 
tax bill. I just want to make one comment before we do that. As 
some of you may know, I introduced a royalty-in-kind bill last 
Congress. Anybody who suggests that that was an effort by the 
oil and gas companies was not around because that was certainly 
not the case. They were less than enthusiastic about that idea.
    The motivation is what it can mean for the taxpayers, and 
those are the ones that I think really have some to benefit, as 
well as the states. And we have a lot to learn from what is 
going on in your states, what is going on in Alberta, the input 
of the industry, and the very valuable input that MMS is 
gaining in their meetings across the country.
    And I want to get that input because my plan in September 
is to introduce another royalty-in-kind bill because I think it 
is important to push this idea forward, to have something to 
talk about, and I want to see this move forward for the 
taxpayers and for everyone. And so that is the kind of input 
that we will look forward to. We will recess temporarily as we 
go vote.
    [Recess.]
    Mrs. Cubin. [presiding] Please pardon me for having to be 
gone. I had a bill that I am the sponsor of being marked up in 
another committee. And then, as you know, for the first time in 
16 years we just voted a tax cut for middle class Americans and 
all Americans. And we are really happy to have done that. I 
think I will let Mr. Brady question the panel to begin.
    Mr. Brady. Thank you, Madam Chairman, very much. I 
appreciate the panel, first, your testimony and, second, the 
patience you have for us to go vote today. I guess for Mr. 
Reid, because I am from Texas and pleased with how the system 
works, as a member of the legislature I have supported some of 
the changes to make that program more efficient, more effective 
as you learn how to do it well and better. And we are very 
pleased with the results.
    Two thoughts: one, I am impressed with the efficiency of 
the Texas R-I-K program versus the current Federal in-value 
system on the basis of employees. And could you at some time 
provide to the Subcommittee a table showing the staff-to-volume 
ratio in Texas for both your oil and your gas programs?
    Mr. Reid. I would be happy to.
    Mr. Brady. And, second, do you have any suggestions on how 
the Texas program could be expanded to a Federal program?
    Mr. Reid. If I understand your question, one of the issues 
with the Texas program, of course, is so much of the benefits 
we receive there come from the agency end-use program. 
Obviously, the Federal Government is a major consumer of gas, 
and there might be a potential for a similar program at the 
Federal level.
    As far as our experience on our in-kind, our spot sales say 
of gas or oil sales, the issue in Texas--we do have a situation 
where we have enough quantities--volumes in enough 
concentration for it to work. I mean, there may be selected 
areas where MMS may have the ability to do that.
    Our spot sales do not generate the spread that our agency 
sales do in terms of our enhancement. When you look at our 
total enhancement, they are probably less than 5 percent of it. 
But in terms of how it works, I mean, we handle it in-house. We 
are looking at a private marketing firm to do it.
    And in Texas it is really a cost benefit analysis. If we 
make more money doing it the other way, we will do it. If we 
don't make more money for the school fund, we won't. And we do 
a cost benefit analysis periodically on our gas program and on 
every oil sale to see whether we are really generating more 
revenue for the school fund than we would have received as a 
royalty payment.
    Mr. Brady. So it is in the State of Texas program. Rather 
than using state resources passively to regulate and audit, you 
use it actively to get the most value for those in-kind 
products that you receive. Is that correct?
    Mr. Reid. Right.
    Mr. Brady. Thank you very much for your testimony. I 
appreciate it. And the representative from Louisiana, a 
question for you. Do you have an assessment or have you done an 
assessment of the cost savings of shifting your current audit 
staff and litigation expenses you have into a marketing type of 
program? Have you had an opportunity to take a look at that 
type of change?
    Mr. Darouse. No, sir, we have not.
    Mr. Brady. Is your program a bit--in your opinion, has it 
been restrictive in its criteria as you have tried to enter the 
market and look at the oil side of it or the gas side of it? Do 
you feel like there are improvements in the Louisiana program 
that could allow you to make it more effective?
    Mr. Darouse. Our written comment addressed that. We think 
that if there are certain changes made legislatively, and if 
conditions change, that it would be beneficial to market our 
gas in-kind. Right now there just seems to be a consensus that 
there are some prohibitions against doing this effectively. I 
know back in 1985 or 1986 we considered a program similar to 
where Texas ended up and that would be taking state gas in-kind 
and sending it to institutions, and it never really got off of 
the ground.
    Mr. Brady. But that would be an implementation that could 
assist the cost benefit part of the program for the State of 
Louisiana and could generate more----
    Mr. Darouse. Yes, sir. To a certain extent, yes, sir.
    Mr. Brady. Great. Thank you. Thank you, Madam Chairman.
    Mrs. Cubin. I want to welcome you, Mr. Magagna. Everyone 
knows you are from my great State of Wyoming, and thank you for 
your testimony. As usual, you always do a yeoman's job for the 
state, for the Governor, and for me as well. And I want to 
thank you for that.
    While I wasn't here to hear your testimony, I did read 
everyone's testimony before the hearing so I do have an idea of 
what all your feelings are. But, Jim, your testimony about R-I-
K was quite specific on what you believe will be necessary for 
a success.
    And one of the things that you stated in your testimony was 
the states must have the right to receive 50 percent of the 
gross share in-kind. Does that mean that it would be entirely 
unacceptable to Wyoming to adopt to a R-I-K program like they 
have in Alberta where private marketers would sell all of the 
mineral?
    Mr. Magagna. Madam Chairman, no, not at all. In fact, we 
believe that the appropriate way for a program to operate would 
be for the state to contract with private marketers to market 
the state's royalty share. All I mean to say by that is that we 
should receive 50 percent of the gross without any obligation 
to any deduction therefrom back to the Federal Government.
    Mrs. Cubin. I am not sure and so I hope someone will 
correct me if I am wrong about this, but I think that in 
Alberta they market all of the mineral so that I think the way 
it would be is that a mar-

keter would sell the Federal share and the state share together 
and then divide the money. Is that right?
    Mr. Magagna. All of it.
    Mrs. Cubin. Right, right. But, anyway, that would be the 
method, and is that an acceptable arrangement do you think for 
the State of Wyoming?
    Mr. Magagna. That the marketer would share----
    Mrs. Cubin. Would sell the Federal share and state share 
and then the money be divided after the sale.
    Mr. Magagna. That would be dependent on who negotiates that 
marketing contract. It is our belief that the state should be 
given the opportunity at least as to the state's 50 percent 
gross of the royalty mineral to arrange for that marketing; in 
other words, to determine what the terms and conditions would 
be, to accept those risks associated with the marketplace, even 
though we would market through a third party marketer.
    We would not be comfortable with a situation that simply 
allowed the Federal Government to market 100 percent of the 
royalty share as they saw fit with the state simply being the 
recipient of a check for half of that amount.
    Mrs. Cubin. So then would it be acceptable for Wyoming to 
be the marketer for all of the mineral and then divide the 
money and then give the Federal Government their share?
    Mr. Magagna. We would certainly find that acceptable, and 
we would anticipate if that were done and would be willing to 
accept that there would have to be some criteria in order to 
assure that the state, in fact, would not be getting less for 
the mineral than what the Federal Government might be capable 
of getting. With those parameters, certainly.
    Mrs. Cubin. I agree with you and your statement that de 
minimus-producing wells could really present a problem with R-
I-K. However, as the provisions of the Royalty Fairness Act 
became implemented which would allow once a year royalty 
payments or a buyout of royalty obligations by lessors once a 
year with de minimus production, perhaps there would be room to 
consider how to take R-I-K for stripper wells. Do you have any 
thoughts on the cutoff production level for de minimus?
    Mr. Magagna. I really would not be prepared today to 
recommend a particular cutoff level. But when you combine the 
provisions in the Royalty Fairness Act authorizing the annual 
payment or the buyout with a royalty-in-kind program, we would 
be hopeful as you put those together you would be able to 
thereby eliminate the need for a continuation of a valuation 
based royalty system because that could be picked up through 
the specific provisions of the Fairness Act.
    Mrs. Cubin. My time is up and because we have already been 
interrupted with the vote and whatnot, with your permission, I 
would like to submit some written questions to you, and then we 
can move on to the next panel. Thank you very much for your 
testimony. And would the second panel please come forward? 
Thank you very much.
    I would like to introduce the second panel that is with us 
today; Mr. Larry Nichols, who is the President of Devon Energy; 
Fred Hagemeyer, the Coordinating Manager, Royalty Affairs for 
Mara-

thon Oil Company; Sue Ann Hamm, Vice President of Oil Marketing 
and Sales for Continental Resources; and Edmund Segner, III, 
Executive Vice President and Chief of Staff for Enron.
    I would like to remind the witnesses that under our 
Committee rules that the testimony must be limited to 5 
minutes, and certainly your entire testimony will appear in the 
record. So the Chair now recognizes Mr. Nichols for his 
testimony.

      STATEMENT OF LARRY NICHOLS, PRESIDENT, DEVON ENERGY

    Mr. Nichols. Well, thank you, Madam Chairman. I am Larry 
Nichols, President and CEO of Devon Energy Corporation, an 
independent producer who has Federal onshore production. I am 
here today on behalf of Devon and 13 oil and gas associations 
who represent most of the payers of Federal oil and gas royalty 
payments.
    For the purpose of the hearing today, I will summarize my 
comments but ask that the entire written statement be included 
in the record, as well as this statement which reflects all of 
the trade associations who are endorsing my statement today.
    Madam Chairman, we always appreciate the opportunity to 
work with you in pursuit of a more simple, a more certain, and 
a more efficient program for collecting royalties due to the 
Treasury and the states from Federal oil and gas production.
    As each year passes, the need to reengineer the royalty 
collection system dramatically increases. With each new 
valuation rulemaking effort, more and more complexity and more 
uncertainly is added to the royalty collection system. Instead 
of accepting a producer's wellhead values, elaborate netback 
schemes are now being developed that will only result in more 
and more disputes.
    All of the agencies' concerns and perceived problems over 
how to value royalty can be addressed by a royalty-in-kind 
program. As a consultant, who is regularly used by the MMS, 
stated in a report to the states, ``The only way to be 
absolutely certain that a fair market value is received for 
royalty oil is to take the oil in-kind for sale.'' We agree 
that royalty-in-kind accurately measures value by capturing all 
the value resulting from a transaction between a willing buyer 
and a willing seller at or near the lease.
    There has been much theorizing about the benefits and 
drawbacks of royalty-in-kind. It is time to bring royalty-in-
kind to the drawing table, to build a successful royalty-in-
kind program, and once and for all to bring to an end years and 
years of disputes and debate about royalty payments.
    This hearing today brings royalty-in-kind into focus as an 
exciting reengineering opportunity for both the government and 
the industry. I would like to tell this committee what the 
industry is doing to bring royalty-in-kind into reality. First, 
industry participated in a series of workshops that the MMS 
held this year in response to their fiscal year 1997 
appropriations which asked them to pursue additional royalty-
in-kind pilot programs.
    At these workshops, the MMS heard a consistent message from 
the oil and gas industry--yes, we are without a doubt 
interested in designing a royalty-in-kind program which would 
result in a more simple and certain royalty collection system.
    During these workshops, the industry agreed to outline for 
the MMS and the states the goals, principles, and design 
elements of a successful royalty-in-kind program. To initiate 
this progress, representatives from oil and gas associations 
from across the country formed a royalty-in-kind workgroup. I 
am glad to report to the committee that this workgroup has 
developed an in-kind mission statement and a common set of 
principles for designing a successful royalty-in-kind program.
    The mission statement and principles I am about to describe 
are supported by the Independent Petroleum Association of 
America, the Domestic Petroleum Council, the California 
Independent Petroleum Association, Colorado Oil and Gas 
Association, Independent Petroleum Association of Mountain 
States, Independent Petroleum Association of New Mexico, 
Louisiana Independent Association, Mid-Continent Oil and Gas 
Association, National Oil Industries Association, New Mexico 
Oil and Gas Association, Oklahoma Independent Petroleum 
Association, Petroleum Association of Wyoming, and the Rocky 
Mountain Oil and Gas Association.
    This is a work in progress for all of us. Many critical 
implementing details need to be developed and discussed among 
these groups before moving beyond support for these principles. 
The agreed-to mission statement for a royalty-in-kind effort is 
to design a royalty-in-kind program that will eliminate 
valuation uncertainty and will be attractive to the Federal 
Government, the state governments, and the private sector 
stakeholders, while recognizing the differences between oil and 
gas production.
    The six agreed-to royalty-in-kind principles are as 
follows: one, reduce the administrative and compliance burdens 
while providing the opportunity for Federal and state 
governments to maximize their revenues. This principle is 
intended to make sure that a royalty-in-kind program does not 
move forward unless it is a win-win for the Federal Government, 
state governments, and the producers.
    Two, require transactions to be at or near the lease as 
required by the lease obligations. Three, provide that when the 
government takes in-kind it must take all royalty production 
for a time certain. Four, require use of private marketing 
expertise to streamline government operations.
    We have heard some comments earlier today that expressed 
concern, with which we agree, that this plan might require the 
government to get into the business. That is not the case at 
all. Just as the Federal Government can build buildings without 
becoming a building contractor and just as the Federal 
Government can construct highways without becoming a highway 
constructor and getting into that business, so can the Federal 
Government market their oil and gas business without getting 
into that business.
    Five, provide the states with the opportunity to be 
involved in designing and implementing the program. And, 
finally, six, to make sure that royalty-in-kind programs are 
broadly available for public purpose. As I just stated, there 
are a number of design issues that need to be worked out to 
determine the success of the royalty-in-kind program. We 
believe that issues such as transportation, aggregation 
processing, and other matters need to be resolved and look 
forward to working on that in the future.
    This is the time when we need to make certain that we can 
work together as a cooperative effort. We are concerned with 
the manner in which the MMS has qualified revenue losses in its 
gas in-kind experiment. We think those mislead people into 
believing that a successful in-kind program cannot be 
implemented.
    And, second, and most importantly, we want to make sure--is 
the concern that a royalty-in-kind program be revenue neutral. 
Let us not forget that the real value of a royalty-in-kind 
program is to save the tremendous administrative costs that are 
currently being incurred by the Federal Government, the states, 
and the industries.
    Before the MMS moves forward with a royalty-in-kind 
program, we need to make sure that a royalty-in-kind program 
can adhere to the six principles that I discussed above. Thank 
you very much, Madam Chairman.
    [Statement of Mr. Nichols may be found at end of hearing.]
    [List may be found at end of hearing.]
    Mrs. Cubin. Thank you, Mr. Nichols. Mr. Hagemeyer, would 
you please give----

  STATEMENT OF FRED HAGEMEYER, COORDINATING MANAGER, ROYALTY 
                 AFFAIRS, MARATHON OIL COMPANY

    Mr. Hagemeyer. Sure. I would be happy to. Thank you, Madam 
Chairman, members of the committee. I am Fred Hagemeyer and I 
am pleased to be here this afternoon representing Marathon Oil 
Company. There are several oil and gas associations that have 
endorsed my written comments, and I would like to introduce 
those into the record if I may.
    Marathon is a fully integrated oil and gas company involved 
in worldwide exploration, production, transportation, and 
marketing of crude oil and natural gas. Marathon holds leases 
both onshore and offshore. In 1996, Marathon paid royalties of 
over $84 million for oil and natural gas produced from Federal 
and Indian lands. In addition to the royalty paid in cash, the 
Minerals Management Service took crude oil valued at over $9 
million in-kind through the small refiner royalty-in-kind 
program.
    We are here today to discuss royalty-in-kind as an 
alternative method for satisfying the royalty obligations of 
producers with Federal oil and gas leases. Public workshops 
were held this spring to discuss and review possible options 
for a major royalty-in-kind program. Marathon actively 
participated in these sessions and welcomed the opportunity to 
candidly discuss critical features of a workable R-I-K program.
    At Marathon, we have learned that reengineering an 
entrenched process is not easy. But if all stakeholders are 
engaged in the process and it is done properly, the results can 
be significant. Many times the benefits are much greater than 
anticipated because it is difficult to identify all the 
indirect benefits. As part of the MMS reengineering effort, 
Marathon believes that a R-I-K program can be created which 
will fundamentally add value to the MMS royalty process.
    Royalty-in-kind is a concept whose time has come. The key 
is turning this opportunity into reality. By taking its royalty 
oil or gas in-kind, the MMS has the opportunity to aggregate 
volumes, determine the most favorable sales locations, arrange 
transportation, and negotiate the terms and conditions of the 
sale of its royalty production.
    Participation in these activities can result in optimized 
value if the MMS manages the risks and costs associated with 
the marketing function. Expertise of a competitive private 
marketer would allow the MMS to participate in these activities 
in the most efficient manner possible and thus achieve the 
greatest possible revenue benefits. The administrative burdens 
of both the MMS and the Federal lessees, especially the audit 
and litigation costs, would be reduced significantly or even 
eliminated.
    As Larry Nichols mentioned, a multi-association task force 
has been recently formed to develop a workable Federal royalty-
in-kind program. Marathon is an active participant in this task 
force. Marathon would welcome and does welcome the certainty of 
knowing its royalty obligation was fulfilled once the royalty 
barrels were delivered to the MMS.
    And Marathon recognizes that expertise in all segments of 
the oil and gas business will be necessary to develop a Federal 
royalty-in-kind program that is both viable and workable. It 
seems that the Subcommittee can benefit tremendously from the 
efforts of this task force. This process is not easy, but we 
feel it is vitally important in developing a successful 
program.
    An important step in this process is to look at examples of 
existing R-I-K programs--the Texas GLO program, which you heard 
about earlier, takes all of its royalty all in-kind from the 
Marathon-operated Yates field, one of the largest onshore oil 
fields in the United States. Overall, Marathon's experience 
with the Texas royalty-in-kind programs has been positive.
    One of the lessons that we have learned from the Texas R-I-
K program is that any new comprehensive program is going to 
experience startup problems. During the first year of the Texas 
programs, there were problems concerning which party was 
responsible for gathering costs, the arrangement and 
verification of transportation, and the proper allocation of 
production.
    However, over time, producers, the purchasers, and the 
state have been able to work through these problems. And for 
this reason the MMS must be very careful if it chooses to 
implement and evaluate any royalty-in-kind pilot program. In 
fact, Marathon believes it may be more prudent to expend this 
effort in developing a permanent R-I-K program that could be 
phased in over time.
    Marathon is concerned at the impact of a royalty-in-kind 
program on the Federal and state treasuries, that it be 
analyzed properly. API recently completed an assessment of the 
MMS review of the 1995 Royalty Gas Marketing Pilot Program. 
Attached to my testimony is the API report which raises a 
number of issues for the underlying validity of the revenue 
assumptions and the cost analysis of the pilot. The concerns 
raised by API should be addressed.
    In summary, I would like to say that Marathon believes the 
time has come for the Federal Government and the oil and gas 
industry to seriously consider royalty-in-kind as the best 
long-term solution to satisfying the Federal lessees' royalty 
obligation. A properly developed R-I-K program could streamline 
the royalty process for the Federal and the state governments 
and the oil and gas industry.
    Working together, we can minimize many of the startup 
problems which may occur and shorten the learning curve for 
both the Federal Government and the lessees. A royalty-in-kind 
program can be a win-win proposition for all the parties 
involved. Thank you very much.
    [Prepared statement of Mr. Hagemeyer may be found at end of 
hearing.]
    [List may be found at end of hearing.]
    Mrs. Cubin. Thank you very much. The vote that is being 
held now is a vote to adjourn, and I think I will just let them 
decide that without me so that we can get this hearing moving 
along. Ms. Hamm, would you please give us your testimony now?

STATEMENT OF SUE ANN HAMM, VICE PRESIDENT, OIL MARKETING/SALES, 
              CONTINENTAL RESOURCES, INCORPORATED

    Ms. Hamm. Thank you, Madam Chairman. I am Sue Hamm, and I 
am Vice President of Crude Oil Marketing for Continental 
Resources. And I am here on behalf of Continental, IPAA, OIPA, 
and the RMOGA, Rocky Mountain Oil and Gas Association, and they 
are all endorsing my written----
    Mrs. Cubin. Excuse me. Could I get you to pull the 
microphone a little closer?
    Ms. Hamm. Oh, I am sorry.
    Mrs. Cubin. Thank you.
    Ms. Hamm. And I would like to submit that for the record. 
And Continental Resources is a small, privately held 
independent producer who has Federal onshore production. And I 
am not going to go into everything I have written to brag a 
little bit about Continental, but we are a growing company, and 
I am very proud of them.
    Two years ago, I began the crude oil marketing department 
for Continental. And I did this after looking at our wellhead 
contracts. Traditionally, we sold at the wellhead. And with 
change in transportation and unbundling and opportunities to 
transport on pipelines, I saw that there were opportunities.
    And so I looked at--checked out all of the alternatives and 
opportunities, and I found that our company is able to realize 
a higher average price per barrel by taking our oil to the end-
user to make all the transportation arrangements, exchanges, 
and final sales. And we have even built our own gathering 
systems where that proved economical for us to lower our 
transportation costs.
    We tried to create as many alternatives as possible. The 
more buyers there are, the higher the price is we find. And we 
have encountered a great deal more risk and costs than we had 
anticipated, but we have been able to work these out just by 
working through them and with the advice. We looked to other 
industry experts. In fact, we even hired a consultant for a 
year and paid him five cents a barrel to guide us through this.
    And even at the five cents a barrel charge, we found a 
significant increase over our net revenue from the wellhead 
price. And we continued to sell some at the wellhead so we did 
know what that wellhead price was, and we continued to 
negotiate very toughly for a wellhead price. But even still we 
had a significant increase by taking on the responsibilities to 
market downstream.
    And as we became more sophisticated in our marketing 
efforts, we began to take our oil and gas from outside 
interests. And this is a little bit like the MMS would be 
encountering because they are not operating the wells in which 
they have their interests, and they are not getting all the 
information as timely as an operator does.
    But we have still found that in most instances we can 
improve our price by taking an in-kind and taking it 
downstream. And to determine whether it is economical, again, 
we look to a number of factors--transportation costs, prices 
downstream, prices the purchasers will offer at the wellhead, 
and the price that the operator is receiving because we can't 
continue to sell through the operator.
    But one factor we do not even consider is what price is the 
operator receiving through his contract. We just look at what 
he is paying us. We do not consider audits a value-enhancing 
measure or it is not our job. And after we consider all the 
factors, we choose the method which we will receive the highest 
price. As I said before, this continues to be marketing 
downstream for the most part except for de minimus volumes.
    And we have a fairly significant volume for a small 
company. In fact, it is about 7 percent of MMS's royalty 
volume. We have 15,000 barrels of oil a day, and we produce 
75,000 Mcf of gas a day. And this is 3 percent of MMS's royalty 
gas. And this is a large amount as far as the MMS's volume, I 
believe, that we are able to handle with two employees. And of 
our volumes, we have 200 equivalent barrels which are Federal 
royalty barrels. And this is a negligible amount for us.
    But this is a small amount when you consider MMS's royalty 
volume where I have heard that they say aggregating volume does 
not enhance the value. Well, it sure did for us even with our 
small amount. The more oil we produce and we include in our 
package, the higher our prices become. The refiners are seeking 
us out. They want to go directly to the producers to ensure 
their oil. Oil is still a valuable product.
    And the present situation between the MMS and the oil and 
gas industry has become one of the most adversarial 
relationships of any agency. And even though we have a 
negligible amount of Federal royalty barrels, it looks like we 
don't have a dog in this fight, I have heard you say.
    But we are taking a broader view as you have recommended, 
and we are going to stay involved in this issue because we are 
in the oil and gas industry to stay. And anything that affects 
us--that affects the industry affects us. And we believe that 
the proposed rules will negatively affect the industry, and, in 
fact, we oppose them. And I really wanted to get into the 
Canadian effort, but I----
    Mrs. Cubin. Go ahead.
    Ms. Hamm. I went to Canada and met with Don Olineck, the 
Director of the Alberta Energy, and went through quite a few of 
his programs, and he was very accommodating. He showed me all 
of his flow charts. He showed me all of his forms. And I 
discussed this thoroughly with him, and he believes that this 
could be transferred to the MMS's properties.
    And he has offered all of his help in setting up the 
program, setting up the computer programs, advising. He will do 
anything he can to help us transfer his program to our 
situation, and he believes it will help. Alberta Energy 
believes that they are increasing their value by taking in-kind 
and selling it downstream.
    And the goals for their R-I-K I believe meet MMS's goals. 
They are simple and certain; simple in the fact that a minimum 
number of employees are required to run the program. Alberta 
Energy for their 146,000 barrels of oil a day have 33 employees 
marketing the oil. MMS has 204,000 barrels of oil a day--a 
little bit more than Alberta--and they have 1,800 employees a 
day. Gas production is roughly equivalent between the two 
companies. Alberta only has 232 total employees for all.
    What is the reason? It is not the MMS employees that are 
not competent. They are very competent people. They are high 
standards, high quality. It is the system they are having to 
work with. That is why it takes so many. This audit--receive an 
audit is not a workable situation.
    And to follow the Alberta program, the MMS would have to 
take its production at the wellhead, and the operator would 
deliver to the MMS's designated representative the royalty 
volume. And the operator would continue to deliver to his own 
purchaser his volume.
    The only difference from the operator's current methods 
would be to carve out the royalty share of volume, as opposed 
to the royalty share of value. And by carving out just the 
royalty share of volume, this would dramatically reduce the 
number of reporting requirements for the operator and for the 
MMS. Thus, the decrease in number of employees.
    And just to look at our situation, two employees for 15,000 
barrels of oil a day; 1,800 employees for 204,000 barrels of 
oil a day. Something is happening there. My husband and I own 
the company. I have a vital interest in increasing our revenue. 
I do not have a stake in keeping a job in crude oil marketing. 
R-I-K works. I recommend it for the MMS. I will help any way I 
can. There are industry experts out here. We are all good at 
this.
    The MMS can be good at this. They have to get in the 
program. They have to get in the market. Just watching it 
doesn't help. You have to get in it and negotiate. And by 
hiring a representative and with transparent contracts, the MMS 
will know and be assured they are receiving market value. Thank 
you.
    [Statement of Ms. Hamm may be found at end of hearing.]
    [List may be found at end of hearing.]
    [Petroleum Marketing Act may be found at end of hearing.]
    Mrs. Cubin. Thank you very much. Mr. Segner.

 STATEMENT OF EDMUND SEGNER, III, EXECUTIVE VICE PRESIDENT AND 
               CHIEF OF STAFF, ENRON CORPORATION

    Mr. Segner. I am Ed Segner, Executive Vice President of 
Enron, a diversified energy company headquartered in Houston. 
As a major participant in the upstream, midstream, and 
downstream domestic energy markets, Enron obviously has a 
direct interest in the proposed R-I-K program, both as a 
marketer, in which we are one of the very largest in the 
country, and as a producer.
    Recent changes in the natural gas industry, including the 
deregulation of wellhead prices and the demise of pipelines as 
the primary purchasers of natural gas, directly affect the 
current debate over royalty valuation. These changes have led 
to a number of controversies between industry and government. 
The Department of Interior has been questioning the principle 
that royalties are to be determined at or near the lease, as 
has been the historical practice now for about 70 years.
    Rather, the Department is apparently considering that 
royalty values be determined far downstream of the lease after 
the value has been enhanced by a variety of services performed 
in the midstream and downstream markets. This position, of 
course, fails to recognize that participants in those markets 
make significant capital expenditures and undertake a variety 
of risks not associated with the risks that are undertaken by 
oil and gas lessees.
    Such a position, obviously, is fundamentally at odds with 
the way in which natural gas is marketed today. Natural gas 
producers no longer dedicate the production from specific 
properties to specific sales contracts. Most production today 
is sold under contracts that specify no source of supply but 
rather require that specified volumes be delivered to 
designated delivery points.
    Producers can and do supply gas to such delivery points 
from various sources of supply, including their own production, 
or in the event of a shortfall in order to meet a firm delivery 
commitment, by purchases from other producers or marketers. 
Even when a producer's own production is used, it may come from 
a number of properties upstream from the point of delivery.
    Similarly, midstream producers do not supply their 
downstream customers with gas obtained under specific purchases 
from identifiable producers. Rather, production is aggregated 
at pooling points where it is bought and sold or transported to 
all other points all in the marketer's efforts to maximize its 
profits by seeking the best market available.
    Gas has become like grain or pork bellies, a fungible 
commodity. Attempting to value gas on the basis of downstream 
transaction would be like determining the value of a particular 
farmer's corn crop, by looking at the prices in the grocery 
store.
    We believe that a properly designed royalty-in-kind program 
can both resolve many of the current controversies arising out 
of these changes, while providing many advantages to the 
government resulting in a win-win situation.
    In a well-designed royalty-in-kind program, the Federal 
Government would use the expertise of sophisticated marketers 
to access markets nationally and provide timely and accurate 
information. Using the services of marketers, the government 
could realize increased revenues through, one, aggregation of 
its substantial volumes; two, the administrative savings of 
simplified auditing; and, three, the absence of disputes.
    Our Enron Oil Canada unit produces oil that is subject to 
Alberta's royalty-in-kind program. Our experience under that 
program has also been extremely positive. Valuation disputes 
under the program are virtually nonexistent.
    Further, the program is simple to administer from both a 
logistical and accounting standpoint. A single accountant in 
our company spends less than 4 hours a month filing the 
required reports. In addition, the province bears its 
proportionate share of downstream costs like any other interest 
owner, thus providing equitable treatment to the lessees.
    In April 1995, after an exhaustive joint government and 
industry study, the Minister of Energy advised that a cash 
based royalty system such as that as used in the U.S. could not 
be implemented because it would result in a financial loss to 
the province and create an administrative burden for both 
industry and government.
    In addition, we have also recently begun to participate in 
the Texas program. We also are very satisfied with that 
program. It has been a positive experience. And, in fact, with 
respect to our operations, it operates so unobtrusively that I 
think that speaks volumes for the quality of the program.
    It is for these reasons that a royalty-in-kind program is 
so important. Competitive bidding for the government's share of 
production would simply and fairly establish its value, while 
providing the best means available to ensure that the 
government receives full value for oil and gas production from 
Federal lands.
    It offers the government the ability to realize the maximum 
value for its share of production, while at the same time 
streamlining its own operations. We thank you very much for the 
opportunity to appear before this Subcommittee today, and at 
the same time, we assure you that we offer our assistance in 
developing a successful program any way we can.
    [Prepared statement of Mr. Segner may be found at end of 
hearing.]
    Mrs. Cubin. Thank you very much. Mr. Thornberry, would you 
like to begin questioning?
    Mr. Thornberry. Thank you, Madam Chairman. I guess my 
number 1 question that I would like to address to each of you, 
because some of you represent a number of companies and 
organizations, is do you think the industry is serious about 
getting this done? Do you think a consensus can be built? And 
what is the primary obstacle to getting it done?
    As I mentioned a few minutes ago, I have been down this 
road before. And while some in industry said they thought it 
was a good idea, it didn't go very far. But I would like to get 
you alls' view on whether it can be done, whether we can reach 
a consensus. Mr. Nichols, do you want to start?
    Mr. Nichols. Yes. I definitely think we can reach a 
consensus, and I would like to put this in some historical 
perspective. Earlier in the hearing today, we heard that 
because last year we had passed the Royalty Fairness Act, with 
the able leadership of this Committee, that now was an 
inappropriate time to go back in and reevaluate or do anything 
different.
    The Royalty Fairness Act dealt with procedures. There is 
nothing in the Royalty Fairness Act that dealt with valuation. 
Both this Committee and the industry and the MMS recognize that 
those valuation issues were out in front of us and were not 
touched at all by the Royalty Fairness Act.
    When we saw earlier this year the MMS proposal on oil 
valuation, which was based upon NYMEX, or despite some earlier 
statements I heard today, NYMEX is not where the oil and gas 
industry trades amongst itself. We trade oil at the lease or 
near that, not at NYMEX. That is totally false.
    Our company sells a lot of oil, and it is not based on 
NYMEX prices. That is not what we have any hope of realizing. 
Sometimes it is up, sometimes it is down, but that is not where 
we trade. That is where they trade in New York City. It is not 
where we trade in Wyoming or the Texas panhandle or wherever.
    When that was proposed with a complicated system to get it 
back to where we really do trade, and the MMS recognized that 
NYMEX was not where it was traded and was only using that as a 
starting place, we had used a fairly complicated and somewhat 
arbitrary within their own control system to get it back to the 
lease or attempt to get it back to the lease, many people in 
the industry looked at that and said, ``Good grief. There has 
got to be an easier way.''
    Mr. Thornberry. So you think there is renewed focus on 
solving the problem?
    Mr. Nichols. The oil valuation program gave tremendous 
focus and tremendous impetus within the industry to please find 
a simpler way, and R-I-K particularly became the simpler way.
    Mr. Thornberry. What do you think is the biggest obstacle?
    Mr. Nichols. The inertia, that change is always difficult, 
working out problems. In my testimony earlier, I listed the six 
principles that 14 trade associations have already in a 
relatively short period of time gone together and agreed upon. 
We need to work on the details of those, broaden the industry 
group to include everyone, but I believe that can be done.
    Mr. Thornberry. Thank you, sir. Mr. Hagemeyer?
    Mr. Hagemeyer. Yes. I also would agree that the industry 
has pulled together to focus on this particular issue for a 
variety of reasons, and we would be remiss in suggesting that 
it wasn't because valuation perhaps was a catalyst. In the 
past, you would have maybe certain components in an integrated 
oil and gas company who would look at valuation regulations. 
And what you have with royalty-in-kind is probably a bigger 
picture.
    So it encompasses all aspects of the oil company, and this 
takes time for the oil companies to focus on this, and this is 
something through this association task force that I think has 
just recently started happening. If there was royalty-in-kind 
discussions in past timeframes, it never had this kind of 
discussion, which is all encompassing, and a realization that 
you just don't do it with little bits and pieces and parts. And 
if you are going to put something forward, it has got to be 
somewhat comprehensive.
    And so it really has energized, in my opinion, a lot of 
companies to really talk through the issues. And as Larry 
pointed out, there were six principles developed in a matter of 
a few weeks by this task force which kind of set a stage, and 
there was a lot of structural elements under that that have to 
be sorted out and talked through. You know, there is a lot of 
very important issues that have been mentioned before in terms 
of voluntary, mandatory, the transportation issues, turning 
over title at what point, and how can that be clean.
    But the key is that it is kind of a reengineering focus. I 
mean, the purpose of this group right now has really been 
trying to look at it from a clean piece of paper, not being 
incumbered by other things, and saying if you had a very, very 
good royalty-in-kind program that tried to satisfy all aspects, 
how would it work? And I really feel confident that over the 
next few weeks or months that that can come about.
    Mr. Thornberry. OK. Thank you. Ms. Hamm and Mr. Segner, I 
would like to get at least you alls' opinion on what the 
biggest obstacle is.
    Mrs. Cubin. And don't worry about the light. You can have 
as much time as you want, Mac.
    Ms. Hamm. The transportation issue and the mandatory versus 
voluntary appear to be the biggest obstacles that I have seen. 
And I believe they are workable, especially--we need from MMS 
what are their problems with transportation. What kind of 
comfort zone do they need in order to work in the marketplace 
on transportation? If we knew what their fears were, then we 
could arrange the principles and issues and help with the rule. 
And then the mandatory versus voluntary we are going to, of 
course, have a consensus on that, and I believe in mandatory.
    Mr. Thornberry. OK. Thank you. Mr. Segner?
    Mr. Segner. I think the biggest issues are going to be in 
the marketing side from the standpoint of dealing with the de 
minimus volumes, finding mechanisms to make sure that a large 
enough percentage of volumes is, in fact, being served under 
this program. Obviously, 100 percent would be best in our view 
because we don't want to see a situation where you end up with 
a lot of administrative costs left over. So we want to be sure 
that we get the whole thing.
    I would say from the marketing standpoint I think clearly 
there is huge competition now in marketing, as we all know, and 
I think that having a producer--in essence, the Federal 
Government, be as large as it is--that is a sizable volume, its 
portfolio well spread out. I think it will be very well-
received by the marketing community, and I think it will be 
very competitively bid and structured.
    Mr. Thornberry. Gives us lots of buying power when you have 
that much oil to sell?
    Mr. Segner. Yes.
    Mr. Thornberry. Let me ask each of you, have any of you had 
experience with the MMS pilot program on gas?
    Mr. Nichols. We participated in a very minor way in the 
pilot program offshore.
    Mr. Thornberry. OK. Do you have comments about that 
program, ways that it can be improved, why we should or should 
not learn particular lessons from it based on your experience? 
And if you don't have enough, that is fine. I just wondered.
    Mr. Nichols. Yes. Our experience with it was extremely 
small as an independent. I know there are a variety of design 
flaws in the way it was implemented, that both we and the MMS 
learned from that that could be corrected in a royalty-in-kind 
program. We see nothing in the comments that I have read about 
that cannot be easily corrected.
    Mr. Thornberry. OK. Madam Chairman, one other thing. Mr. 
Nichols, since your company was specific mentioned in some 
earlier testimony, I thought you might want to have the 
opportunity to respond to the concern that some people have 
that someway a royalty-in-kind will prevent or you will lose 
arm's length transactions, and there will be some sort of 
sweetheart deal and this, and the taxpayers are going to get 
the short end of the stick. If you would like to respond, I 
certainly want to give you a chance to since your company was 
specifically mentioned.
    Mr. Nichols. Well, I must admit I was somewhat amused and 
perhaps flattered to think that our company would be large 
enough to successfully market Federal royalty oil. Earlier this 
year, we were marketing a grand total of about 300 barrels a 
day, and that feeble effort proved to be so small that we 
abandoned it on April 1. So I don't think we have the capacity 
to be a marketer. That is not what we are. We are a pure 
independent producer.
    There is no doubt in our mind that a successful program 
could be implemented. The reason the industry is in favor of a 
royalty-in-kind program is to reduce cost. The government is 
entitled to the royalty oil that it gets. There is no one who 
argues that point--and the royalty gas. You can take that and 
aggregate that together and have a win-win situation where the 
government, because it can aggregate that oil and gas, can 
realize more revenue.
    I know from my own company's experience, we did an 
acquisition at the end of last year that gave us more oil to 
market because we own more oil in west Texas and southeastern 
Oklahoma. Just because of that small aggregation relative to 
us, we are able to realize a higher price for that oil.
    The Federal Government could realize an even higher price 
because they have much, much larger volumes than we do. So you 
have the ability to realize more revenue on one side, and the 
ability to save costs, both for the industry and the MMS, on 
the other side. It looks like a win-win.
    Mr. Thornberry. Thank you. Madam Chairman, I appreciate 
your indulgence. Because of the lateness of the hour, I won't 
continue. I do have some questions I would like to submit for 
the record, and hopefully these witnesses could provide us some 
additional insights if that is all right.
    Mrs. Cubin. And we also would ask unanimous consent for the 
Minority to enter any questions in writing that they would 
like. Mr. Dooley?
    Mr. Dooley. Thank you, Madam Chairman, and I apologize for 
having a conflict and not being able to hear the entire panel. 
I guess my interest here is in terms if you did go to the 
royalty-in-kind process, should it be structured in a way that 
perhaps we just let the states administer it. I mean, we have 
Texas who already has their program in place. You know, why 
should the Federal Government be involved? Why don't we just 
let the State of Texas do it? Anyone that wanted--I guess, Mr. 
Hagemeyer, you----
    Mr. Hagemeyer. I will maybe just try to address that a 
little. I guess you are asking a question that probably we 
haven't ourselves even had time to get into and discuss, and I 
think that is one of the issues on the task force list to talk 
through; not that we have necessarily the solution, but maybe 
we can talk through the pros and cons.
    You know, I think one thing that fundamentally we would see 
is that, you know, the Federal Government would have the right 
of the oil, the title to it when turning it over at the lease. 
And I guess the key there would be what would be the most 
efficient way?
    That is what we all would want to see. So if the states 
could do it more efficiently than the Federal Government 
through a private agency, then that is something to consider. I 
guess the options are still open in reviewing that, and it is 
something that probably when you talk it through, many of the 
states (Texas has quite a bit of an experience, and Wyoming is 
now looking at it in various stages), have a different scope of 
experience level.
    So if you were to move into some program, you may only have 
a few states who have enough experience to do very much. But I 
guess the jury is still out.
    Mr. Dooley. Well, that is kind of the way that I am looking 
at this is that, you know, we have some states that are at 
different levels of I guess competency just by experience by 
and large. But I guess I question, you know, it might be 
something that it might be best administered on state by state 
and basically be a state choice, whether or not to go down that 
path of royalty-in-kind.
    If you went down that track though, you know, I question 
whether or not we ought to have MMS in a position where they 
are required to put together the administrative infrastructure 
to administer a payment-in-kind program in one state that might 
have the capability to do it themselves.
    And maybe we would be better off letting them do that, and 
those states that didn't choose to go into royalty-in-kind that 
we would maintain something, maybe even what is proposed 
hopefully with some modifications.
    Ms. Hamm. The industry workgroup has agreed that it would 
like for the states to have the option to take their royalty-
in-kind so I think that answers your question to a degree. 
States which show an interest we want to allow it to have the 
right to take their oil in-kind.
    Mr. Dooley. And that would just be the state's share of the 
royalty-in-kind?
    Ms. Hamm. That is as far as we have gotten. We haven't 
addressed taking the Federal royalty. We would like for the 
states to have the option to take the Federal royalty too, to 
have the right to bid for it. And we haven't written that down 
as a principle agreed upon that has been discussed to let the 
states take the Federal royalty. But the only thing which has 
been agreed upon is the states to take their own share.
    Mr. Dooley. I had a chance to read some of your testimony, 
and you visited Alberta and viewed theirs. How did they deal 
with--and I think Mr. Segner made the comment, you know, the 
very, very de minimus producer in some instances--you get to 
some level that is not cost effective, you know, to put I guess 
in place an in-kind type of program. Does Alberta have similar 
problems, and how are they addressing that?
    Ms. Hamm. My understanding is that they don't take that 
which they are not able to administratively costwise justify, 
and there are some instances where they take the operator's 
volume totally also and market it for them because the operator 
believes that Alberta Energy has more expertise than they do.
    But I believe they have been at it so long that this was 
not all thrown at them at one time. This has been as a well 
develops, as wells are drilled, they have gotten to make the 
selection. And then once they do have it in place, as wells 
decline, then it is easier to keep the R-I-K in place. Where 
for us, we will have to make the election with wells which are 
already declined whether to take it in-kind of not, so it would 
be a little bit different deciding right off to take 
everything.
    Mr. Dooley. Does anyone else have a comment on any of those 
questions? All right. Thank you.
    Mrs. Cubin. I want to ask you, Mr. Nichols and Mr. 
Hagemeyer, anyone who wants to answer, a little bit more about 
the multi-association task force. That is the same industry 
working group that you were referring to, Ms. Hamm? It is all 
the same group? OK. And, Mr. Nichols, you are here representing 
those groups that are in working on the task force. Is that 
correct?
    Mr. Nichols. Yes.
    Mrs. Cubin. And that is mostly independents. Is that 
correct?
    Mr. Nichols. Yes, of all sizes. There are very large 
independents and very small independents, but they are all 
included in that group.
    Mrs. Cubin. I am not going to ask a lot of questions now, 
but, again, if you would indulge us and allow us to send some 
written questions to you, I would appreciate that. But I do 
want to say one thing. I know Mr. Thornberry is anxious to get 
this moving and anxious to have a bill, and I support him in 
that.
    And we would appreciate it, if you don't mind my speaking 
on your behalf, if the MMS and the states and your task force 
and the majors could come together with some suggestions 
because I think we will have better legislation if everyone can 
work on that than if we just draft something just to get the 
issue moving. That is what we would like and what we would 
appreciate is just some movement on this.
    So I don't really have any other questions. I will just 
leave you with that request, that you work together as much as 
you can in a timely fashion so it makes it a little easier for 
Mac and for me. Mr. Nichols?
    Mr. Nichols. Yes. Madam Chairman, if I might add, included 
in that group and included in those associations are major 
integrated companies, that there really is no schism in the 
industry based on size or character in facing this issue.
    There are individual companies and individuals that are 
still studying and are not yet committed to it. But I think 
that consensus is rapidly forming, and it will be one that is 
from the largest integrated down to the smallest mom and pop. 
You know, we all share the common desire of a more simple and a 
more certain royalty collection system.
    Mrs. Cubin. And I do encourage you to work with the states 
as we go along that I know we can have a better bill by doing 
it that way. Thank you all very much for your testimony today. 
Ms. Quarterman, I certainly appreciate your sitting through all 
of these hours of testimony and voting and whatnot. I know it 
has been a long day for you, and we do appreciate your hanging 
in there with us. So if you would kindly give us your wisdom, 
we would be happy to hear it.

STATEMENT OF CYNTHIA QUARTERMAN, DIRECTOR, MINERALS MANAGEMENT 
                            SERVICE

    Ms. Quarterman. My pleasure. Madam Chairman and members of 
the Subcommittee, I appreciate the opportunity to appear today 
to present testimony on behalf of the Minerals Management 
Service in our ongoing examination of the feasibility of taking 
oil and gas royalties in-kind.
    I would like to say that we are very excited about the 
notion of taking R-I-K. We have been studying this issue and 
considering opportunities that in-kind royalties may offer the 
government, industry, and, most importantly, the American 
taxpayer.
    Over the past several years, MMS has spent a considerable 
amount of time studying the opportunity to take royalty-in-
kind. It has been a major learning process for us. We have, as 
you know, conducted an analyzed R-I-K pilot that was 
implemented during 1995. We have convened six public workshops 
around the country relating to R-I-K.
    We have surveyed energy marketers that we would not 
ordinarily have an opportunity to work with. And we have 
interviewed other government agencies who have experience in R-
I-K, including our international sister nations going over to 
Alberta, Canada, and speaking with them as well.
    In short, I believe that we have developed a significant 
body of knowledge and expertise concerning the potential for 
applying in-kind programs to Federal leases. I ask that my 
prepared testimony be admitted to the record, and I will 
summarize for you here what is in that testimony.
    By way of background, the energy industry has changed 
dramatically over the past 10 years. As some of the folks who 
have been here today have already testified, the once dominant 
wellhead sale has been replaced by more frequent downstream 
sales by affiliated energy marketers and is particularly true 
in the natural gas market.
    A series of downstream activities frequently occur before a 
first sale is ever made. For natural gas, first sales may not 
occur until the burner tip in a residential consumer's home. 
Increased downstream activity has complicated royalty valuation 
to a large extent which has fostered disputes between the 
Minerals Management Service and the producers.
    Administrative appeals and litigation have proliferated as 
a result. And the energy industry and MMS have struggled over 
the past several years to resolve these many issues. Along with 
clearer valuation regulations, R-I-K programs may offer a 
solution to avoid such disputes.
    In what we see as a best case royalty-in-kind scenario, a 
number of things we think would be possible. First, we think 
that valuation disputes could be eliminated or at least 
reduced, that auditing could be reduced to a simple volume 
reconciliation that would be completed quite quickly, that 
there would be less need for royalty reporting and 
verification, which would accrue to administrative savings on 
behalf of both the government and industry.
    We also believe that there is a potential to enhance 
Federal revenues by aggregating volumes and marketing. The 
extent of such benefits requires examination and analysis, and 
that is what we are currently in the process of doing.
    As this Subcommittee will remember, back in 1995 we did 
implement a gas marketing pilot that was pursuant to Vice 
President Gore's Reinvention of Government Initiative. MMS sold 
at that time by competitive bid at the lease approximately 45.6 
billion cubic feet of gas from 14 lessees covering 79 leases in 
the Gulf of Mexico.
    We saw a royalty loss of nine cents per MMBTU which 
overwhelmed a small administrative savings. I came before this 
Committee shortly thereafter about a year ago to present the 
results of that pilot. Despite what some might think as 
disheartening results of the pilot, we continued to pursue the 
notion of the Federal Government taking its royalty-in-kind.
    And we have learned a substantial amount from that pilot. 
We learned that the voluntary nature of the pilot reduced our 
ability to aggregate and enhance volumes, that some of the 
downstream value benefits that are possible were not seen 
because of the way the gas was sold, and, finally, that the 
administrative relief was extremely limited because we 
continued to audit companies who had taken the gas in-kind.
    The R-I-K study that we are currently doing has two primary 
objectives, and the real objective is to ensure that any R-I-K 
program is in the best interests of the United States and its 
taxpayers, meaning that we are looking for a program that would 
offer potential revenue neutrality or enhancement for the 
Treasury, and that would provide extensive administrative 
savings to both the Federal Government and the oil and gas 
industry.
    I will tell you now that we have some preliminary findings, 
but they are only preliminary at this point. Our examination of 
R-I-K is ongoing. A major finding is that under favorable 
circumstances we believe that R-I-K programs could be workable, 
revenue neutral, or hopefully revenue positive, and 
administratively more efficient for both MMS and the industry.
    The favorable circumstances that we see to be necessary 
would include an opportunity for us to participate in 
downstream marketing in sales which could enhance revenues, 
that would allow us to aggregate volumes, which we think could 
assure supply and could increase our market leverage, and, 
finally, a program that would provide administrative relief to 
both the Federal Government and to industry.
    R-I-K programs would have reduced chance of success we 
think under some unfavorable circumstances, and the unfavorable 
circumstances that we have in mind are continuation of our 
auditing, producer's share of production. It would include any 
statutory language which would give the government less 
leverage in creating a workable R-I-K solution.
    And another unfavorable circumstance would be if we were to 
try to put in place a R-I-K program for production that is 
scattered in many different basins with a decreasing potential 
for aggregation and would require an increasing amount of 
learning on our part.
    Our challenge in the future will be to see if we can 
identify appropriate R-I-K programs that meet the favorable 
conditions that I have set forth, to develop a specific R-I-K 
program or programs for these conditions, and to conduct those 
programs and economic analyses associated with them.
    In conclusion, as I mentioned before, we are enthused about 
the prospects for developing a R-I-K program or programs that 
could lead to success. And I agree with many of the witnesses 
before me by saying that success is defined as a program that 
is a win-win-win for all the parties that are involved.
    However, because there are some inherent risks in any R-I-K 
program, we want to caution you not to move too quickly in 
trying to reach a legislative solution. We need to be able to 
conduct more detailed testing and analysis of any programs 
before there is broad application. If there is anything that 
the Subcommittee heard today, I think it would be the 
importance of flexibility in any sort of R-I-K program.
    We caution that we not prematurely provide any legislative 
assistance that would seek to make a one-size-fits-all solution 
for R-I-K implementation in the future. We think success really 
relies on the ability to be flexible because the market has 
changed rapidly and quite a bit and will continue to change, we 
think, and we need to be able to change with the market.
    Legislative initiatives may lock us into a R-I-K program 
that later turns out to be counter to the market and to the 
public interest. If we find that we need legislation after we 
have tested some pilots, we will be back to you and ask you for 
the appropriate legislative changes.
    Considering the magnitude of Federal royalties, this issue 
I believe is too important for us to rush to judgment and to do 
it wrong. We are willing and excited about the prospects of 
working with the states and with industry to develop and test 
R-I-K programs that are amenable to all parties.
    Madam Chairman, that concludes my prepared remarks with 
respect to R-I-K. I did want to make one note unrelated to R-I-
K before I offer myself up to questions, and that is having sat 
here this afternoon, I noticed that there was one piece of 
information that seems to not be accurately communicated to the 
Committee. And I want to make sure that you were aware and that 
is with respect to our oil valuation rule.
    There were some questions earlier and statements about the 
MMS attempting to move the point of valuation away from the 
wellhead, and that independents would not necessarily receive 
fair market price and would not be able to pay royalties 
according to that. That has been a concern of mine as well.
    And I think if you were to go and read the rule, and I 
offer you up my staff, who is more expert than I am on this, to 
come and sit with members of the Subcommittee to talk and walk 
you through the rule, you will see that the discussion of NYMEX 
and ANS prices is a second step in the rule.
    The first benchmark in the rule would permit a producer to 
pay on gross proceeds. If he has a contract for a sale at the 
lease, that is the first benchmark--the first place that we go 
forward. We are not interested in putting independents out of 
business here. So that is the first step.
    And, again, as to NYMEX prices or ANS prices, I remind 
everyone that it is a proposed rule. That means that we are 
open to any other means of valuation that may be out there or 
other indexes that may be more appropriate. With that, thank 
you.
    [Prepared statement of Ms. Quarterman may be found at end 
of hearing.]
    Mrs. Cubin. Thank you very much. I think one thing we can 
agree on--everyone is that the current is sort of a disaster. 
It is too expensive and it is too complicated, and, obviously, 
MMS having proposed a rulemakes a public pronouncement that we 
need change. You stated, Ms. Quarterman, that you have a huge 
volume of information from six workshops, and you have surveyed 
marketers, and you just have a vast amount of information on R-
I-K. Do you need to gather more information, or do you have the 
information and you just need to analyze it?
    Ms. Quarterman. We are in the process of analyzing the 
information. We had a team from our policy shop perform the 
workshops and gather the information. They are in the process 
of drafting a final report which they will present to me 
shortly with a number of recommendations, I imagine.
    Mrs. Cubin. What would be an ideal situation for me is for 
MMS and industry and the states to be working together and get 
moving on this. It seems like it has been dragging to me. And I 
would really prefer a proposal to come from the work that all 
of you have done rather than legislation as you requested. 
Sometimes it seems though that we need legislation to get the 
ball rolling. So I would ask all of you to go ahead and get 
working on that, and let us make some progress and then the 
need won't sit up here. Mr. Dooley?
    Mr. Dooley. Yes. Thank you, Madam Chairman, and thank you, 
Ms. Quarterman, for your really substantive testimony. It 
really was helpful in trying to come to grips on how we should 
move forward.
    I guess what I would like to spend, you know, some time 
with though is on the rulemaking because maybe I have some 
misinformation. But from what I am hearing from a lot of my 
producers in California is that they are at least under the 
impression, unless there has been a modification to the rule 
that was proposed I guess on January 24, that a lot of their 
production was going to be priced based on an ANS benchmark or 
with a function of some adjustments based on sulphur content 
and a couple other issues. Now, is that incorrect?
    Ms. Quarterman. Well, first, there has been a modification 
to the rule since January when it was first published. We 
published a supplemental rulemaking less than 30 days ago. I 
don't know what specific producers you are referring to, but 
the modification would we think make the first provision of the 
rule, the gross proceeds provision, apply to many of the 
independents.
    Mr. Dooley. And how would that differ now from the status 
quo?
    Ms. Quarterman. That is the status quo.
    Mr. Dooley. And what producers then would fall under that?
    Ms. Quarterman. Any producer who is selling through a true 
arm's length sale at the wellhead would fall under that.
    Mr. Dooley. And so that would mean that as long as a 
company wasn't vertically integrated that they would not be--
they would be basically status quo in terms of their pricing?
    Ms. Quarterman. I would not go so far as to say if they are 
not vertically integrated. We haven't done the analysis to see 
exactly how many, if any, independents would have to pay under 
an ANS or a NYMEX scenario, but we don't think that there would 
be that many. The policy would be every single independent 
producer who doesn't have a refiner, but there would be quite a 
few who would be covered. Yes.
    Mr. Dooley. And I guess then the objective was basically to 
some extent exempt the independents from this new methodology 
in terms of valuation?
    Ms. Quarterman. I would say independent producers, yes. 
When you say independents, there are a number. Yes.
    Mr. Dooley. Right. Excuse me. OK. But that is, obviously, 
you know, a significant concern. I guess, you know, the 
definition of arm's length status though is still--you know, 
what does that mean I guess?
    Ms. Quarterman. It means you have a sale with a party who 
is not affiliated with you at the well.
    Mr. Dooley. And how long does that have to be?
    Ms. Quarterman. How often is that----
    Mr. Dooley. How long for that--you know, is that separation 
I guess from that party? Is that always--I mean, is there any--
could there be a past relationship or that could impact, you 
know, whether or not that is defined as arm's length?
    Ms. Quarterman. I don't want to mislead you. Let me ask 
that I have my staff come in and give you a definition of an 
affiliate.
    Mr. Dooley. Excuse me?
    Ms. Quarterman. I don't want to mislead you not having read 
the rule in about 3 months myself about what the definition of 
an affiliate is in the rule.
    Mr. Dooley. And it is obviously what my concerns are here 
in terms--I just don't want--you know, some people are 
producing and primarily the smaller producers, you know, being 
placed with a valuation that is not necessarily reflective of 
what they are getting paid for. And that is the gravest concern 
we have with going to an ANS or a NYMEX benchmark.
    You know, I don't care whether you are a large producer or 
a small producer. You know, sometimes, you know, we are 
concerned that that will not be an accurate reflection. And I 
guess that is the intriguing component of this payment-in-kind 
is that it reverses all of the incentives--is that everyone at 
that point--the producer and everyone else--has the incentive 
to maximize price opportunities and that benefits the Federal 
Government and the taxpayers, as well as the state government.
    My question is if the Department and MMS is seriously 
considering going to a payment-in-kind as it appears that you 
are and you are receptive to that, you know, should we be, you 
know, moving forward with in some ways a fairly significant 
change in the royalty collection, you know, when we might be 
reinventing the process once again in the relatively, you know, 
near future?
    Ms. Quarterman. I don't want to mislead you by my testimony 
in saying that we are very enthusiastic about R-I-K does not 
mean that we think that we are at the point now or, in fact, we 
will ever be at the point where it will be appropriate to take 
all oil and gas in-kind.
    I believe that the study that has been done shows that we 
should consider expanding the gas R-I-K program that was done 
in the past. There may be certain instances where it would be 
appropriate to consider taking oil in-kind. We have been 
approached by the State of Wyoming and have offered to work 
with them on the pilot project that they have in mind. So, in 
other words, we would still need a valuation system for that 
portion of the royalty that was not taken in-kind.
    Mrs. Cubin. Mr. Thornberry?
    Mr. Thornberry. Thank you, Ms. Quarterman. I appreciate 
your testimony. If either of us sit back and look at what has 
happened over the past two or three years, I think MMS and the 
states and industry is all moving in the same direction. There 
is a little bit of difference on how fast we are moving and 
maybe what all is included, but I think the trend is definitely 
going toward royalty-in-kind.
    And, obviously, I would hope that, as the Chairman said, as 
much as possible we could all work together in getting the best 
possible royalty-in-kind plan because it is, obviously, not 
going to do anybody any good if it increases administrative 
costs or if it increases lawsuits or if it doesn't give the 
taxpayer a fair return on the royalties that they are due. Then 
we haven't accomplished very much.
    I am a little concerned about your last statement, and that 
is if basically you to use the expression cherry-pick what 
kinds of leases you want to put in a royalty-in-kind program, 
and some of them don't and so you have to still do the 
administrative evaluation for that, you hadn't really helped 
much of the administrative costs, have you? I mean, you still 
have got to have the folks to do that.
    Ms. Quarterman. Well, I think it is a fallacy to think the 
administrative savings are going to be the savings that are 
important here. I think the opportunity for revenue enhancement 
is the real winner. Our royalty program, as was mentioned at 
the beginning, is about $68 million a year, which is about a 
penny and a half for every dollar that we collect.
    About 18 percent of that is collections that we do on 
behalf of Indian tribes. That, of course, would have to remain. 
We would still have to do collections for solid minerals and 
geothermal leases. We would have to create a royalty-in-kind 
program. The administrative savings are not going to be the 
real winner here I don't think. If there is a winner, it is 
that aggregating of volumes and enhancing the value downstream.
    Mr. Thornberry. Well, except we have heard some testimony 
today about some remarkable differences in how many 
administrative folks it takes to keep up with certain programs. 
And so that is something that we need to work through, but the 
other winner--do you agree that another winner would be reduced 
litigation costs?
    Ms. Quarterman. Oh, absolutely. It would be. When you think 
about administrative savings, don't forget about the possible 
risks. As it stands right now, we bring in close to $5 billion 
a year. We collect that in royalties.
    And basically we have 600 or so people in the royalty 
program who sit out in Denver, and we get $4 billion mailed 
into our office no matter what we do every year. If we were to 
take all that oil and gas in-kind, we put in jeopardy that $4 
billion that we get every year without doing anything. So we 
really need to be careful in what we do, and that is all that I 
wanted to say to the Committee.
    Mr. Thornberry. Yes, ma'am. I think you make a very good 
point, and, as I mentioned, we all want a program that works 
better, not worse. And we don't want to jeopardize the 
taxpayers. Let me ask you, one of the issues that I know you 
all got comments on in your meetings and is the subject of our 
discussion is whether it is mandatory or voluntary. What is 
your view on that subject--whether or not companies or even 
states can opt out?
    Ms. Quarterman. Well, I think if you want to be innovative 
that you need to be open to different ideas. I think it is 
clear under the existing Mineral Leasing Act and the OCS Lands 
Act that the Secretary can take oil or gas on demand is what 
the statute currently reads. So any variation or change in that 
statute some might view as a detriment to the taxpayer.
    Having said that, I think that there are opportunities to 
work together with states and industry to work toward a 
solution that everybody can live with. But what we saw in the 
past was we didn't have enough volumes because it was 
voluntary.
    Mr. Thornberry. Another point which in the notes from your 
meetings I understand that participants were unanimous about is 
that MMS take its royalty at the lease as far as delivery point 
goes. Do you think that makes sense? That is where it has to 
be?
    Ms. Quarterman. Well, it makes it more difficult for the 
government. I think under, again, the existing law and the 
leases onshore, it seems pretty clear that the government would 
have to take it at the lease offshore that we could ask a 
producer to bring it onshore and pay reasonable costs. Again, 
if you want to have an innovative program that everybody agrees 
to, you work those issues out, and you don't make any 
particular thing mandatory.
    Mr. Thornberry. Let me ask you about one more. There was 
concern expressed I know about MMS getting involved in 
downstream marketing, and yet as I understood your testimony, 
you think that is an option that you want to keep in a royalty-
in-kind program. Is that right?
    Ms. Quarterman. When you say MMS, that does not necessarily 
mean MMS employees. I do not think that the Federal Government 
employees that I have now would be capable of that, and the 
recommendations that I see coming forward would not include 
Federal Government employees doing that, but rather getting 
that skill from somebody else. It is easier when you are an 
outside person to stay up to speed on the market changes, and 
all those things would be necessary in order to market oil and 
gas.
    Mr. Thornberry. But in that scenario, MMS would hire 
somebody or some entity?
    Ms. Quarterman. Definitely.
    Mr. Thornberry. But the Federal Government would continue 
to own the product as it moved downstream to some point and 
could market it and sell it there rather than at the lease?
    Ms. Quarterman. Right.
    Mr. Thornberry. OK. And that is something you think is 
good?
    Ms. Quarterman. Well, I think it is something we should 
explore. Again, there are the risks there because if something 
happens to that oil or gas along the way, we have lost it for 
the government. We don't own any pipelines, any storage space. 
You know, there are risks.
    Mr. Thornberry. Yes, and there are concerns, as you know, 
from industry about getting the government involved in 
downstream marketing on particularly the amount of volume that 
the government could potentially bring in, that it would pose 
some danger to them as well.
    Ms. Quarterman. Yes. In the Gulf of Mexico, we have about 
2.5 billion cubic feet of gas a day. I think that would make us 
the largest owner of gas in the Gulf.
    Mr. Thornberry. Let me ask this final question. I 
understood and you have expressed to me before your concern 
about moving too quickly. If we do try to work with industry 
and the states to develop a R-I-K program in legislation, would 
the MMS folks be willing to work with us and offer their 
suggestions even if you were not to believe that sort of thing 
would be needed at that particular time?
    In other words, I think it is important for us to have your 
input whether or not you think the timing is right. And would 
you be willing to work with us even if you thought the timing 
was not right?
    Ms. Quarterman. Well, certainly, we would work with you. 
Whether we would support you in the end is a different issue.
    Mr. Thornberry. Fair enough. Thank you.
    Mrs. Cubin. Mr. Thornberry's questions raise some questions 
in my mind. I don't exactly understand why the $4 billion that 
just automatically comes in would be in jeopardy if we adopted 
a royalty-in-kind policy or a royalties-in-kind policy.
    Ms. Quarterman. Well, essentially, right now what happens 
is that oil and gas companies are required to pay us their 
royalty share, and that amounts to about $4 to $5 billion a 
year. And they mail in that amount and really what we argue 
about are things along the margin--potential increases to that 
amount, audit findings, verification of volumes, et cetera, 
which amount to another $100 or so million every year. That 
happens.
    If we take our oil and gas in-kind, it means that we are 
now responsible for taking that oil or gas from the lease into 
the marketplace. We have to transport it. We have to sell it. 
We have to make sure that if it blows up, we have liability to 
cover any damage that is associated with it. It is a risk.
    Mrs. Cubin. But I really can't see why that is--of course, 
it is a risk. It is a risk to get up in the morning, but I 
don't see why it is a significant risk when you consider the 
fact that the government does have storage, for one thing. It 
is the strategic petroleum reserves. So, you know, there is 
storage available.
    And if the companies or the producers don't have a market 
and can't sell it, then you are not going to be getting a 
royalty. I mean, I just think that is a real exaggerated view 
that all of that money is at risk. I think that the benefits 
certainly far outweigh that risk it would appear to me.
    Then you said one other thing, and I just want to be sure I 
have this right. You weren't making or offering the opinion 
that you wouldn't want to take the mineral at the lease because 
it is more difficult for the government. That would not be the 
reason or any reason that you would not want to take the 
mineral at the lease. Is that right?
    I think the statement you said when Mr. Thornberry asked 
about, ``Then would you be willing to take the mineral at the 
lease?'' and you said, ``Well, it would certainly be a lot more 
difficult for the government to do that.''
    Ms. Quarterman. No, no. I wasn't saying that we would not 
take it at the lease. I was saying that probably we would take 
it at the lease, and, in fact, onshore I think that is a 
requirement.
    Mrs. Cubin. OK. I just wanted to get that clear. Thank you. 
Mr. Brady?
    Mr. Brady. Thank you, Madam Chairman. As a Member of 
Congress, I would agree that it is a risk getting up in the 
morning around here. I had stepped out for a minute, and I only 
have two quick questions. So if I wander into an area that has 
already been covered, let me know please.
    Thanks for the testimony. Thanks for hanging on through all 
this. You mentioned your reluctance to include all the oil and 
gas in the R-I-K program. And I know that in Texas over the 
years we have learned from the process in trying to improve all 
the time, and it has become clear that I think many of us would 
like to see legislation that provides for a staged process 
where we would stage in different regions so that we could 
accumulate and gather as much of that volume as possible. Are 
you supportive of a staged approach as we go forward?
    Ms. Quarterman. Without seeing what the stages are, it is 
hard for me to comment on that.
    Mr. Brady. Obviously, putting in place for both the agency 
and for the industry enough time and thought in different areas 
so that we are, in fact, gathering as many of those different 
wells and producers and all in order to gather all the oil and 
gas in the system.
    Ms. Quarterman. I suppose it is possible.
    Mr. Brady. And it would make sense sort of if----
    Ms. Quarterman. The stage approach could make sense, but it 
is hard to talk to without seeing it.
    Mr. Brady. Considering and thinking through some of the 
benefits of this system, including providing contracts for 
other government agencies using and bidding for these 
contracts, but thinking about the litigation, the time of that, 
the cost of that, especially the delay of that, I see the 
benefit of R-I-K providing, once we are up and moving, money to 
your pocket and taxpayers' pockets sooner and us gaining that 
increase of time value, of having the money in-pocket. Do you 
agree with that?
    Ms. Quarterman. There would be an increase in revenues for 
the time value of money for, again, the incremental amount that 
we would get from audit, not for the bulk of the money. And was 
there a first half to that question?
    Mr. Brady. No, it was just regarding the litigation costs--
--
    Ms. Quarterman. Oh, the litigation.
    Mr. Brady. [continuing] expenses, time, delay.
    Ms. Quarterman. Well, unfortunately, I am not as well 
staffed with attorneys as some of my adversaries. I think we 
have about four lawyers who work on royalty matters of the 
Interior Department. They also work with staff at the Justice 
Department on any Federal litigation. So the costs there are 
not as high as you might think.
    Mr. Brady. OK. Although I would say the Federal Government 
does pretty well with the lawyer pool. I think you all are 
pretty well covered in that area overall.
    Ms. Quarterman. Top notch.
    Mr. Brady. Just a thought. Thank you, Madam Chairman.
    Mrs. Cubin. Maybe if you told the Secretary that you needed 
those lawyers, he could free them up on that mineral bonding. 
Ms. Quarterman, the Ranking Member requested earlier, and so I 
will make the formal request to you if you would please do 
this--he asked that you would send to us a record of the 
estimated litigation costs so we would appreciate if you did.
    Ms. Quarterman. We will do that.
    Mrs. Cubin. Thank you very much and thank all of you for 
attending the hearing today and will look forward to working 
with you in the future. This Subcommittee stands adjourned.
    [Whereupon, at 5:38 p.m., the Subcommittee was adjourned.]


 HEARING ON: ROYALTY-IN-KIND FOR FEDERAL OIL AND GAS PRODUCTION (PART 
                                  II)

                              ----------                              


                      THURSDAY, SEPTEMBER 18, 1997

        House of Representatives, Subcommittee on Energy 
            and Mineral Resources, Committee on Resources, 
            Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:15 p.m. in 
room 1334, Longworth House Office Building, Hon. Barbara Cubin 
(chairman of the subcommittee) presiding.

    STATEMENT OF THE HON. WILLIAM M. ``MAC'' THORNBERRY, A 
       REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS

    Mr. Thornberry. [presiding] The hearing will come to order. 
Ms. Cubin has been detained in another markup, and she will 
join us later. And at this time, I would like to submit her 
opening statement into the record without objection.
    [The prepared statement of Ms. Cubin follows:]

Statement of Hon. Barbara Cubin, a Representative in Congress from the 
                            State of Wyoming

    The Subcommittee on Energy and Mineral Resources will come 
to order. The Subcommittee is meeting today to hear testimony 
on the Feasibility of Taking Federal Oil and Gas Royalties In 
Kind. Under Rule 4(g) of the Committee Rules, any oral opening 
statements at hearings are limited to the Chairman and the 
Ranking Minority Member. This will allow us to hear from our 
witnesses sooner and help Members keep to their schedules. 
Therefore, if other Members have statements, they can be 
included in the hearing record under unanimous consent.
    The Subcommittee meets today to continue its review of 
issues concerning the collection of production royalties due 
the United States from Federal oil and gas leases onshore, and 
on the Outer Continental Shelf (OCS). This oversight follows 
upon our hearing of July 31st for which were unable to hear all 
witnesses identified by both the Minority and Majority as 
having meaningful views on R-I-K feasibility.
    After today I am hopeful that the Subcommittee will have 
gained sufficient insight to begin a legislative initiative 
resulting in a workable R-I-K program at the Minerals 
Management Service (MMS).
    As I said at the last hearing, my intent is to greatly 
diminish the enormous resources spent in the audit and 
enforcement functions of collecting royalty-in-value, because 
these costs are a loss to both the Federal and state 
treasuries. Yes, I understand the administrative costs of the 
Departments of the Interior necessary to conduct audits, bill 
lessees and then attempt to collect those bills is conducted 
with appropriated dollars, not direct spending.
    Likewise, Justice Department costs associated with 
litigation over valuation disputes are subject to 
appropriation, and therefore the obvious savings that an R-I-K 
program ought to bring the government may not appear in a CBO 
analysis. But, my constituents in Wyoming, and I suspect 
Americans everywhere, don't care about arcane budget 
enforcement scoring rules. They, like me, simply want these 
royalties collected in the most efficient manner possible 
because that will result in a net gain for all.
    I need not reiterate my opening statement from July. 
Suffice it to say there must be a better way to collect what is 
owed for the right to produce oil and gas from the public lands 
and the OCS. I trust the testimony from today's witnesses will 
help us in that endeavor.
    Before I turn to our Ranking Member, Mr. Romero-Barcelo, 
for any statement he may have, let me collectively welcome all 
our witnesses. I wish to especially thank Mr. Henderson who has 
traveled all the way from Calgary, Canada, to be with us today 
and shed light upon the private marketing of the Crown's oil 
produced in Alberta Province. I'm sure there are lessons we can 
learn from this system in designing a workable program for the 
U.S. As with the last hearing, I have asked the MMS to testify 
after other witnesses so that I can be sure the feds have 
listened intently to the preceding testimony, and perhaps 
gained some insights from it.
    To wit, I am concerned about MMS' response to written 
questions which I posed in early August (and for which we have 
only yesterday received a response). It seems to me the general 
tone of the response to be ``Remember, the Gulf of Mexico gas 
pilot lost money, so lets be exceedingly slow and cautious 
about doing more R-I-K.''
    I believe that analysis deserves further scrutiny before we 
take as gospel the MMS' extrapolation of an $82 million loss if 
all natural gas in the Gulf had been included. Besides, its 
time we climbed the learning curve and made another attempt to 
avoid the mistakes in the design of the 1995 pilot. Programs in 
Alberta and Texas both are apparently successful at adding 
value for those governments. Its time to get on with making it 
work for the benefit of all our citizens.
    The Chair now recognizes the Ranking Minority Member for 
any statement he may have.

    Mr. Thornberry. The Subcommittee is meeting today to hear 
testimony on the feasibility on taking Federal oil and gas 
royalties-in-kind. Under Rule 4(g) of the committee rules, any 
opening statements at hearings are limited to the chairman and 
ranking minority member. This will allow us to hear from our 
witnesses sooner and help members keep to their schedules. 
Therefore, if any other members also have statements, they can 
be included in the hearing record under unanimous consent.
    I would like to thank Chairman Cubin for holding this 
hearing today. Royalty-in-kind is an issue that I have worked 
on for 2 years, and it is an issue that I believe deserves a 
lot of consideration by all the parties involved.
    The subcommittee meets today to continue its review of 
issues concerning royalty-in-kind. This oversight hearing 
follows our hearing on July 31st for which we were unable to 
hear all the witnesses identified by the minority and majority 
as having meaningful views on RIK feasibility.
    Today I am hopeful the subcommittee will have gained 
sufficient insight to begin a legislative initiative resulting 
in a workable RIK program at MMS.
    Suffice it to say there must be a better way to collect 
what is owed for the right to produce oil and gas from public 
lands in OCS. I trust the testimony from today's witnesses will 
help us in that endeavor.
    Let me collectively welcome all our witnesses. I want to 
especially thank Mr. Henderson, who has traveled all the way 
from Calgary, Canada to be with us and hopefully had, help shed 
light on the private marketing of the Crown's Oil produced in 
Alberta. I am sure that there are lessons we can learn from 
this system in designing a workable program for the U.S., and 
as with the last hearing, Ms. Cubin asked that MMS testify 
after other witnesses so that we can be sure that they have 
listened to the testimony and hear their comments on it.
    Like Mrs. Cubin, I, too, am concerned about MMS' response 
to written questions that were posed in early August and for 
which the subcommittee only yesterday received a response. It 
seems to me that the general tone of the response is remember, 
the Gulf of Mexico gas pilot lost money, so let us be slow and 
careful about doing anything more. Personally, I believe the 
results of the Gulf of Mexico pilot project are invalid and 
have, call into serious question the, the worthiness of, of 
considering that pilot program. The lessons learned with the 
pilot--there were some lessons to be learned with the pilot 
project, but I believe those lessons could be entitled how not 
to administer a pilot project.
    As many of you know, RIK is an important issue to me. For 
the record, I think that most of my colleagues at least know 
that 2 years ago, I was approached by the Texas General Land 
Office with a request to pursue RIK. I admit that at the time, 
it was something I was not familiar with, but after looking 
into it, I believe that it is something important for the 
country. In my view, a well-structured and developed RIK 
program would reduce the size of the Federal Government, 
eliminate burdensome paperwork for oil and gas industry, MMS 
and state governments, and provide additional revenue for the 
Federal Government.
    When I first discussed this issue with the oil and gas 
industry and with MMS, there was a significant level of 
opposition from both sides. I am continuing to press forward, 
because I believe that RIK is in the best interest of the 
Federal Government and the industry and the taxpayers. Two 
years ago, RIK was going nowhere. This year again I reopened 
the file and tried to give it, tried to give it another try. I 
have been meeting with both MMS and representatives of the oil 
and gas industry and have requested their help and assistance 
in crafting legislation. I have indicated to both parties that 
I intend to introduce legislation at some point this fall, and 
it is my request that all interested parties assist us in 
making this program work as, as well as it possibly can. 
Frankly, we have had resistance from the industry. We have had 
resistance from MMS. But I believe it is worth pursuing and, 
and I need, we all need the assistance in making it work as, as 
well as possible.
    Today I am again asking for assistance, because I believe 
it is in everyone, including MMS' best interest, to participate 
while the oil and gas industry is now talking with us about how 
to make RIK work. At times, they have been reluctant 
participants. But I believe it is the right thing to do and 
intend to pursue. And I certainly want to work with all those 
who are interested in completing this legislation.
    Before we begin our testimony, I would turn it over to the 
ranking member for any comments he would like to make.

 STATEMENT OF THE HON. CARLOS A. ROMERO-BARCELO, A DELEGATE IN 
           CONGRESS FROM THE TERRITORY OF PUERTO RICO

    Mr. Romero-Barcelo. Thank you, Mr. Chairman, and we 
appreciate the additional opportunity to review the potential 
for a royalty-in-kind program in the Federal oil and gas 
leasing program.
    We believe that a great deal more analysis and assessment 
is required before we can responsibly determine whether or not 
legislation is required to impose the royalty-in-kind program 
on the Federal Government and the petroleum industry.
    To focus our dialog on this issue, the minority has 
requested that the Congressional Research Service analyze the 
various issues attendant to the royalty-in-kind concept. With 
the agreement of the Chair, I would like to submit for the 
record a September 17 memorandum from the CRS, Congressional 
Research Service, addressing our questions.
    And the CRS report discusses the major issues that would be 
involved in the establishment of a large-scale royalty-in-kind 
program in the United States. In summary, the CRS found, and I 
quote, that ``RIK proponents contend that the system would 
reduce administrative costs and disagreements over the 
valuation of oil and gas production for royalty collections. 
However, such a system also would require an effective system 
for marketing the Federal Government's oil and gas and could 
lead to significant government involvement in oil and gas 
markets.'' As noted previously at our last hearing, our 
experience in Puerto Rico with involvement--involving the 
government in areas of market, marketing areas and private 
business has not been positive. It has been very, very poor 
experience, and we are privatizing again all of those services 
which were made into government services.
    Also, at the Minority's request, we will hear today from 
three highly respected and exceptional individuals who do not 
work in the petroleum industry but who are also very 
knowledgeable on the structure, economics and trends in this 
dynamic sector. Mr. Tim Cohelan, Mr. Ed Rothschild and Ms. 
Danielle Brian each approach this issue from different 
perspectives and will provide the subcommittee with an 
objective and well-informed assessment of the royalty-in-kind 
concept.
    And we commend the Minerals Management Service for taking 
such a positive yet a cautious approach to the royalty-in-kind 
concept in the September 2nd report which we will learn more 
about this afternoon.
    The MMS proposal to conduct a good-sized pilot for natural 
gas in the Gulf of Mexico, built on the lessons learned in the 
1995 effort, should provide quantitative and reliable 
information. Likewise, the proposals for ventures with Wyoming 
and Texas should produce valuable and necessary information.
    And before moving forward with legislation, we need to 
determine that a royalty-in-kind program would be 
administratively feasible and fiscally sound. The detailed 
revenue impact analysis to be conducted by the MMS will assess 
the market risks and costs they would face in this new arena. 
We should allow them the time necessary to analyze the 
advantages and risks before we conclude that royalty-in-kind is 
a better way to more effectively--efficiently collect oil and 
gas royalties.
    Meanwhile, we can and should continue our investigation 
into this area, and it is important that we have a clear 
understanding of the domestic oil and gas industry as it exists 
today, if we are to seriously consider privatizing the Federal 
program.
    Thank you.
    [The prepared statement of Mr. Romero-Barcelo follows:]

 Statement of Hon. Carlos Romero-Barcelo, a Delegate in Congress from 
                      the Territory of Puerto Rico

    Madame Chair, we appreciate the additional opportunity to 
review the potential for a royalty-in-kind program in the 
Federal oil and gas leasing program.
    We believe that a great deal more analysis and assessment 
is required before we can responsibly determine whether or not 
legislation is required to impose a ``royalty-in-kind'' program 
on the Federal Government and the petroleum industry.
    To focus our dialog on this issue, the Minority has 
requested that the Congressional Research Service analyze the 
various issues attendant to the ``royalty-in-kind'' concept. 
With the agreement of the Chair, I would like to submit for the 
Record a September 17 Memorandum from the CRS addressing our 
questions.
    The CRS report discusses the major issues that would be 
involved in the establishment of a large-scale royalty-in-kind 
program in the United States. In summary, the CRS found, and I 
quote, that ``RIK proponents contend that the system would 
reduce administrative costs and disagreements over the 
valuation of oil and gas production for royalty collections. 
However, such a system also would require an effective system 
for marketing the Federal Government's oil and gas and could 
lead to significant government involvement in oil and gas 
markets.'' As noted previously at our last hearing, our 
experience in Puerto Rico with involving the government in 
private business has not been positive.
    Also, at the Minority's request, we will hear today from 
three highly respected and exceptional individuals who do not 
work in the petroleum industry, but, who are also very 
knowledgeable on the structure, economics and trends in this 
dynamic sector. Mr. Tim Cohelan, Mr. Ed Rothschild and Ms. 
Danielle Bryan each approach this issue from different 
perspectives and will provide the Subcommittee with an 
objective and well informed assessment of the royalty-in-kind 
concept.
    We commend the Minerals Management Service for taking such 
a positive yet cautious approach to the ``royalty-in-kind'' 
concept in its September 2 report which we will learn more 
about this afternoon.
    The MMS proposal to conduct a good-sized pilot for natural 
gas in the Gulf of Mexico, built on the lessons learned in the 
1995 effort, should provide quantitative and reliable 
information. Likewise the proposals for joint ventures with 
Wyoming and Texas should produce valuable and necessary 
information.
    Before moving forward with legislation, we need to 
determine that a royalty-in kind program would be 
administratively feasible and fiscally sound. The detailed 
revenue impact analysis to be conducted by the MMS will assess 
the market risks and costs they would face in this new arena. 
We should allow them the time necessary to analyze the 
advantages and risks before we conclude that R-I-K is the 
``better way to more efficiently collect'' oil and gas 
royalties.
    Meanwhile, we can and should continue our investigation 
into this area. It is important that we have a clear 
understanding of the domestic oil and gas industry as it exists 
today, if we are to seriously consider privatizing the Federal 
program.
    Thank you.

    Mr. Thornberry. I thank the gentleman. Now I am going to 
introduce our first panel of witnesses. Mr. William Henderson, 
Market Development Representative, Gulf Canada Resources; 
Danielle Brian, Executive Director, Project on Government 
Oversight; Richard Rorschach, National Chairman, National 
Association of Royalty Owners; Ed Rothschild, Public Affairs 
Director, Citizen Action; Linden Smith, Managing Director, 
Barents Group; Timothy Cohelan, Cohelan & Koury; and Bob 
Neufeld, Vice President, Environmental & Government Relations, 
Wyoming Refining Company.
    I believe all the, the witnesses are at the table. Let me 
remind our witnesses that under the committee rules, they must 
limit their oral statements to 5 minutes but that their entire 
statement will appear in the record. And we also want to allow 
the entire panel to testify, and then we will, we will have our 
questions.
    Mr. Henderson, if you would like to lead off, sir.

      STATEMENT OF WILLIAM HENDERSON, MARKET DEVELOPMENT 
             REPRESENTATIVE, GULF CANADA RESOURCES

    Mr. Henderson. Good afternoon. On behalf of Gulf Canada 
Resources Limited, it is my pleasure to be here this afternoon 
and give you Gulf's thoughts with respect to Alberta's current 
royalty-in-kind process for crude oil. I understand the 
Minerals Management Service is now debating whether to move to 
an in-kind type of system, and I hope my comments will be of 
some benefit to both the service and yourselves.
    Alberta's royalty-in-kind process started in 1974 as a 
result of the energy price shocks in the early seventies 
together with jurisdictional issues involving the Federal 
provincial government over Canada's mineral resources. The in-
kind process has undergone a number of changes throughout the 
years, the most recent being the move toward privatization. 
Previous to June 1996, the Alberta government used the services 
of 100 percent government agency, the Alberta Petroleum 
Marketing Commission, or APMC for short, to market the royalty 
share of crude oil.
    As a result of government funding cutbacks and the general 
desire to get out of the business of being in business, the 
government turned the marketing responsibilities over to three 
agents, Gulf Canada being one of them. The decision to move to 
privatization using agency relationships took over 2 years and 
involved a number of studies and a great deal of industry 
consultation, much the same as you are going through now.
    A number of different alternatives were exampled--or sorry, 
were examined including two variations of a cash royalty 
system. First, royalties would be based on the royalty payer's 
actual cash proceeds of sale. Second, they looked at royalties 
based on a series of reference prices ultimately netted back to 
the field location using the extensive quality and location 
data base maintained by the government. These reference prices 
were to be further adjusted by a market differential obtained 
through pricing surveys of producers. These two options were 
rejected by the government, as we believe that either one 
would, would result in less royalty revenue as compared to the 
in-kind system.
    I should note that it was the first of these two options 
favored by larger industry producers, as these companies were 
very concerned about volume control. Smaller producers 
preferred an in-kind system and were generally--sorry, were 
generally in favor of the status quo. Privatization options 
including bid block sales were also examined but rejected by 
the government due to net back concerns and whether, in fact, 
the government was actually getting out of the sales business.
    Finally, at the end of the review, the government opted on 
retaining the in-kind process using private sector agents to 
market the royalty oil instead of the APMC. Using revenue 
pooling principles, the government would be assured that it was 
receiving the same net backs as its agents while at the same 
time achieving its No. 1 objective of getting out of the sales 
business. With benchmark formulas built into the contracts, the 
government would also be assured the agents were receiving 
market prices for all sales. Also with ownership of the royalty 
volumes staying with the government until point of sale, the 
government could call upon its agents to undertake policy 
initiatives to protect the value of Alberta's resources or in 
making the production and marketing processes more efficient.
    In the decision as to which agents to select, bids were 
solicited and reviewed based on a number of published criteria. 
Although not formally published, I believe one of the 
fundamental criteria was for the government to align itself 
with companies who had the same basic objective as the 
government, to maximize revenue. This is why Canadian producers 
such as Gulf Canada were chosen and large integrateds with 
refining operations, where pipeline companies with marketing 
arms were not.
    The incorporation of the government volumes in the Gulf's 
marketing processes and systems was relatively painless. There 
was a large up-front data load required to get the appropriate 
data into our systems, but this was a one-time process.
    As Crown volumes awarded to Gulf were of similar qualities 
to Gulf's existing volumes, the buyers were the same. The sales 
contracts were easily adjusted or signed. Day-to-day 
operational difficulties have been minimal with the only real 
troublesome spot being royalty volume forecasting. We have seen 
large volume swings between forecast and actual have, have 
resulted in some last minute scrambling, and we are currently 
working with the government to address this problem.
    Gulf believes that both industry and the government have 
benefited from the recent privatization move. Government has 
achieved it is getting out of business objective while keeping 
its revenue streams intact if not enhanced. At the same time, 
it has been able to keep a relatively simple and 
straightforward in-kind process while not increasing 
administrative costs. Industry has benefited as it has not had 
to go through the pain of a major change in royalty systems. In 
fact, other than having to change the name of the organization 
to which reports are directed, there has been absolutely no 
change in industry administration.
    In moving to agency relationships, the government was 
concerned that it would lose its window on market events and 
issues as it had with the APMC. This concern was unfounded, as 
Gulf has been very active in government liaison and maintaining 
the communication channels. For example, we were recently 
partnered with the government in a lengthy regulatory hearing 
regarding the reversal of the strategic Eastern Canadian 
pipeline.
    In terms of benefits to Gulf, the most obvious and direct 
benefit we obtain is the marketing fee attached to the Crown 
barrels. The major indirect benefit is that with larger volume 
control, we are able to provide both the governments and our 
customers with increased service and more flexibility.
    On a final and more subtle note, we are observing a large 
change in the structure of the oil and gas industry throughout 
North America. We see the Shell Texaco, Ashland Marathon and 
other mergers taking place. We see our producing competition 
from the south, Venezuela and Mexico, as huge nationalized 
producers. In order for Alberta to compete, it appears we too 
will have to become bigger. I think the province of Alberta 
realized this when choosing the agents it did.
    Thank you.
    [The prepared statement of Mr. Henderson may be found at 
end of hearing.]
    Mr. Thornberry. Thank you. Ms. Brian.

  STATEMENT OF DANIELLE BRIAN, EXECUTIVE DIRECTOR, PROJECT ON 
                      GOVERNMENT OVERSIGHT

    Ms. Brian. Thank you very much. I ask that my written 
comments are submitted into the record.
    I think it is important for us to sort of step back and 
remember why we are here. The reason we are considering any 
change in the royalty management program is that the government 
has finally recognized, along with other landowners, private 
landowners and states, that we have not been getting enough 
money for the crude that is produced on our land. As a result, 
the MMS finally recognized they needed to make a change, and 
they proposed a new rule in which they would actually be 
collecting more money. Suddenly, as a reaction to that 
suggestion, RIK came up as an idea that industry really wanted 
to pursue, but it absolutely fails to address the reasons why 
landowners have not been able to collect the money that was 
owed to them. It is really simply a diversion tactic from 
focusing on the real problem.
    The reason that we landowners, we American citizen 
landowners, have not been getting enough money for crude 
produced on our land is that there is really no competition at 
the wellhead. As a result, we get the undervalued crude. RIK 
will not change this problem. We start talking about entirely 
different issues leaving the heart of the problem and the 
reason we are all involved in this exercise totally untouched. 
States and private royalty owners, when balancing the 
differences between RIK and being paid in value have chosen to 
go to the NYMEX system.
    Mr. Thornberry, in his opening comments, referred to the 
fact that Texas was interested in RIK a couple of years ago. 
But now that they have really started evaluating the success of 
that system, Texas in their comments to the committee concluded 
the bottom line is that their state in-kind program would not 
exist if royalty payments were based on the market value of 
oil.
    Another example from the states in deciding whether RIK was 
of value to them is when you look at California's success. I 
have four charts showing, actually it is Federal crude in 
California, and when you look at the differences in, in here we 
have at Midway Sunset, the differences between postings and 
RIK, they are getting the same prices. There was no success, no 
added value to going to RIK from postings.
    There are four myths that I want to address in my oral 
statements. The first is the myth that RIK would mean more 
revenue to the government. This was initially industry's 
proposal, this would really be a better thing to do than the 
proposed rule. I have noticed in the last set of comments 
suddenly industry has moved, and now they are saying it is 
revenue neutral. They are no longer trying to claim it is going 
to be a revenue enhancer anymore.
    MMS, in their feasibility study, pointed that out also, 
that when they asked marketers how is government really going 
to come out ahead? How are we going to be making more money? 
The marketers themselves could not give any convincing evidence 
the govern-

ment was going to get anymore money by moving to RIK. These are 
the people who would be doing it, and they said they could not, 
could not explain it.
    I am not opposed to RIK as a concept at all. I am simply 
suggesting that we go in with the pilot programs that MMS is 
already suggesting that we move in. There is really no reason 
to have legislation that would require a nationwide program and 
eliminate the opportunity to actually get paid for the market 
value of our oil.
    The argument also that is being made as to why RIK would be 
better for the government is that we would be reducing the size 
of the MMS. But when you look at the numbers, the entire budget 
of the MMS is $60 million a year, and through their current 
auditing process, which I am the last person to defend, they 
are still making $125 million, and the proposed rule would 
actually, is estimated to increase that revenue by at least 
another $100 million. So if you eliminated MMS entirely through 
going to RIK, we have no government auditors for gas, oil, any 
of the other mineral royalties that they work on, you are still 
going to have to justify $225 million that is coming in through 
a value-based program, and RIK simply cannot do that by itself.
    The other myth that I wanted to dispel is the fear that has 
been spread that independents would be forced to pay the market 
price or the NYMEX price even if they did not receive it. The 
revision to MMS' rule absolutely makes that concern baseless. 
If you see in the rule, they are given the option if an 
independent sells in an arm's-length transaction, they are 
given the option either of paying by, by NYMEX or gross 
proceeds. I was concerned about the independents' plight too, 
actually, and I thought that was really a terribly important 
distinction to make.
    I wanted to just finally say that the argument also that 
the NYMEX does not reflect real prices is really extraordinary 
coming from an industry that uses NYMEX in all of their annual 
statements as a reflection of crude oil prices.
    I am sure it is not lost on you that industry is in favor 
of RIK and opposes the new rule. Of course they are. They are 
interested in their bottom line and not ours. You cannot blame 
them for trying, but we certainly should not let them get away 
with it.
    Thank you.
    [The prepared statement of Ms. Brian may be found at end of 
hearing.]
    Mr. Thornberry. Thank you. Mr. Rorschach.

  STATEMENT OF RICHARD RORSCHACH, NATIONAL CHAIRMAN, NATIONAL 
                 ASSOCIATION OF ROYALTY OWNERS

    Mr. Rorschach. Good afternoon, Chairman Thornberry and 
members of the committee. I am Richard Rorschach. I am an oil 
and gas lawyer from Kilgore, Texas. I am the national chairman 
of National Association of Royalty Owners. I am also the 
managing partner of Pentagon Oil Company which is a minerals 
management company. We own the minerals, and we manage them.
    We are here today to talk about the royalty owners' 
comments concerning the changes to the current cash-based 
collection system and, and maybe to give the committee at least 
insight from, from the royalty owners' standpoint, at least 
the, the owners, private royalty owners' standpoint.
    My organization, NARO, the National Association of Royalty 
Owners, has approximately 5,000 members. We also represent the 
interests of five major indian tribes, the Apache, the Navajo, 
the Sac and Fox, the Osage and the Chickashay--Chickasaw. We 
are dedicated to the needs of the nation's more than 4.5 
million private royalty owners. There is 4.5 million of us 
kicking around this country. A large number of our members are 
over 70 years of age. They rely on their royalty income to 
supplement their Social Security checks. Most of us or many of 
us live in rural areas still. I live on a farm. We have a 
number of farmers and ranchers in our organization. They rely 
on their royalty check during periods of drought in the summer 
and, and bad weather in the wintertime to carry them through. 
The towns around which they live benefit from, from the royalty 
checks that come in, because these royalty owners spend their 
checks, and in fact, an oil country banker has said that 
royalty income is the financial heartbeat of the heartland. So 
you can see that royalty income is very important to the 
members of my organization and to 4.5 million people in this 
country.
    We have wrestled with the problem of posted prices which 
is, is part of the problem for many years, and in recent years, 
the industry has become in disarray about pricing policies. 
Recently has, has been alluded to, there have been a number of 
lawsuits filed, probably the most publicized is the General 
Land Office suit in the state of Texas. However, there have 
been some other class action lawsuits filed throughout the 
country. Now it is apparent to me that as a result of these 
lawsuits that the last few nails are being nailed into the 
coffin of posted prices. We are going to have a new method to 
determine the value on which royalty is calculated. The 
question is what is the best method.
    Well, we think that the best method is one that most easily 
determines the fair market value of the production and which 
generates the least amount of paperwork. Now let us look at a 
couple of things. The Minerals Management Service has about 
61,000 wells on Federal land. Forty six thousand of those wells 
are low volume or marginally producing wells. That accounts for 
about 140,000 barrels of production a day. Now if we overburden 
the producers of these low margin, low margin wells, these low 
volume wells with onerous paperwork, you know what they are 
going to do? They are going to shut those wells in. We are 
going to lose 140,000 barrels of oil a day, and we cannot 
afford to do that.
    I know most of you are familiar with the Commerce 
Department report that stated earlier in the year that imports, 
imported crude oil is, is a threat to our national security. If 
we lose that 140,000 barrels because of onerous paperwork, we 
are going to have to import 140,000 other barrels which, 
according to Commerce Department, is a threat to our national 
security.
    But then, not only that, if all this paperwork is generated 
out in the field, it has got to come to Washington. People in 
Washington have got to look at it. That is going to--I do not 
know how many people. That is--you can remember the old Federal 
Power Commission days if, if some of you remember that, and the 
volumes, the truckloads of paperwork that came into Washington, 
some of which was never even looked at. I do not want to get 
into that situation.
    Now how do we avoid this mass of paperwork and still 
receive a fair market value? Well, the royalty-in-kind may just 
be the answer to this. If we could--and, and I am not talking 
about the Federal Government taking and FISHKA physically 
taking possession of it, because they will think they have to. 
The MMS could set up auctions throughout the various parts of 
the country in which the MMS operates and auction off the crude 
once a month, once every 3 months, whatever, to qualified 
bidders who would--and what would you realize from that? One, 
you would realize the maximum price. At an auction, you are 
going to get the maximum price. The crude oil buyers are going 
to come in there and pay what they need to pay to get what they 
need. Two, you are going to reduce the paperwork. And three, 
you are not going to be required to hire on anymore personnel 
at the MMS.
    Now you have heard the Canadian brother, and Canada 
processes 146,000 barrels of crude oil every day with 33 
people. We have got 950 people in the MMS processing 204,000 
barrels. We ought to be able to do as well as our Canadian 
brothers.
    Our goal in my organization is we want to see the 
establishment of fair, accurate and workable pricing in royalty 
practice--reporting practices to the end that a true value for 
basing royalty calculations can be determined. We in NARO think 
that an RIK program, where feasible, it is not going to be 
feasible in all areas, but in the areas where it is feasible, 
is the way to go.
    That concludes my comments. Thank you for your attention.
    [The prepared statement of Mr. Rorschach may be found at 
end of hearing.]
    Mr. Thornberry. Thank you, sir. Mr. Rothschild.

  STATEMENT OF EDWIN S. ROTHSCHILD, PUBLIC AFFAIRS DIRECTOR, 
                         CITIZEN ACTION

    Mr. Rothschild. Thank you, Mr. Chairman, and we do 
appreciate the opportunity to testify today on RIK.
    Just some observations first, and the most intriguing of 
which is I have been doing energy work, energy policy work on 
the consumer side about 25 years. There are some people in the 
audience that know that quite well. And in all that time, 
there, all the time that MMS has been operating, all that time 
we have had Federal leases, there has been no charge or 
interest in moving to an RIK system. I think that only after 
the states particularly started suing oil companies for 
underpayment, and as a result settling as they have in Texas to 
pay on the basis of market prices based upon NYMEX prices, and 
that the MMS has suggested similar types of pricing, that all 
of a sudden, RIK--importance.
    Now if the industry is so interested in RIK, then I have to 
say well, is this going to be good for the government? And the 
bottom line I think as a government official, as people working 
to protect the fiduciary responsibility of protecting the 
public's interest, the bottom line is simply which system or 
group of systems or combination of systems will generate fair 
market value for the public, for the U.S. Treasury. Not for 
royalty owners or private royalty owners, not for oil companies 
or gas producers or oil producers. They, they will pursue their 
own interests. The job is to protect U.S. Treasury and the 
public's interest.
    So what does that mean? Does that mean we should absolutely 
go mandatory RIK? Absolutely not. I do not think, from the 
evidence that I have seen, that an RIK program would fit 
everywhere. This is not a one-size-fits-all policy, and we 
should not go in that direction.
    Now does that mean that RIK will not work in some areas? It 
may very well. I think there was, as Mr. Chairman you 
mentioned, a test. Was not a very good one. You are absolutely 
right. They had a lot of learning to do, and I think they have 
learned some lessons from that test. But we need a few more 
tests. This may very well work with respect to offshore natural 
gas, and if it does, if it is the best program to use for 
offshore natural gas, we should use it.
    I also suspect, however, that it will not be that good for 
oil, particularly offshore oil. And there, I turn your 
attention to some of the tables in the testimony I have 
submitted. You can see the fact that there has been a severe 
decline in the number of oil producers, that the largest 
producers have remained stable over time, that the eight 
largest companies, you know, have been the eight largest 
companies for a long time, that the amount of U.S. production 
has remained fairly stable at or near 70 percent, and that they 
are the largest royalty payers on Federal land, the top 10 
companies accounting in 1996 for 61 percent of oil royalties, 
which is not true on the natural gas side, where they only 
account for 42 percent of the royalties paid.
    Secondly, in many cases, your transactions that occur with 
respect to oil, we see that there are not arms-length 
transactions, that there is no real competition for those 
sales. And that would put a very great burden on whether the 
government or some marketing outfit that the government hires 
tries to sell that oil. It is not likely to work. And so I do 
not think an RIK program in that situation makes a great deal 
of sense if you are not going to be able to assure that it is 
going to be a competitive price. And I think that has got to be 
the bottom line, and we heard the idea about an auction. An 
auction would be very nice, but if there is a single pipeline, 
if that pipeline is owned by the production company on the, on 
the lease, you have all sorts of structural problems, and if 
you do not really resolve those and account for those and deal 
with those, this kind of program is not going to work.
    So the--I would point out also that the industry has made a 
great issue about the costs of marketing oil or gas. And I 
suspect those are, in most cases, fictitious. The--in their 
comments and response to questions from the committee, I point 
out that Texas, I think, said very clearly that in general, our 
leases require the lessee to deliver the product without 
deduction for the cost of producing, gathering, storing, 
separating, treating, dehydrating, compressing, processing, 
transporting and otherwise making the product ready for sale or 
use. That is what they do. That is what they have done clearly 
in all of these leases, and it seems to me that that ought to 
continue, that that is the job of the companies taking the oil 
from the lease.
    Mr. Chairman, I will be happy to stop there and be willing 
to answer any questions.
    [The prepared statement of Mr. Rothschild may be found at 
end of hearing.]
    Mr. Thornberry. Thank you. A vote has just started, but I 
believe, Mr. Smith, if you would like to proceed, we will have 
time to do your testimony, and then we will probably have to go 
vote on an amendment on the floor.

  STATEMENT OF LINDEN SMITH, MANAGING DIRECTOR, BARENTS GROUP

    Mr. Smith. OK, thank you. My name is Lin Smith, and I am a 
managing director of Barents Group LLC, a KPMG Company. I lead 
the firm's legislative and regulatory policy economics 
practice, and I am appearing today on behalf of 21 industry 
trade associations listed in my written statement. These 
associations represent producers of essentially all the oil and 
gas produced in the U.S.
    I am here today to discuss how a permanent royalty-in-kind 
program can provide a net benefit to the Federal Government, 
the states and lessees, and specifically, to focus on some of 
the Federal policy and budgetary implications of an RIK 
program. Clearly, any serious legislative alternative will need 
to be scored CBO as being at least revenue neutral.
    Several broad principles are important to keep in mind when 
considering a well-designed Federal royalty system. Some are 
basic to good government policy while others are specific to 
the Federal royalty area. I will raise just a few of these now, 
but I encourage you to read my written testimony.
    First, it needs to be market driven. Paying royalties on 
fair market value is the principle that all parties in the 
debate accept. The issue is how to measure it. The most 
accurate measure of market value will be based on arm's-length 
prices actually received.
    Second, it recognizes that value is added after oil and gas 
is produced. Various steps and processes are required to 
deliver crude oil and natural gas to its final destination that 
add value to the product. Adding value requires investment, 
results in cost and necessitates a market rate of return. It is 
no more appropriate to impose royalties on costs downstream of 
the lease, including downstream marketing costs, than it is to 
impose royalties on the cost of operating a gasoline station. 
Both add value to the product. Neither requires investment by 
the lessor. Neither is related to the lessor's mineral rights.
    Third, it is perceived by all parties as providing fairness 
and equity to the Federal Government, state governments, 
producers, operators, marketers and refiners. If some parties 
do not believe they are being treated fairly, the credibility 
of the system will suffer, compliance will be reduced, 
investment and production will fall and the approach will have 
failed.
    Fourth, it avoids economic distortion. Any government 
mandated approach that produces an inappropriate royalty value 
will distort investment and production decisions. This could 
occur if the effective royalty rate exceeds the contractual 
royalty rate with the use of a methodology that overstates 
market value.
    Because it is market based, an RIK program at or near the 
lease meets each of these policy objectives. That is, by being 
responsive to market-driven changes and prices, it will capture 
the full value for Federal royalty purposes without a 
government induced distortion in investment choices.
    Because the committee is not yet considering specific 
legislation, it is impossible to draw any firm conclusions 
about Federal budget effects other than to observe that the 
ultimate design matters greatly in achieving revenue 
neutrality. I would now like to mention a few of the more 
important design issues that matter for scorekeeping purposes.
    First, does the proposal change current law? If legislation 
simply provides additional options to MMS, it is unlikely to be 
scored by CBO.
    Second, will the RIK program be mandatory or voluntary? 
Scorekeepers are unlikely to score a voluntary program where 
MMS can choose which production to take in kind, because it can 
largely do that without legislation. They would likely score 
legislation allowing lessees to choose the RIK leases as 
causing a revenue loss. A well-designed, mandatory system 
avoids both results and would be scored.
    Third, does the program create value for the Federal 
Government? Additional value can be created in a variety of 
ways, including allowing greater volumes to be aggregated, 
capturing a share of the value added by moving production 
downstream and capturing the benefits from increased 
competition. If these can be quantified by the scorekeepers, 
they will be scored.
    Fourth, how will pipeline transportation costs be 
determine? Oil pipeline tariff rules are in a state of flux, 
and that makes it difficult for the scorekeepers to develop a 
current law budget baseline.
    All I can say today is that the revenue impact of this 
issue is far from clear, and CBO must develop an official 
position on current law. Until we reach that point, the 
committee should carefully consider its policy objectives and 
work with CBO to see how they will score the issue. It is 
premature to simply conclude that pipeline transportation 
charges will result in a revenue loss.
    I would like to make two other quick observations. The 
committee should focus on the net revenue impact of the 
comprehensive program. Any legislation will likely include 
revenue raising and losing provisions. Simply observing that 
one feature causes a revenue loss is not by itself a problem. A 
budget problem occurs only if aggregate losses exceed aggregate 
gains.
    The other point is administrative cost savings will benefit 
both the U.S. and the states. Half the onshore oil and gas 
program cost savings under an RIK program will be shared with 
the states. Costs are minimized by a program that applies 
uniformly to all production. The states would get no cost 
reduction benefit from an RIK program just in the OCS.
    In conclusion, a well-designed, mandatory RIK program has 
significant potential to increase economic efficiency, maintain 
Federal and state revenues, reduce controversy and be regarded 
as a fair approach for the Federal and state governments, 
lessees and the nation's taxpayers. It is possible for the 
committee to design an RIK program that applies to all 
production on Federal lands, onshore and offshore, for oil and 
for gas, it is in the aggregate at least revenue neutral.
    Thank you.
    [The prepared statement of Mr. Smith may be found at end of 
hearing.]
    Mr. Thornberry. Thank you, sir. And if--the Subcommittee 
will stand in recess while we go vote right quick. This is a 
vote on Murtha-Tauzin amendment, and we should be back shortly.
    [Recess.]
    Mrs. Cubin. This Subcommittee will come to order. I 
apologize for not being here. We always have conflicts while we 
are trying to do work the last few weeks of the session, so I 
do appreciate all of you being here. Thank you for your 
testimony for those of you who have already given your 
testimony, and I would like to call on Timothy Cohelan to give 
us his testimony at this time.

     STATEMENT OF TIMOTHY COHELAN, ESQUIRE, COHELAN & KOURY

    Mr. Cohelan. Thank you very much, Madam Chairman. Today I 
would like to focus in a general sense by way of background on 
the concerns that, that I have identified based upon my 
observations of the upstream and downstream markets. It appears 
that the, the deliberations and the discussion concerning the 
propriety of this RIK system is appearing in a series of market 
shifts that make it more difficult to, to analyze. It appears 
that again looking at California there has been a substantial 
consolidation of the downstream, that is from the refinery 
level to the street. Those trends basically include the 
consolidation of refinery ownership, the, the use of supply and 
exchange agreements and term sales in a way that has the effect 
of balancing off crude oil capacity as against market share.
    And finally, there is a relationship with branding and 
branded marketing that as we sit here today has resulted in 
California in 95 percent of the motor gasoline being sold 
through seven or eight entities. There is a merger pending 
between the Shell and Texaco downstream operations that would 
mean seven. So we have a substantial consolidation of the 
entities that would be in the marketplace to purchase crude 
oil.
    California's experience, I understand, is, is one that, 
that is, is similar in overall trends to that nationally. There 
is a national trend apparent to move toward refinery 
rationalization. Refinery rationalization as a process is one 
in which surplus refining capacity is generally aligned in a 
closer manner with the downstream markets. To the extent that 
this particular condition continues in the United States as a 
whole, it has implications for the marketing of crude oil.
    In California, again returning to California, there has 
been an additional concentration of upstream. Upstream again 
are the, are the producing, producing properties both offshore 
and domestic. The ownership, as I think I mentioned in my, in 
my statements, the ownership mergers of upstream producing 
properties are going to result very soon in about 60 percent of 
the crude oil produced in California being marketed by just 
three companies.
    Our unique situation in California may also apply in the 
sense that our crude oil reaches the markets. Again, the 
markets are primarily these refineries and are fewer of them. 
Basically, what happens is that the refineries will buy 
domestic and Alaska North Slope crude oil for use in refining 
and manufacturing gasoline for sale. The decisions that are 
going to be made in California then are going to be made by 
those refineries. They are going to be--to the extent there is 
going to be fewer of them in the Northern and Southern 
California marketplaces, and to the extent that there is common 
ownership, it is going to be less of a competitive market. 
Well, that has a lot of implications for, for anyone that is 
talking about attempting to use a market mechanism, because 
when you look at a market mechanism as a substitute for 
something that seems to be working now, you got to ask yourself 
how many sellers there are and how many buyers there are, how 
they interact and what you are going to use to assign a value 
to that.
    Basically, in California again on the downstream basis, we 
have what the economists call an oligopoly. That is a small 
number of sellers in a market. We have had, in my opinion, 
there have been anticompetitive characteristics that will be 
discussed in a civil action in, in the California court system. 
But the implication is that the decisionmaking for crude oil 
domestically in these markets will be made in a different way 
than it has been in the past. There are simply fewer refiners 
to participate in this market. All of our small refiners in 
California have been unable to make the conversions to 
manufacture motor gasoline, and so they are either providing 
feed stocks in some limited situations for other refiners, or 
they are entirely out of business, such as the Power Refinery 
which could not start.
    So the larger companies, the larger manufacturers with the, 
with the larger refineries are in a position now where they 
make all those decisions, and their purchasing agents for crude 
oil are the ones, the traders that will be making these very 
important decisions with regard to what prices are paid. On 
natural gas, I would suggest that what I have read and, and 
learned from the regulatory authorities in California is that 
that is a different marketplace. There may be things about the 
commingling nature of, of natural gas royalties that make it a 
fairer measure. There is apparently other interactions in 
market centers that have been established that may make that a 
better candidate for some kind of an RIK approach.
    But I would like to, if nothing else, point out how 
dangerous I think it might be to adopt a national, a national 
policy without looking at the implications in local markets. 
The second major point I would like to make is you are talking 
about a moving target. Every day there are new mergers 
downstream and upstream, and the marketplaces in which you are 
going to place the government under such a program is changing 
drastically. And finally, your review, in my humble opinion, 
should be done with your fiduciary duty hat on, and you ought 
to have very substantial and compelling reasons that the 
taxpayers and the, and the people who are ultimately receiving 
this benefit are going to be better off as a policy, and we 
ought to go a little farther than just identifying 
administrative burden.
    Thank you very much for inviting me here today, and I will 
be available for questioning.
    [The prepared statement of Mr. Cohelan may be found at end 
of hearing.]
    Mrs. Cubin. Thank you for your testimony. I would like to 
welcome Mr. Neufeld from my home state of Wyoming and ask if 
you would please present us your testimony now.

    STATEMENT OF BOB NEUFELD, VICE PRESIDENT, ENVIRONMENT & 
         GOVERNMENT RELATIONS, WYOMING REFINING COMPANY

    Mr. Neufeld. Thank you, Madam Chairman, members of the 
Committee. My name is Bob Neufeld. I am the Vice President of 
Environment & Governmental Relations for Wyoming Refining 
Company. I am here today because I want to tell the committee 
about how the Minerals Management Service is driving my company 
toward bankruptcy, is inflicting serious damage on other small 
refiners in the country and is destroying a Congressionally 
authorized program that has been operating successfully since 
1946.
    I think the committee would like to hear what I have to 
say, because our experience with the Minerals Management 
Service and the currently authorized small refiner royalty-in-
kind program will shed some new perspective on why 20/20 
hindsight, armchair quarterbacking, second-guessing and post-
hoc valuations have no place in the determination of the value 
of Federal crude oil and will lead you to the common sense 
conclusion that the only fair and equitable way to really know 
that you are getting market value for your oil is to market the 
oil.
    Wyoming Refining Company is a small 12,500 barrel a day 
refinery in Newcastle, Wyoming. We are, nevertheless, the 
largest private employer in Weston County, Wyoming. We provide 
about 50 percent of the motor fuel supply for the Black Hills 
region of Wyoming and South Dakota, and over the last, I would 
say, 10 years or longer, we have provided about 90 percent of 
the jet fuel supply for Ellsworth Air Force Base in Rapid City, 
South Dakota. Our demise would have serious implications for 
that region of the country in terms of availability of refined 
motor fuel products and possibly national defense implications 
as well.
    The royalty-in-kind program in which we participate was 
authorized by Congress in 1946, and it operates this way. When 
the Secretary of Interior determines that adequate supplies of 
crude oil are not available to small refiners, the royalty is 
taken in-kind from select leases and sold to small refiners. 
And historically, that has been at prices reported by the 
producer. The purpose of this is to be sure that large, 
vertically integrated oil companies do not have exclusive 
access to Federal crude oil and that small refiners are around 
to provide a stable supply of national defense fuel supplies.
    We have been in the program since about 1980, and 
historically over the last 10 years, it has provided about 40 
percent of our crude oil supply. And everything was fine until 
1995, when we got a demand letter from the Minerals Management 
Service that said we have audited the producer, we think the 
producer has undervalued the oil that we sold you between 1987 
and 1992, (that is as much as 8 years prior to the letter) and 
because the producer, we think, undervalued the oil, you owe us 
another $2.5 million.
    We could not understand how we could owe $2.5 million for 
somebody else's alleged mistake, and we filed an appeal bond to 
appeal the matter to the Minerals Management Service director. 
The--we have subsequently learned that other leases from which 
we purchase royalty oil are under review and that at the 
present count, we may owe another $4.5 million. Our banks have 
told us that if that letter, demand letter issues, we will be 
taken involuntarily into bankruptcy.
    The lessons to be learned from this are threefold. No. 1, 
we think the damage that is being done is that the Minerals 
Management Service has denied us our opportunity to cancel the 
contract. When we receive a delivery of oil, and then the 
invoice comes 45 days later, we have to pay for that oil, but 
if we do not like the price, we can cancel future deliveries. 
But if we do not find out what the real price of the oil is 
going to be until 8 years after the delivery, we have no chance 
to cancel those deliveries. They forced us to purchase oil. 
Their position is they can force us to purchase oil we would 
not otherwise purchase, and in fact, we would have refused 
delivery on.
    Secondly, and it is what is most egregious about this, is 
that we have evidence, and it is clear from the case against 
the producer, that MMS suspected the prices that it was billing 
us for on this oil were incorrect as early as 2--1 year into 
our audit period, as early as early 1988 or 1990--1989, excuse 
me. Nevertheless, even though they suspected that the prices 
that the producer were reporting might be incorrect, they 
continued to repeat those prices in our invoice and continued 
to sell us oil. In other words, they stood back and watched us 
continue to buy this oil when they should have known that it 
was increasing our contingent liability and our exposure under 
a future audit of the producer.
    And third, and this one is almost as egregious as the 
second, is that we spent somewhere in the neighborhood of 
$250,000, which is a big amount for a company of 95 employees, 
trying to defend the producer's valuations in this matter. MMS 
has said: It does not matter what your evidence is. We had a 
case over here with the producer where we did the audit, and 
that is where we determined what the value is, and we are going 
to bind you to it. So apparently, MMS has determined that there 
is, in fact, an exemption to the due process clause of the 
Constitution for small refiners who are allowed to unknowingly 
purchase oil that they could not afford and would not have 
otherwise purchased.
    My conclusion is that we think that MMS is confused as to 
whether or not it is selling oil or collecting royalty, and it 
cannot do both. If it is going to sell oil, it has to do it in 
an arm's-length transaction. That is not what is happening 
here. Every purchase that we make under this program is a 
contingent liability. There must be some finality in the price 
of oil when it is sold. You cannot go on for ever and ever 
knowing that, not knowing what the price is going to be. The 
consequences go beyond the producers. It goes to our consumers 
and to our employees. And again, I would remind you that the 
only way--we feel that the only way to know what the market 
value of the oil is is to take the oil and market it.
    Madam Chairman, one final comment. I would like to say that 
Gary-Williams Refining, Age Refining of Texas, Placid Refining 
of, of Texas and Louisiana and Giant Industries have authorized 
me to say they concur in my remarks and have added, given me 
some additional testimony statement that they would like to 
have submitted to the record.
    [The prepared statement of Mr. Neufeld may be found at end 
of hearing.]
    Mrs. Cubin. Without objection, it will be so ordered.
    I thank the panel for their testimony, and now we will go 
to the questioning portion of the hearing. I want to remind the 
members that according to the Committee Rule 3(c), we have a 5-
minute limit on our questioning and ask that they will hold to 
that as much as they can, and then if their questions are not 
all asked and answered, and members want a second round of 
questioning, then we will grant that as well.
    So to begin questioning, I will call on the Ranking Member, 
Mr. Romero-Barcelo.
    Mr. Romero-Barcelo. Thank you, Madam Chair. I thank the 
panel for their testimony and for helping us try to figure out 
something, what is the best that we can do as far as the--and 
the states are concerned. And I believe that each one of you 
would agree that even though there, while there are many 
benefits associated with going to a royalty-in-kind program, 
that there are also risks that must be recognized and which 
should be resolved before implementing such a radical change. 
And which one would each, each of you believe it to be the 
greatest risk associated with a national in-kind program? And 
can we go from left to right and start over here?
    Mr. Henderson. I am sorry, your question was?
    Mr. Romero-Barcelo. Which do you believe that the greatest 
risk that would be associated with, in a national in-kind, a 
royalty-in-kind program? Or, or maybe you do not accept that 
there are any risks at all. If you do, which one you think is 
the greatest risk?
    Mr. Henderson. I, I cannot speak from, from the U.S. 
perspective, and I can just give you an indication of what I 
saw happen in Canada over the last 3 years. One of the biggest 
concerns that the, the government had in, in maintaining the 
in-kind system was in fact that it was not achieving market 
value for its crude. I think from that perspective, that is why 
it went to an agency basis and the pooling of revenue concept 
so that would, in fact, ensure that it was receiving market 
value. Together with our contracts, they have benchmarks built 
in to, to test against market, general market prices.
    Mr. Romero-Barcelo. Thank you. Ms. Brian.
    Ms. Brian. I think that is similar to my comment. I think 
that by far the biggest risk is that we would then think we 
fixed the problem and moved on, and we in fact would not have 
done anything toward fixing the problem in the government 
getting market value for its crude.
    Mr. Romero-Barcelo. Thank you, Ms. Brian. Mr. Rorschach.
    Mr. Rorschach. I, I do not, I do not see any very big 
risks. The only, only problem I see is in some areas, and I am 
not familiar with, with Federal leases, in small Federal 
leases, if there are such thing, that it might, a royalty-in-
kind program might be a problem, because it would be very 
difficult to, to aggregate crude so it could be taken in-kind. 
In large leases, no problem there at all. So the only, only 
problem or a risk, if you want to call it that, would be in, in 
small leases, small in area.
    Mr. Romero-Barcelo. Thank you, Mr. Rorschach. Mr. 
Rothschild.
    Mr. Rothschild. I think it is the problem of having one 
shoe fitting all sizes, and I think the, as my testimony made 
clear, while an royalty-in-kind program may be appropriate, may 
work well in some areas, it may be horrible in others. And 
therefore, I think the idea of having a mandatory program is 
inappropriate, and I think a structured program that applies it 
in the right places and not in the wrong places probably makes 
more sense.
    And second, I think the irony here is all of a sudden we 
are, you know, we are trying to get the government out of the 
oil business, as we are in selling off Naval petroleum 
reserves, and all of a sudden here, a national program, if it 
is mandatory, would put the government in a, in a huge way into 
the oil business, and I think you got to consider that as well.
    Mr. Romero-Barcelo. Thank you, Mr. Rothschild. Mr. Smith.
    Mr. Smith. Thank you. My, my reaction would be that I would 
be concerned if we moved too quickly without giving 
consideration to the operational design of the program. There 
are an awful lot of details that must be addressed in looking 
at this kind of program that need to be worked through very 
carefully, and I would view this as something where the MMS and 
industry and the committee have to work together to get these 
details right. I think that if that cooperation exists and that 
willingness to work together exists that we can come up with a 
workable program, but the risk is one of, of moving too fast or 
not working on, together with good faith to try to resolve 
these many issues that, in fact, do have to be considered 
carefully.
    Mr. Romero-Barcelo. Thank you, Mr. Smith. Mr. Cohelan.
    Mr. Cohelan. Yes, very briefly, I think the, the major risk 
is that there would be a substantial revenue loss. The revenue 
loss would then require continued public discussion. Continued 
public discussion would revisit. There would be new hearings. 
There would be a re-examination. Following up on what Mr. Smith 
said, if the appropriate time and consideration is given, 
given, including but not limited to the differences in 
geographic markets and the hardship cases that you are hearing 
about here today, then I think you can minimize that. But a 
revenue loss by a precipitous enactment of a national mandatory 
RIK is something that would just occasion a continued debate by 
the representatives of the public and so on.
    The fact that there is a dispute today is a function of 
their disagreement over valuation. We all like to see disputes 
minimized. We have a civilized society and a good governmental 
structure where we resolve disputes in a focused and 
intelligent way, and our system of government is better at it 
than any other. We should not run away from this just because 
there is disputes. There should be--hard cases generally make 
bad law. Somebody ought to be looking at, at the administrative 
processes and problems that somebody like Mr. Neufeld is having 
and then make a determination whether you have a sufficient 
degree of administrative relief in the system. But when you 
look at 140,000 barrels a day as an example of national 
production, and then you look at a small refinery as a, as a 
focal point for a description of a very large problem, what you 
really want to do is, is help those people in, in their 
individual circumstances and assist them in a systematic way 
that does not require you to re-engineer the whole system.
    Mr. Romero-Barcelo. Thank you, Mr.--Mr. Neufeld.
    Mr. Neufeld. From the other side of the fence as a 
purchaser of the crude oil, we cannot see any risks in an RIK 
program that match the risks involved in the current policy of 
deliver and reprice. We would like to be sure, however, that 
small refiners continue to have an equal opportunity to compete 
for the oil and perhaps a right of first refusal in which the 
best price, if it is put up for bid, the small refiner has an 
opportunity to match that price and purchase it at the same 
price as the winner.
    Mr. Romero-Barcelo. Thank you very much.
    Mrs. Cubin. You want to go last? Mr. Duncan, are you 
prepared at this time to ask questions?
    Mr. Duncan. Well, I will tell you, I know the least about 
this of anybody here, but what I want to ask is this. I am--and 
I did not get to hear all of the testimony. But I see that Mr. 
Rorschach said in his testimony today the average Mom and Pop 
business in the oil field is the operation of marginally 
producing or low-volume wells. These operators are now totally 
over their heads with regulations and Federal environmental 
requirements. And I guess my question is are we, are we heading 
in a direction toward more regulations and more paperwork? Is 
that what you are concerned about?
    Mr. Rorschach. Yes, sir. If, if you go to, if you go to a 
system that is going to require more and more reporting to--and 
my, my thing is if you go to an, an RIK program, you are going 
to get rid of just practically all the reporting that you would 
have that would be required by another system.
    Mr. Duncan. If, if we go to a royalty-in-kind program, you, 
you think that we could do away with a lot of the paperwork? Is 
that what you are saying?
    Mr. Rorschach. I do not think there is any question about 
it.
    Mr. Duncan. And, and----
    Mr. Rorschach. As opposed to some, some of the, as opposed 
to some of the methods that are currently proposed in the 
proposed rules.
    Mr. Duncan. And that would, and that would help the small 
businesses in this----
    Mr. Rorschach. I--as I said in my testimony, I think if 
you, if you put anymore burden on, on the, on the marginal well 
operators, they are just going to shut them in, turn them to 
the right and walk away.
    Mr. Duncan. When I see your testimony that you are over 
your head with the environmental requirements, it seems to me 
that these environmental extremists have become the greatest 
ally to extremely big business. And, and they are doing 
terrible harm to small businesses. And, and I would like to see 
us provide more assistance to the small businesses, and so I, I 
like your testimony.
    Mr. Rorschach. Thank you.
    Mr. Duncan. Thank you.
    Ms. Brian. Mr. Duncan, could I, could I----
    Mr. Duncan. Thank you, Madam Chair.
    Ms. Brian. [continuing] could I make one comment on, on Mr. 
Duncan's question please?
    Mrs. Cubin. Certainly.
    Ms. Brian. Thank you. I just wanted to clarify one point. 
The--what we are talking about is RIK on Federal leases. It is 
really not going to have anything to do with the landowners 
that we are talking about who are suffering. What we are 
talking about here is RIK on, on Federal crude.
    And the second point is that, that what we are talking 
about is an alternative to the current system that everyone 
hates, going to a NYMEX system which is publicly disclosed 
every day where we would have less dispute over value, because 
we would have the market telling all of us when we open the 
paper exactly what we are talking about, so it would actually 
be resulting in less paperwork.
    Mr. Rorschach. If I might respond just briefly, you are 
talking about--we--I understand you are talking about Federal 
leases. It has been my experience, and I have been around this 
oil patch for 35 years, that anytime a Federal program gets 
initiated before very long, that camel's nose is into the 
private owner's tent. And we want to prevent that if we can.
    Mr. Duncan. Well, all I have noticed is that the more you 
regulate an industry, and the more paperwork you require, the 
more it ends up in the hands of a few big giants. And I do not 
care what the industry is. It, it happens in everything and, 
and if we go in the direction of more and more regulation and 
more and more paperwork and more and more red tape, and we have 
gone way overboard on some of these environmental regulations, 
as you point out in your testimony, and if we keep going in 
that direction, we are going to drive all the small guys out of 
any of these major industries. And I will tell you, we are 
going to be really sorry if we do that.
    Mr. Neufeld. Madam Chairman----
    Mr. Rorschach. I think you and I are looking through the 
same knothole.
    Mr. Duncan. Thank you. That is all.
    Mr. Neufeld. Madam Chairman, I, I might have an additional 
perspective to add to that if I might--over here on the end. As 
a person who buys Federal crude oil, we found that the process 
of purchasing Federal crude oil under the current system is 
much more complicated than our ordinary purchases. And anything 
that makes it as simple to buy Federal royalty oil as ordinary 
purchases will be worthwhile and an improvement. I am beginning 
to think, after our current experience with the Minerals 
Management Service, that EPA is like a walk in the park, 
frankly.
    Mr. Rothschild. Madam Chairman, could I just add one thing?
    Mrs. Cubin. As long as that light is green, you----
    Mr. Rothschild. OK.
    Mrs. Cubin. [continuing] you all can have this day. I am 
going to ask you, Mr. Smith, as well, as long as that light is 
green, we are still on Mr. Duncan's time.
    Mr. Rothschild. In Mr. Rorschach's comments, he pointed out 
that the posted price was too low. That is one of the problems 
that has been occurring in the industry, and the question I 
would have is why that happened. And our view of it is that if 
you do not have very much competition in the industry, he may 
want to explain that. Second, it was the state of Texas, for 
example, instead of California, instead of Alaska, that 
intervened on behalf of, and particularly in Texas, on behalf 
of all the royalty owners, the state and the private royalty 
owners, to collect underpayments. So you know, I am very 
intrigued, and I am also intrigued by Wyoming Refining, you 
know. Here we have a program that is a government effect, a 
government subsidy for small refiners, not one that I would 
dispute. But that is what it is, because it keeps them in 
business.
    So on the one hand, you do have the government playing a 
positive role. On the other one, I can understand why he is 
upset about what has happened. But we ought to keep in mind 
that the reason that the government program is there is to be 
able to get crude to his company which he says is as much as 40 
percent of his usage.
    Unidentified Speaker. I will dispute the--comment.
    Mrs. Cubin. However, he could have, he could have not 
purchased that oil and would have not purchased that oil----
    Mr. Rothschild. I understand that.
    Mrs. Cubin. [continuing] had MMS given them any, any 
indication that this might be the end result. I just have to 
add that in trying to be impartial here.
    Mr. John.
    Mr. John. Thank you, Madam Chairman. I, I want to, I want 
to thank the, the committee and the subcommittee for 
undertaking this debate, because I think it is very important. 
I think everybody in this room today, as I look across the 
audience, believe that, that the system that we have in place 
is, is somewhat burdensome, cumbersome and full of paperwork. 
And I think that the bottom line, as we were discussing here, 
is to balance the risk versus the benefits of changing the 
system.
    Ms. Brian was pretty definitive in her remarks about and 
her opposition to an RIK program. And Mr.--the gentleman from 
Puerto Rico asked her, asked Ms. Brian what do you feel this is 
obviously the, the biggest risk, and you said getting the fair 
market value of it, of our crude and making sure that the 
Federal and the state governments are getting the best price 
that they possibly can. Do you feel that the system intact 
today does that?
    Ms. Brian. Oh, no, no. First I would like to say I, I 
specifically was not definitive in my opening statements. I 
hope I did not make that point or appear to be definitively 
opposed to RIK. I am definitively opposed to a nationwide RIK 
program. I think, for example, in Wyoming, it sounds before 
this hearing, I have understood that there really are a lot of 
reasons why maybe Wyoming would be a great pilot program. So I 
am not in any way opposed on principle to RIK at all. My 
concern is this, this absolute, nationwide, mandatory program.
    But what I certainly would never do, and I have spent the 
last 3 or 4 years actually attacking, is defend the current 
system. I have four reports that we have written showing how 
the current system has failed and how the Federal Government 
alone has been owed as much as $3 billion that has not been 
collected because of the fact that Federal crude has been 
undervalued.
    So what we really do believe, however, is that the 
appropriate response is what MMS is proposing. And I frankly 
find it remarkable that I am here saying that, but I think that 
by moving to a market-based valuation system, where we do not 
have an arbitrary posting, which is what we exist with now, 
that is made up. It is not in fact the value of the crude that 
we are getting paid on. If you have a NYMEX or something based 
on the NYMEX, and you take into account the transportation 
costs, which is absolutely reasonable. This calculation has 
been used before and would go on under an RIK program too. That 
would simplify things. We would have an open price that 
everyone would know what it was. It would not be under dispute. 
And then we would be getting towards collecting the money that 
is owed to us.
    Mr. John. Would you agree that the best possible price is 
the actual price at which you could get for that crude?
    Ms. Brian. Not the price the Federal Government has been 
getting. It certainly is not the best possible price, no.
    Mr. John. Well, I think--well, I just believe that we need 
to proceed carefully and slowly, and I think that was 
reiterated through the panel today, about looking at this. My 
state of Louisiana has lots of interest in what is happening 
here. My district is oil and gas and dependent on that 
industry. So I am, I am taking a look at this and, and making 
sure that we do just the right thing. And, and I along with Mr. 
Duncan just believe that we can make it more simple, more--less 
litigious. In a lot of the, the situations that we run into, we 
are in court battling over the, the prices and, and the well 
and the wellhead and arm's-length and, and all of the other 
litigation that happens with it. I think that the, the RIK 
program has some merit, and I think we need to move forward on 
it.
    Mrs. Cubin. Thank you, Mr. John. Mr. Thornberry.
    Mr. Thornberry. Mr. Smith, let me start with you. You did 
not really get into this much in your testimony, but you have 
had considerable experience in the government in estimating the 
revenue effects of, of different things that the Federal 
Government has done and, and your testimony, I think, as a 
matter of fact, you are as qualified as anybody outside of 
government to, to look at these things. Your testimony said 
that it all depends on how the program is written on, on the 
revenue coming back into the government. But I wanted to ask 
you, if it is done, is there anything that you have seen in 
what you have looked at that says that there is no way to 
develop an RIK program that will not be at least revenue 
neutral. I mean is there any impediment that is just going to 
prevent that from happening? That you have seen.
    Mr. Smith. I think--oh, I am sorry. Well, first of all, 
before--one thing I would like to add, I am here representing 
now 22 associations. The Louisiana Independent Oil and Gas 
Association has signed on to this as well, and I just wanted to 
get that in the record.
    In terms of impediments, no, I do not believe there is any 
impediments to a revenue neutral program being designed as long 
as it is carefully considered, and the budget scorekeeping 
effects of specific decisions are taken into account. Can you 
design an RIK program that loses money? Absolutely you can 
design one that loses money. Can you avoid having one that 
loses money by, loses money by carefully designing it? Yes, you 
can, as you can come up with a program that does accomplish 
your objectives of being at least revenue neutral through 
careful design and consideration of its features.
    Mr. Thornberry. Thank you. Now you have heard a great deal 
of discussion from just about every member of the panel today 
about how difficult it is to figure out what the market price 
of, of oil or gas is. And you have heard everything from the 
government coming back 8 years later, or whatever it was, to 
say that is really not what the price was. You have heard the 
difficulties of some people allege that we have not gotten 
nearly as much as we should have in the past. All of these 
disputes about the market price. Can you tell me what would be 
better to figure out the market price of it than actually the 
market itself?
    Mr. Smith. I do not think there is anything that is better 
than the market itself. That is if we look at an RIK program 
where a significant share of production, in this case one-
eighth of onshore production, one-sixth of offshore production, 
is taken in-kind, we are going to have a large new supply 
thrown out to the marketplace up for bid. And that bidding 
process is going to result in a determination of, in fact, a 
fair market value price. And so I think this is exactly the 
kind of direction we want to go in to come up with the correct 
measurement of price.
    Mr. Thornberry. Well, why can you not use a one national 
price all across the board that is posted so everybody knows 
what it is? Why does that not work?
    Mr. Smith. Well, I assume you are referring to something 
like NYMEX. And the problem with NYMEX is NYMEX is what is 
called a derivative price. It derives its value from the 
underlying cash markets. It is trying--and it is trying to use 
that to anticipate what prices will be in the future. NYMEX, 
NYMEX is basically for trading on a futures contract for a 
paper barrel of crude oil. And so you are using something that 
comes from a cash market to forecast what a paper barrel would 
be worth in the future, and you are trying to turn that around 
and apply that back to cash markets again. You get into this 
circularity issue which is just sort of a crazy approach to 
trying to establish a price. The real price is what a willing 
buyer will pay a willing seller for a quantity of any product. 
And I would again say that if you put a large volume of 
production out for bid, you will get a market price. That will 
be the best measure there is of the, of the true market value 
of the, the product.
    Mr. Thornberry. Thank you. Mr. Cohelan, I notice that, that 
you are with a law firm in San Diego specializing in class 
action suits and have, have done a lot of plaintiffs' work in 
litigation over the last few years. From, from your background 
as, as being a trial lawyer, do you not think that if we could 
have an RIK program we could at least reduce the amount of 
litigation that is, is just eating us up from the government 
and private sector fighting about what the price of oil is and 
was?
    Mr. Cohelan. Well, I think the short answer is yes if you, 
if you define it right. You, you mentioned why do we not use 
the market to define the prices. Of course, that is, that is 
saying a whole bunch, because the problem is what is the 
market. The, the NYMEX, use of the NYMEX is an effort, 
imperfect though it is, to establish objective benchmarks. 
People in good faith, you know, using old Adam Smith's 
invisible hand are seeking their own interests, and that is 
great. That is what made our country what it is. The problem is 
when you rub up against public policy, you got to look more 
closely at those markets and ask yourself if you are getting a 
fair market value. If you had an objective benchmark, and you 
perhaps add some kind of arbitration procedure, you could take 
this stuff out of the courts pretty easily. The reason it is in 
the courts right now is that people of good will on both sides 
have real strong disagreements over what fair market value is, 
and you get around that by getting something out of their hands 
that defines fair market value like a NYMEX or ANS crude price.
    Mr. Thornberry. Well, thank you. It seems, going back to 
what we were just talking about, I do not see how you can 
improve on the actual market.
    Mr. Henderson, let me ask you, before my time runs out, in 
Canada, you all have lots of lawsuits?
    Mr. Henderson. No, we do not.
    Mr. Thornberry. And out of the, let us see, you have 36 
people administering this program as I understood. Was that 
about what it was, your, your testimony? You had about thirty 
some odd people and, and you do not have a bunch of other 
lawyer--see, the problem we have got in, in MMS is we have got 
a lot of other lawyers throughout the Department of Interior 
that are involved in these lawsuits, and it is hard to figure 
out exactly how many people are involved in all of the 
litigation that arises. Do you all have that problem?
    Mr. Henderson. I, I do not see that problem arising in 
Canada where we have got, and you say 30 people. I, I am not 
quite sure what the government has over there now. I know when 
they made the transition to, to the private, private sector, 
there was about 10 people that moved over into the private 
sector with that.
    In terms of lawsuits, the government is administering three 
contracts up there with three agents, and when you have that 
few of contracts, and when you have good relationships, you are 
not going to have the problems you see, particularly on the 
marketing side.
    Mrs. Cubin. Thank you. We have a vote on the Tauzin 
amendment to the ethics legislation that is before the 
Congress, so we will go vote, and we will be right back. Two 
more people on this round of questioning, and then we will see 
if we need another round.
    [Recess.]
    Mrs. Cubin. I ask the panel to take their seats please. Mr. 
Dooley, would you care to begin your questioning?
    Mr. Dooley. Yes, thank you. I thank all the panelists for 
coming today.
    Mr. Henderson, I was interested in your testimony where you 
talked about in the case of Alberta they considered a number of 
different options, and they made a decision really stay with 
the royalty-in-kind but went to a privatization in terms of the 
marketing or handling of it I guess I could say. And you also 
made the state-

ment that this was done in, in some ways because this was going 
to maximize returns to the government? Is that--did I--is that 
correct or----
    Mr. Henderson. When the government went through the, the 
process of reviewing all the options, and it is much the same 
as you are doing now, one of the studies they did and, was a 
comprehensive price survey amongst all producers in the 
province. And to appreciate the Alberta, it is very 
concentrated in one location, and they were able to undertake 
this study. The study was subsequently verified by an 
independent consulting firm. What they found is that in 
applying the models on the cash models to the realizations that 
the Alberta petroleum marketing was, was getting is that the, 
the proceeds, the market values the APMC was getting were 
slightly higher than under the, the models applied under the 
cash system, and I think that is one of the, the aspects that 
they looked at thinking well, we are pretty close to be revenue 
neutral. Why change a fairly efficient system and go through 
the, the two to three or four or 5 year pain that would 
probably come in the change of such a massive system when we 
are revenue or slightly better than revenue neutral now?
    Mr. Dooley. Um-hum. Ms. Brian, in your testimony, you 
contend that if we were to go to an RIK type of approach that 
just the opposite would be what you would expect to happen. And 
why would that be the case? Why would it be different----
    Ms. Brian. No, I am not sure I said the opposite would 
happen. One thing I said is--actually, I did not say that I 
would like to say now is that while it sounds that in Canada it 
really has been a very appropriate system, the, the feasibility 
study that just was released by MMS shows there are some 
significant differences between what happens in Canada and what 
happens in the United States. For example, in Canada, the 
marketers cannot have any ownership interest in refineries 
which clearly is not true in the United States. Another point 
is the Canadian marketers are banned from financial hedging. 
They only receive a flat fee in Alberta. They only have 5 cents 
a barrel, so that is--these are elements to their system that 
are really very different from anything we could imagine 
happening in the United States.
    But I am not, as I said earlier, I am not in principle 
opposed to RIK. All I am saying is the reason we are looking at 
changing the system is because there has not been a competition 
at the wellhead. As, as my colleague from NARO was saying, his, 
his members were receiving postings which were unacceptable 
which is what we, as Federal landowners, have also been 
receiving. And by going to an RIK system, we are not addressing 
that fact at all. We are simply going to change the subject and 
continue to be relying on this posted----
    Mr. Dooley. Now were they not--when they discarded 
accepting the proposal that used basically a benchmark and 
brought it back with some of the, putting in some reductions 
for different factors, were they not in effect evaluating what 
you are suggesting, and they made the determination that this 
was not going to be as effective in terms of maximizing 
government returns and also giving the most accurate reflection 
of what actual prices are?
    Ms. Brian. I, I do not, I do not quite understand. Who 
rejected----
    Mr. Dooley. I thought in Canada you I think basically made 
the statement that you looked at posted prices and reference 
prices that would be adjusted, and I would--what I would--my 
extrapolation is that an--or a NYMEX or an ANS is a reference 
price that we are talking about adjusting back, and it appears 
that that is one of the programs that was basically considered 
and then decided that the RIK program was going to be better 
in, in Canada. And Mr. Henderson, is that----
    Mr. Henderson. Yes, that is correct. The, the benchmark 
reference prices they were looking at were Canadian posting 
and, and a NYMEX-type price. The adjustment I was referring to 
would have been an adjustment done by a survey of producer 
prices and adjusted for not arm's-length transactions, those 
type of transaction, exchange transactions, etc. The, the 
survey prices would then come up with an average. The 
benchmarks would have then have been adjusted by that, that 
adjustment.
    Mr. Dooley. I guess the other issue is, and, Ms. Brian, you 
made a statement that if we, we went to the, the royalty-in-
kind is that you would see the marketer capturing the what you 
would, what you would expect to be the difference between the 
posted price and, and the market price which you would----
    Ms. Brian. Or some part of that. I mean you expect them 
to----
    Mr. Dooley. You would contend they would be different. But 
if you had a situation which would, I would expect if we put in 
place any type of RIK system that allowed for, you know, the 
competition or even the bidding on the oil that the government 
would, would be receiving as royalty, why should we not expect 
the competitive pressures of the marketplace to diminish any 
excessive returns to the marketer?
    Ms. Brian. Because the, the implementation of an RIK system 
would not in any way increase the competition at the wellhead. 
It is, it is just not addressing that issue. We are not getting 
more people suddenly with pipelines arriving at the Federal 
land saying we all want to buy the Federal crude, and we are 
going to increase the posting in order to, because we really 
want your crude. That--it just is not addressing that issue.
    Mr. Dooley. And that is where I guess we go back to, you 
know, the concern that I had that I think that the MMS 
proposal, the new proposal is addressed is that you are in 
effect, if you make that argument, you are then acknowledging 
that in some respects the posted price is different than the 
market price or the NYMEX price----
    Ms. Brian. Right.
    Mr. Dooley. [continuing] and that is where the, the 
fundamental issue here is how do we ensure that there is equity 
in terms of the royalty that is being paid, and that royalty 
should be a function of what people are receiving. And I guess 
I am not sure you can have the argument both ways. You know, 
there is a problem there, if we have an imperfect market, you 
know, maybe there are some reasons for that. But I mean the 
whole oil industry is, is somewhat of an imperfect market. 
NYMEX, what happens, you know, when OPEC meets and they, they 
make a, you know, a decision which is basically a function of 
an imperfect market there. NYMEX jumps or goes down. That is a 
function of an imperfect market too, and I guess my concern is 
is what we are trying to ensure is that for the oil that is, 
that we have a royalty that is due that it is fair compensation 
to the government based on the price that is actually received. 
And that is where I, you know, I am struggling with, you know, 
if it is not a royalty-in-kind which would be a direct function 
of what we would hope that that oil, the value of that oil 
would have where it is at, you know, how could we get any 
better than that, I guess? How could we get anything that is 
any, any more responsive to what the real valuation in this 
particular location?
    Ms. Brian. If you will indulge me for a second, I have, for 
example, a chart that shows Exxon's interfield postings where 
you see East Texas, Hawkins, and their prices are down here. 
These are fields where Exxon does not own the land. They have 
to pay royalties on it. The postings are pretty low when you 
compare them here to West Texas Sour and, and Yates which is 
primarily--and the irony here is that, in fact, East Texas is 
closer to the refinery. So if you look at what the market 
should have, what should have happened if this were a 
competitive market is that these prices should have actually 
been higher, because they are worth more with lower 
transportation costs. But this is an example of what we are not 
addressing if we go to RIK. This is going to continue to be 
happening.
    Mr. Dooley. Um-hum. And I would be interested in getting 
some more of the details of that. I am not familiar with that, 
that situation.
    Ms. Brian. Sure. I am happy to submit this for the record.
    Mr. Dooley. Thank you.
    [The information referred to may be found at end of 
hearing.]
    Mr. Smith. Could I just ask one question on that? I--my 
recollection--I have not looked at this in a long time. But I 
thought Hawkins was a much lower gravity field, and so you 
would expect a different kind of price relation----
    Ms. Brian. It is actually not much lower. There is only 
about a .2 difference. And so you can see, actually, if you 
really want to know what is--what is really interesting is is 
you can see when the Texas suits were filed when suddenly the 
postings started going up almost to the day in, in 1995. 
Suddenly, the postings started rising and, and started to 
mirror the spot prices. And what I understand is that 
differential, which is relatively small, really is what 
reflects the quality differential. But these enormous 
differences could not possibly be answered by that.
    Mrs. Cubin. Thank you. And I do apologize again for having 
missed the first part of the hearing when the most of you 
testified. I did read your testimony, and so I have an idea 
where we are coming from. I want to say there was, there was 
some testimony that was somewhat inflammatory to me. It, it got 
my ire up, and particularly some from you, Ms. Brian. I was 
raised in oil patch. I represent all of those people that work 
in the oil and gas industry, and all of those people that 
receive services from the state government and all of those 
people that provide services by the state government and all of 
those people that work in the state. I do not represent oil 
companies or gas companies, and so any, any implication at all 
or any insinuation that my main goal is not maximizing the 
amount of money that goes into the state treasury and the 
Federal treasury is just simply unfair, and it is wrong. 
Wyoming, as you know, receives more Federal mineral royalties 
than the next three or four states put together. And I am 
committed to a system that collects every single penny that is 
due to the Federal Government and the state government but not 
one penny more. And----
    Ms. Brian. I want to apologize if you misunderstood my 
point, and I think that we are really on the same side. I had 
no, in no way meant to suggest that you did not want to get 
everything for the, the landowners and the people who work in 
Wyoming.
    Mrs. Cubin. That is good, and certainly that is the 
intention of the entire subcommittee. We want a program, 
whether it is NYMEX or the program that MMS is proposing or 
whether it is royalty-in-kind, we want the best program that 
there is. And I look--I think about the fact that Americans put 
a man on the moon. Americans have better health care than 
anybody in the world. I do not think this could possibly be--I 
realize it is complicated. But I do not think putting an RIK 
program in place could possibly be so complicated that we 
cannot figure out how to do it and how to do it fairly to all 
the parties involved.
    And certainly, there are problems, and it is so complicated 
that we want to do it right and, and possibly a pilot program 
in a certain area is the thing to do. But, but I think minds 
that are more knowledgeable in this area than mine need to, 
need to make those recommendations.
    I want to start off by talking to--asking Mr. Smith, could 
you expand for me how an RIK program might score?
    Mr. Smith. It, I guess, first of all depends on whether MMS 
implements an RIK program along their recommendation, the line 
of their recommendations or whether the committee takes action 
to implement an RIK program. If MMS goes along with its 
existing recommendations and implements a program, it does not 
score. That is, it is not the result of Congressional action. 
Instead, it is the result of powers that the agency has to use 
today. And so it does not create a scorekeeping issue.
    On the other hand, if, if the committee enacts legislation 
that requires MMS to undertake certain actions that it would 
not take absent legislation, then it will score. Whether it 
scores positive or negative is, is again a function of the 
design of the legislation. And so at that point, I think you 
get into the case where the details matter greatly. So again, I 
think that the committee can come up with something that is 
scorable and can be revenue neutral, but it does require 
legislation in order for scorekeeping to become an issue.
    Mrs. Cubin. Could you give me some, some more background on 
the implications of mandatory versus a voluntary program? Do 
you have any thoughts on that?
    Mr. Smith. Sure. I mean if, if we have a--well, let us 
split voluntary into two pieces, and let us assume this is in 
the context of legislation, so it does become a scorekeeping 
exercise. We have a voluntary program where MMS can determine 
which properties it chooses to take and which properties it 
does not choose to take. I believe that would be consistent 
with their authority under current law, and so it then would 
have no score. CBO would, would not score it.
    Now one of the implications of that is if you should do 
that in the context of something like a budget reconciliation 
bill, the provision could be knocked out under the Byrd rule 
over in the Senate, and the House gets very concerned about 
that, but nevertheless, the Byrd rule is very effective in 
killing legislation where the committee is doing something 
again that the Agency can do already. So I think there is a 
problem there.
    On the other hand, if we have a program that is voluntary 
from the lessee side, then the lessees can in effect cherry 
pick which kinds of properties they want as part of the 
program, and that will trigger a revenue loss. So the only way 
of getting around this, I think, is to have a mandatory program 
where MMS is required to implement the, the program and to 
design it in such a way that, in fact, it will be revenue 
neutral. At that point, you have got a workable program. I 
think a voluntary program just will not accomplish anything 
that you can, can honestly work with.
    Mrs. Cubin. Thank you. Mr. Rorschach, I know that you have 
to leave at 4:20 and it is 4:20. I have one more question, 
because I have the yellow light, and I will be going on into 
the red. I am going to talk to Mr. Neufeld here, but I will be 
submitting questions in writing if you would not mind 
responding--if all of you would not mind responding to those. 
So if you need to excuse yourself, that is fine.
    Mr. Rorschach. I, I would like to make one comment. I do 
not know whether this is particularly germane to the subject, 
but I heard many questions asked about why, why we cannot just 
use the market to determine the market, and I have heard 
comments saying well, there is only one pipeline into the 
lease, and therefore that--well, these people are looking at 
different leases than I have looked at, because most of the 
leases I have seen, there is no pipeline in there at all. The 
truck comes in and picks up the oil. And I am telling you, 
there are lots of trucks around. There are lots of people who 
own trucks who are, who are willing to come pick up that oil 
and, and how it happens is the pumper calls the, the trucker 
and says look, come on out. We got a tank full of oil. And the 
trucker comes out, and the pumper straps out the tank and, and 
off it goes and he leaves him a run ticket. Now there is no 
pipeline involved there, and the market can certainly handle 
that.
    Mrs. Cubin. Thank you.
    Mr. Rorschach. Thank you.
    Mrs. Cubin. Mr. Neufeld, I will be asking this same 
question of Mr. Brown with the MMS, but I want you to, since 
you are up, seems to me that the producers are the ones that 
are liable for paying the royalty. Why in this case is the 
refiner being charged with the royalty retroactively? Do you--
--
    Mr. Neufeld. I, I believe----
    Mrs. Cubin. [continuing] what reasons have you been given, 
or do you understand it? It is beyond me.
    Mr. Neufeld. Yes. The Minerals Management Service points to 
a provision in our contract that says that the price of the oil 
that we are charged will be determined under 30 C.F.R. which is 
a large section of the Code of Federal Regulations. Our 
understanding and, and we believe based on, on memos that were 
written to us by MMS, and this is getting into the legal 
aspects, and I do not want to try the case here. But our 
understanding of that provision is that MMS would take the 
benchmarks in the rules, apply them to their oil and reflect 
that in our invoice. Their interpretation is: no, that was not 
the case. When we said that we agreed to have the oil priced 
under 30 C.F.R., we agreed that when they went back and audited 
the producers, after the fact, that we would be bound by those 
proceedings and agreed to have our prices adjusted accordingly. 
And so it is a difference in interpretation over that section 
of the contract.
    Mrs. Cubin. Well, thank you very much all of you for being 
here today. I know it has been a long time, but we do 
appreciate your coming. It is very important to the process, 
and so if you would like to take your leave, that is fine.
    Now I would like to call Mr. Brown from the MMS to please 
come forward to testify. Thank you very much, Mr. Brown, for 
being here. We have a vote coming up maybe in about 20 minutes, 
and so I think if we all stick to the 5-minutes that we are 
allotted, we will have just about the right amount of time, and 
then we can adjourn this hearing, and everyone can be off on 
their way. So if you would like to present your testimony.

  STATEMENT OF ROBERT E. BROWN, ASSOCIATE DIRECTOR, MINERALS 
      MANAGEMENT SERVICE, U.S. DEPARTMENT OF THE INTERIOR

    Mr. Brown. Thank you, Madam Chairman, members of the 
subcommittee. I appreciate the opportunity to appear today to 
present testimony on the Mineral Management Service's 
examination and implementation of programs to take oil and gas 
royalties-in-kind. We at MMS are excited to be discussing these 
issues. It appears to us from our recently completed royalty-
in-kind feasibility study that the exercise of Federal lease 
rights to take Federal oil and gas production share in-kind may 
offer opportunities to both dramatically streamline the royalty 
management process and at the same time enhance mineral 
receipts, if we deliberately and intelligently design and 
implement RIK programs where appropriate.
    Today I will describe our future plans in this area, but 
first I would like to briefly discuss the major results of our 
feasibility study. I ask that my prepared testimony be entered 
into the record.
    Our final report on the royalty feasibility study was 
issued just about a month ago, and the feasibility study was 
taken as one of a series of MMS initiatives to examine how we 
can improve our royalty management processes through 
innovation. Additionally, we had reported language from the 
Congress in the last session recommending that we undertake 
studies of the feasibility of royalty-in-kind programs. The 
final report is available on our home page at www.mms.gov.
    The primary objective was to determine if RIK programs are 
in the best interest of the United States, meaning if they, 
one, offer potential revenue enhancement or neutrality for the 
Federal treasury, and two, provide extensive administrative 
relief for MMS and for industry.
    We concluded that RIK programs, if implemented under 
favorable conditions, could be workable, revenue neutral or 
positive and administratively more efficient for MMS and for 
industry. What are favorable circumstances? Well, we would 
participate, particularly in, in gas and downstream marketing 
and sales, and particularly again for gas that aggregation 
would provide supply assurance which would provide market 
opportunities for the Federal production, and administrative 
relief both for us and for the producers. Less reporting, less 
auditing for all parties.
    Now unfavorable conditions which could lead to the program 
not being successful we think should be avoided are if we 
continue to audit the producers' shares of production. Second, 
if we required MMS to take in-kind everywhere or at the 
lessee's discretion. Third, if we had to pay above-market 
transportation rates where we encounter nonjurisdictional 
lines. Fourth, if we had to accept RIK volumes that were at 
less than marketable condition, and fifth, RIK on scattered, 
onshore basins with minimis volumes.
    The report recommends three in-kind pilots. The first is a 
royalty marketing program for the Gulf of Mexico involving 
natural gas which we believe would have a high chance of 
success if it involved substantial volumes and ran for at least 
3, if not 5 years and was contractually performed by an energy 
marketer and provided for MMS to share in downstream proceeds 
realized. Although actual revenue returns will depend on 
specific proposals from energy marketers, we believe that 
royalty revenues will increase due to increased aggregation of 
downstream market.
    Thus, the report recommends pursuing a long-term RIK 
program in the Gulf of Mexico in which substantial volumes of 
natural gas would be marketed and sold by an energy marketer 
under contract with MMS. We stress that before decisions are 
made to implement this program, we need to do detailed economic 
studies and make certain that that leading proposal would, in 
fact, be revenue neutral. Implementation would occur if all 
indications are positive.
    The second recommendation of the report concerns crude oil 
in-kind programs. We had workshops and meetings with energy 
marketers which did not produce any clear evidence of revenue 
enhancements or, for that matter, in some cases revenue 
neutrality from crude oil RIK. But based on our research, we 
believe that the revenue implications continue to be uncertain 
for oil RIK. Consequently, we do not endorse widespread 
implementation. However, considering the significant interest 
on the part of producers, marketers, and the State of Wyoming, 
the report concluded that a small-scale program for crude oil 
RIK could be jointly pursued by MMS in that state. Similarly, 
the report notes that the State of Texas has interest in RIK, 
and as a result, the third recommendation calls for a joint 
exploration of options with the state for both 8(g) leases and 
Federal offshore leases for oil or gas.
    Regarding future activities, our senior management team at 
MMS has accepted the report and its recommendations. Within the 
next month, we will begin our implementation of the report's 
recommendations. Our first course is to consult with Congress, 
which we have done with staff and we are doing here today, and 
consult with the states. We sent a formal invitation to 
Governor Geringer of Wyoming and to Commissioner Mauro of Texas 
to form teams to begin implementation. Governor Geringer has 
responded positively and will begin meeting with members of his 
staff in the near future to begin implementation of the pilot.
    We will meet with industry. We have meetings set for next 
week, both the 22nd in Washington and the 24th in Denver, to 
followup on the report and discuss the implementation. And then 
finally, in-reach within our own program explaining to the 
royalty program employees and to the offshore program how these 
programs will work.
    We will soon form an implementation team to pursue the 
report's recommendations. The team will identify the scope and 
overall framework of the offshore gas in-kind program and will 
work with Texas and Wyoming to do the same for the other pilot. 
We would like to work with industry in developing program 
details.
    I would like to reiterate that before actual implementation 
of any program, we will conduct detailed economic analysis 
necessary to determine chances for a program's success. As 
stewards of a public asset, our responsibilities are first and 
foremost to ensure that the public's assets are wisely managed.
    In closing, I would like to express our cautious optimism 
that in-kind programs may provide us with a great opportunity 
to resolve a difficult area of public lands management in the 
manner that could provide substantial benefits for the 
regulated industry, MMS, and most importantly, the American 
taxpayer.
    Madam Chairman, this concludes my prepared remarks, and I 
would be pleased to answer any questions your or members of the 
subcommittee may have.
    [The prepared statement of Mr. Brown may be found at end of 
hearing.]
    Mrs. Cubin. Thank you for your testimony. Mr. Thornberry, 
would you like to begin the questioning?
    Mr. Thornberry. Yes, ma'am. Thank you.
    Mr. Brown, were you here through all the prior testimony?
    Mr. Brown. Yes, sir.
    Mr. Thornberry. OK. A couple of points seemed to me that we 
had pretty much universal agreement on. No. 1 is that, that the 
current system is a mess. The second one is that pretty much 
everybody agreed, in principle at least, that royalty-in-kind 
makes some sense. Would you concur that that is kind of a 
summary of where we are generally among people who are 
interested in this issue?
    Mr. Brown. I think that is fair representation of what the 
people in the panel had to say. Some are more cautious about 
RIK than others.
    Mr. Thornberry. Sure. But I have not heard, and this is the 
second hearing we have had within a couple months, I have not 
had any, heard anybody stand up and defend the current system, 
and I have not heard anybody say that under no circumstances 
would royalty-in-kind make sense. And so what, what that leads 
me to think is now it is a question of working out the details 
of how it is going to work. And I understand that that is, that 
is an important challenge, and we got to get it right.
    I guess what I am really curious about is what is the 
commitment of MMS to sit down with industry folks, others that 
are inter-

ested, to work on these details regardless of whether you all 
think it needs to be mandatory or whether Congress ought to 
impose it nationally or how. But, but what is your commitment 
to sit down and work on transportation issues and these, these 
other things?
    Mr. Brown. Well, I think in regard to the pilots, our 
commitment is to sit down and, do that immediately. As Director 
Quarterman testified in July, we will be happy to sit down and 
look at legislative proposals. We are not going to mandate that 
we or commit to agreeing to them, but we would be happy to 
discuss them.
    Mr. Thornberry. Are you all going to have a legislative 
proposal that you are going to send up here for us to look at?
    Mr. Brown. Well, sir, we do not believe that we need 
legislation to carry forward on these programs, and we believe 
that carrying out these cautious pilots should be able to give 
us indications that would lead later to legislative relief if 
necessary.
    Mr. Thornberry. I understand that, and I understand that, 
that you do not want to commit to supporting something, but you 
are willing to sit down in the meetings next week and, and 
otherwise to work through some of these details with industry 
and talk about how it could work if we were to do something 
like that.
    Mr. Brown. Certainly.
    Mr. Thornberry. OK. Do you have any idea how many disputes 
MMS is currently involved in now relating to the amount of 
Federal royalty owed, whether they are lawsuits or 
administrative claims of some sort?
    Mr. Brown. Well, one of my areas of responsibility is 
processing the administrative appeals, and we have a docket of 
some 600, 700 active appeals. As you remember in the last 
session, the Congress passed legislation, the Royalty 
Simplification and Fairness Act, which requires us to complete 
the docketing of those cases in 36 months. We had substantial 
backlogs in the previous period. We are effectively moving to 
eliminate those. But that would not capture all of the 
disputes. There are other disputes that are farther along with 
the bureau. The Interior Board of Land Appeals, and 
additionally there is litigation, so I could not give you a 
specific number.
    Mr. Thornberry. OK. Let me ask this. One, one of the issues 
that has been discussed is transportation issues, particularly 
for offshore where you have pipelines. As I understand the way 
it works now, royalties are based on a price, and then there is 
a deduction for transportation costs through the pipeline to 
get it onshore.
    Mr. Brown. Correct.
    Mr. Thornberry. And it is also my understanding that MMS 
pretty much sets the amount of that deduction.
    Mr. Brown. Well, what occurs on offshore, the pipelines are 
not covered by FERC tariffs, so the actual calculation is done 
on a calculation of the amortized cost of the production of the 
pipeline. So there is an audited price.
    Mr. Thornberry. OK. Do you have any idea what the 
relationship is between that calculated price and the market 
price for some other company that comes and tries to use that 
pipeline to bring their crude say onto shore?
    Mr. Brown. Well, in this case it is a nonjurisdictional 
pipeline that is privately owned, and well, we would let them 
deduct their actual costs for those firms. In other words, if 
another firm uses that----
    Mr. Thornberry. So----
    Mr. Brown. If another firm uses that pipeline, that firm 
would deduct its actual cost, because it had engaged in an 
arm's-length agreement to transportation. It is only in the 
case of someone who owns the pipeline and would essentially be 
setting the price for themselves that we do that calculating.
    Mr. Thornberry. And do you know what, if one oil company 
say wants to use a owned pipeline, you set the cost for the 
government to be reduced from the government's share. Do you 
know what the relationship is between the market price and that 
generally and what the price that you all set----
    Mr. Brown. I would, I would.
    Mr. Thornberry. My understanding is it is lower, and I, I 
wonder if you, if you----
    Mr. Brown. If the market price is lower than what we 
calculate----
    Mr. Thornberry. That you are, that you are lower.
    Mr. Brown. We may very well be. But that is where we are 
talking about amortizing their costs, and then they have to 
make a profit when they are selling that transportation to 
someone else. So in the first case, it is derived simply from 
their cost, and in the second case, they are deriving a profit 
over and above their costs.
    Mrs. Cubin. Everyone agrees that if we have, in order to 
measure the success of an RIK program, we have to know the 
costs that MMS currently incurs in enforcing what we have right 
now. When Director Quarterman was in front of the committee in 
July, I asked her for a summary of the Federal Government's 
cumulative cost on, associated with audit and enforcement of 
royalty obligations including, but not limited to, other 
Department of the Interior costs such as workload at the Office 
of Hearings and Appeals and the Justice Department resources 
spent in litigation. We have not received that information yet. 
Would you have any idea when we will?
    Mr. Brown. I will make certain you get it as soon as 
possible, Madam Chairman. I regret that we have not provided 
that yet.
    [The information referred to follows:]
------------

Questions from Chairman Cubin
    1. In questions posed to MMS following the July 31, 1997 R-
I-K hearing, I asked for a summary of the Federal Government's 
cumulative costs associated with audit and enforcement of 
royalty obligations, including other Department of the Interior 
costs, such as the workload at the Office of Hearings and 
Appeals, and Justice Department resources spent in litigation 
on these issues. MMS did not provide this estimate, that I can 
see, in any of the follow-up answers received September 17, 
1997. The Subcommittee would like to have this information in 
order to get a better handle on the real costs government-wide 
associated with the current valuation system.
    The Department's costs for audit and enforcement of royalty 
obligations total approximately $28 million for fiscal year 
1997. This includes Royalty Management Program audit and 
enforcement costs of about $26 million, Interior Board of Land 
Appeals costs of $150 thousand, Office of the Solicitor costs 
of $400 thousand, and MMS Appeals Division costs of $1.3 
million. As you may know, litigation on behalf of the 
Department of the Interior is handled by the Department of 
Justice. We are not in a position to provide the Department of 
Justice costs associated with litigat-

ing the issues. It is our understanding, however, that the 
Department of Justice does not routinely calculate the costs of 
individual cases, and therefore does not keep records in the 
form you request.
    We caution that even under the best-designed R-I-K program 
not all litigation costs would disappear. Litigation cost 
savings would depend on the type and scope of oil or gas R-I-K 
programs implemented, and litigation costs would continue for 
Indian, solid, and geothermal minerals that are not taken in 
kind. Further, expected reductions in auditing costs would be 
deferred for at least 6 years as auditors complete reviews of 
prior periods.

    Mrs. Cubin. Because certainly that is very important for us 
to, to know before we proceed.
    Mr. Brown. It is, in some cases, difficult for us to derive 
what the Justice Department spends. But we, we should be able 
to give you a calculated cost.
    Mrs. Cubin. An educated estimate at any rate. CRS did a 
report on the Alberta RIK program in relation to potentially 
one in the United States, and it said that there were two 
factors that seemed to contribute to the Alberta RIK programs 
that, that have caused it to be successful, that is large oil 
volumes and low-cost transportation. And one thing I wanted to 
know is do you think that the pilot project in Wyoming will be 
a true indicator of whether or not an RIK program nationally 
will be successful?
    Mr. Brown. Well, that is a two-stage question, Madam 
Chairman, if I could first address the Alberta situation. As we 
understand the province of Alberta, the--we have large 
concentrations of, of volume, of production with limited 
refining capability. That is, that there is less refining 
capability in the province than there is production. And so 
that crude has to seek a market somewhere else, and it seeks 
the market in the, in Chicago and in Ontario and others--much 
of what the marketer does--the uplift that the marketers are 
achieving they are achieving through moving that crude to those 
markets.
    In Wyoming, there is a certain similarity in that there is 
limited refining capability for the production in Wyoming, and 
there is only certain places that one can take that, and 
perhaps by marketing that crude beyond those refineries and by 
aggregating the volumes, we can achieve the same kind of 
results as have been achieved in Alberta. The state of Wyoming 
is very sanguine about the possibility of that result, and we 
are a little skeptical, but we are willing to attempt to make 
certain that we do everything to make it work.
    Mrs. Cubin. Well, the reason I asked that question is 
because if we really wanted to try to draw some sort of 
similarity to the Alberta experience, the Alberta province is 
approximately 255,000 square miles with a pipeline 
infrastructure that reaches to all of the corners of the 
province. This is just less than the total square miles in 
Wyoming, Utah and Idaho combined and less than the Gulf of 
Mexico. So why not expand the, the pilot program if----
    Mr. Brown. Well, because of the interest of the state we 
have chosen Wyoming. As you pointed out earlier to the earlier 
panel, the onshore states derive significant incomes from 
production on oil, of oil and gas on, on Federal lands. The 
State of Wyoming is interested in RIK and has expressed an 
interest, so many of the other states have expressed no 
interest or have, have said that they are not, they are opposed 
to such a program. We did not think that we could go forward 
with an RIK program that, that poten-

tially had some risk without the concurrence of the state who 
is deriving revenue from that production. So the Wyoming's 
interest is primarily the reason why we are moving forward in 
the Wyoming area.
    Mrs. Cubin. But you----
    Mr. Brown. In addressing the second question, in the Gulf 
of Mexico, there is substantially more refining capability in 
Louisiana and Texas than there is production in the, from the 
Gulf of Mexico. There is gas, oil being brought--excuse me, oil 
being brought in from overseas through--and through Houston and 
Corpus Christi to be refined there so that we do not have the 
same--it is the reverse of the circumstance in Alberta where 
you have large volumes of crude production with limited 
refining capability, and the, in the Gulf of Mexico, you have, 
you have more refining capability than you have production.
    Mrs. Cubin. In the followup question that was submitted by 
Representative Romero-Barcelo after the July 31st hearing, you 
outlined plans for the MMS to proceed on RIK, and specifically, 
you mentioned preparing detailed requirements, program 
strategies and, and analysis of impacts. We have not seen that 
yet either. Do you have any idea when that will be complete?
    Mr. Brown. We have not completed it yet. Now that is the 
next stage right now. What we have done is complete the 
feasibility report, and the next thing we have to do is develop 
implementation plans. And, and part of our, the recommendation 
in the report is that, that we would be using a different 
approach than we did at our previous pilot which we specified 
very clearly the how, how the marketer, where, where they were 
to take the production, which was at the lease, and, and what 
they were to do with it. Very specified classic government kind 
of contract.
    What we are proposing to do here is take a different 
approach and say that we would make available to qualified 
energy marketers the specifics of what production we intend to 
take and ask them to give us a business case solution for how 
they would market that gas and, and how we would share in the 
profits that were derived from that marketing. And the one that 
gives us the best business case and the largest result would be 
the marketer that got the contract. So that would require--our 
analysis will have to go forward until we actually get to the 
point of receiving bids from these folks to really know what 
the results would be.
    Mrs. Cubin. One last question. While I, I am pleased that 
Wyoming will be used as a pilot or a test on this issue, I 
still cannot help but be concerned that, that the results of 
the pilot program really may not be a good reflection of what 
might happen nationally. If in fact the program in Wyoming 
turned out not to be profitable for the government because we 
do not--I am not aware of the major lawsuits, at any rate, like 
have gone on in California, and certainly those costs would not 
be in the Wyoming model, and the, the volume of oil that 
Alberta is dealing with would not be in the model, and we all 
agree that larger volumes give a better profit. So are--do you 
think that absent legislation that MMS would use a not real 
successful program in Wyoming to decline any action moving 
forward on RIK?
    Mr. Brown. Well, I would have to assume that it would 
depend on the reasons why it was not successful. Clearly, if it 
was unsuccessful because of peculiarities of the market that we 
did not anticipate, that should not be a reason why we would 
not go forward with RIK. It might not be unlike the 
circumstances of our 1995 pilot where clearly, we did not 
understand the way in which the market operated. We created a 
pilot that as one of, I believe Mr. Thornberry said was really 
an absolute wrong way to conduct a pilot. We would not do it 
again. And if we--if that was the reason why we were 
unsuccessful, then certainly that should not be a bar for us 
moving forward. If the reason we were unsuccessful was 
peculiarities of the Wyoming market, then again, I do not think 
that would necessarily be a bar to moving forward with the in-
kind programs.
    Mrs. Cubin. Well, thank you very much. I do appreciate the 
testimony. It has been very valuable. We will keep the record 
open for 10 days if there are additional comments. And if there 
is no further business, then this Subcommittee is adjourned.
    [Memorandum from Mr. Condit may be found at end of 
hearing.]
    [Memoranda from Mr. Humphries may be found at end of 
hearing.]
    [Statement of Mr. DiBona may be found at end of hearing.]
    [Whereupon, at 4:47 p.m., the Subcommittee was adjourned.]
    [Additional material submitted for the record follows.]
 Prepared statement of the American Petroleum Institute, submitted by 
                             Charles DiBona

    The American Petroleum Institute (API) is a trade 
association with over 350 members engaged in all aspects of the 
petroleum industry. API respectfully submits this statement of 
its views for the record on the Royalty-in-Kind issue for oil 
and gas valuation.
    The American Petroleum Institute supports the development 
of a Royalty-in-Kind (RIK) program as an alternative to the 
present royalty valuation rules for crude oil and natural gas 
production from Federal leases, and to the Minerals Management 
Service (MMS) proposed rule for the valuation of crude oil 
production. Properly crafted, an RIK program would reduce 
valuation uncertainty and would also reduce administrative 
costs to both government and oil and gas producers. Also, an 
RIK program can be revenue neutral, while reducing government 
administrative costs, thereby yielding a net increase in 
revenues to the government.
    In 1988, the MMS adopted its current regulations governing 
royalty payments for oil and gas produced on Federal leases. 
Under this rule, oil and gas royalties are based on the value 
of production which is measured by either the gross proceeds 
accrued to the lessee, or benchmarks such as posted prices. The 
MMS audits the valuation estimates submitted by the companies 
and challenges estimates when the agency believes errors have 
been made. This process has been characterized by numerous and 
costly disputes, both for the MMS and for the companies that 
must document and defend their valuation estimates. This is why 
both the companies and MMS have concluded that the current 
royalty system has many problems, and should be changed.
    An alternative to the present royalty valuation system is 
an RIK program in which the government takes its royalties ``in 
kind'' (in physical units) and sells its royalties in the open 
market. In 1995, MMS conducted a pilot RIK program for natural 
gas production in the Gulf of Mexico. The aim of the program 
was to test an RIK program operationally and to determine its 
impact on Federal revenues. MMS concluded initially that the 
program appeared to reduce revenue, but API and others have 
indicated that MMS' analysis was incomplete and inconclusive.
    In January 1997, MMS proposed a new valuation rule for 
crude oil. Among other things, this proposed rule would scrap 
the existing rule's reliance on benchmarks, such as posted 
prices, for valuing production in non-arm's length 
transactions. In its place, lessees would be required to use an 
index valuation scheme involving New York Mercantile Exchange 
(``NYMEX'') or Alaska North Slope (``ANS'') prices adjusted for 
locations and product quality. API responded to this proposed 
rulemaking in detail, identifying several serious flaws. API 
also stated that the MMS should fully explore royalty-in-kind 
as an alternative to the proposed index-based scheme.
    Since both the existing royalty valuation rules and the 
MMS-proposed alternative are problematic, many lessees have 
come to view RIK as an alternative. Accordingly, in Spring 
1997, API joined with several industry trade associations to 
form an RIK Workgroup to determine if the industry could 
develop a workable RIK program. Joining API in this effort were 
several other industry associations, including the Independent 
Petroleum Association of America (IPAA), the Domestic Petroleum 
Council (DPC), the Mid-Continent Oil and Gas Association 
(MCOGA), the National Ocean Industries Association (NOIA), and 
a number of state and regional organizations. The Workgroup 
developed six basic principles that all members, including API, 
agreed should govern any RIK program. API supports these 
principles, as key components of any RIK program.
    The first principle calls for the reduction of 
administrative and compliance burdens while providing the 
opportunity for Federal and state governments to maximize their 
respective revenues. The MMS should have the ability to 
optimize value by aggregating volumes, determining the most 
favorable sales location, arranging transportation, and 
negotiating the terms and conditions of the sale. The potential 
for increased revenues would require the MMS to manage the 
risks and incur the costs associated with marketing royalty oil 
and gas. Federal lessees should not see any increase in 
administrative costs or experience operational burden. Federal 
lessees should have certainty through elimination of disputes 
associated with royalty valuation. Similar benefits will accrue 
to the government. Also, lessees should not have any costs or 
obligations beyond the lessee's obligation to deliver at, or 
near the lease. Reporting should be related to volumes produced 
and delivered, not sales prices or other related valuation 
information. Finally, marketers should be provided a business 
opportunity which has an acceptable risk/revenue ratio, thereby 
enticing participation by the most professional and successful 
marketers in the business.
    The second principle requires transactions at, or near, the 
lease to fulfill the lease obligations. Once the production is 
delivered at an RIK delivery point at, or near, the lease, the 
lessee's royalty obligation must be completely satisfied. A 
lessee must have no duty to market or transport the 
government's oil or gas past this point. All risks and costs 
incurred downstream of the RIK delivery point should be borne 
by the lessor or its purchaser, in the hope of realizing 
maximum revenue from reselling the production downstream. An 
effective RIK program should not hold the purchaser liable for 
the lessee's failure to perform under the lease contract.
    The third principle provides that when the government 
elects to take ``in kind,'' it must take all royalty production 
for a time certain. Further, if the government takes its 
royalties ``in kind,'' it must give sufficient notice and, for 
a time certain, take the full royalty fraction tendered by the 
lessee(s) from a given property. The government must have no 
right under the lease to defer its take obligation, or leave 
its production in the ground. Moreover, the government must 
have no right under the lease to defer any production from 
either new or existing leases. Otherwise, lessees will be 
unduly burdened by additional marketing and operational 
problems.
    The fourth principle requires the use of private marketing 
expertise to streamline government operations. The government's 
oil or gas should be marketed through a competitive, privatized 
system in order to maximize benefits, and streamline government 
operations.
    The fifth principle provides that the states should have 
the opportunity to be involved with designing and implementing 
the program. At least one state, Wyoming, has been actively 
promoting royalty-in-kind concepts this year. In addition to 
being actively involved in the design of a government RIK 
program, the states need to be given the opportunity to 
participate in the marketing of the Federal royalty stream 
taken ``in kind.''
    The sixth and final principle makes royalties taken ``in 
kind'' broadly available for public purchase. Any production 
subject to this royalty-in-kind program should be made 
available on an open, competitive basis to a broad-based public 
market. This would include providing the opportunity to market 
to a broad group of interested and qualified marketers.
    If an RIK program for oil and gas were to be implemented 
based on the above principles, MMS would benefit in several 
ways. First, MMS would have the opportunity to maximize the 
value of its oil and gas. Second, an RIK program would 
eliminate many of the complexities and uncertainties 
surrounding valuation of product at the lease. When royalty is 
taken ``in kind'' rather than in value, the market value is 
basically the price the MMS receives in the marketplace from a 
willing buyer. Finally, the administrative burdens for both MMS 
and the Federal lessees, particularly audit, record keeping and 
litigation costs, would be sharply reduced.
    Finally, API supports the MMS's efforts to move forward 
with an examination of potential RIK programs, as described in 
its Royalty in Kind Feasibility Study (August 1997), released 
September 2, 1997. API urges MMS to look closely at the 
workability of an RIK program for crude oil as well as for 
natural gas production. Such a program could accomplish the 
goals stated by MMS Director Cynthia Quarterman last week when 
she noted the potential for RIK programs to ``both streamline 
the royalty reporting and auditing process and to enhance 
revenues to the U.S. Treasury.'' API also fully supports the 
decision by MMS to seek additional input on alternatives to 
crude oil valuation before proceeding further with the oil 
valuation rulemaking.

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