[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]




                      STRATEGIC PETROLEUM RESERVE

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

                           OVERSIGHT HEARING

                               before the

                         SUBCOMMITTEE ON ENERGY
                         AND MINERAL RESOURCES

                                 of the

                         COMMITTEE ON RESOURCES
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             FIRST SESSION

                                   on

   CLINTON ADMINISTRATION'S PROPOSAL TO UTILIZE TWENTY-EIGHT MILLION 
    BARRELS OF FEDERAL ROYALTY OIL TO PARTIALLY FILL THE STRATEGIC 
                        PETROLEUM RESERVE (SPR)

                               __________

                     APRIL 15, 1999, WASHINGTON, DC

                               __________

                           Serial No. 106-20

                               __________

           Printed for the use of the Committee on Resources


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house
                                   or
           Committee address: http://www.house.gov/resources

                                 ______

                 U.S. GOVERNMENT PRINTING OFFICE
56-730cc                 WASHINGTON : 1999




                         COMMITTEE ON RESOURCES

                      DON YOUNG, Alaska, Chairman
W.J. (BILLY) TAUZIN, Louisiana       GEORGE MILLER, California
JAMES V. HANSEN, Utah                NICK J. RAHALL II, West Virginia
JIM SAXTON, New Jersey               BRUCE F. VENTO, Minnesota
ELTON GALLEGLY, California           DALE E. KILDEE, Michigan
JOHN J. DUNCAN, Jr., Tennessee       PETER A. DeFAZIO, Oregon
JOEL HEFLEY, Colorado                ENI F.H. FALEOMAVAEGA, American 
JOHN T. DOOLITTLE, California            Samoa
WAYNE T. GILCHREST, Maryland         NEIL ABERCROMBIE, Hawaii
KEN CALVERT, California              SOLOMON P. ORTIZ, Texas
RICHARD W. POMBO, California         OWEN B. PICKETT, Virginia
BARBARA CUBIN, Wyoming               FRANK PALLONE, Jr., New Jersey
HELEN CHENOWETH, Idaho               CALVIN M. DOOLEY, California
GEORGE P. RADANOVICH, California     CARLOS A. ROMERO-BARCELO, Puerto 
WALTER B. JONES, Jr., North              Rico
    Carolina                         ROBERT A. UNDERWOOD, Guam
WILLIAM M. (MAC) THORNBERRY, Texas   PATRICK J. KENNEDY, Rhode Island
CHRIS CANNON, Utah                   ADAM SMITH, Washington
KEVIN BRADY, Texas                   WILLIAM D. DELAHUNT, Massachusetts
JOHN PETERSON, Pennsylvania          CHRIS JOHN, Louisiana
RICK HILL, Montana                   DONNA CHRISTIAN-CHRISTENSEN, 
BOB SCHAFFER, Colorado                   Virgin Islands
JIM GIBBONS, Nevada                  RON KIND, Wisconsin
MARK E. SOUDER, Indiana              JAY INSLEE, Washington
GREG WALDEN, Oregon                  GRACE F. NAPOLITANO, California
DON SHERWOOD, Pennsylvania           TOM UDALL, New Mexico
ROBIN HAYES, North Carolina          MARK UDALL, Colorado
MIKE SIMPSON, Idaho                  JOSEPH CROWLEY, New York
THOMAS G. TANCREDO, Colorado

                     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       ROBERT A. UNDERWOOD, Guam
WILLIAM M. (MAC) THORNBERRY, Texas   NICK J. RAHALL II, West Virginia
CHRIS CANNON, Utah                   ENI F.H. FALEOMAVAEGA, American 
KEVIN BRADY, Texas                       Samoa
BOB SCHAFFER, Colorado               SOLOMON P. ORTIZ, Texas
JIM GIBBONS, Nevada                  CALVIN M. DOOLEY, California
GREG WALDEN, Oregon                  PATRICK J. KENNEDY, Rhode Island
THOMAS G. TANCREDO, Colorado         CHRIS JOHN, Louisiana
                                     JAY INSLEE, Washington
                                     ------ ------
                    Bill Condit, Professional Staff
                     Mike Henry, Professional Staff
                  Deborah Lanzone, Professional Staff
                            C O N T E N T S

                              ----------                              
                                                                   Page

Hearing held April 15, 1999......................................     1

Statements of Members:
    Cubin, Hon. Barbara, a Representative in Congress from the 
      State of Wyoming...........................................     1
        Prepared statement of....................................     2
    Underwood, Hon. Robert A., a Delegate to Congress from the 
      Territory of Guam..........................................     3
        Prepared statement of....................................     4

Statements of witnesses:
    Cruickshank, Walter, Associate Director, Policy and 
      Management Improvement, Minerals Management Service, 
      Department of the Interior.................................     6
        Prepared statement of....................................    16
    Furiga, Richard D., Deputy Assistant Secretary, Strategic 
      Petroleum Reserve, Office of Fossil Energy, U.S. Department 
      of Energy..................................................     5
        Prepared statement of....................................    14

 
   OVERSIGHT HEARING ON CLINTON ADMINISTRATION'S PROPOSAL TO UTILIZE 
 TWENTY-EIGHT MILLION BARRELS OF FEDERAL ROYALTY OIL TO PARTIALLY FILL 
                 THE STRATEGIC PETROLEUM RESERVE (SPR)

                              ----------                              


                        THURSDAY, APRIL 15, 1999

                  House of Representatives,
      Subcommittee on Energy and Mineral Resources,
                                    Committee on Resources,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:03 p.m., in 
Room 1324, 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 the 
Clinton Administration's proposal to utilize 28 million barrels 
of Federal royalty oil to partially fill the Strategic 
Petroleum Reserve.
    Under Rule 4(g) of the Committee rules, any oral 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 all these members here keep to their schedules. 
So, I am not going to go on and read the rest of this script. 
If all of these members here have any statements, we will put 
them in the record.
    On February 11th of this year, the Energy and Interior 
Departments jointly announced that the proposal to take 28 
million barrels of royalty oil from the outercontinental shelf 
leases in the Gulf of Mexico to replace a like volume which had 
been drawn down since the Gulf War. Although the Subcommittee 
on Energy and Mineral Resources is not the oversight panel per 
se of the SPR, we are the congressional keepers of the mineral 
leasing law from which the obligation to pay these royalties 
arises, and that is how we have jurisdiction.
    And this brings us to our two witnesses here today. I would 
like to establish for the legislative record that the Clinton 
Administration can and will utilize the option of requiring 
lessees to surrender a fraction of their production to the 
government rather than sending the same fraction of value 
received for the production as dollars to the Treasury. I 
continue to be interested in this royalty-in-kind methodology 
as a means to increase efficiency in royalty collections 
through diminished audit burdens certainly for lessees that 
they have paid all that they owe when the oil is delivered as 
well as provide taxpayers with the opportunity to receive added 
value from downstream marketing or direct utilization by the 
Government, such as the MMS is now pilot testing with the R-I-K 
natural gas being burned by the General Services Administration 
to heat the very building that we are meeting in today.
    Now, I realize that the motives of the administration to 
exercise its R-I-K option for this is SPR non-fill idea may not 
be so pure as what I have just described. Indeed, the 
Department of Energy has not had to come begging to the 
Congress for an appropriation to purchase the 28 million 
barrels of oil precisely because R-I-K is an option here. At 
this morning's crude oil price, this represent approximately 
$460 million that they didn't have to ask the Congress for; not 
exactly small change, but if were an appropriator rather than 
an authorizer, I might be upset that my control of the purse 
strings was being subverted by this plan. But I am a supporter 
of this plan chiefly because I believe it makes very good sense 
to take even this small amount of oil out of the supply-demand 
equation at this time.
    When the administration announced the plan, I believe that 
the oil prices were less than $13 a barrel; now, they are 
slightly over $16 for May 1999 deliveries of light sweet crude 
at Cushing, Oklahoma. This recent rise was certainly welcome, 
but my constituents in this business are still hurting, and 
they are getting far less than NYMEX prices for their 
production. Any uptick in prices that will result from the 
100,000 barrels of oil per day not flowing into refineries is 
good for our domestic producers, albeit it is small in 
comparison to the effect which the recent OPEC quota has 
appeared to have on global prices.
    In conclusion, I do wish to thank DOE and the MMS for 
sending us their experts to discuss the mechanics of this 
proposal. I have not asked any oil industry folks to testify at 
this juncture, because no R-I-K deliveries have been made yet, 
so there is no track record to examine. But, I reserve the 
opportunity for follow-up should this Subcommittee become aware 
of problems with the upstream end of the program managed by the 
Interior Department.
    [The prepared statement of Mrs. Cubin follows:]

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

    The Subcommittee meets today to review the Administration's 
plans to partially fill the Strategic Petroleum Reserve, or 
SPR. On February 11th of this year, the Energy and Interior 
Department's jointly announced that proposal to take 28 million 
barrels of royalty oil from outer continental shelf leases in 
the Gulf of Mexico to replace a like volume which had been 
drawn down since the Gulf War. Although the Subcommittee on 
Energy & Mineral Resources is not the oversight panel per se of 
the SPR, we are the Congressional keepers of the mineral 
leasing law from which the obligation to pay these royalties 
arises.
    And this is what brings our two witnesses here today. I'd 
like to establish for the legislative record that the Clinton 
Administration can and will utilize the option of requiring 
lessees to surrender a fraction of their production to the 
government rather than sending the same fraction of value 
received for the production as dollars to the Treasury. I 
continue to be interested in this royalty-in-kind (R-I-K) 
methodology as a means to increase efficiencies in royalty 
collections through diminished audit burdens, certainty for 
lessees that they have paid all they owe when the oil is 
delivered, as well as provide taxpayers with the opportunity to 
receive added value from downstream marketing or direct 
utilization by the government, such as the Minerals Management 
Service is now pilot testing with R-l-K natural gas being 
burned by the General Services Administration to heat the very 
building we are meeting in today.
    Now, I realize that the motives of the Administration to 
exercise its R-I-K option for this SPR non-fill idea may not be 
so pure as what I've just described. Indeed, the Department of 
Energy has not had to come begging to Congress for an 
appropriation to purchase 28 million barrels of oil precisely 
because the R-I-K option is there. At this morning's crude oil 
price this represents approximately $460 million. Not exactly 
small change. If I were an appropriator, rather than an 
authorizer, I might be upset that my control of the purse 
strings was being subverted by this plan. But, I am a supporter 
of this plan, chiefly, because I believe it makes very good 
sense to take even this small amount of oil out of the supply-
demand equation at this time.
    When the Administration announced the plan I believe oil 
prices were less than $13 per barrel. Now they are slightly 
over $16 for May 1999 deliveries of light sweet crude at 
Cushing, Oklahoma. This recent rise has certainly been welcome, 
but my constituents in this business are still hurting--and 
they are getting far less than NYMEX prices for their 
production. Any uptick in prices that will result from 100,000 
barrels of oil per day not flowing to refineries is good for 
our domestic producers, albeit it is small in comparison to the 
effect which the recent OPEC quota cuts has appeared to have on 
global prices.
    In conclusion, I wish to thank the DoE and the Minerals 
Management Service for sending us their experts to discuss the 
mechanics of this proposal. I have not asknot asked any oil 
industry folks to testify at this juncture because no R-I-K 
deliveries have been made yet, so there is no track record to 
examine. But, I reserve the opportunity for follow-up should 
the Subcommittee become aware of problems with the ``upstream'' 
end of the program managed by the Interior Department.

    Mrs. Cubin. The chairman now recognizes the Minority 
Ranking Member for any statement that he might have.

 STATEMENT OF HON. ROBERT A. UNDERWOOD, A DELEGATE TO CONGRESS 
                   FROM THE TERRITORY OF GUAM

    Mr. Underwood. Thank you, Madam Chairman, and please bear 
with me while my voice recovers. Thank you.
    Legislation considered in this Subcommittee during the last 
Congress would have required the Federal Government to abandon 
its traditional practice of taking oil and gas royalties from 
production on public lands and cash payments and begin taking 
them ``in kind'' or as part of the lessees' production in 
barrels or via pipeline.
    Our colleagues, Representatives Mac Thornberry, Kevin 
Brady, and Barbara Cubin, introduced last year's bill, H.R. 
3334. However, the bill would not simply have required oil and 
gas companies to pay royalties-in-kind instead of cash. It 
would have also the Federal Government to turn the royalty oil 
and gas over to a private marketer who would aggregate the oil 
and gas and sell it on the market, deducting the marketing 
costs and keeping part of the proceeds.
    The administration strongly opposed this legislation, 
maintaining that the Mineral Leasing Act and the Outer 
Continental Shelf Lands Act provide adequate authority to take 
royalties-in-kind when and if needed. The Committee did not 
complete action on this bill, and a comparable bill has not 
been reintroduced this Congress.
    Royalty-in-kind is nonetheless he subject of administration 
action and today's hearing. On February 11th, taking advantage 
of historically low crude oil prices and a glutted oil market, 
the administration underscored its belief that it has 
sufficient legal authority by announcing plans to collect 
royalties-in-kind from companies producing oil on Federal 
leases in the Gulf of Mexico to partially refill the Strategic 
Petroleum Reserve.
    The administration's proposal to refill the Strategic 
Petroleum Reserve with crude oil should result in removing some 
surplus crude oil volumes from the market supply and refilling 
the volumes drawn down during and after Desert Storm. Since oil 
that is currently stored in the Reserve was purchased at prices 
that average about $27 per barrel, adding oil to the Reserve 
with the current prices of oil near $15 would result in a net 
decrease in the average price per barrel for oil stored there.
    The oil industry and a bipartisan group of congressional 
House and Senate Members representing oil-rich States have 
enthusiastically endorsed the plan, because is should help our 
domestic producers during a period of all-time low prices of 
crude oil. Their support appears to buttress the 
administration's position regarding its legal authority. Yet, 
despite nearly universal support for the administration's plan, 
there are nevertheless questions about this proposal which 
should be explored today. For instance, how does the 
administration intend to actually transfer the petroleum to the 
SPR? How will the administration deal with the various quality 
factors, such as sulfur-acid content and viscosity?
    Hopefully, today's hearing will provide answers to these 
and other questions. I look forward to hearing the testimony of 
our witnesses--Mr. Rick Furiga, from the Department of Energy, 
and Dr. Walter Cruickshank, from the Minerals Management 
Service, Department of Interior. Thank you, Madam Chairman.
    [The prepared statement of Mr. Underwood follows:]

  Statement of Hon. Robert Underwood, a Delegate in Congress from the 
                           Territory of Guam

    Legislation considered in this Subcommittee during the last 
Congress would have required the Federal Government to abandon 
its traditional practice of taking oil and gas royalties from 
production on public lands in cash payments and begin taking 
them ``in kind,'' or as part of lessees' production in barrels 
or via pipeline.
    Our colleagues, Reps. Mac Thornberry, Kevin Brady and 
Barbara Cubin introduced last year's bill--H.R. 3334. However, 
their bill would not simply have required oil and gas companies 
to pay royalties-in-kind instead of cash. It also required the 
Federal Government to turn the royalty oil and gas over to a 
private marketer who would aggregate the oil and gas and sell 
it on the market, deducting the marketing costs and keeping 
part of the proceeds.
    The administration strongly opposed the legislation, 
maintaining that the Mineral Leasing Act and the Outer 
Continental Shelf Lands Act provide adequate authority to take 
royalties-in-kind when and if needed. The Committee did not 
complete action on H.R. 3334, and a comparable bill has not 
been re-introduced during this Congress.
    Royalty-in-kind is nonetheless the subject of 
administration action and today's hearing. On February 11, 
taking advantage of historically low crude oil prices and a 
glutted oil market, the administration underscored its belief 
that it has sufficient legal authority by announcing plans to 
collect royalties-in-kind from companies producing oil on 
Federal leases in the Gulf of Mexico to partially refill the 
Strategic Petroleum Reserve.
    The Administration's proposal to refill the Strategic 
Petroleum Reserve with crude oil should result in removing some 
surplus crude oil volumes from the market supply, and refilling 
the volumes drawn down during and after Desert Storm. Since oil 
that is currently stored in the reserve was purchased at prices 
that averaged about $27 per barrel, adding oil to the reserve 
with the current prices of oil near $15 would result in a net 
decease in the average price per barrel for oil stored there.
    The oil industry and a bipartisan group of Congressional 
House and Senate Members representing oil-rich states have 
enthusiastically endorsed the plan because it should help 
domestic producers during a period of all-time low prices on 
crude oil. Their support appears to buttress the 
Administration's position regarding its legal authority.
    Yet, despite nearly universal support for the 
Administration's plan, there are nevertheless questions about 
this proposal which should be explored today. For instance, how 
does the Administration intend to actually transfer the 
petroleum to the SPR? How will the Administration deal with the 
various quality factors, such as sulphur, acid content, and 
viscosity?
    Hopefully, today's hearing will provide answers to these 
and other questions. I look forward to hearing the testimony of 
our witnesses, Mr. Rick Furiga, from the Department of Energy, 
and Dr. Walter Cruickshank, from the Minerals Management 
Service, U.S. Department of the Interior.

    Mrs. Cubin. Thank you, Mr. Underwood.
    Now we will hear from the witnesses. Let me remind the 
witnesses that, under our Committee rules, they must limit 
their oral testimony to five minutes, but that your entire 
statement will appear in the record.
    And, with that, I would like to recognize the first 
witness, Mr. Furiga, Deputy Assistant Secretary for the 
Strategic Petroleum Reserve, U.S. Department of Energy.

  STATEMENT OF RICHARD D. FURIGA, DEPUTY ASSISTANT SECRETARY, 
  STRATEGIC PETROLEUM RESERVE, OFFICE OF FOSSIL ENERGY, U.S. 
                      DEPARTMENT OF ENERGY

    Mr. Furiga. Thank you, Madam Chairman. Madam Chairman, Mr. 
Underwood, it is a pleasure to be here for the first time 
before this Subcommittee. I won't take time to go into the 
history of the Strategic Petroleum Reserve or its physical 
makeup. Just let me say that the Reserve consists of four 
separate storage sites on the Gulf Coast, two in Texas and two 
in Louisiana. These four sites have a total storage capacity of 
700 million barrels. In that capacity, we currently have 561 
million barrels of crude oil.
    Let me move right into the Royalty-In-Kind Program which we 
are very enthused about. That program essentially involves 
receiving 28 million barrels of royalty oil from the Minerals 
Management Service to use to add to the Reserve's crude oil. We 
decided to split the program into two phases. When this program 
was announced, interest was extremely high on the part of 
industry. As you have mentioned, we had universal support for 
implementing this program. We decided to strike while the iron 
was hot.
    Under Phase 1, we chose the largest producers of the 
royalty oil and sought to obtain up to 50,000 barrels a day for 
a 3-month period from these large producers to start deliveries 
as soon as we possibly could. As of right now, we have 
completed three agreements with Shell, Texaco and BP-Amoco. 
Tuesday, we finished negotiations with Exxon, and we expect to 
have an agreement signed by next Tuesday. So, we have four 
agreements totaling over 43,000 barrels per day for a 3-month 
period which will be delivered to our Bayou Choctaw site in 
Louisiana. Until Phase 2--which I will describe in a moment--
until Phase 2 of the program is completed, we would prefer not 
to disclose the exchange ratios that were used in reaching 
these agreements so as not to jeopardize the participants in 
Phase 1 offers during Phase 2. We would be pleased to provide 
those in a closed session if you so desire, but we would just 
prefer that they not be public at this particular time.
    I would like to point out that the Strategic Petroleum 
Reserve is experienced in buying, selling, and exchanging oil. 
Recently, we did a very successful exchange of about 11 million 
barrels of very heavy, sour crude for 8.5 million barrels of 
high quality, light sour crude. The ratios that we are 
experiencing under Royalty-In-Kind compare very favorably to 
what we have experienced in the past.
    Phase 2 is where we will seek up to 100,000 barrels per day 
of royalty oil under a competitive solicitation. This 
solicitation will be open to all comers. We expect this 
solicitation to be issued by the end of the month, offers to be 
received by the end of May, contracts by June 15th. The Phase 2 
team is working as I speak to have a solicitation ready so that 
we can meet that schedule.
    In concluding my oral statement, I would like to make a few 
points. The cooperation between the Minerals Management Service 
personnel and the Strategic Petroleum Reserve personnel has 
been very gratifying. They hit the ground running. We formed a 
Phase 1 team and a Phase 2 team made up of personnel from both 
offices, and they have worked extremely well together. It is a 
complex job getting these solicitations together and conducting 
the negotiations, but they have been performing very well. 
Industry interest has remained high, and their cooperation and 
their seriousness in going into these negotiations has been 
very gratifying.
    The first delivery under Phase 1 will start this coming 
Monday. The oil will be put into the pipeline and will be sent 
up to our Bayou Choctaw site. Almost 50 percent of the oil 
being obtained under Phase 1 is domestic crude, which I 
consider very important.
    And, finally, I would like to say that our West Hackberry 
site, one of our largest sites, is in Congressman John's 
district, and to the best of my knowledge he is the person who 
planted the seed of using royalty oil to help fill the SPR last 
year at a meeting with a member of my staff. That idea worked 
its way until it became the number one item on the Secretary's 
list to do to help the oil reserve.
    That concludes my oral statement, Madam Chairman.
    [The prepared statement of Mr. Furiga may be found at the 
end of the hearing.]
    Mrs. Cubin. Thank you, Mr. Furiga.
    The Chair now calls on Dr. Walter Cruickshank, Associate 
Director of Policy and Management Improvement for the MMS, 
Department of Interior.

STATEMENT OF WALTER CRUICKSHANK, ASSOCIATE DIRECTOR, POLICY AND 
MANAGEMENT IMPROVEMENT, MINERALS MANAGEMENT SERVICE, DEPARTMENT 
                        OF THE INTERIOR

    Mr. Cruickshank. Thank you, Madam Chairman, Mr. Underwood. 
I appreciate the opportunity to appear today to talk about the 
joint initiative between the Departments of Energy and the 
Interior to move Federal royalty oil into the Strategic 
Petroleum Reserve Program.
    First, I would like to second Mr. Furiga's comment. I think 
our two agencies have been working exceptionally well together 
to make this project a success.
    The SPR Royalty Initiative will be implemented in two 
phases. In the first phase, we have now concluded negotiations 
with some of the largest crude oil-producing companies in the 
Gulf of Mexico for deliveries of royalty oil to DOE for its 
production months of May through July of this year. We realize 
the importance of filling the SPR as quickly as possible during 
this period of low oil prices, and Phase 1 has been designed to 
accomplish this. By targeting the largest available royalty 
volumes and directly negotiating with the producer, we believe 
we can obtain efficient of significant volumes to the SPR in a 
minimum amount of time.
    Mr. Furiga noted we have successfully completed 
negotiations with four companies to deliver approximately 
43,000 barrels per day over the next 3 months. In Phase 2, we 
will expand the initiative to take the remaining volumes 
identified for this program and increase the fill rate for the 
Strategic Petroleum Reserve. We will conduct a competitive 
process in which the royalty oil at the lease will be offered 
in exchange for the delivery of crude oil meeting SPR 
specifications to locations at or near the SPR facilities. The 
objective is to include all potential market participants in 
order to maximize competition and minimize the cost of 
delivering crude to the SPR.
    All OCS leases are included in this program except for the 
following: leases subject to section 8(g) of the OCS Lands Act. 
These leases are excluded because coastal States receive 27 
percent of the royalty receipts associated with those leases, 
and to the extent the leases are dedicated to this initiative, 
there would be a loss of revenue to those States. We have also 
included section 6 leases, because those leases generally do 
not give the government the option to take royalties-in-kind. 
However, if the lessees agree, we will include those leases in 
this program.
    We also have leases dedicated to supplying small refiners. 
As you know, the OCS Lands Act allows the Secretary to provide 
royalty oil to eligible small refiners if needed, and a 
significant borrowing of royalty oil has been set aside for 
this purpose. These leases will be included when and if they 
are dropped from the Small Refiner Program.
    Finally, some 208 Gulf of Mexico leases are included in the 
Royalty Management Program's reengineering effort. In this 
initiative, we are partnering with industry, States, and tribes 
to streamline and simplify our processes for royalty compliance 
and revenue dispersement. This is a top MMS priority as we 
intend to reengineer our business processes to be cutting edge 
in the next century. Nevertheless, we expect many of these 
leases will be available for under the Phase 2 process in the 
year 2000.
    The MMS role in this initiative is to support the lead 
agency, the Department of Energy, in some of the analyses and 
in the upstream logistics of delivering royalty oil. 
Specifically, the MMS role is to identify the leases from which 
oil royalties will be taken ``in kind'' and to generate the 
information associated with these leases that is necessary for 
program implementation. We will also notify lease owners of the 
decision to take the royalties-in-kind and inform them of their 
rights and responsibilities. We will continue to perform the 
lease measurement and production accounting functions and 
supply the Department of Energy with the data on lease 
production and the royalty entitlement. And, finally, we will 
assist DOE in conducting the Phase 2 competitive solicitation 
and evaluating the offers received in that process.
    Through the combined Phase 1 and Phase 2 Programs, we plan 
to take 28 million barrels of royalty oil at the lease. At the 
time this program was announced, OMB estimated that this will 
reduce revenues to the Treasury by $170 million in this fiscal 
year and $200 million in the next fiscal year. The actual 
fiscal impacts will depend on the delivery dates and the market 
price of oil at that time, and, as you noted in your opening 
statement, the prices have already gone up.
    It is also premature at this time to identify how many 
barrels will actually be delivered into the SPR facilities 
themselves. The primary determinant will be the location and 
quality differentials between the value of the royalty oil at 
the least and the value of the oil delivered to the SPR 
facilities.
    In closing, let me state that we look forward to continuing 
to work with the Department of Energy to complete the transfer 
of the 28 million barrels of royalty oil to the SPR Program. We 
believe that this program will enhance the energy security of 
our Nation, and we also believe that this program illustrates 
that as managers of pubic assets, we can and must remain agile 
and flexible to respond to changing public needs and 
priorities.
    Thank you, Madam Chairman and Congressman Underwood. This 
concludes my remarks, and I would be pleased to answer any 
questions.
    [The prepared statement of Mr. Cruickshank may be found at 
the end of the hearing.]
    Mrs. Cubin. Thank you very much. And I would like to 
express my appreciation, as well, for the cooperation that you 
have had, not only between one another's agencies but also with 
the congressional staff and for the briefing that you came up 
for; it was very beneficial to me, and I wish I could have 
stayed for the whole thing, but, anyway, thank you for that.
    I am going to start my questioning with Dr. Cruickshank, 
because I understand that you are missing the initial--that 
your Ph.D. is in mineral economics and that you are missing the 
initial meeting of--you are the president, I guess, of a 
professional society of those folks, and you are missing that 
initial meeting, and we appreciate that. If it weren't so 
difficult to get room time, we might not have had to have it 
today, but thank you for being here.
    Could you estimate for me, Dr. Cruickshank, what the price 
impact of Phase 1 and Phase 2 will be?
    Mr. Cruickshank. The impact on oil prices?
    Mrs. Cubin. Right.
    Mr. Cruickshank. The Department of Energy may actually be 
more qualified to answer that question, but we think that the 
impact on prices in the oil markets will not be something that 
could actually determine; that there will be some small 
negligible impact on oil prices, but nothing that we could tie 
directly to this program.
    Mrs. Cubin. Like maybe 35 cents or something like that?
    Mr. Cruickshank. I believe the Department of Energy has 
done some estimates on that.
    Mr. Furiga. We have a rule of thumb, a million barrels 
taken off the market a year is a penny, so maybe we are talking 
25 to 28 cents.
    Mrs. Cubin. Okay, thank you. Mr. Furiga, is SPR currently 
able to accept R-I-K oil from onshore producers in the event 
that additional contracts could be solicited for future 
refills?
    Mr. Furiga. We are talking onshore?
    Mrs. Cubin. Onshore.
    Mr. Furiga. Physically--if we are talking the Gulf Coast 
area, physically, we can. I am going to have to defer to Dr. 
Cruickshank on this, but it is my understanding that if we get 
into the onshore, there is a legal prohibition about 
transferring it to us, plus the fact that we have to consider 
the States' revenues that would be lost with onshore royalty 
oil.
    Mrs. Cubin. I think I am speaking more in terms of 
infrastructure than legalities and that sort of thing.
    Mr. Furiga. Infrastructure, we can receive domestic crude 
by pipeline. There are no truck unloading facilities. There 
have been proposals in the past to use stripper well 
production. The Stripper Well Association knows that we can't 
physically move stripper well production to the Reserve, but 
along the Gulf of Mexico we are connected to the industry 
infrastructure, and it is currently moving by pipeline. We can 
probably receive it. So, physically, the answer is yes, Madam 
Chairman.
    Mrs. Cubin. But not to a great degree, is that right? Are 
there any modifications in the SPR infrastructure that would be 
needed to expand that to a realistic level? I don't even really 
know if it is realistic that more contracts will be solicited; 
I hope so.
    Mr. Furiga. Oh, do you mean as far as capacity in the 
Reserve?
    Mrs. Cubin. No capacity.
    Mr. Furiga. Not capacity. Pipeline capacity?
    Mrs. Cubin. That is correct. Just what kind of 
infrastructure is therefore possible onshore?
    Mr. Furiga. We are connected in the eastern part of a 
Louisiana to the Capline Pipeline system which goes all up to 
Illinois. We are connected to the Seaway-Arco Pipeline systems 
west of Texas. We are connected to the Mobil Pipeline system 
and the Texaco Pipeline system. So, we are connected to a lot 
of commercial systems right to our sites. Now, there may be a 
problem, depending on the quantities we are talking about, with 
obtaining space on those pipelines. If someone wants to ship 
oil to us, which would be their responsibility, they would have 
to nominate their shipments, and there may not be room. Some 
pipelines in the recent past have been a proration status.
    Mrs. Cubin. Thank you. Dr. Cruickshank, as you know, I am a 
proponent of using the R-I-K to eliminate disputes over the 
valuation of crude at or near the lease when there is no arm's 
length transaction involved. In your testimony, you 
acknowledged that deliveries of the initial volumes for the SPR 
non-fill plan will be at St. James, Louisiana, not at the 
lease. Would you please elaborate for me the factors necessary 
to net back from St. James to the facility measurement point?
    Mr. Cruickshank. The way this program is actually going to 
work is that we are taking the royalty oil at the least and 
transferring title to the Department of Energy at the facility 
measurement point which is generally at or near the lease. The 
Department of Energy is then arranging--they are negotiating 
agreements with the companies for exchanges of the royalty oil 
at the lease for oil that meets SPR specifications delivered at 
St. James. And, so, in essence, the various costs of moving the 
quality and location differentials of moving from the lease to 
the market center is captured in the rate at which they are 
exchanging oil at the market center for the oil at the lease, 
but we are physically taking delivery of the royalty oil at the 
lease.
    Mrs. Cubin. At the lease. Would you mind explaining that to 
me again? I did not understand your answer.
    Mr. Cruickshank. Okay, we are taking delivery of the 
royalty oil at the lease, and that is where the lessee has met 
his obligation to the Department of Interior for paying 
royalties when we accept delivery of the royalty oil at the 
lease. What is then happening, in essence, is we have 
negotiated these agreements--or will in Phase 2 through a 
competitive process--invite people who want to take the royalty 
oil at the lease and physically take that and deliver us other 
oil at the market center or at the SPR facility. So, in 
essence, we are not physically moving the royalty oil from the 
lease to the SPR facility, but rather we are exchanging it, so 
the company is actually keeping the royalty oil at the lease 
and giving us some other barrels at the SPR facility.
    Mrs. Cubin. Okay, so there is no net back involved in that 
at all.
    Mr. Cruickshank. That is correct.
    Mrs. Cubin. Would you comment on that, too, Mr. Furiga?
    Mr. Furiga. Well, I can add that----
    Mrs. Cubin. About the negotiations with the operators.
    Mr. Furiga. Well, the Strategic Reserve obtains two types 
of crude oil: very high quality sweet crude, which means the 
sulfur is less than 0.5 percent and a very high quality sour 
crude; sulfur there is a maximum 1.99 percent. Those 
specifications were developed in conjunction with industry and 
studies that were done when the program started, and it kept 
up--the ratio runs about 60 percent sweet and 40 percent sour 
crude.
    For Phase I, we are using the available space at our Bayou 
Choctaw site. That space is for sweet crude, high quality 
crude. Not all of the OCS production meets our specifications. 
So, we are meeting with the companies and, as Dr. Cruickshank 
said, we take title at the lease and then the company can 
either make an offer to deliver the lease oil, the royalty oil, 
if it meets our specifications or they can exchange the royalty 
oil for oil that does meet our specifications, again, for 
delivery to the SPR site. Industry is picking up the tab for 
delivery to our site. And, so that would quite naturally mean 
that you are not going to get a one for one just based on 
transportation, let alone a quality difference. We are getting 
very good crude in exchange for royalty oil.
    Mrs. Cubin. Thank you very much. Mr. Underwood, do you have 
any questions for the witnesses.
    Mr. Underwood. Thank you very much, Madam Chairwoman. 
Basically, I guess, as I understand this administration's 
effort, there is widespread support in order to kind of 
alleviate some of the distress that is being felt by domestic 
oil producers, yet, as I understood your presentation, the 
purchase or the acceptance of this oil petroleum has only a 50 
percent requirement that it come from domestic sources. How did 
we arrive at the figure or is that pretty much standard 
practice in that past or is there a way to up that figure or 
exactly what is the basis of that?
    Mr. Furiga. Mr. Underwood, I didn't mean to imply that we 
had established that 50 percent of the oil received has to be 
domestic. Under the Phase 1 agreements, the exchange rates as 
the numbers fell out indicate that 50 percent of the oil came 
using the royalty oil exchange will, in fact, be domestic 
crude, but our viewpoint is that a barrel is a barrel is a 
barrel. Oil is a fungible commodity. If we take a barrel off 
the market in the Gulf Coast, it doesn't matter if it is 
domestic or foreign, it still has that--if it is a million 
barrels of foreign, it has a penny impact; if it is a million 
barrels of domestic, it has a penny impact.
    Mr. Underwood. Well, what happens to the--you know, I mean, 
I understand that in terms of the value to the government, but 
what about the independent producers? I guess, I am trying to 
understand if there is a gap between the way this effort is 
being sold and actually what we are doing. Is that really a 
great assistance to the independent oil producers?
    Mr. Furiga. I think it is a help. As I said, if we take a 
barrel of oil off the market, that affects all producers. Now, 
under Phase 1, we went to the largest producers. Under Phase 2, 
the competitive solicitation, independents will be in that 
particular solicitation, but to get the program off the ground, 
we chose to split it into Phase 1 and Phase 2. Phase 1 was 
confined to the largest producers; Phase 2 will be open to 
everybody.
    Mr. Underwood. I am interested in a couple of statements, 
one about the issue of quality and how that is dealt with in 
terms of your calculations and also in terms of transportation, 
which may help me understand exactly what you are trying to do. 
Mr. Furiga, in your statement, you mentioned that crude taken 
``in kind'' and delivered to the Reserve will be required to 
meet your standard quality specifications, and, then, on the 
other hand, Dr. Cruickshank, you stated that allowances will be 
made and deductions allowed to reflect differences in the 
quality of the oil delivered to MMS and the oil actually 
delivered to DOE. Isn't there some kind of contradiction in 
there about how we are actually dealing and how we are actually 
calculating the effect of the difference in the quality of the 
oil?
    Mr. Furiga. I don't think so. On the one hand, we have----
    Mr. Underwood. Boy, I must be very simpleminded then.
    [Laughter.]
    Mr. Furiga. On the one hand, we have----
    Mr. Underwood. I need a Ph.D. in----
    [Laughter.]
    Mr. Furiga. On the one hand, we have the Reserve's quality 
specifications, which, as I said, it is very high quality 
crude. The royalty oil, some of it does not meet those 
specifications or even come close. In arriving at these 
agreements with industry, we take into consideration the fact 
that their royalty oil is of a lower grade, and, therefore, of 
a lower value, and we know we are not going to get a barrel for 
barrel exchange when we are receiving high quality sweet crude 
and they have, for example, high sulfur sour crude; we know 
that. And, so there are formulas that we use; we have done 
exchanges before; we know how to do that, the people in New 
Orleans who are handling these contracts.
    And then there is the transportation. The tariffs of the 
pipelines, for example, from the Gulf Coast up to the St. James 
terminal are published; they are known. We know what it is 
going to cost industry to transport that oil to our site. That 
value is subtracted off too, which, again, decreases the amount 
of the very high quality crude you are going to get compared to 
what they are giving up at the lease which doesn't meet the 
specifications.
    Mr. Underwood. So, in your own statement, you said that the 
producer in Phase 1 will pay the transportation costs, but now 
you are indicating that, in fact, transportation costs--that 
the calculation will take into account the transportation 
costs.
    Mr. Furiga. Which the producer pays.
    Mr. Underwood. Yes, run that by me again.
    Mr. Cruickshank. If I may add to the answer?
    Mr. Underwood. Sure.
    Mr. Cruickshank. In essence, what is happening is that 
there a certain amount of oil at the lease that, in this case, 
the producer has, and he has promised to deliver some other 
volume of oil to the SPR. The two volumes are not going to be 
exactly the same, because the quality of the oil will be 
different and because the value of the oil at the market center 
is more than the value at the lease. So, in essence, he is 
going to shrink that volume. If he is taking a 100 barrels of 
oil at the lease, he is going to offer something less to us at 
the SPR facility to account for that difference in location and 
difference in quality. And, so, in essence, the cost of 
transportation, if you will, is embedded in that exchange rate. 
And, so we receive fewer barrels at the SPR than we are giving 
up at the lease.
    Mr. Underwood. If I could just ask a question about the SPR 
in general. You said that you have 700 million barrel capacity?
    Mr. Furiga. Yes.
    Mr. Underwood. And how much of that is filled at the 
current time?
    Mr. Furiga. We have 561 million barrels in storage.
    Mr. Underwood. Okay. So, are the current activities in 
Yugoslavia going to affect that in any serious way over the 
next few months?
    Mr. Furiga. I am not aware of any plans to use the SPR as 
we have done in Desert Storm.
    Mr. Underwood. Okay, thank you very much.
    Mrs. Cubin. Just because I am a little dense here, I want 
to get this straight as far as the quality factor and the 
transportation is concerned. Bottom line, if 28 million barrels 
are delivered at the platform, how many barrels go underground 
in the SPR?
    Mr. Furiga. I can't give you an exact barrel number, but it 
will be something less, I can guarantee you that. As I said, 
when Phase 2 is done, we will be pleased to provide the ratios. 
I can tell you that based on the exchanges we have done in the 
past, the ratios we have obtained in Phase 1 compare quite 
favorably to what we have experienced in the past, but it is 
not going to be barrel for barrel.
    Mrs. Cubin. Do you know what those ratios are?
    Mr. Furiga. I know what they are.
    Mrs. Cubin. Is that what you didn't want to say?
    Mr. Furiga. I would prefer not to state them in an open 
hearing; in a closed session, we would be very happy to----
    Mrs. Cubin. Okay. So, 28 million barrels at the platform, a 
lesser amount delivered underground, and that accounts for the 
quality and the transportation.
    Mr. Furiga. Yes.
    Mrs. Cubin. Okay. So, I don't see how, then, that 
transportation is a producer cost. It is not a producer cost.
    Mr. Cruickshank. No, the producer is arranging for the 
transportation, but he is, in essence, charging----
    Mrs. Cubin. Less.
    Mr. Cruickshank. [continuing] for it by keeping some of the 
barrels.
    Mrs. Cubin. Okay, that makes it clear to me then. Thank you 
very much.
    Mr. Underwood. Mr. Inslee.
    Mrs. Cubin. Thank you. Mr. Inslee, did you have any 
questions?
    [Laughter.]
    Mr. Inslee. Thank you, Madam Chair. I don't have any 
questions. Thanks for the assistance from Guam.
    Mrs. Cubin. Oh, you know, when you are a middle-aged woman, 
you can't be held responsible for things.
    Well, I would like to thank the panel very much, again, for 
your cooperation in working together and getting this done, and 
while all of us realize it isn't a solution to the problem that 
the domestic oil is facing, it certainly has been helpful, and 
I truly appreciate your cooperation, and I hope you have a good 
meeting for the rest of your convention, Dr. Cruickshank. Thank 
you very much.
    This Subcommittee is adjourned.
    Mr. Furiga. Thank you.
    [Whereupon, at 2:40 p.m., the Subcommittee was adjourned.]
    [Additional material submitted for the record follows.]
 Statement of Richard D. Furiga, Deputy Assistant Secretary, Strategic 
 Petroleum Reserve, Office of Fossil Energy, U.S. Department of Energy

    Madam Chairman and Members of the Subcommittee:
    I am pleased to represent the Department of Energy and to 
appear with my colleague from the Department of the Interior to 
testify on the resumption of oil acquisition for the Strategic 
Petroleum Reserve.
    A joint DOE/DOI team has been putting this initiative 
together quickly and effectively. The efforts of the staff from 
our Office of Fossil Energy and from Interior's Minerals 
Management Service have allowed us to take advantage of low oil 
prices and begin adding to our Nation's energy security.
    In fact, I am pleased to report that beginning this coming 
weekend the first crude oil will be delivered to the Strategic 
Petroleum Reserve under an expedited delivery request from 
Equiva Trading Company in exchange for royalty volumes from 
Shell and Texaco.
    Before I go into more detail on the progress made to date 
and our plans for the immediate future, let me describe briefly 
the significance of the Strategic Petroleum Reserve to the 
energy and economic health of this Nation.

The Strategic Petroleum Reserve--An Investment in Energy 
Security

    The Strategic Petroleum Reserve is the cornerstone of our 
capability to respond to an energy supply emergency.
    Numerous times in the past three decades the world has 
experienced disruptions in the supply of oil exports. In 1973 
the first energy crisis made most Americans aware that our 
economy is highly dependent upon the availability of imported 
oil, and that crude oil prices were, for the most part, no 
longer within our control. That price shock led to passage of 
the Energy Policy and Conservation Act in December 1975. Among 
other things, the Act authorized the creation of a petroleum 
reserve of up to one billion barrels.
    Today, the Strategic Petroleum Reserve consists of four 
sites, two in Texas and two in Louisiana, with a capacity of 
700 million barrels. All of the storage capacity is in 62 huge 
caverns that have been leached from salt domes thousands of 
feet below the surface.
    The first crude oil was added to the Reserve on July 21, 
1977. In the early 1980s, in the aftermath of the 1979 Iranian 
revolution and accompanying oil disruption, the Reserve was 
filled as fast as the facilities could accept crude oil; by the 
end of 1985, it contained 489 million barrels of oil. In the 
late 1980's and early 1990's, constrained by tightening 
budgets, fill continued albeit at a slower pace. In 1994, fill 
stopped completely at a peak inventory of 592 million barrels.
    The Reserve has been used once under Presidential direction 
in response to oil supply concerns. In January 1991, at the 
onset of Operation Desert Storm and in conjunction with our 
allies in the International Energy Agency, the Department of 
Energy activated a drawdown of the Reserve, ultimately awarding 
competitive contracts for the sale of 17.3 million barrels. The 
Desert Storm sale, and other test sales, successfully 
demonstrated the Reserve's ability to function efficiently in a 
real world emergency situation.
    In fiscal years 1996-97, driven by fiscal requirements, 
three non-emergency oil sales totaling 28 million barrels were 
carried out, leaving the Reserve at its current inventory of 
561 million barrels.

Transfer of Royalty Oil to Restore SPR Inventory

    The downturn in oil prices that began in late 1997 and 
intensified in 1998 and early 1999 continues to pose a serious 
threat to our domestic production capacity and, consequently, 
to our long-term energy security. At the same time, however, it 
has provided an unprecedented opportunity to begin re-acquiring 
crude oil for the Reserve at relatively low prices.
    Secretary Richardson brought this issue before the 
Administration in late 1998. After a series of meetings with 
the Department of the Interior, the Office of Management and 
Budget, and the National Economic Council, it was agreed the 
Administration would move as quickly as possible to transfer 28 
million barrels of Federal royalty oil--the same amount sold 
during 1996 and 1997 largely for deficit reduction purposes--to 
the Department of Energy for use in refilling the Strategic 
Petroleum Reserve. The oil to be transferred would be royalty 
oil from the Gulf of Mexico Outer Continental Shelf.
    This approach to acquiring oil for the Reserve while prices 
are relatively low offers several advantages:

         The acquisition price would be below the price for 
        which the Government had sold oil in FY 1996-97 and 
        significantly below the Reserve's historic average oil 
        acquisition cost.
         By resuming oil fill, we would help improve the ratio 
        between the Reserve's inventory and the daily rate of oil 
        imports which had begun to escalate in recent years.
         Finally, the royalty transfer plan would enable the 
        Federal Government to add oil to the Reserve without requiring 
        new appropriations, particularly important since funding has 
        not been appropriated to purchase oil for the Reserve since 
        1990.
    As Secretary Richardson said in announcing the initiative on 
February 11, 1999, ``By putting royalty oil in the Strategic Petroleum 
Reserve today, we will get a high rate of return tomorrow--enhanced 
national energy security, increased strategic assets, and a very good 
deal for the American taxpayer.''
    Working together, the Department's Strategic Petroleum Reserve 
Office and the Minerals Management Service decided to transfer the oil 
in two phases.
    In Phase 1 the Government negotiated with a small number of the 
largest producers on Federal lease tracts with a target of transferring 
up to 50,000 barrels of oil per day, starting no later than May 1, and 
ending on July 31, 1999. Phase 2 will take the remainder of the 28 
million barrels from eligible producers who respond to a competitive 
solicitation. Deliveries are expected to start on August 1, 1999, at a 
rate of approximately 100,000 barrels per day and end in March or April 
2000.
    In both phases, the Strategic Petroleum Reserve will require that 
the oil delivered to the Reserve meet our standard quality 
specifications. In addition, the Strategic Petroleum Reserve is 
requiring that bids provide for delivering the oil directly to Reserve 
sites rather than to the normal transfer points at which the value of 
the royalty share is calculated for payment in cash.
    Due to the complexity of gathering and transporting royalty oil 
with varying qualities produced from more than 1,000 Federal leases in 
the Gulf of Mexico, we do not expect to transport royalty barrels 
directly to the Reserve. Instead, we will arrange for exchanges of 
crude oil to meet the Reserve's storage specification and provide for 
efficient delivery.
    Under these exchange agreements, the volume of oil received by the 
Strategic Petroleum Reserve will differ from and could be somewhat less 
than the volumes accepted by the Minerals Management Service. This is 
because the oil delivered to the Reserve is expected to be of a higher 
quality than the oil produced at the lease and additionally, the 
producer in Phase 1 or the contractor in Phase 2 will pay the 
transportation expenses.
    For example, in the recently negotiated contracts, the crude oil to 
be received by the Strategic Petroleum Reserve will be a light, low-
sulfur oil, significantly higher in quality than the oil produced from 
the Federal leases. This grade of crude oil is suitable for the 
``sweet'' oil storage capacity available at our Bayou Choctaw site. 
Because the oil to be delivered is of higher quality than the royalty 
crude, the exchange ratio is somewhat less than 1:1 due to adjustments 
for crude quality.\1\
---------------------------------------------------------------------------
    \1\  Exchanging crude oil to enhance the quality of the oil in the 
Strategic Petroleum Reserve is not without precedent. In 1998, P.M.I. 
Norteamerico S.A. de C.V., of Houston, TX, a commercial arm of the 
Mexican oil company PEMEX, delivered 8.524 million barrels of higher-
grade oil in exchange for 11 million barrels of heavier, higher-sulfur 
Maya crude oil.
---------------------------------------------------------------------------
    In the upcoming Phase 2, we expect to continue the exchange 
practice. When the Reserve receives a barrel of crude oil in exchange 
for an equivalent quality royalty crude, the total volume delivered 
will be close to the quantity transferred by the Minerals Management 
Service, adjusted only for gathering and transportation expenses.

Recent Actions and Current Plans

    On March 31, 1999, we announced our contracts under the first phase 
of the royalty in kind program. Shell, Texaco, and BP-Amoco have agreed 
to deliver 38,600 barrels per day of very light, low-sulphur crude oil 
to our Bayou Choctaw, Louisiana, site in lieu of making a royalty 
payment to the Minerals Management Service. The 3-month contracts will 
result in approximately 3.5 million barrels being added to the Reserve.
    Because these companies are all potential bidders during Phase 2 of 
this royalty-in-kind transfer, they have asked us to treat the exchange 
ratios for the royalty versus delivered oil as procurement sensitive 
information, and we therefore, have not included in our public 
testimony the exact volumes of royalty oil included in the contract.
    Phase 2 of the royalty-in-kind program will begin with a 
solicitation that we plan to issue in late April or early May. Unlike 
the first phase, Phase 2 will be open to all bidders for 100,000 
barrels per day of royalty oil from the Gulf of Mexico. We anticipate 
awarding contracts in June and beginning deliveries on August 1, 1999. 
Deliveries will continue until the total 28 million barrels of royalty 
oil is transferred to the Department of Energy.
    Our success in Phase 1 of this program, and our continued close 
working relationship with the Department of the Interior, gives us 
every reason to believe the second phase will also proceed smoothly. We 
expect that the Department of Energy will add inventory to the Reserve, 
lower the average cost of oil acquisition, receive fair value during 
the exchange portion of the contract, and conduct its acquisition in a 
manner to counter balance the extremes of the supply and demand cycles 
rather than exacerbating their peaks and valleys.
    This concludes my prepared statement, I will be happy to answer any 
questions Members may have.
                                 ______
                                 
     Statement of Walter Cruickshank, Associate Director, Minerals 
          Management Service, U.S. Department of the Interior
    Madam Chairman and Members of the Subcommittee, I appreciate the 
opportunity to appear today to present testimony on the Minerals 
Management Service's (MMS) efforts in support of the joint Departments 
of Energy (DOE) and the Interior (DOI) initiative to move Federal 
royalty oil into the Strategic Petroleum Reserve (SPR). My testimony 
today will briefly: (1) describe the initiative and its status; (2) 
outline MMS' role; (3) address some of the operational considerations 
in using Federal royalty in kind (RIK) oil to add to the SPR; and (4) 
explain our plans for the next phase of this project.
    Description and Status of the Project. The SPR RIK Initiative will 
be implemented in two phases.
    In Phase 1, DOE and MMS are now concluding negotiations with 
several of the largest crude oil producing companies in the Gulf of 
Mexico for potential deliveries of royalty oil to DOE and the SPR 
starting on May 1, 1999 for a 3-month period. We realize the importance 
of filling the SPR as quickly as possible during this time of 
relatively low crude oil prices and Phase 1 has been designed to 
accomplish this. By targeting the largest available royalty volumes and 
directly negotiating with the producer, we believe we can attain 
efficient delivery of significant volumes to the SPR in the minimum 
amount of time.
    To date, we have successfully negotiated arrangements with three of 
the largest crude oil producers in the Gulf of Mexico--Texaco, Shell, 
and BP-Amoco--to begin delivering approximately 38,600 barrels per day 
of oil to add to the Federal Government emergency stockpile. Over the 
3-month term of this first phase, these companies will deliver nearly 
3.5 million barrels of oil to DOE at the St. James market center for 
further movement into the SPR facility at Bayou Choctaw, Louisiana. 
Continuing negotiations may provide additional royalty oil volumes to 
the SPR in Phase 1.
    Phase 1 agreements provide for delivery at the St. James market 
center of volumes of oil that are less than the government's royalty 
volume entitlement at the lease. This reduction in volume reflects both 
transportation and the quality and location differentials between the 
generally higher quality of crude oil delivered to DOE at the market 
center and the royalty oil at the lease. Negotiations focused on the 
amount and value of these factors.
    Under Phase 2, the SPR RIK Initiative will expand to potentially 
take the remaining volumes identified for the program and increase the 
fill rate for the SPR. DOE and MMS will conduct a competitive auction 
in Phase 2 in which royalty oil at the lease will be offered in 
exchange for delivery of crude oil meeting SPR specifications to 
locations at or near at least two SPR facilities. Royalty volumes on 
the order of 70,000 to 100,000 barrels per day are anticipated to be 
available for bidding under Phase 2. The objective is to include all 
potential market participants in order to maximize competition and 
minimize costs of delivering crude to the SPR. Phase 2 begins when 
Phase 1 ends, on August 1, 1999, and runs for a 6-month term with the 
potential for a second term. Planning for Phase 2 is currently 
underway.
    All OCS leases will be available for inclusion in the program 
except for:

         Section 8(g) leases: These leases are excluded because 
        the coastal States receive 27 percent of associated royalty 
        receipts, and those States would lose an important revenue 
        stream from SPR-dedicated leases.
         Section 6 leases: These leases generally do not 
        include language giving the government the option to take 
        royalties in kind. They will be included in the program upon 
        lessee agreement.
         Leases dedicated to supply small refiners: These 
        leases will be included when and if they are dropped from the 
        small refiner program.
         Leases in MMS' royalty reengineering program: Some 208 
        Gulf of Mexico leases are included in this important 
        exploration and testing of new methods to manage mineral 
        royalties. Some of these leases may be available under Phase 2 
        in the year 2000.
    DOI/MMS Role. The MMS' role in the SPR initiative is to support the 
lead agency--DOE--in economic analyses and in the ``upstream'' 
logistics of royalty oil delivery at Gulf of Mexico leases. The MMS' 
role is to:

         Identify the Gulf of Mexico leases for which oil 
        royalties can be received in kind and generate lease 
        information for program implementation.
         Notify lease owners of any decision to take their 
        royalties in kind, and inform them of their rights and 
        responsibilities when paying royalties in kind.
         Continue to perform lease measurement and production 
        accounting functions and supply DOE with data on production and 
        royalty entitlement.
         Assist DOE in negotiations with lease owners for 
        delivery of RIK oil to the SPR under Phase 1 of the program.
         In Phase 2 of the program, assist DOE in developing 
        and issuing a competitive solicitation for delivery of oil to 
        SPR facilities. We will also assist DOE in evaluating bids 
        received and selecting the winning bidders.
    Operational Considerations. Operational and logistical 
considerations that have been addressed to date include the following.
    Title transfer and contracting. Using the provisions of the OCS 
Lands Act, DOI will transfer title to royalty oil to DOE at the OCS 
facility measurement point, typically on the lease. DOE will award and 
administer contracts for delivery of crude oil to the SPR facility or 
nearby market center. In both phases, crude oil will move to the SPR by 
standard industry practice. We anticipate that the most common scenario 
will be the award by DOE of exchange contracts in which royalty oil 
will be provided to the contractor in exchange for a market-based 
volume of SPR crude either at or near the SPR facility or at the market 
center. DOE will arrange for any final transportation needed to move 
crude from an exchange point not located at one of the SPR sites.
    Imbalances. The operator/lessee will be required to maintain a 
balancing account to track monthly imbalances that may occur in 
deliveries of royalty oil to DOI. The operator will work together with 
DOI and DOE to resolve monthly imbalances by increasing or decreasing 
deliveries in the subsequent month. However, MMS retains the right to 
settle imbalances via cash payment or accounting adjustment at the end 
of each contract term.
    De Minimis Leases. A substantial number of offshore properties 
produce small amounts of crude oil, much of which is condensate 
associated with natural gas production. For example, nearly 30 percent 
of offshore properties produce less than 1 barrel per day. In Phase 1, 
we have negotiated for RIK deliveries primarily from high producing 
leases. In Phase 2, we have not yet decided whether to include all 
available leases or to exclude those leases producing de minimis 
amounts. The primary factors we are considering are the administrative 
costs for the government to analyze the economics and monitor 
compliance for each of these leases and the transaction costs for the 
industry to deliver RIK for the de minimis leases.
    Next Steps. For the combined Phase 1 and 2 program, DOE/DOI plan to 
take up to 28 million barrels of royalty oil at the lease, which is 
estimated by OMB to have a fiscal impact of $170 mm in Fiscal Year 1999 
and $200 mm in Fiscal Year 2000 (using OMB's FY 2000 budget ecomomic 
assumptions of price projections of $12.39 and $14.12, respectively) in 
decreased revenues to the Treasury. Actual fiscal impact will depend on 
actual delivery dates, quantity of oil transferred, and market oil 
price at the time.
    It is premature to identify at this point how many barrels will be 
actually delivered into the SPR from the up to 28 million barrels of 
royalty oil identified for potential delivery to DOE at the lease. The 
actual amount of crude oil delivered to the SPR will depend on the 
specific details of negotiated agreements (Phase 1) and successful bids 
in the competitive auction (Phase 2). The primary determinant will be 
the location and quality differentials between the value of the royalty 
oil at the lease and the value of the oil delivered to the SPR sites. 
At least 15 percent of the 28 million barrels of RIK oil will be taken 
in the 3-month Phase 1 term.
    We will be very busy this Spring as we work with DOE to develop and 
conduct the competitive bidding process under Phase 2 for royalty oil 
deliveries to the SPR. Specifically, we will assist DOE in developing 
and releasing a Request for Offers (RFO); preparing an evaluation plan; 
arraying economic and lease data to support the economic analysis of 
bids; and evaluating, negotiating, and selecting bids. We anticipate 
that contracts will be awarded on or before July 1, 1999 for Phase 2 
deliveries that will commence August 1, 1999.
    In closing, let me state that we look forward to continuing to work 
with DOE to complete the transfer of 28 million barrels of royalty oil. 
We believe that this program will enhance the energy security of our 
nation. We also believe that this program illustrates that as managers 
of public assets we can and must remain agile and flexible to respond 
to changing public needs. Using our RIK option to partially fill the 
SPR is a good example of how we can retain such flexibility.
    Thank you Madam Chairman and Members of the Subcommittee, this 
concludes my prepared remarks. I would be pleased to answer any 
questions you may have.
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