[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]





                       GETTING ROYALTIES RIGHT:
                        RECENT RECOMMENDATIONS
                       FOR IMPROVING THE FEDERAL
                      OIL AND GAS ROYALTY SYSTEM

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

                           OVERSIGHT HEARING

                               before the

                       SUBCOMMITTEE ON ENERGY AND
                           MINERAL RESOURCES

                                 of the

                     COMMITTEE ON NATURAL RESOURCES
                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                        Tuesday, March 11, 2008

                               __________

                           Serial No. 110-64

                               __________

       Printed for the use of the Committee on Natural Resources



  Available via the World Wide Web: http://www.gpoaccess.gov/congress/
                               index.html
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         Committee address: http://resourcescommittee.house.gov





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                     COMMITTEE ON NATURAL RESOURCES

              NICK J. RAHALL, II, West Virginia, Chairman
              DON YOUNG, Alaska, Ranking Republican Member

Dale E. Kildee, Michigan             Jim Saxton, New Jersey
Eni F.H. Faleomavaega, American      Elton Gallegly, California
    Samoa                            John J. Duncan, Jr., Tennessee
Neil Abercrombie, Hawaii             Wayne T. Gilchrest, Maryland
Solomon P. Ortiz, Texas              Chris Cannon, Utah
Frank Pallone, Jr., New Jersey       Thomas G. Tancredo, Colorado
Donna M. Christensen, Virgin         Jeff Flake, Arizona
    Islands                          Stevan Pearce, New Mexico
Grace F. Napolitano, California      Henry E. Brown, Jr., South 
Rush D. Holt, New Jersey                 Carolina
Raul M. Grijalva, Arizona            Luis G. Fortuno, Puerto Rico
Madeleine Z. Bordallo, Guam          Cathy McMorris Rodgers, Washington
Jim Costa, California                Louie Gohmert, Texas
Dan Boren, Oklahoma                  Tom Cole, Oklahoma
John P. Sarbanes, Maryland           Rob Bishop, Utah
George Miller, California            Bill Shuster, Pennsylvania
Edward J. Markey, Massachusetts      Bill Sali, Idaho
Peter A. DeFazio, Oregon             Doug Lamborn, Colorado
Maurice D. Hinchey, New York         Mary Fallin, Oklahoma
Patrick J. Kennedy, Rhode Island     Adrian Smith, Nebraska
Ron Kind, Wisconsin                  Robert J. Wittman, Virginia
Lois Capps, California
Jay Inslee, Washington
Mark Udall, Colorado
Joe Baca, California
Hilda L. Solis, California
Stephanie Herseth Sandlin, South 
    Dakota
Heath Shuler, North Carolina

                     James H. Zoia, Chief of Staff
                       Rick Healy, Chief Counsel
            Christopher N. Fluhr, Republican Staff Director
                 Lisa Pittman, Republican Chief Counsel
                                 ------                                


              SUBCOMMITTEE ON ENERGY AND MINERAL RESOURCES

                    JIM COSTA, California, Chairman
          STEVAN PEARCE, New Mexico, Ranking Republican Member

Eni F.H. Faleomavaega, American      Louie Gohmert, Texas
    Samoa                            Bill Shuster, Pennsylvania
Solomon P. Ortiz, Texas              Bill Sali, Idaho
Rush D. Holt, New Jersey             Adrian Smith, Nebraska
Dan Boren, Oklahoma                  Don Young, Alaska, ex officio
Maurice D. Hinchey, New York
Patrick J. Kennedy, Rhode Island
Hilda L. Solis, California
Nick J. Rahall, II, West Virginia, 
    ex officio
                                 ------                                



















                                CONTENTS

                              ----------                              
                                                                   Page

Hearing held on Tuesday, March 11, 2008..........................     1

Statement of Members:
    Costa, Hon. Jim, a Representative in Congress from the State 
      of California..............................................     1
        Prepared statement of....................................     3
    Pearce, Hon. Stevan, a Representative in Congress from the 
      State of New Mexico........................................     4
    Smith, Hon. Adrian, a Representative in Congress from the 
      State of Nebraska, Statement submitted for the record......    90

Statement of Witnesses:
    Allred, Hon. C. Stephen, Assistant Secretary, Land and 
      Minerals Management, U.S. Department of the Interior.......    53
        Prepared statement of....................................    57
    Deal, David, Vice Chair, Royalty Policy Committee, U.S. 
      Department of the Interior.................................    12
        Prepared statement of....................................    15
        Response to questions submitted for the record...........    21
    Devaney, Earl, Inspector General, U.S. Department of the 
      Interior...................................................     6
        Prepared statement of....................................     9
        Response to questions submitted for the record...........    10
    Finfer, Larry, Deputy Director, Office of Policy Analysis, 
      U.S. Department of the Interior............................    64
        Response to questions submitted for the record...........    66
    Luthi, Randall, Director, Minerals Management Service........    55
        Prepared statement of....................................    57
    Roller, Dennis, Audit Manager, North Dakota State Auditor's 
      Royalty Audit Section, Minerals Management Service.........    74
        Prepared statement of....................................    76
        Response to questions submitted for the record...........    84
    Rusco, Frank, Acting Director, Natural Resources and 
      Environment, U.S. Government Accountability Office.........    24
        Prepared statement of....................................    26
        Response to questions submitted for the record...........    36
    Stiff, Linda, Acting Commissioner, Internal Revenue Service..    67
        Prepared statement of....................................    69
        Response to questions submitted for the record...........    73

Additional materials supplied:
    Brian, Danielle, Executive Director, Project On Government 
      Oversight, Washington, D.C., Statement submitted for the 
      record.....................................................    90
    Kerrey, Hon. Bob, and Hon. Jake Garn, Co-Chairmen, 
      Subcommittee on Royalty Management, Statement submitted for 
      the record.................................................    19

 
 OVERSIGHT HEARING ON GETTING ROYALTIES RIGHT: RECENT RECOMMENDATIONS 
          FOR IMPROVING THE FEDERAL OIL & GAS ROYALTY SYSTEM.

                              ----------                              


                        Tuesday, March 11, 2008

                     U.S. House of Representatives

              Subcommittee on Energy and Mineral Resources

                     Committee on Natural Resources

                            Washington, D.C.

                              ----------                              

    The Subcommittee met, pursuant to call, at 10:04 a.m. in 
Room 1324, Longworth House Office Building, Hon. Jim Costa, 
[Chairman of the Subcommittee] presiding.
    Present: Representatives Costa, Pearce, Hinchey and Smith.

   STATEMENT OF THE HONORABLE JIM COSTA, A REPRESENTATIVE IN 
             CONGRESS FROM THE STATE OF CALIFORNIA

    Mr. Costa. The oversight hearing of the Subcommittee on 
Energy and Mineral Resources will now come to order. The 
Subcommittee is meeting today to hear testimony on recent 
recommendations on the oil and gas royalty system, something 
that has been the subject of this Subcommittee and the 
Committee over on the Senate for some time now.
    Under Rule 4[g], the Chairman and the Ranking Member may 
make opening statements, and then if any other Members wish to 
do the same, we will submit those statements into the record 
under unanimous consent. Additionally, under Committee Rule 
4[h] additional material for the record should be submitted by 
Members or witnesses within 10 days.
    That includes questions that Members may have but may not 
have had the opportunity to ask during the hearing. We 
obviously urge Members to submit those questions, and we ask 
for the witnesses to provide a timely response on the answers 
to the questions that have been submitted.
    As Chairman, I spoke with the Ranking Member just a moment 
ago. It is our intention to conclude this hearing by around 
noontime. We have a number of votes, and we have other meetings 
that we are compelled to participate in, and so we will try to 
get as much work done as we can in the next two hours.
    Let me just make a brief opening statement. I want to begin 
by thanking the witnesses on Panel 1 and Panel 2 for your due 
diligence and for your testimony. I know you will do your very 
best to answer the questions that we have for you. We are 
obviously here today, as I said earlier, to continue to focus 
on how the government collects royalties for oil and gas that 
is produced on Federal lands.
    This is the third time that the Natural Resources Committee 
has examined the issue in Congress, and my guess is it won't be 
the last. In the past year and a half, there have been multiple 
reports of the problems with royalty collections, some are less 
significant, some I think are much more significant, and we 
will endeavor to find from the witnesses your own take on how 
we best do this job.
    Three of the organizations involved in the reports that 
have written about the success or the level of effectiveness 
that the Minerals Management Service has done its job of 
collecting royalties are here today. Representatives from the 
Government Accountability Office, the Department of the 
Interior's Inspector General and the Royalty Policy Committee 
are first on our panel.
    We look forward to hearing about the recommendations that 
first came out in the Senate hearing, the 100 or so 
recommendations that I understand the Minerals Management 
Service is in the process of implementing. We also have 
Assistant Secretary Stephen Allred and Director Randall Luthi 
here today so that we can find out how some of these 
recommendations are being implemented.
    Dennis Roller from North Dakota is here to describe some of 
the issues from the state and tribal standpoint that also 
participate and are beneficiaries of the collection of these 
royalties. In addition, probably a first for this committee, we 
have a witness, you might be surprised, from the Internal 
Revenue Service, Acting Director Linda Stiff.
    I only asked her to come here today because I have some 
questions about my own taxes. Not true. Of course, we have 
invited the IRS here because one of the recent reports that was 
done earlier discusses how the Internal Revenue Service could 
act as a good model for our oil and gas royalty collection 
system.
    To the degree that there are comparisons, we would like to 
learn whether or not those comparisons make sense or are 
applicable in the case of the Minerals Management Service. I 
also am glad because I think that frames the issue well, in 
part, but the Internal Revenue Service, the IRS, of course can 
be maligned. They are respected for their responsibility in 
collecting money from the American taxpayer.
    Meanwhile, the Minerals Management Service collects money 
for the American taxpayer. One collects it from the American 
taxpayer, the other collects it for the American taxpayer. I 
think we seem to do very well in the first case. Some of my 
constituents argue they do it too well.
    I am not sure that we are doing quite as well in the second 
category with regard to the royalty collection, and that is 
obviously the purpose of today's hearing. The Minerals 
Management Service brings in a staggering amount of money, last 
year over $11 billion, as a source of income for our nation's 
government, and it is expected to do more this year, in part 
because of the rise in oil prices and natural gas.
    The reports we are here to discuss show that, in fact, 
honest folks believe the job could be done better. I believe 
that we have a responsibility and need to ensure that we do the 
best job possible for getting America's taxpayers' dollars, our 
fair share, from our abundance of energy resources.
    As I said, this won't be the last hearing on the subject. I 
look forward to taking the testimony today, and not just as it 
relates to the royalty program but how other efforts can be 
improved, and the issue of in-kind versus royalty collection, 
which is not a new discussion. Ranking Member Pearce and others 
have opined as to their thoughts on what is the best way that 
we can do this.
    I think it is still an issue that we have to try to reach 
some consensus on, and I know there are many differences of 
opinion on that point. Let me conclude by saying that simply 
because we have always done things this way doesn't necessarily 
mean that it is the best way to do them.
    Times change, technology changes. MMS is in the process of 
trying to institute this $150 million new computerized program. 
I keep getting mixed reports on the success of it. I think that 
we need to make sure that we are adaptive to protect the 
American interests of these resources.
    I now would like to, with a great deal of pride, recognize 
the Ranking Member, Mr. Pearce from New Mexico, for his opening 
remarks.
    [The prepared statement of Chairman Costa follows:]

            Statement of The Honorable Jim Costa, Chairman, 
              Subcommittee on Energy and Mineral Resources

    We are here today to discuss the way the federal government 
collects royalties for oil and gas produced from federal lands. There 
will be plenty of discussions about auditing and accounting and various 
other financial complexities, but this is not some esoteric topic that 
only a policy wonk could appreciate. This is about the one of the 
largest sources of revenue for the federal government outside the tax 
system, with over $11 billion brought in last year. Projections are 
that revenues this year could top $15 billion. And let no one forget--
these are the natural resources that belong to the American people. 
Royalties are not a gift that oil and gas companies give back to the 
Treasury. They are the American people's fair share of the resources 
that they are allowing to be extracted and sold. And this fair share 
goes towards schools, it goes towards roads, it goes towards protecting 
wilderness, restoring historic buildings, managing water projects, and 
doing just about everything else that this country needs to do.
    When an oil or gas company signs a federal lease, they're signing a 
contract with the American people, and they're promising to provide 
that fair share that the people rightfully deserve. But in order to get 
that fair share, the American people have to put their trust in the 
government. They have to trust that we will be good stewards of their 
resources; that we will make sure to hold the oil and gas companies 
accountable for that fair share. Anything less is a gross dereliction 
of our duty.
    Unfortunately, it appears that the government has not been as 
diligent as it should. The past few years have seen one revelation 
after another about the sorry state of our royalty collection system. 
As the Inspector General of the Department of the Interior, Earl 
Devaney, says in his testimony, ``the history here is rich and 
disconcerting.'' The Government Accountability Office sums the issues 
up in their testimony when they say, ``ultimately the system used by 
Interior to ensure taxpayers receive appropriate value for oil and gas 
produced from federal lands and waters is more of an honor system than 
we are comfortable with.'' Certainly more than I am comfortable with as 
well.
    The most recent report comes from the Subcommittee on Royalty 
Management, which was appointed by the Secretary of the Interior on 
March 22, 2007, and came back with 110 recommendations to improve the 
royalty system less than nine months later--that's about three 
recommendations a week. Mr. David Deal, Vice-Chair of that 
Subcommittee, is here to discuss some of these recommendations, 
although I don't know if we'll have enough time to get through them 
all.
    But as I have already alluded to, that report is only the latest in 
a line of serious concerns surrounding the royalty system. Inspector 
General Earl Devaney, testifying here today, has completed three 
reports in the past fifteen months, each one detailing serious 
shortcomings in the Minerals Management Service. The audit of MMS' 
increased use of compliance reviews talks of data reliability problems 
and a lack of a proper strategy to identify which companies need to be 
looked at more closely. The investigation of why price thresholds were 
left off offshore leases in 1998 and 1999, which could cost the 
government upwards of $9 billion, resulted in the discovery of a ``jaw-
dropping example of bureaucratic bunging.'' And the investigation of 
cases filed by disgruntled auditors who claimed that MMS was not going 
after royalties it was entitled to uncovered ``a band-aid approach to 
holding together one of the Federal Government's largest revenue 
producing operations,'' and a ``profound failure'' in the development 
of a crucial computer system, one which MMS has spent $150 million on 
already.
    The Government Accountability Office has also uncovered numerous 
fundamental problems with how the royalty program operates. Last year 
they testified that MMS didn't have the data to accurately assess 
whether the Royalty-in-Kind program, which has exploded in recent 
years, was a better deal for the government than taking royalties the 
traditional way, in value. Today, Mr. Frank Rusco of the GAO will 
testify that MMS cannot even verify that they're getting the royalties 
they should. Dennis Roller, an auditor with the State of North Dakota, 
will testify about on-going problems that he sees from his position in 
the trenches, where he fights to ensure that his state gets the share 
of royalties that is rightfully theirs. No one from the Department of 
Energy is here to testify to today, but earlier this year they reported 
that MMS could not account for 30,000 barrels of royalty oil that were 
supposed to be headed to the Strategic Petroleum Reserve--which is over 
$3 million in today's prices.
    There are far too many issues with the royalty program to address 
today. This is just one in what will be a continuing series of hearings 
this subcommittee will hold in order to get to bottom of these 
problems, and figure out what needs to be done better. The entire 
structure of the federal oil and gas leasing system is under scrutiny 
here. I am not satisfied to maintain the dysfunctional status quo 
simply because of historical factors or industry preference. I intend 
to listen carefully to what our witnesses have to say, and start trying 
to figure out what has to be done, by the Department of the Interior 
and by Congress, to ensure that we don't come back here every few years 
to hear the next list of 100 recommendations that need to be 
implemented to make sure the American people get their fair share.
                                 ______
                                 

 STATEMENT OF THE HONORABLE STEVAN PEARCE, A REPRESENTATIVE IN 
             CONGRESS FROM THE STATE OF NEW MEXICO

    Mr. Pearce. Thank you, Mr. Chairman. The hearing today we 
have titled ``Getting Royalties Right.'' If I recall, last year 
we called it ``Royalties at Risk.'' I would say that as we get 
into the hearing I would like to pause because the 
misperceptions that are being created is that there are lost 
royalties when real royalties are being lost because of the 
energy policies that are originating from San Francisco-type 
energy policies.
    My question is when is the Subcommittee going to get 
royalties right? The dollar value is falling, our economy is 
slowing, the price of WTI Oil yesterday closed at a record 
$107.87 per barrel, the spot price for natural gas closed at 
$9.58 per TCF, the EIA is expected to forecast record high 
gasoline prices for the summer and there is an outcry for 
supply, but that outcry is falling on deaf ears.
    This country keeps its potential revenue from royalties on 
energy supply off limits. The majority keeps its off limits by 
creating a misperception that we drill everywhere and all of 
the time. Of the 262 million acres of BLM land, less than five 
percent of that land is being used for oil and gas production.
    The other 95 percent of BLM land has no oil and gas 
production. The resources are there; we just don't produce it. 
So when we talk about the lack of stewardship for the American 
people, we should look in the mirror. Similarly, only 15 
percent of the National Wildlife Refuge Systems has oil and gas 
activities.
    Furthermore, not a drop, zero percent, of our park lands 
permit oil and gas activities. We learned last Congress that 
less than three percent of our outer continental shelf is being 
leased for oil and gas production, and this at a time when we 
are seeing prices of gasoline moving toward $4 a gallon.
    The majority keeps production off limits by convincing the 
American people that we don't have enough energy here in the 
U.S. To keep up the charade, they cut off two trillion barrels 
of shale oil in Colorado and Utah last year in our omnibus 
spending package. Two trillion barrels, that is double all of 
the world's oil. Endless royalties are being now bypassed 
because of a decision made by this Congress.
    These are the royalties at risk if we continue to file 
these Democratic energy policies that will continue to be at 
risk. This hearing is a classic example of penny wise, pound 
foolish. There are billions of dollars of Federal royalties 
left on the table because more and more of our Federal lands, 
where much of the energy is, remains off limits.
    I am looking forward to the testimony. For instance, Mr. 
Devaney says in his comments that four investigations remain 
ongoing.
    I am going to ask Mr. Devaney, and I hope he deals with the 
question up front, what the Justice Department is telling him 
about those investigations because I am concerned that if the 
Justice Department doesn't see his reasons for continuing 
investigations, I am concerned about how we are doing those 
investigations.
    Also, Mr. Rusco, I am interested, in your GAO report you 
state that the Interior lacks adequate assurance that it is 
receiving full compensation for oil and gas produced in Federal 
lands, and yet, when I read this comprehensive report with 
multiple qualified people on the panel that put that report 
together I see that MMS is an effective steward of the minerals 
revenue.
    There is no middle ground between those statements. I am 
diametrically opposed, and I am looking forward to the 
testimony that is going to assure me that the GAO actually used 
the same kind of qualified people that I can find on the list 
here, so I will be asking about that in your testimony. How can 
we come to diametrically opposed opinions from two different 
oversight agencies?
    So I am looking forward to the testimony today. Mr. 
Chairman, I am aware of the criticism of royalties in kind. The 
royalties in kind, every day the price of oil is different in a 
different piece of the country. Price of oil is depending on 
the quality of the amount that it is going to cost to produce 
it, and we have to figure out every single area and every 
single price in the country to see if we get our dollars.
    Yet, if we simply did RIK, royalty in kind, we simply say 
you made that many barrels, we get a percent and we will take 
it here or we will take it there. Similarly, on gas, you just 
read a meter. You don't have to do the complex calculations 
with lawyers and auditors. In the way that we are processing 
right now, the non-royalty-in-kind process attracts lawyers and 
auditors like sharks to blood.
    Again, I look forward to the testimony and discussion 
today. I just ask that all things be put into perspective. 
Welcome to you all. I appreciate your coming here for your 
testimony, and we look forward to it. Thank you, Mr. Chairman.
    Mr. Costa. Thank you, Mr. Pearce. I appreciate your 
comments. I don't want to get in a debate with you at this 
point, but I would indicate in meetings I had last week with 
Shell folks who have done the most in oil shale in the areas 
that you made reference to that they are probably 5 or 10 years 
away even though they think there are tremendous prospects, as 
you noted, in terms of their ability to get the technological 
efforts to make it cost effective.
    As it relates to energy offshore, you and I, I think, have 
closer agreement than we have on others, but under the Clinton 
administration with a Republican Congress record leases were 
given in the late 1990s. Those leases have continued in the 
Bush administration, and they are continuing to provide leases.
    So we do have problems in states like Florida and 
California, which I represent, where folks don't want to drill 
offshore. It is a question, as you pointed out in your 
testimony, of wanting to have it both ways. I might add that 
those are not a circumstance of the majority or a minority 
because in both those cases we had Republican Governors who in 
Florida and California in a bipartisan Court chose not to seek 
that exploration development.
    It is a problem that we have to come together with as a 
nation I think in a bipartisan fashion. I think I just want to 
point out that we have witnesses here who will tell us what we 
are doing and give us their opinion, and we will listen. Then 
the good, sharp questioning that you are always a part of I 
know will be a part of the record of this testimony, and I look 
forward to it.
    Mr. Earl Devaney is the Inspector General of the Department 
of the Interior; Mr. David Deal is the Vice Chairman of the 
Royalty Policy Committee within the Department of the Interior; 
and Mr. Frank Rusco is the Acting Director of Natural Resources 
and Environment for the General Accounting Office.
    The timing lights, gentlemen, on the table, you are 
familiar with I know, and I am sure you have properly focused 
that you will be within that timeframe.
    I would like to now recognize Mr. Devaney to testify for 
five minutes, and we will go from there.

         STATEMENT OF EARL DEVANEY, INSPECTOR GENERAL, 
                U.S. DEPARTMENT OF THE INTERIOR

    Mr. Devaney. Thank you, Mr. Chairman. Mr. Chairman and 
Ranking Member Pearce, I want to thank you for the opportunity 
to appear before you today to discuss the recommendations 
arising from some of my office's most recent work----
    Mr. Costa. Could you bring the mic a little closer so we 
could all hear you?
    Mr. Devaney. Sure--in the oil and gas royalties collection 
program and my thoughts about how this program might be 
improved including a stepped up oversight effort on the part of 
the Office of Inspector General.
    Mr. Costa. I think you need to put that a little closer. We 
really want to hear you, Mr. Devaney.
    Mr. Devaney. The past two years, is that good?
    Mr. Costa. Yes, that is better.
    Mr. Devaney. OK. The past two years, the agency responsible 
for royalty collections on behalf of the Federal Government, 
the Minerals Management Service, has undergone intense scrutiny 
by my office and GAO.
    As you know, I testified on these issues before the House 
Subcommittee on Energy and Resources in September of 2006, the 
full House Committee on Natural Resources in February of 2007 
and the Senate Committee on Energy and Natural Resources in 
January of 2007.
    The history here is both rich and disconcerting. Beginning 
with our audit of MMS's compliance review process, we found 
that while compliance reviews play a useful role in MMS's 
Greater Compliance Asset Management Program they do not provide 
the same level of detail or assurance that a traditional audit 
provides, nor were they being utilized in the context of a 
well-designed, risk-based compliance strategy.
    Following this audit, we made recommendations for improving 
data reliability, strengthening compliance review tools and 
developing that missing risk-based strategy. This audit was 
followed by a complex investigation into the failure of MMS to 
include royalty price thresholds in offshore oil leases in the 
Gulf of Mexico in 1998 and 1999.
    After this investigation we recommended that all policy 
decisions that significantly alter the terms and conditions of 
the offshore/onshore oil and gas leases be memorialized in the 
form of an internal memorandum compiled in one accessible 
place, establish one person that is responsible for the entire 
Notice of Sale document and prior to its final issuance, each 
lease should be legally reviewed by the Solicitor's Office.
    Even while this investigation was ongoing, Secretary 
Kempthorne requested that we initiate another investigation 
into the Minerals Revenue Management, a program within MMS that 
had several qui tam cases filed by its own auditors. The 
results of this investigation presented examples of a systemic 
dilemma in MMS, that of the Bureau's conflicting roles and 
relationships with the energy industry.
    It also hinted of a profound failure in the development of 
a critical IT system, it revealed a working environment with 
poor communication compounded by an element of distrust, and it 
demonstrated a band-aid approach to holding together one of the 
Federal Government's largest revenue producing operations.
    This report included recommendations to, among other 
things, rescind the 1997 ``hardship'' guidance and develop 
clear guidance to industry on interest calculations, develop a 
strategy to eliminate the interest collection backlog on an 
expedited basis, clarify guidance to the industry on sub-sea 
transportation costs, foster better communications between 
MMS's auditors and program people and to develop an enhanced 
ethics program designed specifically for the RIK Program.
    In addition, we discovered a number of other significant 
issues worthy of separate investigations including ethical 
lapses, such as DOI employees who were accepting gifts from oil 
and gas industry representatives. We currently have four 
investigations that remain ongoing. Because these four 
investigations involve potential criminal violations, I am 
currently precluded from discussing them in any detail.
    Suffice it to say, Mr. Chairman, MMS has had more than its 
share of royalty management problems and consumed more than its 
share of my office's attention in the last two years. In 
addition to his request for a qui tam investigation, Secretary 
Kempthorne separately requested a study by the independent 
bipartisan panel, co-chaired by Senators Bob Kerrey and Jake 
Garn, which reported to the Royalty Policy Committee.
    We shared with this panel a list of recommendations that 
had emanated from our efforts. The final report presented to 
the Royalty Policy Committee fundamentally incorporated all of 
the 22 recommendations made by my office thus far. We expect to 
build on these recommendations as our remaining investigations 
come to their conclusion.
    Given the work we have been doing in the royalties arena, 
it might be reasonable to conclude that we drew on a corps of 
subject-matter experts familiar with the intricacies and 
nuances of royalty management. Rather, we grew our so-called 
``experts'' from scratch and on the run. We recognized almost 
immediately that our office would soon need to develop a 
royalties oversight unit and build an expertise for the long 
term.
    We are in the process of doing just that. In the near term, 
we are setting up a modest interspaced royalty oversight 
office. This group will soon complete an evaluation of MMS's 
Royalty-in-Kind Sales Program for oil, and then we will 
undertake an audit of MMS's process for verifying volumes, most 
importantly, oil destined for the Strategic Petroleum Reserve.
    In the longer term, we intend to develop the capacity to 
oversee all minerals-related activities managed by DOI from 
initial leasing of Federal and Indian lands to the final 
determination of those leases which would include the 
management of those leases and the collection of royalty 
payments.
    Of course this vision is attached to a very real need for 
continued funding, and I can assure the Committee that any 
monies that we receive for that funding will be put to good 
use. Mr. Chairman, I would be remise if I failed to acknowledge 
the receptiveness and responsiveness of Secretary Kempthorne, 
Assistant Secretary Allred and MMS Director Luthi to our 
findings and recommendations.
    The challenge, however, comes in the effective 
implementation of the recommendations and in holding 
accountable those responsible for MMS's many past failings. 
This concludes my opening remarks, Mr. Chairman, and I will 
answer any questions.
    Mr. Costa. Thank you very much, Mr. Devaney. We do 
appreciate your focus and due diligence as the Inspector 
General. It is probably a good segue that we now go to our next 
witness who was selected, in part, with some other folks, 
Secretary Kempthorne, to really look at the problems associated 
with the issue that we are attempting to deal with here today 
and have been now for several years.
    [The prepared statement of Mr. Devaney follows:]

    Statement of The Honorable Earl E. Devaney, Inspector General, 
                    U.S. Department of the Interior

    Mr. Chairman, members of the subcommittee, I want to thank you for 
the opportunity to appear before you today to discuss the 
recommendations arising from some of my office's recent work in the oil 
and gas royalties collection program, and my thoughts about how this 
program might be improved, including a stepped up oversight effort on 
the part of the Office of Inspector General (OIG).
    For the past two years, the agency responsible for royalty 
collections on behalf of the Federal Government, the Minerals 
Management Service (MMS) of the Department of the Interior (DOI), has 
undergone intense scrutiny by the OIG and GAO, following revelations of 
systemic management and organizational failures. As you know, I 
testified before the House Subcommittee on Energy and Resources in 
September of 2006 and the full Committee on Natural Resources in 
February 2007; I have done the same before the Senate Committee on 
Energy and Natural Resources in January 2007. The history here is rich 
and disconcerting. Beginning with our audit of MMS' compliance review 
process, we found that while compliance reviews play a useful role in 
MMS' greater Compliance and Asset Management Program, they do not 
provide the same level of detail or assurance that a traditional audit 
provides, nor have they been utilized in the context of a well-
designed, risk-based compliance strategy. Following this audit, we made 
recommendations for improving systems data reliability, strengthening 
the compliance review tools, and developing that missing risk-based 
strategy.
    This audit was followed by a complex investigation into the failure 
of MMS to include royalty price thresholds in offshore oil leases in 
the Gulf of Mexico in 1998 and 1999. From this investigation, we 
recommended that all policy decisions that significantly alter the 
terms and conditions of the offshore and onshore oil/gas leases be 
memorialized in the form of an internal memorandum and compiled in one 
accessible repository, establish one person that is responsible for the 
entire Notice of Sale document, and prior to its final issuance, each 
lease should be legally reviewed by the Solicitor's Office.
    Even while this investigation was ongoing, Secretary Kempthorne 
requested that we initiate another investigation into Minerals Revenue 
Management (MRM), a program within MMS that had had several qui tam 
cases filed against it by its own auditors. The results of this 
investigation presented examples of a systemic dilemma in MMS--that of 
the bureau's conflicting roles and relationships with the energy 
industry. It also hinted of a profound failure in the development of a 
critical MRM information technology (IT) system; it revealed a working 
environment in which poor communication, or no communication, 
compounded an already existing element of distrust; and it demonstrated 
a band-aid approach to holding together one of the Federal Government's 
largest revenue producing operations. This report included 
recommendations to, among other things, rescind the 1977 ``hardship'' 
guidance and develop clear guidance to industry on interest 
calculations, develop a strategy to eliminate the interest collection 
backlog on an expedited basis, clarify guidance to industry on sub-sea 
transportation costs, foster better communication between the MMS audit 
and programmatic functions, and develop an enhanced ethics program 
designed specifically for the RIK program.
    In addition, we discovered a number of other significant issues 
worthy of separate investigations, including ethics lapses, such as 
accepting gifts from and fraternizing with industry, program 
mismanagement and process failures. We currently have four 
investigations that remain ongoing. Because these latter investigations 
involve potential criminal violations, I am currently precluded from 
discussing them in any detail. Suffice it to say, Mr. Chairman, MMS has 
more than its share of royalty management issues, and has consumed more 
than its share of the OIG's attention on these issues over the past two 
years.
    In addition to his request for the qui tam investigation, Secretary 
Kempthorne separately requested a study by an independent bi-partisan 
panel co-chaired by Senators Bob Kerrey and Jake Garn, which reported 
to the Royalty Policy Committee. As our work regarding MMS concluded, 
we shared with this panel a compilation of recommendations that 
emanated from our efforts. The final report presented to the Royalty 
Policy Committee fundamentally incorporated the 22 recommendations made 
by the OIG thus far. We expect to build on these recommendations, as 
our remaining investigations come to conclusion.
    Given the amount of work we have been doing in the royalties' 
arena, it might be reasonable to conclude that we drew on a corps of 
subject-matter experts, familiar with the intricacies and nuances of 
royalty management. Rather, we grew our so-called ``experts'' from 
scratch and on the run. We recognized almost immediately, that the OIG 
would need to develop a royalties' oversight unit, and build an 
expertise for the long term.
    In December, Congress passed the Omnibus Spending Bill for FY 2008. 
Accompanying the bill was report language that instructed the OIG to 
develop a permanent capability to oversee MMS' royalty function. We are 
in the process of doing just that. In the near term, we are standing up 
a modest Denver-based Royalty Oversight Office, consisting of six 
employees--four of which have already been filled by current OIG Staff, 
including the position of Director. The remaining two positions are 
expected to be recruited and on-board by May 2008. The members of this 
small office must first develop an understanding of royalties-related 
activities in MMS; we are also identifying training opportunities to 
cultivate their expertise, including observation and participation in 
royalty audits conducted by States and Tribes. This group will soon 
complete the on-going evaluation of MMS' Royalty-in-Kind (RIK) sales 
program for oil, and will then undertake an audit of MMS' processes for 
verifying volumes delivered as RIK, including, most importantly, oil 
destined for the Strategic Petroleum Reserve. Eventually, this unit 
would also verify that the recommendations we have made and those 
issued by the Royalty Policy Committee have been appropriately 
implemented.
    In the longer term, we intend to develop the capacity to oversee 
all minerals-related activities managed by DOI from initial leasing of 
Federal and Indian lands to the final termination of those leases, 
which would include the management of those leases and the collection 
of royalty payments. Ultimately, we would like to expand our oversight 
coverage beyond MMS to the energy and minerals programs at the Bureau 
of Land Management and Indian Affairs, including oil, gas, and solid 
minerals.
    Of course, to this vision is attached the very real need for 
continued funding to keep this unit operating, and to expand its 
capacity as it develops. I am quite confident, however, that the 
results that will be derived from this unit will more than pay for any 
increase in appropriations that we receive.
    Mr. Chairman, I would be remiss if I failed to acknowledge the 
receptiveness and responsiveness of Secretary Kempthorne, Assistant 
Secretary Allred and MMS Director, Randall Luthi to our findings and 
recommendations. The challenge, however, comes in the effective 
implementation of those recommendations and in holding accountable 
those responsible for MMS' many past failings.
    As we conclude the remaining investigations, I would be surprised 
to see all of the involved DOI employees prosecuted. Any that are not, 
however, will be forwarded to Assistant Secretary Allred for corrective 
administrative action. This will be the accountability test, the 
results of which, I am sure, the Subcommittee and I both await with 
great expectation.
    That concludes my prepared remarks, Mr. Chairman. I would be happy 
to answer any questions you or the members of the Subcommittee might 
have.
                                 ______
                                 

    Response to questions submitted for the record by Earl Devaney. 
           Inspector General. U.S. Department of the Interior

1.  Mr. Devaney, do you believe it is appropriate for MMS to be in 
        charge of analyzing the success of the Royalty-in-Kind Program? 
        It seems that they have a strong incentive to show how well it 
        is working, so would it be better to have someone outside of 
        MMS be doing this review? And if so, who might you suggest?
    Answer: I believe any program in the Federal Government has an 
obligation to critically assess its own performance, but I also 
recognize the difficulty of being completely objective in doing so. An 
additional challenge is to define ``success'' in a program that 
generates considerable revenue for the Federal Government. An analysis 
of the RIK program's success would probably be best conducted by an 
independent oversight entity, like the GIG. If such an analysis were to 
be undertaken, it would also be most effectively accomplished if a 
definition of ``success'' were agreed upon in advance among the 
program, Congress and the oversight entity.
2.  Mr. Devaney, as an audit organization, would you state your 
        thoughts about any conflicts of interest that MMS might have 
        being both the agency in a contractual arrangement with oil and 
        gas companies and the agency responsible for auditing those 
        contracts and payments from those same companies?
    Answer: The appearance of conflict of interest for MMS as an 
organization cannot be ignored, since MMS enters into leases with the 
oil and gas industries, collects the royalties and also audits industry 
payments. However, it is important to note that MMS is a Federal 
Government revenue collecting agency--similar to the Internal Revenue 
Service (IRS) which also collects revenues and conducts audits.
3.  Mr. Devaney, could you discuss your views of the usefulness of the 
        State and Tribal Royalty Audit Committee, or ``STRAC''? And do 
        you see any way to improve the relationship between STRAC and 
        MMS?
    Answer: The states and tribes have a vested interest in the audit 
and collection of royalty payments for the leases on their lands. As 
such, the STRAC provides a forum for those states and tribes to share 
information and communicate with MMS. I see this as a useful function. 
STRAC is also useful for getting input from the states and tribes to 
MMS on audit/oversight policies, procedures and regulations.
4.  Mr. Devaney, I'm pleased to see your office is going to be opening 
        this office in Denver to perform a more active watchdog role. 
        Do you have enough funding to do what you think needs to be 
        done, and what else would you look at if you had additional 
        funding?
    Answer: As I explained in my testimony, we received direction, as 
well as funding from the Appropriations Committees of both the House 
and Senate, to develop a permanent capability to oversee MMS royalties. 
We have done that, and the unit is up and running.
    Over the longer term, we would like to develop the capacity to 
oversee all minerals-related activities managed by DOI Ultimately, we 
would like to expand our oversight coverage beyond MMS to the energy 
and minerals programs at the Bureau of Land Management and Indian 
Affairs, including oil, gas, and solid minerals.
    In order to see our longer term goals through, however, we will 
have a very real need for continued funding to keep this unit 
operating, and to expand its capacity as it develops.
5.  Mr. Devaney, have you looked at any of the issues that were raised 
        in the Department of Energy's Inspector General report that 
        said that 30,000 barrels of oil headed for the strategic 
        petroleum reserve could not be accounted for?
    Answer: We have reviewed the Department of Energy (DOE) OIG's 
report and have discussed their findings with them. As a result, it 
appears that there are weaknesses on the part of both DOI and DOE in 
accounting for the volume intended for delivery to the strategic 
petroleum reserve. As soon as our evaluation of the RIK oil sales 
program is completed, we will be initiating an audit of oil volumes in 
the RIK program, including oil designated for the Strategic petroleum 
reserve.
Minority Questions for Earl Devaney, Inspector General. U.S. Department 
        of the Interior
1.  Mr. Rusco from the Government Accountability Office referred to 
        Mineral Management Service's (MMS') internal controls in his 
        testimony. In your testimony you reference several qui tam 
        cases filed by MMS' own auditors. In our last hearing on this 
        subject we heard from Professor Pamela Bucy (an expert on False 
        Claims Act Laws) that these auditor actions were illegal and 
        that these plaintiffs should not have standing to file qui tam 
        lawsuits because they are using accounting information that 
        they received in the course and scope of their employment for 
        personal gain rather than the taxpayer's gain. Instead, these 
        plaintiffs should have reported their concerns to you, as 
        Inspector General, or internally within the Mineral Management 
        Service (MMS). Have you done anything to improve your internal 
        controls to make sure these cases are reported to you for 
        investigation rather than filed as qui tam cases?
    Answer: Unfortunately, neither DOI nor OIG internal controls can 
ensure that DOI employees properly report concerns to either the OIG or 
Departmental management. The OIG has made efforts by way of outreach to 
inform and educated DOI employees of their obligation to report fraud, 
waste and mismanagement to the OIG; we have enhanced our ``hotline'' to 
include Internet reporting; and have placed posters in most major DOI 
facilities. MMS has also conducted some education and outreach in this 
regard.
2.  One [of] your criticisms of the MMS' administration of the Royalty-
        In-Kind program is the initial lack of experience MMS employees 
        had in marketing the products they were taking in kind. You go 
        further to state that your office is setting up a Denver-based 
        Royalty Oversight Office and the members of this office need to 
        develop an understanding of royalty related activities within 
        MMS. That's a very complicated issue and based upon your 
        reasoning, it seems that this new office will have problems 
        because of lack of experience and knowledge of the issues they 
        have oversight responsibilities for. How useful will this 
        office be and would it not be a better investment to hire 
        additional people for MMS (Especially in light of the fact that 
        many of the criticisms levied against MMS are due to budgetary 
        constraints and the need for additional people to meet the 
        increasing workload)?
    Answer: The OIG has been examining royalties' issues in various 
arenas for over two years straight. When, in 1986--well before my time 
as Inspector General--the royalty audit function was steered to MMS 
rather than the OIG, our oversight, and thus our expertise, diminished. 
When the present royalties' issues began to arise in January 2006, we 
drew upon the limited royalties' experience that we had remaining in 
the organization, but essentially were forced to grow our expertise 
anew. With over two years behind us, however, we are well on our way in 
building OIG expertise for the long term. The OIG Royalty Oversight 
Office is already staffed with our two most knowledgeable royalties' 
auditors, an auditor that we hired from MMS and an auditor from the 
Department of Defense with extensive leasing and contracting 
experience. We also have a strong pool of candidates with state and 
tribal royalties audit experience who submitted their applications in 
response to our vacancy announcements.
    In addition, the first evaluation by this unit is being concluded, 
and has developed some very good information that should be quite 
useful to MMS management for improving the operations of the Royalty-
in-Kind program. I am already pleased with the work that this unit has 
done, and expect that it will only improve with time and experience.
    Finally, if the greater royalty audit function is to remain within 
MMS, then our new unit will also provide vital audit oversight similar 
to the oversight of the IRS' audit work provided by the Treasury 
Inspector General for Tax Administration.
                                 ______
                                 

STATEMENT OF DAVID DEAL, VICE CHAIR, ROYALTY POLICY COMMITTEE, 
                U.S. DEPARTMENT OF THE INTERIOR

    Mr. Costa. David Deal is the Vice Chair of the Royalty 
Policy Committee, and has been part of the Commission that 
Secretary Kempthorne put together to examine this carefully and 
closely with their experience and to provide a set of 
recommendations that was noted earlier, Getting Royalties 
Right: The Recent Recommendations for Improving the Federal Oil 
and Gas Royalty System.
    So we with that introduction look forward to your 
testimony, Mr. Deal.
    Mr. Deal. Thank you, Mr. Chairman and Mr. Pearce. I 
appreciate the opportunity to appear today at this important 
and timely oversight hearing. As you requested, I will offer 
you an abbreviated summary of my written statement already 
submitted. I have over 30 years of experience on oil and gas 
royalty management policy matters.
    In the mid-1980s, I served on the Secretary of the 
Interior's original Royalty Management Advisory Committee 
formed in the wake of the 1982 Linowes Commission Report and 
the landmark 1983 Federal Oil and Gas Royalty Management Act. I 
have been involved in Federal royalty management matters, 
legislation, rulemaking, litigation ever since.
    I now serve as Vice Chair of the Department of the 
Interior's Royalty Policy Committee. I also served as Vice 
Chair of its Subcommittee on Royalty Management, whose December 
2007 report you have received and brings me here today.
    Our subcommittee, co-chaired by former Senators Bob Kerrey 
and Jake Garn, was directed by the Secretary to undertake a 
careful evaluation of the Royalty Management Program to ensure 
that its procedures and processes were in order. The 
subcommittee was initially charged with reviewing three areas: 
reporting and accounting, audit compliance and review 
procedures and royalty in kind.
    Later, a fourth area for our review was added, namely 
Secretary Kempthorne's February 2007 procedures to tighten 
Department review of offshore lease packages, which include but 
are not limited to, royalty provisions, such as price 
thresholds.
    I am pleased to say that the subcommittee's final December 
2007 report was accepted by the multistakeholder Royalty Policy 
Committee at its January 2008 meeting and without change 
transmitted to Secretary Kempthorne. Overall, we concluded that 
the Department's Royalty Management Program is not broken at 
all but does need a major tune up.
    Indeed, we identified 110 recommendations. Technical policy 
as practical as possible, recommendations for change, 
improvements plainly needed to restore public confidence and 
ensure maximum value for the nation's taxpayers. As to our 
specific recommendations, they are quite varied. There are 110 
of them.
    The executive summary includes a summary of major 
recommendations. My co-chair's testimony before the Senate has 
another angle of attack listing 10 areas which involve one or 
more recommendations. Finally, many of the subcommittee's 
recommendations reinforced thoughtful recommendations already 
made by the Inspector General and the Government Accountability 
Office.
    What I would like to do today is rather than reiterate 
those different listings, I would like to identify four 
connecting themes which I think might further illuminate our 
own recommendations, their underlying royalty issues and the 
path ahead.
    1) There are major differences in onshore and offshore 
leases. Over 2,000 offshore leases, and over 20,000 onshore 
leases now generate oil and gas royalties. The sheer numbers 
and many other major differences described in my written 
statement, vintage, location, Bureau of Management, contribute 
to an asymmetrical regulatory picture and stretch staff 
resources, especially onshore.
    Chapter 3 of the subcommittee report offers 36 diverse 
recommendations, many of which have an onshore tilt. Chapter 5, 
which deals with intrabureau coordination, has 10 more 
recommendations affecting onshore.
    2) There are major differences in crude oil and natural 
gas. Oil and gas exhibit fundamental differences in physical 
properties, modes of transportation, end users and marketing, 
price reporting and even government regulation outside the 
Department of the Interior. These differences bear heavily on 
the calculation of royalties.
    My written statement describes two central aspects of the 
calculation of royalties, allowances and marketable condition, 
that reflect the complications that can arise somewhat 
differently for oil and gas, but especially in connection with 
gas, which today accounts for most disputes. These differences 
and other matters are reflected in many of the measurement and 
valuation recommendations of Chapters 3 and 4 of our report.
    3) Improved intra-agency coordination is imperative. Table 
13 at page 78 of our report is as good a snapshot as I have 
seen of the different bureau responsibilities bearing on 
royalty management. Our report offers 10 recommendations for 
improving coordination, many of which address Indian lease 
related matters.
    4) Key elements of the Royalty Management Program need to 
be implemented with more rigor, and more clarity. For example, 
and I will offer just three, in the audits, compliance and 
enforcement areas, that is Chapter 4 of our report, we include 
26 recommendations, many of which are directed at clarifying 
the strategy for choosing among the wide range of available 
audit compliance and review options, most notably, audits 
versus compliance reviews.
    In so many words, the subcommittee concurred with the DOI 
IG's December 2007 report, as you have already heard this 
morning, which concluded that compliance reviews can be an 
effective part of the MMS's CAM Program. It also concluded, 
that we concur with as well, weaknesses related to management 
information in the compliance review process and performance 
measures may keep it from being maximized.
    MMS's adoption of these recommendations should make MMS 
audits compliance and enforcement efforts more cost effective, 
adaptable to changing circumstances and more transparent for 
review by Congress and other stakeholders. Our Chapter 4 
recommendations notably also reflect the advice we sought 
rather aggressively of the Internal Revenue Service, which 
itself has adopted sophisticated risk-based models for choosing 
among its audit, compliance and enforcement options.
    A second just as important option, RIK. RIK, as we all 
know, is an atypical government program with the MMS 
functioning first as a regulator and then as a commercial 
marketer. In this regard, in 2007 GAO expressed some concerns 
about the RIK Program's rapid growth and posed questions about 
the MMS's ability to adequately quantify and compare RIK and 
RIV revenues and administrative costs as required by statute.
    Here again, the subcommittee shared similar concerns 
finding that the MMS had done a credible job managing the RIK 
Program and that RIK offered great royalty management 
advantages but that the RIK deserved, ``more intense oversight 
and distinct program improvements.'' Chapter 6 of the 
subcommittee report lists no less than 31 diverse 
recommendations for clarifying and tightening RIK Program 
management.
    Here again, more rigor and clarity should make the Royalty 
Management Program more cost effective and should enhance 
program transparency for oversight by Congress and other 
stakeholders. Last but not least, a final short but needless to 
say important example of price thresholds.
    In a similar vein, the process, procedure and training 
recommendations of Chapter 7 of our report are centered on the 
need for rigor to assure that OCS leases are issued fully 
consistent with the law and policies of the department.
    Mr. Chairman, as an Attachment B to my written statement, I 
also mention that Attachment B is a simple, one page diagram 
which it was my attempt to perhaps cut through some of the 
complexity of the royalty revenue calculation process and 
linking the different parts of the process to our report. 
Hopefully this will illuminate our recommendations and the 
underlying royalty issues.
    Mr. Chairman, Mr. Pearce, that completes my remarks. I 
would be glad to answer any questions that you might have.
    Mr. Costa. Thank you very much, Mr. Deal. We appreciate 
that concise and to the point testimony. Tune up, I like that. 
Maybe we can come together in a fashion that will provide that 
tune up. We all on occasion need a tune up.
    [The prepared statement of Mr. Deal follows:]

   Statement of David T. Deal, President, Deal Consulting & Dispute 
       Resolution, LLC, and Vice Chair, Royalty Policy Committee

    Mr. Chairman and Members of the Subcommittee, I appreciate the 
opportunity to appear today at this important and timely oversight 
hearing.
    I have over 30 years of experience on oil and gas royalty 
management policy matters. In the mid-1980's I served on the Secretary 
of the Interior's original Royalty Management Advisory Committee formed 
shortly after publication of the Linowes Commission in 1982 and passage 
of the landmark Federal Oil and Gas Royalty Management Act in 1983. I 
have been involved in federal royalty management legislation, 
rulemaking and litigation ever since.
    I now serve as vice chair of the Department of the Interior's 
Royalty Policy Committee (RPC), a federal advisory committee. I also 
served as vice chair of its Subcommittee on Royalty Management, 
established in November 2006, whose December 2007 report brings me here 
today.
    Prompted by criticism of the Department's royalty management 
program from several quarters, Secretary Kempthorne and Assistant 
Secretary Allred directed our Subcommittee to undertake a careful 
evaluation of the program to ensure that its procedures and processes 
were in order. The Subcommittee was initially charged with reviewing 
three areas: reporting and accounting for Federal and Indian mineral 
resources; audit, compliance and review procedures; and, royalty in 
kind.
    After our Subcommittee got underway in mid-2007, a fourth area for 
our review was added: Secretary Kempthorne's February 2007 procedures 
to tighten Department review of offshore lease packages to assure 
consistency with all applicable law and policies. This fourth area was 
prompted by the disturbing omission of royalty relief price thresholds 
for Outer Continental Shelf leases issued in 1998 and 1999.
    I am pleased to say that the Subcommittee's final December 2007 
report, ``Mineral Revenue Collection from Federal and Indian Lands and 
the Outer Continental Shelf,'' was accepted by the parent Royalty 
Policy Committee at its January 17, 2008, and without change 
transmitted to Secretary Kempthorne. I am also pleased to say that the 
Department has energetically begun to address the 110 recommendations 
of the Subcommittee's Report. Indeed, some of the simpler 
recommendations have already been satisfied.
Character of the Subcommittee Report and Its Deliberative Process
    As conceived by Secretary Kempthorne and Assistant Secretary 
Allred, the Subcommittee's task was to be forward looking with a heavy 
emphasis on process and procedures.
    The Subcommittee was directed to address royalty bearing minerals, 
although the heavy emphasis was oil and gas, which lay at the heart of 
so much recent program criticism.
    The Subcommittee was to be an independent panel. I served as vice 
chair and the link to the Royalty Policy Committee, but the 
Subcommittee's membership drew also on the skills of:
      Bob Kerrey and Jake Garn, two former Senators who served 
as co-chairs
      Bob Wenzel, former deputy commissioner, Internal Revenue 
Service
      Perry Shirley, Assistant Director, Minerals Department, 
Navajo Nation
      Cynthia Lummis, former State Treasurer, State of Wyoming
      Mario Reyes, Professor of Finance, University of Idaho.
    Finally, from the outset Subcommittee members were advised that 
nothing was off limits for our review. Moreover, the Subcommittee did 
not limit itself to information within the Department but looked to 
comparable programs outside the Department, most notably, the Internal 
Revenue Service.
Key Recommendations
    Overall, we concluded that the Department's royalty management 
program is not broken but does need a major tune up. We concluded that 
the Minerals Management Service is an effective steward of the Minerals 
Revenue Management Program and that its seasoned, skilled staff was 
eager to explore program improvements. And, as our Report makes clear, 
many improvements are plainly needed to restore public confidence and 
ensure maximum value for the nation's taxpayers.
    At 160 pages in length and including 110 specific recommendations, 
which address a mix of practical policy, management and technical 
concerns, the Report does not read like a novel. To understand the 
Subcommittee Report, our 110 recommendations can be sorted in several 
ways.
    For example, the Executive Summary to the Report itself includes a 
Summary of Major Recommendations and separately identifies 
recommendations that address major issues, some recommendations that 
will require long-term support, other recommendations that can be 
easily implemented, and a few that would need legislation.
    In addition, Subcommittee co-chairs Bob Kerrey and Jake Garn, in 
February 26, 2008, in a statement submitted to the Senate 
Appropriations Committee, and included here as Attachment ``A,'' 
offered a more integrated approach by identifying ten key areas for 
which Subcommittee recommendations were formulated.
    Finally, many of the Subcommittee's recommendations reinforce 
thoughtful recommendations made by the DOI Inspector General and the 
Government Accountability Office.
    Today, I will attempt no detailed analysis of the Report's many 
recommendations. Nor will I reiterate the litany of major 
recommendations in the Subcommittee Report or the key areas already 
ably presented by my Subcommittee co-chairs. To complement that useful 
information, I offer four basic themes that suffuse the Report and 
might further illuminate the recommendations, their underlying royalty 
issues and the path ahead. Toward this same end, I also offer a simple 
one-page diagram, included here as Attachment ``B,'' that lays out the 
basic royalty calculation formula with explanatory notes linking it to 
the major portions of the Subcommittee Report.
Connecting Themes
    1. Major differences in onshore and offshore leases. Whereas about 
2,300 offshore oil and gas leases generate about $6.5 billion in 
royalty revenues, about 23,000 onshore Federal leases generate about 
$2.7 billion. Offshore leases are large, operated by large companies, 
alone or in combination, and often far offshore. Typically, offshore 
leases are relatively modern with highly concentrated production 
facilities and linked to a small number of MMS planning region offices.
    In contrast, onshore federal leases are far more diverse, including 
many small properties often operated by small companies. Onshore leases 
are often of old vintage, scattered around the countryside in several 
states and linked with many BLM field offices. In addition, offshore 
leases are regulated in all respects by the MMS whereas onshore federal 
leases are regulated by the Bureau of Land Management (BLM) for site 
security, production verification, but regulated by the MMS for audits, 
compliance and enforcement.
    These major differences contribute to an asymmetrical regulatory 
picture and stretched staff resources, especially onshore, and are 
reflected in Chapter 3 of the Subcommittee Report. Chapter 3 alone 
accounts for 36 of the Report's 110 recommendations: requiring 
electronic reporting; promoting remote data acquisition; upgrading gas 
plant efficiency reporting and compliance review; examining BLM and MMS 
staffing levels and training; and other matters.
    2. Major differences in crude oil and natural gas. Under applicable 
lease terms crude oil and natural gas produced on federal and Indian 
leases generate royalty obligations. Moreover, crude oil and natural 
gas can both be sold at the wellhead or downstream. But there the 
similarities end.
    These two commodities exhibit fundamental differences in physical 
characteristics, modes of transportation, end users and marketing, the 
reporting of prices, and government regulation. All of these bear 
heavily on the calculation of royalties. Consider, for example, two 
important elements in the calculation of oil and gas royalties, 
allowances and marketable condition, complex issue areas which lie at 
the heart of many royalty issues.
    Allowances. Under federal mineral statutes, royalty is based on the 
``value of production'' and producers are allowed to take deductions 
for certain post-production costs to arrive at the proper base for 
calculation of royalties. In arriving at this value of production for 
the calculation of oil and gas royalties, MMS regulations do not allow 
a producer to deduct the costs incurred for gathering production, or 
satisfying ``marketable condition,'' or achieving any other marketing 
purpose.
    However, consistent with well-established oil and gas law, MMS 
regulations do allow deductions for transportation costs. Consistent 
with well-established oil and gas law, MMS regulations also allow a 
producer to deduct certain processing costs, costs incurred to extract 
after production trace amounts of natural gas liquids (NGLs) which, if 
removed, are royalty bearing and therefore generate extra royalty 
revenue for the U.S. Treasury.
    Marketable condition. MMS regulations require that crude oil and 
natural gas must be in ``marketable condition'' before being valued for 
royalty purposes. For oil, this generally means simple elimination of 
water and sediment before it is shipped and sold. For gas, much more is 
required to satisfy pipeline specifications: acid gas removal to avert 
pipeline corrosion, dehydration and compression. Complicating matters 
here is that certain gas-related costs, otherwise not deductible, may 
be deemed deductible (e.g., supplemental compression).
    Given these differences, calculating gas royalties tends to be much 
more complex and, not surprisingly, gas valuation continues to account 
for most royalty disputes. These differences, and other matters, are 
reflected in many of the measurement and valuation recommendations of 
Chapters 3 and 4 of the Subcommittee Report: improving gas plant 
efficiency information; upgrading gas measurement guidance; exploring 
anew the use of indexing for gas valuation; addressing the issue of 
cost-bundling to simply calculation of allowances; to name but a few.
    3. Intra-agency coordination. In connection with Subcommittee's 
four charges, the need for better coordination among the Department's 
bureaus involved with royalty management (i.e., MMS, BLM and BIA) 
commands a free-standing Chapter 5 of the Report. Table 13 at page 78 
of the Report is a good snapshot of the different bureau 
responsibilities bearing on royalty management.
    While inter-bureau coordination, communication and information 
sharing is not the kind of issue that generates royalty headlines, the 
Subcommittee concluded early on that effective coordination is 
imperative if the Department's sprawling, multi-stakeholder royalty 
program is to operate efficiently and effectively. The Report's ten 
recommendations include, for example: establishing an inter-bureau 
Coordinating Committee; developing common data standards; and several 
Indian lease-related matters.
    4. Rigor and clarity. Stated most simply, the Department needs to 
implement key elements of its royalty management program with more 
rigor and clarity. For example, in connection with audits, compliance 
and enforcement, the topic of Chapter 4 of the Report, the many of the 
26 recommendations are directed at clarifying the strategy for choosing 
among a wide range of available audit, compliance and review options. 
In this regard, in his December 2007 report, the DOI Inspector General 
concluded that ``compliance reviews,'' which are basically desk audits, 
``can be an effective part of MMS' CAM Program,'' but recommended 
strongly that several weaknesses be addressed to maximize the benefits 
of compliance reviews. The Subcommittee concurred and we found that the 
MMS had already adopted an Action Plan that seeks to implement 
important corrective measures. Once adopted, these measures should make 
MMS audit, compliance and enforcement efforts more cost-effective, 
adaptable to changing circumstances, and more transparent for review by 
Congress and other stakeholders.
    In addition, the Report's Chapter 4 recommendations reflect the 
Subcommittee's aggressive effort to seek the advice of the Internal 
Revenue Service, which itself has adopted sophisticated risk-based 
models for choosing among its audit, compliance and enforcement 
options. My understanding here is that the MMS has already sought out 
the IRS for further advice and consultation on best practices to 
improve its royalty collection responsibilities.
    Another key area where the Subcommittee concluded that more rigor 
and clarity was needed is the MMS' Royalty-in-Kind (RIK) Program. RIK 
is an option increasingly used in lieu of royalty in value (RIV) to 
satisfy royalty obligations. When the MMS takes its royalty in kind, it 
can bypass the complexities of valuation--which can be especially 
difficult for non-arm's length transactions involving gas--and realize 
substantial administrative cost savings. Through sales of the 
production taken in kind MMS can then realize the dollar royalty 
revenues it is owed and also generate extra revenues for the U.S. 
Treasury. Crude oil taken in kind can also contribute to Strategic 
Petroleum Reserve fills if the Administration sees fit; by statute, 
crude oil or gas taken in kind can also be used to support any Federal 
low income energy assistance program.
    However, RIK is an atypical government program with the MMS 
functioning first as a regulator and then as a commercial marketer. In 
this regard, the Government Accountability Office (GAO) in 2004 made 
recommendations that the Department has implemented and that have 
improved RIK administration. However, in 2007 GAO expressed some 
concerns about the RIK program's rapid growth and posed questions about 
the MMS' ability to adequately quantify and compare RIK and RIV 
revenues and administrative costs as required by statute.
    The Subcommittee shared similar concerns, finding that RIK offered 
great royalty management advantages but deserved ``more intense 
oversight and distinct program improvements.'' Chapter 6 of the 
Subcommittee Report lists 31 diverse recommendations for clarifying and 
tightening RIK Program management: establishing an Royalty Policy 
Committee RIK Subcommittee to address performance benchmarks, volume 
verification and market positioning; publishing a guidebook of RIK 
processes and procedures; establishing exploring alternative 
organizational arrangements to optimize its performance in a commercial 
environment; seeking reimbursement for costs incurred for Strategic 
Petroleum Reserve transfers; discontinuing the small refiners' set 
aside program and suspending the onshore crude oil RIK program; 
publishing performance measures; maintaining a staff critical mass; 
securing dedicated legal support; emulating sound business practices to 
maintain a competitive marketing position; evaluating different auction 
types; and many others.
    Here again, more rigor and clarity should make the royalty 
management program more cost-effective and should enhance program 
transparency for oversight by Congress and other stakeholders. In a 
similar vein, the process, procedure and training recommendations of 
Chapter 7 are centered on the need for rigor to assure that OCS leases 
are issued fully consistent with the law policies of the Department.
    Mr. Chairman and members of the Subcommittee, I welcome any 
questions or comments on my statement or the Subcommittee on Royalty 
Management's Report that brings me before you today.
Attachment B

[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

                                 
Attachment A

     Testimony of Senators Bob Kerrey and Jake Garn, Co-Chairmen, 
                   Subcommittee on Royalty Management

    The Subcommittee on Royalty Management was established by the 
Secretary of the Interior, Dirk Kempthorne, in March 2007. It was 
created as a consequence of concerns about lapses in ethical behavior 
and inadequacies in lease issuance, royalty collection, and auditing. 
These concerns have been expressed by the Congress and by the 
Department's Inspector General who has investigated allegations of 
ethical lapses of personnel in the royalty in kind (RIK) program.
    As co-chairmen of this Subcommittee, we are pleased to provide this 
statement on the Subcommittee's report entitled ``Mineral Revenue 
Collection from Federal and Indian Lands and the Outer Continental 
Shelf.'' The report was released on December 17, 2007, and is the 
result of nine months of data gathering and analysis by the 
Subcommittee. It presents a comprehensive analysis of the federal 
mineral resource management program in the Department of the Interior. 
The program is a major source of revenue to the U.S. Treasury, with 
revenues in excess of $11 billion in 2007.
    The Subcommittee members conducted an independent evaluation of the 
revenue collection and royalty management program within the Department 
of the Interior. In addition to ourselves, the Subcommittee includes an 
impressive group of professionals: David Deal, our vice chairman, an 
oil and gas expert, and a member of the Royalty Policy Committee to 
whom the Subcommittee reports; Cynthia Lummis, a former Treasurer of 
the State of Wyoming.; Mario Reyes, a professor of finance at the 
University of Idaho; Perry Shirley, the Assistant Director for the 
Minerals Department of the Navajo Nation; and Bob Wenzel, a former 
Deputy Commissioner for the Internal Revenue Service (IRS).
    The companies who lease the right to explore for and develop 
minerals on federal lands and offshore waters pay royalties on the 
minerals extracted from those lands and waters. Those royalties are 
either paid in cash, which is know as royalty in value, or in product, 
which is known as royalty in kind. The royalty in kind program has been 
quite cost effective, especially for natural gas production, and the 
program is expected to continue to grow. The Minerals Management 
Service (MMS) does not stockpile product ``paid'' through the RIK 
program. Rather, it sells the product through a closed bid auction 
procedure. We believe the RIK program is an extremely important 
component of the royalty management program and the RIK recommendations 
in the report are geared toward ensuring the program's survival.
    The Subcommittee's report makes over 100 recommendations for 
improvements in the mineral resource management program. Most of these 
recommendations can be implemented administratively. Many can be done 
quickly. Some will require long term effort and continued vigilance. A 
few of the recommendations depend upon legislative action. The Federal 
employees who work in the mineral leasing and royalty collection 
program are conscientious, hard working, and concerned about the 
reputation of the program and of the Department of the Interior. We 
believe that implementing the recommendations in this report will 
greatly strengthen the management of the program, will restore public 
confidence, and will ensure maximum value for the U.S. taxpayer.
    We support all the Subcommittee's recommendations. However, for the 
balance of this testimony, we focus on a limited number of 
recommendations in 10 key areas that we believe are critical to ensure 
continued improvements in the program. Most of the recommendations will 
require some additional resources from the House and Senate Committees 
on Appropriations. A relatively modest increase in appropriations 
should yield increased revenues that more than offset the additional 
funding.
     1.  Over the past few years, MMS has relied more heavily on 
compliance reviews rather than full audits of industry royalty payments 
for production on federal lands and offshore waters. It appears that 
the increased reliance on compliance reviews has been based on funding 
and personnel constraints rather than on documented data on benefits 
and risks. MMS needs to establish an auditing and compliance program 
that includes an appropriate balance of audits and compliance reviews, 
and the program needs to be based on reliable data.

          Specifically, MMS should implement a risk-based strategy for 
        identifying companies and properties for audits and compliance 
        reviews. This effort will require developing, testing, and 
        refining various strategies over the next several years. While 
        this will be an evolving process, and MMS is instituting a 
        pilot program in this area, MMS needs to take aggressive action 
        to establish an initial program over the short term. MMS should 
        work with the IRS to benefit from the lessons IRS has learned 
        in this area over the years.
     2.  We believe that one recommendation, which requires legislative 
action, deserves very serious consideration by the Congress. We 
recommend that MMS explore the feasibility of establishing an interest-
bearing trust fund within the Treasury. Interest from this fund could 
be used to fund Department of the Interior activities; primarily, but 
not necessarily limited to, royalty management activities.
     3.  The Department of the Interior should strengthen and emphasize 
ethics training for all staff involved in royalty management. Training 
should include guidance on appropriate interaction with the private 
sector, prohibitions on the use of public office for private gain, and 
the handling of official and proprietary information.
     4.  In addition to MMS, the Bureau of Land Management (BLM) and 
the Bureau of Indian Affairs (BIA) play significant roles in onshore 
royalty management. Program improvements in these bureaus are needed, 
as is better coordination among MMS, BLM, and BIA. In particular, 
improved communication and coordination among the various production 
accountability staffs needs to be addressed. Further, data entry in BLM 
and BIA, as well as compliance management information in MMS, should be 
automated to eliminate manual data entry to the maximum extent 
practicable.
     5.  BLM has difficulty recruiting and retaining Petroleum 
Engineering Technicians and Petroleum Accountability Technicians. The 
number of Mining Engineers is also inadequate. The salaries for these 
positions need to be reviewed and training programs need to be 
improved. Also, the total number of positions needed should be 
determined based on workload in individual BLM field offices. For 
example, production accountability reviews are critical for accurate 
revenue collection. However, in 2006, BLM had only 20 Petroleum 
Accountability Technicians (PATs) nationwide and nineteen of the 
thirty-one BLM field offices with oil and gas responsibilities employed 
no PATs.

          Emphasis within BLM over the past several years has been on 
        increased funding for the ``front end'' of the program: namely, 
        additional leasing and processing of applications of permits to 
        drill. As the program has expanded, there has not been 
        sufficient attention to funding the workload associated with 
        the ``back end'' of the process: namely, increased collections, 
        production accountability, and auditing requirements.
     6.  The Indian oil valuation rule has been languishing within the 
Department of the Interior for more than 10 years. Indian Tribes are 
understandably frustrated by the delay. The Subcommittee believes that 
the Department should immediately finalize its ``technical changes'' to 
the Indian oil valuation rule and, by June 2008, MMS should propose a 
rule that values Indian oil based on a market index as is done for 
production from federal oil leases and from Indian gas leases.
     7.  Improved oversight of the mineral revenue collection program 
is essential to ensure the problems that generated so much concern in 
the past are not repeated and new problems in the future are avoided. 
Therefore, we recommend the establishment of an RIK Subcommittee to the 
Royalty Policy Committee. The RIK Subcommittee should address such 
issues as performance benchmarks, volume verification, and market 
positioning. We also recommend the establishment of a Coordinating 
Committee, comprised of senior management officials in MMS, BLM, and 
BIA, to ensure that recommended improvements are implemented in these 
bureaus.
     8.  The skills necessary to administer the RIK program are not 
typical for a government agency. RIK is basically an oil and gas 
marketing operation. The Subcommittee recommends that issues associated 
with hiring and maintaining staff with industry expertise and dedicated 
legal support should be addressed in the RIK program. Also, MMS should 
evaluate the benefits and costs of alternative auction types and should 
develop a pilot program to test alternatives that could improve net 
returns.
     9.  We recommend eliminating programs that are no longer cost 
effective or large enough to support their continuation. These include 
the onshore RIK crude oil program and the small refiners' set-aside RIK 
program. Market conditions in the future may be conducive to 
reinstating these programs but such is not the case today.
    10.  The Subcommittee's charter did not include a review of the 
situation surrounding the offshore oil and gas leases in the Gulf of 
Mexico issued in 1998 and 1999 without price thresholds. However, 
towards the end of our review, we were asked by the Assistant Secretary 
for Land and Minerals Management, Steven Allred, to comment on offshore 
lease issuance procedures enumerated in a February 2007 memorandum to 
him from Secretary Kempthorne.

          Our recommendations are that the Department continue its 
        efforts to pursue voluntary royalty payment agreements with 
        holders of the leases; that Congress and the Secretary continue 
        to explore legislative options that would address the loss of 
        royalties without violating legitimately signed contracts; and 
        that MMS and the Office of the Solicitor develop procedures and 
        guidelines to ensure effective implementation of the 8 
        enumerated items in the memorandum within 60 days of release of 
        the Subcommittee's report.
    Thank you for the opportunity to provide this testimony. We look 
forward to working with you to improve this important program.
                                 ______
                                 

            Response to questions submitted for the record 
                            by David T. Deal

General Questions
1.  Mr. Deal, did your subcommittee consider recommendations aimed at 
        instilling more independence in the audit function within MMS?
    In our discussions of the audit function, the Subcommittee did not 
address independence per se but did address aspects of the overall 
audit process with an independence character. For example, Chapter 3 
addresses several matters that would facilitate the verification of 
production reporting that bear on the efficacy of audit and compliance 
and the ``self-reporting'' concerns identified by the Government 
Accountability Office in its March 11, 2008 testimony. Likewise, 
Chapter 4 of the Subcommittee Report addresses the mechanics of the 
audit and compliance review process, notably the choice of appropriate 
review options.
    The Subcommittee Report also includes a Royalty in Kind-related 
Recommendation 6-16 to assure that RIK personnel have a solid 
understanding of existing ethics guidelines and, perhaps most relevant, 
a generic Recommendation 7-6 which addresses training, inclusive of 
ethics training, for all staff involved in royalty management and 
inclusive of ``guidance on public-private sector interactions, use of 
official and/or proprietary data, and prohibitions on the use of public 
office for private gain.''
2.  Mr. Deal, could you discuss your views of the usefulness of the 
        State and Tribal Royalty Audit Committee, or ``STRAC''? And do 
        you see any way to improve the relationship between STRAC and 
        MMS?
    As direct beneficiaries of onshore production in their 
jurisdictions, States and Indian tribes are important stakeholders, 
underscored by the fact that they have important roles in cooperation 
with the MMS in the overall audit process. See 30 C.F.R. Parts 227-229. 
While STRAC seems like a logical forum for States and Indian Tribes to 
share issues of common concern, I have had no direct experience with 
STRAC and the Subcommittee did not address MMS-STRAC relationships. 
Therefore, I can offer no specific suggestions for improving STRAC-MMS 
relationships.
3.  Mr. Deal, in their testimony, Senators Kerrey and Garn discuss the 
        difference in the so-called ``front-end'' and ``back-end'' of 
        BLM's operations. Can you describe that in more detail?
    To my knowledge, the ``front-end'' and ``back-end'' labels used in 
the testimony of Senator Kerrey and Senator Garn are not terms of art 
but are useful to explain BLM staffing challenges in the royalty 
management arena.
    As the Senators used these terms, ``front-end'' relates to tasks 
associated with new leasing of onshore lands and the start up activity 
that follows leasing, e.g., processing of drilling permit applications, 
although the multiple-use character of BLM lands creates non-mineral 
responsibilities as well. However, ``back-end'' relates to tasks 
associated with leases once production has commenced, which embraces a 
host of tasks, including, but not limited to, onshore royalty-related 
production and accounting.
    While the Subcommittee had neither the time nor the resources nor 
the resources to undertake a careful assessment of BLM funding trends, 
or the panoply of demands on BLM resources, our sense was that BLM 
resources, in terms of staffing numbers and skill levels, fell short of 
that needed to do the royalty-related ``back-end'' job completely and 
competently, an area that is central to Chapter 3 of the Subcommittee 
Report.
4.  Mr. Deal and Mr. Finfer, could you provide more detail on the 
        difference between a ``royalty payor'' and an ``operating 
        rights owner'', and why it would be better for MMS to be able 
        to pursue the royalty payor (as per Recommendation 3-8). Please 
        provide an example to demonstrate the difficulty in the current 
        system.
    Recommendation 3-8 of the Subcommittee Report suggests that the 
Department of the Interior support Section 215 of H.R. 2337 introduced 
in the 110th Congress, which would restore the MMS' ability to pursue a 
designated payor for royalty debts, an option that was expressly 
precluded by prior remedial royalty legislation, namely, the Royalty 
Simplification and Fairness Act of 1996, Public Law 104-185 (RSFA). As 
Chapter 3, page 23, of the Subcommittee Report notes, underlying this 
recommendation, was the fact that the MMS does not have in place a 
system for tracking operating rights owners, which can make enforcement 
costly and cumbersome.
    This recommendation is appropriately intended to simplify the 
collection process and respond to the Debt Collection Improvement Act 
of 1996-related compliance concerns identified in the course of a 2006 
Inspector General audit. Upon reflection, however, my personal view is 
that the Subcommittee Report or Recommendation 3-8 itself should have 
included some caveats reflecting of some important legal and 
operational concerns.
    In oil and gas parlance, an ``operating interest'' or ``working 
interest'' is the exclusive right to explore for, develop and produce 
oil and gas on a lease. For example, as described in the BLM Manual 
(excerpt attached), the owner of operating rights or a working interest 
holds:
        the interest or contractual obligation created out of a lease 
        (such as a sublease) authorizing the holder of that right to 
        enter the leased lands to conduct drilling and related 
        operations, including production, which may include as 
        consideration a share in revenues production. Operating rights 
        may or may not be transferred through an operating agreement; 
        however, transfer of operating rights on Federal leases must be 
        filed and approved on the official assignment form.
BLM Manual, H-3100-1, Oil and Gas Leasing, ``Glossary and 
Abbreviations/Acronyms,'' at 1-14, September, 6, 1985.
    In contrast, a ``royalty payor'' is a party making payments to the 
royalty owner, in this case, the Federal Government. Although a royalty 
payor can be a working interest owner, a royalty payor can be anyone 
(e.g., an operator, a lessee, an accounting firm, etc.) so designated 
by one or more working interest owners and, therefore, is not 
necessarily linked to the underlying royalty obligation.
    My recollection is that in the mid-1990's the MMS was already 
concerned with collection closure times and advanced a ``designated 
payor'' concept intended to simplify the compliance review process by 
making any party designated as payor principally liable for any royalty 
bills due. While industry did not oppose simplification, it balked at 
the particular designated payor concept then under consideration by the 
MMS, raising legal and fairness concerns.
    At the heart of the industry concerns was the view that a 
designated payor was not as a legal matter inherently a surrogate for 
the working interest owners beyond the reporting of royalty information 
and, did not bear the royalty obligation of the working interest owners 
prescribed in the lease document, and should not be liable for the 
working interest owner obligations of other parties.
    When Congress took up RSFA in the mid-1990's, the designated payor 
issue was one of several issues considered. While I was not privy to 
the many stakeholder discussions on the pending legislation at that 
time, there was widespread acceptance of the shortcomings of the MMS' 
expanded designated payor approach. Enactment of RSFA in 1996 
eliminated this liability ambiguity by amending the Federal Oil and Gas 
Royalty Management Act to sharpen the 30 U.S.C. Sec. 1702 definition of 
``lessee'' and amending 30 U.S.C. Sec. 1712(a) as follows:
    (a) Liability for royalty payments
     In order to increase receipts and achieve effective collections of 
royalty and other payments, a lessee who is required to make any 
royalty or other payment under a lease or under the mineral leasing 
laws, shall make such payments in the time and manner as may be 
specified by the Secretary or the applicable delegated State. A lessee 
may designate a person to make all or part of the payments due under a 
lease on the lessee's behalf and shall notify the Secretary or the 
applicable delegated State in writing of such designation, in which 
event said designated person may, in its own name, pay, offset or 
credit monies, make adjustments, request and receive refunds and submit 
reports with respect to payments required by the lessee. 
Notwithstanding any other provision of this chapter to the contrary, a 
designee shall not be liable for any payment obligation under the 
lease. The person owning operating rights in a lease shall be primarily 
liable for its pro rata share of payment obligations under the lease. 
If the person owning the legal record title in a lease is other than 
the operating rights owner, the person owning the legal record title 
shall be secondarily liable for its pro rata share of such payment 
obligations under the lease.
30 U.S.C. 1712 (a) (emphasis supplied).
    Since passage of RSFA working interest owners and payors have 
plainly relied on the bright line distinction between payor and working 
interest owner royalty liability.
    For examples of the problem MMS confronts when it pursues 
collections from several working interest owners represented by a 
designated payor, I believe the MMS itself is best positioned to offer 
that information. I have no direct information on this matter. However, 
I am confident that another oversight hearing witness, MMS Director 
Randall Luthi, and his MMS Minerals Revenue Management staff can offer 
examples to illuminate the collection process. Indeed, the agency may 
be able to offer approaches to collection simplification, other than 
its original designated payor approach, that could satisfy their 
collection concerns without creating other problems in its place.
    In sum, I am unaware of anyone opposed to simplification of the 
collection process to reduce the MMS workload and better satisfy Debt 
Collection Act requirements. However, if legislation akin to Section 
215 of H.R. 2337 were enacted, the legislation and/or any ensuing MMS 
regulation in fairness should apply prospectively only and eliminate 
any ambiguities regarding the respective legal roles and 
responsibilities of royalty payors and operating interest owners for 
royalty collection in the future. In addition, because working interest 
owners and designated payors have been able to rely on RSFA, they would 
need an opportunity to consider realigning their payor arrangements and 
respective responsibilities.
Minority Questions
5.  In your opinion, what is the attitude of people working at MMS in 
        terms of their desire to fulfill their obligation to the 
        American public?
    While my oversight hearing testimony observes that the federal 
royalty management program needs many important improvements, I fully 
subscribe to the Subcommittee's view:
        In general, the Subcommittee concludes that the Minerals 
        Management Service is an effective steward of the Minerals 
        Revenue Management Program, and that MMS employees are 
        genuinely concerned with fostering continued program 
        improvements. The Subcommittee members unanimously agree that 
        MMS is the Federal agency best suited to fulfill the 
        stewardship responsibilities for Federal and Indian leases.
Subcommittee Report at ix.
    In its Report the Subcommittee also observed that over the years 
the MMS managed several rulemakings, stoutly defended its final rules 
against court challenges, and generally prevailed. Subcommittee Report 
at 12, citing, e.g., IPAA v. DeWitt, 279 F.3d 1036 (D.C. Cir. 2002) 
(upholding categorical denial of deductibility of marketing costs, 
except for firm demand charges, under 1997 gas valuation rule) and the 
court's dismissal of industry's challenge of the 2000 oil valuation 
rule.
    Moreover, two more recent, cases not addressed in the Subcommittee 
Report, illustrate MMS' aggressive advocacy. Both cases are non-
rulemaking, coalbed methane cases addressing application of the 
``marketable condition'' rule: Amoco Production Company v. Rebecca 
Watson, 410 F.3d 722 (D.C. Cir. 2005), cert. denied except for statute 
of limitations issue, sub nom. BP America Production Company v. Watson, 
126 S. Ct. 1768, 164 L. Ed. 2d 515, 2006 U.S. LEXIS 2851 (U.S., 2006) 
(upholding Assistant Secretary's denial of deductions for the costs of 
removing excess carbon dioxide from natural gas produced in the San 
Juan Basin); and, Devon Energy Corp. v. Norton, No. 04-0821, appeal 
pending, (D.D.C. Aug. 3, 2007) (upholding Assistant Secretary's denial 
of deductions for many compression, dehydration, and transportation 
costs).
    Indeed, some courts have found that the MMS was overzealous in its 
efforts to fulfill its obligation to the American public. See, e.g., 
the decisions in Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d 
1159 (5th Cir. 1988) (holding that gas take-or-pay payments are not 
royalty bearing) and Fina Oil and Chemical Company v. Norton, 332 F.3d 
672 (rejecting MMS' use of gross proceeds to capture affiliate gas 
resale proceeds even though affiliate was not ``marketing affiliate'' 
under MMS gas rule).
6.  In the Energy Policy Act of 2005 we included a provision to 
        establish pilot offices in areas of increased oil & gas 
        exploration and development to ensure environmental compliance 
        and ensure timely processing of lease applications and 
        Applications for Permits to Drill--it seems that maybe we were 
        on to something and that this program should be expanded to 
        include other aspects of the Nation's oil & gas program, 
        including the collection of royalties. Do you believe this 
        would facilitate better communication between BLM, MMS and the 
        BIA?
    Concentrating agency resources in areas of high activity makes 
sense as a general matter. Whether it would facilitate BLM, MMS and BIA 
communication, however, is unclear to me inasmuch as I have had little 
contact with BLM and BIA staff over the years. However, I would observe 
that further decentralizing BLM offices, especially without the 
staffing and training recommendations of the Subcommittee, might not 
improve BLM performance but deserves careful consideration. Moreover, 
locating extra pilot offices in area of high exploration and 
development activity might not address onshore problems that might be 
associated with older, less active areas.
7.  Can you describe your subcommittee's interactions with MMS and the 
        Department of the Interior while you were working on the 
        report? Was it truly independent from your perspective?
    The Secretary of the Interior conceived of the Subcommittee as an 
independent panel and the Subcommittee so operated.
    At the very outset of the project, at the November 2006 Royalty 
Policy meeting, and before the panel had been filled out, I was 
personally assured by the former MMS Director, Johnnie Burton, that 
``nothing was off limits'' for the Subcommittee's examination. Soon 
thereafter, Assistant Secretary Allred confirmed that view. The 
Subcommittee proceeded on that basis and encountered no barriers 
whatsoever.
    Once the Subcommittee panel was filled out in late March 2007 and 
got underway, the Secretary appointed a small, non-MMS staff group to 
support the Subcommittee. Given the geographic dispersion of the 
Subcommittee members, and the need to collect large quantities of 
information, set up meetings with cognizant MMS and BLM staff, access 
to some basic policy analysis input, and administrative support, this 
staff group was essential, but in no way interfered with Subcommittee 
deliberations.
    In the course of our deliberations, Subcommittee members met with 
BLM and MMS staff via telephone or in person on many occasions, 
especially during the Summer of 2007. My personal experience was that 
on all occasions the MMS and BLM staff were open, prepared and 
forthcoming in all respects. At no point, however, were MMS and BLM 
royalty-oriented staff invited to comment on emerging Subcommittee 
recommendations nor did they tender any such comments. Likewise, I am 
not aware of any intervention at all by any Department political 
appointee. Nor am I aware of any stakeholder (i.e., industry, state or 
Indian) outside the Subcommittee seeking or being invited to opine on 
any recommendation.
                                 ______
                                 

STATEMENT OF FRANKLIN RUSCO, ACTING DIRECTOR, NATURAL RESOURCES 
     AND ENVIRONMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Costa. Our next witness is, last but not least, Mr. 
Frank Rusco, is that the way you pronounce it, who obviously 
comes to the Committee with high recommendations. We look 
forward to your testimony. Mr. Rusco, please begin.
    Mr. Rusco. Thank you. Chairman Costa, Ranking Member Pearce 
and members of this Subcommittee, I am pleased to be here to 
discuss our ongoing work on royalty collections for oil and gas 
produced on Federal lands and waters.
    Mr. Costa. For the record, excuse me, Mr. Rusco, I did fail 
to note you are the Director of Natural Resources and the 
Environment within the General Accounting Office, and you 
testify this morning with that imprimatur.
    Mr. Rusco. Thank you. Interior's Minerals Management 
Service collected almost $10 billion last year in such 
royalties. MMS collects royalties in two forms, as a percentage 
of oil and gas revenues paid in cash or royalties in value and 
as a percentage of actual oil or gas royalties in kind. Oil and 
gas production and royalty data are self-reported to MMS by oil 
and gas production operators and/or royalty ``payors.''
    Because of the large amount of money involved and the fact 
that the basic data used to determine royalties owed are self-
reported, it is imperative that MMS have adequate IT and 
management systems to: 1) prevent and detect errors and 
omissions to production and royalty data; 2) ensure audit 
capabilities can reliably identify and collect additional 
royalties due as a result of errors or omissions; and 3) design 
and implement appropriate performance measures for MMS's 
overall programs.
    Based on our work to date, we must conclude that MMS's IT 
and management systems are inadequate on all three counts. 
Therefore, we do not have assurance that royalties are 
accurately collected. Until late 2004, MMS's IT and management 
systems lacked the ability to reliably identify missing oil and 
gas production reports.
    As a result, MMS has identified a backlog of about 300,000 
missing production reports which will now have to be 
reconciled. Worse, the system still lacks the ability to 
identify missing royalty reports, so MMS does not know if or 
how many such reports are missing. Finally, companies are 
allowed to go back in to MMS's data system and change royalty 
data at any time for up to six years after an initial report is 
filed.
    There is no requirement for companies making such changes 
to notify MMS, and the IT and management systems do not 
systematically flag these changes for MMS review. As a result 
of these and other deficiencies, MMS does not have reasonable 
assurance that data entered into its system are complete or 
accurate to begin with or that they remain so over time.
    We have a number of concerns about MMS's audit capabilities 
including: 1) the lack of systematic and complete collection 
and evaluation of third-party production data and other 
supporting documentation; and 2) increasing reliance on 
compliance reviews, which compared to audits are less rigorous 
checks of the reasonableness, accuracy and completeness of 
royalty reports; and finally, the fact that there is too much 
riding on audits and compliance reviews given that the primary 
royalty data are so unreliable.
    MMS is currently revising its audit and compliance review 
process, and we will be evaluating these revisions in our 
ongoing work. However, based on our work to date, we are 
concerned about the ability of the audit and compliance review 
process to adequately detect or deter missed reporting of 
production and royalty data.
    Finally, MMS lacks adequate performance measures for its 
royalty-in-kind program. First, MMS does not check self-
reported royalty-in-kind gas volumes against third-party 
production data. As a result, MMS does not have reasonable 
assurance that it is even getting the correct volumes of gas, 
which raises questions about MMS's claimed benefits of the 
royalty-in-kind program.
    Second, MMS's methodology for comparing the value of 
royalty-in-kind oil and gas with what it would have received 
had the royalties been paid in cash is subject to a lot of 
unreported uncertainty. We found that even small changes in 
assumptions about prices that royalty and value ``payors'' 
receive for their oil and gas leads to large swings in the 
estimated benefits of the royalty-in-kind program and can even 
make these estimates negative.
    These and other problems raise serious questions about 
MMS's reported measures of the benefits of the royalty-in-kind 
program. I want to conclude by saying that we encountered 
hardworking and knowledgeable staff in all Department of the 
Interior offices we visited, and we have received great 
cooperation in conducting our audit work.
    However, we also found profound and persistent problems 
with IT and management systems that are inadequately designed 
and do not contain common sense checks that could assist staff 
in: 1) detecting and correcting inaccurate or incomplete self-
reported production and royalty data; 2) conducting efficient 
and effective audits and compliance reviews; and 3) 
appropriately measuring program performance.
    Upon completing our audit we will make recommendations that 
will address these and other issues. This completes my oral 
statement. My colleague, Jeanette Franzel, and I will be happy 
to answer any questions you have. Thank you.
    Mr. Costa. Thank you, Mr. Rusco.
    [The prepared statement of Mr. Rusco follows:]

   Statement of Frank Rusco, Acting Director, Natural Resources and 
   Environment, Accompanied by Jeanette Franzel, Director, Financial 
    Management and Assurance, U.S. Government Accountability Office

    Mr. Chairman and Members of the Subcommittee:
    We are pleased to participate in the subcommittee's hearing to 
discuss the Department of the Interior's (Interior) oversight of the 
collection of royalties paid on the production of oil and natural gas 
(hereafter oil and gas) from federal lands and waters. In Fiscal Year 
2007, Interior's Minerals Management Service (MMS) collected over $9 
billion in oil and gas royalties and disbursed these funds to federal, 
state, and tribal accounts. The federal portion of these royalties, 
which totaled $6.7 billion in Fiscal Year 2007, represents one of the 
country's largest nontax sources of revenue. At the same time, oil and 
gas production on federal lands and waters represents a critical 
component of the nation's energy portfolio, supplying roughly 35 
percent of all the oil and 30 percent of all the gas produced in the 
United States in 2006. The Department of Energy's (DOE) Energy 
Information Administration projects that over the next 10 years the 
portion of U.S. production from federal lands and waters will increase 
to 47 percent for oil and 37 percent for gas. In Fiscal Year 2007, MMS 
also transferred $322 million worth of oil to DOE as part of its 
efforts to fill the nation's Strategic Petroleum Reserve (SPR). The SPR 
currently holds nearly 700 million barrels of oil--equivalent to about 
58 days of net oil imports--that can be released at the discretion of 
the President in the event of an oil supply disruption. Recently, both 
oil prices and the demand to drill for oil and gas on federal lands 
have increased dramatically. For example, the price of West Texas 
Intermediate--a commonly used benchmark crude oil--now exceeds $100 per 
barrel, a price that, when adjusted for inflation, is the highest price 
since 1980. Moreover, Interior's Bureau of Land Management (BLM) is 
projecting substantially increased numbers of drilling permit 
applications. It received 8,351 in 2005 and anticipates receiving 
12,500 in 2008.
    Companies that develop and produce federal oil and gas resources 
from federal lands and waters do so under leases obtained and 
administered by Interior--BLM for onshore leases and MMS's Offshore 
Minerals Management (OMM) for offshore leases. Together, BLM and OMM 
are responsible for overseeing oil and gas operations on more than 
28,000 producing leases to help ensure that oil and gas companies 
comply with applicable laws, regulations, and agency policies. Among 
other things, BLM and OMM staff inspect producing leases to verify 
whether oil and gas are accounted for as required by both the Federal 
Oil and Gas Royalty Management Act of 1982 1 and agency 
policies. As a condition of producing oil and gas under federal leases, 
companies are required to self-report monthly production volumes to MMS 
(as part of their monthly production reports). 2 In some 
situations, several companies may be jointly involved in developing oil 
and gas from a lease or a number of adjacent leases, in which case the 
companies designate one of the companies to be the ``operator.'' The 
operator has sole responsibility for submitting production reports for 
all oil and gas produced from the leases.
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    \1\ Federal Oil and Gas Royalty Management Act, Pub. L. No. 97-451, 
Sec. 101(a) (1983).
    \2\ Companies are required to self-report monthly production 
volumes to MMS on an Oil and Gas Operations Report (OGOR) form.
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    Companies, or lessees, compensate the government for producing 
federal oil and gas resources either ``in value'' (royalty payments 
made in cash), or ``in kind'' (royalty payments made in oil or gas). In 
Fiscal Year 2006, 58 percent of the $9.74 billion in oil and gas 
royalty payments were made in value, while 42 percent were made in 
kind. Under the royalty-in-value program, lessees responsible for 
paying cash royalties, also called ``payors,'' calculate the royalty 
payment they owe to the federal government using the key variables 
illustrated in the following equation:
Royalty payment = (sales volume x sales price - deductions) x royalty 
        rate 3
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    \3\ The royalty rate varies somewhat but is typically in the range 
of 12.5 to 18.75 percent. In other words, the federal government 
typically receives between 12.5 and 18.75 percent of revenues less 
allowable deductions for oil and gas produced on federal lands and 
waters. Allowable deductions include payments to pipeline companies and 
other shipping costs required to transport the commodity to a market 
center, as well as adjustments made for the costs of processing natural 
gas.
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    Cash royalty payors are required to submit monthly royalty reports 
to MMS specifying the royalty amount they owe the federal government 
for the production and sale of oil and gas, and generally make the cash 
payment via an electronic fund transfer to an account at the Department 
of the Treasury (Treasury). 4 In many instances, because 
leases are co-owned by multiple companies, multiple payors submit 
individual royalty reports for a single lease. However, in these 
situations a single company is designated the ``operator'' and is 
responsible for submitting the production report for that entire lease. 
As a result, MMS will often receive multiple royalty reports 
corresponding to a single production report. Royalty reports include 
the sales volume (amount sold), the sales revenue (the amount of 
revenue received from the sale), and the royalty payment due to MMS 
(royalty value less allowances taken for transportation and processing 
the gas into a marketable condition), prorated based on the share owned 
by each payor. Some of these data, as well as some of the deductible 
transportation costs, are also available from third-party sources. For 
example, individual royalty payor data on production and some 
transportation costs can be acquired from pipeline statements, which 
are essentially receipts from pipeline companies for shipping oil and 
gas. In contrast, documentation of sales revenue data, as well as data 
supporting allowable deductions, are generally available only from oil 
and gas company records. Royalty payors submit their monthly royalty 
reports through a Web-based portal. Once MMS reconciles the self-
reported royalty payment data from the monthly royalty reports with the 
payments submitted to Treasury, MMS disburses the royalties from the 
Treasury account to the appropriate federal, state, and tribal 
accounts. The transaction information is recorded in MMS's financial 
management system. 5
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    \4\ Companies are required to self-report monthly royalty payments 
to MMS on the Report of Sales and Royalty Remittance Form, Form 2014.
    \5\ This system, also known as the Minerals Revenue Management 
Support System, is designed to store and support the collection, 
verification, and disbursement of royalty revenues from federal and 
Indian mineral leases.
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    As a check on the accuracy of the self-reported data the payors use 
when determining cash royalty payments, among MMS's internal controls 
are audits and compliance reviews. 6 Audits are an 
assessment of the accuracy and completeness of the self-reported 
production and royalty data compared against source documents, such as 
sales contracts and oil and gas sales receipts from pipeline companies. 
By contrast, compliance reviews deal with reasonableness--a quicker, 
more limited check of the accuracy and completeness of a company's 
self-reported data--and they do not include systematic examination of 
underlying source documentation. In addition, some states and tribes 
that receive a share of royalties collected by MMS have agreements with 
MMS authorizing them to conduct both audits and compliance reviews on 
federal and Indian producing leases within their jurisdictions. 
7 MMS has an annual performance goal whereby it evaluates 
the compliance group's performance on the basis of whether the group 
has conducted compliance activities--either full audits or compliance 
reviews--on a predetermined percentage of royalty payments.
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    \6\ Internal controls are a series of management actions and 
activities that occur throughout an entity's operations and include the 
procedures used to meet agency objectives.
    \7\ Eleven states--Alaska, California, Colorado, Louisiana, 
Montana, New Mexico, North Dakota, Oklahoma, Texas, Utah, and Wyoming--
and seven tribes--Blackfeet Nation, Jicarilla Apache Tribe, Navajo 
Nation, Shoshone and Arapaho Tribes, Southern Ute Indian Tribe, Ute 
Mountain Ute Tribe, and the Ute Indian Tribe--conducted compliance work 
under cooperative agreements with MMS in Fiscal Year 2007.
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    In contrast to royalties in value, when paying royalties in kind, a 
payor delivers a volume of oil or gas to MMS as determined by the 
following equation:
Royalty volume = total production volume x royalty rate 8
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    \8\ In some cases, there may be deductions to the royalty oil given 
MMS as a result of costs incurred by the payor to transport the oil to 
the point at which MMS takes possession. In addition, there may be 
credits or deductions that adjust for different qualities of oil 
transported on a pipeline.
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    Once it receives the oil or gas, MMS may either sell it and 
disburse the revenues received from the sales, or transfer it to 
federal agencies for them to use. For example, MMS can transfer oil to 
DOE and DOE, in turn, can trade this oil for other oil of specific 
quality to fill the SPR. Under the Energy Policy Act of 2005, 
9 MMS is charged with ensuring that the revenues it receives 
when it sells oil and gas taken in-kind are at least as great as the 
revenues it would have received had it taken the royalties in value. 
Furthermore, MMS cannot sell oil and gas it takes in-kind for less than 
market value. As required, MMS routinely compares the estimated 
benefits of the in-kind program to the estimated benefits MMS would 
have received if the royalties had been taken in cash and annually 
reports these benefits to the Congress.
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    \9\ Energy Policy Act of 2005, Pub. L. No. 109-58, Sec. 342 (2005).
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    MMS estimates that from Fiscal Years 2004 through 2006 the royalty-
in-kind program generated about $87 million more in net value to the 
government than MMS would have collected had it received royalties in 
cash. Of this $87 million, MMS estimates that (1) $74 million came from 
selling royalty-in-kind oil and gas for more than it would have 
received in cash royalty payments, (2) $5 million came from interest 
from receiving revenues from in-kind sales earlier than cash payments 
are due, and (3) $8 million came from savings because the royalty-in-
kind program costs less to administer than the in-value program.
    Our testimony today is based on two ongoing efforts. The first 
focuses on MMS's royalty-in-value program and addresses (1) whether 
Interior has adequate assurance that it is receiving full compensation 
for oil and gas produced from federal lands and waters and (2) the 
extent to which MMS's compliance efforts provide an adequate check on 
industry's self-reported data. 10 The second, relating to 
MMS's royalty-in-kind program, addresses (1) the extent to which MMS 
has reasonable assurance that it is collecting the right amounts of 
royalty-in-kind oil and gas and (2) the reliability of the benefits of 
the royalty-in-kind program that MMS has reported. 11
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    \10\ This work is being done at the request of Senator Bingaman and 
Mr. Davis, Mr. Issa, Ms. Maloney, and Mr. Rahall, House of 
Representatives.
    \11\ This work is being done at the request of Senator Bingaman and 
Senator Wyden, and Mr. Issa and Mr. Rahall, House of Representatives.
---------------------------------------------------------------------------
    In addressing these issues, we reviewed documentation on MMS 
policies and procedures for collecting royalties; collected and 
assessed information on the sales of royalty oil and gas; and reviewed 
MMS procedures for preparing the administrative cost comparison between 
the royalty-in-value and royalty-in-kind programs. We also interviewed 
officials at offices selected from a nonprobability sample of five BLM 
field offices and the associated BLM state offices--the offices were 
selected based on the numbers of violations, oil and gas volume errors 
identified, and geographic location. In addition, we interviewed 
officials at MMS; toured oil and gas production facilities in Wyoming, 
Colorado, and the Gulf of Mexico; sent questionnaires addressing 
production and royalty data issues to the 11 state and 7 tribal members 
of the State and Tribal Royalty Audit Committee, of which 9 states and 
5 tribes responded. We assessed the reliability of the royalty-in-kind 
sales and performance data by (1) reviewing the systems that MMS has in 
place to help ensure that the data were entered and calculated 
correctly, and (2) comparing the data to aggregate performance results 
that MMS reported to the Congress for Fiscal Years 2004 through 2006. 
We determined that the data were sufficiently reliable for the purposes 
of this testimony. Our work is ongoing and we are continuing to assess 
information related to the objectives and findings presented in this 
testimony. We conducted this work from April 2007 to February 2008 in 
accordance with generally accepted government auditing standards. Those 
standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe that 
the evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives.
    In summary, regarding the royalty-in-value program, our work to 
date has revealed the following:
      Interior lacks adequate assurance that it is receiving 
full compensation for oil and gas produced from federal lands and 
waters. For example, neither BLM nor OMM is meeting statutory 
obligations or agency targets for conducting inspections of meters and 
other equipment used to measure oil and gas production, which raises 
questions about the accuracy of oil and gas measurement. Further, MMS's 
systems and processes for collecting and verifying royalty data are 
inadequate and lack key internal controls. Specifically, MMS lacks an 
automated process to routinely and systematically reconcile all 
production data filed by payors (those responsible for paying the 
royalties) with production data filed by operators (those responsible 
for reporting production volumes).
      MMS's compliance efforts do not consistently examine data 
from third parties to verify whether self-reported industry payment 
data are complete and accurate. Combined with the inadequacy of MMS's 
systems and processes for collecting and verifying royalty data and the 
lack of key internal controls, the absence of a consistent check on 
self-reported data using third-party data raises further questions 
about the accuracy of royalty payments.

        Regarding the royalty-in-kind program, our work to date has 
        revealed the following:
      MMS does not consistently check the accuracy of self-
reported gas collection data against available third-party data, 
putting the accuracy of gas royalty collections at risk. MMS's ability 
to detect gas production discrepancies is weaker than for oil because, 
unlike in the case of oil, MMS does not use third-party gas metering 
data to verify the operator-reported production numbers.

        The methods and assumptions MMS uses to compare the revenues it 
        collects in kind with what it would have collected in cash do 
        not account for all costs and do not sufficiently deal with 
        uncertainties, raising significant questions about the reported 
        financial benefits of the in-kind program.
Interior's Oversight Does Not Provide Adequate Assurance That the 
        Government Is Being Fully Compensated for Oil and Gas 
        Production on Federal Lands and Waters
    Interior lacks adequate assurance that it is receiving the full 
royalties it is owed because (1) neither BLM nor OMM is fully 
inspecting leases and meters as required by law and agency policies, 
and (2) MMS lacks adequate management systems and sufficient internal 
controls for verifying that royalty payment data are accurate and 
complete. With regard to inspecting oil and gas production, BLM is 
charged with inspecting approximately 20,000 producing onshore leases 
annually to ensure that oil and gas volumes are accurately measured. 
However, BLM's state Inspection and Enforcement Coordinators from 
Colorado, Montana, New Mexico, Utah, and Wyoming told us that only 8 of 
the 23 field offices in the 5 states completed both their (1) required 
annual inspections of wells and leases that are high-producing and 
those that have a history of violations and (2) inspections every third 
year on all remaining leases. 12 According to the BLM state 
Inspection and Enforcement Coordinators, the number of completed 
production inspections varied greatly by field office. For example, 
while BLM inspectors were able to complete all of the production 
inspections in the Kemmerer, Wyoming, field office, inspectors in the 
Glenwood Springs, Colorado, field office were able to complete only 
about one-quarter of the required inspections. Officials in 3 of the 5 
field offices in which we held detailed discussions with inspection 
staff told us that they had not been able to complete the production 
inspections because of competing priorities, 13 including 
their focus on completing a growing number of drilling inspections for 
new oil and gas wells, and high inspection staff turnover. However, BLM 
officials from all 5 field offices told us that when they have 
conducted production inspections they have identified a number of 
violations. For example, BLM staff in 4 of the 5 field offices 
identified errors in the amounts of oil and gas production volumes 
reported by operators to MMS by comparing production reports with 
third-party source documents. Additionally, BLM staff from 1 field 
office we visited showed us a bypass built around a gas meter, allowing 
gas to flow around the meter without being measured. BLM staff ordered 
the company to remove the bypass. Staff from another field office told 
us of a case in which individuals illegally tapped into a gas line and 
routed gas to private residences. Finally, in one of the field offices 
we visited, BLM officials told us of an instance in which a company 
maintained two sets of conflicting production data--one used by the 
company and another reported to MMS.
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    \12\ We excluded production inspection results from three BLM field 
offices where BLM state Inspection and Enforcement Coordinators could 
not validate production inspection numbers because they felt the data 
in BLM's Automated Fluid Minerals Support System (AFMSS), the database 
used to track production inspections, were unreliable. We excluded one 
additional BLM field office because it is implementing a pilot project 
inspection program using different selection and prioritization 
criteria; therefore it is not comparable with the other BLM field 
offices.
    \13\ To gain a balance of perspectives of how BLM field offices 
conduct production inspections, we chose a nonprobability sample of 
five field office locations--Meeker, Colorado; Vernal, Utah; 
Farmington, New Mexico; Buffalo, Wyoming; and Pinedale, Wyoming. We 
selected the field offices in each of these states through 
consideration of a number of criteria, ensuring that we visited BLM 
field offices that represented a range of BLM state office 
jurisdictional policies. While this nonprobability sample allowed us to 
learn about many important aspects of production inspections, it was 
not designed to be representative of all the BLM field offices 
production inspection activities. As such, the findings cannot be 
generalized to sites we did not visit.
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    Moreover, OMM, which is responsible for inspecting offshore 
production facilities that include oil and gas meters, did not inspect 
all oil and gas royalty meters, as required by its policy, in 2007. For 
example, OMM officials responsible for meter inspections in the Gulf of 
Mexico told us that they completed about half of the required 2,700 
inspections, but that they met OMM's goal for witnessing oil and gas 
meter calibrations. OMM officials told us that one reason they were 
unable to complete all the meter inspections was their focus on the 
remaining cleanup work from hurricanes Katrina and Rita. Meter 
inspections are an important aspect of the offshore production 
verification process because, according to officials, one of the most 
common violations identified during inspections is missing or broken 
meter seals. Meter seals are meant to prevent tampering with 
measurement equipment. When seals are missing or broken, it is not 
possible without closer inspection to determine whether the meter is 
correctly measuring oil or gas production.
    With regard to MMS's assurance that royalty data are being 
accurately reported by companies, MMS's systems and processes for 
collecting and verifying these data lack both capabilities and key 
internal controls, including those focused on data accuracy, integrity, 
and completeness. For example, MMS lacks an automated process to 
routinely and systematically reconcile all production data filed by 
payors (those responsible for paying the royalties) with production 
data filed by operators (those responsible for reporting production 
volumes). MMS officials told us that before they transitioned to the 
current financial management system in 2001, their system included an 
automated process that reconciled the production and royalty data on 
all transactions within approximately 6 months of the initial entry 
date. However, MMS's new system does not have that capability. As a 
result, such comparisons are not performed on all properties. 
Comparisons are made, if at all, 3 years or more after the initial 
entry date by the MMS compliance group for those properties selected 
for a compliance review or audit.
    In addition, MMS lacks a process to routinely and systematically 
reconcile production data included by payors on their royalty reports 
or by operators on their production reports with production data 
available from third-party sources. OMM does compare a large part of 
the offshore operator-reported production data with third-party data 
from pipeline operators through both its oil and gas verification 
programs, but BLM compares only a relatively small percentage of 
reported onshore oil and gas production data with third-party pipeline 
data. When BLM and OMM do make comparisons and find discrepancies, they 
forward the information to MMS, which then takes steps to reconcile and 
correct these discrepancies by talking to operators. However, even when 
discrepancies are corrected and the operator-reported data and pipeline 
data have been reconciled, these newly reconciled data are not 
automatically and systematically compared with the reported sales 
volume in the royalty report, previously entered into the financial 
management database, to ensure the accuracy of the royalty payment. 
Such comparisons occur only if a royalty payor's property has been 
selected for an audit or compliance review.
    Furthermore, MMS's financial management system lacks internal 
controls over the integrity and accuracy of production and royalty-in-
value data entered by companies. Companies may legally make changes to 
both royalty and production data in MMS's financial management system 
for up to 6 years after the reporting month, and these changes may 
necessitate changes in the royalty payment. 14 However, when 
companies retroactively change the data they previously entered, these 
changes do not require prior approval by, or notification of, MMS. As a 
result of the companies' ability to unilaterally make these retroactive 
changes, the production data and required royalty payments can change 
over time, further complicating efforts by agency officials to 
reconcile production data and ensure that the proper amount of 
royalties was paid. Compounding this data reliability concern, changes 
made to the data do not necessarily trigger a review to determine their 
reasonableness or whether additional royalties are due. According to 
agency officials, these changes are not subject to review at the time a 
change is made and would be evaluated only if selected for an audit or 
compliance review. This is also problematic because companies may 
change production and royalty data after an audit or compliance review 
has been done, making it unclear whether these audited royalty payments 
remain accurate after they have been reviewed. Further, MMS officials 
recently examined data from September 2002 through July 2007 and 
identified over 81,000 adjustments made to data outside the allowable 
6-year time frame. MMS is working to modify the system to automatically 
identify adjustments that have been made to data outside of the 
allowable 6-year time frame, but this effort does not address the need 
to identify adjustments made within the allowable time that might 
necessitate further adjustments to production data and royalty payments 
due.
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    \14\ The Royalty Simplification and Fairness Act of 1996, Pub. L. 
No. 104-185, Sec. 5(a) (1996), provides a 6 year adjustment window.
---------------------------------------------------------------------------
    Finally, MMS's financial management system could not reliably 
detect when production data reports were missing until late 2004, and 
the system continues to lack the ability to automatically detect 
missing royalty reports. In 2004, MMS modified its financial management 
system to automatically detect missing production reports. As a result, 
MMS has identified a backlog of approximately 300,000 missing 
production reports that must be investigated and resolved. It is 
important that MMS have a complete set of accurate production reports 
so that BLM can prioritize production inspections, and its compliance 
group can easily reconcile royalty payments with production 
information. Importantly, MMS's financial management system continues 
to lack the ability to automatically detect cases in which an expected 
royalty report has not been filed. While not filing a royalty report 
may be justifiable under certain circumstances, such as when a company 
sells its lease, MMS's inability to detect missing royalty reports 
presents the risk that MMS will not identify instances in which it is 
owed royalties that are simply not being paid. Officials told us they 
are currently able to identify missing royalty reports in instances 
when they have no royalty report to match with funds deposited to 
Treasury. However, cases in which a company stops filing royalty 
reports and stops paying royalties would not be detected unless the 
payor or lease was selected for an audit or compliance review.
MMS's Compliance Efforts Do Not Consistently Use Third-Party Data to 
        Check Self-Reported Royalty-in-Value Payment Data
    MMS's increasing use of compliance reviews, which are more limited 
in scope than audits, has led to an inconsistent use of third-party 
data to verify that self-reported royalty data are correct, thereby 
placing accurate royalty collections at risk. Since 2001, MMS has 
increasingly used compliance reviews to achieve its performance goals 
of completing compliance activities--either full audits or compliance 
reviews--on a predetermined percentage of royalty payments. According 
to MMS, compliance reviews can be conducted much more quickly and 
require fewer resources than audits, largely because they represent a 
quicker, more limited reasonableness check of the accuracy and 
completeness of a company's self-reported data, and do not include a 
systematic examination of underlying source documentation. Audits, on 
the other hand, are more time- and resource-intensive, and they include 
the review of original source documents, such as sales revenue data, 
transportation and gas processing costs, and production volumes, to 
verify whether company-reported data are accurate and complete. When 
third-party data are readily available from OMM, MMS may use them when 
conducting a compliance review. For example, MMS may use available 
third-party data on oil and gas production volumes collected by OMM in 
its compliance reviews for offshore properties. In contrast, because 
BLM collects only a limited amount of third-party data for onshore 
production, and MMS does not request these data from the companies, MMS 
does not systematically use third-party data when conducting onshore 
compliance reviews. Despite conducting thousands of compliance reviews 
since 2001, MMS has only recently evaluated their effectiveness. For 
calendar year 2002, MMS compared the results of 100 of about 700 
compliance reviews of offshore leases and companies with the results of 
audits conducted on those same leases or companies. However, while the 
compliance reviews covered, among other things, 12 months of production 
volumes on all products--oil, gas, and retrograde, a liquid product 
that condenses out of gas under certain conditions--the audits covered 
only 1 month and one product. As a result of this evaluation comparing 
the results of compliance reviews with those of audits, MMS now plans 
to improve its compliance review process by, for example, ensuring that 
it includes a step to check that royalties are paid on all royalty-
bearing products, including retrograde.
    To achieve its annual performance goals, MMS began using the 
compliance reviews along with audits. One of MMS's performance goals is 
to complete compliance activities--either audits or compliance 
reviews--on a specified percentage of royalty payments within 3 years 
of the initial royalty payment. For example, in 2006 MMS reported that 
it had achieved this goal by confirming reasonable compliance on 72.5 
percent of all calendar year 2003 royalties. To help meet this goal, 
MMS continues to rely heavily on compliance reviews, yet it is unable 
to state the extent to which this performance goal is accomplished 
through audits as opposed to compliance reviews. As a result, MMS does 
not have information available to determine the percentage of the goal 
that was achieved using third-party data and the percentage that did 
not systematically rely on third-party data. Moreover, to help meet its 
performance goal, MMS has historically conducted compliance reviews or 
audits on leases and companies that have generated the most royalties, 
with the result that the same leases and companies are reviewed year 
after year. Accordingly, many leases and companies have gone for years 
without ever having been reviewed or audited.
    In 2006, Interior's Inspector General (IG) reviewed MMS's 
compliance process and made a number of recommendations aimed at 
strengthening it. The IG recommended, among other things, that MMS 
examine 1 month of third-party source documentation as part of each 
compliance review to provide greater assurance that both the production 
and allowance data are accurate. The IG also recommended that MMS track 
the percentage of the annual performance goal that was accomplished 
through audits versus through compliance reviews, and that MMS move 
toward a risk-based compliance program and away from reviewing or 
auditing the same leases and companies each year. To address the IG's 
recommendations, MMS has recently revised its compliance review 
guidance to include suggested steps for reviewing third-party source 
production data when available for both offshore and onshore oil and 
gas, though the guidance falls short of making these steps a 
requirement. MMS has also agreed to start tracking compliance activity 
data in 2007 that will allow it to report the percentage of the 
performance goal that was achieved through audits versus through 
compliance reviews. Finally, MMS has initiated a risk-based compliance 
pilot project, whereby leases and companies are selected for compliance 
work according to MMS-defined risk criteria that include factors other 
than whether the leases or companies generate high royalty payments. 
According to MMS, during Fiscal Year 2008 it will further evaluate and 
refine the pilot as it moves toward fuller implementation.
    Finally, representatives from the states and tribes who are 
responsible for conducting compliance work under agreements with MMS 
have expressed concerns about the quality of self-reported production 
and royalty data they use in their reviews. As part our work, we sent 
questionnaires to all 11 states and seven tribes that conducted 
compliance work for MMS in Fiscal Year 2007. Of the nine state and five 
tribal representatives who responded, seven reported that they lack 
confidence in the accuracy of the royalty data. For example, several 
representatives reported that because of concerns with MMS's production 
and royalty data, they routinely look to other sources of corroborating 
data, such as production data from state oil and gas agencies and tax 
agencies. Finally, several respondents noted that companies frequently 
report production volumes to the wrong leases and that they must then 
devote their limited resources to correcting these reporting problems 
before beginning their compliance reviews and audits.
The MMS Royalty-in-Kind Program Is at Risk of Inaccurate Collection of 
        Natural Gas Royalties because of Inconsistent Oversight
    Because MMS's royalty-in-kind program does not extend the same 
production verification processes used by its oil program to its gas 
program, it does not have adequate assurance that it is collecting the 
gas royalties it is owed. As noted, under the royalty-in-kind program, 
MMS collects royalties in the form of oil and gas and then sells these 
commodities in competitive sales. To ensure that the government obtains 
the fair value of these sales, MMS must make sure that it receives the 
volumes to which it is entitled. Because prices of these commodities 
fluctuate over time, it is also important that MMS receive the oil and 
gas at the time it is entitled to them. As part of its royalty-in-kind 
oversight effort, MMS identifies imbalances between the volume 
operators owe the federal government in royalties and the volume 
delivered and resolves these imbalances by adjusting future delivery 
requirements or cash payments. The methods that MMS uses to identify 
these imbalances differ for oil and gas.
      For oil, MMS obtains pipeline meter data from OMM's 
liquid verification system, which records oil volumes flowing through 
numerous metering points in the Gulf of Mexico region. MMS calculates 
its royalty share of oil by multiplying the total production volumes 
provided in these pipeline statements by the royalty rates for a given 
lease. MMS compares this calculation with the volume of royalty oil 
that the operators delivered as reported by pipeline operators. When 
the value of an imbalance cumulatively reaches $100,000, MMS conducts 
further research to resolve the discrepancy. Using pipeline statements 
to verify production volumes is a good check against companies' self-
reporting of royalties due the federal government because companies 
have an incentive to not underreport their share of oil going into the 
pipeline because that is the amount they will have to sell at the other 
end of the pipeline.
      For gas, MMS relies on information contained in two 
operator-provided documents--monthly imbalance statements and 
production reports. Imbalance statements include the operator's total 
gas production for the month, the share of that production that the 
government is entitled to, and any differences between what the 
operator delivered and the government's royalty share. Production 
reports contain a large number of data elements, including production 
volumes for each gas well. MMS compares the production volumes 
contained in the imbalance statements with those in the production 
reports to verify production levels. MMS then calculates its royalty 
share based on these production figures and compares its royalty share 
with gas volumes the operators delivered as reported by pipeline 
operators. When the value of an imbalance cumulatively reaches 
$100,000, MMS conducts further research to resolve the discrepancy.
    MMS's ability to detect gas imbalances is weaker than for oil 
because it does not use third-party metering data to verify the 
operator-reported production numbers. Since 2004, OMM has collected 
data from gas pipeline companies through its gas verification system, 
which is similar to its liquid verification system in that the system 
records information from pipeline company-provided source documents. 
Our review of data from this program shows that these data could be a 
useful tool in verifying offshore gas production volumes. 15 
Specifically, our analysis of these pipeline data showed that for the 
months of January 2004, May 2005, July 2005, and June 2006, 25 percent 
of the pipeline metering points had an outstanding discrepancy between 
self-reported and pipeline data. 16 These discrepancies are 
both positive and negative--that is, production volumes submitted to 
MMS by operators are at times either under- or overreported.
---------------------------------------------------------------------------
    \15\ Onshore gas properties accounted for less than 1 percent of 
the revenue managed by the royalty-in-kind program from Fiscal Year 
2004 through Fiscal Year 2006, but this area is expected to grow in the 
future.
    \16\ For purpose of this testimony, we used 4 months of data from 
the gas verification system. We chose these months (January 2004, May 
2005, July 2005, and June 2006) because these are the months for which 
MMS has started to work to resolve the discrepancies identified between 
the production reports and pipeline data.
---------------------------------------------------------------------------
    Data from the gas verification system could be useful in validating 
production volumes and reducing discrepancies. However, to fully 
benefit from this opportunity, MMS needs to improve the timeliness and 
reliability of these data. After examining this issue, in December 
2007, the Subcommittee on Royalty Management, a panel appointed by the 
Secretary of the Interior to examine MMS's royalty program, reported 
that OMM is not adequately staffed to conduct sufficient review of data 
from the gas verification system. 17 We have not yet, nor 
has MMS, determined the net impact of these discrepancies on royalties 
owed the federal government.
---------------------------------------------------------------------------
    \17\ Subcommittee on Royalty Management, Royalty Policy Committee, 
Report to the Royalty Policy Committee: Mineral Revenue Collection from 
Federal and Indian Lands and the Outer Continental Shelf (2007).
---------------------------------------------------------------------------
Significant Questions and Uncertainties Exist Regarding the Reported 
        Financial Benefits of the Royalty-in-Kind Program
    The methods and underlying assumptions MMS uses to compare the 
revenues it collects in kind with what it would have collected in cash 
do not account for all costs and do not sufficiently deal with 
uncertainties, raising doubts about the claimed financial benefits of 
the royalty-in-kind program. Specifically, MMS's calculation showing 
that MMS sold the royalty oil and gas for $74 million more than MMS 
would have received in cash payments did not appropriately account for 
uncertainty in estimates of cash payments. In addition, MMS's 
calculation that early royalty-in-kind payments yielded $5 million in 
interest was based on assumptions about payment dates and interest 
rates that could misstate the estimated interest benefit. Finally, 
MMS's calculation that the royalty-in-kind program cost about $8 
million less to administer than an in-value program did not include 
significant costs that, if included, could change MMS's conclusions.
Sales Revenue
    MMS sold the oil and gas it collected during the 3 Fiscal Years 
2004 through 2006 for $8.15 billion and calculated that this amount 
exceeded what MMS would have received in cash royalties by about $74 
million--a net benefit of approximately 0.9 percent. MMS has recognized 
that its estimates of what it would have received in cash payments are 
subject to some degree of error but has not appropriately evaluated or 
reported how sensitive the net benefit calculations are to this error. 
18 This is important because even a 1 percent error in the 
estimates of cash payments would change the estimated benefit of the 
royalty-in-kind program from $74 million to anywhere from a loss of $6 
million to a benefit of $155 million.
---------------------------------------------------------------------------
    \18\ OMB Circular A-94, ``Guidelines and Discount Rates for 
Benefit-Cost Analysis of Federal Programs,'' suggests that such 
sensitivity analysis be done and reported.
---------------------------------------------------------------------------
    Moreover, MMS's annual reports to the Congress present oil sales 
data in aggregate and therefore do not reflect the fact that, in many 
individual sales, MMS sold the oil it collected in kind for less than 
it estimates it would have collected in cash. Specifically, MMS 
estimates that, in Fiscal Year 2006, it sold 28 million barrels of oil, 
or 64 percent of all the oil it collected in kind, for less than it 
would have collected in cash. The government would have received an 
additional $6 million in revenue if it had taken these royalties in 
cash instead. These sales indicate that MMS has not always been able to 
achieve one of its central goals: to select, based on systematic 
economic analysis, which royalties to take in cash and which to take in 
kind in a way that maximizes revenues to the government.
    According to a senior MMS official, the federal government has 
several advantages when selling gas that it does not have when selling 
oil, a fact that helps to explain why MMS's gas sales have performed 
better than its oil sales. For example, MMS can bundle the natural gas 
production in the Gulf of Mexico from many different leases into large 
volumes that MMS can use to negotiate discounts for transporting gas 
from production sites to market centers. Because purchasers receive 
these discounts when they buy gas from MMS, they may be willing to pay 
more for gas from MMS than from the original owners. Opportunities for 
bundling are less prevalent in the oil market. Because MMS generally 
does not have this, or other, advantages when selling oil, purchasers 
often pay MMS about what they would pay other producers for oil, and 
sometimes less. Indeed, MMS's policies allow it to sell oil for up to 
7.7 cents less per barrel than MMS estimates it would collect if it 
took the royalties in cash. MMS told us that the other financial 
benefits of the royalty-in-kind program, including interest payments 
and reduced administrative costs, justify selling oil for less than the 
estimated cash payments because once these additional revenues are 
factored in, the net benefit to the government is still positive. 
However, as discussed below, we have found that there are significant 
questions and uncertainties about the other financial benefits as well.
Interest
    Revenues from the sale of royalty-in-kind oil are due 10 days 
earlier than cash payments, and revenues from the sale of in-kind gas 
are due 5 days earlier. MMS calculates that the government earned about 
$5 million in interest from Fiscal Years 2004 through 2006 from these 
early payments that it would not have received had it taken royalties 
in cash. 19 We found two weaknesses in the way MMS 
calculates this interest. First, the payment dates used to calculate 
the interest revenue have the potential to over- or underestimate its 
value. MMS calculates the interest on the basis of the time between the 
actual date that Treasury received a royalty-in-kind payment and the 
theoretical latest date that Treasury would have received a cash 
payment under the royalty-in-value program. However, MMS officials told 
us that cash payments can, and sometimes do, arrive before their due 
date. As a result, MMS might be overstating the value of the early 
royalty-in-kind payments. Second, the interest rate used to calculate 
the interest revenue may either over- or understate its value because 
the rate is not linked to any market rate. From Fiscal Year 2004 
through 2007, MMS used a 3 percent interest rate to calculate the time 
value of these early payments. However, during this time, actual market 
interest rates at which the federal government borrowed fluctuated. For 
example, 4-week Treasury bill rates ranged from a low of 0.72 percent 
to a high of 5.18 percent during this same period. Therefore, during 
some fiscal years, MMS likely overstated or understated the value of 
these early payments.
---------------------------------------------------------------------------
    \19\ While MMS calls this value ``interest,'' it is not interest 
per se because the money does not go into an interest-bearing account. 
Rather, MMS argues that the government uses the early payments to cover 
expenses that it would otherwise need to borrow money to pay for. The 
interest, then, is the cost that the government avoids by deferring the 
need to borrow.
---------------------------------------------------------------------------
Administrative Cost Savings
    MMS has developed procedures to capture the administrative costs of 
the royalty-in-kind and cash royalty programs and includes in its 
administrative cost comparison primarily the variable costs for the 
federal offshore oil and gas activities--that is, costs that fluctuate 
based on the volume of oil or gas received by MMS, such as labor costs. 
Although MMS also includes some department-level fixed costs, it 
excludes some fixed costs that it does not incur on a predictable basis 
(largely information technology [IT] costs). According to MMS, if it 
included these IT and other such costs, there would be a high potential 
of skewing the unit price used to determine the administrative cost 
savings. However, by excluding such fixed costs from the administrative 
cost comparison, MMS is not including all the necessary cost 
information to evaluate the efficacy of the royalty-in-kind program.
    MMS's administrative cost analysis compares a bundle of royalty-in-
kind program administrative costs divided by the number of barrels of 
oil equivalent realized by the royalty-in-kind program during a year, 
20 with a bundle of cash royalty program administrative 
costs divided by the number of barrels of oil equivalent realized by 
that program. The difference between these amounts represents the 
difference in cost to administer a barrel of oil equivalent under each 
program.
---------------------------------------------------------------------------
    \20\ A barrel of oil equivalent is an amount of natural gas or 
natural gas liquid that contains the same heating value as a barrel of 
oil.
---------------------------------------------------------------------------
    MMS then multiplies the difference in cost to administer a barrel 
of oil equivalent under the two programs by the number of barrels of 
oil equivalent realized by the royalty-in-kind program to determine the 
administrative cost savings. However, MMS's calculations excluded some 
fixed costs that are not incurred on a regular or predictable basis 
from the analysis. For example, in Fiscal Year 2006, royalty-in-kind IT 
costs of $3.4 million were excluded from the comparison. Moreover, 
additional IT costs of approximately $29.4 million--some of which may 
have been incurred for either the royalty-in-kind or the cash royalty 
program--were also excluded. Including and assigning these IT costs to 
the programs supported by those costs would provide a more complete 
accounting of the respective costs of the royalty-in-kind and royalty-
in-value programs, and would likely impact the results of MMS's 
administrative cost analysis.
Conclusions
    Ultimately the system used by Interior to ensure taxpayers receive 
appropriate value for oil and gas produced from federal lands and 
waters is more of an honor system than we are comfortable with. Despite 
the heavy scrutiny that Interior has faced in its oversight of royalty 
management, we and others continue to identify persistent weaknesses in 
royalty collections. Given both the long-term fiscal challenges the 
government faces and the increased demand for the nation's oil and gas 
resources, it is imperative that we have a royalty collection system 
going forward that can assure the American public that the government 
is receiving proper royalty payments. Our work on this issue is 
continuing along several avenues, including comparing the royalties 
taken in kind with the value of royalties taken in cash, assessing the 
rate of oil and gas development on federal lands, comparing the amount 
of money the U.S. government receives with what foreign countries 
receive for allowing companies to develop and produce oil and gas, and 
examining further the accuracy of MMS's production and royalty data. We 
plan to make recommendations to address the weaknesses we identified in 
our final reports on these issues.
    We look forward to further work and to helping this subcommittee 
and the Congress as a whole to exercise oversight on this important 
issue. Mr. Chairman, this concludes our prepared statement. We would be 
pleased to respond to any questions that you or other members of the 
subcommittee may have at this time.
GAO Contact and Staff Acknowledgments
    For further information about this testimony, please contact either 
Frank Rusco, at 202-512-3841, or [email protected], or Jeanette Franzel, 
at 202-512-9406, or [email protected]. Contact points for our 
Congressional Relations and Public Affairs may be found on the last 
page of this statement. Contributors to this testimony include Ron 
Belak, Ben Bolitzer, Lisa Brownson, Melinda Cordero, Nancy Crothers, 
Glenn C. Fischer, Cindy Gilbert, Tom Hackney, Chase Huntley, Heather 
Hill, Barbara Kelly, Sandra Kerr, Paul Kinney, Jennifer Leone, Jon 
Ludwigson, Tim Minelli, Michelle Munn, G. Greg Peterson, Barbara 
Timmerman, and Mary Welch.

[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

                                 

      Response to questions submitted for the record by Dr. Rusco

Majority Question Responses
 1.  Mr. Rusco, do you believe it is appropriate for MMS to be in 
        charge of analyzing the success of the Royalty-in-Kind Program? 
        It seems that they have a strong incentive to show how well it 
        is working, so would it be better to have someone outside of 
        MMS be doing this review? And if so, who might you suggest?
    Answer: Our review of the royalty-in-kind program raised 
significant concerns about the assumptions and methods that MMS uses to 
compare the revenues it collects in kind with what it would have 
collected in cash payments. However, we believe that if MMS addresses 
these concerns, MMS could produce reliable information on this key 
aspect of program performance.
 2.  Mr. Rusco, did GAO identify any specific instances of a breakdown 
        in internal controls related to reporting?
    Answer: We identified several instances where internal controls 
were either absent or not working effectively. One instance of a 
missing internal control we identified was the inability of MMS's 
information technology (IT) system to effectively identify missing 
royalty reports, a critical piece of data used by MMS to determine 
whether royalties were paid. We also identified several instances where 
internal controls were ineffective. For example, while MMS's IT system 
now has the ability to identify missing production reports, it now has 
a significant backlog of production data that staff are spending 
considerable time and resources attempting to reconcile. Finally, MMS's 
interest IT module, which is used to calculate and charge interest 
payments to payors for late payments, never fully worked and is in the 
process of being re-designed, subject to funding.
    We also identified several weaknesses in MMS's system for measuring 
and reporting the performance of the RIK program. Specifically, we 
determined that MMS does not appropriately measure or report: (1) the 
uncertainty of the benefits of taking royalties in kind or (2) the 
interest accrued from receiving royalty-in-kind payments earlier than 
cash payments. Further, we found that MMS's annual reports to Congress 
have not fully reported all the costs of administering the RIK program. 
These weaknesses make it unclear whether the benefits of taking 
royalties in kind have exceeded what MMS would have received had it 
taken royalties in cash instead.
 3.  Mr. Rusco, what is needed for MMS to better ensure the accurate 
        collection of royalties?
    Answer: We plan on issuing a product related to the ongoing work 
from which our testimony was drawn that will include recommendations on 
how MMS can better ensure accurate collections of royalties. Those 
recommendations will deal with improvements to help ensure the 
completeness and accuracy of royalty data and the related collections. 
Furthermore, we have additional ongoing work examining royalty 
collections and will include recommendations in our reporting as 
appropriate.
 4.  Mr. Rusco, it seems that MMS relies heavily on the audit and 
        compliance group to find errors in royalty and production 
        reporting. Is that more efficient than having the financial 
        management system be better controlled?
    Answer: We did not directly address the issue of whether MMS's 
financial management system with better controls would be more 
efficient than relying on audits and compliance reviews. Our work did 
identify that MMS currently uses both up-front edit checks to prevent 
erroneous data from being initially entered into the financial system--
preventive controls--as well as after-the-fact audits and compliance 
reviews to detect incorrect royalty payments--detection controls. An 
effective internal control environment consists of both strong 
preventive controls in addition to detection controls. An appropriate 
balance between the two is also important in achieving effectiveness 
and efficiency of internal controls. For example, where there is a high 
volume of transactions, the lack of preventive controls significantly 
increases the risk of errors and accordingly increases the need for 
particularly sensitive detection controls. In the absence of preventive 
controls, a high number of errors can render detection controls not 
only inefficient but also ineffective in detecting and correcting 
errors in a timely manner.
 5.  Mr. Rusco, in your testimony, you discuss what appear to be 
        significant lapses in key internal controls. Would GAO agree 
        that when controls are weak, particularly when surrounding a 
        ``checkbook'' of billions of dollars, the risk of fraud goes up 
        dramatically?
    Answer: While we did not perform specific tests that might have 
uncovered potential fraud, it is true that the risk of fraud increases 
in the absence of strong internal controls. However, internal controls, 
even when operating optimally, will not provide a 100 percent guarantee 
that someone cannot commit fraud. Because fraud is usually concealed, 
material misstatements due to fraud are difficult to detect. 
Nevertheless, certain events or conditions that indicate incentives or 
pressures to perpetrate fraud, opportunities to carry out the fraud, or 
attitudes and rationalizations to justify a fraudulent action may be 
present at MMS. Such events or conditions are referred to as ``fraud 
risk factors.'' Fraud risk factors do not necessarily indicate the 
existence of fraud; however, they often are present in circumstances 
where fraud exists. During the course of our work, we found that at 
least two of the three key indicators of fraud--an incentive for 
someone to misappropriate assets (for example cash or gas and oil in 
this case), and the opportunity to do so (that is, a relatively low 
risk of being caught)--may exist in MMS's environment of collecting the 
federal government's fair share of royalties from oil and gas produced 
on federal properties. However, we have not uncovered any fraud during 
the course of our work so far.
 6.  Mr. Rusco, in response to a question at the hearing, Mr. Finfer 
        stated that one of the crucial elements to a risk-based 
        compliance strategy is good data. Do you believe that MMS 
        currently has data of sufficient quality to properly implement 
        an effective risk-based compliance strategy?
    Answer: We agree that a crucial element of a risk-based compliance 
strategy is good data upon which to base management's risk assessments 
and judgments. We have previously reported on data accuracy problems in 
limited sets of royalty data extracted from MMS's financial management 
system. At this time, however, we are unable to comment on the full 
extent of the reliability of the underlying data used to assign risk as 
we did not assess many of the data elements that MMS has proposed to 
use in ranking both properties and payors. We are in the process of 
doing additional work in this area and will report out when that work 
is completed.
 7.  Mr. Rusco, we constantly hear from MMS that the Royalty-in-Kind 
        Program is performing well. Your testimony indicates the 
        benefits are less certain. Do you think MMS's reports are 
        giving us the full story, and could you provide an example of 
        this?
    Answer: MMS's annual reports are not providing the Congress with 
the full picture regarding the performance of the royalty-in-kind 
program. By presenting oil sales data aggregated by major sales 
category, the reports do not reflect the fact that, in many individual 
sales, MMS has sold the oil it collected in kind for less than it 
estimates it would have collected in cash. For example, MMS estimates 
that, in Fiscal Year 2006, it sold 64 percent of all the oil it 
collected in kind, for less than it would have collected in cash.
 8.  Mr. Rusco, could you discuss your views of the usefulness of the 
        State and Tribal Royalty Audit Committee, or ``STRAC''? And do 
        you see any way to improve the relationship between STRAC and 
        MMS?
    Answer: The State and Tribal Royalty Audit Committee (STRAC) works 
under authority granted in the Federal Oil and Gas Royalty Management 
Act. It performs compliance work through agreements with MMS and brings 
jurisdictional expertise and staff to MMS's compliance activities. We 
are aware that there are many written communications between STRAC and 
MMS. However, we have not examined whether or how the relationship 
between STRAC and MMS could be improved.
 9.  Mr. Rusco, in your testimony, you seem to say that if a company 
        gets a compliance review or an audit, it can make an adjustment 
        afterwards that MMS will never check? Is that true? Does the 
        MMS ``Adjustment Line Monitoring Initiative'' help with that?
    Answer: A company can make adjustments to data after MMS has 
completed either an audit or a compliance review, and MMS does not have 
controls in place to assess the justification for each of those 
adjustments. In commenting on our draft testimony, MMS stated that 
staff are currently developing requirements for an IT initiative to be 
completed in Fiscal Year 2008 that will assist in monitoring 
adjustments. As of March 2008, MMS has not finalized the IT 
specifications for this module, so we are unable to determine the 
extent to which this would address our concerns. As planned, the new IT 
system module would monitor adjustments made after the module went on-
line and would not address prior adjustments. Accordingly, unless MMS 
goes back and reviews past data, we will not be confident that all past 
adjustments have been warranted.
10.  Mr. Rusco, in their testimony, Senators Kerrey and Garn discuss 
        the difference in the so-called ``front-end'' and ``back-end'' 
        of BLM's operations, saying that increased funding has been 
        focused on additional leasing and processing of applications 
        for permits to drill, but ``there has not been sufficient 
        attention'' to collections, production accountability, and 
        auditing requirements. Has GAO seen evidence of this in recent 
        years?
    Answer: BLM field office staff tell us that many resources are 
dedicated to processing drilling permits. These staff and the official 
BLM inspection strategy guidance, indicates that resources are 
prioritized for ``front-end'' activities, such as drilling inspections 
rather than ``back-end'' activities, such as production verification. 
Furthermore, we reported in Oil and Gas Development: Increased 
Permitting Activity Has Lessened BLM's Ability to Meet Its 
Environmental Protection Responsibilities (GAO-05-418) that BLM's 
ability to meet its environmental mitigation responsibilities for oil 
and gas development has been lessened by a dramatic increase in oil and 
gas operations on federal lands between 1999 and 2005. Since that time, 
permitting activity has continued to increase.
11.  Mr. Rusco, I understand that GAO is now looking at some of the 
        issues with the Accenture computing system that the Inspector 
        General brought up in September. Could you discuss your work on 
        this issue?
    Answer: We agreed with the Department of the Interior's Inspector 
General (IG) that we would examine key functionalities of the IT 
system, whereas the IG would examine the contract Accenture had with 
MMS to develop the IT system and determine whether the end product was 
what the contract specified. Accordingly, we spoke with MMS staff and 
STRAC users of the IT system and are doing further work to evaluate the 
quality of the data managed in that system. We will report on the 
results of this work when it is completed.
12.  Mr. Rusco, the Subcommittee on Royalty Management's report says 
        that ``MMS's processes for evaluating the feasibility of RIK 
        vs. RIV appears to be rigorous and effective.'' Do you agree 
        with that statement?
    Answer: Before MMS decides to take royalties from a particular 
property or pipeline in kind, MMS compares the revenues it expects to 
receive by taking the royalties in kind to what it currently receives 
in cash. We did not evaluate the effectiveness of this prospective 
analysis. Rather, we evaluated the methods that MMS uses to 
retrospectively determine whether the benefits from taking royalties in 
kind were, in fact, better than taking royalties in value. Our review 
raised significant concerns about this retrospective analysis. MMS can 
use its retrospective analysis to help inform prospective decisions 
about which properties or portfolios to keep in the in-kind program. 
For example, MMS placed one portfolio of natural gas leases back into 
the in-value program after noticing that sales from these leases had 
performed poorly. Our concerns about the retrospective analyses also 
raise significant concerns about whether these analyses provide 
reliable information regarding which leases to keep in the in-kind 
program over time.
13.  Mr. Rusco, a footnote in your testimony says that certain BLM 
        state officials believed the data in BLM's Automated Fluid 
        Minerals Support System (AFMSS) were unreliable. Have you 
        assessed the AFMSS and the reliability of its data?
    Answer: We identified a number of discrepancies in the production 
inspection data stored in BLM's Automated Fluid Minerals Support System 
(AFMSS) and determined that it was not sufficiently reliable for our 
reporting purposes. During the course of our work, we took a number of 
steps to assess the reliability of the production inspection data. 
These steps included requesting the Fiscal Year 2007 production 
inspection data from AFMSS from BLM's AFMSS database manager for those 
field offices that we included in our review. We then asked field staff 
to validate the numbers we received from AFMSS. In several cases, field 
office staff stated that the numbers were not correct and subsequently 
revised the numbers in AFMSS. However, in two instances, BLM staff were 
unable to validate the AFMSS production inspection numbers because they 
lacked confidence in the data. Consequently, we were uncomfortable 
reporting the actual production inspection numbers in our testimony. In 
assessing the reliability of the data, we did not perform electronic 
testing, nor did we compare records kept in BLM's paper files with data 
in AFMSS.
14.  Mr. Rusco, in your testimony you say that MMS lacks an automated 
        process to reconcile payor production data with production data 
        filed by operators. However, MMS reports that they have an 
        automated Compliance Process Tool (CPT) which makes those 
        reconciliations. How do these two statements square up, and how 
        does the CPT compare to MMS's old automated process?
    Answer: MMS's prior IT system automatically compared all production 
reports and royalty reports within 6 months without human intervention. 
However, during the course of our work MMS officials told us that the 
that the new system only compared a portion of the production reports 
with the royalty reports through the compliance review process, which 
generally is done 3 years after royalties are reported. Furthermore, 
while this comparison is done via the Compliance Program Tool, it 
requires an analyst to manipulate the menus and query tools to complete 
the actual comparison. The need for staff to perform this comparison, 
rather than its being done automatically, takes time away from other 
compliance efforts. MMS recently told us that it is in the process of 
changing its policies on comparing production and royalty reports. 
However, we have not yet assessed this process.
15.  Mr. Rusco, on page 8 of your testimony, you describe one instance 
        of a bypass built around a gas meter and one instance of a 
        company maintaining two sets of conflicting production data. 
        What action was taken by BLM in these instances, and did the 
        companies face any financial penalties?
    Answer: In the instance of the bypass, BLM staff told us that they 
issued the company an Incident of Non-Compliance. The company 
subsequently removed the bypass. Because the company removed the bypass 
within the allotted timeframe, the company was not issued a financial 
fine.
    In the other instance, according to BLM Petroleum Engineer 
Technicians, the company kept two sets of books--the internal raw data 
and the data reported to MMS on the Oil and Gas Operations Report 
(OGOR). Although, the total volumes of oil and gas on those books were 
the same, the company altered production amounts at the well level that 
they reported to MMS on the OGOR. BLM subsequently asked the company to 
correct and resubmit the OGORs and did not issue the company a 
financial fine.
16.  Mr. Rusco, please describe whether the findings and 
        recommendations of the Royalty Policy Committee report dated 
        December 17, 2007 are consistent with findings reported by GAO 
        in its testimony to the subcommittee on March 11, 2008, and 
        point out any major differences that exist between the two 
        reports.
    Answer: The findings reported by GAO in its testimony to the 
subcommittee on March 11, 2008 are generally consistent with the 
findings and recommendations of the Royalty Policy Committee (RPC) 
report dated December 17, 2007. This similarity is due to the fact that 
both GAO's and RPC's objectives focused on two common objectives--(1) 
to determine whether MMS collects the correct amount of federal and 
Indian mineral royalties, and (2) to assess whether the federal 
government is benefited by taking royalties in kind. To address these 
objectives, both GAO and RPC reviewed management's oversight 
activities, policies, procedures, systems and internal controls.
    While RPC concluded that MMS is an effective steward for federal 
and Indian mineral interests, it also found a number of management 
activities requiring prompt, and in some cases, significant management 
attention, to ensure public confidence. Over 100 detailed 
recommendations to management were reported by RPC. For example, 
several of these recommendations were directed at MMS and BLM to 
improve production accountability and production measurement. GAO 
shares this concern and believes that without improvement in 
verification procedures, MMS cannot be assured that it is receiving 
full compensation for oil and gas produced on federal and Indian 
properties.
    GAO and RPC also evaluated the RIK program and concluded that 
improvements are needed to increase transparency of reporting and 
clarity of management decision-making when determining whether to take 
royalties in kind or in value. For example, RPC recommended, and GAO 
suggested in its testimony, that MMS should report on the uncertainties 
surrounding the benefits of taking royalties in kind. However, there 
are a number of differences between the two reports with respect to the 
RIK program. For example, RPC concluded that MMS should explore the 
feasibility of establishing a trust fund, the interest from which could 
be used to fund royalty management activities. The RPC also concluded 
that MMS should study the use of various governance arrangements for 
the RIK program. GAO has not explored these issues. Moreover, GAO was 
not requested to examine outer continental shelf (OCS) royalty relief 
as part of this testimony, whereas RPC was charged with reviewing the 
Department's procedures established in response to the lack of price 
thresholds for certain deep water leases in the Gulf of Mexico. This 
additional examination by RPC resulted in six recommendations to 
improve management in offshore leases.
17.  Mr. Rusco, please describe to what extent GAO considered the 
        results of (1) audit reports issued by the Department of the 
        Interior's independent public accountants, KPMG, and (2) an 
        agreed upon procedures report issued by TCB&A, an independent 
        accounting firm engaged by Interior, to examine its RIK cost 
        methodology, in assessing and reporting on whether MMS's 
        oversight provides adequate assurance that full compensation is 
        being received from oil and gas produced on federal properties.
    Answer: GAO reviewed and assessed these and other relevant 
accountants' and auditors' reports (e.g. reports of Interior's OIG) in 
planning the scope of our work. We also considered other auditors' 
results during the course of developing our findings and conclusions in 
reporting our work to the subcommittee. However, key differences 
existed between our work and the scope of the work done by both KPMG 
and TCB&A. In addition, key limitations in the scope of work done by 
KPMG and TCB&A required us to perform additional test work to assess 
MMS's oversight and controls over its royalty collections.
    Specifically, with respect to KPMG's audit of Interior's financial 
statements for 2007 and preceding years (a separate audit was not 
completed for MMS's financial statements in 2007), KPMG's report 
specifically stated that the audit of the financial statements was not 
designed to provide an opinion on internal controls over financial 
reporting or over reported performance information. Accordingly, GAO 
performed additional procedures to assess these internal controls.
    Similarly, GAO found that TCB&A's agreed-upon procedures report, 
dated June 30, 2005, was limited to reviewing the RIK/RIV cost 
comparison methodology and certain underlying fiscal 2004 data. While 
the independent accountants reported MMS's methodology to be 
reasonable, they also found that many underlying data were based on 
undocumented estimates or were otherwise in error. Accordingly, GAO 
further analyzed the underlying data, including expenses through fiscal 
2006, and found that key expense elements--principally information 
systems specifically used for the RIK program--had not been previously 
assessed and had not been included in MMS's cost comparison. Therefore, 
this earlier work supported GAO's conclusion that the RIK/RIV 
methodology may be improved and reported results may be made more 
transparent by including full and accurate costs.
18.  Mr. Rusco, please describe the resources employed by GAO in its 
        audits of MMS that led to the findings in its testimony. How 
        many staff days and other resources were allocated and what 
        were the qualifications of GAO staff who worked on these 
        audits?
    Answer: The findings included in our recent testimony on mineral 
revenues were developed over the course of a year by GAO staff with a 
wide range of qualifications, including staff with a juris doctorate, 
doctorates in economics and social science, and master's degrees in 
public administration, public affairs, environmental science, social 
science and research methods, business administration, and geology. 
Team members also hold certifications in public accounting, software 
engineering project management, government financial management, 
information system auditing, and management accounting.
19.  Mr. Rusco, please describe and point out any major differences 
        between GAO's and MMS's estimates of potential losses resulting 
        from royalty relief in the Gulf of Mexico.
    Answer: MMS's estimate for future losses from leases issued in the 
deep waters of the Gulf of Mexico in 1998 and 1999 compare favorably 
with scenarios that GAO developed to show the effect of different 
production levels and prices. In February 2007, MMS estimated that 
potential losses could be between $6.4 billion and $9.8 billion. In 
April 2007, GAO developed and reported the results of scenarios that 
showed the losses from these leases could range between $4.3 billion 
and $10.5 billion. In June 2007, MMS revised its earlier estimate to 
between $5.3 billion and $7.8 billion, based on oil and gas prices of 
$60.78 per barrel of oil and gas prices of $7.52 per thousand cubic 
feet. We plan to update our scenarios in the near-future.
    GAO has not developed scenarios that illustrate potential losses 
from leases issued in the deep waters of the Gulf of Mexico in 1996, 
1997, and 2000. In October 2004, MMS estimated that forgone royalties 
on these leases could be as high as $60 billion should price thresholds 
not apply to these leases. While we reported in April 2007 that this 
estimate was made in good faith, much had been learned since then and 
we believed that MMS may have been overly optimistic about the amount 
of oil and gas production that would occur over the lifetime of these 
leases. MMS concurred and revised this estimate in February 2008 to 
between $15.7 billion and $21.2 billion. We are currently reviewing 
this estimate and plan to develop scenarios that illustrate the effect 
of different production levels and prices.
Minority Question Response
1.  In our experience, when Congress requests the Government 
        Accountability Office (GAO) to conduct a study or 
        investigation, we find that GAO often comes back to negotiate 
        the scope of the investigation. Oftentimes the reason 
        underlying the negotiation is a lack of resources needed for 
        the scope of the original request. In other words, GAO will try 
        to prioritize the salient aspects of the study that they feel 
        they can conduct within budgetary constraints. However, you 
        appear to be criticizing the MMS for prioritizing hurricane 
        recovery from the hurricanes that hit the Gulf in 2004 and 
        2005. Is that true? Wouldn't you agree that cleaning up after 
        several severe and unprecedented storms should have priority 
        over meter inspections? What MMS, Coast Guard, and the oil & 
        gas industry achieved during those storms and their aftermath 
        was remarkable. The fact that: (1) there were no major spills 
        even though many platforms were lost and (2) all oil field 
        personnel were safely evacuated--seems to be the bigger success 
        story rather than whether an internal best practices inspection 
        goal (that exceeds legal requirements) was met. Do you agree or 
        disagree?
    Answer: One of the research objectives of our work was to determine 
whether MMS was completing the required meter inspections as required 
by agency policy and law. We did not consider or evaluate MMS's 
prioritization methodologies for hurricane safety, recovery, or cleanup 
activities. Therefore we cannot comment on the appropriateness of these 
decisions. However, MMS officials did explain to us that one reason 
they had not complied with their internal production inspection policy 
was that their limited resources were devoted to hurricane recovery and 
cleanup efforts, and we reported this in our testimony. An evaluation 
of what the Coast Guard, MMS, and the oil and gas industry achieved 
during and after Hurricanes Katrina and Rita was not within the scope 
of our work on the accuracy of royalties or the royalty-in-kind 
program.
                                 ______
                                 
    Mr. Costa. Now, let us get to the questions. To all three 
of you, does it make sense in looking at the track record of 
the Royalty-in-Kind Program, it seems to indicate that given 
the vagaries of the marketplace that there is incentive or 
seemingly that it is working, but that maybe someone outside of 
the Minerals Management Service should be doing the review.
    Three of you, could you opine quickly on whether or not 
they are in the appropriate place to make the review?
    Mr. Deal. Let me take a----
    Mr. Costa. Please use the mic.
    Mr. Deal. I am sorry. Can you hear me?
    Mr. Costa. Yes.
    Mr. Deal. OK. Let me take a stab at that. My answer to that 
is no, that it is not wise to export this program outside the 
agency. That is an alluring possibility, but I really question 
whether or not that solves any problems that might be 
perceived, and all three of us have identified some 
shortcomings in the program.
    You have heard both of my colleagues at the table here talk 
about the existing staff. They are energetic. More important 
than that, they are very knowledgeable. Royalty management 
involves not just strict accounting but a deep understanding 
of----
    Mr. Costa. I think you are responding to the entirety of 
the program. I was talking about the analysis of the program.
    Mr. Deal. OK. Maybe I don't understand the question. I am 
sorry, sir.
    Mr. Costa. Well, the point is that it is a complicated 
area. I understand they have about 50 people that deal with the 
review of this in kind program, and they are dealing in a very 
complex marketplace in terms of trying to make these 
determinations, and whether or not that analysis is most 
properly done within that segment within the Minerals 
Management Service was my question.
    Mr. Deal. I see. Are you confining this to RIK?
    Mr. Costa. Yes.
    Mr. Deal. Yes, OK. Well, here again, I think my answer 
would be the same, although I would recognize RIK has a 
different character. MMS is still on the learning curve. They 
would be the first to admit that. However, in the last several 
years they have made great progress. The recommendations we 
have made have been to several very discreet recommendations to 
kind of better their game.
    Mr. Costa. We will look at those recommendations. I want to 
get the other response quickly. Mr. Devaney?
    Mr. Deal. OK.
    Mr. Devaney. Mr. Chairman, I think they can do it. I think 
it is a matter of making sure that they have their policies and 
procedures in place. When we first went in there, there weren't 
too many written documents that described how the process was 
supposed to work. Also, I think they need the right people 
there, and I think they are making positive changes to make 
that happen.
    Mr. Costa. All right. Mr. Rusco?
    Ms. Franzel. Hello, Mr. Chairman. I will answer on behalf 
of GAO. Our findings with regard to the program, we did not 
really detect any large governance issues that would cause us 
to say that it needs to be taken outside of the current 
environment, but rather internal control issues and data 
reliability issues which really would reflect the major tune up 
that Mr. Deal characterized as being needed.
    Mr. Costa. All right. Thank you. Mr. Devaney, you indicated 
that in your September 2007 report that other investigations 
might be forthcoming, a result of what you found. Are you guys 
moving ahead with those, and what are the topics?
    Mr. Devaney. Yes. Those are the four cases, investigations, 
I mentioned that involve potential criminal violations. That is 
all we have left, and we are trying very hard to get those 
closed.
    Mr. Costa. All right. Mr. Deal, the whole panel talks about 
the concerns in the report of the lack of price thresholds in 
the infamous 1998-1999 lease sales which, combined with the 
Kerr-McGee case, threaten to impact the Federal Government--
maybe to the tune of $30 billion or more. In your report, you 
recommended to Congress and the Secretary to continue to 
explore legislative options.
    Do you have any suggestions on what we can do, particularly 
if the case is lost?
    Mr. Deal. Well, this is a very tough nut to crack. You have 
heard testimony before from the Department, which I would agree 
with. You know, a contract is a contract. We did exhort, as 
other people have, the Department to continue to seek out 
visional companies, as several companies already have, to 
renegotiate their leases and take into account the price 
thresholds.
    This is tough, though. It poses a very tough legal problem. 
The subcommittee did not spend a lot of time on that, not 
because we were trivializing the issue but it had already been 
studied at great length.
    Mr. Costa. I think we understand it is difficult, and that 
is why we are looking for recommendations.
    Mr. Deal. Yes. Well, I wish I could shed more light on it. 
You know, of course the Kerr-McGee case may moot the whole 
issue if upheld, but it is on appeal so who knows what is going 
to happen. So I wish I could illuminate it more, but I can't.
    Mr. Costa. OK. Last question, quickly. Mr. Devaney, you 
know, when we look at the situation over collections that your 
office has brought in over $700 million in the last 10 years I 
know the Justice Department now gets a small cut of the money 
on the cases they win, three percent I think, do you have any 
suggestion that a similar circumstance might apply in this 
instance?
    Mr. Devaney. Well, naturally I think I would like to see a 
similar opportunity for any inspector general that investigates 
in this area. I think there are about 11 inspector generals 
that do qui tam work. I will speak for myself, we don't do as 
much as I would like to do and it is a resource issue.
    I think you get a big bang for your buck when you do these 
cases, so I think it would be an interesting and fruitful idea 
to try to put maybe one percent toward the investigative 
efforts. I think the DOJ gets three percent.
    Mr. Costa. Yes. All right. Thank you very much. My time has 
expired. The gentleman from New Mexico is poised, waiting and 
ready with his questions.
    Mr. Pearce. Thank you, Mr. Chairman. Poised is never the 
word that I have found used with me much. Unpoised maybe. Mr. 
Rusco, if you remember the conversation in our office, we were 
talking about government take and a report that is coming up. I 
talked about the tendency of the reports coming from you all is 
to maybe use hyperbole.
    So if I can get my staffer to hold up--the government take 
is, in your views, quite more simplistic, but government take 
in Russia is definitely higher than it is here, but you can't 
give a moral equivalence between the Russian system that allows 
this kind of thing to go on and our country where these 
cleanups occur. That is OK. Put it down. It is distracting even 
me.
    You draw rather harsh conclusions I think in your report, 
and one of the things that you are critical of is that it 
relies heavily on self-reporting. That is a curious thing 
because what we did is compare it to IRS, and we even have IRS 
people here. If I am not mistaken, IRS depends on self-
reporting, and so we find it OK with the mass of the public.
    Always I am curious when people find other people's 
behavior suspicious and their own behavior above reproach. So 
when we say that the weakness of the system is self-reporting, 
I don't find in your report where you mention that we actually 
conduct 8.2 percent, where MMS examined 8.2 percent of the 
properties and 25.9 percent of the payors. IRS only looks at 
one percent.
    I wonder if you had an IRS person on your team because this 
big report that comes from Mr. Deal's committee, there were two 
senators on that--by the way, I find people from state 
treasurers, professor of finance, Deputy Assistant Director of 
MMS, Bureau of Land Management economist--and I wonder if you 
had this panel that was led by two senators to see that maybe 
this report came out with less hyperbole and more facts, as we 
are looking at a very complex thing there.
    I wonder. I didn't see any list of people, and I had asked 
for that in my opening statement. I would hope that you would 
provide that for us at some point. Now, you are quick to say 
that the methodology that is calculating financial benefit is 
not good. I wonder in your own methodology, there is an 
independent accountant report that says methodology as 
reasonably and accurate, in your report, did you consider these 
outside sources?
    Mr. Rusco. Yes, we did.
    Mr. Pearce. You did. And so we have this report that says 
it is accurate, and your report says it is inaccurate. How many 
weeks did you spend on your report versus this report here?
    Mr. Rusco. Well, we have been auditing MMS on and off for 
years, but this particular job we have been at for about a 
year. On our team we have economists, accountants, data 
analysts, specialists, licensed IT auditors, oil and gas 
geologists, engineers and general auditor staff.
    Mr. Pearce. Your report considers this but says that this 
finding was inaccurate. We have independent accountants who 
find that it is OK, and your team says it is not OK and you 
were working for a year.
    Now, I have the KPMG. KPMG is one of the big three if you 
are going to get somebody to be an accountant. KPMG for three 
years--three years--says we noted no deficiencies involving the 
design of the internal control over the existence, 
completeness, assertions related to any key performance 
measures, and yet, you find the lack of key internal controls, 
you spent a year on your report--was this the only report you 
were working on during the year?
    Mr. Rusco. No.
    Mr. Pearce. How many reports were you working on during 
this year period?
    Mr. Rusco. Personally, I probably worked on seven or eight.
    Mr. Pearce. OK, so you have seven or eight, so we can say 
that roughly maybe two months dedicated time, unless you are 
working overtime, and I am sure you did. Again, we go back to 
the KPMG reports that find no deficiencies and you find that 
there are lack of key internal controls.
    I wonder if the discontinuity, I wonder if the hyperbole 
that we found--lift that chart up over here one more time--if 
the hyperbole and simplicity of what you have done is the same 
simplicity that said we collect fewer royalties than Russia and 
yet, that is Russia, that it is okay that exists and your 
committee did not, your findings did not include any of that.
    I wonder why you came up with different substantive 
findings than people who audited for three years, two different 
major accounting reports that found exactly the opposite of 
what you found. Mr. Chairman, I will come back in my next 
round.
    Mr. Costa. Seems you were just getting warmed up.
    Mr. Pearce. If you would extend some time, I would go on.
    Mr. Costa. Well, I would be happy to do that except we have 
other Members who obviously would like to get their questions 
in as well. Mr. Hinchey, good to have you here this morning.
    Mr. Hinchey. Thank you very much, Mr. Chairman.
    Mr. Costa. You are up.
    Mr. Hinchey. Nice to be here with you. Good morning. 
Gentlemen, I just wanted to ask a couple of questions if I may. 
With regard to those leases that go back to 1998 and 1999, have 
you had a chance to look at the MMS cost estimates regarding 
the amount of money that we stand to lose if that situation 
isn't fixed?
    Mr. Deal. Is your question directed to all of us?
    Mr. Hinchey. Anyone who wants to take a crack at it. Mr. 
Deal, you may do so if you want to. You probably know as much 
as anyone.
    Mr. Rusco. We issued a correspondence last year in which we 
did an analysis ourselves of the expected costs of the lack of 
price thresholds on those and royalty relief.
    Mr. Hinchey. Could you speak a little louder?
    Mr. Rusco. I am sorry. In our work looking at the royalty 
relief we found similar dollar values to what MMS found in 
their analysis.
    Mr. Hinchey. Well, do you want to be more specific? What is 
the number? Is the $21 billion estimate too low?
    Mr. Rusco. We have not updated the analysis after the 
recent Kerr-McGee ruling.
    Mr. Hinchey. When do you expect to do that?
    Mr. Rusco. Well, we have not yet been requested to do it. 
We will do it at some point when requested.
    Mr. Hinchey. Who are you expecting to request you to do it.
    Mr. Rusco. That is not up to us.
    Mr. Hinchey. Well, no, but who do you expect to request you 
to do it?
    Mr. Rusco. We will take a request from anyone in Congress 
who is interested in that.
    Mr. Hinchey. Would GAO accept this as a request to do it?
    Mr. Rusco. If the request is sent to us, we will accept it 
according to our usual protocol.
    Mr. Hinchey. OK. We will send you a specific request and 
ask you to do it because there is a lot of money at stake here.
    You have a situation where the oil companies are making 
record profits, where the price of oil has gone up to $109 a 
barrel, the price of gasoline has gone up very dramatically, 
and the fact of the matter is that property that is owned by 
the people of this country is not being addressed accurately, 
properly. They are not being paid properly.
    Mr. Deal, I would like to ask you a question. You have a 
lot of experience with the oil industry as a former person who 
worked with the American Petroleum Institute, you were a 
representative for that operation. As a member of the 
Subcommittee on Royalty Management, one of your important 
recommendations was that MMS should continue to renegotiate 
those faulty 1998 and 1999 leases.
    So are you also concerned that MMS has all but ceased 
bringing these leaseholders back to the negotiating table?
    Mr. Deal. Well, I have no information one way or the other 
on that. I have no information about further efforts by the 
Department.
    Mr. Hinchey. Well, you know the negotiations are not going 
on, right?
    Mr. Deal. I am not aware of them. You know, the early 
negotiations weren't very public either, so I am not privy to 
them.
    Mr. Hinchey. Do you believe that they have brought back to 
negotiating table to talk about the amount of money that is at 
stake here just in those two year leases?
    Mr. Deal. I have no information to show that, so I really 
don't know.
    Mr. Hinchey. Do you intend to look into that, to acquire 
information?
    Mr. Deal. Would I or did I?
    Mr. Hinchey. Do you intend to?
    Mr. Deal. If directed, I will.
    Mr. Hinchey. Pardon me?
    Mr. Deal. If directed, I will. I would be glad to.
    Mr. Hinchey. Who would you expect to direct you?
    Mr. Deal. This committee.
    Mr. Hinchey. Well, Mr. Chairman, would we ask him to do so?
    Mr. Costa. I think that is appropriate. We could put 
together a request in the form of a question to the Commission, 
and we will work on that.
    Mr. Hinchey. Good. I would like to help you with that.
    Mr. Costa. OK.
    Mr. Deal. Can I make one observation there?
    Mr. Costa. Certainly. Please, Mr. Deal.
    Mr. Deal. The Department is here today, and they can answer 
your question directly. So I will be responsive to any question 
posed to me, but the Department is here today.
    Mr. Costa. I am sure that Mr. Hinchey will direct that 
question to the Department.
    Mr. Hinchey. Do I have any time left?
    Mr. Costa. Yes.
    Mr. Hinchey. Just let me ask you one last thing. You have a 
lot of experience with the oil industry, so I am wondering if 
you have any specific recommendations for the Congress on how 
best to legislate the renegotiations that need to take place 
with the oil industry in order to get this royalty situation 
straightened out?
    Mr. Deal. I don't have any suggestions. This question has 
already been posed to me. I wish I could offer you a bright 
line. This is a tough nut to crack. You know, there are 
contracts on the table. Fortunately, you know, some companies 
have been willing to renegotiate, others haven't as yet.
    As far as legislation, you know, a few ideas have been 
floated. They don't seem to have legs. I wish I could offer you 
some great suggestion here, but I don't have one.
    Mr. Hinchey. Well, I would think that the General 
Accounting Office would have some input into this. I think that 
we are all responsible to make sure that people who take public 
property pay for it appropriately. Thanks to the initiative of 
our Chairman here, we are overseeing this operation.
    We would like very much for you to be more effectively 
involved in it. Is there any likelihood that you intend to do 
so?
    Mr. Deal. Well, the subcommittee, which was formed that 
resulted in the report you have, has been sunsetted. There is 
nothing on the agenda for that subcommittee to do anything at 
this point, but as before, you know, I am the Vice Chair of the 
Royalty Policy Committee. We have been and will be, continue to 
be responsive to the Secretary and respond accordingly. That is 
about all I can say.
    Mr. Hinchey. Well, that is fascinating because I can see 
that there is no real initiatives being taken here. Nothing 
really is being done effectively to try to straighten this mess 
out.
    Mr. Costa. The gentleman's time has expired, and we will 
get a chance to go back.
    Mr. Hinchey. Thank you.
    Mr. Costa. Thank you. The next member of the Committee is 
Mr. Smith from Nebraska, and you have five minutes.
    Mr. Smith. Thank you, Mr. Chairman. I would like to ask Mr. 
Rusco a couple of questions. In your testimony, you were 
critical of MMS because it relies heavily on self-reporting and 
honor system I guess, as described. Isn't it true that the IRS 
relies on self-reporting. Is that accurate?
    Mr. Rusco. It is accurate except that they also require 
employers to submit W-2s or 1099s and other third-party 
documentation.
    Mr. Smith. OK, and so I guess furthermore, the IRS has 
conducted audits of about one percent of the payors, and yet, 
MMS examined 8.2 percent of the properties and 25.9 percent of 
the payors, and was that included in your testimony?
    Mr. Rusco. Not specifically, but we do agree that there is 
an overreliance on compliance in audits in MMS, and that is 
because the quality of the data coming into the system and the 
integrity of that data are not up to par.
    Mr. Smith. So the integrity of the data is lacking?
    Mr. Rusco. If we could be sure that the self-reported data 
were accurate, and if third-party data were collected in a 
timely fashion and compared to those data and those problems 
were fixed in the IT and management systems up front, that 
would be a better way to do it than to rely more heavily on 
your audit system.
    Mr. Smith. And if we could meet the suggestions that you 
are making what do you think the net result would be?
    Mr. Rusco. I think the system would work much more 
efficiently. I think part of what MMS is doing in trying to 
implement a risk-based system is they are trying to touch fewer 
properties but do it more efficiently and closer to the model 
that the IRS uses.
    Mr. Smith. Would the amount due increase?
    Mr. Rusco. If the data could be assured of being accurate, 
then we would know we had the accurate collection of royalties. 
We don't know at this point, and we can't know because the data 
are not reliable or accurate enough.
    Mr. Smith. So maybe some folks are overpaying? Do I hear 
you saying that?
    Mr. Rusco. It is certainly possible. Likely? I can't 
comment on that.
    Mr. Smith. OK. Thank you. Mr. Deal, if we found the amount 
payable on the amount due to increase what do you think would 
be the impact in the marketplace?
    Mr. Deal. Well, I guess it is kind of hard to say. Depends 
on the impact. About the best way I could say it is the oil 
companies try to be good corporate citizens, they pay what is 
due. Sometimes they overpay and ask for a refund, sometimes 
they underpay and need to pay with interest. What difference 
would it have on the market?
    I would say relative to existing oil prices and gas prices, 
you know, my guess is that it is not likely to have a big 
impact on the market, but, you know, we are kind of talking in 
the abstract here. It depends on the amounts we are talking 
about. There is no obvious big impact that tuning up the 
Royalty Management Program would have.
    Mr. Smith. OK. Thank you. I would yield the balance of my 
time to Mr. Pearce. Thank you.
    Mr. Costa. All right. Gentleman yields the balance of his 
time to Mr. Pearce. Mr. Pearce has one minute and 20 seconds.
    Mr. Pearce. Thank you. Mr. Deal, do the oil companies fill 
out any reports every year about how much production that they 
make and then how much they give? Are there any reports that 
are filed?
    Mr. Deal. Well, there are all kinds of annual reports, but 
on a regular basis they have to submit, you know, every month--
--
    Mr. Pearce. They have to submit something.
    Mr. Deal. Yes.
    Mr. Pearce. So when Mr. Rusco says there is a contrast 
between what IRS does and what MMS does, IRS demands a W-2 from 
every filer, and if I understand your testimony correctly, the 
oil companies have to turn in some similar document saying we 
produced this much and we pay this much, is that not accurate?
    Mr. Deal. That is accurate.
    Mr. Pearce. OK. Mr. Rusco, what was GAO saying the stakes 
were last year in this 1998, 1999 lease, the offshore leases? 
How much was going to be lost in the Kerr-McGee case?
    Mr. Rusco. I am sorry, I don't remember the exact figure. I 
will have to get back to you on that.
    Mr. Pearce. If I gave you a number would you verify it? 
Because I am going to give you a number. Sixty billion is what 
the GAO said last year. Publicly they said $60 billion is at 
stake. How much is at stake this year in your opinion?
    Mr. Rusco. We have not updated that work since the recent 
Kerr-McGee ruling.
    Mr. Pearce. I am sorry, can you?
    Mr. Rusco. I am sorry. We have not updated our----
    Mr. Pearce. MMS is saying $20 billion this year after a 
study, so you are 300 percent off, yet, you say these audit 
reports that declare--and KPMG can't say this stuff. They can't 
say that it is in conformity, and they do. They say it is in 
conformity. I wonder if your GAO report is 300 percent off like 
your estimate on the amount to be achieved.
    Mr. Costa. All right. The gentleman's time has expired. Mr. 
Rusco, this may be appropriate for you. In the Royalty-in-Kind 
Program there is an industry practice that I have learned about 
that is called swinging. My understanding is that when the 
price is low, the industry provides more supply, and when the 
price is high, they provide less. I guess that is the 
definition more or less?
    Do you think you could explain that practice and whether or 
not you think that is a problem with the royalty-in-kind 
payment?
    Mr. Rusco. The process would exist if a royalty-in-kind, 
and I will speak for gas producers in particular, because there 
has been a case that MMS identified of that going on in natural 
gas, this would be the case if MMS had contracted with someone 
to provide natural gas, royalty-in-kind, and then sold that to 
a buyer and then the deliveries would vary according to the 
price of natural gas.
    The deliveries would be lower if the prices were higher and 
greater if the prices are lower. That is what swinging is. MMS 
did identify some of that going on.
    Mr. Costa. So you think it may be a problem?
    Mr. Rusco. The extent of which the problem, we don't know, 
but we do know that it has happened in the past. MMS has 
identified it. You would have to ask them.
    Mr. Costa. All right. OK. Before my time expires, Mr. 
Devaney, you have expressed concerns about the culture in your 
own testimony of the Royalty-in-Kind Program in the past, 
especially as it relates to ethics or potential ethics 
violations that are on.
    Your investigations I know are now ongoing, and I know that 
you can't speak specifically about that, but I would like to 
get a general sense without talking about the specifics whether 
or not we are talking about petty types of crime or whether we 
are talking about wholesale criminal intent that could cost the 
American Treasury significant amounts of money?
    Mr. Devaney. I think the way I would like to answer that, 
Mr. Chairman, is most of the continued investigations involve 
personal behavior, at a minimum, ethical lapses with potential 
criminal violations involved as well. I think that has stopped, 
and I think the Department has made some personnel changes that 
were very helpful.
    I think at the end of the day if people are not prosecuted 
we are going to turn this matter over to Assistant Secretary 
Allred for administrative action, and I am confident that he 
will take that action.
    Mr. Costa. All right. Mr. Rusco and Mr. Devaney, there has 
been a recommendation from the Royal Policy Committee that Mr. 
Deal is dealing with that they establish a trust fund for MMS 
operations. What do both of you think about that, quickly?
    Mr. Deal. I will just say that I really don't have an 
opinion on that.
    Mr. Costa. Mr. Rusco?
    Mr. Rusco. We have not addressed that either.
    Mr. Costa. You haven't? OK. Mr. Rusco, you talked about the 
focus of the Minerals Management Service on compliance review 
versus audits, and I was inferring from your testimony that you 
were suggesting that they perform greater focus on audits than 
comparative compliance review. Would you like to speak a little 
more in detail about the problems and why you think so?
    Mr. Rusco. Yes. I think that in our work we found that the 
data coming in to MMS are unreliable, that there aren't enough 
controls on that data, there aren't enough verification with 
third-party data, and, as a result of that, when MMS does 
compliance reviews or audits they frequently find that 
additional royalties are due.
    We are concerned about the mix of compliance reviews and 
audits because compliance reviews are less rigorous than 
audits. However, we are not commenting on the precise mix 
because we have not evaluated that.
    Mr. Costa. Well, you know, when I talk to the Minerals 
Management Service, and I talk about how many auditors they 
have and whether or not they have the sufficient tools to do 
the job, and I think about the companies that they are engaged 
with and how sophisticated an operation it is, it just seems 
like a lot of manual paper entries are taking place.
    Why can't a lot of this data be automated and transferred 
to the Minerals Management Service' computer with paper copies 
being kept for independent reviews? It just seems to me like so 
much of their effort, notwithstanding the $150 million 
investment, has gone for naught. Quickly.
    Mr. Rusco. We agree that the IT systems are inadequately 
designed and there are many gaps that need to be filled.
    Mr. Costa. OK. Good. My time has run out. Do either of you 
have a quick comment on that? Do you concur? Disagree?
    Mr. Devaney. I would concur. I think this IT system really 
needs to be fixed.
    Mr. Costa. All right. Very good. The gentleman from New 
Mexico is up to the plate again for five minutes.
    Mr. Pearce. Thank you, Mr. Chairman. Mr. Devaney, what is 
your definition of timely? In other words, we asked for timely 
responses back so if we have some questions today, what is 
timely to get an answer back?
    Mr. Devaney. I will get it back as soon as I possibly can.
    Mr. Pearce. About how much?
    Mr. Devaney. Two weeks.
    Mr. Pearce. Two weeks. Be aware that we asked you last year 
about why you excluded the letter from Carolina Calure out of 
your report. You said there was no smoking guns to say that the 
Clinton administration purposely left off, and so we brought 
the smoking gun, and we gave it to you and you never really 
responded to that.
    So by your own definition, a couple of weeks, that is a 
month and 12 months, 13 months. I really appreciate you getting 
back with us on that, sir. In your testimony, you say that MMS 
is not using risk-based strategies for compliance reviews. Mr. 
Deal, did you find any evidence that risk-based strategies are 
being used?
    Mr. Deal. Well, we did.
    Mr. Pearce. That is all. You did or you didn't. Yes, you 
did. You did not?
    Mr. Deal. No. We did, but found a need for more rigor and 
clarity.
    Mr. Pearce. Well, you found some use of risk-based 
strategy?
    Mr. Deal. Yes, yes.
    Mr. Pearce. So, Mr. Devaney, your comments last year were 
that there was no risk-based strategy in your comments. Did you 
actually go to MMS and ask them if they had implemented? 
Because in the report I find that we have implemented 
significant risk-based strategies in the last 12 months. I 
again wonder about your definition of timely. When is the last 
time you went to talk to MMS about that?
    Mr. Devaney. Well, Mr. Pearce, I think that, you know, when 
we did that audit we didn't find that MMS was adequately using 
a risk-based strategy. Today, I think they are.
    Mr. Pearce. Yes, but your testimony today says they are not 
doing it. I am wondering if you did any more--no, we didn't do 
any more timely look on this than you did----
    Mr. Devaney. I am sorry if you misunderstood my testimony. 
I was characterizing my prior report.
    Mr. Pearce. I understand you are characterizing your prior 
report, but people are going to use your words in this hearing 
today saying there is no risk-based strategy and come here 
using loose words.
    I just think that you really should be aware that people 
are going to use your testimony today not to characterize what 
you were wanting to characterize a year ago, they are going to 
take your report today as if it were given today and as if you 
actually did something in between last year and this year, 
which you didn't answer my questions, and I have to assume, I 
hope that you actually talked to MMS before you came here today 
to make your assertions here that we are not doing our job when 
I find really dedicated public servants that are wrestling with 
a very complex issue.
    Now, in your testimony last year you mentioned these four 
investigations. Have you turned that over to DOJ? That is 
pretty serious allegations of misconduct. Did you turn that 
over to DOJ?
    Mr. Devaney. Yes. We have been working with them all along.
    Mr. Pearce. And so DOJ has had that information for 13 
months?
    Mr. Devaney. It is not a matter of turning the 
investigation over. We have been working with DOJ for 13 
months.
    Mr. Pearce. But this is serious allegations you are making 
in front of this Committee, and has DOJ decided to prosecute or 
not?
    Mr. Devaney. They have not made that decision yet.
    Mr. Pearce. They haven't made a decision. They have had it 
for 13 months, and, yet, you come here and you talk about--you 
mentioned the qui tam cases.
    Mr. Devaney. Right.
    Mr. Pearce. We all remember Mr. Maxwell. He was in front of 
this talking about this same thing. What happened to his case 
in Court?
    Mr. Devaney. I believe it was found in his favor in Court.
    Mr. Pearce. It was found in his favor.
    Mr. Devaney. Right.
    Mr. Pearce. Can I check with staff? It was found not to 
have standing. He was found not to have standing, and I wonder 
about your internal processes when you write your report. He 
took his case straight to the Courts, you mentioned that in 
your testimony, and yet, he was thrown out of Court for not 
having standing, and yet, you talk today about it as if it was 
still a legitimate thing that he did, and Mr. Maxwell was 
pitched out of Court because he did bypass all.
    I wonder what your internal controls are doing about people 
who will go outside the system to try to get personal gain. 
Now, this is actually, Mr. Rusco, an actual document and 
circumstance of somebody's behavior that would say we ought to 
be suspicious, yet, we don't find that suspicion directed 
there, we find the suspicious stuff directed--I have a very 
complex report that states over and over that it is pretty 
good.
    Yes, we have 100 assertions that could be dealt with, but 
overall, it is pretty good. Then I have Mr. Devaney's report, 
and I have Mr. Rusco's report that says diametrically opposed. 
I just wonder what facts were looked at. Thank you, Mr. 
Chairman. I appreciate your indulgence.
    Mr. Costa. Thank you, Mr. Pearce. We can agree to disagree, 
but you are correct, the gentleman was found on the qui tam 
case not to have standing because of the position he held. The 
Court did find his allegations to be correct.
    Mr. Smith, you are closing this panel.
    Mr. Smith. I am----
    Mr. Costa. OK. Very good. Well, then let us move on to the 
next panel. Gentlemen, to be continued. I am sure that Mr. 
Pearce, and I--and maybe other members of the Subcommittee--
will have questions that we will submit to you. We hope that 
you will respond in a timely manner. I think Mr. Pearce is 
correct.
    If he didn't get an answer to last year's question, that is 
inappropriate, and I would hope that would be corrected. So 
with that understood, gentlemen, thank you, again, for your 
testimony. We look forward to continuing this discussion as we 
try to, as Mr. Deal said, tune up the deficiencies that exist 
within the Minerals Management Service.
    The next panel involves the following witnesses. The 
Honorable Stephen Allred, who is the Assistant Secretary of 
Land and Minerals Management with the U.S. Department of the 
Interior. In addition, we have Mr. Dennis Roller, who is the 
Audit Manager for the North Dakota State Auditor's Office that 
will give us a state and tribal, a local perspective.
    We also have Ms. Linda Stiff, who is also testifying, as I 
noted before, the Acting Commissioner for the Internal Revenue 
Service. Then the last two individuals that will testify are 
Mr. Randall Luthi from the Minerals Management Service, and Mr. 
Lawrence Finfer, who is the Deputy Director of the Office of 
Policy Analysis within the Department of the Interior.
    So lady and gentlemen, we would like you to be focused on 
the five-minute rule.
    Mr. Costa. Let us begin with The Honorable Stephen Allred, 
Assistant Secretary for Land and Minerals Management within the 
Department of the Interior. Mr. Allred. Yes. You need to keep 
it close I think. Is it on?

    STATEMENT OF THE HONORABLE C. STEPHEN ALLRED, ASSISTANT 
SECRETARY, LAND AND MINERALS MANAGEMENT, U.S. DEPARTMENT OF THE 
                            INTERIOR

    Mr. Allred. Is it on now?
    Mr. Costa. Now, you have it.
    Mr. Allred. Mr. Chairman, Mr. Pearce, members of the 
Committee, it is a pleasure to be here and to visit with you 
about what is a very important program to the United States. 
Our testimony, and we are going to kind of tag team this 
between I and Director Luthi, but I am going to focus in early 
on the subcommittee and why we asked it to do the report and a 
little bit about the recommendations.
    Mr. Luthi will talk a little bit later about what we are 
doing about those recommendations and how we are implementing 
them. As you know, we recently received the report that 
contained the recommendations developed by the Subcommittee on 
Royalty Management. What I would like to do very quickly is 
tell you why the committee was formed and the claim we made to 
ensure that it was an independent review.
    As you know and as you have discussed here in the last 
panel reports from the Office of the Inspector and others had 
questions about the royalty program as to whether it was 
adequate to ensure that the public received the royalties that 
Congress had intended.
    While at the time that I looked at this I concluded that 
there were not major programs, and I visited all of the 
Minerals Management Service's offices and talked to a lot of 
people when I first came onboard, I felt that there were no 
significant problems that threatened the viability of the 
program, but I also recognized that with anything as complex as 
the operations of the Minerals Management Service and the other 
agencies within Interior, that there were probably lots of 
opportunities for improvement.
    I felt a comprehensive look across the board at those 
issues was warranted. The Secretary agreed and determined that 
a fully independent examination of the program was warranted, 
both to restore credibility to this important revenue 
generating program and to make sure that we were focused on the 
changes that were needed.
    On my recommendation in March of 2007, the Secretary 
appointed the Subcommittee on Royalty Management to conduct 
that independent examination. Mr. Deal has already identified 
the three charges that we gave to the committee, so I won't 
repeat those. We made it clear from the onset that the 
Department would not direct, manage or influence the 
subcommittee's work.
    The subcommittee was comprised of seven distinguished 
members, and while you have indicated already who those were, I 
think it is important to reiterate it.
    They were, as Co-Chairman, U.S. former Senator and Nebraska 
Governor Bob Kerrey; and former U.S. Senator Jake Garn of Utah; 
Cynthia Lummis, who is a former Wyoming official and State 
Treasurer and who in that position had received, Wyoming 
receives the largest amount of the royalties that we distribute 
to the states; Mr. Perry Shirley, who is Director of the Navajo 
Nation's Mineral Department and who has been involved in these 
issues for some period of time; Mr. Robert Wenzel, who was from 
1998 to 2003 the highest ranking career official in the 
Internal Revenue Service and who brought a great amount of 
expertise to this committee; Dr. Mario Reyes, who is Associate 
Dean and Director of the Business Economics Program at the 
University of Idaho; and David Deal, who has already testified 
in front of you.
    We provided staff out of our Department Office of Policy 
Analysis and the co-chairs selected a staff member 
independently of the Department to assure the independence of 
the work that was being done for them. The Minerals Management 
Service in that analysis played no role except to answer 
questions.
    I want to really express my appreciation and that of the 
Department for the work that this committee did. They spent 
many long hours, traveled extensively and we think prepared an 
excellent report which was delivered to the Royalty Policy 
Committee on December 17, 2007. That, incidentally, became a 
public report while it laid before the Royalty Policy 
Committee.
    The subcommittee concluded that the Minerals Management 
Service was an effective steward of the Minerals Revenue 
Management Program and that the MMS employees were generally 
concerned with fostering continuing program improvements. The 
subcommittee members unanimously agreed that MMS was the 
Federal agency best suited to fulfill the stewardship 
responsibilities for Federal and Indian leases.
    However, as we expected and as you indicated, the report 
identified many areas that warrant management attention to 
improve operations and ensure the public confidence. There were 
110 recommendations. Thirty-five related to collections and 
production accountability, 30 relate to the Royalty-in-Kind 
Program, 27 to audit compliance enforcement, 10 to 
coordination, and 5 to the OCS Royalty Relief Program.
    We have developed an action plan that includes the three 
bureaus within the Department. It is an extensive action plan 
for those 110 recommendations. Most of those can be implemented 
without additional legislation. Some cannot, and we will bring 
back those recommendations to these committees. With that, Mr. 
Chairman, I would be most happy to answer at the appropriate 
time any questions you might have.
    Mr. Costa. All right. Thank you very much, Mr. Allred. We 
also want to thank you and the Department on behalf of the 
committee for the submission of the breakdown of the Royalty 
Policy Committee Report, and the recommendations by category 
and the charts that you provided. I think they are helpful.
    On your last point, as it relates to the legislative 
changes, both Mr. Pearce and I are interested in looking at 
those, and we will talk about them and confer with the 
Department at the appropriate time.
    Mr. Costa. So my understanding is Mr. Luthi is here to 
provide back up, is that correct, or did you prepare testimony?
    Mr. Luthi. Of course I prepared testimony, Mr. Chairman.
    Mr. Costa. Well, we always like hearing from you. Mr. 
Luthi, you have five minutes.

             STATEMENT OF RANDALL LUTHI, DIRECTOR, 
                  MINERALS MANAGEMENT SERVICE

    Mr. Luthi. Thank you, Mr. Chairman. Our Royalty Management 
Program today is not the same program as it was 15 years ago or 
even two years ago. In the last seven months, I have learned 
that the Royalty Management Program is the culmination of 26 
years of ideas, findings and recommendations from many 
partnerships with the best and brightest, both internal and 
external, to our agency.
    Our people are dynamic, resourceful and agile. We are ready 
to change when necessary to keep pace with an ever challenging 
business environment and changing legal mandates. Each month 
approximately 2,100 companies report and pay royalties 
associated with over 68,000 producing and nonproducing Federal 
and Indian leases.
    In Fiscal Year 2007 alone, the 537 employees of the 
Minerals Management Program processed over 400,000 reports 
containing 7.7 million lines of data, closed 304 audits, 
completed 4,171 compliance reviews, held 10 RIK sales, 
conducted 81 Indian outreach sessions, distributed $11.7 
billion to the states, counties, Indian tribes, individual 
mineral owners and other Federal agencies including the U.S. 
Treasury, and that was before lunch.
    Mr. Costa. Sounds like you have been busy.
    Mr. Luthi. That represents the monitoring of approximately 
5.7 trillion cubic feet of natural gas and 585 million barrels 
of oil from Federal and Indian leases. Since 2003, we have 
completed 59 internal control reviews, identified 713 
recommendations for improvement and we have successfully 
implemented 612. The Royalty Management Program has been 
reviewed and analyzed by the GAO, OIG, annual CFO audits and 
external independent peer reviews.
    Since Fiscal Year 2003, 24 external reviews have resulted 
in 195 recommendations of which at this time we have closed 
124. Annual audits in our royalty management and financial 
statements are conducted by an independent firm, KPMG, under 
contract with the IG. We have received an unqualified, which is 
a good, clean audit, for the past six years with some minor 
findings.
    We have worked to correct those findings to improve the 
overall processing of our system and to make these reports more 
useful to the public. In addition, the recent RPC subcommittee 
report contains 110 recommendations spanning the three bureaus: 
MMS, Bureau of Land Management and Bureau of Indian Affairs. Of 
the 110, we are responsible for 73. Twenty-two of these 
recommendations are going to require coordination.
    As of February 11, 16 of the 110 are complete. Of the 
remaining 94, 29 are already under way. We have developed a 
Joint Action Plan with the other two agencies, and we have a 
plan to implement or evaluate all of the subcommittee's 
recommendations. Some of the recommendations we will need to 
consult with the state, and tribal and other stakeholders as 
well.
    One of the common themes throughout the subcommittee's 
report is the need for the three royalty management bureaus to 
work as partners to make sure we are using the best practices 
available, and we are doing that. Internally, we already 
identified the need for better coordination and flow of 
communication between our Offshore Minerals Program and 
minerals royalty management.
    Those efforts are under way. The stovepipes are being 
breached and new connections are being forged. Our partnership 
and communications with our external reviewing organizations do 
not stop when we receive a report. Now, for example, 
subcommittee member, Mr. Bob Wenzel, and the subcommittee's 
efforts paved the way for us to establish an ongoing 
relationship with the IRS to compare and contrast our risk-
based compliance approaches and to learn from their experience.
    This last fall we met with the U.S. Attorney's Office and 
the IG's office to strengthen our relationship regarding qui 
tam cases. This group meets every month now to discuss joint 
training on detecting and referring false claims and how best 
to work with the U.S. Attorney's Office. It wasn't a surprise 
to me when the RPC concluded that we are an effective steward 
for the Minerals Management Program and that we are generally 
concerned about its improvements.
    I see this every day, but where much is given, much is 
expected. Like the IRS, we have targeted high revenue producers 
with compliance reviews and audits. As part of our evolution, 
we are now developing an in place, a risk-based strategy for 
compliance, that extends coverage to a greater number of 
companies and properties.
    The IG and the RPC recommended we develop this strategy, 
and it will help us we believe in the future to help target 
those properties and lessees where audits and compliance 
reviews are warranted and where we need additional resources. I 
am very pleased with those efforts but recognize there is more 
work to be done. We will work quickly to implement the 
remaining recommendations concerning the GAO draft report.
    It seems very clear to me that this is still clearly a work 
in progress and that the findings represented today may not be 
complete. We stand ready with additional data and to work 
closely with them to complete their analysis. In conclusion, 
Mr. Chairman, a director can have no greater goal than to leave 
an agency better when they arrived.
    With the efforts of our MMS employees, you and your 
Subcommittee's willingness to work with us, and the other 
partnerships we have developed, that goal is clearly within 
reach. Thank you for your time.
    Mr. Costa. Thank you very much, Mr. Luthi.
    [The prepared statement of Mr. Allred and Mr. Luthi 
follows:]

 Statement of C. Stephen Allred, Assistant Secretary Land and Minerals 
 Management, and Randall Luthi, Director, Minerals Management Service, 
                    U.S. Department of the Interior

    Mr. Chairman and Members of the Committee, we appreciate the 
opportunity to testify today. This Committee has been instrumental in 
shaping our domestic energy program, particularly with regard to the 
sound development of our domestic oil and gas resources on the Outer 
Continental Shelf (OCS) and onshore Federal and Indian lands, and the 
management of mineral revenues from these lands. Our testimony will 
focus on the recently issued report from the Royalty Policy Committee's 
Subcommittee on Royalty Management and the Department of the Interior's 
(Department) subsequent implementation efforts, and the status of the 
Department's response to findings and implementation of the 
recommendations contained in the previous reports and audits from the 
Department's Office of Inspector General (OIG), the General 
Accountability Office (GAO), and internal reviews. As we are all aware, 
GAO is currently working on a similar analysis and report of the 
Department's royalty management program. I anticipate that GAO's 
findings will be similar to and support the findings and 
recommendations of the Royalty Policy Committee (RPC) Subcommittee.
Background
    The Department and its agencies serve the public through careful 
stewardship of our Nation's natural resources. The Department also 
plays a vital role in domestic energy development. Approximately one-
third of all energy produced in the United States comes from resources 
managed by the Department of the Interior.
    The Bureau of Land Management (BLM) is charged with managing 700 
million acres of our Nation's onshore subsurface mineral estate. The 
BLM issues onshore leases, establishes lease terms and conditions; and 
conducts on-the-ground inspections to ensure that unnecessary 
environmental impacts do not occur; that drilling operations are 
completed in accordance with an approved drilling plan; that measuring 
points for production of oil and gas are secure; and, that the onsite 
physical infrastructure for transporting oil and gas from a lease is 
secure so as to prevent theft of oil and gas. Furthermore, to 
supplement the on-the ground inspections, production reviews are 
performed to verify the production figures that operators have sent to 
the Minerals Management Service (MMS).
    MMS is responsible for managing off-shore mineral resources and 
providing the American people with an accurate and transparent 
accounting of revenue that production from all Federally-owned minerals 
generates. In Fiscal Year 2007, MMS collected more than $11.4 billion 
in revenues from Federal production, disbursing the revenue to states, 
American Indians, and the U.S. Treasury as directed by various 
statutes. Since its establishment in 1982, MMS has collected and 
disbursed more than $176 billion in oil, natural gas and other mineral 
revenues. I am happy to point out that for the past five years, as part 
of its annual CFO audit, MMS consistently has received clean audit 
opinions from the Office of the Inspector General's contracted 
independent auditing firm.
    In addition to the BLM and MMS roles, the Bureau of Indian Affairs 
(BIA) maintains ownership information for Indian lands that determines 
the distribution of revenue to tribes and individual Indians. Given 
these shared responsibilities, the success of the royalty program 
requires close coordination and sharing of information between these 
three bureaus. The roles that BLM and BIA play in the process are 
equally important and significantly impact the ability of MMS to 
successfully achieve its mission.
    As you know, the Secretary recently received a report that contains 
recommendations developed by the Subcommittee on Royalty Management. We 
would like to discuss how the Subcommittee came to be established, its 
composition, areas of responsibility, and the current status of our 
efforts to implement the recommendations contained in the report.
Establishment of the RPC Subcommittee
    On March 22, 2007, upon my recommendation, Secretary Kempthorne 
appointed the Subcommittee on Royalty Management (``the Subcommittee'') 
to conduct an independent examination of the minerals revenue 
management program. As you are aware, reports from the Department's OIG 
and others questioned whether the Department's royalty programs were 
adequate to assure that the public received the royalties that Congress 
had intended. While I had concluded at the time that there were not 
major problems in the royalty program, I felt that there needed to be a 
comprehensive look at the royalty program and that there would be many 
opportunities to improve those operations. As a result, the Secretary 
determined that a fully independent examination of the program was 
warranted, both to restore credibility to this important revenue-
generating program, and to focus on the improvements that were needed.
    Specifically, we asked the Subcommittee to review:
      the extent to which existing procedures and processes for 
reporting and accounting for Federal and Indian mineral revenues are 
sufficient to ensure MMS receives the correct amount;
      MMS's audit, compliance and enforcement procedures and 
processes to determine if they are adequate to ensure mineral companies 
are complying with existing statutes, lease terms, and regulations as 
they pertain to payment of royalties; and
      the operations of the Royalty in Kind (RIK) Program to 
ensure that adequate policies, procedures, and controls are in place to 
ensure the decisions to take Federal oil and gas royalties in kind 
result in net benefits to the Federal government.
    Subsequently, the Subcommittee was also asked to review procedures 
promulgated by the Department in response to the lack of price 
thresholds in Gulf of Mexico deep water leases from 1998 and 1999 sales 
to ensure that future leases with royalty suspension provisions include 
price thresholds.
    The panel was organized as a Subcommittee of the Royalty Policy 
Committee (RPC), a Federal Advisory Committee Act (FACA) body that 
advises the Secretary on matters related to mineral revenues, and was 
comprised of seven distinguished members:
      Former U.S. Senator and Nebraska Governor Bob Kerry and 
former U.S. Senator Jake Garn, of Utah;
      Cynthia Lummis, a former Wyoming official who served as 
State Treasurer, and as a member of the Wyoming House and Senate, 
concentrating on natural resource and taxation issues;
      Perry Shirley, Assistant Director of the Navajo Nation's 
Minerals Department, who serves as the Principal Investigator 
responsible for administering a Cooperative Agreement between the 
Navajo Nation and the Minerals Management Service;
      Robert Wenzel, the highest ranking career official in the 
Internal Revenue Service from 1998 to 2003, whose responsibilities 
included the day-to-day operation and strategic management of the 
United States tax administration system;
      Dr. Mario Reyes, Associate Dean for Administrative 
Affairs and Director of Business Economics Programs in the College of 
Business and Economics at the University of Idaho; and
      David Deal, who serves as the vice-chair of the full 
Royalty Policy Committee, and served as the Royalty Policy Committee's 
representative on the Subcommittee.
    To ensure independence, the Subcommittee staff came primarily from 
the Department's Office of Policy Analysis, but also included BLM staff 
and an independent staff member, Loretta Beaumont, who was selected by 
the co-chairs. MMS played no role in the Subcommittee's work beyond 
responding to requests for information.
    I want to express my deep appreciation to each member of the 
Subcommittee and staff for their hard work in the preparation and 
completion of this thorough report.
Royalty Policy Committee Report
    The Subcommittee issued its report on December 17, 2007, as a 
public document and in a public meeting on January 17, 2008, the RPC 
voted to accept the Subcommittee's Report. By letter dated January 25, 
2008, the RPC Chairman transmitted the Report to the Secretary.
    The Subcommittee concluded that MMS is an effective steward of the 
Minerals Revenue Management (MRM) Program, and that MMS employees are 
genuinely concerned with fostering continued program improvements. The 
Subcommittee members unanimously agreed that MMS is the Federal agency 
best suited to account for and distribute royalties that are paid for 
the production of oil and gas from Federal and Indian leases.
    As we expected, however, the report identified many areas that 
warranted management attention to ensure public confidence.
    The report contains 110 recommendations, including 35 
recommendations related to collections and production accountability 
from both onshore and OCS operations; 30 regarding the royalty in-kind 
(RIK) Program; 27 on audits compliance and enforcement; 10 related to 
coordination, communication, and information sharing among MMS, BLM, 
and BIA; and 5 on OCS royalty relief and ethics (See Attachment #1). At 
least three of the recommendations would require legislative action. 
Notably, the Report concluded, ``the advantages of including an RIK 
approach among MMS asset management options are clear and MMS's process 
for evaluating the feasibility of RIK versus royalty in-value (RIV) 
appears to be rigorous and effective. Nevertheless, in order to ensure 
the program's successful operation, a number of challenges must be 
addressed.''
    The Report's recommendations span the responsibilities of all three 
Departmental Bureaus involved in royalty management--MMS, BLM, and BIA 
(See Attachment #2). Examples of the roles of the three bureaus 
include:
      The results of Production Accountability Reviews 
performed by BLM and the MMS Offshore program are sent to the MRM 
program when there is a discrepancy of production reported to MRM and 
what is actually discovered by the accountability review. MRM then 
orders the operator to correct their production report and, if 
necessary, also orders the payor to pay additional royalties.
      BIA maintains ownership information for Indian lands that 
determines the distribution of revenue to tribes and individual 
Indians;
      Land title maintained by BLM for federal lands, i.e. 
classification of land, determines the distribution of revenue between 
the Treasury, States, and other funds;
      Lease terms and conditions established by BLM determine 
the royalty rate and provisions for royalty rate reductions for onshore 
leases;
      Authorizations and regulations control drilling of wells 
and construction of facilities, pipelines, and measurement equipment; 
and
      BLM inspections ensure the integrity of the facilities 
and the protection of the environment.
    Of the 110 recommendations, MMS is solely responsible for 73 and 
BLM is solely responsible for 15. The remaining 22 recommendations 
require coordination among the Bureaus. We are in the process of 
establishing a Production Coordination Committee with representatives 
from the BLM, MMS, and BIA whose task will be not only to coordinate 
and implement the cross cutting recommendations contained in the 
Report, but to also provide on-going coordination of issues related to 
the management of Federal and Indian mineral leases as suggested by one 
of the recommendations contained in the Report
    Secretary Kempthorne and I are grateful to the Subcommittee for the 
time and energy it devoted in its review. The Department is committed 
to working with our stakeholders to implement the recommendations 
contained in the Report. We agree with the statement of the 
Subcommittee that implementing the recommendations in this report will 
greatly strengthen the management of the program, restore public 
confidence, and ensure maximum value for the U.S. taxpayer.
    Randall Luthi, Director of the MMS, is here today to provide the 
Subcommittee with an update on the work being done to implement the 
findings and recommendations of the RPC Subcommittee and other previous 
reviews.
    The MMS's royalty management program of today is not the same 
program of 25 years ago when it was in its infancy, or even 5 or 2 
years ago. The MMS royalty management program of today is the 
culmination of 26 years of ideas, findings and recommendations for 
program enhancements from the best and the brightest, both internal and 
external, to the agency. Since FY 2003, the MRM has completed 59 
internal control reviews, identified 713 recommendations for 
improvement, and successfully closed 612 of the recommendations. Since 
FY 2003, 24 external reviews by the GAO and OIG, and annual CFO audits 
and external peer reviews have resulted in 195 recommendations, of 
which MMS has successfully closed 124.
    Notably, many significant changes were identified through the 
internal review process and were ultimately supported in the findings 
and recommendations reported by the various external reviews. For 
example, as part of the MRM program-wide Strategic Business Planning 
process, the MMS royalty management program identified in June 2006 the 
need for a risk-based compliance approach that expands compliance 
coverage to a greater number of companies and properties. In its 
December 2006 audit of MMS's compliance review process, the OIG also 
recommended a risk-based compliance approach. MMS recently completed 
the pilot project for this initiative. Additionally, in February 2006, 
MMS identified the need for an automated adjustment line monitoring 
tool to ensure that companies' royalty adjustments are made within the 
allowed timeframes and in compliance with applicable laws and 
regulations. Funding was appropriated for this initiative as part of 
the FY 2008 budget. The royalty management program continues to make 
improvements. For example, in June 2006, as part of its strategic 
planning initiative, MMS began pursuing the development of a risk-based 
strategy for compliance that expands compliance coverage to a greater 
number of companies and properties. This strategy will allow us to rank 
companies and properties according to particular risk identifiers, to 
provide the detail needed to identify properties or payors where audits 
or compliance reviews are warranted, and to identify when and where we 
need additional resources. Also, MRM proposed to improve the timeliness 
and efficiency of the interest assessment to companies by implementing 
computer system enhancements. The President's Fiscal Year 2009 Budget 
includes a request for an additional $3.7 million for these two 
initiatives.
Implementation of Subcommittee Recommendations
    I would like to turn your attention to our progress to implement 
the RPC Subcommittee Report. In a memorandum dated January 14, 2008, 
Secretary Kempthorne asked the Department to review the Report, develop 
an action plan, and begin implementing the Subcommittee's 
recommendations. I am pleased to report that as of February 11, 2008, 
16 of the 110 recommendations are already complete (See Attachment #3). 
Of the remaining 94 recommendations, 29 are underway. We have developed 
a Joint Action Plan to address all of the Report's recommendations.
    The Plan identifies by recommendation the responsible Bureau, 
estimated timeframes for completion, and status. Points of contact are 
designated within each Bureau to monitor implementation and report on 
progress on a monthly basis. Many of the recommendations require 
further evaluation, and to that end, teams are being formed to 
determine appropriate actions and schedules. Likewise, many 
recommendations will need to be explored further through consultations 
with State and Tribal officials, and other organizations before they 
can be adequately implemented. We have developed a tracking system and 
have been and will continue to hold regular meetings to assess progress 
on the implementation of each action item.
    Examples of the major focus areas contained in our Joint Action 
Plan include the following:
      Completing Production Accountability Reviews at BLM and 
MMS for producing leases to make certain that royalties are being paid 
on the correct volume and quality of oil and gas from Federal and 
Indian lands.
      Improving the coordination, collaboration, communication, 
and information sharing between BLM, MMS, and BIA.
      Requiring more reporting of data electronically and 
ensuring that bureaus have easy access to each other's systems.
      Implementing a risk-based compliance strategy and 
determining the extent to which a more flexible approach to audits, 
similar to that used by the IRS, is feasible.
      Ensuring the RIK program has the right personnel with the 
right skills to get the job done.
      Ensuring that all staff receives ethics training, 
including training focusing on public-private sector interactions.
      Ensuring that we have sufficient staff to support the 
Department's onshore and offshore royalty management activities.
    The BLM has already taken measures to strengthen its Production 
Accountability Reviews by increasing funding in FY 2008 and FY 2009, 
and, for FY 2009, BLM plans to hire an additional 15 Production 
Accountability Technicians (PATs) to increase the number of reviews in 
order to verify production reported to MMS by oil and gas operators. In 
addition, as part of the Joint Action Plan, the BLM is examining issues 
and recommendations to lower the thresholds for production of oil and 
gas for which annual reviews will be given; revise its policy and 
regulations on evaluating the quality of oil (API gravity) and gas (BTU 
factor) when doing production verification, as inaccurate reporting of 
these values will impact royalty collections; consolidate its policy on 
oil and gas measurement and when gas can be used on a lease without 
paying royalties on that gas; and update and consolidate policy across 
the program for more effective implementation of the oil and gas 
inspection program, including production accountability. The BLM is 
also examining further increased staffing of Production Accountability 
Technicians, ensuring PATs are properly trained, and developing 
standardized position descriptions for PATs. Finally, BLM is working to 
develop better communications with MMS, including scheduling annual 
workshops on production accountability, and developing protocols for 
operators who have been identified as underreporting production.
    Recently, Assistant Secretary Allred sent to Chairman Costa and 
Ranking Member Pearce, MMS's status update on the action MMS has taken 
to address the findings of the OIG in two of its most recent reports. I 
am pleased to report that as of February 29, 2008, MMS completed all of 
the 23 items in the action plan associated with the December 2006 audit 
report on MMS's compliance review process, and 12 of the 15 actions 
associated with the September 2007 OIG report on false claims 
allegations.
    The OIG's December 2006 report on the compliance review process 
represents the culmination of an audit that the OIG performed of MMS's 
compliance review process. The objectives of the audit were to 
determine (1) whether compliance reviews are an effective part of the 
Compliance and Asset Management's (CAM) operation, and (2) whether MMS 
is effectively managing the compliance review process.
    The OIG concluded in its audit that compliance reviews can serve a 
useful role as part of MMS's CAM program operations. The OIG further 
reported that compliance reviews are a legitimate tool for evaluating 
the reasonableness of company-reported royalties and allow a broader 
coverage of royalties, while requiring fewer resources than audits. 
While the OIG report concluded that compliance reviews are an effective 
part of MMS's CAM program operations, it made recommendations to 
strengthen policies and procedures to improve automated tracking and 
verification systems and improve the compliance review process.
    MMS administers a royalty Compliance and Asset Management operation 
charged with ensuring that fair market value is received for the 
mineral assets removed from Federal and Indian lands. MMS is committed 
to the administration of a Federal and Indian mineral revenue 
compliance program of the highest quality and integrity. Our efforts 
are to ensure that Federal and Indian mineral revenues are timely and 
correctly reported and paid by the minerals industry in compliance with 
applicable laws, regulations and lease terms.
    Our compliance strategies and activities are carried out through a 
nation-wide MRM field audit structure and partnership through delegated 
and cooperative audit agreements with 11 States and 7 Indian tribes. 
This strategy effectively utilizes a combination of targeted and random 
audits, compliance reviews, and royalty in kind property 
reconciliations. The strategy calls for completion of the compliance 
cycle within 3 years of the royalty due date. In Fiscal Year 2007, this 
strategy ensured reasonable compliance on $5.8 billion in Federal and 
Indian mineral lease revenues, 64.7 percent of total mineral revenues 
paid for calendar year 2004 production. MMS's royalty compliance 
activities have yielded over $3.4 billion in additional mineral 
revenues since program inception in 1982. The cost benefit analysis of 
compliance reviews and audits for Fiscal Years (FY) 2005 through 2007 
shows that for every $1 spent on compliance reviews, MMS collected 
$5.49. In August of 2007, MMS reached a $105.3 million settlement with 
Burlington Resources, resulting from complex, multi-year audit work. 
Without this anomaly being recorded in FY 2007, the cost benefit 
analysis for audits shows that for every $1 spent on audits, MMS 
collected $4.71 (See attachment #4). We agree with the OIG and the RPC 
Subcommittee that compliance reviews are a valuable management tool.
    Through the implementation of MMS's compliance action plan we have 
taken steps to strengthen the compliance review process by establishing 
and implementing a pilot project to further develop and begin 
implementing risk-based compliance strategies, restoring MMS's access 
to BLM's Automated Fluid Minerals Support System that was interrupted 
by the Cobell litigation, amending production verification procedures, 
and ensuring state and tribal auditors have access to compliance tools.
    The OIG's September 2007 report on the false claims allegations 
responded to Assistant Secretary Allred's request that they look into 
the qui tam lawsuits that were filed by some MMS employees (relators) 
against several energy companies alleging fraudulent activities. The 
OIG report indicates that 1) the relators did not follow MMS 
procedures, and 2) there was no evidence of retaliation by management 
against employees. The report also identified a number of areas for 
improvement that MMS embraced and moved aggressively to build upon.
    As a result of this report, MMS analyzed its practices and, where 
applicable, identified opportunities to implement policy and procedural 
changes. These opportunities were outlined in the action plan 
containing 15 items, 12 of which have been completed.
    Significant accomplishments include eliminating the backlog in 
interest billing; fully briefing decision makers on the interest 
calculation policy; updating manuals and other guidance on safeguarding 
proprietary and business confidential information and on procedures for 
reporting suspected fraud; and establishing policies to ensure 
mandatory training and performance management requirements are met. Of 
special note, in FY 2007, MMS billed more than $66 million of interest 
on late royalty payments and is now regularly billing the lessees for 
any late payments on a monthly basis. The MMS will complete the 
remaining three action items this spring.
    In addition, in October 2007, MMS met with the U.S. Attorney's 
Office (USAO) and the OIG to begin the process of strengthening our 
relationships regarding the referral and investigation of false claims 
cases. As a result of MMS's initiative, this group has begun meeting 
every month to discuss joint training on detecting and referring false 
claims and referral of potential royalty cases to the USAO.
Conclusion
    Each month, approximately 2,100 companies report and pay royalties 
associated with over 28,000 producing Federal and Indian leases. In FY 
2007 alone, the 537 employees of the MRM program processed over 400,000 
reports containing more than 7.7 million lines of data. The magnitude 
and complexity of this program requires that the Federal government 
work with all its partners to ensure the use of best practices, the 
best technology, and the most efficient use of available resources. We 
will continue to identify and respond to opportunities to improve our 
efficiency and streamlining our processes, within the confines of 
available resources. The Department's goal is to ensure that companies 
are in compliance with applicable laws, regulations, and lease terms 
and the Government is receiving fair market value. We are pleased with 
the results of MMS's efforts thus far, but recognize that there is much 
more work to be done. We can assure you that MMS will successfully 
implement the remaining recommendations of the OIG and that the three 
Bureaus will continue to work together to implement the RPC 
Subcommittee's recommendations.
    We welcome your input on all of these initiatives, and look forward 
to working with the Committee as we strengthen and improve the royalty 
management program.

[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]


STATEMENT OF LAWRENCE FINFER, DEPUTY DIRECTOR, OFFICE OF POLICY 
           ANALYSIS, U.S. DEPARTMENT OF THE INTERIOR

    Mr. Costa. We will now move on to the next witness, Mr. 
Lawrence Finfer, is that correct? Mr. Finfer is the Deputy 
Director of the Office of Policy Analysis for the Department of 
the Interior. Mr. Finfer, please.
    Mr. Finfer. Thank you, Mr. Chairman, Mr. Pearce. I am 
Lawrence Finfer, Deputy Director of the Office of Policy 
Analysis, but I was also Staff Director to the Subcommittee on 
Royalty Management. As you know, our co-chairs, Senators Bob 
Kerrey and Jake Garn, submitted a statement for the record. I 
would like to briefly summarize that statement.
    The subcommittee was formed in March 2007 to provide an 
independent examination of the royalty program and its 
proceeded over a nine month period. As mentioned, the 
subcommittee concluded that overall MMS was an effective 
steward of the royalty program.
    The Senators, in particular, included the following 
statement, both in their statement for the record and in the 
announcement of the subcommittee's report, namely, ``that the 
Federal employees who work in the mineral leasing and royalty 
collection program are conscientious, hard working and 
concerned about the reputation of the program and the 
Department of the Interior.''
    Nonetheless, the committee found many areas in which 
improvements were needed, and some of those improvements need 
to be substantial. Hence, the 110 recommendations provided by 
the subcommittee. I would like to just highlight a number of 
the ones that were included in the Senators' statements.
    First, the subcommittee embraced the Inspector General's 
recommendation that compliance reviews are an appropriate tool 
but need to be used in conjunction with audits in a 
comprehensive, well thought out strategy. This means 
specifically the implementation of a risk-based approach.
    In that light, the subcommittee consulted with what we 
regarded as the pros, namely the IRS, which has decades of 
experience in risk-based approaches, and we learned quite a 
bit, which we included in our report. Further, we recommended 
that MMS pursue an ongoing relationship with the IRS as it 
implements a risk-based approach.
    My understanding, that it is doing just that at this point. 
That is absolutely critical to its success. Second, one 
recommendation which has been touched on before is the 
recommendation to establish a trust fund with royalty revenues. 
The subcommittee's recommendation was made because a number of 
these improvements will cost money, and a trust fund properly 
invested will yield interest, a small portion of which could 
help fund those improvements.
    Third, building off of some of the recommendations of the 
IG, the subcommittee recommended ethics training for all 
employees involved in the royalty program, particularly the 
Royalty-in-Kind Program.
    Government employees do receive ethics training, but the 
subcommittee believes that this particular ethics training 
should be targeted to the particular issues and situations 
faced by employees in this program so that they know what 
interactions are appropriate and which ones are not.
    Fourth, as noted, better coordination needs to occur 
between BLM, and the MMS and the BIA in a variety of areas, 
production accountability and otherwise. This is essential in a 
variety of areas. We also made recommendations for improving 
some of the reporting, such as the MMS 2014, to include BPU 
values, and perhaps most important, to ensure that we go to an 
all electronic reporting format as soon as possible.
    Without an all electronic reporting format it will be 
difficult to implement a risk-based approach. Also, as noted, 
the subcommittee spotlighted some of the problems BLM has in 
getting a sufficient number and a sufficiently well-trained 
production technician workforce. This significantly affects 
production accountability, and this is a situation that needs 
to be addressed.
    The onshore program has grown rapidly, and frankly, this 
area needs some catch up work to ensure appropriate production 
accountability. Finally, with respect to the Royalty-in-Kind 
Program, the subcommittee concluded strongly that the RIK 
Program is a valuable program and should be continued. However, 
the program has grown rapidly from one that barely existed five 
or six years ago to the point where it is not a major facet of 
royalty collections.
    That growth now needs to be accompanied by more structured 
procedures and better oversight. We recommended the 
establishment of a subcommittee on royalty in kind to the 
Royalty Policy Committee, among other things, and much more 
consistent application of procedures across the board, both in 
terms of auction, performance measures and so on and so forth.
    That combination will produce greater transparency, which 
is essential for a program of this type. Simply put, the 
program has grown so quickly it is now time to catch up and 
give it the foundation that it needs and deserves. At the same 
time, however, while concluding that the Royalty in Kind 
Program was a valuable program there were certain areas we 
recommended that be discontinued.
    These include the Small Refiner Program and the Onshore Oil 
Program. Mr. Chairman, this concludes my testimony, and I will 
be pleased to take questions.
    [The response to questions submitted for the record by Mr. 
Finfer follows:]

     Response to questions submitted for the record by Larry Finfer

 Question 1: Mr. Finfer, you stated that one of the crucial elements to 
        a risk-based strategy is good data. Do you believe that MS 
        currently has data of sufficient quality to properly implement 
        an effective risk-based compliance strategy, given that both 
        Mr. Rusco and Mr. Roller testified that there were problems 
        with MMS data?
    Answer: The issues raised with respect to the quality of MMS's data 
do not necessarily bear upon whether data exist that are sufficient to 
implement a risk-based approach. As the risk-based approach is 
designed, those needs will be defined as will the systems support 
needed to apply the data to implementation activities. That will also 
inform the issue of whether existing systems can be readily adapted to 
use data for risk-based activities or whether a new and more tailored 
systems design effort is needed.
 Question 2: Mr. Finfer, did the committee ask whether or not MMS had 
        enough staff to complete its audit and compliance tasks? They 
        currently have about 126 auditors, far less than the nearly 170 
        they had at the beginning of the decade? Is that enough?
    Answer: The committee did review staffing issues and a number of 
recommendations address those concerns. In general, although a portion 
of the reduction is explicable given the efficiencies realized as a 
result of the Royalty-In-Kind program, it appears that the some of the 
reduction also reflected budget limitations as opposed to reduced 
needs. Some of the committee recommendations address this issue. For 
example, Recommendation 4-2 (Chapter 4, page 62 of the report) 
recommends a systematic review of staffing and budgetary needs related 
to anticipated compliance strategies. In particular, the development of 
the risk-based approach should further inform the effort to define 
appropriate staffing levels.
 Question 3: Mr. Deal and Mr. Finfer, could you provide more detail on 
        the difference between a ``royalty payor'' and an ``operating 
        rights owner,'' and why it would be better for MMS to pursue 
        the royalty payor (as per Recommendation 3-8). Please provide 
        an example to demonstrate the difficulty in the current system.
    Answer: The operating rights owner/working interest owner is 
defined in BLM manuals as: ``The interest or contractual obligation 
created out of a lease (such as a sublease) authorizing the holder of 
that right to enter the leased lands to conduct drilling and related 
obligations, including production, which may include as consideration a 
share in revenues therefrom.'' The lessee of record title is the owner 
of the lease, and there can be numerous lessees of a lease including 
individuals who acquire an interest as a passive investment. The payor 
can be the operator, purchaser, lessee, operating rights owner and the 
accounting service hired by the owner to report on and pay the 
royalties. There can be multiple payors on a given lease.
    There are a number of problems with the current system that led to 
the committee's recommendation. First, as noted in the report (Chapter 
3, page 23), MMS does not have a system in place to track the identity 
of operating rights owners. Enforcing an obligation against a lessee 
could be costly and cumbersome and involve actions including hundreds 
of entities. Added complications arise because when MMS pursues 
nonpayments or underpayments against a payor, it must notify all 
operating rights owners and lessees (which, as noted above, MMS is 
currently unable to track). Further, under the Debt Collection 
Improvement Act, MMS has only 180 days to collect payments. Given the 
above circumstances, this has proved to be a near-impossible deadline. 
Accordingly, the committee concluded that restoring pre-Royalty 
Simplification and Fairness Act requirements was merited, and that is 
reflected in Recommendation 3-8. However, if MMS received such 
statutory authority, it would be important for it to work with industry 
in the implementation phase to ensure requirements were imposed in a 
reasonable and efficient manner.
                                 ______
                                 
    Mr. Costa. Thank you very much. We appreciate a number of 
the comments you made with regard to both risk assessment as 
well as to the computerization program. I know a number of us 
will have questions on a number of the points you raised.

STATEMENT OF LINDA STIFF, ACTING COMMISSIONER, INTERNAL REVENUE 
                            SERVICE

    Mr. Costa. Our next witness is Ms. Linda Stiff, the Acting 
Commissioner for the Internal Revenue Service, is that correct?
    Ms. Stiff. That is right.
    Mr. Costa. Thank you, and we look forward to your 
testimony.
    Ms. Stiff. Good morning, Chairman Costa, Ranking Member 
Pearce and members of the Subcommittee. Thank you for the 
opportunity to appear before you today. I have served as the 
acting Commissioner of the IRS since September. I am a career 
IRS employee having started as a revenue agent more than 27 
years ago.
    Mr. Costa. Congratulations.
    Ms. Stiff. While the IRS has no role relative to the 
Federal Oil and Gas Royalty Program, it is my understanding 
that you want me to review for the Subcommittee the IRS's 
compliance procedures relative to the collection of Federal 
income taxes.
    My written statement provides a detailed overview of the 
IRS compliance program, so what I would like to do this morning 
is highlight what I think to be the most important aspects of a 
strong compliance program. For the IRS, the most fundamental 
premise of our compliance efforts involve balancing taxpayer 
service with our enforcement programs.
    Service is critical to sound tax administration because we 
know that some portion of noncompliance results from taxpayers 
failing to fully understand their tax obligations. The primary 
goal of our service program is to assist taxpayers in complying 
with their Federal tax responsibilities and to help them 
navigate the complexities in the Tax Code.
    To accomplish this, we provide extensive outreach and 
education to individual and business taxpayers as well as to 
tax practitioners. The IRS taxpayer services programs ensure 
that taxpayers know their obligation, they understand how to 
meet them and we provide assistance when appropriate.
    Our service programs mitigate compliance problems due to 
inadvertent errors and lack of understanding, particularly for 
taxpayers who are inclined to comply. At the IRS we believe 
that services with enforcement equals compliance. Enforcement 
programs are critical to verify compliance as reported and to 
ensure that all taxpayers can count on the system to be fair 
and be a system that requires everyone to pay their share and 
meet their tax requirements.
    Additionally, our enforcement programs enable us to address 
those instances where the noncompliance is willful and 
intentional. The IRS employs a number of enforcement tools that 
includes notices, matching of third-party information to 
returns, audits and collection activities. In each of these 
cases, we integrate risk-based strategies to select what work 
will be done.
    There are two critical factors that were actually mentioned 
earlier by the first panel that assist us in ensuring 
compliance with the tax laws. One is transparency. Simply put, 
the more transparent a transaction is, the easier it is to 
understand. Fostering greater transparency within this nation's 
administration system enhances compliance with the tax laws.
    The second critical factor to ensure compliance actually 
flows from the transparency issue as well; it is third-party 
information reporting. Research and compliance studies confirm 
that compliance is greater in the presence of third-party 
reporting. In fact, for the tax system, compliance exceeds 95 
percent where third-party reporting exists.
    Where income is not subject to either withholding or third-
party reporting requirements the misreporting percentage rises 
to as high as 54 percent. We continue to seek means of 
improving third-party reporting in transactions where it does 
not now exist. Another critical component of our compliance 
effort is balanced coverage or presence.
    We know there is a ripple effect when we reach out and 
interact with the taxpayer through our enforcement programs. It 
is similar to the efforts of the police. They may not catch 
every speeder, but if a motorist sees them they do tend to slow 
down and abide by the law. Finally, from both a service and 
enforcement perspective, we understand that we operate in an 
environment where resources are limited.
    We are challenged, just as our colleagues are, to find ways 
to improve processes and increase productivity. We are doing 
this by continuing to improve efficiency and productivity 
through process changes and streamlined business practices, and 
we are leveraging technology to deliver both increased services 
and improve our enforcement efforts.
    Mr. Chairman, I hope this overview has been helpful. I 
thank you, again, for the opportunity to appear this morning 
and will be happy to respond to any questions that you may 
have.
    Mr. Costa. Thank you. I appreciate your comments. How much 
of that is applicable in this sense we will try to determine, 
but we thank you for being here.
    [The prepared statement of Ms. Stiff follows:]

   Statement of Linda Stiff, Acting Commissioner of Internal Revenue

    Chairman Costa, Ranking Member Pearce, and members of the 
Subcommittee, thank you for the opportunity to appear before you today. 
While the IRS has no role relative to the Federal oil and gas royalty 
program, it is my understanding that you want me to review for the 
Subcommittee IRS's compliance procedures relative to the collection of 
Federal income taxes.
Background
    The IRS administers America's tax laws and collects the revenue 
that funds most federal government operations. Each year we collect 
more than $2 trillion, or over 96 percent of the revenues that fund the 
federal government each year. This revenue comes from over 144 million 
Federal income tax returns filed by individuals and corporations 
throughout the U.S. In many ways, the IRS and its employees represent 
the face of U.S. government to more American citizens than any other 
government agency.
    What is perhaps most impressive about our Federal tax collection 
system is that it is largely self-enforcing, and yet we collect what we 
estimate to be approximately 85 percent of the taxes owed each year. We 
are able to do this by maintaining a system that balances strong 
taxpayer service with an equally strong compliance program.
Maintaining the Service and Enforcement Balance
Taxpayer Service
    Research has shown us that the complexity of the U.S. tax code is 
an important factor in the ability of many taxpayers to remain 
compliant with tax laws. It is important for us to differentiate 
between this type of noncompliance and willful noncompliance where the 
taxpayer fully understands their obligations but refuses to pay the 
taxes due. The primary goal of IRS service programs for individual 
taxpayers is to facilitate compliance with federal tax obligations.
    We attempt to assist taxpayers through three primary means: the 
internet, the telephone and direct contact.
      The Internet--One of the most frequently visited websites 
in America is IRS.gov. In FY 2007 there were more than 215 million hits 
on the web site, a 10-percent increase over the previous year. IRS.gov:
        Provides taxpayers information on the economic stimulus 
program enacted by Congress in February;
        Assists taxpayers in determining whether they qualify for 
the Earned Income Tax Credit (EITC);
        Assists taxpayers in determining whether they are subject 
to the Alternative Minimum Tax (AMT);
        Allows more than 70 percent of taxpayers the option to 
file their tax returns at no cost through the Free File program. Free 
File is a public/private partnership that allows more than 97 million 
taxpayers to file their returns at no cost. In 2007, approximately 4 
million taxpayers took advantage of the Free File service.
        Allows taxpayers who are expecting refunds to track the 
status via the ``Where's My Refund?'' feature; and,
        Allows taxpayers to calculate the amount of their 
deduction for state sales taxes.
      Telephone--Many Americans still prefer to pick up the 
telephone to have their questions answered. In FY 2007 the IRS customer 
assistance call centers answered 33.2 million assistor telephone calls 
and maintained an 82.1 percent level of service on the telephone with 
an accuracy rate of 91.2 percent on tax law questions. The agency 
reached a 95 percent customer satisfaction rating for its toll-free 
telephone service, up from 94 percent the year before.
      Face to Face--While we attempt to direct taxpayers to 
less costly, and in many ways more effective, means of assistance such 
as the internet, we understand that there will always be a number of 
people who prefer direct contact with an individual to have their 
questions answered. We continue to meet that need through our 401 
Taxpayer Assistance Centers (TACs). These TACs are scattered across the 
country and act as walk-in sites for millions of Americans each year. 
Another important element of our face-to-face contact with taxpayers is 
the nearly 12,000 manned volunteer sites. These volunteer sites assist 
in the preparation and submission of income tax returns, primarily for 
low-income Americans. In FY 2007, over 76,000 volunteers prepared 2.63 
million returns at these sites.
    The overriding strategy that guides our taxpayer service program is 
the Taxpayer Assistance Blueprint (TAB). This collaborative effort of 
the IRS, the IRS Oversight Board, and the National Taxpayer Advocate 
began in July 2005 in response to a Congressional mandate to develop a 
five-year plan that outlines the steps we should take to improve 
taxpayer services. This was in recognition of the critical role that 
taxpayer service plays in improving compliance.
    TAB represents a significant milestone in a decade-long history of 
service enhancements by the IRS. During this period taxpayer 
satisfaction with IRS services has grown significantly, due in large 
part to the strength of our commitment to continual improvements. 
Increases in electronic filing and on-line service transactions, high 
levels of toll-free access and accuracy, extensive stakeholder 
engagement, and increasingly diversified efforts to reach taxpayers 
through local partners and community coalitions have all led to better 
taxpayer understanding and participation in the tax system.
    Another critical component of our compliance program is a strong 
customer service focus toward the business community. A key component 
of this has been our outreach program. In FY 2007, we:
      Maintained relationships with business industry and tax-
professional organizations and coordinated or participated in events 
across the country, sharing education and outreach messages and 
information to better enable their members to comply with the law.
      Engaged practitioners and payroll providers through 
national and local chapters of prominent organizations such as the 
American Institute of Certified Public Accountants (AICPA), American 
Bar Association (ABA), the National Association of Enrolled Agents 
(NAEA), the National Payroll Consortium (NPRC), and the Independent 
Payroll Provider Association (IPPA).
      Maintained a close working relationship with the Internal 
Revenue Service Advisory Council (IRSAC) and the Information Returns 
Program Advisory Committee (IRPAC) to address small business issues 
through their Small Business/Self-Employed Sub-Working Group. 
Currently, both groups are working to address issues to improve 
voluntary compliance.
Enforcement
    Through a renewed focus on improving our enforcement efforts, we 
have been able to increase enforcement revenue from $33.8 billion in FY 
2001 to $59.2 billion in FY 2007, an increase of 75 percent. This 
represents a 5.6 to 1 return on investment for all IRS activities in FY 
2007.
    In FY 2007, both the levels of individual returns examined and 
coverage rates have risen substantially. We conducted nearly 1.4 
million examinations of individual tax returns in FY 2007, an 8 percent 
increase over FY 2006. This is over three-quarters more than were 
conducted in FY 2001, and reflects a steady and sustained increase 
since that time. Similarly, the audit coverage rate has risen from 0.6 
percent in FY 2001 to 1 percent in FY 2007.
    While the growth in examinations of individual returns is visible 
in all income categories, it is most visible in examinations of 
individuals with incomes over $1 million. Audits of individuals with 
incomes of $1 million or more increased from 17,015 during FY 2006 to 
31,382 during FY 2007, an increase of 84 percent. One out of 11 
individuals with incomes of $1 million or more faced an audit in 2007. 
Their coverage rate has risen from 5 percent in FY 2004 to 9.25 percent 
in FY 2007.
    In looking at our audit numbers for individual taxpayers, it is 
important to understand that we conduct two types of audits. The first 
is the traditional field audit where an auditor actually meets with the 
taxpayer to conduct an examination. The second is a correspondence 
audit. These occur in instances where we are unable to match the 
taxpayer's return with third-party documents that are filed with us. 
For example, a taxpayer's return that does not report income that is 
reported to us as part of an interest statement provided by the 
taxpayer's bank would raise a red flag. We would send a letter to the 
taxpayer assessing the additional tax as well as any interest and 
penalties that may apply. The taxpayer is then provided an opportunity 
to dispute this assessment if they desire or they can send the 
corrected assessment directly to us.
    In the business arena, we attempt to allocate resource to the areas 
where we think they will be most effective. In FY 2007 for example, the 
IRS continued efforts to review more returns of flow-through entities--
partnerships and S Corporations. Our business statistics reflect that 
we have placed more emphasis in the growing area of these flow-through 
returns. We also increased our focus on mid-market corporations--those 
with assets between $10 million and $50 million.
    Operating in an environment where resources are limited, we are 
challenged to find ways to improve processes and increase productivity. 
We are doing this by continuing to improve efficiency and productivity 
through process changes and streamlined business practices.
    A critical component in ensuring the most productive use of 
compliance resources is a greater reliance on information technology 
(IT) modernization. The IRS strategic vision includes IT systems that 
would allow for identification of the cases to be worked, routing of 
those cases to the most appropriate workstream, and the availability of 
cost effective technology analytics to manage cases in the stream 
optimally.
    The National Research Project (NRP), which analyzed some 46,000 
individual income tax returns from Tax Year (TY) 2001, has provided us 
with significant data to help us facilitate the selection of the most 
productive returns to examine. It is envisioned that the case selection 
process will be further enhanced through automated classification 
processes, including expert systems, electronic database analysis, and 
leveraging e-filed data from corporations--efforts that are currently 
underway. Technology enhancements are also on track for more effective 
and efficient workload selection models within the non-filer 
population.
    The FY 2009 Budget for the IRS includes $51 million to expand our 
commitment to quality enforcement research. This enforcement initiative 
will support and expand ongoing research studies of filing, payment, 
and reporting compliance to provide a comprehensive picture of the 
overall taxpayer compliance level. Research allows the IRS to better 
target specific areas of noncompliance, improve voluntary compliance, 
and allocate resources more effectively to reduce the tax gap. Improved 
research data will refine workload election models reducing audits of 
compliant taxpayers.
    We also use current audit information from ``issue management'' 
systems to improve case selection criteria and provide for immediate 
identification of emerging issues. For collection programs, we are 
using improved decision analytics to select cases and route them to the 
most appropriate collection enforcement stream. For large corporate 
returns, data is now available earlier due to the corporate e-file 
mandate, and we are using data from returns filed electronically, 
including the Schedule M-3, for risk assessment and issue 
identification.
    Delivery systems are also being modified to move audit work into 
the system more effectively and efficiently. Return classification and 
delivery will be more automated and digital, eliminating the manual 
time-consuming and expensive process of ordering returns and sending 
examiners out to Campus locations for classification details. 
Additionally, the IRS will replace manual processes with electronic 
case building and instant access to multi-year tax return information.
    Automated systems are also being deployed to allow more batched 
processing of high-volume examinations. Technology enhancements will 
allow employees to work cases in an online environment, where returns 
and case-related data can be downloaded, and actions can be tracked 
electronically. We will continue to link multiple internal and external 
databases to enhance overall effectiveness, allowing better 
identification, management, and performance monitoring for compliance 
workload. In utilizing these automated systems, IRS remains committed 
to protecting taxpayer data from being accessed inappropriately.
    The large corporate entities monitored by the IRS are highly 
sophisticated, well-capitalized, well-organized, and adept at tax 
planning. Particularly in the case of public companies, they are driven 
to show high after-tax profitability to shareholders in a very 
competitive and complex economic environment. They have the resources 
and willingness to defend their reporting positions and contest 
proposed adjustments aggressively.
    However, these taxpayers also face significant changes in corporate 
governance, including increased public disclosure and transparency. A 
number of these changes have been the result of legislative or 
administrative changes including:
      New requirements were imposed on corporate officers and 
directors by the Sarbanes-Oxley Act.
      There was increased scrutiny of outside auditors by the 
creation of the Public Corporation Accounting Oversight Board.
      Increased requirements of disclosure were included in the 
American Jobs Creation Act.
      New SEC/FASB (FIN48) rules limit the discretion companies 
can apply in determining their unresolved tax positions for financial 
accounting purposes.
    For some corporations, these changes have created a desire for 
certainty regarding their tax liability as soon as possible. Tax 
certainty--or lack thereof--can have a real effect on a company's share 
price, because a more accurate picture of a company's finances is now 
required and publicly available.
    We recognized long ago that our traditional approach to corporate 
tax administration, which centered on lengthy, detailed tax return 
examinations, was no longer viable. As a result, we developed a 
proactive approach to dealing with the challenges of effective tax 
administration in a global environment with an increasingly complex tax 
code. Overall, this strategy depends on making compliance checks, when 
possible, on a real-time basis, remaining current in our examinations, 
and having as much transparency to book-tax differences and other 
indicators of risk as possible. To that end, we have initiated several 
programs that foster transparency, currency, pre-filing compliance 
opportunities, and improved efficiencies in issue and risk 
identification.
    First, to improve transparency on corporate tax returns, the IRS 
introduced a new Schedule M-3. The Schedule M-3 provides transaction-
specific detail on book-tax differences, enabling the IRS to identify 
and focus more quickly and precisely on those tax returns and issues 
that present the highest potential compliance risk.
    Second, our Large and Mid-Sized Business (LMSB) division has 
introduced the Compliance Assurance Program (CAP). The CAP program is 
designed to improve both currency and transparency. It is a real-time 
approach to compliance review that allows LMSB, working in conjunction 
with the taxpayer, to determine tax return accuracy prior to filing. 
CAP is more efficient than a post-filing examination, as it provides 
corporations certainty about their tax liability for a given year 
within months, rather than years, of filing a tax return. CAP is a pre-
filing initiative designed to provide certainty for both the IRS and 
the taxpayer, that a return (in its entirety) is substantially 
complaint when it is filed. This win-win program greatly reduces 
taxpayers' compliance burden and their need for contingent book tax 
reserves, while increasing currency and allowing for more efficient use 
of IRS resources.
    Third, the IRS is continuing the Pre-Filing Agreement (PFA) program 
to provide taxpayers an opportunity to request that revenue agents 
examine and resolve potential issues before tax returns are filed. This 
is distinguished from the CAP program as it provides certainty on a 
single issue(s), as opposed to certainty of a tax return (in its 
entirety). We continue to explore ways to improve and create additional 
pre-filing compliance opportunities that may limit the number of issues 
we need to examine in a post-filing examination.
    Fourth, working with Treasury and Chief Counsel, LMSB identifies 
emerging high-risk issues as early as possible, issuing guidance to 
taxpayers and examiners on the proper treatment of these issues, and 
efficiently and vigorously examining those returns where taxpayers 
engage in that behavior.
    Fifth, the IRS is mandating, in stages, the electronic filing of 
corporate returns (E-Filing) in order to improve issue identification 
and the selection for examination of high-risk returns. Large 
corporations are required now to file their tax returns electronically 
and this mandate will expand in future tax years. E-filing will provide 
more consistent treatment and data analysis for efficient, near real 
time identification of high-risk issues and taxpayers. E-filing and 
Schedule M-3 together also allow us to identify and exclude more 
efficiently lower-risk taxpayers from consideration for examination.
    The approaches described above better position the IRS to address 
the rapid change of business in the domestic and global arenas in a 
timelier manner. The earlier we learn of emerging trends, the better 
positioned we will be to adjust resources to address compliance risks 
appropriately.
    Increasing timeliness and reducing cycle time means that less time 
is spent on each audit. This has allowed us to continue to show 
improvement in enforcement results at the same time we are increasing 
our coverage of these taxpayers. We believe that the more compliance 
``touches'' that occur (even if that does not include a full audit in 
the traditional sense), the better the direct and indirect enforcement 
benefits will be.
Summary
    Any agency with limited resources must make difficult decisions on 
how to allocate those resources in the most effective way. It also must 
be accountable for those decisions, and so appropriate metrics must be 
established to measure the success or failure of the actions taken.
    While we understand that we can still do some things better, we 
believe that our approach, which balances service and enforcement in an 
effort to improve compliance, is working effectively. We base that 
conclusion on the metrics that show how enforcement--particularly 
enforcement against high-income individuals and large corporations--
have grown substantially in the last five years without any diminution 
in our taxpayer service levels.
    Thank you for the opportunity to appear this morning, and I will be 
happy to respond to any questions.
                                 ______
                                 

    Response to questions submitted for the record by Linda Stiff, 
                Acting Commissioner of Internal Revenue

Questions for Ms. Linda Stiff, Acting Commissioner, Internal Revenue 
        Service
1.  Commissioner Stiff, in a report issued last year by the Interior 
        Department's Inspector General, a manager at MMS says that when 
        companies file their royalty reports, they are allowed to take 
        deductions and it's up to MMS to figure out whether or not 
        those deductions are valid. Apparently, a company can never get 
        in trouble for filing a false deduction, since they're not 
        required to verify whether it is or isn't. Does the IRS operate 
        that way with individual taxpayers?
    ANSWER: The IRS cannot comment on Mineral Management Services (MMS) 
rules regarding royalty reporting requirements. However, with regard to 
federal income tax returns, taxpayers are expected to maintain adequate 
records (such as a check or a receipt) to substantiate any deduction on 
their income tax return. Upon audit, a number of penalties--both civil 
and criminal--can be applied if false deductions are claimed on an 
income tax return. The IRS does not allow taxpayers to knowingly file 
``false deductions.''
    Individual taxpayers who receive royalty income normally receive a 
Form 1099. The Form 1099 reports the gross royalty income received by 
the taxpayer. Generally, the taxpayer may be entitled to deduct 
depletion and production taxes from the income reported.
2.  Commissioner Stiff, it seems to me that IRS would have similar 
        problems that MMS is having in terms of retaining a trained 
        workforce. You have highly trained accountants and tax experts 
        who are in demand in the private sector. Are you seeing high 
        turnover rates, and how do you attract and retain skilled 
        individuals?
    ANSWER: The IRS takes a holistic approach to managing its human 
capital. We ensure that planning, recruitment and hiring, employee 
development, retention and the management of attrition are looked at as 
a continuum and not as individual processes. We are fortunate that we 
are not experiencing unusually high turnover rates among our Mission 
Critical Occupations (MCO) at this time. However, with the potential 
for increasing retirements, we are studying and implementing multiple 
programs to ensure we meet hiring goals and have a well trained 
workforce with the needed level of expertise. These programs include 
targeted recruitment, marketing and advertising, as well as integrating 
skills assessments into the hiring process. We are also expanding 
strategic use of reemployed annuitants to enhance our training efforts 
for newly hired MCO positions. Use of reemployed annuitants has proven 
to be very successful. However, use of this program continues to 
require special authority and/or legislative change to ensure there is 
no impact on the annuitant's retirement income.
    The IRS continuously reviews its programs to market itself as an 
``employer of choice''. Relationships have been established with 
veteran's organizations such as Military.com, Operation Warfights (DoD) 
and the Department of Veterans Affairs ``Coming Home to Work Program''. 
In addition, a Service-wide recruiter cadre participates in targeted 
events at colleges and a video game-like tool is being developed to 
target high school students for a possible career with the IRS. Work 
life flexibilities, such as telework and alternate work schedules, are 
also touted as tools to provide/ maintain a work life balance and 
achieve business goals.
    The IRS is currently challenged in the area of retaining some new 
hires. New hires in MCO positions, such as Revenue Agents, are being 
lost about one year ahead of the past trends. The trend is being 
monitored and addressed through the use of: exit interviews; a 
retention benefit index model; training and development studies; and 
continued analysis of workforce drivers. The IRS has also adopted a 
corporate incentive strategy that allows for recruitment, relocation 
and retention payments for hard to fill positions.
    In addition, we are focusing efforts on identifying and moving 
employees into career paths for leadership. The IRS has established a 
comprehensive Leadership Succession Review program that provides a 
systematic approach to identify a leadership pipeline of high 
performers early in their career. We expect that these efforts will 
help us understand the causes of attrition and reduce the overall 
impact on the organization.
Minority Question for Linda Stiff, Acting Commissioner, Internal 
        Revenue Service
1.  Can the Internal Revenue Service please estimate the impact on the 
        federal treasury from corporate and personal income taxes over 
        the life of an oil and gas lease?
    ANSWER: Perhaps the best approach to this request would be to 
develop a profile of a ``typical'' oil and gas property, with estimates 
of the costs incurred and revenues generated over the production life 
of that property. Then a set of assumptions would be made regarding the 
tax characteristics of the owner of that property and these 
characteristics would interact with the revenue stream and costs 
incurred to generate a set of estimates of income taxes due on the 
earnings from that property.
    Unfortunately, the income tax return of an investor in an oil and 
gas property does not contain sufficient information for the Internal 
Revenue Service to estimate the revenues, costs, and ultimately the 
total amount of individual and corporate income taxes paid over the 
life of an individual oil and gas property. The Department of Energy, 
in conjunction with the Office of Tax Policy at the Department of 
Treasury, is probably in the best position to answer a request along 
these lines.
                                 ______
                                 

  STATEMENT OF DENNIS ROLLER, ROYALTY AUDIT SECTION MANAGER, 
           OFFICE OF THE STATE AUDITOR, NORTH DAKOTA

    Mr. Costa. Our last witness is Mr. Dennis Roller, who is 
the Royalty Audit Section Manager for the Office of the State 
of North Dakota. I assume that when you testify this morning, 
Mr. Roller, that you also do so with the fact that you meet and 
confer with other auditors from other states throughout the 
country and with tribal groups, and that there is a general 
sense of the challenges you face.
    Mr. Roller. Yes, sir.
    Mr. Costa. Yes, you do?
    Mr. Roller. Yes, we do. Yes, I do.
    Mr. Costa. You like my statement. OK.
    Mr. Roller. It is not STRAC's voted upon view, but there is 
general consensus, as I state, to my testimony and certain 
areas that need review or need a tune up.
    Mr. Costa. Thank you.
    Mr. Roller. Mr. Chairman and members of the Committee, 
thank you for the opportunity to comment and share my views 
concerning the wide array of challenges faced by the Minerals 
Management Service and state and tribal compliance delegations.
    The first major challenge we are facing is a state of 
misreporting of the oil and gas operations report, or OGOR, the 
production reporting document, and the MMS 2014s, as a payment 
reporting document. Many state and tribal delegations have 
expressed their concerns over the lack of correct reporting and 
additional compliance hours used because of the incorrect 
reporting, as has the GAO earlier today.
    This reporting issue goes to the core of having an 
effective and efficient Royalty Management and Compliance 
Program. Having complete and current OGOR data is one of the 
first steps in having an efficient and effective compliance 
system. The MMS does not have complete and current OGOR data.
    The next step to have an effective Royalty Compliance 
Program is having correct and complete 2014 data. The FBMS 
states that overall, company 2014 reporting accuracy is around 
97 percent, but that measure is based on the percentage of 
lines processed through the MMS acceptance system the first 
time.
    This appears to be a good measure. The problem is that 
there are very few edit checks in the acceptance system, so 
very few lines are not accepted the first time. Because of the 
lack of correct and complete 2014 reporting our audits now 
entail a reconciliation of all 2014 payments made by a company 
for the review period in order to determine what the company 
intended to report and pay.
    In my written testimony, I explained what is meant by 
reconciling every single 2014 payment. In general, it means 
that the lease number or agreement number was not reported 
correctly, and we have to try to determine what the correct 
lease number or agreement number is.
    An IRS comparable scenario of this would be if I file my 
taxes under Friend A's Social Security number and Friend A 
files it under Friend B's Social Security number, et cetera. 
You can see the mess that would present for Social Security 
retirement benefits.
    Comparing the OGOR data, what volume we expect to receive 
royalties on, to what was actually received, 2014 payments, is 
a must in order to have an effective and efficient compliance 
program. Another area of concern that has been expressed to me 
by several delegations is interest. The MMS reengineered system 
did not have an interest module to bill late payment interest 
until May 2003.
    In a recent IG report, the MMS stated that interest will be 
caught up by the end of Federal Fiscal Year 2007, but based on 
the interest data the MMS has provided, there are many 
compliance royalty collections and late paid royalties for 
which interest has not been billed.
    More importantly, we have determined that in many instances 
when a company pays the royalties late the system doesn't bill 
late paid interest and doesn't recoup the interest that was 
paid to the company on their estimate. In essence, the company 
is paid interest to pay their royalties late.
    Another area of concern expressed by several delegations is 
MMS's unwillingness to accept STRAC input or make a STRAC 
suggested change. An example of this is STRAC's written request 
on January 15, 2003, to then director, R.M. Johnnie Burton to 
immediately withdraw the guidelines regarding statute of 
limitations for demands, orders and appeal decisions for 
Federal leases.
    Under these guidelines, MMS required: 1) that the 
prospective only statute of limitations enacted under RSFA be 
applied retroactively to oil and gas production; and 2) that 
RSFA statute of limitations apply to solid minerals, although 
not covered under RSFA. The result of the guidelines was that 
appeals were being lost, demands for payments were not issued, 
audits were closed and royalties uncollected.
    The dollars lost is unknown because MMS never evaluated the 
impact of the guidelines before issuing them, making them 
binding on the state delegations. In 2007, the U.S. District 
Court for the District of Columbia, in a suit brought by the 
California State Controller invalidated the guidelines as 
arbitrary and capricious noting as grounds many of the 
arguments STRAC made to MMS in 2003.
    In November of 2007, the MMS director issued a memorandum 
rescinding those guidelines, yet, MMS has done nothing to date 
toward collection of royalties impacted by the guidelines. 
Another area of concern, as expressed by several delegations, 
states mainly, as it does not affect tribes, is the net receipt 
sharing or the administrative provision which reduces by two 
percent the state's share of the royalties from public domain 
lands.
    The two percent results in approximately a $40 million 
decrease in royalty revenue to states from which the minerals 
are produced. However, every U.S. citizen benefits from the 
royalty revenue program because of the revenue generation of 
the program. If every U.S. citizen benefits from the program, 
then why is the cost of administering the program being 
unfairly applied to only the states that produce the Federal 
mineral.
    The final area that I was asked to discuss is the RPC 
report on MMS. I was asked as STRAC's chair to discuss STRAC's 
opinion and views of the report. Unfortunately, due to the 
timing of this hearing and the report, STRAC has not had an 
opportunity to meet as a whole and discuss the report. However, 
several STRAC delegations have provided comments to me upon 
learning that Congress wanted STRAC's views of the report.
    Those have been included in my written testimony. A general 
summation of those comments, as the report highlights, many 
important areas of concern, but STRAC delegations should have a 
voice in how those concerns are addressed and corrected. In 
closing, this is about giving the U.S. citizens what they 
deserve: an effective and efficient Royalty Management Program 
for their minerals.
    Ultimately, it is about data management, and without good 
data, the program cannot be effective and efficient. This 
concludes my testimony. Thank you for the opportunity to appear 
before the committee today. I will be happy to answer any 
questions you may have and go into more details.
    Mr. Costa. Thank you very much, Mr. Roller. We appreciate 
your testimony.
    [The prepared statement of Mr. Roller follows:]

 Statement of Dennis Roller, Audit Manager for the North Dakota State 
  Auditor's Office--Royalty Audit Section, Minerals Management Service

    Mr. Chairman and members of the committee, I want to thank you for 
the opportunity for me to comment and share my views concerning the 
wide array of challenges faced by the Minerals Management Service and 
State and Tribal compliance delegations.
    The North Dakota State Auditor's Office Royalty Audit Section (ND 
delegation) was created in 1982 under the authority of section 205 of 
the Federal Oil and Gas Royalty Management Act of 1982 (FOGRMA). For 
the past 25 years the ND delegation has performed compliance work on 
federal mineral royalties paid in North Dakota.
    The ND delegation from 1982 through 2001 collected over $26.6 
million. During that same period, the costs of the ND delegation were 
less than $4.2 million. That's over $6 of revenue for every $1 spent. 
For all States that had a 205 delegation for 1982 through 2001 the 
total collections were over $296.5 million, while costs were under 
$58.5 million.
    Given the delegations success in the past, I would like to discuss 
some of the challenges the MMS and the delegations are currently 
facing.
    Before I go into those challenges however, I would like to express 
that my testimony is not being given without some trepidation. I'm 
testifying in the hopes and beliefs that the royalty compliance program 
will be improved for the benefit of all U.S. citizens. However, my 
testimony about the challenges and ineffectiveness of the program may 
be viewed differently by the Department of Interior, who is in control 
of ND's delegation contract funding.
    In fact, in October 2006, a now former high ranking MMS official 
advised several STRAC delegation managers (including myself) to not 
testify at the upcoming House and Natural Resources Subcommittee 
hearing that eventually took place on March 28, 2007. This official 
expressed to us that Congress only requests that you testify so you 
aren't obligated to testify and that it is best to keep any problems in 
house. I'm of the view that as a government employee we are to serve 
the people and accountability to the people is a priority.
    That said the first major challenge is the state of misreporting 
for the MMS 2014s, payment reporting document, and the Oil and Gas 
Operations Report (OGOR), production reporting document. Many State and 
Tribal delegations have expressed their concerns to me and others over 
the lack of correct reporting and the additional compliance hours used 
because of the incorrect reporting.
    With the re-engineered system that went into place on November 1, 
2001, the MMS changed the property numbering system used by company's 
to report the 2014s. The MMS also stopped doing any automated 
comparison of the OGOR and the 2014. Without any automated check, 
company reporting accuracy has drastically deteriorated.
    This issue goes to the core of having an effective royalty 
management program and an effective compliance program. Having correct 
and current OGOR data is one of the first steps in having an efficient 
and effective compliance system. Without complete and current OGOR 
reporting, the MMS does not know what they should be being paid 
royalties on. The ND delegation recently sent 48 different properties 
to MMS for which OGOR reporting was at least six months behind and in 
some cases OGORs had not been filed for over two, three or more years. 
In one case, the property started production in February 2002 and no 
OGORs had ever been filed. The ND delegation is aware there are even 
more properties in ND for which the OGOR filings are late or never been 
done, but has not had the time to complete this reporting project (the 
known unreported OGORs in ND are for CY05 or later--a period for which 
the ND Delegation has not done our automated comparison for--so when we 
do that period these unreported OGOR issues will be addressed). Having 
complete and current OGOR data is one of the first steps in having an 
efficient and effective compliance system and the next step is having 
correct and complete 2014 data.
    Because of the lack of correct and complete 2014 reporting, our 
audits now entail a reconciliation of every single 2014 payment made by 
a company for the review period in order to determine what the company 
intended to report and pay.
    Here's an example of a recently worked ND delegation case depicting 
this (with the well name, lease numbers and company name changed). 
Federal well #1 is a lease well on lease A (meaning that 100% of the 
wells production is attributable/payable to that lease). For January 
2003 through July 2003, Company XYZ paid (2014 reporting) well #1's 
sales incorrectly to communitization agreement #410, and allocated 75% 
to lease A and 25% to lease B. For July 2003, Company XYZ paid 100% of 
the sales to lease B. For August 2003 through June 2004, Company XYZ 
again paid well #1's sales to communitization agreement #410, and 
allocated 75% to the lease A and 25% to lease B. For July 2004, Company 
XYZ paid 100% of well #1's sales to lease C. Finally, for August 2004 
through December 2004, Company XYZ paid well #1's sales to unit #160, 
and allocated 58% to lease A, 2% to lease C, 16% to lease D and 24% to 
lease E. Net effect being that Company XYZ paid royalties on 100% of 
the production from well #1, so no additional royalties are due, but it 
was never once paid to the correct property on the 2014.
    In this instance, the land types for all leases were the same 
(acquired lands) and thus there was not a land type issue. If the 
incorrect reporting crosses land types then the incorrect entity 
receives the royalties, public domain lease is distributed 48% to the 
State and 52% Federal Government, versus an acquired lease distribution 
of 75% Federal Government and 25% to the county from which the mineral 
was produced.
    An IRS comparable scenario of this would be if I filed my tax 
return using friend A's social security number, and friend A filed his 
taxes under friend B, and so on. If you tried to file your taxes with 
the wrong social security number electronically the IRS would not even 
accept them, because the social security number did not match the name.
    This ``reconciliation'' process (determining where the payments 
made by the company actually belong) has added a tremendous amount of 
hours and inefficiency to our audits. In order to combat this, the ND 
delegation requested the authority to perform volume and royalty rate 
automated verifications on October 1, 2005, as allowed for under the 
Federal Oil and Gas Royalty Simplification and Fairness Act of 1996 
(FOGRSFA). The ND delegation was denied that request on January 20, 
2006. However, the ND delegation later was granted by MMS the ability 
to perform limited scope compliance reviews using our comparison tool. 
The ND delegation has been performing limited scope oil volume and 
royalty rate compliance reviews (an automated comparison of the OGOR to 
the 2014 for oil) since October 1, 2006 and have discovered countless 
reporting issues, non payment issues, missing reporting documents 
issues and two company's that just quit paying their federal royalty 
obligation in ND. The ND delegation has taken on this comparison 
process at a time when ND's delegation funding has went from 6 FTE to 4 
FTE and the audits we perform have become complicated by the 
misreporting, as already discussed.
    The ND delegation efforts in this area for royalties paid for CY01 
through CY02 resulted in identification of nearly $200,000 of 
incorrectly paid royalties at a cost less than $30,000. The automated 
comparison process that MMS used to perform was as successful too. Per 
the 2001 Minerals Management Service budget justification document, the 
last year such collection data was reported by the MMS, the AFS/PAAS 
automated comparison process collected $56.2 million in additional FY98 
paid royalties and per the 2000 budget justification document the AFS/
PAAS comparison collected $32.7 million for FY97 paid royalties.
    Comparing the OGOR data (what volume we expect to receive royalties 
on) to what was actually received (2014 payments) is a must in order to 
have an effective and efficient compliance program.
    This OGOR-2014 automated comparison process was a recommendation of 
the Fiscal Accountability of the Nation's Energy Resources of January 
1982, commonly referred to as the Linowes Commission, which was the 
driving force for the creation of the MMS. Recommendation #5 of the 
internal controls section (Chapter 3) of the Linowes Commission report 
states ``That the Federal royalty managers incorporate production data 
into the royalty management system in order to cross check the data 
with sales and royalty data for all leases each payment period.'' 
(emphasis added) The MMS did this automated comparison for years, 
commonly referred to as the AFS/PAAS comparison. However, since the 
implementation (11/1/01) of the re-engineered system this is no longer 
done.
    Another area of concern that has been expressed to me by several 
delegations is interest. The MMS re-engineered system (implemented 11/
1/01) did not have an interest module to bill late payment/collection 
interest until May 2003. In a recent IG report the MMS stated that 
interest will be caught up by the end of Federal Fiscal Year 2007 (9/
30/07). However, based on the interest data the MMS provided the ND 
delegation through September 30, 2007 (the MMS has not yet provided any 
interest data information beyond September 30, 2007) there are many 
compliance royalty collections and late paid royalties for which 
interest has not been billed as of September 30, 2007.
    In addition and more importantly, the ND delegation has determined 
that in many instances when a company pays their royalties late the 
system doesn't bill late paid interest and doesn't recoup the interest 
that was paid to the company on their estimate. An estimate is like a 
security deposit. It stays with the MMS until the company is no longer 
the payor and it allows the company to pay the royalties for the lease 
one month later than originally due.
    For example, Company A has a $10,000 estimate for lease 55555. 
Company A pays $10,500 for January royalties on April 1, one day late 
since the January royalties are due the last day of February but 
because of the estimate they are due the last day of March. Because no 
royalties were paid by the due date (March 31) the system assumes no 
royalties are due and automatically calculates and pays interest to 
Company A for the entire month of March on the company's $10,000 
estimate. On April 1st, the system should determine that the January 
royalties of $10,500 was paid late and bill Company A interest for 1 
day on $10,500 and also bill Company A interest on $10,000 for the 
Month of March (recoup the interest paid on the estimate because the 
system assumed no royalties were due when in fact there were royalties 
due that were just paid late). The ND delegation has discovered that 
the calculation and billing of this interest often doesn't occur. In 
essence, Company A was paid interest to pay their royalties late. 
Specific examples of this can be provided by me upon request.
    Another area of concern expressed by several delegations is MMS' 
unwillingness to accept STRAC input or make a STRAC suggested change. A 
good example of this is MMS' Government Performance Results Act (GPRA) 
goals. MMS set the goals based on dollars voluntarily paid by the 
company (2014 payments). The delegations for years argued that is not a 
good way to set goals (what about the property for which nothing is 
paid on but there should be royalties paid--one that compliance work 
should be done on--but you accomplish $0 toward the GPRA goals because 
$0 was paid on the property--it moves the compliance efforts away from 
severely under paid properties because less of the goal is 
accomplished). MMS refused to change the goals until a recent Inspector 
General report stated the goals should be revised.
    An even better example of this is STRAC's written request to then-
Director R.M. ``Johnnie'' Burton to immediately withdraw the 
``Guidelines Regarding Statute of Limitations for Demand, Orders and 
Appeals Decisions for Federal Leases'', which was approved on October 
15, 2002. Under these Guidelines, MMS required: (1) that the 
prospective only statute of limitations, enacted under the Royalty 
Simplification and Fairness Act (RSFA), be applied retroactively to oil 
and gas production, and (2) that the RSFA statute of limitations apply 
to solid mineral royalties, although not covered under RSFA.
    The result of the Guidelines was that appeals were deemed lost and 
royalties uncollected, although MMS could claim a reduction in the 
number of outstanding appeals. Also, demands for payments were not 
issued and audits were closed. The dollars lost is unknown because MMS 
never evaluated the impact of the Guidelines before issuing them and 
making them binding on the State delegations.
    On January 15, 2003, STRAC warned MMS that the Guidelines were of 
doubtful legality and that they would most likely result in an 
unnecessary litigation, but STRAC's concerns were dismissed. In 2007, 
the U.S. District Court for the District of Columbia, in a suit brought 
by the California State Controller, invalidated the Guidelines as 
arbitrary and capricious, noting as grounds many of the arguments STRAC 
made to MMS in 2003.
    On November 17, 2007, MMS Director Randall Luthi issued a 
memorandum rescinding the Guidelines. Yet, MMS has done nothing to date 
towards collection of royalties impacted by the Guidelines.
    A final example of MMS not willing to accept input from STRAC is in 
the development of the recent Compliance Program Tool (CPT). CPT is a 
new MMS tool (STRAC delegations were provided training on the tool in 
mid CY07) used by MMS to perform their compliance reviews. In this 
instance, the MMS didn't even ask STRAC for input, even though they 
profess STRAC to be their partner. They developed the tool and they 
want all the delegations to use it, but unfortunately the tool is 
ineffective because the tool was built backwards. Instead of starting 
with production data (OGOR) and then comparing that to 2014 data, MMS 
used their GPRA philosophy of starting with dollars voluntarily paid 
(2104 payments) and then compared those to the OGOR. What this means, 
is that for all the OGORs that no payments were received (the ones that 
compliance should be looking at), the CPT tool doesn't show a 
difference (because there was no 2014 and thus there is no starting 
point). I refer you back to the earlier example of lease well #1's 
royalties being attributed 100% to lease A--but no payment was made as 
a lease well to lease A so the CPT would not show a difference. If MMS 
would have asked STRAC for input, this fatal tool error could have been 
avoided.
    An IRS comparable scenario of this would be me not filing my taxes 
and the IRS never catching that I didn't file any taxes because there 
were no taxes filed by me in the universe that they looked at (taxes 
paid), even though the State of ND files with the IRS a w-2 showing 
that they paid me a salary.
    Another area of concern as expressed by several delegations (States 
as it does not affect Tribes) is the net receipts sharing or the 
administrative provision which reduces by 2% the States share of the 
royalties from public domain lands as established under the Minerals 
Leasing Act. This was passed as part of the Federal Fiscal Year 2008 
Interior Appropriation Bill (HR2764) and is again included in the 
Presidents Budget for Federal Fiscal Year 2009. The 2% results in 
approximately a $40 million decrease in Mineral Leasing Act royalty 
revenue to the States from which the minerals are produced. However, 
every U.S. citizen benefits from the royalty revenue program because of 
the revenue generation of the program. If every State benefits from the 
program, then why is the cost of administering the program (2% 
reduction of States share) being unfairly applied to only the States 
that produce the Federal Mineral? Plus, it's applied by the States with 
the most production shouldering the most administrative costs. Why 
should the States that produce the Federal Mineral, for the benefit of 
every U.S. citizen, solely bore the costs of administering that 
program?
    Should the State of Montana bore most of the Core of Engineers 
costs associated with administering the dams on the Missouri River just 
because the majority of the water was originally produced from the 
mountains of Montana? No, the whole country benefits from those dams 
through electricity generation, barge traffic, water supply for cities, 
etc., so the cost should be bore by the country as a whole (Federal 
Government), not mostly by the State of Montana.
    Should the State of Florida or Arizona pay more of the 
administration cost of the Social Security Benefit Program because they 
have more retirees in those states?
    Secondly, the 50% State share as provided for originally under the 
Minerals Leasing Act was provided to the States because the States and 
Counties within the States were incurring large infrastructure and 
maintenance costs (road building, maintenance of roads costs, etc.) 
from development of the minerals on Federal Lands. However, the States 
and Counties did not receive any revenues from those lands (through 
taxation, royalties, agricultural use, etc.). So the Mineral Leasing 
Act provided the States 50% of the royalties to compensate for the loss 
of revenues from the Federal Lands (Bankhead Jones Act provided 25% to 
the Counties for acquired lands). Today the lack of revenue generation 
(other that the sharing of the royalties as provided for by the Mineral 
Leasing Act and the Bankhead Jones Act) from those Federal Lands is 
still the case, so why should the State's share to compensate for the 
lack of revenue be reduced by 2%?
    The final area that I was asked to discuss is the Royalty Policy 
Committee (RPC) report on MMS. I was asked as STRACs chair to discuss 
STRAC's opinion and views of the report. Unfortunately, do to the 
timing of this hearing and the report, STRAC has not had an opportunity 
to meet as a whole and discuss the report. However, several STRAC 
delegations have provided comments to me upon learning that Congress 
wanted STRAC's views of the report. See attachment 2 for a summary of 
those comments about the recommendations. Note that these are not STRAC 
views as a whole, just a summation of views as presented by several 
STRAC delegations to myself.
    I would sum up the comments on the RPC report to be that the report 
highlights many important areas of concern, but STRAC delegations 
should have a voice in how those concerns are corrected and addressed.
    In closing, the STRAC delegations have been very successful in the 
past at collecting additional royalties owed from Federal Lands. 
However, the MMS has consistently shown over the last several years 
that they are not interested in accepting STRAC's opinion or more 
recently even willing to ask for STRAC's opinion, despite the fact that 
they profess STRAC to be their partner. With the increase in oil and 
gas prices over the last two years bringing on a flurry of activity 
that hasn't been seen for over twenty years, now is not the time to be 
reducing audits and compliance activities and resisting improving a 
system that has many problem areas.
    This concludes my formal testimony. Thank you for the opportunity 
to appear before the Committee today. I will be happy to answer any 
questions you may have and to go into more detail surrounding these 
issues.
                                 ______
                                 
Attachment 1
                State and Tribal Royalty Audit Committee

 State of Alaska  Blackfeet Nation  State of California 
    State of Colorado  Crow Tribe  Fort Peck 
  Tribes  Jicarilla Apache Tribe  State of Louisiana 
 State of Montana  Navajo Nation  State of New 
   Mexico  State of North Dakota  State of Oklahoma 
  Shoshone & Arapaho Tribes  Southern Ute Indian Tribe 
   State of Texas  State of Utah  Ute Indian 
    Tribe  Ute Mountain Ute Tribe  State of Wyoming

 
                   ,--                                   ,
 
Jay Norman, Chairman (505) 827-0986       Former Ex Officio:
Harold St. Goddard, 1st Vice Chair (435)  Ellwood V. Soderlind
 722-5141                                 (307) 777-6467
lnge-Lise Goss, 2nd Vice Chair (801) 297-
 4608
 


January 15, 2003

R. M. "Johnnie" Burton, Director
Minerals Revenue Management
Minerals Management Service
1849 "C" Street NW. Room 4212
Washington, D.C. 20240

Dear Ms. Burton:

    On behalf of the State and Tribal Royalty Audit Committee (STRAC), 
we are writing to request that you immediately withdraw the 
``Guidelines Regarding Statute of Limitations for Demands, Orders and 
Appeals Decisions for Federal Leases,'' which were approved by you on 
October 15, 2002. With all due respect, the ``Guidelines'' cannot be 
considered legally binding upon pending appeals and audits involving 
any minerals produced from Federal lands prior to September 1996. The 
``Guidelines'' are inconsistent with the Royalty Simplification and 
Fairness Act (RSFA) and its legislative history.
    Under RSFA, Congress set a 7 year statute of limitations on 
judicial actions and demands relating to oil and gas produced from 
Federal leases after August 1996. 30 U.S.C. '1724(b)(l). Under the 
``Guideline'' the preclusive reach of '1724(b)(l) would be expanded, as 
a matter of MMS policy, to include the following additional categories 
of royalty matters:
      Orders to perform issued both before and after the 
'1724(b)(l) effective date;
      Pending administrative appeals of demands for royalties 
owed on oil and gas produced before the '1724(b)(l) effective date;
      Pending audits of royalties on oil and gas produced 
before the '1724(b)(l) effective date, including outstanding issue 
letters, draft demands or demand letters resulting from such audits;
      Audits, demands, orders to perform and appeals, related 
to minerals other than oil and gas produced from Federal lands either 
before or after the '1724(b)(l) effective date.
    Under the terms of the ``Guidelines,'' the Minerals Revenue 
Management and Appeals Division staff, as well as auditors under RSFA 
Section 205 audit agreements, are required to implement this guidance 
effective immediately. In short, through this policy statement, MMS has 
legislated its own 7 year statute of limitations applicable to audits, 
orders, demands and appeals not covered by RSFA '1724(b)(l).
    As set out in the ``Guidelines,'' the only way that an audit 
program can avoid application of this binding norm \1\ to the royalty 
matters listed above is through retroactive application, often post-
audit, of a fact bound campelling circumstance standard that has no 
known statutory origin. While MMS staff has informed us that all of the 
factual circumstances that may be considered compelling, are not set 
forth in the Guidelines, both that standard and the 7 year norm 
substantially limit audit judgment and discretion. \2\ Moreover, the 
``Guidelines'' are currently being applied by MRM/Lakewood to reduce 
State drafted demand orders without the benefit of any standards on 
what will be considered a compelling circumstance, other than the 
``Guideline'' examples. \3\
    The only legal justification for the policy set forth in the 
``Guidelines,'' is the legislative intent of RSFA not to pursue claims 
for royalties due more than 7 years before a demand or order to pay or 
to perform restructured accounting.(p.2) With regard to this 
justification, STRAC briefly notes the following:
      Through Section 11 of RSFA, Pub. L. 104-185, 30 U.S.C. 
Sec.1701 note, Congress provided that RSFA amendments shall apply with 
respect to production of oil and gas after the first day of the month 
following the date of the enactment of this Act [August 13, 1996], 
unless a particular provision specified otherwise. RSFA, including the 
7year limitation period, was intended to be applied prospectively only. 
The statute of limitations established here [RSFA] is prospective only, 
meaning that obligations arising from production of oil or gas from 
Federal leases prior to enactment of this bill are not affected, House 
Report 104-667, p. 18, reprinted in 1996 USCAN 1442, 1447-1448 
[emphasis supplied]. Instead of being supported by RSFA's legislative 
intent, the policy set forth in the ``Guidelines'' is directly contrary 
to Congress's expressed intent under RSFA and contrary to standard 
principles of statutory construction. See e.g., 73 Am. Jur. 2d Statutes 
'245 (even where congress is silent, the presumption is that a statute 
is prospective only); Chevron USA, Inc., v. NRDC, 467 US. 837, 842-843 
(1984) (agency must give effect to the unambiguously expressed intent 
of Congress).
      Under its plain language, RSFA's 7 year limitations 
period does not apply to orders to perform restructured accounting, 
whether those orders are issued before or after August 1996. Instead, 
RSFA's 7 year limitations period applies only to a judicial proceeding 
or demand. 30 U.S.C. '1 724(b)(l). A demand, as defined in RSFA Section 
1, 30 U.S.C. '1 701 (22), includes only orders to pay, not any and all 
Administrative orders as stated in the ``Guidelines"(p.l). Applying the 
7 year limitation to orders to perform is inconsistent with the fact 
that the statute of limitations, if one exists, is tolled once audit is 
initiated \4\; limiting the scope to seven years prior to the date of 
such an order does not give the public credit for the tolled period.
      The expansion of the 7 year limitation to the categories 
of appeals, demands and audits listed above does not comport with the 
statute of limitations case law applicable to such matters. 
Representatives of the Solicitor's Office have repeatedly and publicly 
stated that the Department has not acquiesced in the decision in OXY 
USA, Inc. v. Babbitt, 268 F. 3d 1001 (10th Cir. 2001). \5\ Even to the 
extent that the decision is controlling, however, it does not preclude 
all means of collection of royalty debts; it applies only to judicial 
actions initiated by the Department to collect royalty debts. As the 10 
Circuit emphasized, 28 U.S.C. '2415 includes two narrowly drafted 
exceptions to the time-bar, permitting the government to defensively 
assert time-barred claims by way of offset or counter claim. 268 F.3dat 
1106. Moreover, application of the statute of limitations, if any, is 
not an issue subject to administrative resolution. E.g. Marathon Oil 
Co., 149 IBLA at 290-291.
    Under RSFA 30 U.S.C. '1735 and its predecessor, any standards 
applicable to delegated state audits are required to be promulgated by 
rule, not agency proclamation. Cf: IPAA v. Babbit, 92 F.3d 1248, 1256 
(D.C. Cir. 1996) nothing in DOI's procedures vest authority in the 
Associate Director of MMS..., or even the Director to issue 
proclamations binding on the agency. RSFA also requires that standards 
be designed and implemented only after consultation with State 
authorities. E.g., 30 U.S.C. 7 735(d). The ``Guidelines'' were issued 
without notice to or consultation with States, and, thus, in this 
respect too, are directly contrary to congressional intent.
    While MMS may have some enforcement flexibility with regard to 
individual royalty cases, it does not have unfettered enforcement 
discretion. See e.g., cases cited supra footnote 2. In fact, Interior 
shall give priority to those lease accounts identified by States and 
Tribes as having significant potential for underpayment. 30 US. C. 
'1711 (c)(l). This mandatory language limits any arguable power of MMS 
to unilaterally discriminate among issues or cases it will pursue. 
Heckler v. Chaney, 470 U.S. 821, 833 (1991).
    In sum, the ``Guidelines'' are simply another instance of an 
advance MMS policy statement that, as in the past, will only serve to 
complicate and confuse the audit and collection process, and lead to 
unnecessary litigation. There is no identification of any statutory 
authorization and, to our knowledge, no Solicitor's or other legal 
opinion, government regulation or case law supporting what is, in 
essence, a waiver of royalty debts. Cf American Central Gas Companies, 
Inc., 156 IBLA 367, 371 (2002) (MMS has no authority to waive 
interest). Indeed, according to MMS staff, these guidelines were issued 
without any analysis of the potential revenue loss, either in terms of 
royalty income or wasted audit resources. \7\
    What is even more unfortunate, in STRAC's view, is what the 
``Guidelines'' suggest about Interior's current attitude toward State 
and Tribal participation in the royalty audit program. State and Tribal 
audit programs are not a subdivision of the Federal bureaucracy. 
Instead, each STRAC jurisdiction represents an independent and 
sovereign government. While there has always been some disagreements in 
the relationship between the MMS and STRAC jurisdictions, it is a 
working relationship that Congress sanctioned first in FOGRMA and then 
in RSFA by requiring MMS to, in effect give these jurisdictions a full 
seat at the table. Because of their expertise and more direct financial 
interest (and because of Federal mis-steps), Congress wanted the States 
and Tribes to be active participants and watchdogs over the federal 
collection of revenues owed to their jurisdictions, not passive 
subordinates of a Federal bureau or hapless recipients of whatever MMS 
determines. The issuance of the ``Guidelines'' was not only 
inconsistent with Secretary Norton's public commitment to Consultation, 
Communication and Cooperation, it was also a serious step backwards in 
over 20 years of slow but steady progress in forging mutually 
acceptable compromises and an amicable working relationship on royalty 
matters. It is particularly disheartening to see the legacy of 
Secretary James Watt being casually disregarded by today's Department.
    The next STRAC/MMS meeting is scheduled for February 4-5, 2003 in 
Sacramento, California. We understand that you are currently scheduled 
to attend that meeting. Our hope is that you will have withdrawn the 
``Guidelines'' before that meeting. If not, we request that you or 
someone designated by you, be prepared to respond in detail to the 
legal and administrative issues out lined above. We also ask that MMS 
disclose for STRAC's review all of the Departmental documentation that 
would explain the genesis of the ``Guidelines''. We trust that Interior 
is open to providing such information voluntarily, but nonetheless, as 
a formality, we will submit a request under the Freedom of Information 
Act.
    If you have questions regarding this letter or the issues, please 
feel free to call me at 505-827-0986.

Sincerely,

Jay Norman STRAC
Chairman
State of New Mexico
Taxation and Revenue Department
Oil & Gas Bureau
1200 S. St. Francis Drive
Santa Fe, NM 87509
[email protected]
_______________________________________________________________________
    \1\ Cf. American Business Assoc. v. US., 627 F.2d 525,529 (D. C. 
Cir. 1980)
    \2\ Compare Shell Oil Ca. v. EPA, 950 F. 26 741, 763-764 (D. C. 
cir. 1991; Alliance for Billntegrity v. Shalala, 11 6 F. Supp. 2d 166, 
171 (D.C. Cir. 7P97Xenforcement Discretion limited to decisions in 
individual cases; does not extend to broader policies imposed on 
categories of agency matter).
    \3\ The example set forth in the ``Guidelines'' (p-2) misstate the 
reality of MMS's pre-1996 audit program and enforcement practice. For 
example, prior to 1996, MMS and the Solicitor's Office simply refused 
to use its subpoena power, despite State/Tribal requests and lessee 
refusal to turn over documents. Indeed, according to MMS staff, there 
are no outstanding subpoenas relating to the pre-1996 time period. 
Moreover, MMS does not conduct fraud audits and never has. Thus the 
examples of compelling circumstances listed in the ``Guidelines'' are 
essentially administratively meaningless.
    \4\ E.g. Phillips Petroleum v. Lujan, 963 F.2d 1380 (lojh Cir. 
1992).
    \5\ E.g. Marathon Oil Co., 149IBLA 287, 291 (1999); Amoco 
Production Co., 144 IBLA 135, 140)1998)(lntQrior is not obligated to 
follow decisions of federal courts, especially if contrary decisions 
exist or are likely).
    \6\ Cf. Opinion of Office of Legal Counsel, US. DOJ (July 28, 
1998).
    \7\ It was also disturbing to learn from MMS staff that, while 
issued under your and the Associate Director's signatures, the 
Guidelines were actually a product of a decision made elsewhere in the 
Department and with little, if any, input by MMS itself.
                                 ______
                                 
Attachment 2

                RPC Report Comments/Key Recommendations

    Report was released without any STRAC involvement or comments. As 
stakeholders we should have some say.
    Report recommendations 4-1, 4-4, 4-5 and 4-9 which identify 
development of Risked Based audit and compliance strategies, tools and 
pilot projects. States and Tribes should be directly involved in this 
development as each State and Tribe is unique in nature as it relates 
to oil and gas production and valuation.
    Recommendation 4-16 which identifies that the DOI should improve 
processes and procedures associated with calculating interest on 
royalty payments. This recommendation should go even further. DOI 
should work with Congress in deleting the requirement that the federal 
government pay interest on overpayments.
    Recommendations 3-16 and 3-17 which identifies that the DOI/MMS 
should implement gas plant studies and periodic reporting. This 
recommendation, if implemented would strengthen the audit and 
compliance functions and would support recommendations 3-15 and 3-27.
    Recommendations 3-15 and 3-27 which identifies development and 
implementation of new software to perform accounting comparisons 
between Production and Royalty reporting and enforcement of accurate 
reporting via written orders and civil penalties. If implemented, it 
also would support validating incorrect reporting and would ensure that 
the audit and compliance functions are working from accurate data.
    Recommendation 5-5, 5-6 and 5-7 which identifies that the BLM/MMS 
should coordinate onshore production issues in conjunction with royalty 
reporting. This implementation should go beyond the Federal Government 
entities and incorporate shareholders from States and Indian Nations.
    On page 57, E. Royalty Collections As a Result of Audit and 
Compliance Activities: It reinforces how good compliance reviews are 
because of the large increase in collections as summarized in Table 9 
on page 58. Are there any new compliance review collections that 
wouldn't have existed through exception processing (automated), which 
includes AFS/PAAS comparisons ($56 million in 1999), AFS exceptions 
($12 million in 1999) and allowance exceptions ($101,000 in 1999)?
    Recommendation 4-27 for revising regulations and guidance for 
calculating solid minerals prices especially for non-arms-length 
transactions. This has been discussed on numerous occasions at the RPC 
Coal Subcommittee. If MMS implements this recommendation it will 
enhance our solid minerals audits.
                                 ______
                                 

Response to questions submitted for the record by Dennis Roller, Audit 
  Manager for the North Dakota State Auditor's Office--Royalty Audit 
              Section for the Minerals Management Service

    Mr. Chairman, I want to thank you for the opportunity to provide 
testimony at the hearing and the opportunity to provide further clarity 
and information for your additional questions.
Question 1:
    Mr. Roller, if a company has an estimated payment on file, and they 
don't report their royalties by the due date, the system assumes that 
they didn't owe any royalties and pays them interest on the entire 
estimated payment?
Answer 1:
    Yes, that is correct. The system does not do a check of the 
production report (Oil and Gas Operations Report - OGOR) to determine 
if there were actual sales that royalties have not been paid on. It 
just automatically pays interest on the estimate. Of course, with my 
testimony about the state of misreporting, the check I just mentioned 
would not be useful since the MMS doesn't have complete and accurate 
OGOR data. It all hinges on having complete and accurate data.
Question 2:
    Mr. Roller, about two years ago, the House adopted an amendment to 
the Interior Appropriations bill that would have increased STRAC 
funding by $1 million. It had bipartisan support, and showed our 
interest in making sure that STRAC was adequately funded. Has STRAC 
seen any additional funding recently?
Answer 2:
    STRAC did see an increase of $500,000 in the total STRAC FFY07 
budgets--per MMS. I nor does any one STRAC delegation have all 
delegations budget levels to know that the total STRAC delegations 
budgets were increased. The reason STRAC was given by MMS that the 
increase was only $500,000 rather than $1 million is because of how MMS 
views the budget. MMS feels that the base budget for STRAC at that time 
was $6.9 million--which is based on the 1996 DOI budget justification 
document (page 134). In the 1996 DOI budget justification document, 
$6.9 million was requested as STRAC funding. Since 1996, MMS does not 
mention total STRAC funding in their budget justification document. 
Instead, the MMS tells STRAC that the base funding is $6.9 million and 
any additional funding the MMS gives STRAC is out of the MMS budget. So 
for FFY06, the MMS funded STRAC at $8.6 million ($6.9 million base and 
then $1.7 million out of the MMS budget). Then in FFY07 (the year 
Congress adopted an amendment for $1 million more funding for STRAC), 
the MMS funded STRAC at $9.1 million ($6.9 million base, $1 million 
amendment, and $1.2 million out of the MMS budget).
Question 3:
    Mr. Roller, I understand you have an example where a company 
reported a negative royalty by accident and got paid interest on that. 
Could you explain that situation?
Answer 3:
    Because of the proprietary nature of the company 2014 reporting I 
will change the company name when I explain the situation. See Exhibit 
I for the detailed 2014 and interest lines and see below for a written 
explanation.
    For the October 2001 oil sales on lease 2550898320, due November 
30, 2001 (the company did not have an estimate), XYZ Company in May 
2002 paid on document # ROY100011534 a negative $928.11. The MMS paid 
XYZ company interest in the amount of $22.41 (interest invoice 
#INT100015538)--interest calculated from the due date of November 30, 
2001 until the paid date in May 2002. The interest was paid as the 
system assumed it was an over payment (since it was negative payment). 
Then in June 2002 on document #ROY100014923, XYZ Company paid $928.11 
making the royalty royalties paid for October 2001 to be $0. The MMS 
then billed interest of $3.56 (interest invoice #INT100036045) for the 
late paid royalties. I have no clue how the interest was calculated as 
it should have been calculated from the due date of November 30, 2001 
to June 2002 when paid--but that would be more than what was originally 
paid to XYZ of $22.41. In fact one month's interest at the 6% rate 
applicable at the time on $928.11 is over $4.50, so I'm puzzled how the 
amount billed is only $3.56. Finally, in May 2007 the company paid over 
$7,300 (based on a ND OGOR to 2014 comparison finding) for the October 
2001 royalties on document #ROY100154907. No interest to date has been 
billed on this collection (latest interest information MMS has provided 
is through December 2007). Although, today (3/27/08) in a conference 
call with States and Tribes the MMS director, Randall Luthi, assured us 
that interest billing was current. Net effect is that the company has 
been paid $18.85 ($22.41 paid to XYZ less $3.56 billed to XYZ) to 
borrow money from the MMS for a month and to pay their $7,300 of 
royalties owed over 5 years late.
    I hope these additional answers and explanations help you to better 
understand my testimony and the challenges the delegations have and are 
currently facing.

[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

                                 
    Mr. Costa. Director Luthi, in reference to the comments 
that Mr. Roller made, last year, as you know, a Federal Court 
ruled that the Minerals Management Service's guidelines about 
not pursuing certain unpaid royalties were unlawful.
    About a week and a half ago I sent you a letter that was 
signed by some of my colleagues asking for details on how you 
were planning to follow up on the cases that you stopped 
because of the, as the Court said, unlawful guidelines. Can you 
provide any information yet, and what the follow-up is on these 
cases that were dropped?
    Mr. Luthi. Thank you, Mr. Chairman. I did receive your 
letter. We put it into our system, and I had asked to get a 
response as soon as possible. I would like to wait until that 
written response is available so I know it is accurate.
    Mr. Costa. All right. Well, speaking of your system, I 
understand that Accenture, the computer company or the company 
that was contracted with, received $150 million on a program 
that it seems, based on the testimony here this morning, isn't 
working, at least to the expectation levels. Some have said it 
is a failure. Some said that, in part, because a new contract 
was awarded last fall.
    When you awarded the new contract last fall, did you factor 
in the shortcomings of the previous contract, and are we going 
to be able to get beyond this, what I would refer to as green 
eye shade approach of accounting that the Department seems to 
be plagued with?
    Mr. Luthi. Mr. Chairman, appreciate the question. Accenture 
was the contractor that put together this system. As you might 
guess, this isn't an off the shelf system, and now, frankly, it 
has been a challenge to make it work. The award that you 
mentioned last fall is currently under review one more time 
because one of the other contractors asked some questions, and 
we are going back and looking at the award.
    I think in general the answer to your question is it is a 
system that has not been perfect, we have had to go in and make 
several changes to it, but it is to the point now where it is 
working and it is working I would say for the most part 
effectively. We are going to continue to work with it. I think 
it is going to make more financial sense to stay with the 
current program rather than try to throw it out and start all 
over again.
    Again, it is not a system that you normally see. It has to 
be a system that can calculate interest, which was difficult 
for it to do, it has got to recognize different production 
values----
    Mr. Costa. I appreciate the complexity, but this is 
something that we will continue to follow obviously. It seems 
to frustrate a lot of us. Mr. Finfer, could you describe a 
little more detail what MMS could learn about how the Internal 
Revenue Service handles its compliance activities?
    Mr. Finfer. Yes, sir. We consulted with the IRS on the 
risk-based approach. Again, they have 40 years more experience 
in this.
    Obviously they are dealing with a much more complex 
universe, many more industries, many more layers and so on, but 
in meeting with a wide variety of their senior managers, and I 
must say IRS was very generous about affording us the time with 
them, one of the key things that came out was you have to have 
a very strong data support system and underlay.
    Without good data, without reliable data and data system 
support it is very hard to implement a risk-based approach. 
Another thing was that you are never in a situation where you 
can set it and forget it. Your work is never done. What is 
today's big risk may not be a big risk tomorrow and vice versa, 
so you have to constantly evolve the system through constant 
evaluation, feedback, retooling and so on.
    Third, that a fundamental objective of a risk-based 
approach isn't necessarily increasing collections, per se, but 
it is identifying behaviors which might not necessarily be 
costing the taxpayers a lot of money now but if they 
proliferated would cost a lot of money and getting on those 
quickly so that you don't create problems. Those were among the 
many key insights.
    Mr. Costa. No, and there were a lot of recommendations. My 
time is quickly going. I am really intrigued with this further 
development. I was talking with the Ranking Member on risk 
assessment versus risk management because, frankly, I think 
there is a lot to be gained in that area. I also believe, 
whether we are talking about in this instance or whether we are 
talking about health and safety, it is one of the areas that we 
in government generally perform poorly.
    That is my opinion. Quickly, your reports mention the 
possibility of an alternative government structure for the 
Royalty-in-Kind Program. Could you describe what those are?
    Mr. Finfer. Yes. Royalty in kind involves the government 
operating an enterprise pure and simple. Unless one is opposed 
to that, and some are, but if you are not opposed to that then 
obviously the goal needs to be to enable it to operate 
effectively as a business to get the greatest net returns for 
the taxpayers.
    So we recommended a cost benefit analysis of potential 
alternative governance structures. This might include, for 
example, something comparable to what is called an FFRDC, 
Federally funded research and development center, like the 
National Labs. Those sorts of entities are tied to the 
respective departments, in that case, DOE, and in this case it 
would be tied to Interior and MMS.
    The advantage of that structure is that they would be freed 
from some of the strictures that inhibit the ability of the 
program to operate like an enterprise. For example, some of the 
personnel requirements they would be free from so that they 
could compete to get high quality personnel, there wouldn't be 
any question about whether they had followed contracting 
procedures that other programs might have to follow.
    However, we said at the same time that if an alternative 
governance structure is proposed to the legislation it would 
need to be balanced by heightened oversight. There is a trade 
off here. If you are going to get more freedom to operate, you 
also need to have heightened oversight.
    In that case, we recommended the establishment of an 
independent oversight board which would have the power to make 
recommendations to the Secretary which the Secretary would have 
to respond to with a published finding as to why he or she 
accepted, modified or rejected the board's recommendations.
    Mr. Costa. All right. I have gone beyond my time, but I 
would like to ask unanimous consent that a statement from the 
Project on Government Oversight be entered into the record. 
Without objection.
    Mr. Pearce will be the last questioner. With his 
indulgence, though, if you could give me a quick response, Mr. 
Roller, do you see any positive changes as a result of the 
recommendations MMS has already implemented? Quickly, because I 
have exceeded my time.
    Mr. Roller. To be honest, I haven't had any experience in 
knowing what recommendations have been implemented that weren't 
discussed with STRAC or anyone.
    Mr. Costa. Well, obviously you can answer it very quickly 
then. I may follow up with you then on that question. The 
gentleman from New Mexico has his time, and when he completes 
his questioning we will conclude this hearing.
    Mr. Pearce. Well, we may not complete my questioning until 
2:00 or 3:00 then. I am sorry to hear the gentleman say that.
    Mr. Costa. I won't be here until 2:00 or 3:00.
    Mr. Pearce. OK, thank you, Mr. Chairman.
    Mr. Costa. Godspeed.
    Mr. Pearce. Mr. Luthi you heard the testimony of Mr. Rusco 
feeling like all the oil and gas operators are out there to 
cheat the American government and the American people. What 
would it take to cheat on your royalties? Beginning at what 
level to be significant?
    Mr. Luthi. Thank you, Mr. Chairman.
    Mr. Pearce. Scoot it closer, if you would, and push the 
button. There we go.
    Mr. Luthi. There we go. To paraphrase your question a 
little bit, what would it take to cheat on the royalties? It 
takes quite a complicated process as far as I can understand 
because your royalty is developed upon a basic formula of 
volume, value and the royalty that is set. The only set 
standard there is the royalty amount, rather, the 18 and three-
quarters percent, 12.5 percent, whatever that is.
    So then you go back and you look at the volume and the 
value of either the gas or the oil. The volume is normally run 
through at least one, if not several, meters, so there is an 
opportunity to----
    Mr. Pearce. So you would have to have meters that don't 
work that have been jimmied with, and then you would have to 
have complicity up and down. In other words, if the guy at the 
top, the CEO, says cheat, you have to have the mid-level say 
cheat, and then he has got to have a guy at the field level say 
cheat and they all have to kind of agree, but then you have 
different operators at the well.
    So if I can get this guy over here on the ground that 
actually pumps and works that well to cheat, I have to also get 
every single guy out there at field level. CEO, you could get 
one guy that issues the instructions, then you get different 
mid-level people, but you have individuals on the ground.
    If one of them says I am not going to do that, I am going 
to report, isn't that--I just find that absurd that we have a 
GAO report that begins to say that we have that sort of--have 
you all stumbled on any kind of complicity like that throughout 
the nation?
    Mr. Luthi. No, we haven't, Congressman.
    Mr. Pearce. OK. All right. The document that came out, 
actually, as we looked through it, it came up with a lot of 
findings and about 100 or more recommendations, but at the 
beginning it says the process is working well, but, yes, it 
could be tuned up a lot. How many of those findings had you 
already started implementing even maybe before the findings 
were given or since you have seen the report?
    Tell me a little bit about the contrast of MMS today versus 
maybe the MMS of the Clinton years?
    Mr. Luthi. That is going back a few years, but, yes, many 
of the findings, especially those 16 that I referenced in my 
testimony, we actually had underway. A good example of that--or 
they were the easy ones to fix--one of those was the Indian Oil 
Valuation Rule. That particular one wasn't an easy fix.
    It is a very complex rule, it is an important rule. What it 
does is help clarify how we value Indian oil. That is out, it 
is on the street, it is out there now. Other things that we 
did, we did recommend, and it has been done, we have the 
subcommittee now dedicated to RIK. We have increased some 
security, the easy stuff, on the computers, the passwords.
    The coordination was a big factor, which I thought the 
subcommittee did an excellent job of identifying, and we have 
broken down some barriers. It is amazing to me, as coming from 
a small, you know, Wyoming I would say bureaucracy and a 
legislature, to see how we do get on our own stovepipe area.
    We don't have a chance for those that are actually 
monitoring the meters, seeing the producers on a daily basis 
don't always have that coordination with those that are 
actually requesting the money be paid. We have broken that 
down. We are very pleased with the progress----
    Mr. Pearce. Well, I think that is an important piece to 
know from this hearing today. One report says that you are 
doing fairly well and you are even implementing many of the 
findings before and during. By the way, you can go out to New 
Mexico. They spent almost $200 million.
    I was on the Appropriating Committee trying to work out 
this thing or trying to figure out the royalty payments, and 
New Mexico's budget at that time was maybe $2 billion and we 
spent $200 million, so you can imagine kind of how trying that 
was because it is very complex.
    Mr. Finfer, if it is that complex to figure out the 
royalties because the wellhead prices are different every day, 
you have a floating price, and then you got people that got all 
these partners, and subpartners, and unit operators and unit 
members, tell me a little bit about the Royalty-in-Kind 
Program.
    I continue to see it to be a fairly simple operation 
compared to the other operation that we spent billions, or 
millions, or whatever. Tell me a little bit about the RIK.
    Mr. Finfer. RIK isn't foolproof, but, yes, it is simpler. 
It is a more cut and dried process. One of the ways in which it 
has an advantage is, as you know, there have been many disputes 
about valuation over the years. Just simply writing the 
valuation rules took 10 years or so. In the Royalty in Value 
Program there are many disputes about valuations, deductions 
and so forth that can take quite a bit of time to resolve.
    Royalty in Kind has less of that sort of a problem, and so 
there is a significant advantage in that regard.
    Mr. Pearce. So, if I understand you correctly, it is not 
foolproof, but it might be damn foolproof, so, if you get it 
narrowed down. OK. Mr. Chairman, I see my time is up. We have 
come within one minute of your expectations of a noontime 
adjournment, so I would thank you for your indulgence all day 
long. I appreciate it.
    Mr. Costa. Thank you, Mr. Pearce, the gentleman from New 
Mexico. We will continue to work with the various parties on 
this issue, and we will look at the recommendations and see if 
we can figure out a way in a collaborative fashion that we can 
peruse those as I think Mr. Deal said tune up. I kind of like 
that term. Every once in a while I need a tune up.
    So I want to thank all the witnesses for your testimony and 
your patience. We look forward to continuing to work with you. 
I have some comments I need to make here. We want to note for 
the members of the Subcommittee that if they have additional 
questions for witnesses, we will ask you to respond to these in 
writing.
    The hearing record will be held open for 10 days to allow 
those responses to be submitted. If there is no further 
business before the Subcommittee, once again, I want to thank 
the members of the Subcommittee, and the staff and all those 
who worked to put this hearing together. The Subcommittee now 
is adjourned.
    [Whereupon, at 12:03 p.m., the Subcommittee was adjourned.]

    [Additional material submitted for the record follows:]

    [A statement submitted for the record by The Honorable 
Adrian Smith, a Representative in Congress from the State of 
Nebraska, follows:]

 Statement of The Honorable Adrian Smith, a Representative in Congress 
                       from the State of Nebraska

    Good morning. There are a number of challenges facing domestic oil 
and gas production, and I thank you, Chairman, for holding this hearing 
today on the ``Recent Recommendations for Improving the Federal Oil and 
Gas Royalty System.''
    As Congress continues to examine our energy needs, we must 
encourage and promote the development and utilization of domestic oil 
and gas production. We can sustain this goal while ensuring federal 
management practices meet the highest standards.
    While oil and gas production on federal lands generates revenue 
from royalty payments, all domestic oil and gas production generates 
revenue from corporate and personal income taxes. As my home state of 
Nebraska has seen an increase in production on non-federal land, I am 
very interested in how this also contributes to the federal treasury.
    I appreciate the Subcommittee for holding this hearing today on the 
recommendations for improving the Minerals Management Service. I look 
forward to hearing from the Department of the Interior, the Government 
Accountability Office, the Inspector General's office, the Internal 
Revenue Service, and all of our witnesses. What we learn here today 
will play a critical role for achieving the greatest possible benefit 
from our vital, irreplaceable natural resources.
    Chairman, I look forward to working with you. Thank you.
                                 ______
                                 
    [A statement submitted for the record by Danielle Brian, 
Executive Director, Project On Government Oversight, 
Washington, D.C., follows:]

           Statement of Danielle Brian, Executive Director, 
                  The Project On Government Oversight

    The Project on Government Oversight (POGO) has long worked for 
accountability and honesty within the federal government. By that 
standard, we applaud the Royalty Policy Committee's report shedding 
light on the many problems inherent within the royalty collection 
systems at the Department of Interior's Minerals Management Service 
(MMS) and encouraging reform, oversight, and transparency. However, 
much of what we know about the agency from its own Inspector's General 
reports, press reports, Congressional oversight, state and tribal 
auditors, and whistleblowers leads us to believe that the Committee's 
report does not go far enough.
    Rather than depicting MMS as ``an effective steward'' 1 
of the nation's oil and gas royalty collection program, the report is a 
damning picture of the inability of the program to effectively collect 
the taxpayers' money. Combined with a recent report by the Department 
of Interior's Inspector General that found that the agency was 
collecting the largest share of non-tax revenue within the government 
using a ``band-aid'' approach, it is easy to conclude that MMS and its 
revenue collection agency, Minerals Revenue Management (MRM), are 
failing to effectively collect taxpayer money. 2
---------------------------------------------------------------------------
    \1\ Report to the Royalty Policy Committee, Mineral Revenue 
Collections from Federal and Indian Lands and the Outer Continental 
Shelf, Submitted by: the Subcommittee on Royalty Management, with staff 
support from the Department of Interior, Office of Policy Analysis 
(Office of the Secretary) and the Bureau of Land Management, December 
17, 2007, page ix. (Referred to as Report to the Royalty Policy 
Committee from this point forward.)
    \2\ Department of Interior. Memorandum from Earl E. Devaney, 
Inspector General, to Secretary Kempthorne and C. Stephen Allred, 
Assistant Secretary, Land and Minerals Management, September 19, 2007, 
page 1.
---------------------------------------------------------------------------
    Despite having spent close to $150 million over the last several 
years on information technology, the report finds that MMS' technology 
systems, as well as MMS strategies for using those systems are failing 
in a multitude of areas. 3 It is critical the agency have an 
effective strategy for determining which companies to audit. 
4 It is also critical that the agency have information 
technology systems that collect the appropriate information. 
5 It is critical that the agency know for certain how much 
royalty is owed to the government. 6
---------------------------------------------------------------------------
    \3\ United States Department of Interior, Office of Inspector 
General, ``Minerals Management Service: False Claims Allegations,'' 
Transmitted on September 19, 2007, page 38.
    \4\ Report to the Royalty Policy Committee, Recommendations 4-1, 4-
9, 4-19.
    \5\ Report to the Royalty Policy Committee, Recommendations 3-6, 3-
10, 4-10, 4-16, 4-17, 4-18, 4-22.
    \6\ Report to the Royalty Policy Committee, Recommendations 3-1, 3-
14, 3-15.
---------------------------------------------------------------------------
    The Committee's report recommends 110 ways that improvements should 
be made. Many of the Committee's recommendations are straightforward 
common sense strategies for good management. It is easy for POGO to 
support making manuals and procedures available to the public, 
increasing communication among agencies, enhancing performance 
measures, conducting more studies, and ensuring better reporting for 
all endeavors at the agency. For instance, mandatory electronic 
reporting for all lessees would reduce manual entry errors, speed up 
calculation, and ease auditing and compliance reviews. 7 
Additionally, POGO always supports systems that encourage 
whistleblowers. We urge adoption of a whistleblower hotline combined 
with incentives to encourage whistleblowers to come forward. 
8
---------------------------------------------------------------------------
    \7\ Report to the Royalty Policy Committee, Recommendations 3-7, 3-
11, 3-13, 3-16, 4-8, 4-21, 4-22.
    \8\ Report to the Royalty Policy Committee, Recommendations 4-6.
---------------------------------------------------------------------------
    While these nuts and bolts recommendations are key to begin 
reforming the ailing systems within the agency, they fail to address 
important questions of independence, oversight, and transparency. The 
Committee was charged with determining if royalty collection and audit, 
compliance, and enforcement systems and procedures are adequate, as 
well as reviewing the operations of the program to take royalties in 
the form of product, rather than cash. While they may have discovered 
110 ways to improve these systems, avoiding reforms that target larger 
systemic problems will only lead to continued skepticism of the 
agency's ability to effectively steward the program.
    Following are the four larger issues connected to reforming the 
agency we believe the Congress should address, as well as two areas 
raised by the Committee to which we are vigorously opposed.
Additional Reforms:
    1.  Presidential appointment and Congressional confirmation for the 
Director of the Minerals Management Service would provide additional 
oversight and scrutiny of the agency, as well as elevate the status of 
one of the largest non-tax revenue operations within the federal 
government.
    2.  Moving the compliance and audit function out of MMS is a 
critical step to improving the independence of the agency from oil and 
gas companies and reducing conflict of interest within the agency. The 
same people responsible for working with companies to see that federal 
lands are used to their greatest leasing potential and working in 
partnership with those companies to sell royalty oil should not also be 
in charge of auditing those companies.
    3.  Transparency of MMS leases, contracts, documents, and 
procedures is paramount to reducing opportunities for fraud and 
increasing public confidence in the agency.
    4.  An independent and public study of the royalty in kind program 
and its use to fill the nation's Strategic Petroleum Reserve should be 
commissioned to determine if this is in the best interest of the 
taxpayers. While this program may have many benefits, evidence is 
mounting that it compromises the integrity of the agency and squanders 
taxpayer money through inefficiencies.
Areas of Concern:
    1.  POGO urges the Congress to reject the Committee's 
recommendation that a trust fund be established and the interest used 
to fund audit and compliance activities without Congressional approval. 
9 Rather we urge the Congress to reign in all spending 
activities outside the annual Congressional appropriations process.
---------------------------------------------------------------------------
    \9\ Report to the Royalty Policy Committee, Recommendation 6-6.
---------------------------------------------------------------------------
    2.  POGO urges that any consideration of moving to market indices 
for gas valuation, whether for affiliated transactions or not, be 
carefully considered in light of continuing court cases proving 
manipulation by oil and gas companies. 10
---------------------------------------------------------------------------
    \10\ Report to the Royalty Policy Committee, Recommendation 4-26.
---------------------------------------------------------------------------
    While this list is by no means exhaustive, it represents 
significant opportunities to reform the agency by taking an expansive 
view on what it means to be an effective steward of federal lands and 
funds. We are preparing in-depth comments on our primary policy 
objectives and concern as well as on individual chapters of the Royalty 
Policy Committee report, and will supply the document to the Committee 
when it is complete. We appreciate the Chairman's interest in this 
critically important area and trust you will find our comments helpful.
    We would like to sincerely thank the Royalty Policy Committee for 
its thoughtful and expansive work on this critical issue. We believe 
this report, combined with others generated in the recent past, are an 
urgent call for reform of the royalty system. We hope that this report 
will be used to springboard the agency into action so that the 
taxpayers are assured of receiving their fair share from the nation's 
mineral rich lands.

                                 
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