[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
COLLECTION AND DISPOSITION OF FEDERAL OIL AND GAS ROYALTIES TAKEN IN-
KIND
=======================================================================
OVERSIGHT HEARING
before the
SUBCOMMITTEE ON ENERGY AND
MINERAL RESOURCES
of the
COMMITTEE ON RESOURCES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
June 12, 2001
__________
Serial No. 107-36
__________
Printed for the use of the Committee on Resources
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
or
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_______
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COMMITTEE ON RESOURCES
JAMES V. HANSEN, Utah, Chairman
NICK J. RAHALL II, West Virginia, Ranking Democrat Member
Don Young, Alaska, George Miller, California
Vice Chairman Edward J. Markey, Massachusetts
W.J. ``Billy'' Tauzin, Louisiana Dale E. Kildee, Michigan
Jim Saxton, New Jersey Peter A. DeFazio, Oregon
Elton Gallegly, California Eni F.H. Faleomavaega, American
John J. Duncan, Jr., Tennessee Samoa
Joel Hefley, Colorado Neil Abercrombie, Hawaii
Wayne T. Gilchrest, Maryland Solomon P. Ortiz, Texas
Ken Calvert, California Frank Pallone, Jr., New Jersey
Scott McInnis, Colorado Calvin M. Dooley, California
Richard W. Pombo, California Robert A. Underwood, Guam
Barbara Cubin, Wyoming Adam Smith, Washington
George Radanovich, California Donna M. Christensen, Virgin
Walter B. Jones, Jr., North Islands
Carolina Ron Kind, Wisconsin
Mac Thornberry, Texas Jay Inslee, Washington
Chris Cannon, Utah Grace F. Napolitano, California
John E. Peterson, Pennsylvania Tom Udall, New Mexico
Bob Schaffer, Colorado Mark Udall, Colorado
Jim Gibbons, Nevada Rush D. Holt, New Jersey
Mark E. Souder, Indiana James P. McGovern, Massachusetts
Greg Walden, Oregon Anibal Acevedo-Vila, Puerto Rico
Michael K. Simpson, Idaho Hilda L. Solis, California
Thomas G. Tancredo, Colorado Brad Carson, Oklahoma
J.D. Hayworth, Arizona Betty McCollum, Minnesota
C.L. ``Butch'' Otter, Idaho
Tom Osborne, Nebraska
Jeff Flake, Arizona
Dennis R. Rehberg, Montana
Allen D. Freemyer, Chief of Staff
Lisa Pittman, Chief Counsel
Michael S. Twinchek, Chief Clerk
James H. Zoia, Democrat Staff Director
Jeff Petrich, Democrat Chief Counsel
------
SUBCOMMITTEE ON ENERGY AND MINERAL RESOURCES
BARBARA CUBIN, Wyoming, Chairman
RON KIND, Wisconsin, Ranking Democrat Member
W.J. ``Billy'' Tauzin, Louisiana Nick J. Rahall II, West Virginia
Mac Thornberry, Texas Edward J. Markey, Massachusetts
Chris Cannon, Utah Solomon P. Ortiz, Texas
Jim Gibbons, Nevada, Calvin M. Dooley, California
Vice Chairman Jay Inslee, Washington
Thomas G. Tancredo, Colorado Grace F. Napolitano, California
C.L. ``Butch'' Otter, Idaho Brad Carson, Oklahoma
Jeff Flake, Arizona
Dennis R. Rehberg, Montana
------
C O N T E N T S
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Page
Hearing held on June 12, 2001.................................... 1
Statement of Members:
Cubin, Hon. Barbara, a Representative in Congress from the
State of Wyoming........................................... 1
Prepared statement of.................................... 3
Kind, Hon. Ron, a Representative in Congress from the State
of Wisconsin, Prepared statement of........................ 64
Maloney, Hon. Carolyn B., a Representative in Congress from
the State of New York, Press release and statement
submitted for the record................................... 51
Tancredo, Hon. Thomas G., a Representative in Congress from
the State of Colorado, Prepared statement of............... 63
Statement of Witnesses:
Cruickshank, Walter, Associate Director, Policy and
Management Improvement, Minerals Management Service........ 29
Prepared statement of.................................... 31
Harpole, John A., President, Mercator Energy LLC............. 34
Prepared statement of.................................... 36
Jacob, James M., Manager of Consumer Advocacy, KeySpan
Corporation................................................ 45
Prepared statement of.................................... 47
Leggette, L. Poe, Fulbright & Jaworski LLP, on behalf of the
American Petroleum Institute, Independent Petroleum
Association of America, Independent Petroleum Association
of Mountain States, Domestic Petroleum Council, and U.S.
Oil and Gas Association.................................... 18
Prepared statement of.................................... 19
McMahon, M. Brian, McMahon & Spiegel,........................ 4
Prepared statement of.................................... 6
COLLECTION AND DISPOSITION OF FEDERAL OIL AND GAS ROYALTIES TAKEN IN-
KIND
----------
Tuesday, June 12, 2001
U.S. House of Representatives
Subcommittee on Energy and Mineral Resources
Committee on Resources
Washington, DC
----------
The Subcommittee met, pursuant to notice, at 10:05 a.m., in
Room 1324, Longworth House Office Building, Hon. Barbara Cubin
[Chairman of the Subcommittee] presiding.
STATEMENT OF THE HONORABLE BARBARA CUBIN, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF MYOMING
Mrs. Cubin. The oversight hearing by the Subcommittee on
Energy and Mineral Resources will come to order.
The Subcommittee is meeting today to hear testimony on
collection and disposition of Federal oil and gas royalties
taken in-kind. Under Rule 4(G), the Chairman and the Ranking
Member are the only ones that can make opening statements, and
so I wonder if Ron would mind if I made his. In this hearing, I
think it would probably be okay, but he will be here later. He
is on a flight back to Washington and I am sure he will be able
to make it for part of the hearing.
This hearing will continue to focus on the Subcommittee's
inquiry on issues relevant to our energy supply for the nation
from public lands and the outer continental shelf. But we are
not today here to decry the lack of access to potential
reservoirs of oil and gas, or seams of coal, or geothermal
resources on our public land. Nor are we here today to ponder
ways to get those energy reserves into production and thence to
consumers more quickly than the current regulatory regime has
allowed. Rather, the topic for today's discussion is about
whether the Federal Government ought to consider greater use of
in-kind collections for oil and gas royalties owed on producing
leases.
The Subcommittee has a history over the past several
Congresses of debating the problem of valuing oil and gas for
royalty purposes in those instances where no arm's length
transaction exists at the wellhead. Royalty in-kind, or RIK, is
simply the exercise by the Secretary of Interior of her
existing authority to demand that a Federal lessee surrender to
the government his or her royalty obligation, not in a cash
payment but rather as a fraction of the oil and gas volume that
is produced.
In this manner, the morass of calculating the wellhead
value of the commodity from a downstream price with a net-back
formula for processing, transportation, and marketing
deductions is eliminated. Auditing of the volume of oil and gas
produced must still occur, but this has to happen with in-value
royalty payments, as well, so what it amounts to is checking
the flow meters and seals against tampering, which would be a
far easier job than calculating value.
But what happens then? The Secretary must dispose of these
volumes in some manner. In the Wyoming crude oil pilot MMS
project, royalty oil was aggregated (and oil from State leases,
as well) and they were bid out at semi-annual auctions. This
appears to have been a success in terms of demonstrating an
ability to receive an uplift for the Federal Government and the
State of Wyoming compared to those leases which did not
participate in the RIK project.
On the outer continental shelf of the Gulf of Mexico,
natural gas royalties have been targeted for in-kind pilot
programs. As I have noted in previous hearings, MMS has
transferred gas to the General Services Administration, which
has used it to heat Federal facilities, including the Longworth
House Office Building, which we are now in--In fact, I wish
they would use a little bit more of it, John, to get the air
conditioning a little cooler in here, please.
This is as far as the General Services Administration has
used RIK so far, but in what other ways is it possible that RIK
might provide flexibility to fill another governmental need?
Well, President Bush's National Energy Policy report
recommends that the Secretary of Interior work with the
Secretary of Health and Human Services to draft legislation to
bolster the Low-Income Home Energy Assistance Program, or
LIHEAP, through the dedication of oil and gas royalties. While
this could be done with royalty dollars rather than royalty gas
molecules, is there a reason to explore the latter approach? I
think there is.
Could a pilot program be established to test the benefits
of directing Federal royalty natural gas volumes to a utility
with experience in delivering energy to low-income households?
If so, would OCS leases be the better choice for a pilot, or
would onshore public land leases?
These are several of the questions that we shall pose to
our witnesses today to begin to flesh out, or put some flesh on
the bones of the President's recommendation.
And lastly, I would like to thank all of our witnesses for
coming to educate us on this issue. The RIK idea has engendered
passionate debate in the past about whether the oil and gas
industry is trying to escape its proper obligation to pay
royalty based on a fair market value of the production. I think
at this time it is demagoging to portray the industry as
``cheats.'' Yes, we all acknowledge that large sums have been
proffered by companies in settlements of lawsuits, and a recent
judgment in an Alabama court levied a huge award against one
major oil company. But a jury in California a few years ago
rebuffed claims that this same energy company had cheated on
its State lease obligations.
One point should be obvious, that had the Federal lessees
paid these disputed royalties, in-kind, the U.S. taxpayer would
have been the immediate beneficiary because there would have
been no delay in collecting the proper value. My position
continues to be that each and every lessee is obligated and
must pay every single penny that it owes in royalties, whether
it is in cash or in-kind, no more and no less. But they have to
be held responsible for that.
Within the context of all of this, now let us turn to the
issue of whether RIK can provide a benefit to our less
fortunate citizens on a cold winter's night or a hot summer's
day, like today.
[The prepared statement of Mrs. Cubin follows:]
Statement of The Honorable Barbara Cubin, Chairman, Subcommittee on
Energy and Mineral Resources
This hearing will continue the Subcommittee's inquiry on issues
relevant to energy supply for our Nation from public lands and the
outer continental shelf. But we aren't today to decry the lack of
access to potential reservoirs of oil and gas, or seams of coal, or
geothermal resources.
Nor are we here today to ponder ways to get those energy reserves
into production and thence to consumers more quickly than the current
regulatory regime has allowed.
Rather, the topic for today's discussion is about whether the
Federal Government ought to consider greater use of in-kind collections
for oil and gas royalties owed on producing leases.
The Subcommittee has a history over the last several Congresses of
debating the knotty problem of valuing oil and gas, for royalty
purposes, in those instances when there is no arm's-length transaction
at the wellhead. Royalty-in-kind, or R-I-K, is simply the exercise by
the Secretary of the Interior of her existing authority to demand that
a Federal lessee surrender to the government his or her royalty
obligation not in a cash payment but rather as a fraction of the oil
and gas volume produced.
In this manner, the morass of calculating the wellhead value of the
commodity from a downstream price with a net-back formula for
processing, transportation, and marketing deductions is eliminated.
Auditing of the volume of oil and gas produced must still occur, of
course, but this must happen with in-value royalty payments, too, and
it amounts to checking the flow meters and seals against tampering - a
far easier job than calculating value.
But, what happens then? The Secretary must dispose of these volumes
in some manner. In the Wyoming crude oil pilot MMS has aggregated its
royalty volumes (and those of State leases as well) and bid them out at
semi-annual auctions. And this appears to have been a success in terms
of demonstrating an ability to receive an ``uplift'' for the feds and
the State of Wyoming compared to those leases which did not participate
in the R-I-K pilot.
On the outer continental shelf (OCS) of the Gulf of Mexico, natural
gas royalties have been targeted for in-kind pilot programs. As I have
noted in previous hearings, MMS has transferred gas to the General
Services Administration which has used it to heat Federal facilities -
including the Longworth House Office Building in which we sit.
This is fine as far as it goes, but in what other ways might R-I-K
provide flexibility to fill a governmental need?
Well, President Bush's National Energy Policy report recommends
that the Secretary of the Interior work with the Secretary of Health &
Human Services to draft legislation to bolster the low income home
energy assistance program, or LIHEAP, through the dedication of oil and
gas royalties. While this could be done with royalty dollars rather
than royalty gas molecules, is there a reason to explore the latter
approach?
Could a pilot program be established to test the benefits of
directing Federal royalty natural gas volumes to a utility with
experience in delivering energy to low-income households? If so, would
OCS leases be the better choice to pilot or would onshore public lands
leases? These are several questions we shall pose to our witnesses
today to begin to put flesh onto the bones of the President's
recommendation.
Lastly, I'd like to thank all of our witnesses for coming to
educate us on this issue. The R-I-K idea has engendered passionate
debate in the past about whether the oil & gas industry is trying to
escape its proper obligation to pay a royalty based upon a fair market
value of the production. I believe that demagoging the industry as
``cheats'' is unproductive. Yes, large sums have been proffered by
companies in settlements of lawsuits and a recent judgment in an
Alabama court levied a huge award against one major oil company. But a
jury in California a few years ago rebuffed claims that this same
company had cheated on its state lease obligations.
One point should be obvious - had the Federal lessees paid these
disputed royalties in-kind, the U.S. taxpayer would have been the
immediate beneficiary because there would have been no delay in
collecting the proper value. My position continues to be that each and
every lessee is obliged to pay every penny of royalty owed in-cash or
in-kind. No more and no less.
Within this context let us now turn to the issue of whether R-I-K
can provide a benefit to our less fortunate citizens on a cold winter's
night, or a hot summer's day.
______
Mrs. Cubin. Since the Ranking Member is not here, I would
be happy to recognize Mr. Inslee, if he would like to make an
opening statement.
Mr. Inslee. I will defer, Madam Chair. Thank you very much.
Mrs. Cubin. I would like to introduce the first panel of
witnesses and welcome them and thank them very much for being
here with us today. Mr. M. Brian McMahon, McMahon and Spiegel;
Mr. L. Poe Leggette, Fulbright and Jaworski, on behalf of API,
IPAA, IPAMS, EPC, and USOGA.
The Chair now recognizes Mr. McMahon. I would like to
remind you that your verbal testimony is limited to 5 minutes,
but your entire testimony will be put in the record, and point
the timing lights out to you.
STATEMENT OF M. BRIAN McMAHON, McMAHON AND SPIEGEL
Mr. McMahon. Thank you, Madam Chairman. I would like to
thank you for inviting me to appear today to this hearing, and
I would like to thank specifically Carolyn Maloney,
Representative from New York, who personally invited me to talk
at this hearing Friday afternoon.
In May 1998, I appeared before--
Mrs. Cubin. Well, that was quick work and good work to get
here.
Mr. McMahon. I got little sleep. In May 1998, I appeared
before this Subcommittee to support MMS's efforts to adopt new
valuation regulations for Federal royalty oil. At that time, we
discussed the use of RIK sales. These are important issues for
California. We have a large amount of Federal oil production in
California and California's share of royalties goes directly to
support its educational system.
California is concerned that the recent Wyoming RIK
experience not be misinterpreted and used to justify unwise or
costly RIK policies. As we pointed out in 1998, California has
decades of experience in conducting RIK sales. We made the
following points then in 1998 and we make them today.
First, Long Beach and California have been conducting
royalty in-kind sales since the early 1970's.
Second, RIK sales achieve prices consistently higher than
posted prices for California crudes.
Third, major oil companies, with rare exceptions, will not
bid on RIK sales. The reason is that if they bid higher than
their posted prices, they would undermine their posted prices.
They use posted prices as the basis of their royalty
obligations for non-Federal oil and for many of their purchases
of crude oil from producers and non-working interest owners.
Fourth, although RIK sales prices are consistently above
posted prices, they are consistently below fair market value.
We noted then and note now that the price of Alaska North Slope
crude oil, ANS crude oil, sold in Long Beach is consistently
above the royalty in-kind's prices that we receive in
California. Attached to my written testimony, you will see a
bar chart which compares posted prices, RIK sales in
California, and ANS prices as quoted in Long Beach.
For these reasons, we supported MMS's efforts to base
Federal royalties on readily available and competitive market
prices, such as the spot price of ANS on the West Coast and the
reported spot market prices for West Texas sour crude and West
Texas intermediate crude.
The observations we made before the Committee 3 years ago
about Long Beach's and California's RIK sales are still true
today. Major oil companies, with rare exception, still do not
bid on RIK sales, but when we do get RIK sales, non-majors bid
on RIK sales and their prices are higher than postings.
One preliminary observation: MMS published their new
regulations on April 15 of last year and they were to go into
effect June 1 of the year 2000. MMS, as far as I know, has no
reliable data on the prices they have received under the new
regulations. I am not faulting MMS for doing this, but when
they did their study of the Wyoming RIK sales, they did not
compare the prices received under those sales with the prices
they are to receive under the new regulations. There is no
reason to ignore the impact of the new regulations, even though
we still do not have any results yet. Much less is there any
reason to abandon the new regulations in favor of an all-out
RIK program on the basis of this pilot study.
Let me look now to the Wyoming study itself. As shown in
the report that I have prepared and attached to my testimony,
its striking feature is that it is consistent with California
and Long Beach's experience. First, only 15 companies ever
bothered to submit comments. Only one of those, Exxon, was a
major oil company. Only seven companies were winning bidders
and none of them was a major oil company. Most of them were
marketers or brokers, not refiners, which suggests that these
firms would be reselling the oil to refiners at even higher
prices.
Second, as in the California experience, the accepted bids
were higher than the prices posted by the major oil companies.
And third, as discussed below, the RIK sales prices were
lower than market prices. We are going to use Canadian crude
oil prices to measure the effectiveness of the RIK sales in
Wyoming.
Fourth, the sales constituted 1.6 million barrels over an
18-month period, and that represents less than 1 percent of the
total crude production of the Rocky Mountain area.
I guess I am out of time already?
Mrs. Cubin. You are out of time, if you could just sum it
up.
Mr. McMahon. Okay. What we did, in brief, Madam Chairman,
was we compared Canadian crude prices, we adjusted for
transportation to Wyoming, and as three charts show that are
attached in a study we commissioned on the RIK sales in
Wyoming, they show that in all cases, the prices that--we will
call this market prices for Canadian crude--are higher than the
RIK sales prices.
That does not mean that we believe that MMS did not conduct
the sales correctly. We approve of the way MMS conducted the
RIK sales. But what this shows is that unless major oil
companies are willing to participate in RIK sales, that is, bid
on oil and bid prices higher than their postings, you are going
to continuously find, even in the future, that the prices
received in RIK sales are less than true market prices. That is
why we recommend that the MMS new regulations, which do depend
on market prices, are continually used in the future.
I think at some appropriate time, when MMS gets more data
on the new regulations and how the costs of the new regulations
compare with the RIK sales and the prices received under the
new regulations, then I think we are in a more appropriate
position to be determining the effectiveness of the RIK
program. Thank you very much.
Mrs. Cubin. Thank you, Mr. McMahon.
[The prepared statement of Mr. McMahon follows:]
Statement of M. Brian McMahon, for the City of Long Beach as Trustee
for the State of California
Madam Chairman and members of the Subcommittee:
Thank you for your invitation to appear today to testify in this
hearing on the collection and disposition of Federal oil and gas
royalties taken in kind.
Introduction
In May 1998, I appeared before this Subcommittee to support MMS's
effort to adopt new valuation regulations for Federal royalty oil. At
that time, we discussed the use of royalty-in-kind (RIK) sales. These
are important issues for California. We have a large amount of Federal
oil production in California, and California's share of royalties goes
directly to support its educational system. California is concerned
that the recent Wyoming RIK experience not be misinterpreted and used
to justify unwise and costly RIK policies.
As we pointed out in 1998, California has decades of experience in
conducting RIK sales. The points we made then are still valid today:
LLong Beach and California have been conducting royalty-
in-kind sales since the early 1970's.
LRIK sales achieve prices consistently higher than posted
prices.
LMajor oil companies, with rare exceptions, will not bid
on RIK sales. The reason is that if they bid prices higher than posted
prices, they would undermine their posted prices. They use posted
prices as the basis for their royalty (non-Federal) obligations, and
for many of their purchases of crude oil from producers and non-working
interest owners.
LAlthough RIK sales prices are consistently above posted
prices, they are consistently below fair market values. We noted that
Alaska North Slope (ANS) crude prices in Long Beach are consistently
above the RIK prices in sales by Long Beach and California, as shown by
the attached bar chart.
For these reasons, we supported MMS's efforts to base Federal
royalties on readily available and competitive market prices, such as
the spot price of ANS on the West Coast and the reported spot market
prices for West Texas sour crude and West Texas Intermediate crude.
The observations we made before this subcommittee three years ago
about Long Beach and California's RIK sales are still true today: major
oil companies still do not bid and RIK sales prices continue to be
higher than posted prices, but lower than market values.
One final preliminary observation must be made: MMS published the
new pricing regulations on March 15, 2000 to go into effect on June 1,
2000. Thus, MMS does not yet have any reliable data concerning the
amount of royalties collected under the new regulations. MMS has not
been able to compare the prices received in RIK sales of Wyoming crude
oil with the prices they receive under the new regulations.
Nonetheless, that is no reason to ignore the impact of these
regulations in evaluating a pilot RIK program. Much less is there any
reason to abandon the new regulations in favor of an all out RIK
program on the basis of a very small pilot study.
The MMS Wyoming Study
This brings us to the Wyoming study itself. As shown by the
attached report, its most striking feature is that it is consistent
with Long Beach's and California's experiences in RIK sales. First, as
to participants, only 15 companies ever bothered to submit comments on
the proposed program and only one, Exxon, was a major oil company. Only
seven companies were winning bidders. None of the winning bidders was a
major oil company. Most winning bidders were marketers or brokers, not
refiners, which suggests that these firms could resell the oil to
refiners at even higher prices.
Second, as in the California experience, the accepted bids were
higher than the prices posted by the major companies.
Third, as discussed below, the RIK sales prices were lower than
market prices.
Fourth, these sales of 1.6 million barrels over an 18 month period
represent less than 1% of the total crude oil production in the Rocky
Mountain area.
Canadian Crude Oils are a proper Benchmark to Evaluate the RIK Prices
Contrary to MMS claims, Canadian crude prices are the appropriate
standards for evaluating the Wyoming RIK program. The Rocky Mountain
area is a crude deficit area, i.e., it produces less crude oil than it
refines. Canadian crude oils are the marginal supply for refineries in
the Rocky Mountain area. Canadian crude oils are refined in Colorado,
Wyoming, Montana and Utah and constitute about one third of the crude
oil refined in the Rocky Mountain states. Canadian crude oil is an
appropriate pricing benchmark for the Rocky Mountain area.
The RIK Prices are below Market Value
We compared spot prices for both sweet and sour Canadian crude oils
that are shipped into the United States with the three Wyoming RIK
crude types. The RIK prices for Wyoming sweet crude were compared with
the spot price of Edmonton Par crude (a sweet crude) after adjustment
for transportation into Wyoming. See Figure 1 of the study by our
consultant, which shows that the spot prices of Edmonton Par crude were
significantly higher than the RIK prices for the relevant time period.
The difference was $2 to $3 per barrel. Put another way, the RIK prices
were $2 to $3 per barrel below market value.
The RIK prices for Wyoming General Sour crude were compared with
the spot prices for Canadian Bow River Crude oil (a sour crude oil).
(See Figure 2). In the early months of the pilot program, the Canadian
Bow River spot price exceeded the RIK price for Wyoming General sour
crude by as much as $4.50 a barrel, although in the last five months of
the program, the prices fell much closer in line.
We also compared the RIK prices for Wyoming Asphaltic crude with
the spot prices for Canadian Bow River crude (see Figure 3). The RIK
price was considerably below the Canadian crude price during the first
pilot sale and then was not as much below the Canadian crude price in
the other two pilot sales. RIK prices for Asphaltic crude reached near
parity with the spot prices of Canadian Bow River crude oil in the
second half of the third sale.
The fact that Canadian crude oils were generally priced above the
RIK pilot prices is evidence that the RIK sales prices usually did not
equate to market value.
MMS was wrong to reject Canadian Crude Oils as Benchmarks
MMS alluded to three reasons why Canadian crude oils should not be
used as a benchmark for the RIK sales prices. First, not all Wyoming
crude oils compete with Canadian crude oil at Billings (Montana).
Second, Canadian crude production is less mature than Wyoming crude
production. Third, Canadian crude is transported to both Midwest
refineries and Rocky Mountain refineries. None of these is a valid
reason to reject Canadian crude oils as benchmarks for RIK sales of
Wyoming crude oils. None of these considerations is sufficient to
reject Canadian crude as a benchmark with which to compare the Wyoming
RIK prices.
First, whether Canadian crude oils compete with Wyoming crude oils
at Billings is irrelevant. They do compete with Wyoming crude oils
generally in the Rocky Mountain area. Second the fact that Canadian
crude oil production is less ``mature'' than Wyoming crude oil
production is similarly irrelevant. Presumably, MMS means that crude
oil is cheaper to produce in less mature areas than in mature areas.
Although that fact may be important to the profits of crude oil
producers in both areas, that is no reason why it should have anything
to do with how much refiners should be willing to pay for crude oils.
Therefore, the maturity of crude oil producing areas does not affect
the market values of crude oils.
Finally, both Canadian crude oils and Rocky Mountain crude oils are
refined in both the Rocky Mountain area and the Midwest. These crudes
compete with one another in both areas.
Other alleged Benefits of RIK Sales
MMS admits that, because it is still developing its processes for
managing RIK, it is unable to document cost savings at this time. Just
as the costs of the RIK program are uncertain so are the costs of using
the new MMS valuation regulations. In analyzing the possible benefits
of the RIK program, MMS has compared the RIK prices with posted prices
and not with the prices established by the new valuation regulations.
The proper comparison is with the prices established by the new
valuation regulations. So, too, in documenting any cost savings
achieved by RIK sales, the cost of the RIK program should be compared
to the cost of implementing the new valuation regulations. Those
regulations, like the RIK program, are designed to reduce the costs of
auditing.
In short, because the costs of auditing under the new MMS valuation
regulations are uncertain at this time, no legitimate estimate of any
cost savings using RIK sales can be made at this time.
Congress should not take money from the states
The probable losses from the Wyoming pilot underscore that Interior
needs to experiment and evaluate the pros and cons of an RIK program
further before Congress begins legislating. The need for legislation
is, indeed, doubtful. The right to take in kind exists under current
law. The respective obligations of the lessee and lessor are set out in
the lease and in long held interpretations of leases. Neither the
government nor industry has demonstrated a need for an additional
authority to operate an RIK program. Moreover, other than speculation,
no evidence has been offered that the additional authority requested
will result in enhancing, rather than decreasing, royalty revenues to
the public beneficiaries. It is noteworthy that the former Chairman of
this Committee exempted his own State of Alaska from the RIK
legislation then under consideration.
Under current law, states receive a percentage of the United
States' ``royalty interest.'' A royalty interest is a cost free
interest. It is unlike, for example, a working interest, under which
the owner of that interest shares in the costs of exploring, developing
and operating the lease. The cost of those obligations that a lessee is
required to perform are not deductible from a royalty interest.
The oil industry, however, seeks to allow Interior to use royalty
revenues to pay for performing certain services--services that are not
deductible from the United States' interest when royalties are paid in
value.
Clearly, industry is supporting this added authority as an adjunct
to its claims that Federal lessees are not required to pay for these
types of costs. Their assertion of a need for Interior to have funds to
pay ``downstream'' costs is but a euphemism for post-production and
marketing costs. Their claims for deducting those costs from royalties,
however, were rejected repeatedly during the lengthy rulemaking leading
to the 1988 regulations, and during the more recent rulemaking on the
new oil rules. Interestingly, industry prohibits deducting those same
type of costs when it is the royalty owner.
The oil industry advocates allowing Interior to use royalty
revenues to pay for such matters as the hiring of independent brokers
or marketers to sell production taken in kind. Let's be honest: if the
government feels that it is inadequate to the task of marketing--that
privatization will be of assistance--it should continue to take royalty
in value. Taking royalty in value is the essence of ``privatization''.
Moreover, such ``privatization'' can only reduce the ``royalty
interests'' of states like Wyoming and California by forcing them to
assume costs that currently do not reduce their royalty revenues.
Last year, Congress finally passed legislation to end the Net
Receipts Sharing program, under which the costs of Interior's
administration of the mineral leasing laws were deducted from the
states' share of royalties. As the Chair will surely recall, the Net
Receipts Sharing program resulted in substantial disputes between the
states and Interior because the Federal Government could not justify
and account for its costs. Indeed, Wyoming was at the forefront of the
Net Receipts sharing battle. The authority that industry seeks for
Interior is simply Net Receipts Sharing in a different form.
If Congress wants the government to be in the oil business, it
should appropriate the money to do so through the annual appropriations
process, where its performance can be evaluated and budgeted on a
yearly basis. What it should not do, however, is transform the very
nature of the public's royalty interest into a working interest through
the guise of making the in-kind program ``permanent.'' If Congress
wants Interior to stand in the shoes of a lessee, without the express
consent of the royalty beneficiaries, the Federal Government should
assume those costs that lessees assume today, leaving the states' and
the public's cost free royalty interest intact.
I will be happy to answer any questions the Committee may have.
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Mrs. Cubin. The Chair now recognizes Mr. Leggette.
STATEMENT OF L. POE LEGGETTE, FULBRIGHT AND JAWORSKI, ON BEHALF
OF AMERICAN PETROLEUM INSTITUTE (API), INDEPENDENT PETROLEUM
ASSOCIATION OF AMERICA (IPAA), INDEPENDENT PETROLEUM
ASSOCIATION OF MOUNTAIN STATES (IPAMS), DOMESTIC PETROLEUM
COUNCIL (DPC), AND U.S. OIL AND GAS ASSOCIATION (USOGA)
Mr. Leggette. Madam Chairman, Mr. McMahon went over by a
minute and 20 seconds, so I will make up for it by going under
by a minute and 20 seconds.
Mrs. Cubin. And we will appreciate that very much.
Mr. Leggette. Madam Chairman, the associations on whose
behalf I appear today want to thank you for the leadership that
you have shown in prodding the Federal Government into taking
more of its royalties in-kind. As the record of this hearing
will show, your efforts are beginning to pay off. MMS is
beginning to find that it can, at least in many cases, make
more money with less administrative expense than it can when
taking royalty in-value. It is beginning to find that it can
manage RIK with fewer personnel than is needed to manage
royalty in-value.
Madam Chairman, you are right to continue to press MMS to
pursue RIK. The reason is simple. Members of this Subcommittee
know that all claims that RIK is bad financial business for the
government boil down to a debate over one of two things, either
the so-called duty to market production at no cost to the
Federal Government, or a debate over whether comparison of the
oil that is being sold, such as Wyoming oil or oil from the San
Joaquin Valley in California, can fairly be compared with other
oil, such as Alaskan North slope crude oil or Canadian crude
oil, with multiple adjustments to try to make it equivalent.
Now, on the duty to market point in particular, if members
believe that lessees have such a duty, then they are likely to
think that the government will be worse off if it takes
royalties in-kind. Let me explain why that position hurts the
Treasury.
Even the prior administration agreed that no lessee is
required to sell production downstream. It said so repeatedly
in legal briefs. If the duty to market does exist, MMS cannot
be sure that it will capture the benefit of value added
downstream if it relies on royalty in-value. The lessee always
has the option of selling at the lease. The only way the
government can be sure to gain value added downstream is to
take the royalty in-kind and sell it itself.
Furthermore, we have litigated with the government over
this so-called duty. So far, we have won. If we continue to win
in IPAA v. Armstrong, the government will never get more than
the value at the lease if it takes royalty in-value, even when
the lessee markets downstream. Again, the only way the
government can be sure to gain value added downstream is to
take royalty in-kind and sell it itself.
The most important issue today, however, is not the value
of gas at the wellhead, it is the high cost of gas at the
burner tip, in the homes of low-income families. Using RIK gas
to benefit LIHEAP, the Low-Income Housing Program, is a
brilliantly creative idea. Some have introduced legislation to
take Federal royalty revenues from royalty in-value and help
fund LIHEAP, a good idea, perhaps, but let me suggest a better
one. Use RIK. Why? For the reasons that you gave yourself at
the start of this hearing.
A unit of gas is a unit of gas. When I produce six units of
gas in the Gulf of Mexico, I owe the government one of those
units. All reasonable people can agree on that. But people will
disagree over whether the unit that I owe the government is
worth $3, $3.25, or $4. In short, if Congress funds LIHEAP
through royalty in-value, it will import into that program
years of controversy over what the value of production really
is. If it supports LIHEAP through RIK, it dramatically reduces
the controversy. Better yet, as the next panel will explain, it
can reduce the administrative costs of running the LIHEAP
program itself.
If Congress decides to pursue RIK for LIHEAP, our
associations stand ready to help the Committee prepare
legislation to make the concept work. The LIHEAP concept is an
exciting new use of the RIK program, a program that recent MMS
experience shows can equal or exceed the value obtained from
royalty in-value, take fewer personnel to administer, and
increase the certainty for all stakeholders.
Again, we thank you, Madam Chairman, and all members of
this Subcommittee who continue to support a program where
everyone wins. Thank you.
Mrs. Cubin. Thank you, Mr. Leggette.
[The prepared statement of Mr. Leggette follows:]
Statement of L. Poe Leggette, Partner, Fulbright & Jaworski
Introduction
Good afternoon, Madame Chairman and members of the subcommittee. My
name is Poe Leggette. I am a partner at the law firm of Fulbright &
Jaworski, LLP. I am grateful for the opportunity to appear here before
you today on behalf of the American Petroleum Institute (API), the
Independent Petroleum Association of America (IPAA), the Independent
Petroleum Association of Mountain States (IPAMS), the Domestic
Petroleum Council (DPC) and the U.S. Oil and Gas Association (USOGA).
My testimony will discuss the advantages of royalty-In-kind (RIK),
for both the industry and the government. We applaud the committee for
holding a hearing to explore the potential efficiencies available to
the Federal Government and to industry if the use of in-kind royalty
collections is broaden beyond current practice, and to compare and
contrast this with the more typical practice of in-value collections.
The entire oil and gas industry believe RIK provides the government
numerous opportunities to creatively provide energy to in-need end-
users while at the same time efficiently ensuring that the Country is
receiving each royalty molecule of gas or oil due to the government. In
fact Madame Chairwoman, it is this very committee that has led the way
for encouraging RIK since the 104th Congress. We appreciate your
efforts, including the RIK appropriations language contained in fiscal
year 2001 Interior Appropriations, which gave MMS limited flexibility
to do more with RIK.
For several years, there has been and remains today widespread
support for RIK in the oil and gas industry. So much so, in fact, that
in 1997 the trade associations mentioned above, which represent
substantially all of the U.S. oil and natural gas industry, united to
organize a multi-association committee to work in conjunction with the
Minerals Management Service (MMS) and other stakeholders to formulate
and promote a workable system through which Federal royalties might be
taken in-kind.
I am pleased to be able to report to you today that MMS has made
great strides in this arena through the establishment and continuing
operation of its RIK pilot projects. The industry applauds the MMS RIK
management team for the creativity and flexibility it has demonstrated
in putting together these RIK pilots. While problems have inevitably
arisen, industry views none of these as being intractable so long as
the agency maintains its demonstrated commitment to cooperatively
searching for the best and most efficient solutions.
Despite the successes of these RIK pilots, industry believes much
work remains to be done. The pilots can only go so far, given certain
legislative barriers. We encourage Congress to provide MMS the
legislative RIK tools needed to fully expand the volumes of oil and gas
royalties it takes in kind, it Congress and the Administration deem
appropriate, to provide energy to in need consumers.
Complexity of the Royalty In-Value Process
RIK offers the most logical and efficient means of avoiding the
kinds of disputes over oil and gas valuation that have arisen in recent
years. The markets for oil and gas are extremely volatile, and their
rapidly changing nature renders the determination of product value at
various points of sale a very complex, labor-intensive exercise which
all too often results in protracted, costly disputes. Any set of
regulations designed to capture value in such an uncertain atmosphere
must of necessity be vague and open to interpretation by the various
players in the process. Interpretations lead to disagreements,
disagreements to disputes, disputes to litigation.
Capturing volume is a very simple process by comparison. A barrel
of oil is a barrel of oil. A cubic foot of gas is a cubic foot of gas.
So long as the measuring devices used are accurately calibrated, there
is no room for interpretation, and no need to estimate the value of the
production. For example, if a lessee in the Gulf of Mexico produces six
barrels of oil, he satisfies his royalty obligation by delivering one
barrel to the government. Simple as that.
With RIK, the accounting is simplified. There is no need to
estimate the value of production. The auditing is simplified; all that
needs to be verified is the volume of production and the volume
delivered as royalty. Disputes are fewer.
This simplicity of process is the main reason for the industry's
support of the RIK process. Lessees have a business need for certainty
in the royalty payment process, but simplicity should be appealing to
every stakeholder; the lessee, who produces the oil and gas and pays
the royalties; the Federal Government, who collects the royalties; and
the beneficiaries who share in the royalty revenues, states like
Wyoming, New Mexico, Colorado and California.
We urge the Federal Government to take full advantage of RIK and
make it the standard method for collecting royalties, with royalty in-
value becoming the exception rather than the rule. A permanent RIK
program would greatly enhance government flexibility by offering
several options for disposing of its royalty share: selling the royalty
production on the open market or to small refiners; making available
the royalty production for use in government/public facilities; filling
the strategic petroleum reserve; or providing cheaper energy to pre-
approved low-income families. For example, satisfying low-income
heating needs via RIK versus sending royalty payments, ensures that
every molecule is delivered in a timely fashion and provides the
government and utilities an opportunity to provide further advantage to
low income families by participating in the market place.
We were pleased that RIK was referenced in the Administration's
National Energy Policy as a way to accommodate the strategic petroleum
reserves. Additionally, the National Energy Policy proposes the use of
royalty payments for LIHEAP. As you will hear today, by taking this
payments in-kind, many benefits will occur to both the government and
the recipients under the LIHEAP program.
Need for Legislative Action
The governing mineral leasing statutes already allow the Secretary
to take royalties in-kind. The pilot projects thus far conducted by MMS
demonstrate that RIK works. However, some enhancements to the current
statutory language would make RIK work even better.
It is important to note that the RIK concept had its germination
and grew rapidly during the last years of the Clinton Administration.
Clinton Administration officials were resistant to the idea at first,
but commendably were willing to explore the idea through the conduct of
a series of pilot projects. Over time, these pilots evolved and became
better tests of RIK as experience was gained. The pilot projects now
demonstrate that RIK can increase revenues to the Treasury and reduce
administrative costs. The pilot projects also show that the Secretary
is handcuffed in some instances by existing statutory language and by
budgetary constraints that prevent the department from fully exploiting
the concept. MMS and industry joined together last year to endorse
language that would have corrected some of these roadblocks, but much
of that language was unfortunately struck on the floor of the House.
We urge Congress to work together with the Administration to craft
solutions to eliminate or avoid unnecessary obstacles to optimization
of an already proven RIK program. . Industry does believe the current
statutes provide MMS much flexibility to enter into creative RIK
programs, but to eliminate any uncertainty legislative language should:
LClearly delineate producer and government obligations
LProvide the government use of in-value proceeds to cover
any expenses downstream of the lease
LProvide for reports to congress
LAllow disposition to Federal agencies or entities
designated by the Federal Government
In closing, let me again thank you for this opportunity to appear
before you today on behalf of the industry trade associations
The industry also wishes to commend you, Madame Chairman, and this
Committee for all the hard work you and your staff members have put in
over the years, encouraging the creation and growth of the Federal RIK
program. Working together, this Committee, the Congress, MMS and
industry have demonstrated that RIK is a very useful tool to optimize
MMS's royalty collection efforts. Working together, we can ensure that
RIK ultimately achieves its maximum effectiveness.
I would be happy to answer any questions the committee may have.
______
Mrs. Cubin. I will begin the questioning. I would remind
the members and have them remind me if I go over that our
questioning is limited to 5 minutes.
I wanted to ask you, Mr. McMahon, your testimony seemed to
be more about RIK in general than its application to LIHEAP,
which is really what the subject of this hearing is. So I would
just like to know what your opinion about royalty in-kind being
used for LIHEAP, what is your opinion for that?
Mr. McMahon. To tell the truth, I have not had a lot of
time to think about that, but I will share with you some
experiences we have had in California recently.
Mrs. Cubin. Well--
Mr. McMahon. And I am going to tie it in to LIHEAP.
Mrs. Cubin. Okay, because your testimony focused just
really pretty much on RIK in general--realizing you had such a
short time to prepare.
Mr. McMahon. Right.
Mrs. Cubin. So please do not think in any way I am being
critical about that. But I would really sort of like a broader
picture, because the question that I would like to have
answered is, is RIK for LIHEAP a reasonable option, especially
in times when we are in a situation where we have energy
problems? Would gas from the outer continental shelf or from
the public lands be better used if we channeled that to a
utility to distribute it?
It seems to me common sense that when you eliminate the
audits, you eliminate the lawsuits from royalty, or for the
value, and you eliminate the middleman, that you could deliver
more energy to the houses of poor people if you did that. So if
you would just respond to that, that is what I am trying to get
at.
Mr. McMahon. Sure. But our California experience is this.
Where we get gas is from the Gulf Coast area and New Mexico.
Let us suppose that the government does have production of gas
in that area and we use some of that gas. It has to go through
a pipeline which is owned by a company called El Paso. El Paso,
as far as I know, does not own the production. So some
arrangement would have to be made to go through El Paso
pipeline--
Mrs. Cubin. Sure. There would be transportation costs,
right.
Mr. McMahon. And more than that. Because there is a
constriction in the pipeline now, it is not clear now much of
the extra gas can go through. The next step is the utilities in
California, like Southern California Gas Company, PG&E. Again,
what obligation do they have to ship Federal gas over their
lines?
Mrs. Cubin. I would think that it would be ludicrous to
assume that gas would be coming out of California to take care
of this proposal, or at least this idea that we are
entertaining. No, California needs everything it has got, so
that would not be it.
I would like to ask Mr. Leggette, you have been working, as
you said in your statement, on royalty in-kind issues and
talking about this issue for a long time. Could you please
describe to me the problems that there are with the
administration of a royalty in-kind program? And what I am
specifically talking about are the accurate volumes being
recorded and those kind of things and what you would do to go
about making sure that the correct volumes were reported and
that the government got its correct share?
Mr. Leggette. For Federal production, production from
Federal leases, lessees are required to submit plans to the
government for approval in advance of installing their
production equipment. The government is entitled to veto those
plans or require alterations if it feels it necessary to make
sure that oil or gas will be accurately measured. MMS then
conducts, or onshore, the Bureau of Land Management, periodic
site inspections to check the meters, and companies are
required routinely to check the meters and provide the results
of those checks to the Federal Government.
Now, this regulatory hand is in addition to the incentive
in the private sector between producer and purchaser to make
sure that these instruments are working correctly. But it is,
compared with determining what royalty value is, it is a
relatively simple process.
Mrs. Cubin. And certainly, it seems that there is room for
mischief there, measuring volumes.
Mr. Leggette. Oh, absolutely.
Mrs. Cubin. But that same mischief is available when you
measure the volumes when they are going to be charged in-value,
the royalties in-value, because it has to come out of the well
and the volume has to be measured correctly and that is when
the arguments start. So RIK is not any more vulnerable to this
sort of tampering, or mischief, if you will, than royalty in-
value, would you agree with that?
Mr. Leggette. That is exactly right.
Mrs. Cubin. And could you explain to me how you think the
duty to market issue would play out under RIK?
Mr. Leggette. Well, it would be addressed because the
government would be fulfilling its obligation to market its
production and to get the best return it can for the taxpayers,
or alternatively, to serve alternate purposes that reduce the
cost of government or other government programs, such as
heating this building or perhaps benefitting a program like
LIHEAP.
Mrs. Cubin. Or preferably cooling it today.
Mr. Leggette. Point well taken.
[Laughter.]
Mrs. Cubin. The Chair now recognizes Mr. Inslee.
Mr. Inslee. Thank you. I may ask some fairly low-level
questions here, but I hope you will appreciate this is a
relatively new issue, at least to me.
I would ask both gentlemen to comment. As I understand the
proposals for universal RIK, its intent is to reduce
litigation, reduce uncertainty, and the like. But it would seem
to me if we go that route, it is going to set up a whole new
level of responsibility for the Federal Government, both as to
merchandising, marketing, transporting, storing, insuring, a
whole new system of the Federal Government for handling this
product as a marketing agent. Is that a fair assessment, and if
so, what are the challenges and how would that be done? I just
ask both gentlemen to comment on that.
Mr. Leggette. Mr. McMahon yields.
Mr. McMahon. For the time being.
Mr. Leggette. For the moment. Yes, he reserves the right to
rebut.
There is no reason why the Federal Government would have to
create a large new marketing department to make royalties in-
kind work. Experience in Alberta, Canada, indicates just the
opposite, and I believe, if you were to ask that question of
the MMS witnesses coming after me, they would say that the
early indication is that they can manage a large volume of
Federal production with far fewer people when promoting it in-
kind rather than claiming it in-value, and the reason is that
the Federal Government, even without the aid of help from
outside marketers, enjoys a very important position in the
marketplace. It has access to substantial volumes in every
field in which there is a Federal lease.
And so companies can come to MMS with creative proposals,
unusual transportation arrangements that can beat the market
and give the government better value than other producers can
get. More importantly, one change that we would hope the
Congress would consider would be to allow MMS to contract with
the expertise of private marketers to further enhance its
position in the market.
Mr. McMahon. Let me respond. Right now, as far as we can
tell, MMS does not have the qualifications to market crude oil.
The option would be, if all the oil is sold in-kind, if you do
not want MMS marketing Federal production, then MMS is subject
to being passive and let oil companies come in and tell MMS
what price they are willing to pay.
Obviously, in my mind, you are going to have to set up a
bureaucracy to deal with marketing. Marketing is complicated;
not a simple matter, and you simply cannot let oil companies
dictate the processes that will be used to market the crude
oil. You have to go out and market it aggressively. So I think
there is a large cost involved in RIK which is not involved in
an intelligent, comprehensive evaluation procedure.
I emphasize again, I think the major issue here is unless
you have competition, true competition among major oil
companies for RIK sales, you are not going to get competitive
prices. We have yet to see that happen, either in Long Beach or
California or even in the Wyoming experience. You do not have
majors coming in to bid, and if they do not come in and bid,
then you are only going to have a small segment of the market
that is bidding on the crude oil. So far, we have not had the
experience of the major oil companies bidding on RIK sales.
Mr. Inslee. When you say bid, do you mean bid for purchase
from the government?
Mr. McMahon. Correct. We have not seen that. In 30 years in
California, only one major oil company has ever won a bid, and
that is Texaco, and Texaco is about to disappear because it is
being purchased by Chevron. Chevron, Mobil, and Exxon, even
though they have large presence on the West Coast, have never
bid on royalty crude oil, and we do not see any majors in
Wyoming bidding on Federal royalty crude oil. What you see are
the marketers, the middlemen, and the only sense that that
makes is that they are going to resell it at a higher price. I
mean, why else would you be a middleman if you did not think
you could get a higher price from a refiner?
Now, why do the refiners not go out and bid for royalty
crude oil? Because then they would have to turn to their
royalty owners and say, well, we did bid this price which is
higher than what you are getting for your crude. So you see the
conflict they would be in. So they would rather have the
middlemen come in, do the bidding, do the dirty work, and then
purchase from then, so then they can turn to their royalty
owners and say, we did not buy the crude at the lease and so,
therefore, we do not have to pay you the higher price. So they
are in a conflict situation regarding the royalty in-kind and
that is why, as far as we can tell, they will never bid on the
royalty in-kind oil.
Mr. Inslee. Mr. Leggette, do you want to respond to that
concern?
Mr. Leggette. Well, in the time remaining, probably the
most effective thing I can do is to defer to the answer that
the Minerals Management Service people will give you. They have
the experience not only with the Wyoming project, but with a
gas pilot project in the Gulf of Mexico. My impression is that
some very heavy-duty players in the gas market are bidding on
those programs, but they have the details.
Mr. Inslee. Thank you.
Mrs. Cubin. The Chair now recognizes Mr. Otter.
Mr. Otter. Thank you very much, Madam Chairman, and
gentlemen, I apologize for being late. If I cover some ground
that has already been plowed, I sincerely apologize for it.
One of the things that is always of interest to me in a
marketplace is what is the next generation going to look like.
Perhaps, and I do not know if you are willing to speak for the
industry or your segment of that industry, but what I would
really like to know is where do we go from where we are today?
My question centers to how much of the industry profit today is
actually being spent on alternate forms of energy, research and
development, alternate forms of drilling and recovery, proving
up an oil field, blocking new oil bodies or ore bodies? How
much of the industry profit or cash flow is going into the next
generation of energy needs?
Mr. Leggette. I will only be able to give you a most
general answer. It, of course, varies from company to company,
but my impression is that for most companies, it is quite a
lot. Many--
Mr. Otter. What is quite a lot?
Mr. Leggette. Money is going back into looking for new
reserves, but also exploring alternative forms of energy. Some
of the majors have established whole new business units that
focus on alternative forms of energy. Shell and British
Petroleum come prominently to mind, but they are hardly alone.
And the independents that IPAA and IPAMS represent are very
active in plowing the money that is currently being made in the
prevailing price regime back into new exploration, to
enhancement of declining fields, to new drilling in existing
fields to further enhance the ability to deliver through the
existing pipeline infrastructure.
Mr. Otter. Mr. McMahon?
Mr. McMahon. I am really not qualified. I will make two
observations, though. One is that the major oil companies are
pulling out of California. For example, Chevron turned back
some leases they had offshore which were already being
developed. They appear to be sending their money overseas
because they make higher overseas profits.
The second point is, the L.A. Times reported just this past
week, the opposition of the oil companies against the use of
ethanol in California as a way of cleaning up the gasoline. So
at least on that issue, they appear to be opposed to that kind
of alternative energy source. But generally speaking, I am not
in a position to answer the question.
Mr. Otter. Well, gentlemen, what I am concerned about, as
we see the consolidation of energy resources and energy
production, I know 20 years ago when I was drilling oil wells
in the Knox zone of Kentucky, Tennessee, and Ohio, there was an
awful lot of folks that were interested in the development side
of it, and today, we were at five and now it looks like we are
going to be at four with the Texaco and Chevron merger. I am as
concerned about that consolidation and what that consolidation
can do to our dependence on those consolidated efforts, and I
am well aware that not all the consolidation is purely
marketplace driven. But I am concerned that where our next
generation of energy is going to come from along the line I
just asked on energy production and the research and
development for the future.
How about on the conservation side, and if you could give
me a percentage. Now, if you were telling me, for instance, Mr.
Leggette, that 15 or 20 percent of the cash flow or 35 or 40
percent of the profits that the industry is generating is going
in to develop the next generation, is that too high? Is 35 to
40 percent of the profit going into the next generation, is
that too high? Let me ask you that question first.
Mr. Leggette. I would be guessing wildly, although I would
be happy to try to get that information for you.
[The information referred to follows:]
Members of the Independent Petroleum Association of America are
largely non-integrated oil and gas exploration and production companies
whose focus is the development of oil and gas reserves. It is estimated
that these companies put nearly all of their profits back into
exploration and production activities. These companies typically do not
allocate funds to the pursuit of alternative or renewable energy
sources.
Mr. Otter. How about you, Mr. McMahon?
Mr. McMahon. I would have no idea.
Mr. Otter. Along that same line, how much research and
development is going into conservation? When are we going to
see 70 miles a gallon for an internal combustion engine? When
are we going to see more kilowatts produced per 250 megawatt
hydropower plant now on X-number of cubic feet per second? And
I am not exactly sure what that figure is, but it seems to me
that if the lowest-hanging fruit here in this whole thing is
conservation, or getting a larger bounce for our buck, that is
where we ought to be spending our profits for the future. If
you could just review that--I am out of time, but if you could
just quickly embrace that for me for a minute, I would
appreciate it.
Mr. McMahon. All I could tell you, Congressman, is that in
California, the electricity-generating facilities are not owned
by major oil companies. They are owned by much smaller
companies. It appears that the major oil companies have figured
they cannot make money generating electricity, so they are not
devoting their resources to more efficient electrical
generating facilities.
Mr. Leggette. Questions about car fuel efficiency really
will have to be addressed to Detroit, not to Houston, and about
kilowatt hours to the Edison Electric Institute and not the
American Petroleum Institute or the IPAA.
But plainly, as I think the President's plan recognizes, we
have to attack both sides of the equation. The NRDC issued a
report earlier this year indicating that if two steps were
taken, increasing the CAFE standards for cars and imposing
requirements on replacement tires, the nation could save 50
billion barrels of oil over the next 50 years. That is about a
billion barrels a year.
The Department of Energy, however, projects that increase
in demand domestically for crude oil between now and 2020 will
be two billion barrels of oil a year, meaning even if we did
everything that the NRDC was proposing, that would only reduce
the increase in our demand for petroleum. Plainly, both sides
of the equation need to be addressed, production and
conservation.
Mrs. Cubin. The Chair now recognizes Mrs. Napolitano.
Mrs. Napolitano. Thank you, Madam Chairman. I am very much
interested in the statements, and I, too, also was a little bit
late in getting here, so I am assuming some of the information
might have been covered.
Part of what really troubles me, and I have been in
government long enough to know that private industry normally
says, government, stay out of business. You are not in the
business to do business. You are in the business to do
government policy, et cetera. So to buy into an idea that the
government can begin to have in their hands, and as Mr. McMahon
was indicating, to set up another infrastructure, another
bureaucracy to deal with the sale and the proceeds and
everything that goes with it just does not quite make sense. To
me, I would think industry would be saying, government, stay
out of it. We will take care of it.
One of the questions that I have is the industry itself is
asking that the government take in-kind?
Mr. Leggette. Yes, ma'am.
Mrs. Napolitano. And the reason is?
Mr. Leggette. Unlike proposals in the 1970's, where the
Federal Government was considering forming its own oil and gas
company to drill offshore and install its own production
platforms, this is a much more limited role for Federal
Government in the marketplace. The government is not taking on
the geologic risks of drilling and the safety risks and
operational risks of installing and operating platforms.
Mrs. Napolitano. But it is taking other risks, sir.
Mr. Leggette. Certainly, it is taking some market risks,
like other entities in the marketplace. The reason that the
industry supports that move is that, in the long run, it is
more efficient both for the government and for industry to let
the government make its money on its own, because the
alternative is to have companies exposed to endless rounds of
lawsuits under the False Claims Act and investigations and
criticisms by Members of Congress.
Mrs. Napolitano. How would those be avoided, sir, because
right now, from what I am reading in some of the information
given to us, is there are already several--a few suits against
some of the major oil companies, as well as some of the minor
companies, in regard to the False Claims Act. It seems to be
there is a serious issue in underreporting.
Now, if we were able to bring that into compliance somehow,
and I do not understand why the oil companies would be not
happy to do what is naturally requested of almost any business,
is adequately report, and they are trying to overturn that law,
it just does not make sense for us to say, on one hand, it is
okay to go ahead and start having the government set up its
own, we will take care of it, when they are not even providing
fully adequately reported sales, if you will.
Mr. Leggette. There is only one lawsuit of which I am aware
where someone is claiming that companies have underreported the
volume of natural gas. That is a case where the government took
its royalties in-value, not in-kind, the Chairman's point
earlier. That case was investigated by the Department of
Justice, which has declined to intervene. But under law, the
relator is entitled to go forward, and that matter is in
litigation and we will see what comes of it. But that is a
problem that is a possibility that can occur whether you take
royalty in-value or in-kind. If you take it in-value, you have
two potential sources of dispute. If you take it in-kind, you
only have one.
Mrs. Napolitano. But it would be very expensive for the
government for me. How could an RIK program be designed that
would minimize the pitfalls?
Mr. Leggette. To minimize the pitfalls?
Mrs. Napolitano. Right. In other words, be able to do away
with that second pitfall you were just talking about, the
thicken problem.
Mr. Leggette. The value pitfall?
Mrs. Napolitano. Right.
Mr. Leggette. Well, by taking royalty in-kind, the
government is then putting the production out for bidding and
we think the best way to make sure that the government does the
best job it can is to allow the government to hire outside
marketing expertise to advise it. Let me assure you that it is
a whole lot cheaper for the government to hire a marketing
consultant than it is to pay millions of dollars in royalties
to False Claims Act private relators in these cases. There
would be a big savings for the government there alone.
Mrs. Napolitano. Well, I am afraid that government does not
do things expediently, so I would be prone to challenge that a
little bit.
Mr. McMahon, your comment?
Mr. McMahon. Yes, a couple of comments. One is that you are
absolutely correct that in order to market properly, you have
to have a bureaucracy to do it. You do not want people that are
not sophisticated trying to market the crude and getting a good
price for the Federal Government. Some of the oil is in out-of-
the-way places, for example, offshore, California for one
place, and in order to bring it to a market center where there
are competitive prices, you need someone that is sophisticated
to be able to do that.
The second point I will make is that we have heard a lot
here today about litigation, and why was there litigation?
There was litigation because, in the past, what the oil
companies did was they reported the value of crude oil in terms
of their own prices. That is, oil companies like Chevron,
Mobil, Exxon would say, this is what the crude is worth and
this is, therefore, what we are going to pay you. There was no
check on them.
What we found, and throughout the country this was
happening, was that the oil companies were setting up
affiliated oil companies in which they were selling the
production at posted price to an affiliate and the affiliate
would then turn around and sell at a higher price. That was
clearly an unfair situation.
Now, what MMS has done, it took them 4 years because of oil
industry objections, they went to market-based criteria for
value. When you are hearing in the news every day the price of
West Texas crude is X-amount of dollars, it is because that is
a market that is recognized throughout the oil industry. The
price is not dependent on a single oil company. It is like the
stock market. The reported price of West Texas crude oil is the
result of lots of buyers and sellers coming together. That is a
great indication of what the value of the crude is, and there
cannot be a dispute about what the value of West Texas crude
oil is. So we will expect fewer disputes under the new
regulations, and that is what we would like to see actually put
in place and look at it maybe in a year or two as to whether it
is working or not.
Mrs. Napolitano. Thank you very much, Madam Chairman.
Mrs. Cubin. I would like to thank the witnesses for their
testimony and answers to the questions. Thank you, Mr. McMahon,
for coming on short notice. We appreciate your being here.
Mr. McMahon. Thank you, Madam Chairman.
Mrs. Cubin. Likewise, Mr. Leggette.
Mrs. Cubin. The Chair now would like to recognize the
second panel, Mr. Walter Cruickshank, the Associate Director of
Policy and Management Improvement of the Minerals Management
Service, who has been a regular visitor with this Committee. He
is accompanied by Mr. Milt Dial, the Assistant Program Director
for Royalty In-Kind; Mr. John Harpole, the President of
Mercator Energy; and Mr. James Jacob, Manager of Consumer
Advocacy, KeySpan Corporation.
I would like to also welcome all of you gentlemen and thank
you very much for being here. We always appreciate hearing from
Mr. Cruickshank, who has been, as I said, a regular person here
in front of this Committee, and so now I will recognize him for
5 minutes. I point out again that the timing lights will be
there on the table.
STATEMENT OF WALTER CRUICKSHANK, ASSOCIATE DIRECTOR OF POLICY
AND MANAGEMENT IMPROVEMENT, MINERALS MANAGEMENT SERVICE,
ACCOMPANIED BY MILT DIAL, ASSISTANT PROGRAM DIRECTOR, ROYALTY
IN-KIND, MINERALS MANAGEMENT SERVICE
Mr. Cruickshank. Thank you, Madam Chairman. Good morning to
you and members of the Subcommittee. Thank you for the
opportunity to testify this morning about the MMS's royalty in-
kind program. I have submitted written testimony for the
record, and given your background on this issue, I will just
briefly provide an overview of the current status of our RIK
projects and a summary of our findings of our initial
evaluation of the Wyoming oil RIK pilot.
Turning first to Wyoming, MMS and the State have been
cooperatively developing an oil RIK program since 1998. MMS has
been taking up to 6,000 barrels per day of RIK crude oil and
competitively selling that production in the open market. The
State of Wyoming has also included RIK oil from the State lands
in this program. Currently, we are selling approximately 2,000
barrels per day of Federal RIK oil in Wyoming.
In March of this year, MMS issued its initial evaluation of
the Wyoming pilot for the first 18 months of operations. The
report concludes that the Wyoming pilot demonstrates that in
some, but not all, circumstances, taking oil royalties in-kind
and selling it through a competitive bidding process is a
viable alternative to the historical method of collecting
royalties in-value. We used the following criteria as the basis
for evaluating success: Revenue neutrality for the government;
reduced administrative burdens for both lessees and the
government; and simplicity, accuracy, and certainty for all
parties.
To summarize, the main findings of the report, first,
selective use of RIK can be revenue neutral. We received an
average premium of about 45 cents per barrel over the value
reported to the State for royalty and severance tax purposes.
And I would note that the State's regulations for royalty and
severance tax, in essence, are the same as the requirements for
value under the new oil valuation rule. However, at the time of
the evaluation, the payments to the State had been largely
unaudited.
Second, lessees benefit from a reduced administrative
burden, from both the dramatic reduction in reporting to MMS as
well as the avoided costs of audits and valuation disputes.
Third, there is greater certainty for both lessees and the
government. Not only are the valuation disputes avoided, but
the potential exists for completing the volume reconciliation
process in 90 to 120 days, allowing us to close the books on
royalty obligations in months rather than years.
However, RIK does not work across the board. One of the
things we found in Wyoming is that a number of properties
served only by trucks were not drawing competitive bids or
purchaser interest, and, therefore, we stopped offering those
properties in the State.
Currently, we are working with the State in planning the
next phase of competitive sales of Wyoming RIK oil, with
deliveries commencing this fall.
In 1998, MMS also started working with the State of Texas
General Land Office on a second RIK pilot involving natural gas
production from Federal leases in the 8(g) zone, offshore
Texas. The primary activity under this pilot was to mutually
explore ways to market Federal RIK from 8(g) leases, building
on GLO's experience with their own successful RIK program.
Competitive sales began in June 1999 and initially focused on
monthly spot market sales of natural gas. Total sales volumes
reached 75,000 MMBTUs per day, with deliveries to both Federal
facilities and private purchasers.
For reasons of administrative simplicity, this pilot was
merged this fiscal year with our broader OCS gas pilot. We have
started work on our evaluation of the Texas gas pilot and
expect to complete that by the fall.
In November 1999, MMS began our third RIK pilot involving
natural gas from OCS leases across the Gulf of Mexico. Much of
this initial gas was sold to the General Services
Administration for use in managing its program of supplying
natural gas to Federal facilities. As previously mentioned, we
did combine the two gas pilots together and today we are
selling approximately 380,000 million BTUs per day of natural
gas at offshore and onshore delivery points.
An important feature of this pilot is that with the
authority provided in the fiscal year 2001 appropriations bill,
we have begun entering into agreements for transportation of
the RIK gas to pooling points and market centers away from the
lease. Because of our strong presence across the Gulf, we have
found this authority to be a cost effective means for shipping
the government's share of production. In some cases, we have
been able to negotiate better rates than other shippers along
the pipeline. We have also used the new authority to pay
processing costs, and that has proven beneficial in situations
where pipeline companies have issued operational flow orders
requiring gas to be processed. We feel the continuation of this
authority beyond fiscal year 2001 is critical for testing
alternative approaches to selling production at market centers
removed from the lease.
In August of 2000, we commenced our fourth pilot for RIK
crude oil in the Gulf of Mexico. We are currently selling about
7,600 barrels per day and planning the next sale with
deliveries in October.
Finally, I would note that we are continuing to operate our
small refiner RIK program, currently providing five small
refiners with a total of 70,000 barrels of RIK oil per day from
the Gulf of Mexico and the Pacific.
In closing, I would like to say that we are continuing to
study RIK as a possible business approach for managing oil and
gas royalties. Pilots are founded on the premise that oil and
gas royalties are a revenue-generating asset for the public and
the decision whether to take royalties in-kind or in-value
would be based on the best way to manage that asset.
Your Subcommittee is now considering whether to broaden RIK
beyond this current practice. MMS is prepared to provide
technical assistance to you as you proceed. We also expect to
work with all stakeholders as the administration implements the
recommendation from the President's National Energy Policy to
bolster LIHEAP funding using a portion of oil and gas royalty
payments.
I thank you, Madam Chairman, and I would be happy to answer
any questions.
Mrs. Cubin. Thank you, Mr. Cruickshank.
[The prepared statement of Mr. Cruickshank follows:]
Statement of Walter Cruickshank, Associate Director, Policy and
Management Improvement, Minerals Management Service
Madam Chairman, I wish to thank you and the members of your
Subcommittee for the invitation for the Minerals Management Service
(MMS) to be here today to present testimony regarding its royalty in
kind (RIK) activities.
Introduction
As you are aware, MMS's mission consists of two major programs:
Offshore Minerals Management and Minerals Revenue Management (MRM). The
leasing and oversight of mineral operations on the OCS and all mineral
revenue management functions for Federal (onshore and offshore) and
American Indian lands are centralized within the bureau. In 2000, OCS
oil and natural gas production accounted for roughly 25 and 26 percent,
respectively, of our Nation's domestic energy production--
oil production was over 500 million barrels and natural gas production
was over 5 trillion cubic feet. The amount of oil and natural gas
production in 2000 was the most ever produced on the OCS. In addition,
in fiscal year 2000, MMS collected and distributed about $7.8 billion
in mineral leasing revenues from Federal and American Indian lands.
By provisions of law and lease terms, Federal oil and gas royalties
can be paid by the lessee either as a share of cash proceeds realized
by the lessee (in value) or with a share of production (in kind). The
decision as to whether royalties will be paid in value or in kind is
solely the lessor's (the Government). Historically, the MMS collected
royalty payments in value, except for its Small Refiner Program whereby
the Government receives oil royalty payments in kind on selected leases
and in turn sells the production to qualified small refiners at fair
market value.
RIK Feasibility Study
In 1997, the MMS formed an RIK Study Team to investigate the
feasibility of the U.S. Government taking its oil and gas royalties
from Federal leases in kind rather than in value. The Study Team
concluded that under the right circumstances, RIK could be workable,
revenue neutral or positive, and administratively more efficient for
MMS and industry. The Study Team also recommended the following:
LDevelopment of a long-term OCS RIK pilot program with
input from the States of Texas and Louisiana for the marketing of
substantial volumes of U.S. royalty gas.
LEstablishment of a joint MMS/Wyoming team to examine the
viability of an oil RIK program in Wyoming.
LEstablishment of a joint MMS/Texas team to identify and
assess a range of possible RIK programs involving OCS 8(g) leases
offshore Texas.
LEvaluate the potential for additional RIK pilot programs
upon the successful implementation of any pilot project.
In response to the recommendations of the Study Team, MMS
aggressively initiated a series of pilot projects with the following
goals:
LTo determine the circumstances (market conditions) in
which RIK makes sense and identify those key success factors.
LTo determine if the government (and industry) can save
money by reducing the administrative cost and burden of collecting and
verifying royalties.
LTo determine if RIK can provide accurate, simple and
certain royalty collection.
LTo determine if RIK can create value (revenue enhancement
or neutrality) for the taxpayer.
LTo conduct evaluations, which will include the criteria
listed above, of each of the pilots and share with all interested
parties.
RIK Pilot Program
The RIK pilot program commenced in 1998 with the initiation of its
first pilot with the State of Wyoming involving crude oil. Since then,
the pilot program has continued to expand in Wyoming and on the OCS in
the Gulf of Mexico for both oil and gas. Each of the pilot projects is
designed to test a variety of approaches to utilization of the RIK
option for managing the Federal royalty asset. Pilot evaluations are
being conducted to ascertain pilot successes and lessons learned that
are incorporated into succeeding pilot activities. I would like to
briefly address each of MMS's RIK pilots and the evaluation work that
has been completed to date.
The Wyoming Oil RIK Pilot
Under the Wyoming pilot, the MMS and the State of Wyoming's Office
of State Lands and Investments have been cooperatively developing an
oil royalty in kind program. Since 1998, MMS has been taking up to
6,000 barrels per day of RIK crude oil produced from Federal leases in
the Powder River Basin and Big Horn Basin of Wyoming and competitively
selling the production in the open market under 6-month term contracts.
The State of Wyoming has also included State lands RIK oil in the pilot
sales. Currently approximately 2,000 barrels per day of Federal RIK oil
are being sold under the Wyoming Pilot.
In March 2001, MMS issued its evaluation of the Wyoming Pilot for
the period October 1998 through March 2000. The report concludes that
the Wyoming Oil RIK pilot successfully demonstrates that in some but
not all circumstances, taking oil production in kind and selling it
through a competitive bid process is a viable alternative to the
historical method of taking royalties in value. The following criteria
were established as the basis for evaluating its success:
LSimplicity, accuracy, certainty for lessees and
government.
LRevenue neutral (or better) for government;
LReduced administrative burdens for lessees and
government.
To summarize the main findings of the report, the Wyoming oil RIK
pilot demonstrated:
LSelective use of RIK can be revenue neutral--MMS received
an average premium of 45 cents per bbl over the values reported to the
State for royalty and severance tax purposes.
LLessees benefit from a reduced burden--an 80% decline in
the number of lines reported and the avoided costs of valuation
disputes.
LGreater certainty for both lessees and the government--
valuation disputes are avoided and the potential exists for completing
the volume reconciliation process in 90-120 days.
LRIK does not work across the board--MMS stopped offering
trucked properties because of the lack of competitive bids and
purchaser interest.
The Wyoming pilot also provided the MMS and the State with valuable
experience in operating an ongoing RIK program. In several areas,
experience from the three sales allowed the MMS and State to review
previous results and improve processes for the next cycle. Reviewing
the bidding mechanisms and the properties which were receiving bids led
to the expansion of the possible bidding and pricing mechanisms and to
the elimination of trucked properties from subsequent sales. Feedback
from sale participants provided impetus to eliminating burdensome and
unnecessary qualification requirements. On the pricing side, MMS gained
valuable insights into the complexities of the Wyoming oil market and
discovered the need for MMS and the State to further investigate
alternative pricing mechanisms and different sales terms. Although the
overall value received in kind was at or above the comparable in-value
number, this was not the case for every month for every property.
MMS and the State of Wyoming are currently in the planning phase
for the next competitive sale of Wyoming RIK oil for deliveries
commencing in the Fall 2001.
The Texas 8(g) Gas Pilot
In 1998, MMS in partnership with the State of Texas General Land
Office initiated the second RIK pilot project involving OCS natural gas
production from Federal leases in the Texas 8(g) zone of the Gulf of
Mexico. The 8(g) zone refers to leases within 3 miles of State waters
and from which Texas receives 27 percent of the revenues. The primary
activity under this pilot was to mutually explore ways to cost-
effectively market both Federal RIK gas from the 8(g) zone and State
leases. Sales began in June 1999, and initially focused on monthly spot
market sales of about 25,000 mmbtu/day of natural gas. Total sales
volumes reached 75,000 mmbtu/day with deliveries to both Federal
facilities and private purchasers. For reasons of administrative
simplicity, the pilot was merged in fiscal year 2001 with the OCS pilot
for non-8(g) gas. Sales of 8(g) gas to Federal facilities and other
purchasers continues under the overall Gulf of Mexico gas pilot.
The MMS has commenced its evaluation of the Texas 8(g) gas pilot
and expects to complete its analysis in the Fall 2001.
The Gulf of Mexico Gas Pilot
In November 1999, MMS began a third RIK pilot, involving non-8(g)
Federal offshore leases in the Gulf of Mexico. Initial activities
centered around competitively-offered contracts with successful bidders
taking approximately 200,000 mmbtu/day of royalty natural gas from
specified offshore locations and delivering natural gas volumes and
qualities of equivalent value to a specified onshore location. Much of
this gas was sold to the General Services Administration for use in
managing its program of supplying natural gas to Federal agencies. As
previously mentioned, for reasons of administrative simplicity, the MMS
merged the OCS Texas 8(g) and the non-8(g) gas into one pilot in fiscal
year 2001. Under the merged gas pilot, the MMS is today selling
approximately 380,000 mmbtu/day of natural gas at offshore and onshore
delivery points.
An important feature of this pilot is that, with the authority
provided in the fiscal year 2001 appropriations bill, MMS began
entering into agreements for the transportation of RIK natural gas to
pooling points and market centers away from the lease. Because of the
strong presence of MMS royalty production throughout the Gulf, the MMS
has found this authority to be a cost-effective means for shipping the
Government's share of production. In some instances, MMS has been able
to negotiate better rates than other shippers along the pipeline.
Authority for the payment of processing costs has also proved
beneficial for operating this pilot, particularly in situations where
MMS was forced to process its royalty share due to operational flow
orders. Continuation of this authority beyond fiscal year 2001 is
critical to the RIK pilots for testing alternative approaches to
selling production at market centers removed from the lease.
The Gulf of Mexico Oil Pilot
In August 2000, the MMS commenced a fourth pilot for the
competitive sale of RIK crude oil from Federal offshore leases in the
Gulf of Mexico. Under this pilot, MMS is currently selling about 7,600
barrels of crude oil per day through September 2001. We are now in the
planning phase for the next sale with deliveries beginning October
2001.
Small Refiner RIK Program
Beyond the RIK pilot program, the MMS continues to operate its
existing Small Refiner RIK Program. The objective of the Small Refiner
Program is to help assure adequate supplies of crude oil at equitable
prices are available to eligible small refiners. The business processes
followed in operating the program have historically been complicated
and labor intensive. The MMS has worked with parties affected by the
Small Refiner Program in the last several years to bring about a number
of improvements including:
Lintroduction of a competitive bidding process that
increases price certainty for the small refiner and MMS.
Lestablishment of a volume nomination process for MMS to
manage operators' deliveries of oil to small refiners thereby reducing
monthly imbalance problems
Lchanges in MMS payment requirements to have small
refiners pay on actual oil deliveries rather than estimated volumes,
thereby reducing problems with small refiners having to pay for oil
they did not receive, and
Lstreamlined information collection by no longer requiring
operators to report RIK sales on the MMS royalty report.
Today, MMS is providing three small refiners in the Gulf of Mexico
and two small refiners in the Pacific with a total of about 70,000
barrels of RIK oil per day.
Managing MMS's RIK Activities
To provide the needed management focus and visibility to RIK
activities for the future, the MMS established through its October 2000
reorganization of the Royalty in Kind Office within the MRM. The RIK
Office is the focal point and accountable for the management and
coordination of all MMS activities related to the operation of the RIK
pilots, the Small Refiner Program, and other RIK activities. The RIK
Office is staffed with employees experienced in the pilot program and
the Small Refiner Program. The Assistant Program Director for RIK
reports directly to the Associate Director for the MRM.
Evolving MMS's RIK Activities
In January 2001, MMS published its RIK Road Map to the Future. The
Road Map outlines a 3-year business plan for further development and
operation of MMS's RIK pilots and Small Refiner Program, and
integration of the RIK option into the overall asset management
strategies of the MMS.
Closing Remarks
We at the MMS are striving to adopt a balanced approach in
developing the RIK option as a viable tool for the management of the
Nation's royalty assets. We have been deliberate in exploring new
opportunities for optimizing value and gaining market insight, yet have
remained cautious to proceed slowly and build upon the lessons learned
through experience.
This MMS is continuing to study RIK as a possible business approach
for managing oil and gas royalties. MMS is evaluating experiences to
date and will continue to explore the potential of RIK through pilot
projects and long-term projects.
Madam Chairman, this concludes my prepared remarks. However, I will
be pleased to answer any questions Members of the Subcommittee may
have.
______
Mrs. Cubin. The Chair now recognizes Mr. John Harpole to
testify.
STATEMENT OF JOHN HARPOLE, PRESIDENT, MERCATOR ENERGY, LLC
Mr. Harpole. Thank you, Madam Chairman and members of the
Committee. I am John Harpole, President of Mercator Energy. I
would just like to thank you all for having me here today. I
come from a big family. I am the eighth child of nine and I am
really not used to people wanting to hear what I have to say,
so thank you for this opportunity.
Mercator Energy is a natural gas services consulting
company based in Denver that provides marketing services to
natural gas end users and producers. During my 20-year career
in the gas industry, I have purchased gas for most of General
Electric's industrial facilities and also marketed gas for
producers such as McMurry Oil Company located in Casper,
Wyoming. Those varied experiences have provided me with an
extensive view of the natural gas industry, from the wellhead
to the burner tip.
Today, I am here representing myself. My goal is to help
author an efficient solution for low- and fixed-income
individuals who have been and continue to be hurt by rising
natural gas prices. I would like to describe the efficiencies
of a novel concept to expand existing low-income energy
assistance programs by taking Federal royalty gas in-kind and
allocating that gas directly to prequalified low-income energy
assistance needs.
This Committee is certainly aware of the dramatic increase
in natural gas prices during the last 12 months. I have
prepared an illustration that shows the average gas prices from
1991 to 2001. You can see that just in the 2001 time period as
compared to the 10-year average, we have got a 126 percent
increase.
All three sectors of the natural gas customer base have
been dramatically impacted by the price increase. Residential
customers, the largest consumer sector, have naturally screamed
the loudest. Most residential customers are what natural gas
derivative traders refer to as ``naked the forward price'' for
natural gas. While commercial and industrial customers have the
option to lock down forward prices to ease the impact of
volatile pricing, residential customers remain exposed. The
financially naked residential natural gas customer is too often
the one turning off the thermostat and throwing on the extra
blankets.
The irony of all this is apparent in this illustration. In
sheer numbers, the 58 million residential customers are those
that vote, and as a result, they can drive public policy on an
issue that they rarely have control over. Of those 58 million
residential customers, 24 percent, nearly 13.8 million people,
qualify for LIHEAP assistance. LIHEAP assistance is available
to households whose income is 150 percent of the Federal
poverty level, or 60 percent of the State median income.
Administrative expenses for LIHEAP organizations are required
to stay at or below 10 percent of total monies funded.
Now, how can royalty gas help? It is simple. As an owner of
royalty interests in all Federal lands, the Federal Government
is the largest natural gas producer in the U.S. In 1999, the
Federal Government received $2.1 billion in revenue for natural
gas. In 2001, based on the price increase, the Federal
Government should receive nearly $6 billion, a $4 billion
increase as compared to 1999.
Why not incorporate those dollars in a solution for the
needy? I would like to walk you through one possible solution.
KeySpan Corporation, the largest gas utility in the Northeast,
serves about 2.4 million customers in three States. KeySpan
consumes about one million MMBTU of gas per day in their New
York service territory. One of their many long-term supply
contracts calls for the purchase of gas from an offshore Gulf
of Mexico producer in the amount of 60,000 MMBTU per day, so
60,000 a day as compared to the million a day that they consume
in New York City. That volume is then transported a distance of
1,400 miles on Transco pipeline to KeySpan service territory in
New York City. In January of 2000, KeySpan's 54,000 low-income
customers burned about 8,200 MMBTU per day. That is, the low-
income used about 8,200 MMBTU per day.
Under the proposed solution, the offshore producer could
change the price for that 8,200 a day--that is the portion of
that 60,000 MMBTU sale to KeySpan--to $2 or whatever the
Secretary of Interior deems an appropriate price for the price
transfer to the LIHEAP folks. This one transaction, one
transaction, could lower the natural gas price for 54,000 low-
income customers in New York City. Under this solution, the
utility simply transfers the price benefit directly to the low-
income recipient via their monthly utility bill. LIHEAP incurs
no additional administrative burden because it has already
qualified the recipient for assistance.
Additionally, a number of other flexible royalty in-kind to
LIHEAP approaches can be pursued that help address issues
raised by various industry participants. This concept is not
meant to be a long-term social welfare entitlement program.
Rather, when natural gas spot market prices return to levels
near the 10-year average, the program could be reviewed on a
seasonal basis. We need enabling legislation to see this thing
happen.
The benefits are three-fold, at least beyond helping the
low-income. The proposed program could provide an additional
benefit to the low-income in addition to increasing LIHEAP
funding. The LIHEAP program, and this is a quote from the Chair
of the National Fuel Funds Network, ``The LIHEAP program may be
nearing its administrative capacity in terms of delivering
significantly more dollars. Additional delivery mechanisms,''
and I quote, ``such as utilities, would expedite delivering
dollars to people in need.''
Producers, pipelines, and utilities could work in
collaboration in pursuit of the solution, and the diversity of
this approach would allow residential customers perhaps to
better understand how the molecule of gas gets to the
burnertip.
In conclusion, we are requesting this Subcommittee's
assistance in putting together the required enabling
legislation. That is my reason for appearing here today. The
efficiencies of this proposal and the benefits to all parties
involved should motivate us to move forward. Thank you for your
time.
Mrs. Cubin. Thank you, Mr. Harpole.
[The prepared statement of Mr. Harpole follows:]
Statement of John A. Harpole, President, Mercator Energy LLC
Introduction
Madam Chairwoman and members of the Committee: I am John Harpole,
President of Mercator Energy. Mercator Energy is a natural gas services
consulting company based in Denver, Colorado that provides marketing
services to both natural gas end-user and natural gas producing
customers. In the mid-1980's, the Federal Energy Regulatory Commission
(FERC) created open-access transportation on interstate natural gas
pipelines via FERC Order 436. At that time, I was employed by an oil
and gas production company owned by General Electric. As a result of
FERC Order 436, I was put in charge of supplying natural gas to 55
General Electric industrial plants behind 34 utilities and 18
interstate pipelines. It may also be of interest to you, Madam
Chairwoman, to note that my company marketed all of the natural gas
production out of the Jonah Field in Sublette County, Wyoming, for
McMurry Oil Co. from 1992 to 2000. Those varied experiences have
provided me with an extensive view of the natural gas industry--from
the wellhead to the burnertip.
Additionally, I have served as Vice-Chairman of the Natural Gas
Committee of the Independent Petroleum Association of America and on
the governing boards of two regional producer trade associations, the
Colorado Oil and Gas Association and the Independent Petroleum
Association of Mountain States. Over the last twelve years, I have
authored articles about a number of timely issues affecting the natural
gas industry for such publications as American Oil & Gas Reporter, Oil
and Gas World, Hart's Energy Markets, and Natural Gas Focus. Although I
have testified before FERC, this is my first opportunity to testify
before Congress.
I am here representing myself and my company, an independent,
regional natural gas consulting firm, not an industry organization or
political entity. My participation is the result of my interest in
seeing the idea that I will describe further herein, reach fruition.
While the resulting program should provide opportunities for positive
public relations and increased public awareness of how the natural gas
industry ``works'', my true goal is to help author an efficient
solution for low- and fixed-income individuals who have been and
continue to be hurt by rising natural gas prices.
Last month, President Bush's National Energy Policy Development
Group specifically recommended that the President ``take steps to
mitigate impacts of high energy cost on low-income consumers'',
including ``directing the Secretaries of the Interior and Health and
Human Services to propose legislation to bolster LIHEAP [Low Income
Home Energy Assistance Program] funding by using a portion of oil and
gas royalty payments'' and ``redirecting royalties above a set trigger
price to LIHEAP, whenever crude oil and natural gas prices exceed that
trigger price, as determined by the responsible agencies.'' (Chapter 2,
page 2-12)
Today, I appear before you to describe and explain the efficiencies
of a novel concept to expand existing low-income energy assistance
programs by taking Federal royalty gas in-kind and allocating that gas
directly to pre-qualified low-income energy assistance needs. On
February 7, 2001, Colorado Governor Bill Owens sent a letter to Vice
President Cheney's office outlining the general terms of the concept.
That letter resulted in press coverage from a number of natural gas
industry trade publications. I have attached copies of the letter from
Governor Owens and the response from Vice President Cheney's office as
exhibits to this testimony.
After the effort that a number of parties contributed to this
concept, it was gratifying to see the National Energy Policy
Development Group select it for inclusion in the policy document that
was released last month. As evidence of the bi-partisan support this
concept has received, a variation of this idea was introduced in the
House of Representatives on March 8, 2001 by Carol Maloney, (D-NY) as
HR962, and a similar bill in the Senate by Charles Schumer (D-NY) and
Hillary Rodham Clinton (D-NY).
The Need
This Committee is certainly aware of the dramatic increase in
natural gas prices during the last 12 months. Most experts agree that
the two major driving forces behind the price increase were the
following:
1. LA wholesale shift from coal to natural gas as the fuel of
choice by electric utilities. This change is a result of stricter
Federal air quality standards for coal-fired power plants; and
2. LThe exploration and production communities' inability to keep
pace with increases in demand which has been exacerbated by more
restrictive Federal land access and right-of-way regulations.
We, as a country, cannot simultaneously restrict coal-fired
electric generation emissions, access to Federal lands, waters, and
right-of-ways, and not expect a resultant increase in natural gas
prices. Recent Federal policy and regulations have contributed
significantly to the recent surge in gas prices. If the Federal
Government decides to pursue the concept I am proposing, the irony of a
Federal solution that would address the needs of those individuals most
severely impacted,--that is, those with low or fixed incomes--might not
be lost on the American public.
In an effort to convey the dramatic price increase, I have prepared
an illustration that shows the average gas prices from 1991 to 2001.
[GRAPHIC] [TIFF OMITTED] T3043.017
All three sectors of the natural gas customer base have been
dramatically impacted by the price increase. Unlike their industrial
and commercial counterparts who can lock down gas prices either
physically or financially, residential customers--the largest consumer
sector--who rely on utilities to supply their natural gas, do not have
access to individually-negotiated fixed-price contracts or any other
type of long-term, fixed-price hedging tools. In fact, as a result of
various state public utility commission rulings, regulated utilities
generally are allowed to pass through the actual cost of natural gas to
residential customers, regardless of what the price may be. However,
the utilities are not allowed to earn a rate of return on the commodity
portion of those pass-through gas charges. If they were allowed to do
so, simple logic would dictate that the more they paid and charged for
gas, the higher the utility's rate of return would be.
Furthermore, most utilities have no incentive to try to predict or
``outguess'' the forward price for natural gas by locking down long-
term, fixed-price contracts for their residential customer base.
Utilities face the 20-20 regulatory hindsight of state public utility
commissions whenever commodity prices increase. Many of those
utilities, instead, buy gas for their residential customer base under
contracts that are tied to a monthly spot-price index. Utilities have
found themselves in a no-win situation. There is no incentive to pursue
the absolute lowest prices available, and their purchasing strategy is
constantly second-guessed when higher prices occur. This situation
results in a purchasing methodology relegated to a laissez-faire
monthly spot-market price. Many public utility commissions are now
rethinking purchasing policies as a result of the recent dramatic
natural gas price increase.
Because of the trend toward spot-market purchasing, most
residential customers are what natural gas derivative traders refer to
as ``naked the forward price'' for natural gas. The spot market
purchasing strategy provides tools for commercial and industrial
customers to mitigate the impact of volatile pricing, but residential
customers remain vulnerable. The financially ``naked'' residential
natural gas customer is too often the one turning off the thermostat
and throwing on the extra blankets.
The irony of all this is apparent in the illustration below.
Residential gas consumers in this country total about 58 million, more
than ten times the number of commercial customers and 250 times the
number of industrial customers. Yet residential customers are those
most severely impacted by gas prices. In sheer numbers, the 58 million
residential customers are the voting public, and consequently, they can
drive public policy on an issue that they rarely have control over. Of
those 58 million residential customers, 13.8 million qualify for LIHEAP
assistance.
[GRAPHIC] [TIFF OMITTED] T3043.018
LIHEAP
``The Low Income Home Energy Assistance Program (LIHEAP) was
created under the Omnibus Budget Reconciliation Act of 1981 (OBRA) to
help low and fixed income households pay their fuel and utility bills.
LIHEAP funding is allocated by the Department of Health and Human
Services (HHS) and administered by the states, with the states having
maximum flexibility in directing program funds.
``LIHEAP is one of the original seven block grants authorized by
OBRA. Over the last decade, the LIHEAP program has evolved from
providing only financial assistance to low-income households to today's
efforts that include residential weatherization and home-energy repair.
``[under the program] states are given the flexibility to direct
program funds as needed, allowing individual states to tailor programs
according to the needs of its low and fixed income residents. In
addition, states are required to maintain administrative expenses at or
below ten percent [of the total allocated dollars], ensuring that most
of the monies go directly to needy households.--Finally, LIHEAP serves
as discretionary, in many cases one-time, assistance providing a bridge
that helps the working poor and avoiding dependence on welfare
programs.'' (LIHEAP Issue Brief 1998-04)
According to the qualification criteria set forth by the Federal
LIHEAP program, approximately 24% of the country's 58 million
residential customers qualify for energy assistance. LIHEAP assistance
is available to households whose annual income is 150% of the Federal
poverty level or 60% of the state median income. As you can well
expect, the number of applicants increased dramatically in conjunction
with the natural gas price increase over the last heating season.
Nearly 70% of the households receiving LIHEAP assistance in 1995
survived on an annual income of less than $8,000. Nearly 34% of those
households had at least one member 60 years of age or older. In
addition to low-income households, senior citizens and individuals on
fixed-incomes have been especially impacted by high natural gas costs.
The Source
The Federal Government is the largest natural gas producer in the
United States. When royalty volumes from every onshore and offshore
well are aggregated, the volume of daily production owned by the
Federal Government exceeds that of the country's largest commercial
natural gas producer. In 1999, the Federal Government received $2.1
billion in total revenues from onshore and offshore natural gas royalty
payments paid individually each month by each natural gas ``wellhead
operator''. Based upon actual NYMEX natural gas settlement prices for
the first six months of 2001 and the projected NYMEX futures prices for
the remainder of this year, the Federal Government should receive
nearly $6 billion in royalty payments in 2001.
The Federal Government, through the Minerals Management Service
(MMS), currently takes in-kind approximately 400,000 MMBtu per day of
its total 2.5 million MMBtu per day of offshore royalty gas. That is,
the Federal Government sells the gas itself rather than relying on a
sale by the wellhead operator. The administration of this program and
its associated costs and benefits represent a true success story within
the Department of Interior. Fewer than 14 employees at the MMS sell the
400,000 MMBtu per day of gas in the open market on a monthly basis. The
Federal Government also manages a successful onshore oil royalty-in-
kind program in the state of Wyoming.
By any standard, the royalty revenues received in 2001 by the
government can be considered a windfall for the Federal treasury and
for the onshore states that receive a 50% share of these onshore
royalty revenues. Rather than see that windfall ``disappear'' into
Federal and state treasuries, why not incorporate those dollars in a
solution for the needy?
One Approach
Most, if not all, utilities in the eastern United States have
arranged for long-term natural gas supplies from producers in the Gulf
of Mexico. As you are aware, the Federal Government, under the terms of
Federal leases granted to exploration and production companies, has the
option to receive a one-sixth royalty payment on production located in
offshore waters or take the equivalent volume of gas in-kind.
Nearly every utility in the western half of the country acquires a
portion of its natural gas supplies from production located on Federal
lands in the Rocky Mountains. On those lands, the Federal Government
receives a one-eighth royalty payment and also retains, under its lease
agreements, the option to receive its royalty in-kind.
In the majority of cases, whenever a utility purchases gas from
producers with production on Federal lands, the utility utilizes its
own transportation contracts on interstate pipelines in order to
effectuate the transportation of gas ``from the water'' (Gulf of
Mexico) or from ``The Rockies'' to their utility's front door, the
``citygate.
As an example, KeySpan Corporation, the country's fifth largest gas
utility and the largest gas utility in the Northeast, serves 2.4
million customers in three states. On an average January ``peak'' usage
day, KeySpan consumes 1,100,000 MMBtu in its New York City service
territory alone.
In January of 2000, in KeySpan's New York City service territory,
54,000 pre-qualified residential low-income customers accounted for a
``low-income average daily demand'' of 8200 MMBtu per day. Obviously
the 8200 MMBtu per day of usage related to low-income demand is just a
fraction (seven-tenths of one percent) of the total volume of gas
consumed in New York City by KeySpan customers. The ``low-income
volume'' was calculated by identifying the LIHEAP recipients by account
number and totaling the daily usage for each account. That aggregate
demand volume obviously changes each month. Note that the ``low-income
volume'' for KeySpan's New York City service territory of the largest
gas utility in the northeast amounts to less than three-tenths of one
percent (0.3%) of the Federal Government's total offshore royalty gas
volume.
One of KeySpan's many purchase contracts calls for delivery of gas
from an offshore Gulf producer in the amount of approximately 60,000
MMBtu per day. That volume is then transported by KeySpan under a firm
transportation agreement with Transcontinental Gas Pipe Line Corp. a
distance of 1400 miles to KeySpan's service territory in New York City.
As a result of this transaction, the offshore producer/wellhead
operator, pays the Federal Government a monthly royalty equal to one-
sixth of the Gulf Coast sales price arrived at with KeySpan. The
producer remits payment to MMS with MMS Form 2014.
Under this proposed program, KeySpan, in conjunction with the
offshore producer, could change the price for the 8,200 MMBtu per day
of the total 60,000 MMBtu per day to $2.00 per MMBtu (or whatever ``set
trigger price'' might be determined by the Secretary of Interior). This
one transaction could lower the natural gas price for 54,000 LIHEAP and
other prequalified low-income customers in New York.
This solution adds no net administrative burden or cost to either
the offshore producer, the utility or the state LIHEAP administrator.
The producer could simply indicate on the required Federal royalty
paperwork (a simple redesign of Form 2014 would be required) that a
specified portion of the royalty gas was sold in-kind at the
predetermined LIHEAP set trigger price to the producer's utility
customer, who verifies the sale volume and price for audit purposes.
The utility then transfers the price benefit directly to the pre-
qualified low-income recipients via their monthly utility bills. LIHEAP
incurs no additional administrative burden because it has already
qualified the recipient for assistance.
Under this approach, the producer handles the sales transaction of
in-kind royalty gas. The only additional administrative burden is MMS's
audit of the transaction. By not having to add special purchase
contracts, the utility can simply transport the gas under existing
long-term arrangements.
The above approach is not the only solution to moving royalty in-
kind gas to low-income recipients. A number of flexible options can be
pursued that help address the concerns of various industry
participants. For example, some utilities may not have the information
systems infrastructure necessary to allow them to identify specific
recipients and pass through the lower-priced royalty-in-kind gas.
Additionally, it may make more economic sense to have the government
purchase firm transportation directly from the pipelines or pipeline
shippers in those few instances where short-term ``released-capacity''
transportation may be cheaper than the utility's underlying firm
transportation agreements.
Enabling Legislation and Pilot Projects
This novel concept is not meant to become a long-term social
welfare entitlement program. Rather, when spot market prices return to
levels near the ten-year average (which could be calculated on either a
NYMEX, regional, or citygate basis), the need for the program could be
reviewed on a seasonal basis.
Enabling legislation is, however, needed to address the Mineral
Leasing Act and the Outer Continental Shelf Lands Act to allow the
Secretary of Interior to accept a price that benefits the low-income.
We must move quickly in order to implement a pilot program that
will address the high natural gas prices that are anticipated for this
coming winter's heating season. Utilities could be selected for pilot
programs in which each utility could tailor the concept to its own
needs and requirements.
More than enough Federal royalty gas exists to satisfy all of the
low-income demand nationwide. The nation's top 25 natural gas utilities
serve 52.5% of all residential consumers in the United States. Under
the above-described ``KeySpan'' approach, one ``deal'' alone can
``cover'' the low-income needs behind one of the largest gas utilities
in the country utilizing only 3/10ths of one percent of the available
offshore Federal royalty gas volumes. Imagine what 25 ``deals'' a month
could do for other low- and fixed-income consumers! Auditing 25
transactions a month would be a nominal task for the MMS given the
measure of benefit it would provide to recipients. MMS's cost to audit
would be minuscule compared to the ``up-to-ten-percent'' cost of LIHEAP
administration.
The Benefits
Important collateral benefits to this program are apparent beyond
lowering the price of natural gas for low- and fixed-income households.
1. LThe proposed program could provide an additional benefit to the
low-income in addition to increasing existing LIHEAP funds. This is
best described by Karen Brown, current Chairman of the National Fuel
Funds Network, who says in a letter (copy attached) that,
``Additionally, in times of such crisis as last year, simply increasing
dollars to be delivered through a finite and, in some cases, much
outdated delivery structure such as LIHEAP is not fully effective. The
LIHEAP program may be nearing its administrative capacity in terms of
delivering significantly more dollars--especially without investing
more dollars to improve such an infrastructure. Additional delivery
mechanisms such as utilities would expedite delivering dollars to
people in need.
2. LBy working in collaboration, producers, pipelines and utilities
can direct more dollars to the needy by avoiding the ``up-to-ten
percent'' administrative cost inherent in the LIHEAP program. As an
example, if this Federal royalty-in-kind (RIK) solution results in $1
billion in benefits to LIHEAP customers, eliminating the 10%
administrative charge adds another $100 million to the bottom line for
low- and fixed-income customers.
3. LLIHEAP and similar programs could redirect a larger pro-rata
share of their funds to conservation efforts as a result of the base
cost of natural gas being addressed by this program.
4. LThe diversity of this approach allows for a greater level of
understanding about how a ``molecule of gas'' travels from the wellhead
to the burnertip. For example, utilities could provide informative
leaflets with their bill that describe the program in simple, everyday
terms, thereby helping to educate and raise the level of awareness
among those customers who know the least amount about our industry and
yet are impacted the most by price volatility.
Conclusions
If, as many industry experts indicate, natural gas prices continue
to remain 30% higher than just one year ago, more and more individuals
on low or fixed incomes will continue to seek energy assistance from
state and Federal programs. Under this proposed program, the Secretary
of Interior has the option to decide if and when natural gas prices
become high enough to warrant allocation of royalty in-kind gas to
LIHEAP programs. If the Secretary so designates, producers, utilities
and state LIHEAP organizations will not need to scramble to introduce
new programs overnight, but will have the flexibility to reduce the
price of gas supplies designated for LIHEAP recipients.
While LIHEAP offers other energy assistance programs that can
benefit from any additional dollars the Federal Government may allocate
to them in times of high energy prices, 100% of the benefit of low-
priced, in-kind royalty gas is passed on to LIHEAP recipients free of
any additional administrative fees.
Requesting this Subcommittee's assistance in putting together the
requisite enabling legislation is my reason for appearing here today.
The efficiencies of this proposal and the benefits to all parties
involved should motivate us to move forward.
______
[A map and letters attached to Mr. Harpole's statement
follow:]
[GRAPHIC] [TIFF OMITTED] T3043.005
[GRAPHIC] [TIFF OMITTED] T3043.006
[GRAPHIC] [TIFF OMITTED] T3043.007
Mrs. Cubin. The Chair now recognizes Mr. James Jacob to
testify.
STATEMENT OF JAMES JACOB, MANAGER OF CONSUMER ADVOCACY, KEYSPAN
CORPORATION
Mr. Jacob. Good morning, Madam Chairman and members of the
Committee. KeySpan is the largest gas company in the Northeast
and the fifth largest in the country. We serve 2.4 million gas
customers in three States. We are also the largest privately-
owned power producer in New York State, with 6,200 megawatts of
generation.
Since 1998, KeySpan, formerly known as the Brooklyn Union
Gas Company, has grown from one of the most respected local gas
distribution companies in the country to a diversified energy
company with a footprint in the Northeast. KeySpan also
provides management services for the electric transmission and
distribution services owned by the Long Island Power Authority.
In addition to our natural gas customers, KeySpan serves 1.1
million electric customers on Long Island.
KeySpan is committed to providing assistance to low-income
and special needs households. We have over many years
established partnerships with State and local government social
service agencies and community-based organizations to maximize
the use of the limited resources available to serve this at-
risk population. KeySpan is an active participant in the New
York State HEAP Block Grant Advisory Council. We take an active
role in promoting, advertising, and enrolling eligible
customers in this vital program.
Recognizing our corporate obligation to the communities we
serve, KeySpan has supported urban renewal initiatives through
our Cinderella program, now in its 31st year. In 1983, we
created a fuel fund in New York City that we call the
Neighborhood Heating Fund. This fuel fund has been a critical
part of KeySpan's response to the need for public and private
partnerships to supplement LIHEAP funding. We have created or
support similar fuel funds in all of our service territories.
This winter was extraordinary in the Northeast because of
two main factors, the cold weather lasting for longer than
average and the high price of gas used in heating homes.
Understanding the incredible burden faced by low-income
customers, KeySpan responded by adding additional funds to
their heating fund. To date, KeySpan has contributed more than
$7.4 million to these energy assistance programs. As there was
an increased demand for energy assistance, this money quickly
made its way to the households desperately in need of
assistance.
In the early 1990's, KeySpan created two targeted low-
income assistance programs. The first is On Track, a
comprehensive behavioral modification program focused on energy
and financial management that serves 1,700 customers per year
in New York State. The second is the Residential Reduced Rate.
This program helps make energy more affordable for our low-
income customers in New York City by providing a discount on
their basic service charge.
I would like to focus on our New York City operation today
as I ask for your support in piloting a natural gas royalties
in-kind program for low-income customers. KeySpan Energy
Delivery of New York serves 1.1 million customers in three
counties within New York City. We currently have identified
over 120,000 special needs households in this area. Studies we
have conducted tell us that over 43 percent of our payment
trouble customers have incomes at or below 150 percent of the
Federal poverty level. Census data and other income studies
conducted for our service territory support the findings of our
research.
Every year, KeySpan works with thousands of low-income
households struggling to meet their energy expenses. These are
good people and they are facing hard times. Many are having
difficulty with their bills for the first time. We see families
that have had their income reduced by catastrophic illness,
senior citizens adjusting to the loss of a spouse and the
associated change in their financial status, and single-parent
households struggling to keep their families together, and many
of our neighbors who, because of loss of employment, are facing
a crisis.
Recognizing that a large number of households are facing
difficult choices, KeySpan implemented a discount rate for low-
income customers in 1993. We currently have 54,000 households
enrolled in this program. The special needs customers enrolled
in this program receive a 30 percent reduction in their basic
service charge.
As we develop the proposals I am supporting today, we
approached our regulatory agency, the New York State Public
Service Commission, and we are pleased to report that they are
supportive of this undertaking. While this project was
underway, the price of natural gas has increased substantially.
We believe that the timing for a new public-private partnership
to assist low-income households is critical.
In our residential reduced rate, we have a self-identified
group of low-income and special needs customers who have asked
us for the lowest possible residential rate. Our proposal would
not mandate participation, but offers the lower-priced
commodity based on program eligibility criteria. We believe
that the voluntary enrollment provision is critical since we
support the right of customers to choose and to make informed
decisions in the emerging competitive marketplace. As these
customers are already aggregated for our discount rate, they
are the group that would benefit the most from the commodity
discounts associated with royalties in-kind. This group has a
better bill payment history than our normal residential
customers and this has been a multi-year experience, and we are
concerned that with the growing energy crisis, that these
customers will face additional terminations for non-payment in
the near future unless we come up with a mechanism to reduce
energy burden.
With your support, the Department of the Interior can
arrange for the delivery of natural gas as royalties in-kind.
In the program that we are proposing, KeySpan would need an
average of 8,200 decatherms of natural gas per day for these
customers during January. When this has been accomplished,
KeySpan could supplement the already discounted transportation
rate with a much lower commodity cost. We would continue to
provide all the customer care functions for these customers and
we would use our existing capacity to transport the natural
gas. We would also seek to reduce or eliminate any associated
demand charges related to this new supply.
This partnership would reduce the energy burden for low-
income households, helping them to reach the elusive goal of
energy affordability. We ask that you support the proposal for
natural gas royalties in-kind as a direct and meaningful method
of addressing the energy burden of low-income households.
LIHEAP and royalties in-kind are essential to the well-being of
a major segment of our population. Thank you very much.
Mrs. Cubin. Thank you very much, Mr. Jacob.
[The prepared statement of Mr. Jacob follows:]
Statement of James M. Jacob, Manager of Consumer Advocacy, KeySpan
Corporation
Introduction
Madame Chairman and members of the committee: I am James Jacob,
Manger of Consumer Advocacy for the KeySpan Corporation. KeySpan is the
largest Gas Company in the Northeast and the 5th largest in the
country. We serve 2.4 million gas customers in three states. We are
also the largest privately owned power producer in New York State with
6,200 Megawatts of generation. Since 1998, KeySpan formerly known as
The Brooklyn Union Gas Company has grown from one of the most respected
local gas distribution companies in the country to a diversified energy
company with a footprint that spans the Northeast. KeySpan also
provides management services for the electric transmission and
distribution services owned by the Long Island Power Authority. In
addition to our natural gas customers, KeySpan serves 1.1 Million
electric customers on Long Island.
KeySpan is committed to providing assistance to low income and
special needs households. We have, over many years, established
partnerships with State and Local Government social service agencies
and community based organizations to maximize the use of the limited
resources available to serve this ``at risk'' population. KeySpan is an
active participant on the New York State HEAP Block Grant Advisory
Council. We take an active role in promoting, advertising and enrolling
eligible customers in this vital program. Recognizing our corporate
obligation to the communities we serve, KeySpan has supported urban
renewal initiatives through our ``Cinderella'' program now in its 31st
year. In 1983, we created a fuel fund in New York City that we call the
Neighborhood Heating Fund. This fuel fund has been a critical part of
KeySpan's response to the need for public/private partnerships to
supplement LIHEAP funding. We have created or support similar fuel
funds in all of our service territories. This winter was extraordinary
in the northeast because of two main factors, the cold weather lasting
for longer than average and the high price of gas used in heating
homes. Understanding the incredible burden faced by low-income
customers, KeySpan responded by adding additional funds to their
heating funds. To date, KeySpan has contributed more than $7.4 Million
to these energy assistance programs. As there was an increased demand
for energy assistance, this money quickly made it's way to the
households desperately in need of assistance.
In the early 1990's, KeySpan created two targeted low-income
assistance programs. The first is ``On Track'' a comprehensive
behavioral modification program focused on energy and financial
management that serves 1,700 customers per year in New York State. The
second program is the Residential Reduced Rate. This program helps make
energy more affordable for our low-income customers in New York City by
providing a discount on their basic service charge for qualified
customers.
I would like to focus on our New York City operation today as I ask
for your support for piloting a Natural Gas Royalties in Kind program
for low-income customers. KeySpan Energy Delivery of New York serves
1.1 Million customers in three counties within New York City. We
currently have identified over 120,000 special needs households in this
area. Studies we have conducted tells us that over 43% of our payment
troubled customers have incomes at or below 150% of the Federal poverty
level. Census data and other income studies conducted for our service
territory support the findings of our research. Every year KeySpan
works with thousands of low-income households struggling to meet their
energy expenses. These good people are facing hard times. Many are
having difficulty with their bills for the first time. We see families
that have had their income reduced by catastrophic illness, senior
citizens adjusting to the loss of a spouse and the associated change in
their financial status, single parent households struggling to keep
their families together and many of our neighbors who because of the
loss of employment are facing a crisis.
Recognizing that a large number of households were facing very
difficult energy choices, KeySpan, implemented a discount rate for low-
income customers in 1993. We currently have 54,000 households enrolled
in this program. KeySpan's Residential Reduced Rate offers a discounted
transportation rate or basic service charge that includes the first 6
therms of natural gas. The special needs customers enrolled in this
program receive a 30% reduction on their basic service charge.
In order to qualify for the Residential Reduced Rate, a customers
must be currently receiving Medicaid, SSI, Public Assistance, LIHEAP,
Food Stamps, Child Health Plus (New York State health insurance for
uninsured children), Veteran's Disability Pension or Veteran's
Surviving Spouse Pension.
Four years ago, as part of our ongoing advocacy program, we
initiated research into a mechanism to deliver lower priced natural gas
to this identified special needs population. Traditional utility rate
setting mechanisms do not have a provision for directing the lowest
priced commodity to a sub-set of customers. As we developed our
proposal, the Company approached our regulatory Agency, the New York
State Public Service Commission, and we are pleased to report that they
are supportive of this undertaking. While this project was underway,
the price of natural gas has increased substantially. We believe that
the timing for a new public/private partnership to assist low-income
households is critical.
In our Residential Reduced Rate, we have a self-identified group of
low-income and special needs customers who have asked us for the lowest
possible residential rate available. Our proposal would not mandate
participation but offers the lower priced commodity based on program
eligibility criteria. We believe that the voluntary enrollment
provision is critical since we support the right of customers to choose
and to make informed decisions in the emerging competitive marketplace.
As these customers are already aggregated for our discount rate, they
are the group that would benefit from commodity discounts associated
with the Royalties-In-Kind proposal. Our Residential Reduced Rate
customers as a group have demonstrated a better bill paying history
when compared to the general residential customer population. This
multi-year collection experience shows the direct results of affordable
energy for low-income consumers. However, current collection forecasts
project a somewhat darker future as low-income consumers react to
higher energy prices. We have already seen growth in the amount of our
past due accounts. We expect that delinquency and subsequent
terminations of service for non-payment will grow if a mechanism for
reducing energy burden is not found.
Many of the customers in our program were recipients of Public
Assistance. We believe that additional targeted energy education
materials including the use of bill inserts, coupled with affordable
energy, will assist these households in the transition to self-
sufficiency.
With your support, the Department of the Interior can arrange for
the delivery of natural gas as royalties in kind. In the program that
we are proposing, KeySpan would need an average of 8,200 dth of natural
gas per day for these customers during the month of January. When this
has been accomplished, KeySpan could supplement its already discounted
transportation rate with a much lower commodity cost. KeySpan would
continue to provide all of the customer care functions for these
customers and would use its existing transportation capacity for this
program. We would seek to reduce and or eliminate any associated demand
charges related to this new supply with our existing natural gas
suppliers.
This new public/private partnership would reduce the energy burden
for these low-income households helping them to reach the elusive goal
of affordable energy.
Conclusion
We ask that you support the proposal for using Natural Gas
Royalties in kind as a direct and meaningful method of addressing the
energy burden of low-income households. In today's uncertain economic
climate with energy costs rising, there are more people in need of help
than ever before. In the face of daily announcements of layoffs,
industry restructuring, and downsizing, programs such as LIHEAP and
Royalties in Kind are essential to the well being of a major segment of
our population.
______
Mrs. Cubin. I will begin the questioning. I would like to
start with Mr. Cruickshank. Rumor has it that Joe Skeen's
Subcommittee markup of the fiscal year 2002 appropriation for
Interior has the same RIK language that it had last year. Is
that sufficient or do you think Secretary Norton needs more
authority?
Mr. Cruickshank. I think that that language will be
sufficient for us continuing what we are doing now. If the
Secretary wanted to consider taking the program in a different
direction, then we would have to see if the authority was
sufficient for those decisions.
Mrs. Cubin. So to use RIK gas for LIHEAP, you would think
that it would be necessary for Congress to take action or not?
Mr. Cruickshank. It might. I think we would have to work
through the specific proposal and see how it fit with our
existing authorities. Some things we would be able to do, some
we might not, and we would need to really work through specific
proposals on that.
Mrs. Cubin. Okay.
Mr. Cruickshank. But as you have noted, the President's
energy plan does call for us to propose legislation to use
royalties to bolster LIHEAP, so I am sure we will be
considering those authorities in that context.
Mrs. Cubin. How would an RIK LIHEAP program actually work?
Mr. Cruickshank. Do you want to handle this one, Milt?
Mrs. Cubin. I mean, I have been working with royalty in-
kind ever since I have been here, and so has Mr. Thornberry,
but the other members of the Committee have not, and so I think
what I would like you to describe is the collection, the
distribution, the offset of the value or just how a program
works, how an RIK program works and how we would get it out to
the people that we are trying to take care of.
Mr. Dial. In answering that question and making reference
to Mr. Jacob's proposal, basically, from an RIK perspective, if
we were dealing with outer continental shelf leases in the Gulf
of Mexico and we were dealing with natural gas, typically, what
would occur would be an identification of properties where a
royalty obligation exists, or a royalty collection is
occurring. That collection, if it were currently in-value,
would be converted at the discretion of the Secretary to an in-
kind collection, basically, a one, for most leases, a one-sixth
of total production coming off a lease be converted to an in-
kind take of royalty, and that in-kind take of royalty, that
physical production, would be delivered to a central
aggregation point.
What I heard Mr. Jacob describe would be that KeySpan would
either itself or through intermediaries arrange for the
physical movement of that gas to New York. That is the physical
aspects of how, I guess, we would envision, just in the short
discussion that we have had, of this particular proposal.
Mrs. Cubin. So in other words, the gas itself would go to
the utility. The utility would deliver the gas to the homes and
that would replace an additional appropriation that the
Congress would make. Would that be a shortcut to it? Mr.
Harpole?
Mr. Harpole. Can I try to answer your first question, and
then I will try to clarify the second? Deanna, can you put up
the map, please? The concept that I have discussed with KeySpan
is that they hold firm transportation on Transco right now that
actually picks up gas in the Gulf Coast. And so one of their
purchases--they may have 40 different packages of gas that they
buy on a daily basis, but one of their purchases is directly
with the producer on the Gulf Coast. That accounts for about
60,000 MMBTU per day, 60,000 of the million that they use
behind their New York City service territory.
And so if you imagine there is a one-sixth royalty on all
that gas, 10,000 of that, if the producer did not do it in-
kind, 10,000 of that MMBTU would be paid to the Federal
Government on a 2014 Form. What I am saying is, instead of
doing that, let us have KeySpan identify the volume that they
need under the existing contract. KeySpan says, I need 8,200 of
that 60,000 at the Secretary of Interior's price, but I will
transport it. I will transport it even though my transportation
value is probably--the value of that transportation that they
hold in the winter is four to five times less than what the
market could charge for that similar transportation quantity.
So it is kind of a seamless transaction. You do not have to
buy new gas to cover those people, and I would love to kind of
address the California question that was asked earlier, but it
is a pretty seamless transaction that would cover 54,000 people
with one deal.
One thing I would like to point out is that only three-
tenths of 1 percent of the available royalty gas offshore, only
three-tenths of 1 percent would cover all of KeySpan's New York
City service territory.
Mrs. Cubin. I realize my time is out, and rather than going
to a second round of questioning, I wanted to ask one question
of Mr. Cruickshank. It has been alleged or suggested here today
that MMS would have to establish a huge new big bureaucracy to
market this gas. I would like your response to that.
Mr. Cruickshank. I do not think that would necessarily be
the case, Madam Chairman. Right now, our operating principle is
to collect the royalties in-kind and get them to a pooling
point or a market center that is close to the producing area.
It is not the most complicated of transactions to do and
selling gas at a market center is also fairly straightforward.
I think if we were to get ourselves heavily involved with going
downstream from there, then we would have to pick up a lot of
additional skills and that would become more complicated. But
the way we are operating right now, I do not think we need to
build up too big a bureaucracy to do so.
Mrs. Cubin. In conjunction with that statement was the
statement that MMS does not have the expertise to do this.
Would you agree with that or not?
Mr. Cruickshank. We have been developing the expertise, and
that is part of the reason for the pilots. I think that the
folks that have been working the pilots since 1998 have
developed a lot of that expertise and are operating very well
and doing things that all the other marketers do out there very
successfully. That is only a small number of people, and if we
were to grow the program by a large amount, we would certainly
need to train more people and acquire additional expertise over
time. But it is the folks doing the work now that have
developed that expertise.
Mrs. Cubin. Thank you very much.
The Chair now recognizes Mrs. Napolitano.
Mrs. Napolitano. Thank you, Madam Chairman. First, I would
like to put into the record Representative Maloney's statement,
Madam Chair. She has not been able to be here.
Mrs. Cubin. Without objection.
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Mrs. Napolitano. It is with great interest that I am
listening to the actual process by which we could accomplish
the assistance to the low-income, and that is of great interest
to me, but I still have concerns whether or not the system will
be able to function. Mr. Cruickshank, you indicate that there
are some pilots.
Mr. Cruickshank. We have been operating pilots where we
have been taking royalties in-kind and selling them at the
market centers. There has not been a pilot yet to deliver
royalty in-kind to the LIHEAP program.
Mrs. Napolitano. So we are just speculating that that would
work. What would you think would be the most, I would not say
onerous, but what would be the biggest obstacle to be able, to
any of you gentlemen, to be able to put a program that would
actually serve the low-income and still be able to have the
government be able to maintain a fairly good process that would
not endanger future programs, because if you realize, once you
set it in place, all you have to do is keep adding to it, and
we want to be sure that there is something that is going to be
there for a good number of years, that is going to be adequate
to serve the people that it is meant to serve, and that it does
not infringe upon either the business sector, i.e., the gas
companies, or that it does not impact other areas that will
eventually be impacted, because you are going to have a rise
and fall of prices much as you have in gasoline, and you have
seen that increase. In 10 years, you have had a 100 percent
increase almost. How would you be able to keep that?
I mean, there are all kinds of questions that come into my
mind, because people on fixed income do not have, generally, a
doubling of their income within a certain period of time. So
you are talking about being able to provide those folks with
adequate sources of gas and still maintain a price that is not
going to affect both the government and private industry.
Gentlemen?
Mr. Harpole. Can I take the first swing at that?
Mrs. Napolitano. Please.
Mr. Harpole. It is a good question, several different
questions in there.
Mrs. Napolitano. A lot of them.
Mr. Harpole. A couple come to mind.
Mrs. Napolitano. In my mind, there are more.
Mr. Harpole. I will try my best. This, in no way, shape, or
form, is meant to upset the marketplace. In fact, the royalty
gas that is purchased by a marketer or a utility right now is
inherent in the 8(a) production that they buy from a producer.
So when you think about it, when they buy that gas and take it
to the utility, they are not allowed to earn a rate of return
on the commodity portion of their gas cost. They have to pass
that through. Utilities earn a rate of return based on their
cost of service. If they are allowed to earn a rate of return
on $20 gas, they would buy $40 gas. So it is a pass-through and
so there is no inherent impact on the marketplace from that
standpoint.
It is not meant to be a social or a welfare-type program.
If the alternative is to buy gas--if the alternative is to
transfer monies to LIHEAP, LIHEAP can spend up to 10 percent of
those monies on administrative cost. So in my mind, if the top
25 utilities cover 52 percent of the residential customer base
and we just solved New York City's KeySpan service area problem
with one deal, imagine what 25 deals could do in terms of
solving 52 percent of the residential customers' exposure to
low-income high heating bills.
And then, in addition, think about what it does when LIHEAP
can reschedule other funds to go to conservation and other
programs. It is meant to kind of augment the LIHEAP program and
the ease and efficiency of it is such that if you just took $1
billion of royalty gas--just $1 billion of royalty gas--but if
you took $1 billion of royalty gas in-kind and gave the money
to LIHEAP, $100 million of that could be spent on
administrative costs. It would not cost a fraction to audit
this program, where you see where the utility says, this is how
much I need for my low income. I cannot imagine a utility
overstating that so that they can make more money. This is one
where we are kind of all helping--the entire industry is
helping that person lower their energy cost, and the efficiency
is, in part, is the elimination of the administrative overhead.
Mrs. Napolitano. That is great, and Madam Chair, may I just
stress one point, is that I have heard the utilities would not
want to make a profit, but let me tell you, I have had
utilities tell me they have to make a profit for their
investors, and I told them I do not get that kind of assurance
from my stockbroker. So it is kind of like, do we allow it? How
much of it? Is it a fair return? Look at what is happening with
the price increases, both in the energy and electricity and
also in gas. So to me, it is very open. It is like anybody can
do anything they want until we begin to close the gaps and the
loops. Your statement that the transporter will not charge
because it is a seamless thing, they will make some money
somewhere.
Mr. Harpole. They are allowed to earn their cost of service
rate of return on the transportation.
Mrs. Napolitano. That is what we heard of energy, too.
Mr. Harpole. But honestly, for me, I would hate to be a
utility, because you are allowed to earn a rate of return, but
there is no incentive for you to go out there and buy gas at a
cheaper price, because if you guess wrong, you cannot pass
through that cost to your customer base. And so they live in a
box. These folks from KeySpan--
Mrs. Napolitano. In other words, it is--
Mr. Harpole. Right. It is a no-win situation and there is
constant 20/20 regulatory hindsight.
Mrs. Napolitano. But you understand from our vantage point
is we have our constituents saying to us, take care of it. How?
And so we need to find out, how do we best work with the
industry to be able to be sure that we are doing the right
thing for them.
Mr. Harpole. I think what you have before you,
Congresswoman, today is a producer group, an interested party
in myself, and a utility group that are saying, this is a great
solution. It is a seamless-type solution. And the utility is
willing to allow their transportation that is worth a lot more
in the marketplace to be utilized to save money for the low
income.
Mrs. Napolitano. Thank you, gentlemen, and I have gotten
that message.
Mrs. Cubin. The Chair now recognizes Mr. Otter.
Mr. Otter. Mr. Harpole, I am interested in your comment
that this was not meant to be a welfare program. What was it
meant to be, then?
Mr. Harpole. It is definitely a transfer of wealth right
now. This is--
Mr. Otter. What would you call it? If you did not call it a
welfare program, what would you call it?
Mr. Harpole. It is the Federal Government helping step in
to solve a problem that they helped create.
Mr. Otter. That they helped create?
Mr. Harpole. The higher natural gas prices, in my opinion,
are a direct result of more air emissions standards. Now, I am
from the natural gas industry and when I see every utility out
there choosing natural gas as a generation of source, I feel
like the dog that was chasing the car and I caught it. So every
utility out there--of the 250 projects, electric generation
projects, that are proposed, all but five are natural gas fired
right now nationwide. And so we have seen the shift, and you
can blame it on the Federal Government or just blame it on
people that want to try to reduce emissions, but we have seen a
shift in the fuel of choice to natural gas. But at the same
time, as a third generation native of Colorado, we see access
to Federal lands where a lot of those unknown and undeveloped
reserves, or the undeveloped reserves, are situated.
And so from my perspective, having seen this from the
wellhead to the burnertip, those two Federal issues have helped
create a price increase. We cannot be surprised by the fact
that gas prices have increased when we increased the demand and
then also reduced access. At the beginning of the hearing
today, the Chair recognized that we do not want to go into
issues about why prices have increased and why we need more
access to Federal lands, but I think that issue is a direct--
the pricing that we are realizing today is a direct result of
several different conflicting policies, restrict air emissions,
restrict access to Federal lands.
Mr. Otter. Well, given your enthusiasm for this kind
program, then why would not the Federal Government, why would
not this Committee also include the rights-of-way across
Federal ground for pipelines, for instance, as in-kind as well?
Why not allow the use of Federal lands for rights-of-way and
the transmission of pipelines and use that as sort of a toll.
Say, well, we are going to toll you X-number of dollars per
cubic foot and that is going to go into the in-kind, as well. I
can see a tremendous new bureaucracy being built up in order to
keep track of all these little accounts that would absolutely
delight those who believe that government ought to be the one
that is dividing up scarcity.
Why would we not include all these other things? Say, in
low-cost housing, if you are going to harvest forests off of
Federal land, then out of every 1,000 feet, say 100 feet of
that has got to go to low-cost housing. Where would we stop?
Mr. Harpole. Congressman Otter, I am about as right-wing a
Republican as you will ever find. The gentleman to your left
actually is my Congressman and he knows that for a fact.
Mr. Tancredo. I can attest to that.
Mr. Harpole. There was a time when the Federal Government,
to create an incentive to expand the nation actually awarded
every other section on either side of the railroad.
Mr. Otter. Yes.
Mr. Harpole. We have a problem right now. We have an energy
crisis. It is hitting the people that do not understand the
issue the most, the 58 million residential customers, and we
need to come up with some creative solutions to solve that
problem.
What I would like to do, in coming up with this idea, let
us release the pressure valve on the people that are the most
affected, and that is the low-income portion of those 58
million customers that really do not understand the flow of the
molecule of gas from the wellhead to the burnertip. This is a
program that you could dial up and down. If the gas prices
return to a 10-year average, the program is terminated and
the--
Mr. Otter. And the bureaucracy goes away?
Mr. Harpole. The bureaucracy goes away. And it is not the
bureaucracy that you create in the LIHEAP program. It is a much
more efficient approach.
Mr. Otter. We have got to have some institutional memory
here, and the institutional memory that I can recollect is that
I have never seen one go away, but that is a subject probably
for a different day.
Mr. Cruickshank, have you audited any of these pilot
projects for success?
Mr. Cruickshank. We have done an evaluation of the Wyoming
oil pilot.
Mr. Otter. Is that an audit?
Mr. Cruickshank. It is not an audit. That would, in
essence, be auditing ourselves in a sense. We are taking the
production. We do use our auditors from the royalty program to
verify that the volumes delivered are the correct volumes. But
we are selling the product under contractual obligations with
private companies or with the General Services Administration,
and as we verify the volume, since the price is written in the
contract, we are able to tell without a full-scale audit
whether we are being paid the right amount.
Mr. Otter. I see. What would be wrong with the government
just assuming a working interest in an ore body, or not in an
ore body, but in a gas field? Why would we not just assume a
working interest like if we were the landowner, which I think
we are?
Mr. Cruickshank. In a sense, when we take royalties in-
kind, the operators are treating us as a working interest in
terms of delivering the production to us and giving the
information that one needs to manage the production one takes
off of a lease. We are not a full working interest in the sense
that we are not at the table to help decide how the oil and gas
reservoir is going to be developed and what investment
decisions to make, and I think that that would be the big issue
with your proposal. Should the government be there with the
lessee deciding exactly what sorts of investments to make and
when to make them?
Mr. Otter. But is that not what happens? If Butch Otter
owns a chunk of ground and there is a gas reserve underneath
it, there is a gas deposit underneath it and they drill down
and I maintain a one-eighth working interest in that well or in
that whole field, do I not then come to the table and say to
the folks who would develop it, who are actually getting the
resource as a result of their development and their ability to
accommodate the money necessary, the investment and exploratory
funds necessary in order to develop the field, I make those
decisions, and the decisions that I would make, Mr.
Cruickshank, would be based upon how much more return am I
going to get for my one-eighth, right?
Mr. Cruickshank. The fundamental difference between a
working interest and a royalty interest is that role in the
decision making about the operations on the lease.
Mr. Otter. One more question, then. Are we not the
landowner?
Mr. Cruickshank. Yes, we are.
Mr. Otter. Thank you.
Mrs. Cubin. The Chair now recognizes Mr. Rehberg.
Mr. Rehberg. Thank you, Madam Chairman. You will note that
I sit to the right of the entire Committee. There is a reason
for that on the conservative meter.
I do not have a problem with your idea. In fact, I think we
do need a short-term solution and we have to be very creative
without masking what created the problem, and that is supply
and demand.
As I look at your map, that is a nice pipeline, but it does
not do anything for Montana, and over the course of the
testimony, we have heard that there is a bottleneck at the
pipeline. Can it work in areas where there are, in fact, the
inability to get our gas into the pipeline?
Mr. Harpole. Yes. I was hoping someone would ask that
question to clarify a statement that Mr. McMahon made earlier.
He indicated that it would require additional transportation
volumes to get to California. In anticipation of that question,
I pulled down the list of parties that transport gas on the El
Paso pipeline and Trans-Western pipeline from the San Juan
Basin, predominately Federal lands, from the San Juan Basin
into California, and SoCal has 500,000 MMBTU a day of gas
transportation. Similar in concept to the offshore idea, they
could take advantage of that.
As you well know, Montana Power sources gas from all over
Montana. In addition to doing this on Federal lands, that is
gas that is brought in from Montana, you could do it on State
lands, also, but that would be left up to the individual States
to solve that problem. But Montana, as you well know, is
surrounded by Federal lands and one-eighth of that royalty gas
would be available. Now, remember, one-eighth of that royalty
gas is transferred to the State once it is received and one-
eighth goes to the Federal Government.
There may be some people in New Mexico that do not want 50
percent of their share going to California to solve a problem,
but in my estimation, the Federal Government has more than
ample volumes of gas to cover the low-income heating needs in
Southern California. You will not be using 80 to 100 MMBTU a
day in Southern California for the low-income just because of
the temperature difference there.
Mr. Rehberg. Let us assume I am with you, then. By creating
an opportunity for people to become dependent upon Federal
sources for their natural gas, do we, in effect, then leverage
them into supporting our additional, not only construction of
pipelines, but also taking land out of production in places
like the Missouri Breaks, which they most recently did under
the President's Executive Order?
Mr. Harpole. That was not the initial thought. That was not
the motivation behind the idea. But for once, we might have
what I would characterize as non-producing States. You might
finally have even a Republican that has never voted for lands
access issues, his constituents might finally be impacted by
access to Federal lands by virtue of the royalty gas that is
available from Federal lands that helps his constituents. And
so it is a terrific link in the sense that, again, we just need
to educate people as to where the gas resource comes from.
If you want to know where natural gas is consumed, look at
a population density map of the U.S. If you want to know where
it is produced, look at a pipeline map of the U.S. They are not
the same. And so I think, honestly, all Americans need a better
appreciation of where we source natural gas and how critical it
is for us to maintain our own domestic energy policy to
continue to source that gas in U.S. waters and on U.S. lands.
Mr. Rehberg. I tried to follow the conversation with
Congressman Otter. Do you think there is an opportunity--let me
use as an example Montana again. A lot of our natural gas comes
in from Canada, and so that is clearly not a Federal gas, but
it is mixed with Federal gas, but the pipeline does, in fact,
go across Federal properties. Could we, in fact, then make a
connection between the pipeline going across the Federal
properties and use some of the Canadian gas that is in that
line if it is a higher percentage than would be available under
your pilot program?
Mr. Harpole. Yes. I actually did some expert witness work
on a case involving Montana Power several years ago and
Colorado Interstate Gas has an interconnection south of
Billings that sources gas in the Powder River Basin and also in
the Green River Basin, and at that time, I think it was
responsible for about 20 percent of the gas volumes delivered
into Montana Power. About 80 percent does come in off of
Caraway, the connection in Canada.
But as you saw in New York City, 80 to 100 MMBTU a day, I
mean, honestly, my father was born in Deer Lodge. What is the
usage in Billings? We are not talking about a lot of gas volume
there. So there should be plenty, I mean, in order of magnitude
of 100 times more than what you might actually need for the low
income.
Mr. Rehberg. Thank you.
Mrs. Cubin. The Chair now recognizes Mr. Thornberry.
Mr. Thornberry. Thank you, Madam Chairman. As you mentioned
a few minutes ago, you and I have been dealing with royalty in-
kind issues since we have been here, partly out of a
frustration of trying to put a value on gas and then figure out
what that is so that proper payments can be made to the Federal
Government, and then the continual lawsuits that seem to go on
forever after that is made.
And so we have talked about royalty in-kind as far as
figuring out a way to take the Federal share of gas and selling
it on the market and receiving the money that way. We have also
looked at ways to use the Federal share of gas to heat Federal
facilities. There, of course, is a little of that going on.
There is a State program that does that in Texas, run by the
General Land Office. And we have explored the possibility of
military bases or other Federal facilities that could use this
gas in a more direct way.
I think this suggestion kind of takes it even to the next
step and tries to get around all of the difficulties in putting
a value on what that is worth but making some good use. I think
you are right. I think it is creative and it is interesting to
me.
Mr. Harpole, I am still trying to understand, and I am sure
it is just me, on the transportation side of this, obviously
you have gas that these utilities will just pass along to the
low-income folks. What is the motivation for them to provide
the transportation, or is that something that we, the Federal
Government or the LIHEAP program, has to pay to get
transported?
Mr. Harpole. I would like to take a crack at this and then
turn it over to Jim Jacob for KeySpan, if I can, to further
answer the question. But there is in most States, and I would
say 95 percent of the States, State utility commissions require
public utilities to hold upstream firm transportation on
interstate pipelines in adequate volumes to cover a peak day
need on their system. Now, there are a lot of thoughts in that
one sentence. But again, the only utility that I know of in the
country that has relinquished firm transportation to the
marketplace is Atlanta Gas Light, and if you have read any
paper in the last 3 years, you realize that that was not
necessarily the best program in the country.
Yesterday, I asked some gentlemen from KeySpan how many
utilities on the East Coast have firm transportation all the
way to the Gulf Coast in order to satisfy some of their supply
and they said--they did not hesitate--they said 100 percent,
100 percent. And so that is transportation that is already in
the queue because those are the customers that they have to
cover. They are the last supplier of resort for that customer
base. And so those utilities will always be able to cover the
residential customer base. They will be required to by their
State utility commission.
I do not know, Jim, if you have something to add to that.
Mr. Jacob. I would just like to add that in New York State,
we do have an obligation to serve all customers who ask us for
service, and even in recent hearings for providers of last
resort in the emerging competitive marketplace, it has been
determined that somebody, even if it was not a utility, and
that is several years downstream, it would have to be an entity
within the State, either a marketer or a utility company, who
will have that capacity to supply natural gas and electricity
to customers as needed. So I think that certainly in New York
State, utilities will be the provider of last resort for the
next several years, and we can certainly benefit low-income
customers in New York State by using a royalties in-kind
program at this time.
Mr. Thornberry. But you have to be compensated to transport
that gas from production areas up to New York, because it costs
you something to do that, right?
Mr. Jacob. We would already be transporting gas for these
customers. This would simply be a lower-price commodity that we
could pass on to consumers. So our cost, and I am not an expert
on our contract, certainly, but we already have supply
contracts, as John noted, in the Gulf region, and so we would
simply be passing this through the same pipeline system,
through our city gate at the beginning of our territory and to
our customers who were enrolled in this low-income initiative.
So for us, it would simply be a mechanism that we could show on
their utility bill as a reduction, along with some of the
education programs that we would like to do with these same
customers to help them to understand this changing competitive
marketplace that is the energy world today.
Mr. Thornberry. So it would not cost you anything
additional to transport this gas, more than it already costs to
get the gas to each residential home?
Mr. Jacob. It is my understanding that there would not be
any change in those structures. We are already transporting gas
from that region to the New York City gate.
Mr. Harpole. And if I could add something to kind of help
toot KeySpan's horn here, KeySpan is one of the few utilities,
if you unbundle the cost of gas to residential customers, say
there is a commodity cost, there is an interstate pipeline
transport cost, then there is a cost to transport across the
utility grid to get it to the residential customer, that last
piece, they have actually cut that cost for the low-income by
30 percent. No other utility in the country has ever even
offered something that large in terms of percentage cuts. And
so this is one where they would benefit by the lower commodity
cost, they pass through the same interstate transport costs
under their costs of service, but then again, they even give
that set of customers, the low-income, a 30 percent discount on
what they charge to transport across their pipe.
Mr. Jacob. And if I could just add, as I said in my
testimony, these customers who have benefitted from this 30
percent discount to date pay much better than the average
residential customer base that we serve, so that once we have
addressed an affordability issue, it really makes a difference
in their lives and many of them have transitioned from public
assistance and they are still on the food stamp program and
still categorically eligible for LIHEAP, but it makes a real
difference and we have seen that.
Now, the higher energy costs of the last year are starting
to affect that. This program would allow us to reduce that
burden by the commodity cost. We would still retain our
discount rate of 30 percent and these customers would benefit
and learn about the process of gas supply and competition at
the same time.
Mrs. Cubin. The Chair now recognizes Mr. Tancredo.
Mr. Tancredo. Thank you, Madam Chairman, and I apologize
for, first of all, being late and then having to run in and out
here. As a result, I probably will not ask a question that may,
in fact, end up being redundant. I would just say that your
particular leadership in this area, Madam Chairman, has been
very helpful to me and elucidative, and although I have not
spent the same amount of time in the Congress or on this issue
as Mr. Thornberry and you, I have come to the conclusion that
royalty in-kind is a far better way of determining the exact
value of the royalty that the Federal Government should be
obtaining from the industry than is the present process that
leaves so much up to--that causes so much confusion about
whether we are talking about wellhead prices or downstream
prices upon which that valuation is determined.
So I have somewhat reluctantly come to the conclusion that
royalty in-kind is the best way to go. The only thing I have
ever heard as a major sort of argument against it from a
philosophical standpoint is that it puts the Federal Government
into the position of being one of the world's largest oil and
gas brokers if the program is fully implemented. But it seems
to me that if we could direct a portion of these direct
payments to LIHEAP and the Strategic Petroleum Reserve, as has
been recommended by the National Energy Policy, that we could
diffuse some of that criticism, and appropriately so.
Along with that, of course, the program does eliminate the
middleman that costs all energy consumers additional money, and
oil and gas producers must provide exhaustive accounting, as
has been attested to--I did hear that--valuation paperwork
costing millions of dollars. The Federal Government must
process that paperwork. In a way, we could, I guess, present
this as being an energy savings plan, not have to cut down so
many trees to produce so much paper.
But I must say that my added support for this concept is
brought to bear as a result of Mr. Harpole's analysis and
participation in it. I think he is one of the most
knowledgeable individuals in this field. He has been a leader
and a pioneer of the concept in Colorado, and, in fact, I know
that Governor Owens, our governor, is strongly supportive of
the RIK to the LIHEAP concept, and his confidence in that, by
the way, I am sure, comes to a large extent from his support
and confidence in you, Mr. Harpole. So I think we can all learn
a great deal from your testimony and I look forward to reading
the various testimonies that have been provided for the record,
and I thank you all.
[The prepared statement of Mr. Tancredo follows:]
Statement of The Honorable Thomas G. Tancredo, a Representative in
Congress from the State of Colorado
Thank you Madame Chairman. Your leadership on this Royalty in Kind
concept for oil and gas leases is so strong and well developed, and I
applaud you for holding a hearing which adds a new, and logical, twist
to the royalty-in-kind program.
The only criticism I've heard regarding royalty-in-kind that holds
any weight is the assertion that the Federal Government would, itself,
become one of the world's largest oil and gas brokers when the program
is fully implemented. If we could direct a portion these royalty-in-
kind payments to LIHEAP and the Strategic Petroleum Reserve, as
recommended by the National Energy Policy report, we could certainly
diffuse some of that criticism. Not to mention the fact that royalty-
in-kind programs should eliminate the ``middleman'' that costs all
energy consumers additional money, as oil and gas producers must
provide exhaustive accounting and valuation paperwork costing millions
of dollars, and the Federal Government must process that paperwork. Who
knows? With royalty in kind, we could probably save a few trees.
No one commands more knowledge on this topic, and the LIHEAP
``twist'', than Mr. John Harpole a constituent and friend of mine who
is here today. He has been a leader and pioneer of the concept in
Colorado. In fact, I know that Governor Bill Owens is strongly
supportive of the royalty-in-kind-to-LIHEAP concept, and his support
comes largely from his confidence in Mr. Harpole. I think we should all
learn a great deal from his testimony.
Again, thank you Madame Chairman for holding this hearing today
______
Mr. Tancredo. I guess I should say one other thing. If
there is something that we have not asked you that we should,
anyone can go ahead and respond, and this is the time to do it.
Mr. Harpole. I think the one that I would just like to
reiterate, would this work for California utilities? Yes, it
would. Would this idea work to maybe perhaps lower electricity
costs by taking royalty gas to electric generators? Yes, it
possibly could. I really believe in this idea. You can probably
tell, I speak about it so passionately. I think it is a concept
that is terrific because all the different parties work
together. It really would be the Federal Government, the
pipelines, the producers, the utilities, kind of working in
conjunction and coming up with a solution for people that are
most impacted by our commodity, and perhaps at the same time
help educate them.
Mr. Jacob. And if I could just add that the LIHEAP delivery
network is strained to capacity. It is difficult to administer
programs. In New York State, we only serve 50 percent. We have
12 percent of the national allocation of funds and we are only
able to serve 50 percent of the eligible households. This
mechanism, using utilities, takes that burden off. It allows us
to bring direct assistance to the low-income households who are
LIHEAP-eligible or members of other low-income programs and it
does so while allowing the network to redirect its sources to
help other fuels, to help other people in crisis, maybe to
mitigate some emergencies, to reduce the number of terminations
for non-payment, and perhaps to allow some additional dollars
from LIHEAP to go to weatherization and conservation efforts to
solve the longer-term initiatives.
So I think that this is a wonderful opportunity to use the
natural gas that currently goes for valuation as royalties in-
kind that would help low-income customers directly. As a
consumer advocate, that is the piece that I see. This is not to
replace the LIHEAP program. Certainly, it needs to be funded
and funded appropriately. But this is a wonderful way to
supplement that, particularly during this time of crisis.
Mrs. Cubin. Thank you. The Committee thanks the witnesses
for their testimony and for the answers, the good answers to
the questions. I think we have had a great discussion here
today. I also thank the members for their thoughtful questions.
I would like to include a statement from Congressman Ron
Kind in the record, without objection.
[The prepared statement of Mr. Kind follows:]
Statement of The Honorable Ron Kind, Ranking Democrat, Subcommittee on
Energy and Mineral Resources
This morning we meet to review and discuss the Federal oil and gas
``royalties-in-kind'' or R-I-K program in preparation for Committee
consideration of a national energy bill.
The witnesses today have been asked to focus on the pilot projects
currently underway at the Minerals Management Service. And, also to
comment on a proposal sponsored by our colleague, Representative
Carolyn Maloney, to utilize royalties-in-kind in the Low Income Home
Energy Assistance Program.
Let me state at the outset that the proposal to explore using
Federal royalty oil and gas in a pilot with LIHEAP has merit.
This in no way means we would support a proposal to convert the
current Federal oil and gas royalty system from cash payments to a
wholesale marketing scheme. Under current law, the Secretary of the
Interior has the option to take royalties-in-kind at her discretion.
Studies by the GAO and CBO have concluded that a nationwide, mandatory
RIK system would not be in the public's best interest.
The oil and gas industry's abysmal record on underpayments has
rendered their support of a national mandatory RIK system highly
suspect. As an April 6, 2001, editorial in USA TODAY stated, ``By
assorted estimates, the industry has shorted the government on oil-
royalty payments alone by about $100 million a year through a variety
of price-fixing and record-fiddling games. That's almost 10% of the
government's $1.1 billion annual collections.
However, to the extent that we can merge the extraction of our
Nation's natural resource base with positive social goals, such as
providing low-income energy assistance, we are open-minded and
interested in hearing the testimony of our witnesses today.
______
Mrs. Cubin. The hearing record will be held open for 10
days in case there are some other questions that the members
come up with and we would appreciate your response in writing.
So if there is no other business before the Subcommittee, I
again thank all of you for being here and the Subcommittee is
adjourned.
[Whereupon, at 11:48 a.m., the Subcommittee was adjourned.]