[Senate Hearing 110-7]
[From the U.S. Government Publishing Office]
S. Hrg. 110-7
OIL AND GAS ROYALTY MANAGEMENT AT DOI
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
on
ISSUES RELATING TO OIL AND GAS ROYALTY MANAGEMENT AT THE DEPARTMENT OF
THE INTERIOR
__________
JANUARY 18, 2007
Printed for the use of the
Committee on Energy and Natural Resources
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota LARRY E. CRAIG, Idaho
RON WYDEN, Oregon CRAIG THOMAS, Wyoming
TIM JOHNSON, South Dakota LISA MURKOWSKI, Alaska
MARY L. LANDRIEU, Louisiana RICHARD BURR, North Carolina
MARIA CANTWELL, Washington JIM DeMINT, South Carolina
KEN SALAZAR, Colorado BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
JON TESTER, Montana MEL MARTINEZ, Florida
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Frank J. Macchiarola, Republican Staff Director
Judith K. Pensabene, Republican Chief Counsel
Patty Beneke, Senior Counsel
C O N T E N T S
----------
STATEMENTS
Page
Allred, C. Stephen, Assistant Secretary, Land and Minerals
Management, Department of the Interior......................... 18
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................ 1
Devaney, Earl E., Inspector General, Department of the Interior.. 6
Domenici, Hon. Pete V., U.S. Senator from New Mexico............. 4
Gaffigan, Mark E., Acting Director, Natural Resources and
Environment, Government Accountability Office.................. 9
Sanders, Hon. Bernard, U.S. Senator from Vermont................. 3
Wyden, Hon. Ron, U.S. Senator from Oregon........................ 3
APPENDIX
Responses to additional questions................................ 57
OIL AND GAS ROYALTY MANAGEMENT AT DOI
----------
THURSDAY, JANUARY 18, 2007
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 9:32 a.m., in
room SD-G50, Dirksen Senate Office Building, Hon. Jeff
Bingaman, chairman, presiding.
OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW
MEXICO
The Chairman. Why don't we call the hearing to order? I
thank everybody for coming today. We thank our witnesses for
being here. Today the committee will hear from witnesses on the
topic of oil and gas royalty management in the Department of
the Interior. Problems in this program have been the subject of
work both by the Department, the Department's Inspector
General, Mr. Devaney, who is here today and also by the
Government Accountability Office. Mr. Gaffigan is here today
representing that office.
I've had a chance to briefly review the IG's report that is
being released today and it's obvious there is a lot of blame
to spread around on this issue. Almost a year ago, we became
aware that Outer Continental Shelf oil and gas leases issued in
1998 and 1999 in the Gulf of Mexico did not contain so-called
price thresholds, therefore allowing a certain volume of
royalty-free production under the Deep Water Royalty Relief Act
of 1995.
At that time, I was joined on a bipartisan basis by 21
members of the Senate and some members from the House in
requesting the General Accountability Office to look into the
matter. The problem may result, I'm informed, in losses to the
Treasury of $10 billion over 25 years.
While this error initially occurred in the Clinton
administration, I think it is clear that it was an error that
was accomplished by civil servants working in the Department.
Lease terms were changed without the Solicitor's Office being
asked to review the modifications. Communications were confused
when the error was discovered. Mid-level managers did not raise
the issue with departmental officials higher up in the
Department.
Subsequently, when the problem became known in the Bush
administration to some of their officials, there was not much
done initially, but efforts in the last year have resulted in
settlement agreements with, I believe, six different companies.
There are still many companies that have leases that have not
agreed to settle.
From my vantage point, the entire matter raises serious
questions about management and organization at the Department,
and the adequacy of resources committed to this activity,
particularly in the Solicitor's Office. I hope the testimony
today can lead to some concrete, constructive steps, such as
increasing resources that are needed, any changes in
management, management reforms, and legislative solutions, if
those are required.
I'm also deeply concerned about pending litigation that has
been brought by the Kerr McGee Corporation. They have recently
been acquired by Anadarko Petroleum. That litigation relates to
the same Deep Water Royalty Relief Program. The lawsuit
challenges the authority of the Secretary of the Interior to
impose price thresholds for any leases issued from 1996 through
2000. I believe Congress intended that price thresholds apply
but if the industry were to prevail in that litigation, the
exposure to the Treasury and the windfall to the industry could
be very large. I'm told it could be in the range of $60 billion
over 25 years.
Unfortunately, the royalty management problems don't end
with those items that I've mentioned. Last month, the IG issued
a report related to the audit and compliance review process for
both onshore and offshore royalties. That report indicates MMS
has reduced the number of auditor positions by over 20 percent
since 2000. The number of audits has been reduced by 22 percent
over the period from 2000 to 2004. Ensuring the MMS collects
the proper amount of royalties has implications not only for
the Federal Treasury, it also has implications for the States
that share in the royalty proceeds and for Indian tribes, with
Indian oil and gas resources involved and they are in some of
what we're talking about.
I've been concerned also that for-government auditors who
have monitored leases for oil and gas on Federal lands have now
alleged that the Interior Department suppressed their efforts
to recover millions of dollars from leasees. These individuals
have filed qui tam cases under the Federal Government Civil
False Claims Act, seeking to recover these amounts on behalf of
the Government. I believe the IG is looking into this matter. I
don't know if he will be able to testify on any aspect of it
today.
Finally, last June, Chairman Rahall and I requested GAO to
review whether the royalty rates for oil and gas leases are
commensurate with royalties received by States and by private
interests on their lands. I note with interest that this last
week, the administration announced an increase in royalty rates
for OCS leases in the deep waters of the Gulf of Mexico. I hope
the GAO will be able to give us some initial findings in that
regard.
The final point I would mention is that Mr. Devaney, in
your testimony last fall, I believe on the House side, you made
a statement that I thought was fairly striking. You said short
of a crime, anything goes at the highest levels of the
Department of the Interior. Congress needs to take its
oversight responsibilities seriously. Obviously that's the kind
of statement that needs to get our attention. We're anxious to
hear any comments you have on that issue today.
Let me defer to Senator Domenici for any statement he has
and then we'll go to the witnesses.
[The prepared statements of Senators Sanders and Wyden
follow:]
Prepared Statement of Hon. Bernard Sanders, U.S. Senator From Vermont
Mr. Chairman, Mr. Ranking Member, thank you for holding this
hearing today. The mismanagement of the royalty program at the
Department of the Interior is something that this Committee rightly
must thoroughly oversee. And, it isn't only the mismanagement that
needs oversight--although clearly, with a billion dollars already lost
and billions more at risk, we must get a grip on what is happening. We
need to thoughtfully assess the underlying idea of royalty relief,
which is nothing more than an embarrassing giveaway of taxpayer
dollars. At this point in time, when we should be encouraging movement
away from fossil fuels that cause global warming and moving toward
clean, renewable sources of energy, why would the federal government
give oil and gas companies--while they are making record profits and
consumers feel the pain--free money for the resources they take from
public lands? If I didn't know better, I would laugh if someone tried
to tell me about the situation.
Unfortunately, it is no joke.
Along with many of my colleagues, I am glad that the New York Times
exposed the mismanagement issues last year and I look forward to
helping ensure that the Department of the Interior changes its tune. I
appreciate the work done by the Interior Department's Inspector General
and the GAO, and I thank them for appearing here this morning. I also
appreciate the Assistant Secretary for Lands and Minerals Management
spending time with the Committee today.
______
Prepared Statement of Hon. Ron Wyden, U.S. Senator From Oregon
Thank you, Chairman Bingaman and Senator Domenici, for scheduling a
hearing on this important subject--how American taxpayers are getting
fleeced for billions of dollars by oil and gas companies drilling on
public land and on the Outer Continental Shelf. Drilling in these
places isn't a right, it's a privilege, and I am deeply concerned about
the on-going taxpayer ripoffs in this program uncovered over the last
year.
In December, the Inspector General issued a report documenting
numerous problems in how the Mineral Management Service is failing to
make sure that companies pay what they owe. Not surprisingly, the
amount of money collected through MMS enforcement actions in 2005 was
about one-fourth what it had been a few years earlier.
Things are apparently so bad in the audit program that four MMS
auditors have filed their own lawsuits under the Federal False Claims
Act on behalf of the government to collect tens of millions of dollars
in unpaid royalties. The auditors--agency veterans--say their superiors
at MMS ordered them not to pursue these cases on the job, so they are
doing it on their own. And how did the Interior Department respond? One
of the auditors claims he was forced out of his job and the other three
have been reassigned to other jobs and are the subject of internal
Department investigations.
Today, the IG has released another report, this one on why hundreds
of leases in the Gulf of Mexico were signed without price thresholds, a
failure that will cost the taxpayers billions of dollars in lost
royalties while oil companies report record profits. Despite the IG's
best efforts, it's still not clear exactly how this happened--we hear
that nobody read the leases, that it was bureaucratic bumbling at its
worst, that current MMS officials have known about the problem for
years but did nothing--and this is all a damning indictment of the way
the Department handles billions of dollars worth of oil and natural gas
leases.
Mr. Chairman, the problems with the mineral leasing programs don't
end here. The program is also the subject of multiple criminal
investigations, at least one involving the Royalty-In-Kind program--a
program that started with serious problems, as documented by the GAO in
2003 and 2004, and which appears to have gotten worse. States and
Indian tribes that carry out royalty audits under agreement with MMS
say they are being reined in so they can't properly do their job or
challenge the agency's decisions. I could go on.
The bottom line, Mr. Chairman, is that today's hearing is a good
first step, but there is much more to do. And I want to work with you
and our colleagues on the Committee on both sides of the aisle, and
especially on the Public Lands Subcommittee, to understand this mess
and fix it. The way things are being handled at the Interior Department
and MMS is simply unacceptable.
STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR
FROM NEW MEXICO
Senator Domenici. Senator Bingaman, first, thank you for
your statement. Thank you for calling the hearing and thank you
for your demeanor. As usual, you have, in my opinion, laid this
issue properly before the Congress. Thank you.
First, let me make sure we understand that thresholds are
missing from 1998 and 1999 leases and that equals 1,032 leases
in that time period that we did not have thresholds. It's not
leases before that and it's not leases after that. It's leases
during that period of time. Now, just so we straighten out who
was in office and running the show, not by way of laying blame
because right now, I don't think we lay blame on anybody. But
those were Clinton years, followed by Bush years. Somehow or
another, for those 2 years, leases that were issued--they were
issued under this new act, which was supposed to sensitize that
part of the gulf to more activity. Senator Craig, the act was
supposed to be something that would excite the leasees to go
out and bid and in spite of us being here today, worrying about
what happened, the truth of the matter is, the act did work. A
lot more people bid to get a leasehold going because of the act
that we're speaking of that invited more activity.
So, we are able to determine how much occurred during those
2 years and already, the action has cost the Treasury and I
think all of you sitting in front of me will confirm this--if
not all of you, at least some of you, will confirm that $900
million was lost during that time period because of the price
of oil and we are assuming, a lack of a threshold. A threshold
wasn't there. We should have been gaining money and the
estimate is $900 million. We hear another term, $10 billion.
Well, that is projected further out by GAO to cost $10 billion
and that's a GAO estimate. If you go all the way out, that's
what it would cost for the leases that are missing thresholds
during the 2 years that I've talked about.
Now, obviously, we all know enough now, Senator Salazar.
Nobody contemplates putting these leases on without thresholds,
at least I hope so. With these hearings, it ought to make
anybody thinking about doing that rather uncomfortable, it
would seem to me.
Now having said that, again, I want to thank the chairman
and I want to thank the witnesses. I have not had a chance to
talk to all of you but I did get a chance to talk to you, Mr.
Secretary, yesterday for just a few moments. You have a
difficult job and I thank you for coming here and being very
forthright and I urge that you continue to do so. There are
some unanswered questions that still, as of this morning, if
you read the GAO and your report, you still don't get the
answers to all the questions. There are some unanswered
questions about what happened to whom, who was there to take
telephone calls, who died and who has dementia among those
people that are part of this overall activity.
What I want you to know is that the issue is of enormous
significance to the American people and to our Nation's fiscal
well being. According to the Interior Department, I've already
told you that the MMS collected $9.9 billion in royalties from
approximately 27,800 producing leases. So the stakes of getting
this right are terrifically important. In 1998 and 1999, the
Department of the Interior failed to include so-called price
thresholds in deep-water oil and gas leases. From all accounts,
from this time, it appears that the omissions of these
thresholds were the result of negligence and not a nefarious
action.
Nevertheless, according to an initial estimate from the
GAO, this failure during the Clinton administration Interior
Department, it could have cost the taxpayers $10 billion over
25 years.
Last summer, I sponsored an amendment that passed the
Interior Committee that among other things, encouraged, Mr.
Chairman, the negotiation of 1998 and 1999 leases and provided
the Secretary of the Interior with the clear authority to
negotiate these leases to include price thresholds. Though the
Interior Appropriations bill was never brought up on the Senate
floor, I suspect that the committee vote sent the proper signal
to the companies and the Department.
In December, six companies negotiated, as I understand it,
with you, Mr. Secretary. You're the one doing that work. Six
companies negotiated the terms of the agreements to include
price thresholds. The Department of the Interior believes that
this will bring an estimated 20 percent of the outstanding lost
royalties as a result of the error in the 1998 and 1999 leases.
I continue to encourage all companies to come forward and
re-negotiate with the Department of the Interior. It is
important for our Nation's fiscal stability. It's important
that we know what these leaseholds will yield. That's a very
important fact for us to know. It is significant. It is
important to get this issue resolved so that the Department and
these companies, these holders can get back to doing what they
do best--that is, produce American oil and gas supplies to help
reduce our energy dependence.
As we heard at last week's global oil hearing, this is an
economic security issue. It is a foreign policy issue and a
national security issue and we should keep our focus on that
fact. Additionally, I want to make it clear that the Deep Water
Royalty Relief Act of 1995 was a good thing. We should not
confuse the failure of the Clinton administration's
implementation for 2 years with its substantive policy advance
and achievement made as a result of this act. Since President
Clinton signed the act into law, our domestic oil and gas in
deep water has increased dramatically. In 2005, oil production
was over 400 percent greater than 1995 and natural gas was 340
percent greater than 1995 and as we begin to make our judgments
on how to resolve this issue of the 1998 and 1999 leases, I
trust that we will examine the important and difficult legal
issues, contractual and property and constitutional issues,
that this situation presents for all of us.
I hope this Congress will resist the temptation of the
headlines and will act in a thoughtful, practical way. We
should know that the eyes of the world and Mr. Chavez and Mr.
Putin are watching how we treat shareholders of property and
contract rights on our Federal lands.
I thank the chairman for holding this important hearing and
look forward to hearing my colleagues ask questions. Thank you,
Mr. Chairman.
The Chairman. Thank you very much. Why don't we just go
through each of the witnesses, if they would each take 10
minutes or so and give us the substance of their testimony.
Obviously, your written testimony will be included in the
record but if you have significant points you want us to focus
on, we'd be anxious to have you explain what those are. Why
don't we start with you, Mr. Devaney and we'll just go right
across the row that way.
STATEMENT OF EARL E. DEVANEY, INSPECTOR GENERAL, DEPARTMENT OF
THE INTERIOR
Mr. Devaney. Thank you Mr. Chairman and members of the
committee. I want to thank you for the opportunity to address
the committee this morning about the various oversight
activities being conducted by my office regarding the Minerals
Management Services Royalty Program.
Specifically, I'm here today to discuss the results of our
audit of MMS's compliance review process, which was released
publicly in December 2006 and the results of our investigation
into the circumstances surrounding MMS's failure to include
price thresholds in deep water leases entered into during 1998
and 1999, which is being released this morning.
Our audit of the compliance review process was initiated in
response to requests from this committee and other members of
Congress. This is not our first audit of MMS's Compliance and
Asset Management Program. For instance, in 2003, we conducted
an audit of MMS's audit function in which we concluded that
MMS's internal quality control system could not ensure that the
audits were being conducted in accordance with government
auditing standards. We also found incredibly, that MMS auditors
had recreated and backdated working papers prior to that audit.
Since that time, however, MMS audit offices have undergone
and passed two external peer reviews, an indication that MMS
has corrected the problems we identified in 2003.
From our most recent audit of the compliance review
process, we found that compliance reviews can provide a broader
coverage of royalties using fewer resources than traditional
audits. They do not, however, provide the same level of detail
or assurance that a traditional audit provides. As a result, we
concluded that compliance reviews should only be used in
conjunction with audits and in the context of a well-defined
risk based compliance strategy. We discovered two principle
weaknesses that are preventing MMS from maximizing the benefits
of compliance reviews.
First, we discovered that very few full audits were ever
triggered by anomalies discovered during those compliance
reviews. We also learned that because the program's performance
measures were tied to dollar figures, only the big companies
and leases were being reviewed, leaving hundreds of smaller
companies that MMS never looks at. With few exceptions, MMS
agreed with our recommendations and as promised, they have
provided us with an action plan for implementing these changes.
We've just finished our investigation into the failure of
MMS to include price thresholds in the terms of deep-water
leases issued in 1998 and 1999. We conducted our investigation
with two primary purposes in mind: how and why price thresholds
were omitted from the leases and what happened once the
omissions were discovered. During the course of our
investigation, we conducted 44 interviews and reviewed
approximately 19,000 e-mails and 20,000 pages of documents. We
determined that MMS intended to include price thresholds in
leases issued pursuant to the Deep Water Royalty Relief Act, as
evidenced in the first leases issued in 1996 and 1997, as well
as in 2000. But while MMS was developing new regulations
relating to the Deep Water Royalty Relief Act, there was
significant confusion among the MMS's operational components
and the Office of the Solicitor as to whether or not the
regulations would address price thresholds. In the end, the
regulations did not and the price thresholds were left out of
the leases.
The person responsible for directing the preparation of the
leases said he was told by persons in MMS's Economic and
Leasing Divisions to take the price threshold out of the
leases. He successfully passed a polygraph exam. The people in
the Economics and Leasing Divisions denied telling him to take
the language out and the one person involved in both the
regulation development and the notice of sale review process, a
solicitor's attorney, conceded that he should have spotted the
omission but did not. The official who signed the leases on
behalf of MMS told us he relied on that same solicitor attorney
and his own staff before signing.
When the omission was discovered by MMS staff in 2000, it
was unexplainably not conveyed up the chain of command to the
MMS Director. Unfortunately, the official who made this
particular decision is now deceased. We interviewed the former
MMS Directors who were in place at the time of the omission and
the time of its discovery as well as the present Director. Each
told us that they only became aware of the omission when the
first New York Times article came out last fall.
Near the end of the investigation, however, we found a
series of e-mails, which suggested that the present Director
had been advised of the price threshold omission as early as
2004. We went back to her with this information and when she
read the e-mails, she appeared genuinely surprised but conceded
that the e-mails indicated that she probably had been told of
the omission in 2004. She still had no independent recollection
but speculated that she was probably told of the mistake in
conjunction with being informed that the Solicitor's Office had
opined that nothing could be legally done to remedy the
situation.
Mr. Chairman, this, at a minimum, is a shockingly cavalier
management approach to an issue with profound financial
ramifications, a jaw-dropping example of bureaucratic bungling
and a total reliance on surname process, which diluted
responsibility and accountability. Although we found massive
finger pointing and blame enough to go around, we do not have a
smoking gun or any evidence that this omission was deliberate.
We do, however, have a very costly bureaucratic mistake.
I'd like to tell you that this concludes the summary of
oversight activities my office is conducting relative to MMS's
royalty program. Unfortunately, it does not. We have several
other investigations ongoing, some of which are criminal in
nature. As a result, I'm not at liberty to discuss them with
you here today. However, we have coordinated closely with the
Department in order to provide Assistant Secretary Allred with
enough general information so that he could take some interim
preventative measures. In fact, I'd like to publicly thank both
Secretary Kempthorne and Assistant Secretary Allred for being
very receptive to our findings and recommendations of these
matters. I'm encouraged that they both share my belief that
beyond any actual impropriety, appearances do matter.
This concludes my formal testimony. Thank you for the
opportunity to appear before the committee today. I'll be glad
to answer any questions any of you might have.
[The prepared statement of Mr. Devaney follows:]
Prepared Statement of Earl E. Devaney, Inspector General,
Department of the Interior
Mr. Chairman and members of the Committee, I want to thank you for
the opportunity to address the Committee this morning about various
oversight activities being conducted by the Office of Inspector General
(OIG) for the Department of the Interior (DOI) concerning multiple
issues involving the Minerals Management Service (MMS). Specifically, I
am here today to discuss the results of our audit of MMS' Compliance
Review Process, which was released publicly in December 2006, and the
results of our investigation into the circumstances surrounding MMS'
failure to include price thresholds in deepwater leases entered into
during 1998 and 1999, which is being released publicly this morning.
Our audit of the compliance review process--one of several tools
utilized by MMS' Compliance Asset Management (CAM) Program--was
initiated in response to a request from this Committee and other
members of Congress to assess the effectiveness of these compliance
reviews. This audit was timely--not only because it followed the first
of several New York Times articles on MMS and its royalty program, but
also because the compliance review process, which was launched in 2000,
was ripe for an audit in 2006.
This is not our first audit of MMS' Compliance Asset Management
Program. In 2003, we conducted an audit of MMS' audit function in which
we concluded that MMS' internal quality control system could not ensure
that its audits were being conducted in accordance with policies,
procedures and Government Auditing Standards. We also found an instance
of MMS auditors recreating and back-dating working papers. Since that
time, however, the MMS audit offices have undergone and ``passed'' two
external peer reviews, an indication that MMS has corrected the
problems we identified in 2003.
From our audit of the compliance review process, we found that
compliance reviews play a useful role in MMS' greater Compliance and
Asset Management Program. Compliance reviews can provide a broader
coverage of royalties, using fewer resources than traditional audits.
They do not, however, provide the same level of detail or assurance
that a traditional audit provides. As a result, we concluded that
compliance reviews should only be used in conjunction with audits, in
the context of a well-designed, risk-based compliance strategy. We also
discovered two principal weaknesses that are preventing MMS from
maximizing the benefits of compliance reviews. First, we discovered
that very few full audits were ever triggered by anomalies discovered
in the compliance review process. We also learned that because the
program's performance measures were tied to dollar figures, only the
big companies and leases were being reviewed, leaving hundreds of
smaller companies that MMS never looked at.
In addition, we made several recommendations to improve CAM's
management data, and to strengthen the compliance review process
overall. With few exceptions, MMS agreed with our recommendations; most
notably, MMS agreed to revise its performance measures and to develop
and pilot a risk-based compliance strategy for its compliance review
process; and, as promised, MMS has now provided us with an Action Plan
for implementing these changes.
Contemporaneous with our audit of the compliance review process, we
conducted an investigation into the failure of MMS to include price
thresholds in the terms of deepwater leases issued in 1998 and 1999. We
conducted our investigation with two primary questions in mind: How and
why were price thresholds omitted from the leases; and what happened
once the omission was discovered. During the course of our
investigation, we conducted 44 interviews and reviewed approximately
19,000 e-mails and 20,000 pages of documents. We have determined that
MMS intended to include price thresholds in leases issued pursuant to
the Deepwater Royalty Relief Act, as evidenced in the first leases
issued in 1996 and 1997, as well as in 2000; but while MMS was
developing new regulations relating to the Deepwater Royalty Relief
Act, there was significant confusion among MMS operational components
and the Office of Solicitor (SOL) as to whether or not the regulations
would address price thresholds. In the end, the regulations did not,
and the price thresholds were left out of the leases.
The person responsible for directing the preparation of the leases
said he was told by persons in MMS' Economics and Leasing Divisions to
take the price threshold language out of the leases. The people in the
Economics and Leasing Divisions denied doing so. The one person
involved in both the regulation development and lease review process, a
SOL attorney, conceded that he should have spotted the omission, but
did not. The official who signed the leases on behalf of MMS told us he
relied on the SOL attorney and his own staff.
When the omission was discovered by MMS staff in 2000, it was not
conveyed up the chain of command to the MMS Directorate. Unfortunately,
the official who made this particular decision is deceased. We
interviewed the former MMS Directors who were in place at the time of
the omission and the time of its discovery, as well as the present
Director. Each told us that they only became aware of the omission when
the first New York Times article came out last fall.
Near the end of our investigation, however, we found a series of e-
mails that suggested that the present Director had been advised of the
price threshold omission as early as 2004. We went back to her with
this information and conducted a follow-up interview. When she read the
e-mails, she appeared genuinely surprised, but conceded that the e-
mails indicated that she had probably been told of the omission in
2004. She still had no independent recollection, but speculated that
she was probably told of the mistake in conjunction with being informed
that the Solicitor's Office had opined that nothing could be legally
done to remedy the issue.
Mr. Chairman, this, at a minimum was a shockingly cavalier
management approach to an issue with such profound financial
ramifications, a jaw-dropping example of bureaucratic bungling, and a
reliance on a surname-process which dilutes responsibility and
accountability. Although we found massive finger-pointing and blame
enough to go around, we do not have a ``smoking gun'' or any evidence
that this omission was deliberate; we do, however, have a very costly
mistake which might never have been aired publicly absent the New York
Times, the interest of this Committee, the House Subcommittee on Energy
and Resources and that of several other interested members of Congress.
I would like to say that this concludes the summary of the
oversight activities my office is conducting relative to MMS;
unfortunately, it does not. We have several other investigations
ongoing, some of which are criminal in nature. As a result, I am not
presently at liberty to discuss them. With regard to these matters,
however, we have coordinated closely with the Department in order to
provide Assistant Secretary Allred with enough general information so
he could take some interim preventive measures. In fact, I would like
to publicly thank both Secretary Kempthorne and Assistant Secretary
Allred for being receptive to our findings and recommendations. I am
encouraged that they both share my belief that beyond actual
improprieties, appearances do matter.
This concludes my formal testimony. Thank you for the opportunity
to appear here before the Committee today. I will be happy to answer
any questions you may have.
The Chairman. Thank you very much for your testimony, Mr.
Devaney. Next is Mark Gaffigan, who is the Acting Director of
the Natural Resources and Environment section in the Government
Accountability Office. I appreciate you being here.
STATEMENT OF MARK E. GAFFIGAN, ACTING DIRECTOR, NATURAL
RESOURCES AND ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE
Mr. Gaffigan. Thank you, Mr. Chairman, ranking member
Domenici, members of the committee. Good morning. I'm pleased
to be here to assist you in your oversight of royalties
obtained from the sale of oil and natural gas produced from
Federal lands and waters.
MMS recently reported collecting about $10 billion in
annual oil and gas royalty revenue from Federal production that
supplies about one-third of all the oil and one-quarter of all
the natural gas produced in the United States. Obviously, such
a large and financially significant resource must be carefully
managed and developed to strike a balance between meeting our
Nation's significant energy needs while also ensuring a fair
return to the American people, especially in light of the
current and long range fiscal challenges facing the Nation.
As part of this balance, the Federal Government has
provided royalty relief, which is the waiver or reduction of
royalties in order to encourage the development of oil and gas.
However, to maintain balance and ensure a fair return, royalty
relief also typically includes volume limitations or price
thresholds that limit relief and restore royalties once a
certain amount of oil or gas has been produced or once market
prices reach certain levels.
In 1995, in a period of lower prices and declining
production, a significant royalty relief act, the Deep Water
Royalty Relief Act of 1995, mandated relief for oil and gas
leases issued in the deep waters of the Gulf of Mexico. Sadly,
the establishment of limitations on the royalty relief provided
by this act has been fraught with problems, likely costing
billions of dollars in foregone royalty revenues and placing
into question whether a fair return has been achieved.
Based on our ongoing work reviewing the fiscal impact of
royalty relief, I would like to emphasize three points. First,
a series of mistakes and legal challenges in implementing
relief under the 1995 Act will likely add billions in
unanticipated costs. For example, Interior lost a 2004 court
case on MMS's establishment of volume units for royalty relief,
resulting in higher volume limits being applied and thus, more
relief. MMS has estimated that this decision could cost up to
$10 billion in foregone revenue.
Another problem that has been widely reported has been the
price thresholds left off the 1998 and 1999 leases. MMS has
estimated that this could cost another $10 billion, a billion
of which has already been foregone.
Finally, Kerr McGee, in a current lawsuit, is questioning
whether MMS even has the authority to establish price
thresholds for any of the leases issued under the 1995 Act,
thus bringing into question another 2,300 leases issued in
1996, 1997 and 2000. If this case is lost, again MMS has
preliminarily estimated that this could add up to another $60
billion.
My second point--while we are reviewing these cost
estimates, even without the uncertainty stemming from this
litany of problems that has resulted in these potential,
unanticipated costs, determining the fiscal impact of royalty
relief is inherently difficult. It is difficult because of
uncertainty about the amount and timing of future oil and gas
production and future prices. In addition, potential benefits
that may offset costs should also be considered. For example,
benefits might include increased production or higher amounts
companies are willing to pay for leases.
My third point--although leases are no longer issued under
the 1995 Act, royalty relief can still be granted today under
two basic existing authorities. First, MMS currently offers
several royalty relief programs under the discretionary
authority granted to the Secretary of the Interior. In
addition, the Energy Policy Act of 2005 also contains several
royalty relief provisions. Relief under these discretionary
programs and legislation may further impact future royalty
revenues.
Royalty policy can be an important tool in striking a
balance between encouraging production and ensuring a fair
return. However, this balance must be struck in careful
consideration of both the costs and benefits of all royalty
relief provisions. Unfortunately, the Federal Government has
not consistently given this careful attention, resulting in
unforeseen costs and many questions about the ultimate impact
of royalty relief.
As we continue our work, GAO looks forward to assisting the
Congress and MMS in the future, through its reviews of these
issues. This concludes my opening remarks. I have submitted a
written statement for the record and I welcome any questions
you might have. Thank you.
[The prepared statement of Mr. Gaffigan follows:]
Prepared Statement of Mark E. Gaffigan, Acting Director, Natural
Resources and Environment, Government Accountability Office
why gao did this study
Oil and gas production from federal lands and waters is vital to
meeting the nation's energy needs. As such, oil and gas companies lease
federal lands and waters and pay royalties to the federal government
based on a percentage of the oil and gas that they produce. The
Minerals Management Service (MMS), an agency in the Department of the
Interior, is responsible for collecting royalties from these leases. In
order to promote oil and gas production, the federal government at
times and in specific cases has provided ``royalty relief,'' waiving or
reducing the royalties that companies must pay. However, as production
from these leases grows and oil and gas prices have risen since a major
1995 royalty relief act, questions have emerged about the financial
impacts of royalty relief.
Based on our work to date, GAO's statement addresses (1) the likely
fiscal impacts of royalty relief on leases issued under the Outer
Continental Shelf Deep Water Royalty Relief Act of 1995 and (2) other
authority for granting royalty relief that could further impact future
royalty revenue.
To address these issues our ongoing work has included, among other
things, analyses of key production data maintained by MMS; and reviews
of appropriate portions of the Outer Continental Shelf Deep Water
Royalty Relief Act of 1995, the Energy Policy Act of 2005, and
Interior's regulations on royalty relief.
OIL AND GAS ROYALTIES
Royalty Relief Will Likely Cost the Government Billions, but the Final
Costs Have Yet to Be Determined
what gao found
While precise estimates remain elusive at this time, our work to
date shows that royalty relief under the Outer Continental Shelf Deep
Water Royalty . Relief Act of 1995 will likely cost billions of dollars
in forgone royalty revenue--at least $1 billion of which has already-
been lost. In October 2004, MMS estimated that forgone royalties on
deep water leases issued under the act from 1996 through 2000 could be
as high as $80 billion. However, there is much uncertainty in these
estimates. This uncertainty stems from ongoing legal challenges and
other factors that make it unclear how many leases will ultimately
receive royalty relief and the inherent complexity in forecasting
future royalties. We are currently assessing MMS's estimate in light of
changing oil and gas prices, revised estimates of future oil and gas
production, and other factors.
Additional royalty relief that can further impact future royalty
revenues is currently provided under the Secretary of the Interior's
discretionary authority and the Energy Policy Act of 2005.
Discretionary programs include royalty relief for certain deep water
leases issued after 2000, certain deep gas wells drilled in shallow
waters, and wells nearing the end of their productive lives. The Energy
Policy Act of 2005 mandates relief for leases issued in the Gulf of
Mexico during the five years following the act's passage, provides
relief for some gas wells that would not have previously qualified for
royalty relief, and addresses relief in certain areas of Alaska.
Mr. Chairman and Members of the Committee:
We appreciate the opportunity to participate in the Committee's
hearing on federal royalties obtained from the sale of oil and natural
gas produced from federal lands and waters. Oil and gas production from
federal lands and waters is vital to meeting the nation's energy needs,
supplying about 35 percent of all the oil and about 25 percent of all
the natural gas produced in the United States in fiscal year 2005. Oil
and gas companies that lease federal lands and waters agree to pay the
federal government royalties on the resources extracted and produced
from the lease. In fiscal year 2006, oil and gas companies received
over $77 billion from the sale of oil and gas produced from federal
lands and waters, and the Minerals Management Service (MMS), the
Department of the Interior's (Interior) agency responsible for
collecting royalties, reported that these companies paid the federal
government about $10 billion in oil and gas royalties. Clearly, such
large and financially significant resources must be carefully developed
and managed so that our nation's rising energy needs are met while at
the same time the American people are ensured of receiving a fair rate
of return on publicly owned resources, especially in light of the
nation's current and long-range fiscal challenges.
In order to promote oil and gas production, the federal government
has at times and in specific cases provided ``royalty relief''--the
waiver or reduction of royalties that companies would otherwise be
obligated to pay. When the government grants royalty relief, it
typically specifies the amounts of oil and gas production that will be
exempt from royalties and may also specify that royalty relief is
applicable only if oil and gas prices remain below certain levels,
known as ``price thresholds.'' For example, the Outer Continental Shelf
Deep Water Royalty Relief Act of 1995, also known as the Deep Water
Royalty Relief Act (DWRRA), mandated royalty relief for oil and gas
leases issued in the deep waters of the Gulf of Mexico from 1996 to
2000. These deep water regions are particularly costly to explore and
develop. However, as production from these leases has grown, and as oil
and gas prices have risen far above 1995 levels, serious questions have
been raised about the extent to which taxpayer interests have been
protected. These concerns were brought into stark relief when it was
learned that MMS issued leases in 1998 and 1999 that failed to include
in the lease contracts the price thresholds above which royalty relief
would no longer be applicable, making large volumes of oil and natural
gas exempt from royalties and significantly affecting the amount of
royalty revenues collected by the federal government. Although leases
are no longer issued under DWRRA, further royalty relief is currently
available under other legislation and programs, raising the prospect
that the federal government may be forgoing additional royalty
revenues.
Recently, congressional committees, the Department of the
Interior's Office of the Inspector General,\1\ public interest groups,
and the press have questioned whether our nation's oil and gas
royalties are being properly managed. Many of these entities have also
amplified questions about whether the oil and gas industry is paying
its fair share of royalties, especially in light of rapidly rising oil
and gas prices, record industry profits, and a highly constrained
federal budgetary environment. GAO has expressed similar concerns, and
the U.S. Comptroller General has highlighted royalty relief as an area
needing additional oversight by the 110th Congress.\2\
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\1\ Minerals Management Service's Compliance Review Process,
Department of the Interior Office of the Inspector General, Report No.
C-IN-MMS-0006-2006 (Washington, D.C.: December, 2006).
\2\ Suggested Areas for Oversight for the 110th Congress, GAO-07-
235R (Washington, D.C.: November 17, 2006).
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You asked us today to address royalty relief issues based on our
ongoing work for this Committee. Specifically, my testimony (1)
discusses the likely fiscal impacts of royalty relief for leases issued
under the Deep Water Royalty Relief Act of 1995 and (2) describes other
authorities for granting royalty relief that could further impact
future royalty collections. To address these issues, our ongoing work
has included interviews of MMS personnel in the Economics Division in
Herndon, Virginia and the Gulf of Mexico OCS Region in New Orleans,
Louisiana. We have collected and are analyzing key production data
maintained by MMS and are examining numerous documents and studies. We
are also reviewing appropriate portions of the Deep Water Royalty
Relief Act of 1995, the Energy Policy Act of 2005, and Interior's
royalty relief regulations. Our work follows the issuance of our report
last year explaining why oil and gas royalties have not risen at the
same pace as rising oil and gas prices.\3\ In addition, we are
conducting other work for your Committee on federal oil and gas royalty
rates and the diligent development of federal oil and gas resources.
Our work is being done in accordance with generally accepted government
auditing standards.
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\3\ Royalty Revenues: Total Revenues Have Not Increased at the Same
Pace as Rising Natural Gas Prices due to Decreasing Production Sold,
GAO-06-786BR (Washington, D.C.: June 21, 2006).
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In summary, we have found the following:
Our work to date shows that the likely fiscal impact of
leases issued under the Deep Water Royalty Relief Act of 1995
is in the billions of dollars in lost royalty revenues, but
precise estimates of the costs are not possible at this time
for several reasons. First, MMS's failure to include price
thresholds for leases issued in 1998 and 1999 along with
current attempts to renegotiate these leases have created
uncertainty about which leases will ultimately receive relief.
MMS estimates that the failure to include these price
thresholds during a period of higher oil and gas prices could
cost up to $10 billion in forgone royalty revenue. To date,
about $1 billion has already been lost. In addition, a recent
lawsuit questions whether MMS has the authority to set price
thresholds for the leases issued from 1996 through 2000.
Depending on the outcome of this litigation, MMS preliminary
estimates indicate that this could result in up to $60 billion
in additional forgone royalty revenue. Beyond the problematic
implementation of the royalty relief provisions, assessing the
ultimate fiscal impact of royalty relief is a complex task,
involving inherent uncertainty about future production and
prices. We are currently assessing MMS's estimates of royalty
relief costs in light of two years worth of additional
production data and several other variables, including changing
oil and gas prices, revised estimates of the amount of oil and
gas that these leases are expected to produce, the availability
of deep water rigs to drill untested leases, and the present
value of these royalty payments. In addition, any loss in
royalty revenues may be partially mitigated by the potential
benefits of royalty relief, such as increased production or
increased fees that companies are willing to pay the federal
government to acquire these leases.
Additional royalty relief, potentially affecting future
federal royalty collection, is offered under other programs and
legislation. More specifically, royalty relief can be provided
under two existing authorities: (1) the Secretary of the
Interior's discretionary authority and (2) the Energy Policy
Act of 2005. MMS currently administers several royalty relief
programs in the Gulf of Mexico under discretionary authority
provided by the 1978 amendments to the Outer Continental Shelf
Lands Act of 1953. These programs largely address royalty
relief for certain leases issued in deep waters after 2000,
certain deep gas wells drilled in shallow waters, and wells
nearing the end of their productive lives. In addition, the
Congress authorized additional royalty relief under provisions
of the Energy Policy Act of 2005. Certain provisions in the
Energy Policy Act of 2005 are similar to those in DWRRA in that
they mandate royalty relief for leases issued in the Gulf of
Mexico during the five years following the act's passage. The
Energy Policy Act of 2005 also extends royalty relief to gas
produced in the Gulf of Mexico from certain new wells that
previously would not have qualified for royalty relief. Other
provisions in the act address royalty relief in areas of Alaska
where there currently is little or no production.
background
The Department of the Interior (Interior), created by the Congress
in 1849, oversees and manages the nation's publicly owned natural
resources, including parks, wildlife habitat, and crude oil and natural
gas resources on over 500 million acres onshore and in the waters of
the Outer Continental Shelf. In this capacity, Interior is authorized
to lease federal oil and gas resources and to collect the royalties
associated with their production. Onshore, Interior's Bureau of Land
Management is responsible for leasing federal oil and natural gas
resources, whereas offshore, MMS has leasing authority. To lease lands
or waters for oil and gas exploration, companies generally must first
pay the federal government a sum of money that is determined through a
competitive auction. This money is called a bonus bid. After the lease
is awarded and production begins, the companies must also pay royalties
to MMS based on a percentage of the cash value of the oil and natural
gas produced and sold.\4\ Royalty rates for onshore leases are
generally 12 and a half percent whereas offshore, they range from 12
and a half percent for water depths greater than 400 meters to 16 and
two-thirds percent for water depths less than 400 meters. However, the
Secretary of the Interior recently announced plans to raise the royalty
rate to 16 and two-thirds percent for most future leases issued in
waters deeper than 400 meters. MMS also has the option of taking a
percentage of the actual oil and natural gas produced, referred to as
``taking royalties in kind,'' and selling it themselves or using it for
other purposes, such as filling the nation's Strategic Petroleum
Reserve.
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\4\Specifically, royalties are computed as a percentage of the
monies received from the sale of oil and gas, with the total federal
royalty revenue equal to the volume sold multiplied by the sales price
multiplied by the royalty rate.
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the deep water royalty relief act will likely cost the federal
government billions of dollars in forgone royalty revenues, but precise
estimates remain elusive
Based on our work to date, the Deep Water Royalty Relief Act
(DWRRA) will likely cost the federal government billions of dollars in
forgone royalties, but precise estimates of the costs are not possible
at this time for several reasons. First, the failure of MMS to include
price thresholds in the 1998 and 1999 leases and current attempts to
renegotiate these leases has created uncertainty about which leases
will ultimately receive relief. Second, a recent lawsuit is questioning
whether MMS has the authority to set price thresholds for the leases
issue from 1996 through 2000. The outcome of this litigation could
dramatically affect the amount of forgone revenues. Finally, assessing
the ultimate fiscal impact of royalty relief is an inherently complex
task, involving uncertainty about future production and prices. In
October 2004, MMS preliminarily estimated that the total costs of
royalty relief for deep water leases issued under the act could be as
high as $80 billion, depending on which leases ultimately received
relief. MMS made assumptions about several conditions when generating
this estimate and these assumptions need to be updated in 2007 to more
accurately portray potential losses. In addition, the costs of forgone
royalties need to be measured against any potential benefits of royalty
relief, including accelerated drilling and production of oil and gas
resources, increased oil and gas production, and increased fees that
companies are willing to pay through bonus bids for these leases.
Implementing Royalty Relief Has Been Problematic and Resulted in
Unanticipated Costs
The Congress passed DWRRA in 1995, when oil and gas prices were low
and production was declining both onshore and in the shallow waters of
the Gulf of Mexico. The act contains provisions to encourage the
exploration and development of oil and gas resources in waters deeper
than 200 meters lying largely in the western and central planning areas
of the Gulf of Mexico. The act mandates that royalty relief apply to
leases issued in these waters during the five years following the act's
passage--from November 28, 1995 through November 28, 2000.
As a safeguard against giving away all royalties, two mechanisms
are commonly used to ensure that royalty relief is limited and
available only under certain conditions. The first mechanism limits
royalty relief to specified volumes of oil and gas production called
``royalty suspension volumes,'' which are dependent upon water depth.
Royalty suspension volumes establish production thresholds above which
royalty relief no longer applies. That is, once total production for a
lease reaches the suspension volume, the lessee must begin paying
royalties. Royalty suspension volumes are expressed in barrels of oil
equivalent, which is a term that allows oil and gas companies to
combine oil and gas volumes into a single measure, based on the
relative amounts of energy they contain.\5\ The royalty suspension
volumes applicable under DWRRA are as follows: (1) not less than 17.5
million barrels of oil equivalent for leases in waters of 200 to 400
meters, (2) not less than 52.5 million barrels of oil equivalent for
leases in waters of 400 to 800 meters, and (3) not less than 87.5
million barrels of oil equivalent for leases in waters greater than 800
meters. Hence, there are incentives to drill in increasingly deeper
waters. Before 1994, companies drilled few wells in waters deeper than
500 meters. MMS attributes additional leasing and drilling in deep
waters to the passage of these incentives but also cites other factors
for increased activity, including improved three-dimensional seismic
surveys, some key deep water discoveries, high deep water production
rates, and the evolution of deep water development technology.
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\5\ One barrel of oil equals one barrel of oil equivalent. One
thousand cubic feet of gas (mcf) is converted to barrels of oil
equivalent by dividing it by 5.62.
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After the passage of DWRRA, uncertainty existed as to how royalty
suspension volumes would apply. Interior officials employed with the
department when DWRRA was passed said that they recommended to the
Congress that the act should state that royalty suspension volumes
apply to the production volume from an entire field. However, oil and
gas companies paying royalties under the act interpreted the royalty
suspension volumes as applying to individual leases within a field.
This is important because an oil and gas field commonly consists of
more than one lease, meaning that if royalty suspension volumes are set
for each lease within a field rather than for the entire field,
companies are likely to owe fewer royalties. For example, if a royalty
suspension volume is based on an entire field composed of three leases,
a company producing oil and gas from a 210 million barrel-oil field
where the royalty suspension volume is set at 100 million would be
obligated to pay royalties on 110 million barrels (210 minus 100).
However, if the same 210-million barrel field had the same suspension
volume of 100 million barrels applied to each of the three leases, and
70 million barrels were produced from each of the three leases, no
royalties would be due because no lease would have exceeded its royalty
suspension volume. After passage of the act, MMS implemented royalty
relief on a field-basis and was sued by the industry. Interior lost the
case in the Fifth Circuit Court of Appeals.\6\ In October 2004, MMS
estimated that this decision will cost the federal government up to $10
billion in forgone future royalty revenues.
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\6\ Santa Fe Snyder Corp. v. Norton, 385 F.3d 884 (5th Cir. 2004).
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A second mechanism that can be used to limit royalty relief and
safeguard against giving away all royalties is the price threshold. A
price threshold is the price of oil or gas above which royalty relief
no longer applies. Hence, royalty relief is allowed only so long as oil
and gas prices remain below a certain specified price. At the time of
the passage of DWRRA, oil and gas prices were low--West Texas
Intermediate, a key benchmark for domestic oil, was about $18 per
barrel, and the average U.S. wellhead price for natural gas was about
$1.60 per million British thermal units. In an attempt to balance the
desire to encourage production and ensure a fair return to the American
people, MMS relied on a provision in the act which states that
royalties may be suspended based on the price of production from the
lease. MMS then established price thresholds of $28 per barrel for oil
and $3.50 per million British thermal units for gas, with adjustments
each year since 1994 for inflation, that were to be applied to leases
issued under DWRRA.
As with the application of royalty suspension volumes, problems
arose with the application of these price thresholds. From 1996 through
2000--the five years after passage of DWRRA--MMS issued 3,401 leases
under authority of the act. MMS included price thresholds in 2,370
leases issued in 1996, 1997, and 2000 but did not include price
thresholds in 1,031 leases issued in 1998 and 1999. This failure to
include price thresholds has been the subject of congressional hearings
and investigations by Interior's Office of the Inspector General. In
October 2004, MMS estimated that the cost of not including price
thresholds on the 1998 and 1999 leases could be as high as $10 billion.
MMS also estimated that through 2006, about $1 billion had already been
lost. To stem further losses, MMS is currently attempting to
renegotiate the leases issued in 1998 and 1999 with the oil and gas
companies that hold them. To date, MMS has announced successful
negotiations with five of the companies holding these leases and has
either not negotiated or not successfully negotiated with 50 other
companies.
In addition to forgone royalty revenues from leases issued in 1998
and 1999, leases issued under DWRRA in the other three years--1996,
1997, and 2000--are subject to losing royalty revenues due to legal
challenges regarding price thresholds. In 2006, Kerr McGee Corporation
sued MMS over the application of price thresholds to leases issued
between November 28, 1995 and November 28, 2000, claiming that the act
did not authorize Interior to apply price thresholds to those
leases.\7\ MMS estimated in October 2004 that if price thresholds are
disallowed for the leases it issued in 1996, 1997, and 2000, an
additional $60 billion in royalty revenue could be lost.
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\7\ Kerr-McGee (Andarko) suit 3/17/06, W.Dist. LA, CV06-0439LC.
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Assessing the Fiscal Impact of Royalty Relief Is Inherently Complex
Trying to predict the fiscal impacts of royalty relief is a complex
and time-consuming task involving considerable uncertainty. We reviewed
MMS's 2004 estimates and concluded that they had followed standard
engineering and financial practices and had generated the estimates in
good faith. However, any analysis of forgone royalties involves
estimating how much oil and gas will be produced in the future, when it
will be produced, and at what prices. While there are standard
engineering techniques for predicting oil and gas volumes that will
eventually be recovered from a lease that is already producing, there
is always some level of uncertainty involved. Predicting how much oil
and gas will be recovered from leases that are capable of producing but
not yet connected to production infrastructure is more challenging but
certainly possible. Predicting production from leases not yet drilled
is the most challenging aspect of such an analysis, but there are
standard geological, engineering, and statistical methods that can shed
light on what reasonably could be expected from the inventory of 1996
through 2000 leases. Overall, the volume of oil and gas that will
ultimately be produced is highly dependent upon price and technology,
with higher prices and better technology inducing greater exploration,
and ultimately production, from the remaining leases. Future oil
prices, however, are highly uncertain, as witnessed by the rapidly
increasing oil and gas prices over the past several years. It is
therefore prudent to assess anticipated royalty losses using a range of
oil and gas prices rather than a single assumed price, as was used in
the MMS estimate.
Given the degree of uncertainty in predicting future royalty
revenues from deepwater oil and gas leases, we are using current data
to carefully examine MMS's 2004 estimate that up to $80 billion in
future royalty revenues could be lost. There are now two additional
years of production data for these leases, which will greatly improve
the accuracy of estimating future production and its timing. We are
also examining the impact of several variables, including changing oil
and gas prices, revised estimates of the amount of oil and gas that
these leases were originally expected to produce, the availability of
deep water rigs to drill untested leases, and the present value of
royalty payments.
To fully evaluate the impacts of royalty relief, one must consider
the potential benefits in addition to the costs of lost royalty
revenue. For example, a potential benefit of royalty relief is that it
may encourage oil and gas exploration that might not otherwise occur.
Successful exploration could result in the production of additional oil
and gas, which would benefit the country by increasing domestic
supplies and creating employment. While GAO has not assessed the
potential benefits of royalty relief, others have, including the
Congressional Budget Office (CBO) in 1994, and consultants under
contract with MMS in 2004.\8\ The CBO analysis was theoretical and
forward-looking and concluded that the likely impact of royalty relief
on new production would be very small and that the overall impact on
federal royalty revenues was also likely to be small. However, CBO
cautioned that the government could experience significant net losses
if royalty relief was granted on leases that would have produced
without the relief. The consultant's 2004 study stated that potential
benefits could include increases in the number of leases sold,
increases in the number of wells drilled and fields discovered, and
increases in bonus bids the amount of money that companies are willing
to pay the federal government for acquiring leases. However, questions
remain about the extent to which such benefits would offset the cost of
lost royalty revenues.
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\8\ Waiving Royalties for Producers of Oil and Gas from Deep
Waters, Congressional Budget Office, May 1994. Effects of Royalty
Incentives for Gulf of Mexico Oil and Gas Leases, P.K. Ashton, L.O.
Upton III, and M.H. Rothkopf, under Contract No. 0103CT71722, U.S.
Department of the Interior, Minerals Management Service, Economics
Division, Herndon, VA, OCS Study 2004-077.
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additional programs and legislation authorize royalty relief,
potentially affecting future federal royalty collection
Although leases are no longer issued under the Deep Water Royalty
Relief Act of 1995, royalty relief can be provided under two existing
authorities: (1) the Secretary of the Interior's discretionary
authority and (2) the Energy Policy Act of 2005. The Outer Continental
Shelf Lands Act of 1953, as amended, granted the Secretary of the
Interior the discretionary authority to reduce or eliminate royalties
for leases issued in the Gulf of Mexico in order to promote increased
production. The Secretary's exercising of this authority can
effectively relieve the oil and gas producer from paying royalties. MMS
administers several royalty relief programs in the Gulf of Mexico under
this discretionary authority. MMS intends for these discretionary
programs to provide royalty relief for leases in deep waters that were
issued after 2000, deep gas wells located in shallow waters, wells
nearing the end of their productive lives, and special cases not
covered by other programs. The Congress also authorized additional
royalty relief under the Energy Policy Act of 2005, which mandates
relief for leases issued in the Gulf of Mexico during the five years
following the act's passage, provides relief for some wells that would
not have previously qualified for royalty relief, and addresses relief
in certain areas of Alaska.
MMS Currently Administers Royalty Relief Using Discretionary Authority
Under discretionary authority, MMS administers a deep-water royalty
relief program for leases that it issued after 2000. This program is
similar to the program that DWRRA mandated for leases issued during the
five years following its passage (1996 through 2000) in that royalty
relief is dependent upon water depth and applicable royalty suspension
volumes. However, this current program is implemented solely under the
discretion of MMS on a sale-by-sale basis. Unlike under DWRRA, the
price thresholds and the water depths to which royalty relief applies
vary somewhat by lease sale. For example, price thresholds for leases
issued in 2001 were $28 per barrel for oil and $3.50 per million
British thermal units for natural gas, with adjustments for inflation
since 2000. As of March 2006, MMS reported that it issued 1,897 leases
with royalty relief under this discretionary authority, but only 9 of
these leases were producing.
To encourage the drilling of deep gas wells in the shallow waters
of the Gulf of Mexico, MMS implements another program, the ``deep gas
in shallow water'' program, under final regulations it promulgated in
January 2004. MMS initiated this program to encourage additional
production after noting that gas production had been steadily declining
since 1997. To qualify for royalty relief, wells must be drilled in
less than 200 meters of water and must produce gas from intervals below
15,000 feet. The program exempts from royalties from 15 to 25 billion
cubic feet of gas per well. According to MMS's analysis, these gas
volumes approximate the smallest reservoirs that could be economically
developed without the benefit of an existing platform and under full
royalty rates. In 2001, MMS reported that the average size of 95
percent of the gas reservoirs below 15,000 feet was 15.7 billion cubic
feet, effectively making nearly all of this production exempt from
royalties had it been eligible for royalty relief at that time.\9\ This
program also specifies a price threshold for natural gas of $9.91 per
million British thermal units in 2006, substantially exceeding the
average NYMEX futures price of $6.98 for 2006, and ensuring that all
gas production is exempt from royalties in 2006.
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\9\ The average of the other 5 percent was 105 billion cubic feet,
and these reservoirs are within the highly productive Norphlet Trend.
---------------------------------------------------------------------------
Finally, MMS administers two additional royalty relief programs in
the Gulf of Mexico under its discretionary authority. One program
applies to leases nearing the end of their productive lives. MMS
intends that its provisions will encourage the production of low
volumes of oil and gas that would not be economical without royalty
relief. Lessees must apply for this program under existing regulations.
MMS administers another program for special situations not covered by
the other programs. Lessees who believe that other more formal programs
do not provide adequate encouragement to increase production or
development can request royalty relief by making their case and
submitting the appropriate data. As of March 2006, no leases were
receiving royalty relief under the ``end of productive life,'' and only
three leases were receiving royalty relief under the ``special
situations'' programs.
The Energy Policy Act of 2005 Authorizes Additional Royalty Relief
The Congress authorized additional royalty relief under the Energy
Policy Act of 2005. Royalty relief provisions are contained in three
specific sections of the act, which in effect: (1) mandate royalty
relief for deep water leases sold in the Gulf of Mexico during the five
years following passage of the act, (2) extend royalty relief in the
Gulf of Mexico to deep gas produced in waters of more than 200 meters
and less than 400 meters, and (3) specify that royalty relief also
applies to certain areas off the shore of Alaska. In the first two
situations, the act specifies the amount of oil and/or gas production
that would qualify for royalty relief and provides that the Secretary
may make royalty relief dependent upon market prices.
Section 345 of the Energy Policy Act of 2005 mandates royalty
relief for leases located in deep waters in the central and western
Gulf of Mexico sold during the five years after the act's passage.
Similar to provisions in DWRRA, specific amounts of oil and gas are
exempt from royalties due to royalty suspension volumes corresponding
to the depth of water in which the leases are located. However,
production volumes are smaller than those authorized under DWRRA, and
this specific section of the Energy Policy Act clearly states that the
Secretary may place limitations on royalty relief based on market
prices. For the three sales that MMS conducted since the passage of the
act, MMS included prices thresholds establishing the prices above which
royalty relief would no longer apply. These price thresholds were $39
per barrel for oil and $6.50 per million British thermal units for gas,
adjusted upward for inflation that has occurred since 2004. The
royalty-free amounts, referred to as royalty suspension volumes, are as
follows: 5 million barrels of oil equivalent per lease between 400 and
800 meters; 9 million barrels of oil equivalent per lease between 800
and 1,600 meters; 12 million barrels of oil equivalent per lease
between 1,600 and 2,000 meters; and 16 million barrels of oil
equivalent per lease in water greater than 2,000 meters. MMS has
already issued 1,105 leases under this section of the act.
Section 344 of the Energy Policy Act of 2005 contains provisions
that authorize royalty relief for deep gas wells in additional waters
of the Gulf of Mexico that effectively expands the existing royalty-
relief program for ``deep gas in shallow water'' that MMS administers
under pre-existing regulations. The existing program has now expanded
from waters less than 200 meters to waters less than 400 meters. A
provision within the act exempts from royalties gas that is produced
from intervals in a well below 15,000 feet so long as the well is
located in waters of the specified depth. Although the act does not
specifically cite the amount of gas to be exempt from royalties, it
provides that this amount should not be less than the existing program,
which currently ranges from 15 to 25 billion cubic feet. The act also
contains an additional incentive that could encourage deeper drilling--
royalty relief is authorized on not less than 35 billion cubic feet of
gas produced from intervals in wells greater than 20,000 feet deep. The
act also states that the Secretary may place limitations on royalty
relief based on market prices.
Finally, the Energy Policy Act of 2005 contains provisions
addressing royalty relief in Alaska that MMS is already providing.
Section 346 of the act amends the Outer Continental Shelf Lands Act of
1953 by authorizing royalty relief for oil and gas produced off the
shore of Alaska. MMS has previously included royalty relief provisions
within notices for sales in the Beaufort Sea of Alaska in 2003 and
2005. All of these sales offered royalty relief for anywhere from 10
million to 45 million barrels of oil, depending on the size of the
lease and the depth of water. Whether leases will be eligible for
royalty relief and the amount of this royalty relief is also dependent
on the price of oil. There currently is no production in the Beaufort
Sea. Although there have been no sales to date under this provision of
the act, MMS is proposing royalty relief for a sale in the Beaufort Sea
in 2007. Section 347 of the Energy Policy Act also states that the
Secretary may reduce the royalty on leases within the Naval Petroleum
Reserve of Alaska in order to encourage the greatest ultimate recovery
of oil or gas or in the interest of conservation. Although this
authority already exists under the Naval Petroleum Reserves Production
Act of 1976, as amended, the Secretary must now consult with the State
of Alaska, the North Slope Borough, and any Regional Corporation whose
lands may be affected.
conclusions
In order to meet U.S. energy demands, environmentally responsible
development of our nation's oil and gas resources should be part of any
national energy plan. Development, however, should not mean that the
American people forgo a reasonable rate of return for the extraction
and sale of these resources, especially in light of the current and
long-range fiscal challenges facing our nation, high oil and gas
prices, and record industry profits. Striking a balance between
encouraging domestic production in order to meet the nation's
increasing energy needs and ensuring a fair rate of return for the
American people will be challenging. Given the record of legal
challenges and mistakes made in implementing royalty relief to date, we
believe this balance must be struck in careful consideration of both
the costs and benefits of all royalty relief. As the Congress continues
its oversight of these important issues, GAO looks forward to
supporting its efforts with additional information and analysis on
royalty relief and related issues.
Mr. Chairman, this concludes my prepared statement. I would be
pleased to respond to any questions that you or other Members of the
Committee may have at this time.
The Chairman. Thank you very much. Our third and final
witness today is the Honorable C. Stephen Allred, who is the
Assistant Secretary for Land and Minerals Management at the
Department of the Interior. We appreciate you being here very
much.
STATEMENT OF C. STEPHEN ALLRED, ASSISTANT SECRETARY, LAND AND
MINERALS MANAGEMENT, DEPARTMENT OF THE INTERIOR
Mr. Allred. Thank you very much, Mr. Chairman, Senator
Domenici and members of the committee. I appreciate the
opportunity to visit with you today about these issues. I
believe that our government institution employees must always
act to protect the public interest of the United States and as
well, must be perceived that we are doing so. The controversies
that we are discussing here today, whether in fact or
perception, damage that image to the detriment of all of us.
You have the report of the Inspector General in front of
you and that information will be interpreted by different
individuals in different ways. However, what I want to do in
the next couple of minutes, to allow you the maximum time for
questions, is to tell you what the Secretary and I are doing to
deal with these issues that are the subject of this hearing.
After the Senate confirmed me as Assistant Secretary some
3\1/2\ months ago, which sometimes seems like a lifetime,
Secretary Kempthorne asked me to review the issues involving
the Minerals Management Service. As you know, he places great
importance on the Department, its agencies and its employees
acting in a highly ethical manner, again both in fact and
perception.
With regard to the first issue that Mr. Devaney discussed,
as to whether or not MMS is collecting the full amount of oil
and gas revenues, which are due the United States, the States
and the Tribes, I have reviewed the Inspector General's report.
I have traveled to the Minerals Management Service's Denver
Operation Center where these activities take place and have
been thoroughly briefed on their royalty collection processes.
We are forming a high-level review panel to look at those
processes and procedures. We hope to announce that very
quickly. Based on my review, however, I believe that we are
collecting the revenues that are due to the United States, the
States and the Tribes. As with any large organization with
complex operations, there are many opportunities to improve
those operations. The Inspector General's recommendations and
those of the review panel will give us the opportunity to
continue to do so.
Regarding the price threshold issue in the 1998 and 1999
leases, we have just started to review the voluminous report
that the Inspector General has provided to us. As we begin to
understand and review the information contained in the report,
we will take further steps regarding this issue. It is
important, as many of you have said, to understand that this
issue occurred in 1998 and 1999. Since 2001, this
administration has made sure that price thresholds have been
included as part of any royalty relief granted under the Deep
Water Royalty Relief Act that you have passed.
I have discussed this issue with the companies who hold
these leases and in those discussions, I have three guiding
principles. The first, there is a valid contract between the
United States and the companies. Second, my goal has been to
focus on the greatest amount of royalties available, those
which will be derived from future production and third, I have
sought to minimize to the extent possible, the opportunities
for legal challenges to the processes that we will follow.
As you are aware, we have been successful in negotiating
for future royalties with six companies. We are continuing
discussions with the companies but I believe that we will not
make further progress until Congress has defined the role that
it chooses to play in this issue.
The Inspector General has discussed ongoing investigations
regarding employees in the Denver office. I want to very
briefly address this issue. The Director of the Minerals
Management Service asked the Inspector General to investigate
this matter. The Director, with my concurrence, removed those
subject employees from positions that they held and placed them
in less sensitive positions for the duration of the
investigation. I have looked at this issue and subject to
forthcoming information from the Inspector General, I do not
believe that these issues involve the royalty program itself.
The Director of MMS has also recently taken action in a
separate incident at another location, to terminate an employee
who failed to follow the agency's ethics rules.
I assure you that the Secretary and I take these issues
very seriously. We will demand that our employees conduct
themselves according to the highest ethical standards and we
will hold individuals accountable when they fail to do so. I
also believe, based on my experience in the Interior so far,
that our agencies and employees are serving the public well. I
intend to make sure that we continue to do so and improve upon
that.
Mr. Chairman, we've submitted testimony for the record and
I'd be most happy to answer questions from the panel.
[The prepared statement of Mr. Allred follows:]
Prepared Statement of C. Stephen Allred, Assistant Secretary, Land and
Minerals Management, Department of the Interior
Mr. Chairman, thank you for the opportunity to appear here today to
discuss with you the Department of the Interior's role in managing
energy production on the Outer Continental Shelf and revenue from all
Federal and Indian mineral leases. I know this Committee has been
instrumental in shaping our domestic energy program, particularly with
regard to encouraging environmentally sound development of our domestic
oil and gas resources on the Outer Continental Shelf.
The Department and its agencies, including the Minerals Management
Service (MMS), serve the public through careful stewardship of our
nation's natural resources. The Department also plays an important role
in domestic energy development. One third of all energy produced in the
United States comes from resources managed by the Interior Department.
As energy demand continues to increase, these resources are all the
more important to our national security and to our economy. The Energy
Information Administration estimates that, despite increased
efficiencies and conservation, over the next 20 years energy
consumption is expected to grow more than 25 percent. Even with more
renewable energy production expected, oil and natural gas will continue
to account for a majority of energy use through 2030. Interior's
domestic energy programs, particularly offshore oil and gas production,
will remain vital to our national energy portfolio for some time to
come, as evidenced in Figure A attached at the end of my statement.*
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* Figures A-D have been retained in committee files.
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Since assuming the duties of Assistant Secretary of Land and
Minerals Management three months ago, I have developed a deeper
appreciation for the complexities involved in managing federal energy
production. I also am committed to ensuring we provide an accurate and
transparent accounting of the revenue this production generates for the
American people.
At the direction of Secretary Kempthorne, two important topics have
been my major focus over the past three months--the deep water leases
issued without price thresholds for royalty relief in 1998 and 1999,
and the management of royalty revenues.
I would like to begin by providing some background on MMS's role in
Federal energy production and revenue collection. I then will discuss
in greater detail the two primary issues I am focusing on with MMS.
mms background
The MMS has two significant missions: managing access to offshore
federal energy resources and managing revenues generated by federal and
Indian mineral leases, on and offshore. Both of these functions are
important to the nation's economic health and are key to meeting the
nation's energy needs.
The Federal Outer Continental Shelf (OCS) covers 1.76 billion acres
and is a major source of crude oil and natural gas for the domestic
market. In fact, according to the Energy Information Administration, if
the Federal OCS were treated as a separate country, it would rank among
the top five nations in the world in terms of the amount of crude oil
and second in natural gas it supplies for annual U.S. consumption.\1\
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\1\ EIA U.S. Imports by Country of Origin, 12-21-2006.
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Since 1982, MMS has overseen OCS production of 9.6 billion barrels
of oil and more than 109 trillion cubic feet of natural gas.
During that time, OCS leasing increased by 200 percent and since
1994, OCS oil production has increased by 63 percent. According to
MMS's calculations, within the next 5 years, offshore production will
likely account for more than 40 percent of oil and 20 percent of U.S.
natural gas production, primarily due to deep water discoveries in the
Gulf of Mexico.
Attached Figure B shows the Energy Information Administration's
2007 forecast for total domestic oil and gas production and illustrates
what the significance of the OCS contribution is to the Nation's energy
security.
To support increased production offshore, MMS's Proposed 5-Year OCS
Oil and Gas Leasing Program for 2007-2012 calls for a total of 21 lease
sales.
We are closer to achieving the goals of this proposed program since
the President last week modified a Presidential withdrawal in order to
allow leasing in two areas previously closed--the North Aleutian Basin
in Alaska and an area in the central Gulf of Mexico. The President
modified the leasing status of these two areas in response to
congressional action and the request of Alaska State leaders. In
addition, this Administration has increased the royalty rate from 12.5
percent to 16.7 percent for any new deep water leases offered in the
Gulf of Mexico.
In implementing the mandates of the Gulf of Mexico Energy Security
Act, MMS will offer deep-water acreage in the ``181 South'' area and in
a portion of the Sale 181 area remaining in the Eastern Gulf of Mexico.
Our analysis indicates that implementing the new program would
result in a mean estimate of an additional 10 billion barrels of oil,
45 trillion cubic feet of gas, and $170 billion in net benefits for the
nation over a 40-year time span.
In addition to providing and managing access to the OCS, MMS
administers and enforces the financial terms for all Federal mineral
leases, both onshore and offshore and on Indian lands.
These activities have generated an average of more than $8 billion
in revenue per year over the past five years, representing one of the
largest sources of non-tax revenue to the Federal Government. (In FY
2006, $12.6 billion was collected, and 60 percent of that was from
offshore activities).
Since 1982, the MMS has distributed approximately $164.9 billion to
Federal, State, and Indian accounts and special funds, including
approximately:
$101.1 billion to the General Fund of the U.S. Treasury;
$20.4 billion to 38 states;
$5.2 billion to the Department's Office of Trust Funds
Management on behalf of 41 Indian tribes and 30,000 individual
Indian mineral owners; and
$38.2 billion to the Land and Water Conservation Fund, the
National Historic Preservation Fund, and the Reclamation Fund.
MMS carries out these responsibilities under statutory mandates and
ongoing oversight by Congress, the Government Accountability Office
(GAO) and the Department's Office of Inspector General.
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 and its delegated
independent auditing firm.
1998-1999 ocs leases without price thresholds for royalty relief
Earlier today, the Department's Office of Inspector General
presented its findings on the 1998-1999 deep water leases issued
without price thresholds. The MMS requested this independent review
last year. We appreciate the Inspector General's work and look forward
to further reviewing the report.
The Department of the Interior shares Congress's frustration that
during the previous Administration price thresholds were not included
in the 1998-1999 deep water leases. This Administration has included
price thresholds in all deep water leases it has issued with royalty
relief. The American people own these resources and are entitled to
receive a fair return.
The Deep Water Royalty Relief Act of 1995 required deep water
leases issued from 1996-2000 to include a royalty incentive to allow
companies to produce a set volume of oil and gas before they began
paying royalties. Since enactment, the deep waters of the Gulf of
Mexico have become one of the Nation's most important sources of oil
and natural gas. Price thresholds limit royalty relief when oil and gas
prices are high. Price thresholds were included in leases before 1998
and after 1999. They were not included in the 1998-1999 leases.
This matter has been a focus of mine since I assumed this position
last fall. In an attempt to address the missing price thresholds, we
are now negotiating with companies to obtain agreements to apply price
thresholds to the deep water leases issued in 1998-1999. We are
focusing our negotiations on obtaining the much larger royalty amounts
to be realized from future production, estimated to exceed $9 billion.
To date our progress has included agreements reached in December
2006 with six companies. This is a significant but first step; there is
still much more work to do in reaching agreements with additional
companies.
I have adopted three basic principles to guide my actions in
seeking to resolve this matter. First, our focus will be to negotiate
price thresholds in leases prospectively; second, we will not give
economic advantage to one company over another; and finally, we will
strive to amend these agreements in a way that will minimize litigation
risk.
To achieve these principles, the Administration and the Congress
must work together. We cannot do this alone.
We know that Congress will consider addressing this issue
legislatively. We appreciate Congress's efforts to encourage companies
to come to the negotiating table. However, we must be mindful of
potential unintended consequences. For example, potential new
legislation could conceivably result in litigation. If legislation
addressed future lease sales, and if a judge were to enjoin future
lease issuance for a period of time, the resulting impacts would be
significant. Litigation could take years to resolve. The MMS has
attempted to project what the potential loss of production, revenue and
royalties if lease sales were delayed for a three-year period could
look like.
Attached Figure C shows for example, for a 3-year delay, production
over 10 years would be reduced 1.6 billion barrels of oil equivalent
(boe).
Attached Figure D shows for example, the expected cumulative
revenue decline over a 10 year period of $13 billion for a 3-year
delay.
We all can agree this would not be in the Nation's best interest.
The OCS is a significant supplier of oil and gas. We cannot afford
major delays in offshore energy production due to unintended
consequences.
We look forward to working with Congress on resolving this issue of
national interest.
management of royalty revenue
My second focus is the management of royalty revenue collected from
Federal and Indian mineral leases. In FY 2006, about 2,600 companies
reported and paid royalties totaling $12.6 billion from approximately
27,800 producing Federal and Indian leases.
MMS's mineral revenue processes and procedures are complex and
involve implementing myriad statutory authorities and regulations, as
well as a complex set of case law from over 50 years of administrative
and judicial decisions on Federal royalty matters.
The process begins when companies calculate their payments for
royalties owed the Federal government. Royalties are calculated based
upon four components: the volume of oil and gas produced from the
lease, which is verified by BLM or MMS officials during regular on-site
inspections; the royalty rate, which is specified in the lease
document; the value of the oil and gas as determined by regulations;
and any deductions for the the costs of transporting and/or processing
the oil and gas production, which are also determined by regulations.
Companies are required to report this information and submit their
royalty payments to MMS on a monthly basis.
MMS receives reports and payments from payors and accepts them into
the accounting system, similar to filings with the Internal Revenue
Service. Fundamental accounting processes identify revenue sources, and
funds are distributed to recipients as prescribed by law. Interest is
assessed on late and/or under payments.
MMS's audit and compliance program assesses whether royalty
payments are correct. The types of questions that arise during
compliance activities include whether the company reported and paid its
royalty on the right volume, royalty rate, and value and whether the
company correctly calculated allowable transportation and processing
costs. Findings of underpayments are followed by collection of the
payment plus interest. Enforcement proceedings range from alternative
dispute resolution to orders to pay and penalty actions.
The current compliance strategy uses 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 2006, this
strategy resulted in compliance reviews on $5.8 billion in Federal and
Indian mineral lease revenues, 72.5 percent of total mineral revenues
paid for calendar year 2003.
In recent years, MMS has completed an increased number of audits,
doubling the number of audits in the most recent three-year period over
the previous three years. From 1998-2001, MMS, State, and Tribal
auditors completed 784 audits compared to the 1,572 audits completed
from 2002-2005. This increase is partially the result of the effort in
2005 on the part of MMS to close a significant number of old audits as
a result of a recommendation from an external peer review of our audit
activities. Collections based on audit work fluctuate from year to
year. The apparent reductions in collections resulting from compliance
efforts from 2001 through 2004 stand in contrast with very large
collections in the 1998-2001 period. This anomaly is due to resolution
of numerous lawsuits on undervaluation of crude oil and natural gas
during the 1998-2001 period. The result of the resolution of these
issues was large payments of additional royalties. Because these issues
were resolved, no additional large payments were owed in 2002-2005.
The MMS compliance and enforcement program has generated an annual
average of more than $125 million for each of the last 24 years. In
other words, MMS has collected a total of more than $3 billion dollars
in additional mineral revenues since program inception in 1982.
From FY 2003 through FY 2005, for every dollar spent on compliance
reviews, MMS has collected $3.27. For every dollar spent on audits, MMS
has collected $2.06.
MMS aggressively pursues interest owed on late payments as required
by law. In Fiscal Year 2006, MMS issued over 3,800 late payment
interest bills and collected a net amount of $7 million.
MMS has authority to use civil penalties in situations where
routine compliance efforts have been unsuccessful. During the last 5
years MMS has collected over $23 million in civil penalties resulting
from MRM enforcement actions. So far in FY 2007 MMS has issued over $2
million in civil penalty notices that are now in the administrative
process. When combined with other MMS enforcement actions during the
same time frame, MMS collected a total of 52.4 million.
Last year, the MMS while performing reconciliation of volume
imbalances, promptly identified that the Kerr McGee Oil and Gas
Corporation had underdelivered royalty gas volumes to MMS's Royalty-In-
Kind (RIK) program--at a time of very high gas prices. MMS pursued the
issue and collected $8.1 million--based on these high price periods--to
resolve the issue.
In December, MMS announced that a bill for over $32 million had
been issued to BP America Production Company for additional royalties
and interest due identified through audit work of BP's coalbed methane
production that occurred in the state of New Mexico.
These day-to-day efforts are just part of MMS's normal course of
business. These efforts are not only effective at ensuring compliance,
but also beneficial in bringing the appropriate revenues to the states,
Indians, and the American public.
I would like to emphasize, however, that although this work is
important, our focus is not on numbers of audits or amounts obtained in
collections. The real goal is to increase upfront compliance. We
measure success in having higher levels of upfront compliance so that
companies are making correct payments the first time. Audits act as a
deterrent, but we hope that audits will reveal fewer problems as
companies increase voluntary compliance.
MMS has taken steps to improve compliance rates in order to achieve
this goal. They include the following:
Clearer regulations--MMS has made significant progress in
developing and implementing clearer regulations, eliminating
much uncertainty and ambiguity that previously resulted in
major findings.
RIK--MMS is receiving an increasing percentage of revenues
through its RIK program and has eliminated many valuation
issues for the RIK volumes. During FY2005, for example, MMS
received about one-third of its revenues through RIK.
More effective compliance strategies--Compliance reviews
have allowed MMS to cover more properties than were possible
using audits alone, thereby increasing the deterrent effect.
This increased presence encourages companies to be more
vigilant about proper reporting and payment.
We appreciate the recent report of the Office of Inspector General
concerning the audit and compliance program. The results are similar in
substance to audits I have reviewed in State government or in the
private sector. My experience is that in any organization with such
large and complex operations, I would expect any performance audit to
find opportunities for improvement. MMS has embraced virtually all of
the findings, and has an action plan to address them.
We note the Inspector General's major conclusion that compliance
reviews are a useful tool in our program, and we look forward to
implementing recommendations to further improve our application of
compliance reviews. We submit for the Committee's attention our
``Action Plan to Strengthen Minerals Management Service's Compliance
Program Operations'' which documents improvement actions taken and
planned in this area.
MMS does not work alone in its efforts to ensure the proper
collection of royalties; MMS collaborates with the States and tribes on
our compliance and audit activities. In addition, every three years,
the federal audit function of MMS is peer-reviewed by an outside
independent certified public accounting firm. Most recently, in 2005,
the MMS audit program was found to meet all applicable government
auditing standards. I am also happy to point out that for the past five
years, as part of its annual Chief Financial Officer audit, MMS
consistently has received clean audit opinions from the Office of the
Inspector General and its delegated independent auditing firm.
Having said that, it is also true that MMS continues to look for
ways to improve its programs, practices and performance. We welcome
input from this Committee, the full Congress, the Office of the
Inspector General, GAO and the public.
In response to the recent interest regarding the accuracy and
effectiveness of the MMS's royalty management program, Secretary
Kempthorne and I determined that an independent panel should be
convened to review the procedures and processes surrounding MMS's
management of mineral revenue. We are committed to ensuring our
processes are effective and transparent, and we welcome advice and
counsel.
The new panel will operate as a Subcommittee under the auspices of
the Royalty Policy Committee, an independent advisory board appointed
by the Interior Secretary to advise on royalty management issues and
other mineral-related policies.
The Subcommittee on Royalty Management has been asked to review
prospectively:
The extent to which existing procedures and processes for
reporting and accounting for federal and Indian mineral
revenues are sufficient to ensure that the MMS receives the
correct amount.
The audit, compliance and enforcement procedures and
processes of the MMS to determine if they are adequate to
ensure that mineral companies are complying with existing
statutes, lease terms, and regulations as they pertain to
payment of royalties.
The operations of the Royalty-in-Kind program to ensure that
adequate policies, procedures and controls are in place to
ensure that decisions to take federal oil and gas royalties in
kind result in net benefits to the American people.
The Subcommittee will conduct its review over a six-month period
and then provide its final findings and recommendations to the full
Royalty Policy Committee and the Secretary of the Interior. We will be
happy to share the recommendations with you when they are available.
Members of the Subcommittee will be announced in the near future.
conclusion
In the three months since I was confirmed to this position, I have
been working closely with the MMS to understand the complex processes
associated with accounting for the revenues generated from oil and gas
development on Federal lands, including the Outer Continental Shelf. In
an effort to gain a greater understanding of this work, earlier this
month I traveled to MMS's Denver office where I reviewed the procedures
and controls used to ensure that minerals revenues are properly
reported and accounted for. I also visited offices and reviewed
operations in the Gulf of Mexico Regional Office.
This work is very important and must be undertaken carefully.
Equally important, and very important to Secretary Kempthorne and me,
is that we conduct business with the highest standards of ethics
possible. Making sure we can live up to that standard has been a high
priority of mine. I have stressed, and will continue to stress, our
obligation to conduct ourselves in accordance with the highest ethical
standards and to be accountable for our actions. Moreover, our conduct
must be ethical both in fact as well as in perception.
To summarize my remarks today, I want to reiterate I will continue
to focus on several key areas as I provide oversight to the Minerals
Management Service.
We will issue our 5-year proposed OCS leasing program on time. This
is an important plan that addresses national energy security and
facilitates the development of critical energy resources now and in the
future.
I will continue to seek prospective royalty agreements with the
companies that entered into leases issued in 1998 and 1999 that lack
price thresholds in order to capture the majority of the revenues the
government would have received.
I am pleased at the results of our efforts thus far, but recognize
that there is much more work to be done. I look forward to continuing
to work with you, the members of Congress, to address this important
issue.
In addition, I will continue to work with MMS to review and improve
our royalty management programs. I have every confidence that MMS will
successfully implement appropriate Inspector General's recommendations
and that the review by the soon-to-be finalized royalty policy
subcommittee will provide a fresh perspective on royalty management
issues and challenges.
I welcome your input on all of these initiatives, and I look
forward to working with you.
Mr. Chairman, this concludes my remarks. I would be happy to answer
any questions you have.
The Chairman. Thank you very much. Let me ask a few
questions and then we'll do 7-minute rounds here.
Mr. Devaney, let me first just ask by clarification, you
make reference to a--I think it's a surname process. I think
your testimony says a surname process, which dilutes
responsibility and accountability. This is in connection with
the way that these leases were entered into or managed or
drafted. Could you explain that somewhat? I'm not clear what
you mean by a surname process there.
Mr. Devaney. Mr. Chairman, that's the process by which MMS
sends the documents forward and gets signed off from various
officials within the Department. It tends to be very stove
piped and comes up different stovepipes of MMS and Assistant
Secretary Allred and I have briefly discussed this issue. We're
both concerned, I think, that too many people are involved.
Nobody is being--I'll let Assistant Secretary Allred speak for
himself but my concern is that nobody is actually held
responsible and accountable for the final product that comes
out of Interior, that people are just getting these voluminous
documents, putting their initials on top and passing it on to
the next person and in the case of when it went over, at least
in one case, when it went over to the Solicitor's Office, it
wasn't reviewed as thoroughly as we all might have hoped. So
it's a process that needs fixing. It's some lessons learned
here and I think it can be fixed but it's broken right now.
The Chairman. Does this management plan that you referred
to that is the action plan for correcting the problems, does it
do the job in your view, the MMS Action Plan?
Mr. Devaney. I was pleased with two things. First, I was
pleased with the reception that our recommendations actually
got from Secretary Kempthorne and Assistant Secretary Allred
and I was also pleased that I got so quickly an action plan to
implement those changes. So I am, at this point, very pleased.
The Chairman. To try to just understand, obviously the
mistakes in the drafting of these leases were made in 1998 and
1999. My impression is that in addition to that mistake, it was
a mistake not to go ahead and confront the issue and try to
correct the problem more quickly once it did come to light. Am
I understanding that right? It would seem to me that trying to
get these leases re-negotiated or trying to deal with this
issue has become more and more difficult as time has gone on.
Is that your view of things, Mr. Devaney?
Mr. Devaney. Well, it's extraordinarily difficult to
predict what would have happened had it been confronted head
on. Suffice to say, in hindsight, with the benefit of
hindsight, I would have hoped that the issue would have been
thought about in a much more robust way than it was. I mean,
when it was first identified in 2000 by an analyst down in the
gulf and for some unexplained reason, it never reached the
higher levels of MMS for full discussion. Then in 2004,
similarly, there appeared to be just a casual conversation that
was held that suggested that well, the Solicitor's Office has
already made a decision on this so there is no use talking
about it.
I think, in hindsight, a more--a fuller discussion should
have occurred. I would hope that that would happen today if it
happened again but I have no way of knowing whether that would
have actually resulted in any additional revenues being
collected.
Senator Domenici. Mr. Chairman, could I ask a question?
The Chairman. Sure.
Senator Domenici. You just asked Mr. Devaney when ``it''--
what is the ``it?'' What we are talking about?
Mr. Devaney. I'm sorry, Senator?
Senator Domenici. It--I T. You said--you referred to the
``it''--what is the ``it?'' What is it that is being
considered?
The Chairman. I think it was a mistake----
Mr. Devaney. Oh, that the--excuse me, Senator. I think what
I meant to say was, if that kind of an issue was brought to
management's attention today, I would hope that they would call
the Solicitor himself in, perhaps DOJ in and have a discussion.
Now, the answer might be, we can't do anything about it. But
that is the going back, retrospectively and asking the oil
companies to pay back royalties.
Senator Domenici. Thank you very much.
Mr. Devaney. Sure.
The Chairman. Mr. Gaffigan, you cited the various problems
that you've identified looking forward as far as ability to
collect appropriate royalties and I think I heard you say that
one of the problems is, is that there is no requirement in the
law now for the Secretary to charge a royalty or to impose a
royalty above any threshold--that that's purely discretionary.
Is that what I heard you say?
Mr. Gaffigan. Well, the discretionary authority I was
referring to is that the Secretary does have the discretionary
authority to offer royalty relief, under different programs and
he or she has done so over time, through the MMS and MMS has
administered several different discretionary programs. I think
the major one that they've looked at has sort of extended the
relief in the deep water of the gulf and I think there were
about 1,800 leases potentially, to date, that have had that
kind of relief put on there. And of course, they have put in
thresholds and volume limits using their discretion.
The Chairman. But am I correct in understanding, for
example, in last year's bill, we put a provision in saying that
the Secretary may place limits on royalty relief, not that the
Secretary has to. The Secretary may.
Mr. Gaffigan. Right.
The Chairman. Do you see that as problematic?
Mr. Gaffigan. It just depends in terms of the
implementation. Given our track record of the legal challenges
and such that have come up, I would look closely at how we're
implementing that act. Again, we have not done that. We're not
aware that there are any problems and we do know that in the
implementation of the EPAct, the MMS has put in both price
thresholds and volume limits.
The Chairman. OK. Mr. Allred, let me ask you. What is your
opinion as to the best way forward to try to obtain for the
U.S. taxpayer, a reasonable royalty on the resources that have
been and are continuing to be produced in this outer
continental shelf?
Mr. Allred. Mr. Chairman, members of the committee, I still
think that negotiations between the Government and the
companies is what has to happen. I'm afraid that if there are
other measures taken which would abrogate those contracts, we
will end up with substantial problems going forward in leasing
and developing new oil resources and in the full testimony,
there are some numbers in there in what I call the ``unintended
consequences'' that could involve both drastic reductions in
production and significant loss of revenues to both the U.S.
Government and the States. Now, how do you obtain agreement to
modify those contracts that we currently have? First of all, I
want to point out that six have and these are six--the majority
of them are large companies that we know on an everyday basis.
I believe that we could bring more in and perhaps also solve a
problem by offering some additional incentives that do not
result in monetary losses to the U.S. Government and I would be
glad to work with this committee on some of those ideas.
But I believe that given the right set of circumstances and
the right actions designed to accomplish that by Congress, we
can re-negotiate those agreements and obtain what we need to
do.
The Chairman. My time is up.
Senator Domenici.
Senator Domenici. Sir, the last statement that you made
goes to the heart of the issue. If I heard you right, you said
to the committee here that you thought the best way we could
handle this would be to permit you to negotiate this matter out
and to negotiate the best deal you could with the companies
that have leases during that span and have no threshold on
them, thus they are not paying any royalties. That's what we've
been struggling with all along. What leads you to believe that
they will do that? I tend to have a feeling much like you but
it's just my opinion. Do you have something more than just your
opinion, which would lead you to think that's the way to do it,
that we could just start negotiating? What would we have to do?
Have a resolution saying we urge it? We already adopted a
resolution in a Subcommittee of Interior Appropriations, which
encouraged the negotiations, is that not correct? What else are
you talking about us doing that would give you the latitude to
go negotiate?
Mr. Allred. Mr. Chairman, what I'm suggesting is that
Congress give us additional tools that we do not now have.
Senator Domenici. Like?
Mr. Allred. One, for example, would be to offer for those
who would sign and those who would have had diligence on their
leases, to offer them an extension on the deep water leases
that they have. I think that would be of advantage to them and
of advantage to the United States because as you well
understand, these are very expensive, very difficult
developments to undertake and the 5-year period * that we
currently provide on the leases may not be sufficient to
maximize the results of those leases.
---------------------------------------------------------------------------
* In the Gulf of Mexico, deep water leases have 5 year lease terms
in water depths between 200 and 400 meters, 8 year terms in water
depths between 400 and 800 meters, and 10 year lease terms for leases
in water depths greater than 800 meters.
---------------------------------------------------------------------------
Senator Domenici. First let me back up and commend you on
the work you've done. You have not been there a long time. I
have not heard anyone from the outside looking at your work
that has been anything other than rather laudatory of the way
you do it. I hear Mr. Devaney talking here. He's doing that.
He's nodding affirmatively.
But I'm of the opinion that for those who say why don't we
just go out and cancel the leases--that's kind of acting the
way Hugo would act, the way the Russians would act and it would
not be considering the sanctity of contracts--we'll just decide
that we're going to go pick and choose and cancel these certain
kinds. I believe that would be detrimental over the long run to
the United States. What is your feeling and if you know the
Department's feelings on that, could you tell us?
Mr. Allred. Senator Domenici, with your permission, if I
could show you a couple of graphs that I have, I think perhaps
it will illustrate it as to what we believe the impact would
be, the unintended consequences of any law which could be
challenged in the courts. The first one I'd like to show you is
with regard to the loss of production.
This particular graph shows that with regard to--if we were
to proceed with the next sales which will be this fall and if
we were to be enjoined by a court from issuing leases, this
graph demonstrates our estimate of what might be the foregone
production in a 10-year period from a 3-year delay due to court
action and as you can see here, with regard to production, it
would equal about 1.6 billion barrels of oil equivalent from
that 3-year delay. That is a significant amount of delay in the
production of oil with regard to our energy security.
The second graph I would like to show you is the estimate
of the decline in revenue, again during a 10-year period from a
3-year period of delay in issuing new leases and you will see
there that that is a $13 billion decline during that 10-year
period from what would be an unintended consequence.
I'll only point this out from the standpoint that I think
it is--I think there is an important role here for Congress to
play in solving this. I cannot solve it or the Department
cannot solve it by ourselves. But how we do it is extremely
important, such that we do not get into a situation where the
United States cannot issue new leases. So that's why I'm very
concerned about--we need to do it but we need to be very
concerned about how we do do it.
Senator Domenici. Thank you very much. Thank you, Mr.
Chairman.
The Chairman. Senator Wyden.
Senator Wyden. Thank you. Thank you very much, Mr.
Chairman. Gentlemen, in my view, this oil royalty relief
program has the stench of conflict of interest and incompetence
all over it and every time you think you're at the bottom of
the slump, you seem to come up with more muck.
Let me start with you, if I might, Mr. Allred. I'm looking
at the press release you issued on November 14 of last year.
This was many months after I went to the floor of the Senate
and spent almost 5 hours in one spot, talking about problems
with the program and you announced this new panel that you're
talking about to review this particular program where so much
has gone wrong. And the person named to head the program is a
gentleman named David Deal. I went to his website to look at
his background and let me just read to you from his own website
with respect to his background. He said on his website that he
was centrally involved in all Federal royalty management
rulemaking since 1980. He was the principle author of all
American Petroleum Institute written comments on Federal
royalty rulemaking from 1986 to 2004. He was the principle
author of all inner association oil industry comments from 1996
to 2004 and he was the regular industry spokesman at agency
hearings and workshops. How does it send a message of
independence to put at the head of your new watchdog group,
somebody with that background?
Mr. Allred. Senator Wyden, first of all, I might clarify
that he was not--we did not pick him. He was picked by the
chairman of the Royalty Policy Group, which is a FACA outside
group that advises the agency. He is the person off the Royalty
Policy Group who will have a role in supporting another group,
which is being created under that FACA Committee. I guess I
would urge you to wait and see who the appointees are. I would
hope that when you see those, you will feel very comfortable
with the people who are the co-chairs on that group.
Senator Wyden. I'm just looking at your press release and I
will say, given the fact that this was so touted in November.
Now this was long after we'd been in it that that would have
been an opportunity to show it was a fresh day and it looked
like once again, the foxes were going to be in charge of the
henhouse.
Let me ask one other question of you, Mr. Allred, again
dealing with today's circumstances. It has come to light
recently that Ms. Burton was warned about the leases as early
as 2004. She told a congressional committee she didn't know
about that. Now you all are moving in areas that were
interested in working with you on with respect to re-
negotiating leases but why wasn't any action taken to this date
to hold people accountable for what is now on the record?
Wouldn't you have moved Ms. Burton to another position?
Wouldn't something be done to show that when the people who are
responsible for these mistakes face some consequences?
Mr. Allred. Senator Wyden, first, we have just received
this information, as you have and while I have reviewed the
summary, I have not had an opportunity to go through this in
detail. I have talked with Mr. Devaney about what's in it.
These mistakes that occurred did not occur under her
management. My experience at this point in time with Director
Burton is that I have found her to have the highest integrity
and be a very competent person. I have not seen a reason yet to
make a change in her status.
Senator Wyden. But she knew about the problems as early as
2004 and she told a congressional committee she didn't know
anything about it until 2006. I'm going to see if I can get one
other question, if I might and one for you, Dr. Devaney. As I
understand it, with respect to this audit process, essentially
as of right now, the Government pretty much takes the oil
companies' word for what's really going on. There are these
compliance reviews and that's pretty much where we are as of
today. After all that has come out on this program, we pretty
much take the oil companies' word for what goes on. Is that
correct?
Mr. Devaney. It's more or less of an honor system. There
are checks and balances that take place during the compliance
review process to ensure that the numbers being put forward
are, relatively speaking, industry standards. There also are
some audits being done. So there are audits although as the
chairman pointed out earlier, there are fewer audits today than
there used to be.
Senator Wyden. My time has expired, I think, but my
understanding is with respect to recoveries, the royalties are
really coming in from all of you--the $568 million--you are the
ones bringing in the royalties, isn't that correct?
Mr. Devaney. Well, it is true that in the context of qui
tam investigations that we've done, we've raised that--we've
brought in that kind of----
Senator Wyden. That is the amount that the Department did
not catch that you did. Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Senator Thomas is next.
Senator Thomas. Thank you, Mr. Chairman. I'm glad we're
having this hearing. It certainly is an issue that is very
important to us. I think we ought to get right into the real
issue and that is, why were these thresholds omitted and how
were they omitted and more importantly, now what do we do about
it? Now we seem to be pretty busy from time to time, blaming
some of the current people that are there about it, which
distresses me a little bit but in any event, we need to know
why this took place, we need to know what we can do about it.
We need to know how it can be done. We certainly don't want to
be in the process of breaking contracts. I don't think we want
to be in the process of the Government going back and doing
Venezuelan kinds of things in terms of changing the contracts.
I don't know why we're quite so involved in the personnel
aspect of it, quite frankly but I think Mr. Devaney, it's your
reports that have kind of caused that. You described Johnnie
Burton's management as shockingly cavalier and her reaction to
hearing the Clinton administration as a jaw-dropping example of
bungling. But you refrain from similar language about the
Clinton administration officials who did it in the first place.
Now, the fact is, Johnnie in the meantime, has done something
about it, has gotten six of them going and so how do you
respond to that assessment of management style in this way?
Mr. Devaney. Senator, I was not attributing those remarks
to Johnnie Burton herself. My remarks were not directed towards
Johnnie Burton. My remarks were directed towards--after the
mistake was made in 1998 and 1999. In 2000, the mistake was
discovered by our low level employee down in the gulf and for
some unexplained reason, that mistake was never brought to the
attention of the two former Directors or anybody in Washington.
In 2004, it appears through the e-mails we discovered and from
talking to Johnnie Burton, there was a very brief discussion
about the fact that the omissions had been raised again and the
discussion was very brief and centered around the fact that the
Solicitor's Office had opined that there was nothing that could
be done about it and that was the end of the discussion. Our
remarks were, quite frankly, to be fair in hindsight, I think,
a much more robust discussion should have occurred in which the
Solicitor himself as opposed to a line solicitor, perhaps the
Department of Justice and others came together and discussed
what, if anything, could be done. Now I have no reason to
believe that anything would have changed but I am disappointed
that that conversation did not occur.
Senator Thomas. I guess I was a little interested too, why
the New York Times' writing detailed accounts of your report
before this committee and the American people were given a
chance to review it.
Mr. Devaney. I have no idea how that happened. I was not
happy myself. Quite frankly, the purported remarks did not
reflect my true feelings or my testimony today.
Senator Thomas. I see. In your testimony, you mentioned an
attorney from the Solicitor's Office during the Clinton
administration who admitted that he should have spotted the
mistake but did not. Who was that?
Mr. Devaney. His name is Milo Mason.
Senator Thomas. Do you believe it would have been
productive for Mr. Mason to provide the committee with
testimony?
Mr. Devaney. Mr. Mason did testify on the House side about
this issue in the fall of last year and he probably is somebody
that you might want to hear from.
Senator Thomas. The leases from 1998 and 1999 did not
contain the price threshold but leases issued in 2000 did.
Apparently somebody discovered it and remedied the problem.
Mr. Devaney. Yes. They did. They took care of that.
Senator Thomas. So why are we complaining about 2004 then,
if we took care of the problem--we need to get down to the core
of the problem but all the discussion seems to be about who was
here, who heard what when and frankly, I think I've kind of
observed and I have a little more involvement than most with
Johnnie Burton but I think she's done a great job and she seems
to be getting all the complaints about it when there is no
evidence that that should be the case. At any rate, I hope we
can move on to find some answers to the thing and I appreciate
your interest.
The Chairman. Senator Dorgan.
Senator Dorgan. Mr. Chairman, thank you very much. I regret
I had to go chair another hearing for a brief period and missed
part of the presentation. I've had a chance to read through
your presentations. Let me ask a question--maybe it's already
been asked. What percent of the production that exists on these
disputed leases, disputed contracts--what percent of the
production comes from companies with whom you've now made an
agreement on the price thresholds? Mr. Allred, could you answer
that?
Mr. Allred. Senator Dorgan, it's about 20 percent of what
we believe might be future production. These are estimates.
Senator Dorgan. So about 80 percent, at this point, is
still outside the area that has been settled and would be
producing under circumstances in which there is not a price
threshold?
Mr. Allred. That is correct. There is about--there is 20
percent within these companies. There is another 20 percent
held by one other company and then there is about another 20
percent that are held by what I'll call offshore foreign
companies and then a smattering of others.
Senator Dorgan. Does that 20 percent mean that we are, with
the estimate of $10 to $11 billion that 20 percent of that now
will be recovered and there is a shortfall of perhaps about $8-
plus billion to the American taxpayer? Is that a proper way to
calculate that?
Mr. Allred. Senator, our numbers--about $1.5 billion would
be produced by these new agreements with those six companies.
Senator Dorgan. You know, I don't understand this issue as
well as I should. Some others perhaps do. But I come from a
town of 300 people and if there are businesses on main street
of my home town doing contracts with each other and one
contract is done and there is a major omission by mistake and
the person that is the beneficiary of that omission says, you
know what? That's tough. You've signed it. Tough luck. You're
out of luck. I'm not re-negotiating anything. You know what the
first business would say? That's just fine. Don't come around
here anymore then. Don't show up here if that's the way you're
going to be. You understand it's a mistake. We understand it's
a mistake. This is a windfall for you. If we both understand
it's a mistake and we do and you're not willing to negotiate
and you're not willing to correct this mistake, don't show up
here anymore because you're not going to do business with me
anymore. Why would you not take that position, Mr. Allred? Why
would the Government, why would the Department not at this
point, take that position? Say, you know what? Either you re-
negotiate with us or sorry, Charlie. You're out of luck. We're
not going to do business with you.
Mr. Allred. Senator Dorgan, obviously we have to enforce
the laws that you pass and those laws don't allow us to do
that. Before you were able to get here, we did talk a little
bit about unintended consequences and I can go over that a
little bit or I can brief you separately if you'd like.
Senator Dorgan. I'm sorry--you did, I believe, indicate
that you would like some additional incentives or tools with
which to go to these companies to say, you know what? We need
to redo this because there was a mistake and you want some
tools or incentives. I'm just saying that the best incentive is
to say, you know what? Either you come clean on this. This was
a mistake. We both understand that or don't show up the next
time there is a bid. The next time there is a lease you want to
bid on, don't show up around here. Now, if you don't have the
capability to do that and you need some legal authority to do
that, I'm perfectly happy and I know there will be great
dispute about that, perhaps but I'm perfectly happy to give you
that. But my sense is that the Department has not been as
aggressive as I would prefer to have it. I mean, there is a
legal doctrine called mutual mistake. I don't know whether you
pursue that. Maybe it's a long shot, maybe not. It seems to me
you would be very aggressive and pursue every opportunity you
have to get what we should get here and what was omitted by
mistake in those contracts. The fact is, this is not a perfect
government. Mistakes are made. This one is--I'm sure everybody
up here feels the same frustration. It's unbelievable that
somebody would be involved in contracts like this and make a
mistake that has the consequence of $10 or $11 billion over the
long term but if that's where we find ourselves, then let's try
to figure out how we deal with it and I say, deal with it
aggressively. We've got about 80 percent of the potential
ramification for the Government and therefore the taxpayer is
still laying out there that may never be collected unless we
become more aggressive. How can you become more aggressive?
What tools do you need from us?
Mr. Allred. I have, in a previous discussion, identified
one that I think would be very helpful and it has to do with
creating a reason for companies to sign without giving them a
benefit which would decrease royalties to the United States.
There are probably some other things that we could do as well
and as I have volunteered to the committee, I would very much
like to work with your staffs to develop that suite of tools
that I think could bring the companies to the table. I will say
that I have been aggressive and I'm sure you've heard,
probably, some complaints about how aggressive I've been. I
clearly believe these are contracts that we cannot abrogate but
I think there is a responsibility to re-negotiate them. We have
looked at the mistakes theory and information that while we
still have to look at in detail, based upon the information
that Mr. Devaney has provided to us, it appears that these were
conscious decisions to remove these in 1998 and 1999. I don't
believe they were malicious but they were conscious. That would
make it, as I understand it from our solicitor, very difficult
to argue a mistakes theory.
Senator Dorgan. Mr. Allred, I understand about contracts
sanctity and I understand the concerns others have expressed
about abrogating a contract. On the other hand, this is a
different situation than just abrogating a contract. It is a
contract that was produced by error. Those who are the
beneficiaries of that, I'm sure are smiling all the way to the
bank and will for 10, 20 years. But I think it is our
responsibility to decide that we're going to try to make this
right on behalf of the American taxpayer. The American
taxpayers, at this point, have a significant interest here and
I'm not--boy, I don't think we need a lot of sugar here to lay
out as sweeteners. You need the tools from us. I think we
should give you the tools to say to these companies, you want
to keep bidding? Then own up on this issue to a mutual mistake.
We made it, perhaps, in the agency but everyone understands
it's an omission and a mistake. Own up to it and you're going
to be a partner here and keep bidding. If not, go somewhere
else because we don't need you if that's the way you're going
deal with us. So I hope you will tell us what you need. I think
you have plenty to proceed ahead but if you need more, I'm
perfectly willing to work to get it there because I don't think
we need sweeteners. You just need to say that we're open for
business only for those folks who in good faith understand
they're willing to join us in correcting a very serious mistake
that disadvantages the American people to the tune of $10 or
$11 billion.
Finally, my time is up but I do want to say, Mr. Devaney,
I've read your work extensively and when I chaired the Interior
Appropriations Subcommittee, I read the statements you made
about the Interior Department. I am very concerned about that
as the chairman indicated he was in his statement. All of us
want good government and you keep being aggressive and keep
pushing and keep giving us information we need with which to do
our job as well. I want to thank all three witnesses for coming
today, Mr. Chairman.
The Chairman. Thanks very much.
Senator Craig.
Senator Craig. Well, Mr. Chairman, thank you. I apologize
like my colleague did, a few moments ago for not being here for
your testimony. I was involved elsewhere but I have read a fair
amount of it and I have focused on this issue quite a bit and
Mr. Chairman, thank you for doing the oversight that is clearly
important here, as we deal with, I think, this issue.
I find it interesting that in reading Mr. Devaney's report
and listening to the Secretary that this was not an omission
but a bad decision. Is that something that is a reasonable
conclusion to draw? Either of you?
Mr. Devaney. Sir, I would say it was not a deliberate
omission. It was a mistake.
Senator Craig. Mr. Secretary?
Mr. Allred. Well, I'm depending upon Mr. Devaney's
information but it would appear there was a decision to remove
them, whether that was good or bad. I don't believe it was done
at the--it was not designed to be to the detriment of the
United States but I think it was a decision that either was not
fully understood or was not carried through as it should have
been.
Senator Craig. Therein lies, I think, for any prosecutable
effort a very real frustration if that is the reality of what
we're dealing with here and there is a reality of contracts,
our contracts and they have some degree of sanctity and they
must have in our Nation of laws. At the same time, I am
extremely frustrated that we don't get it corrected and do so
in an appropriate way with the companies involved.
I find it interesting that you had a number of companies--
Marathon, Conoco, Phillips, BP and Shell in December become
very proactive in solving the problem. Then all of the sudden,
it appears to have stopped. Mr. Secretary, is there any reason
for that, from your knowledge and experience now in the
position that might have caused that?
Mr. Allred. Senator Craig, I have an opinion. I don't know
for sure but my opinion is that those companies that have not
signed are waiting to see the role that Congress will play in
this issue.
Senator Craig. That's an interesting opinion because there
is a bit of street talk out there that suggests that that is
exactly what's happening--that companies, more of them, would
be forthcoming to solve this problem but with a new Congress,
in some instances, they are being told, step back. We are going
to legislate this so that we can score it for the budget or in
fact, we will gain political points by muscling this issue
around a bit. If that is happening out there, if that is what
some of us are saying to these companies, shame on us. We ought
to get this problem solved, first of all, voluntarily if we can
and it appears that that was happening at a fairly rapid rate
and a substantial amount of money has been saved as a result of
that in royalties to come and some retrieved. And I would hope,
more to come so I think I join with my ranking member in saying
to the companies involved here, don't wait for the vicissitudes
of Congress or the politics of this issue. Move forward now. I
don't blame the Senator from North Dakota for saying what he
says but there is goodwill and if contracts were negotiated in
good faith--South Dakota, I'm sorry. It's so cold in those two
States right now, I can't tell one from the other. But I don't
blame him for that frustration.
But the major finds of oil in the next decade for our
supply are going to come out of the gulf and there are a
limited number of companies who have the capability to drill in
deep water and bring that production to this country and into
our system. We ought to be working to solve the problem,
enhance the situation and move on. Let me conclude with these
questions, then.
Mr. Secretary, do you believe the audits and compliance
reviews relating to royalty payments should be undertaken by
MMS or another entity?
Mr. Allred. Senator Craig, I think that operation is so
integral into MMS's operations; it would be very difficult to
do it. For example, we monitor the meters--there are MMS
supervised meters on every offshore well on every offshore
gas--both oil and gas that determines the amount of product
that is being produced. We do the analysis of the material
being produced. We collect information with regard to
transportation costs and processing costs. My own personal
viewpoint is that it would be very difficult to separate that
sort of information from the operation of the audit program or
the compliance program. Audit is only part of it. The
compliance, I believe, as Mr. Devaney agrees, is an important
tool that we need.
Senator Craig. Well, do you believe the IG should have a
permanent role in overseeing MMS audit and compliance
activities?
Mr. Allred. Senator Craig, that's not something I've really
thought much about, but my own opinion would be that the reason
to have an Inspector General is to have someone who is in an
oversight role and who does not have a conflict of interest in
reviewing the operations of the agency. My concern would be
that--not specific to the Inspector General but to put any
oversight role into an actual operating process would certainly
lesson the independence of that review.
Senator Craig. OK. My last question, Mr. Chairman. Mr.
Devaney, do you believe that the current budget for the
compliance and assessment management program is adequate?
Mr. Devaney. Senator, we really didn't address that issue.
My sense is they could always use more resources to do that
job. As we've identified in our audit, we believe that it is
the combination of audits and compliance reviews done in a
strategic risk based compliance system that would ensure the
greatest possibility of total oversight and they need the
resources to do that.
Senator Craig. You've answered the question then, I guess
and we will certainly take a look at that as we deal with your
budgets in the coming months to make sure that these tools are
right and that hopefully, mistakes and/or decisions of this
kind are not made in the future. Obviously, it is important
that this be a resource for our government; therefore for our
citizens. At the same time, we want to maintain a solid working
relationship with these companies that do have the capability
to reach out into that deep water and supply us with these
resources and that's only going to happen when those
relationships are legal, stable, transparent, understandable,
and predictable as it relates to production and certainly that
will fit with the costs at hand in dealing with these kinds of
production units. So we thank you very much, Mr. Chairman.
Thank you for our role and responsibility and let me close by
saying, I would hope that the companies who are still out there
waiting, would come forward. If they are waiting for the
politics of this issue to settle and for legislation to come
about, they may wait a while longer. I hope we do act
responsibly here and we don't cause companies to say, this is
no place to do business. More importantly, our government is no
partner in a business relationship. Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Tester, you're next.
Senator Tester. Thank you, Mr. Chairman, a couple of
questions. Mr. Devaney, the audit was publicly released in 2006
and I will follow the other ones--excuse me if this has been
covered and I haven't been here to hear it. But in 1998 and
1999, the offense was committed. When did you start your audit?
Mr. Devaney. We started our audit about a year ago.
Senator Tester. And was that at the direction of this
committee? Or why did you start that audit? Why was it
initiated?
Mr. Devaney. It was a request not only by this committee
but also of a dozen or so individual members of the committee--
members of the Senate and House.
Senator Tester. Is there a normal audit that would catch
this situation? I mean, you talk about the compliance audit. Is
that the only way?
Mr. Devaney. We did an audit in 2003 and looked at the
program. We had some findings that I spoke about in my opening
remarks that have been corrected now and they have gone through
two peer reviews. We periodically drop in on this program. What
I mean by that is, every 3 or 4 years.
Senator Tester. Every 3 or 4 years?
Mr. Devaney. Right.
Senator Tester. Okay, so that would have been 2003?
Mr. Devaney. That was 2003.
Senator Tester. As some of my comrades on this committee
have already stated, hopefully the situation from a business
standpoint will be cleaned up. I can't help to think that if I
was in the business of oil production that I would have known
exactly what the rules were when I went into the contract and
known exactly if I was going to get a good deal that actually
subverted somewhat the rules. So I too, hope it's cleared up.
In your testimony here, you said you don't have any evidence of
a smoking gun or evidence that this omission was deliberate and
then in the next paragraph, it talks about investigations are
going on. Can you tell me how many people are being
investigated?
Mr. Devaney. We're looking at the behavior of perhaps a
dozen.
Senator Tester. A dozen people? Can you tell me if that
investigation includes personal financial benefits?
Mr. Devaney. I'm not prepared to say that today, Senator.
Senator Tester. OK. As many steps as this went through the
bureaucracy, this type of mistake is hard for me to think that
it was a mistake. Now I know you said that it wasn't
deliberate. It may be a question to revolve around. What makes
you think it wasn't deliberate? I mean, I saw at least three
steps here.
Mr. Devaney. We have taken a very close look at the people
involved in this and heard them out and tried to understand the
context in which they were making those decisions. The
organizational components of MMS were in different parts of the
country. There was clearly a communications breakdown. They
were trying to understand themselves, the ramifications of the
Royalty Relief Act. It appears to us at the end of the day that
this was a mistake, a bureaucratic mistake and a very costly
one.
Senator Tester. Point well taken. Was there a reduction in
audit staff force on this or has this been kind of the way
business has been done for the last 10, 15 years as far as the
frequency of the audit?
Mr. Devaney. We're talking about MMS's audit program, not
our audit program in my office but MMS's audit program has had
a slight reduction in auditors and a definite shift in thinking
that they wanted to do more compliance reviews in the belief
that that would allow them to cover a broader range of
companies and leases. Those compliance reviews are not
traditional audits and do not provide as good of coverage as a
traditional audit would provide so they have had a shift in
philosophy by trying to cover a broader range of companies and
leases, to more or less go to this compliance review, which is
sort of a checklist process. It is done from a desk in an
office as opposed to knocking on the door and saying, let us
see your books.
Senator Tester. In your personal opinion, do you think that
there would be a cost benefit ratio if we were able to bump up
not the compliance audit but more of the regular audits like
you are doing?
Mr. Devaney. As I tried to answer the earlier question,
this is a place where investments might be wise because of the
financial ramifications of what we're talking about.
Senator Tester. Thank you very much. Thank you, Mr.
Chairman.
The Chairman. Thank you very much.
Senator Sessions is next.
Senator Sessions. Thank you, Mr. Chairman. It's a very
valuable hearing and important hearing. Mr. Devaney, you have
suggested--said flatly that there was no one to take
responsibility. I assume you mean that was a mindset that
papers just got moved along. But Mr. Allred, somebody had
responsibility when a lease is signed, any lease, particularly
one that involves billions of dollars, who is it? Is it the
Assistant Secretary? Is it the Secretary? Or who?
Mr. Allred. Senator, my belief is that the top management
of the Department is always responsible for----
Senator Sessions. Well, top management. Is that you?
Mr. Allred. That is I and the Secretary.
Senator Sessions. Well, which one of you is ultimately
responsible for signing the lease?
Mr. Allred. We are responsible for the activities of the
agency. Neither I nor the Secretary were here when this
happened.
Senator Sessions. I'm well aware of that. But today, if a
lease is signed, who in this Department is the person
responsible for final approval and authorization of the lease?
Mr. Allred. I and the Secretary.
Senator Sessions. Both of you?
Mr. Allred. Well, I first and then the Secretary.
Senator Sessions. You make a recommendation to the
Secretary?
Mr. Allred. That's correct.
Senator Sessions. And he ultimately signs the lease?
Mr. Allred. The actual signature does not take place at
that level but we are responsible for assuring that that is
done in the manner in which we instruct people to do it.
Senator Sessions. Well, there we go. Now, does the
Secretary himself or herself sign some document to say I
approved the lease?
Mr. Allred. No.
Senator Sessions. Well, then I would say that the Secretary
is not actually deeply involved if they don't make any
signature. Whose signature is required on such a document?
Mr. Allred. The signature on the document itself is
delegated to the Mineral Management Service. The agency--I and
the Secretary--specify what they are to consider and how they
are to do that.
Senator Sessions. Well, first let me just suggest to you,
Mr. Allred, that the legal department doesn't seem to have
functioned well in this. Is that department that reviews these
leases--do they report to you? Are you responsible for their
ultimate effectiveness?
Mr. Allred. The Solicitor's Office does not report to me
but we utilize the services of the Solicitor's Office. There is
a solicitor within the Department of the Interior. It is our
responsibility to make sure that we ask the right questions and
get adequate advice.
Senator Sessions. Mr. Gaffigan, I believe your comments
troubled me. Along that very same line, you said there were a
series of mistakes, vague language that may be as to what the
threshold may be and maybe litigation over that. Of course, the
issue we're confronting here, the thresholds that were not in
that and even Kerr McGee's threat of a lawsuit. Would you say
that in any major Federal agency, you need the best legal
department you can get and when you're dealing with millions,
even tens of billions of dollars, that these are--every word in
these leases and documents must be given the most careful
scrutiny and you need the best legal team available?
Mr. Gaffigan. Given the track record of the legal
challenges in this area and this whole area of royalties has a
whole history of litigation going back to litigation over the
value of royalties and what the sales value is there. So I
would say yes, it's very important that we look at both the
regs and the laws.
Senator Sessions. And Mr. Allred, you say the Congress
needs to help you. Senator Domenici asked exactly what, exactly
how. Are you an attorney and an expert in the legal matters of
leasing and so forth, yourself?
Mr. Allred. Senator, I am not. I am just an engineer.
Senator Sessions. Well, with regard to that then, I think
it is incumbent upon you to get the Solicitor General and the
Secretary of the Interior and when you ask us to do something,
it needs to have been thought through from every possible
angle. That's all I'm saying. We've got to have a higher degree
of responsibility here to make this system work. We don't want
to end up continuing to have lawsuits and vague language that
leads to disagreements.
Mr. Devaney, I have to follow up on this a little bit.
According to your report, the person responsible in 1998, I
guess, for directing the preparation of leases, said he was
told by persons in MMS's economic and leasing divisions, to
take the price threshold language out of the leases. Now you
keep saying that was a mistake. Somebody made a decision to
take that out. Who did it? Was it negotiated with the oil
companies? Did the legal staff review that? Who came up with
this idea to take the language out?
Mr. Devaney. Well, we spent a considerable amount of time
trying to identify the person that told him. He suggested to us
that it was one of three people. We talked to all of those
three people. All three denied that they had told him to take
that out. I will say that my reference to the mistake was that
it's--at the end of our investigation, we believe that the
mistake was that there was an assumption that the Royalty
Relief Act regulations would actually include the price
threshold language when in fact it did not. When the Royalty
Relief Act regulations finally came out, it did not have any
threshold language in it. And up until that time----
Senator Sessions. I'm not arguing with you but your report
here would indicate that this was as to whether this language
was actually going to be incorporated by reference and to do it
in a certain way?
Mr. Devaney. That's right.
Senator Sessions. Not to actually change the policy of
previous leases and to eliminate the threshold.
Mr. Devaney. That's right.
Senator Sessions. And you never discovered any discussions
about actually changing the threshold limit by any policy
makers or lawyers?
Mr. Devaney. No.
Senator Sessions. And Mr. Allred, then therefore, I think
you have a potential--the main thing, mutual mistake. It was
never explicitly discussed, an intention to change it. I'm not
sure that cause of action is gone.
Mr. Allred. Senator, we have not discarded that
opportunity. Congress has asked the Attorney General to provide
an opinion and we look forward to that opinion.
Senator Sessions. I would be curious and will issue some
written questions, Mr. Allred, about the impact that this could
have, for example, on the legislation we passed, the Security
Act of 2005 and the way we have on my home State of Alabama and
other States. I hope you would review that and give us some
information. But I think you need to tell us what you need to
fix this thing and we need to evaluate it and see if we can do
it, consistent with principles of contract law and the
constitution. Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. I was eager to
join with you in asking for the IG's report and I am
appreciative of this hearing today. You know, as I listen to
some of the statements, I'm reminded of the story of lawyers;
when you have the law on your side, you argue the law. When you
have the facts on your side, you argue the facts. And when you
have neither the law nor the facts, you pound on the desk and
you create a diversion. It seems to me that either under the
guise of political intrigue or dire consequences based upon
some calculation of the action of Congress, that we are moving
to a diversion of the real issue here, which is the rip off of
billions of dollars in taxpayers' money.
Now, Mr. Secretary, you were quoted by the New York Times
last month as saying with regards to the royalty program,
``while I think there is a lot of room for improvement, I have
not been able to find anything that's drastically wrong.'' Do
you stand by that assessment today?
Mr. Allred. Senator Menendez, that's correct.
Senator Menendez. Well, I don't understand that. Now here
is a process that has effectively cheated the American
taxpayers, at this point, out of billions of dollars. It
resulted in several criminal investigations, and has auditors
filing their own suits under the Civil False Claims Act because
they claim the Department won't pursue action against oil and
gas companies. Sounds like we're ready for another ``heck of a
job'' comment.
Mr. Allred. Senator, I've looked at all of those and I'd be
glad to respond individually but I do not believe the conduct
of the agency at this point in time is such that it puts the
United States at risk. It can be improved. There is no question
about it.
Senator Menendez. Mr. Devaney, there is nothing drastically
wrong here?
Mr. Devaney. Oh, I think that there is plenty of room for
improvement here.
Senator Menendez. I think that is very charitable. Now I
want to join Senator Wyden in saying to you, Mr. Secretary,
that I have a real concern that the panel to review complaints
and problems with the royalty program is headed by the former
General Counsel for API. There are a great deal of people in
this country who expect the Department of the Interior to act
as the American peoples' watchdogs on this issue and I am
hopeful that you and the Secretary will be making the changes
necessary to restore our trust in your mission. But I'm not
sure that having an API lawyer head an independent royalty
review panel is a step in the right direction in restoring that
trust. So I want to echo Senator Wyden's concerns.
But the most pressing question, of course, is how are we
going to fix the problem that the IG reported on today. The
House has been debating several options and we will have some
of our own ideas but what I want to know is, Director Burton
testified before the House that MMS had met with about ten
companies and I heard you say today, you've actually re-
negotiated with about six of them. So there are four or so that
you are still working with, is that correct?
Mr. Allred. Senator, there is more than that. I've talked
to not all of the leaseholders but probably a majority of the
leaseholders, including the offshore companies.
Senator Menendez. I think she was talking about some of the
major companies. Are there still four major companies that are
outstanding?
Mr. Allred. Probably more than four if you count the
offshore.
Senator Menendez. Is ExxonMobile one of those?
Mr. Allred. Pardon?
Senator Menendez. Is ExxonMobile one that is outstanding?
Mr. Allred. Yes, it is.
Senator Menendez. Well, in the third quarter of 2006,
ExxonMobile reported over $10 billion in profit--in one
quarter. That's the second highest profit of all time, second
to their own record from a year ago. And right now, they and
many others have wildly profitable companies and are taking
advantage of a mistake--a mistake made against the clear intent
of Congress and the Department of the Interior and it seems to
me that we're already contributing billions of dollars to
ExxonMobile at the gas pump as American consumers. It is
outrageous that they are unwilling to re-negotiate. And that is
what jumps at me about this whole issue, the huge disparity
about how we treat the American taxpayer and the multi-national
oil conglomerates.
Mr. Devaney, I believe you recently found that MMS doesn't
have a good way to determine interest payments for companies
that underpay royalties, is that true?
Mr. Devaney. That's an ongoing inquiry we're conducting. It
appears to us that they are collecting interest but not in a
way that we would all hope. It is very slow.
Senator Menendez. Meaning they are not collecting as
comprehensively as they should, as much as they should? What do
you mean?
Mr. Devaney. Well, the collection of interest in the modern
world is done by computer and their computer program is not up
to speed and it's a very slow process to collect this interest.
Senator Menendez. Well, it's interesting. If the average
taxpayer has an amount due, the IRS has no problem in sending
them a notice with penalty, the exact amount that they are
owed, including interest to the very penny. Yet we can't do
that with the oil industry. Ask the American taxpayer if they
think that that's fair.
Now let me ask you with reference to the audits. I
understand, Mr. Secretary, that MMS has cut the number of
auditor positions by over 20 percent since the year 2000 and
reduced the number of audits by roughly 22 percent, and I
believe that the amount of money that the Department has
collected through auditing and compliance has gone from an
average of $115 million per year before 2002 to about $48
million since. Do those numbers sound right to you?
Mr. Allred. Mr. Chairman, I don't have those in front of me
but I know that our opinion with regard to compliance is that
we are seeing more people comply than we did previously. I
think it is because of two reasons. First, the regulations and
our activities are much clearer to people. They understand
better. Second, there were a large number of settlements that
had to do with when we were first implementing the act that
came in the previous time period. We are covering a wider
number both in our audits and in our compliance reviews.
Senator Menendez. Something is going wrong because we have
gone to nearly a third of collections of what we had before
when we had a greater number of auditors.
Mr. Allred. Senator, I would hope that what we're seeing is
people are doing a better job of paying their royalties up
front.
Senator Menendez. Well, I hope that's the case but to be
very honest with you, audits are not the only ways to keep the
companies honest, they are a revenue raiser to the people of
this country, and with the economic situation we find ourselves
in, with the struggle of middle class families in this country,
I think they would find it totally intolerable that they can be
told to a penny what they owe the government and we cannot get
the oil companies to do what is right. Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Senator Murkowski.
Senator Murkowski. Thank you, Mr. Chairman. Very important
hearing this morning and gentlemen, I had really hoped that I
was going to be able to come in here this morning and gain
truly a better sense about how we got to where we are today and
we've heard the discussion around the dais here about it is a
mistake, it is a decision--extremely costly decision for this
country and I have to admit that after listening, I'm not quite
sure whether it was a mistake, or an omission, it sounds like
there was a decision that was made. And it was a very wrong
decision. I come from a State where we negotiate with the oil
companies on a relatively frequent basis and let me tell you,
they have the best and the brightest going over every single
word of every single contract and if we as a State aren't
similarly matched, we know that we get into this ongoing,
endless litigation over royalty and other terms related in that
contract. So the fact that you could have, perhaps vague
language in the Deep Water Royalty Relief Act that might have
suggested that you didn't have to include the language is one
thing but then to know that in the year 2000, just 2 years
afterwards, we went ahead and we did include the provisions
within the leases, if I understand the testimony correctly,
leads me to believe that we caught our mistake in relatively
short order then. We have just failed to do anything about it
for quite some time, which I think is greatly distressing.
Mr. Gaffigan, I guess I'd pose a question to you. We had
this vagueness, if you will, within the Deep Water Royalty
Relief Act and hopefully, we're beyond that now. We know what
it says and what it means and how we can interpret that. But we
also have royalty relief provisions within the OCS Lands Act,
within the Energy Policy Act of 2005. Is there any possibility
that in these two acts, we might have similar problems that
we've either discovered or may discover a few years down the
road? Give me some assurance.
Mr. Gaffigan. I wish I could. The reason we raised the
issue is that there is this relief out there under those two
provisions. Again, we are not aware of any problems but who is
to say, given the track record and how we have consistently
lost cases in this matter that there might be other challenges
out there that we are not aware of. So I would be taking a
good, hard look at all these provisions and not only looking at
the cost benefits of them but also making sure we're sound
because as you say, everyone does take a good, hard look at
these things from a litigation standpoint.
Senator Murkowski. So we in the Congress need to be making
sure that the laws that we are drafting are very, very clear
but from the administration perspective and within the
Department and within the agencies, they too, need to be making
sure that there is no uncertainties.
Mr. Gaffigan. I think everyone shares in that
responsibility.
Senator Murkowski. Let me ask then, I've said that
extremely costly mistake or decision that we are in today,
facing potentially a $10 billion loss and we recognize, if I am
to believe your charts, Secretary Allred here, that the
decisions that we make going forward as a Congress could add
even more loss revenue to this Nation if we do not figure out
how to do it right. So it is not just pointing the finger at
how we got here but we have got an obligation to move very
carefully and make sure that we are acting responsibly as we
figure out what we do next. You have mentioned one possible
tool and that was in terms of additional incentives. You
indicated that perhaps an extension on deep-water leases might
be one way that we can get some of these companies to re-
negotiate. Has this been put in front of them? Have they been
receptive? Do you think that this is going to be a useful tool
for you as you try to re-negotiate some of these?
Mr. Allred. Senator Murkowski, in trying to figure out what
tools we might use, I have had some very preliminary
discussions, being careful not to commit to anything, with some
of the companies and I believe that there are significant
companies who would find that very attractive.
Senator Murkowski. Can I ask you--and I'm going to ask you
to speculate a little, Mr. Allred, on the likelihood of success
on the Kerr McGee suit. I believe that I heard somebody mention
that the potential liability to us on that was $60 billion. Am
I correct in that? Mr. Allred?
Mr. Allred. Senator, I'm not sure about the total liability
but I believe it's in that range. The argument in that case, as
you probably know, is whether or not the law gave us the
authority to impose price thresholds. Our solicitor tells me
that they are confident in our position. I've been around long
enough to know that you can never predict what a court will do
but the arguments that the Solicitor has he believes are very
sound.
Senator Murkowski. So the potential for us could be $10
billion that we are seeing as a loss now and if Kerr McGee were
to be successful in its litigation, an additional $60 billion
on top of that. Is that correct?
Mr. Allred. Senator, I believe that those are inclusive,
that if we are not able to impose price thresholds totally, the
lost opportunity for income could be up to $60 billion. The $10
billion would be a portion of--if we are unable to recover the
1998 and 1999.
Senator Murkowski. OK. And then one final question for you,
Mr. Allred and this is how the Department sets the royalty
rates and there has been some discussion about the discretion
of the Secretary. Traditionally we've seen these royalty rates
set at 12.5 percent with some of the more prospective leases at
16\2/3\ percent. It was, I guess, just a few weeks ago that the
Administration recently raised the royalty to 16\2/3\ percent
in most places with the exception of Alaska, where it remains
at 12.5. I just wanted to ask kind of what the rationale was
behind that decision.
Mr. Allred. Senator, when we were asked to evaluate whether
or not that should be done or not, we looked at a number of
items but specifically, in our consideration, as to whether or
not the 12.5 was needed offshore, continentally offshore. Our
conclusion was that as we looked at the competition that was
available and the interest in the oil companies and the state
of the technology and that's very important--the state of the
technology with regard to deep water offshore development that
we did not think that the reduction in royalty rate was no
longer necessary. It certainly probably was when we started but
the technology has been developed sufficiently and there is
sufficient interest and competition that we felt that it was
appropriate to bring it up to 16\2/3\ as it is in shallow water
on the OCS.
Senator Murkowski. Thank you. Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Cantwell.
Senator Cantwell. Thank you, Mr. Chairman. Mr. Devaney, as
you started your investigation, did you advise the agency on
not deleting e-mails?
Mr. Devaney. Actually I didn't have to, Senator. Under the
Cobell lawsuit, the agency retains their e-mails. It is a
wonderful thing for IGs.
Senator Cantwell. And in that process, did you review e-
mails between--the personnel and any of these companies that
are involved in this?
Mr. Devaney. We looked at some 19,000 e-mails so while I
can't definitively say, my assumption is, we have done that,
yes.
Senator Cantwell. So it wasn't just internal communication,
it was communication between those employees and these
companies as well?
Mr. Devaney. I believe so.
Senator Cantwell. Is that in the report that we're
receiving today? Are those e-mails in that report?
Mr. Devaney. No. But it is much more common that the e-
mails reflected conversations within the Department. It would
be few and far between e-mails with the oil companies
themselves.
Senator Cantwell. So we do not know whether those were
asked for?
Mr. Devaney. I don't know as I sit here right now. I'm
assuming that because we looked at such a large volume that it
included--if there were any e-mails, it would have included
them.
Senator Cantwell. But that is something that we could go
back and look at as well, is that correct?
Mr. Devaney. We could go back and look at them but our
investigators have looked at them to see if there was
conversation in those e-mails that might relate to these
issues.
Senator Cantwell. Mr. Chairman, I'm assuming we're getting
a copy of this report today, with these e-mails, that members
can review, is that correct?
Mr. Devaney. My belief is you are not getting the 19,000 e-
mails, no.
Senator Cantwell. In this report?
Mr. Devaney. No. You're getting today the e-mails that are
relevant to the discussions, which go to the issue of whether
or not anyone at MMS knew about these issues in 2004. There are
four or five e-mails. It's a brief string of e-mails.
Senator Cantwell. OK. But we are getting those e-mails, is
that correct?
Mr. Devaney. Yes.
Senator Cantwell. The committee will have access to those?
Mr. Devaney. Yes.
Senator Cantwell. And we can get a clarification about this
issue of external e-mails between employees?
Mr. Devaney. I would be glad to work with you on that.
Senator Cantwell. Thank you. Secretary Allred, do you know,
since this is an ongoing investigation, do you know of any
discussions, meetings, or verbal reports that aren't included
in the information today that might be cover-up discussions
within the organization about this issue and ways in which to
take this information and package it differently for Congress?
Mr. Allred. Senator, I'm not aware of any discussion that
would present this information any differently than what Mr.
Devaney has supplied it to you with.
Senator Cantwell. I know you haven't been on the job very
long, along with the Secretary--but didn't you come onto the
job and hear discussions between employees about well, this is
the way we ought to present this or change what's happened or
anything of that nature? You're not aware of any such e-mail?
We're not going to show you an e-mail later and you're going to
say, oh, I don't remember receiving that?
Mr. Allred. Senator, one of my problems is I can't type so
you probably won't see any e-mails but no, in fact, I found
just the opposite. When I came on board, I found a very high
level of concern about how to fix the problem and of course,
Director Burton and others were actively involved in trying to
figure out how to solve this issue with the oil companies and
we have discussed a lot of strategy with regard to that.
Senator Cantwell. Help me then understand your comments
that you just made here this morning about this decision in the
change of these 1998, 1999 contracts being a conscious
decision. Help me in understanding that.
Mr. Allred. Senator, in the information that Mr. Devaney
has supplied to you and to us, there is indication there that
there was direction to an individual who was drafting the
leases that they were to remove the price threshold. So that
was a definitive decision.
Senator Cantwell. By whom?
Mr. Allred. That is a problem and that's probably where you
need to follow up with Mr. Devaney. But my understanding is
that it was one of three people. He has interviewed all three
of those. I understand one of them is not capable of
responding. So how that happened and for what reason, the
report is not indicative of that.
Senator Cantwell. I think that's not a $10 billion
question, it's the $80 billion question this morning. So you're
saying it was a conscious decision and you're saying some
individual made this decision and communicated that.
Mr. Allred. That's my understanding.
Senator Cantwell. And Mr. Devaney, I'm just reading your
report, which Deputy Director Cruickshank is simply saying,
well it was a screw up and internal miscommunication. So we're
hearing from the Secretary that it was a conscious decision by
an individual and we're also having a report that kind of
contradicts that. To me, that's a very interesting development
this morning, that your report says it was just an internal
screw-up and we're having the Secretary testify here that it
was a conscious decision.
Mr. Devaney. Let's see here if I can not add to the
confusion but perhaps make something clear--clearer. When
Assistant Secretary Allred states that someone deliberately
told somebody to do something, that's true. But it was done in
the belief that--see, the price threshold language was always
contained in the previous leases in an addendum that was
attached to the leases.
Senator Cantwell. I'm very well aware that the final rule
mysteriously does not refer to this and that the agency then
tried to say that they were covering their bases by referring
to that rule that is then absent of the price threshold
language. What I want to know is who gave that direction and
why did the agency continue to pretend like this wasn't costing
the taxpayers $10 billion. Now, this is a very important issue
for the U.S. Senate and I hope, Mr. Chairman, that we will
exercise our oversight responsibilities in getting to the
bottom of this. I applaud the IG and the GAO for their
diligence thus far but we don't have the whole story. I
appreciate Mr. Allred being honest this morning and saying that
he thinks it was a conscious decision. We need to get the
bottom of this and I know I'm going to run out of time, Mr.
Chairman, but as somebody who has spent the last 5 years on
contract sanctity as it related to Enron, I appreciate the
committee's really good work and due diligence on this issue.
When it came to the bottom line, we saw some regulatory capture
within the Federal Energy Regulatory Commission and them
interpreting the statute the way they wanted to interpret it at
the benefit of those industries that they were supposed to be
regulating. So I hope that's not the case here. I hope that's
not the case here. But I hope that we will not be buffeted by
the notion of contract sanctity and then somehow forget our
responsibilities to the taxpayers of this country. We have to
get to the bottom line here and we have to make sure that there
is reform within this agency that it does its proper job in
oversight responsibilities to the taxpayers.
Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Landrieu.
Senator Landrieu. Thank you, Mr. Chairman. I'd like to
follow up by saying, as someone who's been very focused on this
issue for any number of reasons for quite a long time, that
obviously there is a need for reform, for revamping, for
transparency to give taxpayers both in Louisiana and throughout
the gulf coast that now benefit rather directly or will benefit
rather directly by this royalty sharing provision as well as
taxpayers everywhere that this agency can operate, it can
collect the revenues that are due and support an industry that
creates hundreds of thousands of jobs for this country.
And in my view, Mr. Chairman, there really is hardly an
issue other than the global issue of energy and dependence and
balance that is more central than this one for that purpose
because when we talk about more production, it's important that
we get that production done correctly, which is where to drill,
how to drill and how the revenues will be divided between
either the State where the drilling is or the taxpayers
generally and to move forward without this being corrected and
addressed is going to be very difficult.
So I, for one, am willing to spend as much time as it takes
to get to the bottom of exactly what happened. Senator Cantwell
is very correct and as usual, has done a very good job. It is
extremely important, Mr. Chairman, for this committee, whether
through an oversight function or otherwise, to get to the
bottom of whether this was a decision or a mistake because that
will govern which direction we can move forward.
No. 2, I understand that the three people most responsible
for this--whatever it was--a mistake or a decision, was Bruce
Babbitt, who was the Secretary of the Interior during this
time, Bob Armstrong, who was the Assistant Secretary for Land
and Minerals Management, who was responsible for overseeing
that, who is now in a health condition that he is unable to
testify, correct? Mr. Devaney?
Mr. Devaney. No, that's not a name I'm familiar with.
Senator Landrieu. That is not correct so he can testify?
Mr. Devaney. I believe he could. I don't know the man.
Senator Landrieu. Well, I'd like--does anybody know at this
table if he can or can't testify?
[Answer inaudible.]
Senator Landrieu. OK. Carolita Kallaur? K A L L A U R, who
was Associate Director from 1998. She is deceased.
Mr. Devaney. Yes.
Senator Landrieu. OK, so she is obviously unable to
testify. Those are the three people most responsible for
whatever this was, an error or a decision. Is there anyone else
that is a principal that we should know about?
Mr. Devaney. Those are--leaving aside the individuals that
are deceased. We focused our attention on three employees of
the Minerals Management Service.
Senator Landrieu. Could you, for the record, state their
names?
Mr. Devaney. The names are Mr. Rodi, who was the person who
actually changed the language. When we asked him why he did it,
he said he was told to do it by one of three people.
Senator Landrieu. Who were those three people?
Mr. Devaney. We asked him to take a polygraph exam and he
passed that polygraph exam.
Senator Landrieu. Who were the three people though?
Mr. Devaney. One person by the name of Rose. If you just
give a second, I'll----
Senator Landrieu. You can take a minute. While you're
looking at that, I think it is important for the record to
reflect that, Mr. Chairman. But let me step back for a minute
and take a second for this committee to recognize that the
revenue increases from offshore oil and gas revenues have grown
in a tremendous way over time and we don't want to do anything
on this committee to reverse that positive trend. It's positive
for the Treasury. It's positive for domestic job creation and
now because of the good work of this committee, it's a very
positive development to protecting and supporting America's
energy coast and just for the record, Mr. Chairman, I'm going
to submit what the actual numbers are projected to be between
2006 and 2016 but I'm also going to go back to the 1950's when
this program started, in 1954, when the first offshore lease
sale was done, I believe, in the mid-fifties and show to the
country that this is a substantial increase.
Estimated Yearly Receipts From the Outer Continental Shelf
2006: $7.575 billion
2007: $8.875 billion
2008: $10.125 billion
2009: $9.775 billion
2010: $9.975 billion
2011: $10.075 billion
2012: $9.425 billion
2013: $10.975 billion
2014: $10.825 billion
2015: $10.850 billion
2016: $11.175 billion
Source: Congressional Budget Office 1/30/06.
Senator Landrieu. No. 2, the 1995 Act that Senator Bennett
Johnson, Chairman of this committee and our predecessor
passed--one of its purposes--the Senator from Oregon should
know and the Senator from Washington wasn't to diminish
revenues to the Treasury but to increase revenues to the
Treasury. That 1995 Deep Water Relief Act was drafted
specifically to increase economic production and to generate
more royalties, not less.
So I know for a fact that the principle author of this
legislation had it as his intention and I'm sure if he would
have been asked to testify, would tell you the same thing I'm
testifying to you. It wasn't to get less revenues for the
Treasury but more. And if it operates correctly, Mr. Chairman,
that's exactly what will happen, which is going to be a great
benefit for everyone.
Oil companies and gas companies drill more, the public gets
more money so we can lower taxes if we wish or invest in
education or highways and now because of the act that this
committee took, the gulf coast, the energy coast that produces
100 percent of these revenues--they are not produced off the
western coast, Mr. Chairman, and they are not produced off the
eastern coast, Mr. Chairman and they're not produced in the
Interior. They are produced in the Gulf of Mexico. So the gulf
coast States have as much interest in getting this straight as
anyone and I think this committee should hold as many hearings
as possible until we determine, was it a mistake or was it a
decision because then we can move forward so we don't get
caught up in court for the next 10 years, recover the money
that is owed, reform an agency, produce transparency, and allow
an industry that can do good work and does good work, continue
to do good work for America.
I hope--my final point is--as people are so anxious to
wield these huge clubs, that we don't wield the club so huge
that we hit our own self in the head by doing it and this is
not that complicated, frankly, with the right information. So
Mr. Chairman, I thank you for that and I will finally say one
thing, if the committee will indulge me. I don't mind holding
the people responsible accountable and I'd like to read again
that it was the Secretary, former Secretary Bruce Babbitt,
where this error occurred and his staff and whoever was in the
Department. But for current people to be held liable for what
happened in 1998--now they are, for not correcting it and we'll
see, then fine. But please, let's direct our anger on the
people responsible for when this occurred. Thank you.
The Chairman. Let me just clarify. I think there is a lot
of confusion about the testimony we've had here. When a
contract is entered into, it involves, presumably a meeting of
the minds, an agreement between the two parties as to what is
contained in the contract. From the Government's perspective,
as I understand your testimony, Mr. Devaney, you say this was a
bureaucratic mistake. You're saying that these lease thresholds
or price thresholds were left out, consciously left out, based
on a mistaken belief that the price thresholds were otherwise
provided for in statute or regulation. Am I right?
Mr. Devaney. Yes.
The Chairman. So there was no decision by the Government to
enter into a lease that did not contain price thresholds. They
believed that the legal effect of the lease was to continue to
have price thresholds?
Mr. Devaney. That is the conclusion we draw from our
investigations.
The Chairman. So there was no conscious decision to enter
into a lease that was very different from the previous leases
or than was very different from the subsequent leases on the
part of the Government?
Mr. Devaney. We found no evidence of that.
The Chairman. On the part of the companies, do we have any
reason to believe that they understood that they were getting
away with not having to pay any royalty ever, to the Government
on the production from these leases? I assume that they were
ignorant as well at the time these leases were signed. Do you
have any reason to believe otherwise, Mr. Devaney?
Mr. Devaney. I think actually it was the companies
themselves that brought the mistake to the attention of MMS in
both 2000 and 2004. There were still companies that were
involved in these leases that were expressing to MMS, could you
clarify it for us? Did you really mean this? And those
questions were being directed to folks in sort of the lower
levels of MMS and the issue bubbled up, both in 2000 and 2004
because of those inquiries.
The Chairman. So the companies were coming forward and
saying, you know, this has come to our attention here. It
hadn't come to our attention before but it now has, that these
leases are different than the ones that we previously entered
into and maybe could you clarify what the deal is here. Is that
basically what happened?
Mr. Devaney. Well, it's difficult to understand what their
motivation for asking the question was, but it is true that
during the course of our investigation, we found evidence that
they were asking that question.
The Chairman. And in the bidding on these leases, as I
understand the way this process works, when leases are let,
companies come in and bid and give a bonus bid to get the
lease. Is there any evidence that people were willing to bid
more for these leases because these leases were written in such
a way that companies were never going to have to pay any
royalty and that was a great boom to them?
Mr. Devaney. That certainly was not uncovered during our
investigation, no.
The Chairman. All right. Well, I guess at least from what I
take from your statement, this was a mistake. It was a
bureaucratic mistake. It was a mistake in what wound up in the
language that was operative on the leases, and it seems to me
that in light of that, we need to try to get it corrected. I
mean, the companies didn't understand that they were getting
away without having to pay royalties. The Government didn't
understand that they were entering into leases that didn't
require payment of royalty, regardless of the price of oil or
gas and it seems to me, we ought to get it corrected and
companies ought to be willing to come in and agree to re-
negotiate these leases to get a reasonable royalty to the
taxpayers of this country. I think that's the best result.
Now if that result isn't possible, then obviously we need
to look at alternatives, legislative alternatives to get the
problem fixed. But I would hope that we would have more
companies willing to step up and be willing to recognize and
acknowledge that a mistake was made here and that they should
not take unfair advantage of that, as they have been taking for
some period of time here.
Let me also just clarify, Mr. Devaney, I think you said
that your investigation indicated that the decisions about this
were made by the individuals involved and that there was no
communication to higher officials in the Department about the
issue, since there was no decision made not to include these
price thresholds. Obviously, that wasn't communicated. But the
fact of the mistake was not communicated either, to higher
officials until 2000, is that what I'm informed?
Mr. Devaney. Even in 2000, the mistake, when it was
uncovered by a lower level MMS employee, it was communicated to
the individual mentioned earlier who is now deceased and we, of
course, would have liked to have asked her why she decided,
apparently, not to communicate that to the Assistant Secretary
level.
The Chairman. She did not communicate that to Mr. Armstrong
or to Mr. Babbitt or anybody else in the Department?
Mr. Devaney. No.
The Chairman. Let me just ask about this chart. Mr. Allred,
I understand your good faith and your concern about potential
downside risks to the Government of sort of forcing this issue
or enacting something that would wind us up in court. But there
is a very substantial financial incentive for these companies
to want to see leasing continue in the gulf coast. I mean, we
just had quite a debate last fall and there are a lot of people
walking the halls up here, lobbying in favor of additional
leasing in the gulf coast.
So as I understand it--I'll give you a chance to respond
here, but I hope you're not saying that we should not insist on
fairness for the taxpayer because to do so or to be too heavy-
handed in it would run the risk that industry would go to court
to prohibit additional leasing from occurring. It doesn't sound
credible to me that it is in the interest of industry to
prohibit additional leasing from occurring.
Mr. Allred. Mr. Chairman, my concern is not what we do. I
believe we have to take action and I think Congress has a real
role in that action. The only thing I'm urging is to think that
through very carefully so that we minimize the possibility of
being enjoined from doing leasing. I could--if you would like
me to, I can lay out for you the scenario that has me concerned
and that is, where a company would be prohibited from bidding
and then because they were prohibited from bidding, it might be
in their interest to delay the bidding process until they could
have that resolved. And that is the action that I'm concerned
about that could result in a significant delay in the
development of the oil resources, an actual reduction in
production and the delay of income to the U.S. Government.
I think there are many ways to do this and my concern in
bringing this forward is just to illustrate that we have to
make sure that we think through unintended consequences of an
action and as I said before, I pledge to this committee to work
with you and your staff to make sure that we consider what we
do so that we avoid unintended consequences. I believe there is
a real role for this committee to play.
The Chairman. Thank you very much.
Senator Wyden.
Senator Wyden. Thank you, Mr. Chairman. And Mr. Chairman,
let me just say, as the incoming chair of the Subcommittee on
Public Lands, it's my intent to work very closely with you to
follow up on this and to work with all of our colleagues on a
bipartisan basis because obviously we've got a number of
outstanding issues.
I want to follow up on something also, to state in the
clarification of business. We've had a lot of discussion back
and forth about whether the central problem stemmed from a
decision or a mistake. That is sort of how it was framed. I
want to be very clear, Mr. Devaney. I want you to confirm
something. This was not a one-time occurrence involving one
lease. As far as I can tell, this involved hundreds of leases.
Is that correct?
Mr. Devaney. I think there were over a thousand leases
involved in this.
Senator Wyden. All right, because we've now framed this as
if we've got to get out and find one person who said--one
instance that there was a mistake or a conscious decision but
what we have, in my view, is an incredible pattern here, a
pattern of incompetence and I believe, conflict of interest.
Let me, if I might, with you, Mr. Allred, go through
something else that I find disquieting about what is happening
right now. As you know, there have been a number of auditors
with the agency, MMS, that have filed False Claim Act cases--at
least two different courts of appeals, including the 10th
Circuit where these auditors live and are pursing their cases,
have held that the auditors--that the Federal employees have
legal standing to file these claims under the False Claims Act.
And other whistle-blower protection statutes may also come into
play but let me tell you what I'm very troubled about this.
I've got a copy of an e-mail that was sent on January 9 of
this year--this is an MMS e-mail asking for the sign-up sheets
for any and all mandatory training courses taken by these three
auditors in 2004, 2005 and 2006. Mr. Chairman, I ask your
consent that this e-mail be made part of the record.
The Chairman. We'll include it in the record.
[The e-mail referred to follows:]
From: Sawicki, Michelle
Sent: Tuesday, January 09, 2007 2:06 PM
To: Ohadi, Pauline
Cc: Gilmore, Holly-Jean; Fields, Gary; Johnson, Ralph; Tyler,
Paul
Subject: Documentation request
Importance: High
Debbie Gibbs Tschudy has asked for sign-in sheets for any
and all mandatory courses (i.e. Ethics, FOIA, Privacy Act,
Fraud, IT Security Awareness, Illegal Acts, etc.) taken by
Randy Little, Joel Arnold and Lannis Morris during 2004, 2005
and 2006.
I am having Jeryl pull any sign-in sheets we may have for
courses entered into the MRM Training Database. I will let you
know if there are any we cannot find.
During the 03/04 CPE cycle each office had differing
opinions on entering courses that did not carry CPE into the
MRM Training DB. So, our dilemma is that many of the mandatory
courses were not entered into the MRM Training DB. Therefore,
we do not have record of those employees attending the
mandatory training. We need for you to provide any sign-in
sheets for those courses to Gary Fields no later than noon on
Thursday January 11th.
Holly-Jean told me that the 05/06 training files are in
Houston. If there are any sign-in sheets that we need during
that time frame, we will have to have Holly-Jean get those for
us.
Thanks for your cooperation on this in such a quick turn
around time.
Paul, if you are not Pauline's supervisor, please forward
to the appropriate person.
If you have any questions or need anything from me, please
let me know.
Michelle
Senator Wyden. My question, Mr. Allred, because I'm
concerned about the climate of making sure that these whistle-
blowers, who've told us an awful lot about what is actually
going on there, that this climate does not degenerate further
and that whistle-blowers will come forward. So my question is,
why are the managers at the Mineral Management Service checking
the training records for just these three employees? It sure
looks to me like this is not a kind of coincidence. If it's a
program, you look at a lot of people, but what the e-mail shows
is that it's just these three people. Do you find that
troubling? Do you have any explanation? What message would you
like to send today with respect to whistle blowing at the
Department?
Mr. Allred. Senator, I'm not familiar with that e-mail but
I can tell you, I will not allow any retribution against these
people. I do not approve of what these people have done. It
appears to me it's to their own benefit. But they still have
that right and I will just not stand for reprisals against
them. The responsible agency for investing what's going on is
the Inspector General and that is where these sorts of
questions and investigations should take place.
I can assure that--and now that I am aware of that, I will
find out what's going on and I will not allow any retribution
against these or any other people.
Senator Wyden. Pretty hard, Mr. Allred, to see it as a
coincidence, that nobody else's records get tracked except
these three courageous public servants who watched, year after
year, as the taxpayer got fleeced. These were the only three
who have their records tracked. Wouldn't you say that's a
little unusual?
Mr. Allred. Senator, again I don't know the circumstances.
The first time I've heard about this is when you asked it. I
would hope that you will reserve judgment on the claims that
those people have made until the Inspector General has
investigated it and reported it. I am aware, there are a number
of circumstances that would raise questions about some of the
statements they have made. But I will not allow any retribution
against anybody like that.
Senator Wyden. I understand the controversy that surrounds
some of their claims, but we do know that a number of non-
partisan officials, people who have no partisan bias on this,
have been willing to step forward at considerable risk to their
careers. Now they're the ones who are having their sign-up
sheets pulled and apparently nobody else and that again,
strikes me as hard to accept as coincidence.
Let me wrap up with you, Mr. Devaney and again, just
commend you as my colleagues have, for your comments. It really
strikes me that even today, at the heart of this, the
Government is taking the oil companies' word with a program
like this. Where it is clear we are going to be out several
billions of dollars and it may even be $80 billion and I would
tell my very good friend from Louisiana who I admire greatly,
we all understand this program began when the price of oil was
$19 a barrel.
When I was on the floor, trying to get a vote to make some
changes, the price of oil was $72 a barrel. So we very much
want the people of Louisiana to be productive and contributing
to our energy security, but we have a program where it is now
on the record that the taxpayers have been fleeced and it has
not happened once. There hasn't been just one ``mistake'' or
one ``decision.'' It involved hundreds of leases and as we wrap
up this morning, after Chairman Bingaman's thorough and
commendable hearing, we are left with the fact that today, by
Mr. Devaney's words, we've got an honor system.
I asked you about the oil companies, essentially being able
to have the Government sign off on their figures. Your words
were, we have an honor system. I just don't think that's good
enough and Mr. Chairman, I want to say again that as chair of
the Subcommittee on Public Lands, I'm going to work very
closely with you and with Senator Domenici and all our
colleagues as we follow up today.
The Chairman. Thank you very much.
Senator Cantwell, did you have additional questions?
Senator Cantwell. I did, Mr. Chairman but I will be brief.
I just wanted to ask of the Secretary about a report that they
commissioned in 2003 that over a 40 year period, the current
incentive program would lead to the discovery of only 1.1
percent more oil reserves than if there was no system of
royalty relief at all. Are you familiar with that report?
Mr. Allred. I'm aware of the report but I have not had the
opportunity to study it. Understand that again, I have not seen
the thing, other than I am aware of some news reports of
another study that was done like that.
Senator Cantwell. But this, I think, was your own agency
saying that it is--basically giving us a 1.1 percent return.
Mr. Allred. I just--I could not intelligently comment on
that report. I would be glad to visit with you after I've had a
chance to look at it.
Senator Cantwell. And second, if we had not seen or if the
New York Times had not run this article, would--and your
testimony today is that it was a conscious decision--would
anything have changed if we hadn't seen anything in the
newspaper?
Mr. Allred. Senator, it's hard to speculate on what would
have happened in the agency. When I came into the agency,
management did know about it and so I don't know what might
have happened in the previous times. I can tell you that the
current management, the Secretary and I take this very
seriously.
Senator Cantwell. But in the context of you saying earlier
there was a conscious decision and then they knew about it. If
it hadn't been in the newspaper then maybe the policy would
have continued beyond 1998.
Mr. Allred. Senator, obviously somebody discovered the
discrepancy in 2000 because the leases after 2000 all contained
the price thresholds.
Senator Cantwell. But as Senator Wyden was talking about,
within this time period, there were still thousands of leases
that haven't been acted on. So I think we're getting maybe like
20 percent of the revenue that you might end up getting from
these. I mean, we've only fixed 20 percent of the problem, is
my point, as it relates to these thousand-plus leases. We still
need to come back and fix that.
My last question--the President opposes the House
legislation that is moving through as a proposed solution to
this problem. Could you be specific about why the
administration opposes that legislation?
Mr. Allred. I'm aware that there is a statement that the
administration has drafted. I don't know that it has gone
forward, and I would not be capable of intelligently briefing
you on that.
Senator Cantwell. Well, it too, is in the press, along with
these other things so if we could get the Secretary to respond
to whether the proposals being put forth by the House--my guess
is, will probably pass overwhelmingly, what specific provisions
of those changes the administration doesn't support. That would
be very helpful. Thank you.
The Chairman. Senator Landrieu, did you have additional
questions?
Senator Landrieu. Just to clarify a few things because I
want to talk for a second and clarify this pattern issue and
the quantity of the leases in question, because again, I think
it is very important that we focus to find this solution and
not run down rabbit holes.
Can somebody on the panel--maybe Mr. Allred, you would be
the best one, explain how many leases are usually entered into
in these 5-year trenches. Now this has been going on almost
every 5 years since the 1950's and there is a big difference,
Mr. Chairman, whether this is a pattern over time, from the
1950's to the present or whether it is an aberration or a
terrible mistake or whatever, a change in that pattern starting
in the lease sale that we're speaking about. Mr. Allred, could
you add? How many leases are, on average, leased in a 5-year
period?
Mr. Allred. Well, Senator in a typical----
Senator Landrieu. Or in a lease sale?
Mr. Allred. In a lease sale, there could be as many as 600
leases.
Senator Landrieu. Lease sales occur twice a year?
Mr. Allred. Yes. In the new 5-year program, for example,
there would be 21 lease sales in that 5-year period. Perhaps
just for some comparison purposes, we currently have some 20--
almost 28,000 leases that we deal with--over 8,000 on the OCS--
and of course, those rotate as they come back in and we put
them out in new lease sales.
Senator Landrieu. But what you're saying is in the next 5
year lease sale, there are going to be 21 lease sales in 5
years so that's about 4 lease sales per year. And in each one
of those lease sales, there are approximately how many?
Mr. Allred. Well, we haven't defined that yet. We do it at
the time of the sale but typically you might look at 600 leases
in a sale.
Senator Landrieu. Okay but out of those 600, like in this
instance, how many were actually active in terms of actually
producing out of those 600? In these leases in question, in
this particular lot?
Mr. Allred. If we look at the 1998 and 1999, which is where
I have some information, there originally were 1,032 leases.
Five hundred and seventy of them are still in force, being
actively developed by 45 companies. Of those, 19 are producing.
Senator Landrieu. So Mr. Chairman, it's important for the
record that we understand that it's been 19 producing leases
that we have to focus on in terms of contracts entered into
where royalties are not being collected and what that revenue
stream might be and then focus on the other several hundred
that are ``active,'' which I don't have time now but I'm going
to get into some specifics about what that term actually means
because prospectively, Mr. Chairman, if a lease is not being
drilled and it is not active, it is released.
So in other words, we can correct prospectively this quite
easily. It's the issue of the leases that are now producing
under this faulty or bad decision contracts that if we could
focus on, we could resolve this in a way that continues to
produce money for the Treasury, relief to the gulf coast, and
jobs for the taxpayers and that is what I'm hoping the bottom
line here will be, instead of us either trying to whatever--
beat up on oil companies or beat up on the Government or beat
up--I mean, that can be done. I hope it's not done in a way
that prevents us from actually solving the taxpayer problem
right now. Thank you.
The Chairman. Thank you very much. Thank you to the
witnesses for all of your time and good testimony. I think this
has been helpful. In case there are members who came or who
were not able to come who have questions, we'd ask that they
provide those in writing by the end of business tomorrow and
then we would ask sometime in the next couple of weeks, if you
could respond to those in case there are written questions.
Thank you again and that will end the hearing.
[Whereupon, at 12:02 p.m., the hearing was adjourned.]
APPENDIX
Responses to Additional Questions
----------
Department of the Interior,
Office of Inspector General,
Washington, DC, February 6, 2007.
Hon. Jeff Bingaman,
Chairman, U.S. Senate, Committee on Energy and Natural Resources,
Washington, DC.
Dear Senator Bingaman: With this letter, I am transmitting my
written responses to questions submitted by you and members of the
Committee following my testimony on January 18, 2007 on issues relating
to oil and gas royalty management at the Department of the Interior.
I respectfully request that my written responses be included in the
record. If you have any additional questions or concerns, please do not
hesitate to contact me at (202) 208-5745, or your staff may contact
Associate Inspector General for External Affairs, Kris Kolesnik, at
(202) 513-0326.
Sincerely,
Earl E. Devaney,
Inspector General.
[Enclosure.]
Responses to Questions From Senator Bingaman
Question 1. Pending Work--Turning to the royalty management issues,
could you please describe the additional work and related
investigations that you have pending? When do you expect this work to
be completed?
Answer. The additional investigations related to royalty management
issues presently underway involve the outstanding Qui Tam cases, and
several criminal investigations. My investigative staff is working hard
to conclude each of these matters as expeditiously as possible. Given
the recent verdict in the Qui Tam case against Kerr-McGee, however, we
must evaluate the impact that the verdict might have on our Qui Tam
investigation which will undoubtedly extend the time it takes for us to
conclude the matter. As for the criminal investigations, I am hesitant
to estimate when our work will be completed, as additional
investigation is often requested by the Department of Justice in
criminal matters.
Question 2. Management Issues--Your testimony makes reference to a
``surname-process which dilutes responsibility and accountability.''
Could you please elaborate and explain how this may have played into
the royalty price threshold problem?
Answer. The surname process that I referred to in my testimony is a
review process that requires the reviewers to sign their surname on a
form, indicating their approval or assent to forwarding the document in
question to the next reviewer. We have found that in many instances, an
excessive number of people are expected to review and surname a
document. This, in my view, spreads responsibility for the accuracy and
appropriateness of a document among too many people, leaving no one
ultimately responsible. In the royalty price threshold matter,
signatories to the surname process told us they signed off without
thorough review, in reliance upon staff that reviewed and surnamed
before them. This dilutes responsibility further, and undermines the
very purpose of the surname process.
Question 3. Ongoing Price Threshold Issues--Your report on the OCS
lease price threshold problem identifies e-mail from last year that
indicates some ongoing confusion in the MMS with respect to
implementation of price thresholds for royalty relief provisions
enacted as part of the Energy Policy Act of 2005. Is this correct? What
should be done to address this?
Answer. An e-mail from a lower level MMS employee was found seeking
guidance regarding application of price thresholds in lease sales that
were pending at the time. We feel that this e-mail is a symptom of a
much bigger organizational issue regarding communication and policy
documentation. To address this one issue, immediate policy must be
developed and disseminated to all MMS and SOL individuals involved with
the lease process. Once developed and disseminated, the policy must be
memorialized for future reference.
Question 4. Audit and Compliance Action Plan--With respect to your
report last month on the audit anti compliance review process (December
2006, ``Minerals Management Service's Compliance Review Process,''
Report No. C-IN-MMS-0006-2006), I understand that MMS has committed to
preparing an action plan to address your recommendations. How will you
track MMS's implementation of this plan?
Answer. We will track the recommendations in accordance with Office
of Management and Budget Circular No. A-50, Audit Followup, and the
Department of the Interior's implementing regulations. In its response
to the final audit report, MMS provided an action plan for implementing
all of our recommendations. We have forwarded that action plan to the
Department's Assistant Secretary for Policy, Management and Budget
(PMB) for tracking of implementation. PMB maintains the inventory of
open recommendations and is responsible for ensuring that
recommendations are implemented before they are closed. After PMB
notifies us that all of the recommendations from this audit report have
been closed, we will conduct a verification review to ensure that the
recommendations have actually been implemented.
Question 4a. In your view, what are the key reforms on which this
Committee should focus to ensure substantial improvements are made in
the agency's existing compliance review system?
Answer. Our report provides three recommendations for 1) improving
data reliability, 2) improving the compliance review process, and 3)
revising performance measures to better reflect program operations. We
believe that these are the three key reforms on which the Committee
should focus.
Improving Data Reliability: MMS needs to develop and
implement a plan to provide reliable data for managing and
reporting on its compliance activities. Until this is
accomplished, MMS cannot:
--effectively use existing systems for day-to-day management and
reporting purposes;
--develop an effective strategy for deploying personnel and other
resources between audits and compliance reviews;
--provide accurate information on program operations and results to
stakeholders, including the Congress and state and tribal
audit organizations; and
--determine the true costs and benefits of compliance reviews and
audits.
Improving the Compliance Review Process: Our report
identifies numerous improvements that MMS can make to its
compliance review process. Most importantly, MMS needs to
develop risk-based criteria for selecting companies for audits
and compliance reviews. MMS also needs to strengthen its
procedures for verifying volumes and allowances reported by
companies.
Revising Performance Measures: We found that the performance
measures used by MMS to manage and report on its operations
were either unreliable or misleading. MMS needs to revise its
performance measures to better reflect the program operations
and allow stakeholders, including the Congress, to assess MMS'
performance.
Question 5. Audits and Impacts on States and Tribes--Are the
shortcomings that you have identified in the audit and compliance
review process impacting revenues owing to states and tribes? If so, do
you have estimates of the magnitude of the impacts? What
recommendations do you make to avoid this?
Answer. The issues that we identified could be impacting royalty
revenue to states and tribes because the issues prevent MMS from
maximizing the outcome of its compliance program; however, we cannot
estimate the magnitude of any potential impact. Because MMS lacks
quality data, it cannot develop an effective strategy for deploying
resources and cannot determine the true costs and benefits of
compliance reviews and audits. Our report identifies improvements that,
if implemented, could ultimately result in MMS identifying and
collecting additional royalties. States and tribes would share in any
additional collections resulting from improved compliance reviews.
Additionally, the ability of states and tribes to conduct compliance
reviews is hindered because they do not have full access to MMS'
automated tools.
Unfortunately, there is no way to estimate additional royalties
that might be collected as a result of more effective strategies and
improved compliance reviews. MMS lacks the quality data needed to make
such estimates. Ultimately, collection of any additional royalties
would depend on 1) the amount of royalties underreported by companies
and 2) MMS' ability to identify those additional royalties through its
audit and compliance reviews.
Question 6. Incomplete Data--Regarding your finding that MMS'
compliance review process relies on four separate databases, which in
turn contain unreliable, incomplete and inconsistent information: what
do you believe would be a reasonable timeline, enabling the MMS to
correct its system's biggest flaws?
Answer. MMS' action plan indicates that it will complete
implementation of our recommendation concerning data reliability by
September 2007. This is an aggressive schedule, but reasonable if MMS
focuses its attention and resources on the implementation of this
recommendation.
Question 7. Compliance Review Actions Plan Implementation--flow
will you track implementation of the MMS action plan for compliance
with the recommendations of your December 2006 audit of the compliance
review and audit process? In your view, what are the key reforms that
this Committee should focus on, to ensure substantial improvements are
made in the agency's existing compliance review system?
Answer. We will track the recommendations in accordance with Office
of Management and Budget Circular No. A-50, Audit Followup, and the
Department of the Interior's implementing regulations.
Our report provides three recommendations for 1) improving data
reliability, 2) improving the compliance review process, and 3)
revising performance measures to better reflect program operations. We
believe that these are the three key reforms on which the Committee
should focus. Once MMS addresses these issues, it will be able to
better develop and implement effective strategies for ensuring company
compliance with royalty regulations. MMS should periodically evaluate
and monitor the effectiveness of its strategies and recalibrate them to
improve its overall performance goals under the Government Performance
and Results Act.
Question 8. Variance Thresholds--I was troubled by your conclusion
in the December 2006 report that MMS cannot adequately explain its
rationale or methodology for establishing acceptable ``variance
thresholds'' between the revenues MMS expects to receive, and the
royalty obligations a company reports to the agency.
What are your suggestions for how the agency might best revisit its
methodology for establishing these thresholds, in a way that would
provide more clarity and consistency?
Answer. We support MMS' use of thresholds in the compliance review
process. Compliance review procedures calculate the expected royalties
from a company based on available data and then compare the expected
royalties to the royalties actually reported. These procedures are less
precise than audit procedures; therefore, MMS needs to establish
thresholds for when variances between the expected royalties and
reported royalties are unreasonable and should be pursued in more
depth. Where to set that threshold is a matter of professional judgment
which should primarily be based on an analysis of costs and benefits of
the additional procedures MMS would undertake to pursue the issue. If a
threshold is too high, MMS risks loss of significant additional
royalties. If a threshold is too low, MMS risks spending more resources
pursuing the matter than it will ultimately collect in additional
royalties.
While we agree with the use of thresholds, we were concerned that
MMS had not documented its rationale or methodology for the thresholds
that it had established. We found that the thresholds separately set by
each of the program components differed significantly. For example, one
component applied both a monthly and an annual limit, one component
applied only an annual limit, and one component simply used
``professional judgment'' on an individual case basis. While we
understand that thresholds may differ among the components, MMS should
document how each was derived and why it is reasonable for them to
differ. We also concluded that the threshold at one component was set
so high that significant underpaid royalties may not be collected. No
matter how the thresholds are derived, MMS should have the methodology
clearly documented in writing to provide uniform guidance to all of the
components.
In addition to costs and benefits, MMS should incorporate elements
of risk into its establishment of thresholds. For example, if MMS has
evidence that a company has underreported royalties in the past or has
misreported information to other federal agencies, then MMS might lower
the threshold for that company. A lower threshold might be warranted in
this high risk situation because there is a greater likelihood of
underreported royalties, a greater likelihood of additional
collections, and the additional procedures could provide a deterrent
for the company to underreport in the future.
MMS agreed with our conclusion and has indicated that it will
revise its thresholds for pursuing underpayments. As part of this
process, it will incorporate an analysis of costs and benefits to
determine at what level it makes sense to pursue an underpayment. MMS'
action plan indicated that this will be accomplished by December 2007.
As MMS addresses its data reliability issues, it will have better data
on the costs and benefits of audits and compliance reviews. This data
should allow MMS to periodically reassess its thresholds and make
changes in the future as necessary. Additionally, since states and
tribes participate in compliance activities and are affected by their
outcome, MMS should consult with them in establishing future
thresholds.
Question 9. Qui Tam Cases--You noted in your audit that while MMS
reported $699 million in collections from compliance activities from
October 1999 to March 2006, about $134 million--or 19 percent of the
total--actually resulted from qui tam royalty settlements, which were
initiated when individual citizens file claims with the Department of
Justice under the federal False Claims Act.
Please elaborate on your rational for recommending that collections
resulting from qui tam cases be excluded from MMS' calculation of
revenues claimed by its compliance review program.
Answer. Because collections resulting from Qui Tam cases do not
originate from activity initiated by MMS' Compliance and Asset
Management (CAM) Program, we believe that the inclusion of collections
resulting from Qui Tams distorts the results of CAM's efforts.
Qui Tam collections are a result of lawsuits filed by individuals
on behalf of the government to collect underpayments. These are
generally cases where an underpayment has been identified and pursued
by someone outside of MMS. Collections from these Qui Tam lawsuits do
not result directly from MMS' audits and compliance reviews and should
therefore not be considered as part of the benefits of the program.
MMS points out that, in some cases, it provides support for the Qui
Tam lawsuits. While we agree and can support tracking of Qui Tam
collections, we don't believe those collections should be included in
the analysis of costs and benefits of the compliance program.
Collections from Qui Tam lawsuits depend primarily on the number of Qui
Tams that are filed and the time it takes for those lawsuits to be
settled. Including those collections in the cost/benefit analysis skews
the benefits of the program and makes it difficult to compare benefits
of the program from one year to another. It also does not aid in
developing strategies for conducting MMS' audits and compliance
reviews.
I understand you are continuing to investigate allegations
surrounding the most recent batch of qui tam cases, filed by a group of
current or former MMS auditors, Please give the Committee an idea about
the scope and timeline of this ongoing investigation.
Answer. The primary scope of our on-going investigation regarding
the Qui Tams includes:
Allegations raised by Relators,
MMS response to allegations,
Whether Relators followed DOI/MMS policy on disclosing
allegations,
Did MMS retaliate in any manner against Relators.
We have also received additional allegations from the Relators some
of which will be incorporated into the current investigation; others
may result in additional, separate investigations. The investigation is
targeted to be complete by early spring.
Responses to Questions From Senator Domenici
Question 1. Attachment 56 of the Price Threshold Report of
Investigation (the ``Report'') has a time line relating to 3/15/04, but
the page 18 and 19 account of this event discussed within is far from
definitive. Please provide the material that demonstrates the assertion
made in the timeline.
Answer. The timeline contains a typographical error. The entry
referring to 3/15/04 states the following: ``Director of MMS makes
formal decision that price thresholds will not apply to leases issued
in 1998 & 1999.'' The entry should have stated, ``Directorate of MMS
makes formal decision that price thresholds will not apply to leases
issued in 1998 & 1999.'' (emphasis added)
Question 2. Please clarify specifically who you are referring to in
your testimony when you refer to a, ``cavalier attitude'' at MMS? Is
this a reference to the current Director of MMS?
Answer. When I referred to the ``cavalier attitude'' associated
with the price threshold omission, I did not intend to disparage
Johnnie Burton herself by my comments. In my testimony, both written
and spoken, I was referring to virtually everyone involved in this
debacle, to include Ms. Burton, but particularly those who in 2000 knew
of the price threshold omission and failed to bring it to the
Director's attention, as well as those who raised the issue in 2004
through a series of e-mails and, apparently, through oral discourse
which was referenced in the e-mails.
While Johnnie Burton has told us that she has no independent
recollection of being told about the issue in 2004, she readily
conceded that the e-mails we presented to her suggested otherwise. She
went on to speculate what her thinking may have been nearly 3 years
ago. Neither I nor my investigators found reason to question Ms.
Burton's veracity about this issue.
I have known Johnnie Burton for nearly 5 years, and have found her
to be forthright and responsible. She is one of the very few bureau
directors in this Department who has made an effort to meet with me on
a regular basis. She has also been, perhaps, the most responsive of the
bureau directors to Office of Inspector General (OIG) findings and
recommendations. I have never had a reason to question her integrity.
Question 3. Please provide any conclusive evidence that the current
Director of the Minerals Management Service (MMS) knew of the price
threshold omissions of 1998/1999 in 2004? Do you feel that you should
clarify the record to reflect that e-mails between and among MMS
employees regarding this issue in 2004 did not include messages sent
directly to the current Director?
Answer. The only evidence we have to suggest that the current
Director of MMS knew of the price threshold omissions in 2004 is the
series of e-mails and personal recollections we identified in the
report. None of these e-mails was sent directly to the current
Director.
Question 4. Upon all evidence available as to when the current MMS
Director knew of the missing price thresholds, what specific legal
steps could the Director have taken to include price thresholds in the
1998 and 1999 leases?
Answer. Recognizing that I am armed with the benefit of hindsight,
I believe that Ms. Burton should have conducted a much more thorough
vetting, including a formal documented decision, for an issue of such
enormous financial magnitude, although the end result may have been the
same in 2004 as today. The informal and cavalier manner in which this
matter was communicated by career staff from MMS and the Solicitor's
office, however, did not serve Ms. Burton--or the previous MMS
Directors--well.
Question 5. Please explain why the Report refers to certain
individual Department of the Interior officials by name and position,
while identifying other individuals by position only. Similarly, please
explain why the Report does not identify by name political appointees
serving at the Department of the Interior during the time of the issued
leases which are the subject of the Report while identifying current
political appointees by name.
Answer. Two versions of the Report of Investigation were provided
to the Committee--an unredacted version which contained the names of
all individuals interviewed, as well as all attachments, and a redacted
version which was prepared for public dissemination which did not
include attachments or the names of certain individuals, including the
former Directors of MMS. The practice of my office is to issue a public
version of high-profile reports which protects the personal privacy
interests of those individuals whose identity warrants protection
pursuant to the balancing of personal privacy interest against public
disclosure, as required by the Freedom of Information and Privacy Acts.
In this case, we concluded that the identities of the former Directors
who have since left public service and who were not advised of the
omission during their tenure, should be protected. They are, however,
identified by name in the unredacted version of the report that was
provided only to the Department and the Committee.
Question 6. In your testimony before the Committee, you stated
that, ``there is blame enough to go around.'' However, would you
acknowledge that the Report fails to determine who is ultimately
responsible for omitting price thresholds on the leases issued in 1998
and 1999 and who is responsible for the failure to address this issue
when first discovered (as shown by the Report's evidence in 2000)?
Answer. While I continue to believe that there is blame enough to
go around, I agree that our investigation and the resulting report
fails to identify precisely who was ultimately responsible for omitting
price thresholds on the leases issued in 1998 and 1999. I believe our
report does, however, identify the individual responsible for the
decision not to address the discovery in 2000. Unfortunately, that
person is deceased.
Question 7. In your judgment, who told Mr. Rodi to omit price
thresholds from the 1998 and 1999 leases in question? Why was Mr. Rodi
given this directive?
Answer. While I have no reason to believe that Mr. Rodi changed the
language in the lease documents unilaterally, our investigation was
unable to definitively discern who gave Mr. Rodi this direction.
Because we could not identify precisely who gave this direction,
however, and we could not find a paper trail to support this decision,
we are left to speculate as to why.
Question 8. In the Report, there are references to several
interviews. Are these interviews transcribed? And, if so, is the record
of these interviews made available? Are these interviews performed
under oath?
Answer. The interviews we conducted were neither transcribed nor
performed under oath. Investigative Activity Reports documenting the
interviews were included in the unredacted Report of Investigation as
Attachments. In the case of four witnesses, we asked that they prepare
written statements that they then signed under oath. These are also
included as Attachments to the unredacted Report.
Question 9. In as complete a manner as possible, please identify
all employees of the Department of the Interior employed at any period
of time between January 1993 and January 2007 who participated in any
manner, (and specify the individual's title, office, role and level of
participation) in the following:
The drilling of the Deepwater Royalty Relief Act of 1995
(DWRRA).
The consideration of the Statement of Administration
Position of the DWRRA.
The consideration and/or drafting of any rules and/or
regulations implementing the DWRRA.
The consideration, preparation and approval process of any
oil and gas leases issued between the years 1995 and 2001.
Please specify the leases and employees.
The preparation for and participation in public meeting held
in Louisiana on March 12 and March 13, 1996 referenced on page
5 of the Report.
The phone conversation and subsequent discussions relating
to the phone conversation involving Mr. John Rodi referenced on
page 7 and page 8 of your report.
The 1998 APPL Committee meeting referenced on page 14 in
your report.
The consideration and approval of all Proposed Notice of
Sales Final Notice of Sales from January 1, 1997 to January 1,
2001, including those individuals participating in the surname
process.
The decision to exclude addenda incorporating royalty relief
restrictions in the first instance on 1998 leases referenced on
page 8 of the Report.
The decision in the first instance to include an addendum on
leases issued in 2000.
Answer. Much of the information requested here goes beyond the
scope of our investigation. To the extent our investigation addressed
these issues, they are contained in our report and the attachments.
Most of this information could be best provided by MMS.
Question 10. To the best of your knowledge, please identify all
communications between the Office of Inspector General and the New York
Times between January 1, 2007 and January 7, 2007.
Answer. The Office of Inspector General had no communications with
the New York Times between January 1, 2007 and January 7, 2007.
Question 11. Under the byline dated January 16, 2007 Edmund Andrews
of the New York Times wrote the following, in reference to MMS Director
Johnnie Burton, ``A top official was told nearly three years ago about
a legal blunder that allowed drilling companies to avoid billions of
dollars in payments for oil and gas pumped from publicly owned waters,
a report by the department's chief independent investigator has
found.'' Is this statement accurate in its entirety? Is this statement
an accurate reflection of your thoughts or the Report findings? If this
statement is not accurate, please elaborate specifically on how it
conflicts with the findings of the Report.
Answer. The statement in the January 16, 2007 New York Times
article was more conclusory than our report was. In this regard, I
reiterate a portion of my response to question #2, above: While Johnnie
Burton has told us that she has no independent recollection of being
told about the issue in 2004, she readily conceded that the e-mails we
presented to her suggested otherwise. She went on to speculate what her
thinking may have been nearly 3 years ago. Neither I nor my
investigators found reason to question Ms. Burton's veracity about this
issue.
Question 12. Please list the date that the Report was made
available to the public?
Answer. The redacted version of our report was made available to
the public via the Office of Inspector General website
contemporaneously with my testimony on January 18, 2007.
Question 13. Please list all applicable federal statutes pertaining
to the public availability of information in a Report of Investigation
from the ice of Inspector General of the Department of the Interior.
Answer. The Freedom of Information and Privacy Acts are the primary
federal statutes guiding public availability of a Report of
Investigation issued by the Office of Inspector General for the
Department of the Interior. Additional statutes governing grand jury
secrecy, confidential business information, and other privileges may
also apply to our determination of the content of reports made
available to the public.
Question 14. Are you investigating how the New York Times reported
on aspects of the content and substance of the Report prior to its
receipt by the U.S. Senate Committee on Energy and Natural Resources
and prior to its public release?
Answer. The New York Times has reported on several issues being
investigated by my office. Various articles have contained information
that had not been publicly released at the time of publication. In one
instance, we had provided limited information to the Department about
the investigation, but had also conducted a considerable number of
interviews. In regard to the Report of Investigation which we released
publicly on the date of my testimony, we had provided copies of the
report to the Department and the Committee 2 days prior. I do not know
how the New York Times obtained the information that was published in
the articles, in either instance, but the article referred to
``sources'' that appear to have been disgruntled MMS employees. The OIG
is not, however, conducting an investigation into these incidents.
Question 15. Are you concerned that with the approximately 40
stories published by the New York Times in just the past year on the
issue of royalty relief, the release of privileged and confidential
information prior to its public availability could prejudice the
integrity of your investigations and the fairness of any potential
civil or criminal litigation? What steps are you taking to avoid this?
Could improvements be made with regard to this issue? If so, please
specify.
Answer. While I am concerned about information being reported
prematurely in a national publication, I do not believe that any
potential civil or criminal litigation has been compromised by the
articles. Because I am obligated by the Inspector General Act of 1978,
as amended, to inform the Secretary and Congress of problems and
deficiencies related to the programs and operations of the Department,
I cannot necessarily control the further dissemination of such
information. To the extent that information I provide to the Secretary
or Congress is privileged or confidential, I will always identify it as
such and request that it be treated accordingly.
Question 16. In Feb. 2001, the Associate Director of Offshore
Minerals wrote, ``For Notices of Sales held in 1998 and 1999 the price
trigger language was left out of the Notices and lease document. This
was within the discretion of MMS and the Secretary.'' The Associate
Director does not note that this was a ``mistake.'' Since your report
does not determine who directed Mr. Rodi to modify these terms, in
1998, or why they were modified, please provide specific evidence that
allows you to conclude that this change was a ``mistake.''
Answer. Several of the interviews included in the report identify
statements of MMS employees indicating their belief that the omissions
were the result of a mistake. Additionally, the e-mails included in the
report indicate that the authors of the e-mails in 2000 (after
discovery of the omissions) considered the omissions to be a mistake.
Moreover, the action taken by MMS in 2000 after discovery of the
omissions, to include the price thresholds in the leases for Sale 175,
indicate that MMS was attempting to correct a mistake, rather than
changing a conscious decision to not include them in 1998 and 1999.
Ultimately, a distinction must be made between the intentional act
by Mr. Rodi to include reference to regulations in the leases and the
mistaken result, which was the omission of price thresholds.
Question 17. Please reconcile seemingly conflicting findings on
page 5 and 6 of the Report, which suggest that both thresholds on all
deepwater leases issued between 1996 and 2000 was a Department of the
Interior policy and that threshold language was affirmatively excluded
from 30 CFR 260 because according to the Report, Mr. Cruickshank
asserted that, ``MMS wishes to remain flexible in deciding whether the
thresholds would apply on a sale-by-sale basis.''
Answer. According to MMS Deputy Director Cruickshank, it was the
policy of MMS to include the price thresholds in all of the leases
issued between 1996 and 2000. Cruickshank also stated that MMS decided
not to include price thresholds in 30 CFR 260 because MMS wished to
retain flexibility in deciding ``whether the thresholds would apply on
a sale-by-sale basis.'' These findings are not conflicting. MMS did in
fact retain its flexibility in applying the thresholds because it
theoretically could change its policy at any time not to include the
price thresholds if they desired to do so, whereas, if the thresholds
were placed in the regulation, MMS' flexibility in applying the
thresholds would be greatly diminished since MMS could not readily
change the regulation.
Question 18. Please provide all evidence to support the contention
that the inclusion of price thresholds on deepwater leases issued from
1996 through 2000 was an Official policy of the Department of the
Interior. Please specify in the evidence that you proffer, how one
typically shows that a particular practice of the Department of the
Interior is classified as Department policy.
Answer. All evidence was included in our report. MMS record keeping
on policy development and retention was found to be deficient and a
major obstruction to our investigation. We relied upon interviews and
e-mail reviews to corroborate statements that asserted it was MMS
policy to include thresholds.
Question 19. On page 5 of the Report, Mr. Cruickshank is reported
to state that based upon Section 303 of the DWRRA, MMS made the policy
decision in 1995 to apply price thresholds to all new leases issue
under the Act. However, in February 1996, the MMS in its Advanced
Notice of Proposed Rulemaking (as detailed on page 3-4 of the Report)
asked for comments on whether price thresholds should apply to
suspension volumes for new leases. How do you reconcile these
inconsistencies?
Answer. The PowerPoint presentation that occurred on March 12-13,
1996, which is the only documentation we identified indicating MMS'
intention to apply price thresholds to upcoming sales, occurred prior
to MMS receiving responses to the ANPR. We can not explain the rational
behind the ANPR question. This would be better answered by MMS.
Question 20. On page 6 of the Report, Mr. Mason is quoted as
testifying on June 21, 2006 to the House Subcommittee that, ``most of
my legal advise is oral.'' Please provide evidence beyond this
testimony that shows that it was the practice of the Office of the
Solicitor during the time of the issuance of leases in question to
render advice on matters of such significance as the applicability of
price thresholds on oil and gas leases in oral rather than in written
form, through memos or opinions.
Answer. The OIG has, through various audits and investigations,
identified multiple instances in which the Office of the Solicitor
renders legal advice in oral or summary check-list form, rather than in
formal written form through memoranda or opinions. We have shared our
concern about this practice with the Solicitor who has said he is
taking corrective action.
Question 21. In your investigation, did you find any written advice
or opinion from the Office of the Solicitor during the time of the
issuance of the leases in question bearing on the question of whether
to include price thresholds in either leases or by regulation? If so,
please provide that information to the fullest extent possible and
available.
Answer. We did not find any such written advice or opinion.
Question 22. Please comment specifically on the kind of flexibility
pursuant to the DWRRA that the Secretary of the Interior is given in
choosing to omit price thresholds from regulation and instead apply
such thresholds on a lease-by-lease basis.
Answer. We did not analyze the authority of the Secretary under
DWRRA as a part of our investigation. We relied on the information
provided by witnesses as to MMS' interpretation of this authority.
Question 23. How many leases did the Department of the Interior
issue in 1998 and 1999 pursuant to the DWRRA? Now many of the leases
contained thresholds? How many of these leases are still active at
present? Please explain with specificity the status of all of the
leases that are not active.
Answer. According to information supplied to us by MMS, 1032 leases
were issued in 1998 and 1999 and 570 remain active, and none of the
leases contain thresholds. MMS would be better situated to explain the
status of all of the leases that are not active.
Question 24. With respect to royalty collections, are their (sic)
compliance review practices employed by the private sector and other
federal agencies that you believe should be adopted by the MMS? If so,
which?
Answer. We determined that MMS could benefit from adopting
practices similar to the Internal Revenue Service (IRS). IRS has a
similar mission to collect monies that are due to the federal
government. In addition to audits, IRS extensively uses automated
procedures to analyze tax returns and identify potential errors or
irregularities. These procedures can identify discrepancies within the
tax returns that are potential errors to be corrected. Additionally,
the procedures can match information submitted by the taxpayer with
related information submitted by other parties, such as the taxpayer's
employer.
MMS would benefit by implementing similar automated procedures.
These automated procedures could identify discrepancies in the
information provided by companies reporting both production and royalty
information. MMS could also match data provided by companies to other
independent sources, such as the Bureau of Land Management's inspection
data.
We also believe that MMS would benefit by adopting some of the
performance measurement practices of the IRS. MMS should consider
additional performance measures and goals to assess the efficiency of
its operations. The IRS has multiple measures related to processing tax
returns and resolving compliance issues, which help evaluate the
efficiency of its operations. For example, in FY2005, one IRS
efficiency measure was calculated by dividing the total number of
examined tax returns by the number of employees. MMS could compute
similar efficiency rates for its own audits and compliance reviews.
We did not identify any private sector practices that we recommend
MMS adopt.
Question 25. Do you believe that the MMS should continue to
undertake audits and compliance reviews? If not, which entity should be
responsible for these activities?
Answer. Having the royalty audit function in MMS creates the
potential for a conflict of interest, either in fact, or at minimum, in
appearance. Audit organizations have a responsibility to maintain
independence so that their opinions, conclusions, judgments and
recommendations will be impartial and will be viewed as impartial by
knowledgeable third parties. Royalty audits require auditors to
independently assess the accuracy of royalty information reported by
companies to MMS. Reasonable questions can arise about independence
when the auditors are within MMS, the organization whose primary
mission includes collecting, accounting for and distributing royalty
revenues.
In addition to its fiduciary role over royalties, MMS also
establishes and enforces applicable regulations and negotiates leases
with the companies extracting minerals. It can be difficult for third
parties to consider MMS auditors as independent when MMS is party to
the leases under review. Whether or not the perception of
``friendliness to industry'' is accurate, the current positioning of
the audit organization within MMS lends credence to the ability of MMS
to use the audit function to push an agenda.
The Office of Inspector General (OIG) may be better suited to
manage the royalty audit function because of its status as an
independent audit and investigative organization. The Inspector General
Act of 1978 establishes the independence of the Inspector General by
removing the inherent conflict of interest that exists when audit and
investigative functions are under the authority of the program being
reviewed. This independence is brought about by the fact that the
Inspector General, by law, reports to both the Secretary of the
Department and the Congress. Moving the function from MMS to OIG would
sever the relationship between audits and the programmatic functions of
managing leases and collecting, accounting for, and distributing
royalty revenues. The Department would be less prone to criticism
concerning its compliance program, because audits would be conducted by
the organization responsible for auditing the Department.
Question 26. Do you believe you should have a permanent role in
overseeing MMS' audit and compliance activities?
Answer. I believe that the GIG already has a permanent role in
overseeing MMS' audit and compliance review activities, as long as MMS
is a part of the Department of the Interior.
Question 27. Do you believe that additional funding is required in
order for MMS to adopt the recommendations contained in the Compliance
Review Report? If yes, what do you believe would he an adequate amount?
Answer. This question would be better addressed by MMS, which could
better assess the amount of resources it needs to implement its action
plan. In our opinion, it is possible that MMS may need some additional
resources on a temporary basis for initial implementation of our
recommendations. Once the recommendations are implemented, however, we
do not believe that there would be an ongoing need for additional
resources to maintain the new processes. For example, addressing data
reliability will require a significant one-time effort to evaluate and
correct existing data in MMS' systems and to develop new procedures to
ensure the reliability of future data entered into the systems. This
one-time project may require significant resources or the redirecting
of current resources from other activities such as current audits and
compliance reviews. Once MMS implements new procedures for ensuring
reliable data, the need for additional resources would diminish. MMS
should make a determination of whether additional resources are
necessary.
Question 28. If additional funding for MMS is required for proper
royalty collection, for what purposes should it be appropriated? To
hire additional employees? To improve information technology?
Answer. In our opinion any additional funding in the near future
should be limited to those resources needed to implement the
recommendations in our report. For example, implementing the
recommendation designed to address data reliability issues may require
additional IT resources and expertise. Or MMS may need additional
resources to research and resolve the backlog of data needed to update
the system. Additional resources may also be required to implement the
recommendations aimed at strengthening the compliance review process by
increasing data testing. MMS should determine whether it needs
additional near term resources to meet the milestones set in its action
plan to implement the recommendations.
Currently, MMS does not have the data that would be needed to
develop a cost/benefit analysis to support a general increase in
funding for compliance operations. In our opinion, MMS should first
address the data reliability issues, improve its compliance review
procedures, and develop performance measures that better reflect its
operations, before expanding its program. Once those tasks are
accomplished, then an evaluation could be performed to determine the
optimal amount of funding that would ensure MMS effectively completes
its mission.
Any additional funding that is provided should be specifically
directed to the Compliance and Asset Management Program to ensure that
the funds are solely used to improve the royalty compliance process.
Additional funding could be used by MMS in the future to increase the
number of companies subjected to compliance reviews and/or audits,
perhaps increasing the identification of underreported royalties.
Question 29. It is my understanding that you are preparing a report
on pending Qui Tam suits in which four government auditors allege that
lessee companies failed to pay adequate royalties. When do you
anticipate that this report will be completed?
Answer. My investigative staff is working diligently to conclude
the investigation related to the Qui Tam suits as expeditiously as
possible. Given the recent verdict in the Qui Tam case against Kerr-
McGee, however, we must evaluate the impact that the verdict might have
on our pending investigation which will undoubtedly extend the time it
takes for us to conclude the matter. In addition, we have received
additional allegations from the Relators, some of which will be
incorporated into the current investigation; others may result in
additional, separate investigations. The pending investigation is
targeted to be complete by early spring.
Question 30. Can you assure this Committee that the privileged and
confidential nature of the information of this investigation regarding
the Qui Tam suits will be protected vigorously by the Office of
Inspector General and that information related to this investigation
will be provided to the public in a manner consistent with all
applicable Federal laws?
Answer. Yes. The OIG takes seriously its obligation to protect any
privileged and confidential information that becomes the subject of an
investigation or audit. We also take seriously our obligation to inform
the Secretary, the Congress and the public of the results of our audits
and investigations, in keeping with applicable laws and regulations. In
this regard, the general practice of the OIG is to provide a limited
number of unredacted reports to the Secretary, and to the Congress,
when we receive a written request from the Chair of a Committee or
Subcommittee. The OIG must rely on the Secretary and Congress to assist
in protecting such information when it is disclosed in such a limited
way.
The OIG also goes to great lengths to issue a reader-friendly,
public version of high-profile reports which protect privileged and
confidential information as well as the personal privacy interests of
those individuals whose identity warrants protection pursuant to the
balancing of personal privacy interest against public disclosure,
required by the Freedom of Information and Privacy Acts.
Question 31. Between 1998 and 2001, the Justice Department settled
16 Qui Tam lawsuits for nearly $440 million. The suits alleged that
between 1980 and 1998, lessee companies underpaid on royalty
obligations. What new regulations, if any, were promulgated by the
Department of the Interior as a result of these lawsuits?
Answer. This was beyond the scope of our investigation. We believe
that this question would be best answered by MMS.
Question 32. Please comment on the duties and responsibilities of
the MMS as well as the duties and responsibilities of lessees to oil
and gas leases on federal lands as it currently exists pursuant to the
Federal Oil and Gas Royalty Management Act or 1982 and amendments to
that Act, as well as all other relevant Federal law. And, do you think
these duties and responsibilities ensure fairness and accuracy in the
process of royalty valuation and collection?
Answer. The MMS is responsible for Outer Continental Shelf leasing
and monitoring activities as well as for collecting, accounting for,
and distributing royalties paid by companies that extract oil, gas, and
other minerals from leased federal and Indian properties. Lessees are
responsible for accurately reporting and paying royalties from leased
federal and Indian properties. The applicable royalty and leasing laws
include the Allotted Indian Land Leasing Act of 1909, as amended; the
Mineral Leasing Act of 1920, as amended; the Indian Mineral Leasing Act
of 1938; the Minerals Leasing Act for Acquired Lands of 1947, as
amended; the Outer Continental Shelf Lands Act of 1953, as amended; the
Geothermal Steam Act of 1970; the Combined Hydrocarbon Leasing Act of
1981; the Indian Mineral Development Act of 1982; the Federal Oil and
Gas Royalty Management Act of 1982; the Federal Oil and Gas Leasing
Reform Act of 1987; the Federal Oil and Gas Royalty Simplification and
Fairness Act of 1996; and the Deep Water Royalty Relief Act.
The royalty monitoring process is complicated due to the large
number of leases, differences in lease terms, and various valuation
issues. Royalty valuation has been a contentious issue since at least
the early 1980s. MMS has made efforts to improve valuation guidance and
has issued revised guidance on both Federal Oil and Gas regulations as
well as Indian Gas regulations. MMS has worked to keep those
regulations up-to-date by amending them as appropriate.
Our December 2006 audit report concluded that compliance reviews
can serve a useful role as part of MMS' Compliance and Asset Management
Program. However, compliance reviews do not provide the same level of
assurance as an audit and therefore should only be used in conjunction
with audits in a coordinated compliance strategy. We believe that
implementation of the report's recommendations should improve the
accuracy of royalty collections.
Responses to Questions From Senator Thomas
Question 1. Can you provide me with the following lists of Interior
Department Officials? Please indicate their tenure at the Department of
the Interior and whether or not they are still working for the federal
government in any capacity? I would like to know:
Who at the Department of the Interior was involved in the issuance
of offshore oil and gas leases in the 1998 to 1999 time frame.
Who at the Department of the Interior was involved in the drafting
of the Deep Water Royalty Relief Act of 1995.
Who at the Department of the Interior was responsible for including
price thresholds in leases issued during 1998 and 1999.
Answer. Our investigation focused on how and why price thresholds
were not included in the 1998 and 1999 leases, and what the
Department's response was once the omission was discovered. In our
Report of Investigation, we have identified everyone that we were able
to determine may have been involved in either of these two aspects. We
did not endeavor to discern who, if anyone, at the Department was
involved in the drafting of the Deep Water Royalty Relief Act of 1995.
Question 2. You have shared in testimony before the House and
Senate your assessment of the way in which Johnnie Burton initially
handled finding out about the omission of price thresholds in the 1998
and 1999 leases. Assuming the Solicitor's opinion that there was no
legal option at Director Burton's disposal to recover lost revenues is
accurate and would have remained so regardless of how public those
deliberations were, do you care to elaborate on the way in which
Director Burton has subsequently handled the effort to fix this
problem?
Answer. I commend the efforts of Director Burton, Assistant
Secretary Allred and the Office of the Solicitor to seek voluntary re-
negotiation of the leases by the lessee oil companies. I believe that
they are now exploring all possible avenues to ameliorate this problem.
______
Government Accountability Office,
Natural Resources and Environment,
Washington, DC, February 6, 2007.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate.
Hon. Pete Domenici,
Ranking Minority Member, Committee on Energy and Natural Resources,
U.S. Senate.
Hon. Jeff Sessions,
U.S. Senate.
This letter acknowledges the questions you submitted concerning our
testimony on oil and gas royalty management before the Senate Committee
on Energy and Natural Resources on January 18, 2007. Please see the
enclosure for our responses.
Mark E. Gaffigan,
Acting Director.
[Enclosure.]
Responses to Questions From Senator Bingaman
Question 1. Royalty Rates--Chairman Rahall and I asked you to look
at whether the royalty rates being charged for the production of oil
and gas by the Department are commensurate with rates charged by states
on state land and by private landowners on their lands. Can you share
your findings to date with us?
Answer. We are currently in the process of evaluating and comparing
the federal government's royalty rates to those of Alaska, Colorado,
Louisiana, Montana, New Mexico, Texas, Utah, and Wyoming as well as
private landowners, where possible. As part of this study for you and
Representative Rahall, we are also considering other contract terms
that may impact the royalty rates charged, including factors such as
bonus bids and rental fees. We plan to share our preliminary findings
with your offices in February 2007.
Question 2. Price Assumptions--Your testimony indicates that
precise estimates of the revenues forgone to the Treasury remain
elusive. However, MMS has indicated that the price threshold issue may
result in up to $10 billion in forgone revenues over 25 years and that
the Kerr McGee (Anadarko) litigation puts $60 billion at risk. What are
the price assumptions underlying these estimates?
Answer. It is our understanding that MMS estimates assumed prices
from January 2005 onwards of $45 per barrel of oil and $5.63 per
million cubic feet of gas adjusted by an annual inflation rate of 2.1
percent.
Question 3. Ongoing Work--Can you please describe GAO's ongoing
work with respect to oil and gas royalties and provide us with a
timeline for completion of the work?
Answer. We currently have three engagements underway in response to
congressional requests about oil and gas royalties. The first
engagement is reviewing the laws and regulations for the offshore
royalty relief program and estimating the fiscal impact of royalty
relief on leases issued under the Outer Continental Shelf Deep Water
Royalty Relief Act and other authorities. The second engagement
currently focuses on two major blocks of work (1) comparing federal oil
and natural gas royalty rates, as well as other contract terms, with
state and private royalty rates and terms; and (2) describing statutory
and regulatory ``diligent development'' requirements for federal lands.
We plan to discuss the timeline for the completion of both of these
assignments with your staff in February in order to attempt to best
meet the needs of the Committee. The third engagement, which will be
staffed in February, will analyze the accuracy of royalties collected
on oil, condensate, and natural gas produced under leases of federal
and Indian lands. A timeframe for this work has not yet been agreed
upon with the requesting members' offices.
Responses to Questions From Senator Domenici
Question 1. In your testimony, you state that the failure to
include thresholds in the 1998 and 1999 leases could cost up to $10
billion in forgone royalty revenue. How did you arrive at this
estimate? How does this estimate change by the fact that six of the
company lessees have come forward and renegotiated these leases?
Answer. The estimate of $10 billion in foregone royalty revenues,
resulting from the failure to include price thresholds in the 1998 and
1999 leases, was developed by the Minerals Management Service (MMS).
GAO has not yet completed an independent assessment of these foregone
royalties. Further, the scope of our ongoing work does not include an
assessment of how the ongoing negotiations between MMS and the six
companies will affect estimates of foregone royalty revenues.
Question 2. How did you arrive at your estimate to the potential
cost to the Federal Treasury with respect to the possibility of an
unfavorable outcome for the United States in the Kerr McGee lawsuit,
referenced in page 7 of your testimony as Kerr-McGee (Anadarko) suit 3/
17/06, W Dist. LA, CV06-0439LC? Was this MMS estimate of $60 billion
referenced on page 7 of your testimony ever published by MMS? Please
state what the GAO estimate is at present?
Answer. MMS developed the $60 billion estimate in foregone royalty
revenues should the Kerr-McGee (Anadarko) lawsuit result in an
unfavorable outcome for the United States--whereby MMS could not
enforce price thresholds on any of the leases issued under the Deep
Water Royalty Relief Act of 1995 for the period 1996-2000. As noted
above, GAO's assessment of MMS' estimates is ongoing. To our knowledge,
this MMS estimate was not published.
Question 3. In the introductory page of your written testimony
dated January 18, 2007, you state that, ``at least (emphasis added) $1
billion [of which] has already been lost'' because of the failure to
include price thresholds on the 1998 and 1999 leases. On page 3 of your
statement you state that, ``about (emphasis added) $1 billion has
already been lost. Can you provide a precise amount of royalty revenue
that has been lost? Please comment on the accuracy of your estimate,
describe how you arrived at this estimate and comment on whether this
is consistent with the Department of the Interior's estimate of
revenues lost thus far.
Answer. Because GAO's work is still ongoing, we do not have a
precise estimate of the foregone royalty revenue resulting from the
lack of price thresholds in 1998 and 1999 leases. Our reference of $1
billion refers to an analysis performed by MMS, which showed forgone
royalty revenue of slightly greater than $1 billion.
Question 4. In the introductory page of your written testimony, you
state that, ``In October 2004, MMS estimated that foregone royalties on
deep water leases issued under act from 1996 through 2000 could be as
high as $80 billion.'' Please specify who at MMS made this estimate and
whether this estimate was ever published in any form. Please also
comment on whether the Director of MMS made or was aware of this
estimate.
Answer. The Economics Division of MMS, located in Herndon,
Virginia, prepared this estimate. The $80 billion estimate is the
combination of potential foregone royalties from: (1) litigation that
overturned MMS's application of royalty suspension volumes on a field
basis ($10 billion); (2) MMS's failure to include price thresholds in
the 1998 and 1999 leases ($10 billion); and (3) MMS potentially losing
Kerr McGee's (Anadarko's) legal challenge to the application of price
thresholds for 1996, 1997, and 2000 leases ($60 billion). We are not
aware of whether this estimate was published, nor do we know whether
the Director of MMS was made aware of this estimate.
Question 5. You state on page 2 of your testimony that the GAO is
reviewing appropriate portions of the Energy Policy Act of 2005
(EPAct). Can you please specifically identify the sections that contain
oil and gas royalty relief provisions and of those sections, please
identify those that do not allow for the application of price
thresholds. Additionally, please identify those sections in which
leases issued pursuant contain price thresholds and those which do not.
Answer. As stated in our testimony, the sections of the Energy
Policy Act of 2005 that contain oil and gas royalty relief provisions
include Sections 344, 345, 346, and 347. For these sections, the Act
provides the authority to the Secretary of Interior to place
limitations on royalty relief based on market prices.
Question 6. On page 6 of your testimony, you state that the Santa
Fe Snyder decision cost the federal government up to $10 billion in
foregone future royalty revenue. Would it be more accurate, in fact, to
state that the Fifth Circuit Court of Appeals affirmed Federal District
Court's holding that the Department of the Interior was in fact
implementing royalty relief in a manner contrary to the intent of the
Deepwater Royalty Relief Act? Would it be more accurate to state that
the Department of the Interior's decision in the 1990's to apply this
royalty relief on a field basis was contrary to the law?
Answer. GAO's work examines the fiscal impacts of royalty relief on
leases issued under the Outer Continental Shelf Deep Water Royalty
Relief Act of 1995. Specifically, GAO is reviewing the revenue that the
government would have collected but for the Act, which in our
testimony, we referred to as ``forgone'' or ``lost'' revenue. The
Court's interpretation of the Act in the Santa Fe Snyder decision, that
the royalty relief in question must be implemented on a lease basis,
resulted in an increase in the dollar amount of forgone revenue under
the Act, as compared to the dollar amount based on MMS's field basis
interpretation. As we noted in our testimony, MMS estimates that the
decision increased future forgone royalty revenues under the Act by up
to $10 billion. Whether MMS's initial determination to apply the relief
on a field basis was contrary to law, was not relevant to our estimate
of revenue forgone under the Act.
Question 7. How many leases did the Department of the Interior
issue in 1998 and 1999 pursuant to the Deepwater Relief Act? How many
of the leases contained thresholds? How many of these leases are still
active at present? Please explain with specificity the status of all of
the leases that are not active.
Answer. According to data provided by MMS, 1,032 leases were issued
in the Gulf of Mexico in 1998 and 1999, none of which included price
thresholds. As of December 31, 2006, 574 of the 1998 and 1999 leases
were still active. GAO does not have detailed information on the
remaining 458 leases.
Question 8. On page 8 of your written testimony, you state that,
``to fully evaluate the impacts of royalty relief one must consider the
potential benefits in addition to the costs of lost royalty revenue.''
Why was such an evaluation and assessment not made?
Answer. A number of Congressional members asked GAO to examine the
costs of royalty relief--in light of rapidly rising oil and gas prices
and press reports and questions by other interested parties as to
whether the oil and gas industry was paying its fair share of
royalties--not the benefits. However, as GAO indicated in its
testimony, benefits are an important part of an overall assessment of
royalty relief. These benefits may include increased bonus bids,
greater production, and increased oil and gas exploration, among other
things. We are in the process of identifying studies that attempt to
analyze the benefits of royalty relief.
Question 9. Please elaborate more fully on your statement on page 9
of your written testimony, ``However questions remain about the extent
to which such benefits would offset the cost of lost royalty
revenues.'' Should such ``benefits'' factor into estimates of lost
revenue?
Answer. The potential benefits of royalty relief should be netted
out of the foregone revenue associated with royalty relief to get a
full accounting of the costs and benefits of the relief. These benefits
include potentially higher bonus bids on leases as well as any
associated benefits that accrue as a result of an increase in oil
production that would otherwise not have occurred.
Question 10. The estimates from GAO fail to take into account
potential increased production (and thus increased royalties) as a
result of providing royalty relief. Does the GAO similarly fail to
estimate the economic impact that increased domestic production has on
a reduction in our nation's trade deficit in providing economic
analysis of the impacts of royalty relief?
Answer. To our knowledge, no full cost-benefit study of the Outer
Continental Shelf Deep Water Royalty Relief Act of 1995 has been
conducted. Such a complete study would be very difficult to achieve
with any assurance of accuracy because (1) the final costs depend on
future oil production and future oil prices and these are difficult to
predict, and (2) estimating the benefits depend on determining how much
of the oil production that will occur is the result of, rather than
simply coincident with, royalty relief. Because oil prices are much
higher now than in 1995, when the royalty relief act was passed, the
expected costs of the relief have gone up considerably. In addition,
such higher oil prices would likely have led to greater oil exploration
and development in the deep water regions of the Gulf of Mexico, even
in the absence of royalty relief. These changing conditions are
indicative of the difficulty in estimating the full costs and benefits
of royalty relief.
Responses to Questions From Senator Sessions
Question 4. Based on your understanding of the Energy Security Act
of 2005 (``Act'') (Public Law No. 109432), and assuming that no further
negotiations are successful in including price thresholds in existing
leases, what is the actual impact, in dollar terms, of the exclusion of
price thresholds in the leases in question on the amount of royalty
revenue that is shared with producing states under the revenue-sharing
provisions of the Act during the next ten years? What is your estimate
of the impact on the revenue shared with the state of Alabama,
specifically?
Answer. The scope of GAO's work to date has not included the
estimated fiscal impacts of the revenue-sharing portions of Gulf of
Mexico Energy Security Act of 2006 on producing states. We are unaware
of any estimate having been completed on this issue.
Question 5. Based on your understanding of the Energy Security Act
of 2005 (``Act'') (Public Law No. 109-432), and assuming that no
further negotiations are successful in including price thresholds in
existing leases, what is the actual impact, in dollar terms, of the
exclusion of price thresholds in the leases in question on the amount
of royalty revenue that is shared with producing states under the
revenue-sharing provision of the Act in the years between 2017 and the
expiration of any then existing leases? What is your estimate of the
impact on the revenue. shared with the state of Alabama, specifically?
Answer. The scope of GAO's work to date has not included the
estimated fiscal impacts of the revenue-sharing portions of Gulf of
Mexico Energy Security Act of 2006 on producing states. We are unaware
of any estimate having been completed on this issue.