[Senate Hearing 110-326]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 110-326
 
 OVERSIGHT OF THE OUTER CONTINENTAL SHELF OIL AND NATURAL GAS ROYALTY 
                               MANAGEMENT 

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

                                HEARING

                                before a

                          SUBCOMMITTEE OF THE

            COMMITTEE ON APPROPRIATIONS UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                            SPECIAL HEARING

                   FEBRUARY 13, 2007--WASHINGTON, DC

                               __________

         Printed for the use of the Committee on Appropriations


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

                               __________


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                      COMMITTEE ON APPROPRIATIONS

                ROBERT C. BYRD, West Virginia, Chairman
DANIEL K. INOUYE, Hawaii             THAD COCHRAN, Mississippi
PATRICK J. LEAHY, Vermont            TED STEVENS, Alaska
TOM HARKIN, Iowa                     ARLEN SPECTER, Pennsylvania
BARBARA A. MIKULSKI, Maryland        PETE V. DOMENICI, New Mexico
HERB KOHL, Wisconsin                 CHRISTOPHER S. BOND, Missouri
PATTY MURRAY, Washington             MITCH McCONNELL, Kentucky
BYRON L. DORGAN, North Dakota        RICHARD C. SHELBY, Alabama
DIANNE FEINSTEIN, California         JUDD GREGG, New Hampshire
RICHARD J. DURBIN, Illinois          ROBERT F. BENNETT, Utah
TIM JOHNSON, South Dakota            LARRY CRAIG, Idaho
MARY L. LANDRIEU, Louisiana          KAY BAILEY HUTCHISON, Texas
JACK REED, Rhode Island              SAM BROWNBACK, Kansas
FRANK R. LAUTENBERG, New Jersey      WAYNE ALLARD, Colorado
BEN NELSON, Nebraska                 LAMAR ALEXANDER, Tennessee
                    Charles Kieffer, Staff Director
                  Bruce Evans, Minority Staff Director
                                 ------                                

 Subcommittee on Department of the Interior, Environment, and Related 
                                Agenics

                 DIANNE FEINSTEIN, California, Chairman
ROBERT C. BYRD, West Virginia        WAYNE ALLARD, Colorado
PATRICK J. LEAHY, Vermont            LARRY CRAIG, Idaho
BYRON L. DORGAN, North Dakota        TED STEVENS, Alaska
BARBARA A. MIKULSKI, Maryland        THAD COCHRAN, Mississippi
HERB KOHL, Wisconsin                 PETE V. DOMENICI, New Mexico
TIM JOHNSON, South Dakota            ROBERT F. BENNETT, Utah
JACK REED, Rhode Island              JUDD GREGG, New Hampshire
BEN NELSON, Nebraska                 LAMAR ALEXANDER, Tennessee
                           Professional Staff
                            Peter Kiefhaber
                              Ginny James
                             Rachel Taylor
                             Scott Dalzell
                             Chris Watkins
                       Leif Fonnesbeck (Minority)
                        Rebecca Benn (Minority)
                         Calli Daly (Minority)

                         Administrative Support
                         Katie Batte (Minority)
































                            C O N T E N T S

                              ----------                              
                                                                   Page

Opening statement of Senator Dianne Feinstein....................     1
Statement of Hon. C. Stephen Allred, Assistant Secretary, Land 
  and Minerals Management, Department of the Interior............     2
    Prepared statement...........................................     5
Statement of Senator Lamar Alexander.............................    13
Statement of Senator Pete V. Domenici............................    17


 OVERSIGHT OF THE OUTER CONTINENTAL SHELF OIL AND NATURAL GAS ROYALTY 
                               MANAGEMENT

                              ----------                              


                       TUESDAY, FEBRUARY 13, 2007

                           U.S. Senate,    
Subcommittee on Department of the Interior,
                 Environment, and Related Agencies,
                               Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 10:02 a.m., in room SD-124, Dirksen 
Senate Office Building, Hon. Dianne Feinstein (chairman) 
presiding.
    Present: Senators Feinstein, Reed, Craig, Domenici, and 
Alexander.


             opening statement of senator dianne feinstein


    Senator Feinstein. The meeting of the Interior 
Appropriations Subcommittee will come to order. Senator Craig 
is unavoidably delayed for a few minutes, but he will be along 
soon and has asked that we proceed ahead. I know there are 
meetings of other committees, so we might be short of members 
this morning, but I am delighted to see Senator Alexander here. 
Welcome, Senator. Great to have you here.
    This morning the subcommittee will hear from Stephen 
Allred, the Interior Department's Assistant Secretary for Land 
and Minerals Management. As the administration's designated 
point man on the royalty relief issue, Mr. Allred is here this 
morning to shed light on what is being done to recoup the 
billions of dollars lost to the Treasury as a result of the 
flawed 1998-1999 offshore oil and gas leases.
    Through bureaucratic oversight, the Department of the 
Interior issued offshore oil and gas leases in 1998 and 1999 
that did not include the necessary royalty price threshold 
language. The companies holding the leases have taken advantage 
of the oversight to avoid paying royalties, while at the same 
time reaping record profits. These companies know the 
Government does not give away drilling rights for free, but 
most of them have decided to stick to their position. As a 
result, they have deprived the American taxpayer of $1 billion 
thus far and may deprive the taxpayer of another $9 billion 
before the 1998-1999 leases expire.
    This should bother all of us on this subcommittee. No 
company should be allowed to earn enormous profits off the 
resources taken from publicly owned land and water without 
paying back a fair return to the taxpayer.
    Mr. Allred, I know you are not personally responsible for 
the fact that the Minerals Management Service signed leases 
with oil and gas companies that essentially gave away $10 
billion in royalty payments that were due the taxpayer. But you 
have nevertheless been delegated the unenviable task of 
resolving this problem. I want to assure you that I am ready to 
work with this administration to see that this enormous leak on 
the Nation's finances is plugged.
    We are gratified that you have been able to reach agreement 
with six companies to renegotiate their leases and pay 
royalties on their oil and gas revenues. That is a very 
important first step. But more needs to be done and I believe 
it is up to Congress to provide an additional stimulus.
    As you know, Mr. Allred, I proposed legislation that would 
require Secretary Kempthorne to enter into good faith 
negotiations over the 1998-1999 leases and deny a new lease to 
any company refusing to negotiate. I also look forward to 
exploring an additional idea with you that may in fact bring in 
the lion's share of what is still outstanding.
    Finally, I want to note that recently President Bush 
decided to open new areas in the Gulf and Alaska to deep water 
exploration. I am concerned about the ecological safety of 
additional offshore oil drilling. According to your own agency 
data, 113 platforms were destroyed and another 52 were 
extensively damaged by Hurricanes Katrina and Rita. One oil 
pipeline was moved 5,000 feet by Hurricane Rita. I hope you 
will be able to shed some light on the extent of ecological 
damages from oil spills during these hurricanes.
    I note that Senator Craig has not yet come, but what we 
will do when he comes, if it is agreeable, we will proceed with 
your presentation and perhaps interrupt you if necessary to 
hear from the ranking member.
    We are also joined by Senator Reed. Delighted to have you 
here this morning.
    The rule we will use will be the early bird rule modified 
by party. So we will do early bird, but go back and forth so 
that one side just cannot stack the deck, so to speak.
    So we are delighted to have you here, Mr. Allred, and 
unless members have a statement that they like to make we will 
proceed with your statement.
STATEMENT OF HON. C. STEPHEN ALLRED, ASSISTANT 
            SECRETARY, LAND AND MINERALS MANAGEMENT, 
            DEPARTMENT OF THE INTERIOR
    Mr. Allred. Thank you very much, Madam Chairman, Senator 
Alexander, Senator Reed. It is a pleasure to be here and I 
appreciate the opportunity to meet with you today to discuss 
our ongoing work as we address the absence of the price 
thresholds in the deep water leases that were issued in 1998 
and 1999 in the Gulf of Mexico.
    At the outset, let me state my belief that our Government 
employees have an obligation to protect the public interest of 
the United States and they must be perceived as doing so. If 
the public believes that we have somehow failed in this 
obligation, whether it is in fact or perception, the damage 
operates to the detriment of all of us.
    What I want to do in the next couple of minutes is just to 
allow you the maximum time for your questions, is to tell you 
what the Secretary and I are doing to deal with the issues that 
are the subject of this hearing. After the Senate confirmed me 
as Assistant Secretary some 4 months ago, Senator Kempthorne 
asked me, as you indicated, to review and manage the issues 
that were involved in the 1998 and 1999 leases and to deal with 
other royalty matters that were of concern.
    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 in perception. The Department 
has reviewed the Inspector General's report concerning the 1998 
and 1999 leases and the collection of oil and gas revenues. In 
addition, I have traveled to the Minerals Management Service 
Denver operations office, which is responsible for collecting 
the revenues that are due the United States, the States, and 
Indian tribes, and I have been thoroughly briefed and reviewed 
their processes.
    I have also traveled to the New Orleans Regional Office, 
which is the office in MMS that is responsible for both issuing 
the leases and managing those leases and in regulating the 
operations of the oil companies on the OCS.
    We have also formed, as you probably are aware, a high-
level review panel that will look at how we collect revenues to 
make sure that we have the input of an outside group as to how 
we can improve our operations. We hope to complete the 
selection of the panel members in the near future so that we 
can officially announce the membership of that panel.
    I would like to say, though, that, in my opinion and after 
my review, I believe that we are collecting the revenues that 
are due the United States, the States and the Tribes. However, 
with any large organization with complex operations, there are 
many opportunities to improve our operations and we look 
forward to doing that as we go forward.
    Now with regard to the absence of price thresholds in the 
1998 and 1999 leases. We are reviewing the Inspector General's 
report, which we asked for, to review or to gain a more 
complete understanding of what happened in 1998 and 1999. When 
that review is fully complete, I have asked the Minerals 
Management Service to form a group, including a member of the 
Inspector General's staff, to conduct a lessons-learned review 
to apply these lessons to our ongoing leasing activities.
    As you are aware, since 2001 the Department of the Interior 
has made certain that price thresholds have been included as 
part of any royalty relief granted under the Deep Water Royalty 
Relief Act that Congress has enacted. I have discussed this 
issue with most of the companies who hold these leases and in 
these discussions, I have had three guiding principles:
    First, there is a valid contract between the United States 
and the companies.
    Second, my goal in these discussions has been to focus on 
the greatest amount of royalties available, those which will be 
derived from future production.
    Third, and this is one I will talk about a little bit 
further, I have sought to minimize to the extent possible the 
opportunities for legal challenges to this process, the 
processes that we will follow.
    As you indicated, Madam Chairman, we have been successful 
in negotiating amendments with six of the companies that have 
those leases. We have continuing discussions with the rest of 
the companies. However, I believe that we will not make further 
progress until Congress has decided and defined the role that 
it chooses to play in this issue.
    It is clear that our Nation's demand for oil and gas will 
continue to grow and that a significant portion of that supply 
will continue to come from the Gulf of Mexico. Madam Chairman, 
members of the committee, I have a chart up on the board and, 
while it is probably too far away to see--and you, 
incidentally, have a copy of these--I think what is important 
to look at is that top red line. That top red line indicates 
what the Energy Information Agency believes will continue to 
happen with the growth in the demand for energy in the United 
States. You will also, as you get a chance to look at that 
chart in more detail, see that that is in spite of a 
significant increase in renewables and alternative energy 
sources.
    As you can see from that chart, the demand for oil has 
risen steadily and is projected to continue. The Gulf of Mexico 
is where a significant portion of that U.S. production occurs 
and will continue to occur. Given these trends, I am 
particularly concerned that as you and we go forward to address 
the missing price thresholds, that we do it in a way that will 
not result in unintended consequences that might otherwise 
disrupt the ability to supply the Nation's continuing energy 
needs.
    Specifically, I am concerned as we decide what to do that 
we not provide an opportunity for a company that has entered 
into the leases with the Federal Government to be disadvantaged 
in such a way that they might convince a court to enjoin all 
future lease sales in the Gulf of Mexico until the matter is 
resolved. The impacts of such an action that the courts might 
take I think cannot be overstated.
    I have two graphs here I would like to show you. The first 
indicates that if we were enjoined from issuing further leases, 
beginning with the sales that will occur this fall, what the 
effect would be on production in the gulf. The production 
delays over a 10-year period that could result in such a 
challenge and such an injunction for a period of 3 years would 
be some 1.6 billion barrels of oil, and that certainly would 
have a ripple effect through our economy.
    Equally profound, I think to this committee particularly, 
would be the cumulative revenue impacts to the U.S. Treasury. 
Again, from a 3-year delay in leasing programs, which is what I 
think it might take to resolve it through the Supreme Court, 
the Treasury could lose some $13 billion over a 10-year period.


                           prepared statement


    These are difficult issues and are not going to be easily 
resolved. Nevertheless, I believe that we and Congress are 
making progress and we will continue to do so in concert with 
this committee and other committees.
    Madam Chairman, I stand ready to work with you to address 
these challenges as we move forward and I would be most happy 
to answer questions from yourself or from the committee.
    [The statement follows:]
              Prepared Statement of Hon. C. Stephen Allred
    Chairman Feinstein, 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. 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. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    Since assuming the duties of Assistant Secretary of Land and 
Minerals Management four 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 4 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\
---------------------------------------------------------------------------
    \1\ EIA U.S. Imports by Country of Origin, 12-21-2006.
---------------------------------------------------------------------------
    Since 1982, MMS has overseen OCS production of almost 11 billion 
barrels of oil and 116 trillion cubic feet of natural gas.
    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. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    Attached Figure B shows the Energy Information Administration's 
2007 forecast for total domestic oil and gas production and illustrates 
the significance of the OCS contribution 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.
    Last month, the President 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. The 
President's action allows the Secretary of the Interior the option of 
offering these areas during MMS's next 5-year OCS oil and gas leasing 
program. 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 5-Year OCS Oil and 
Gas Leasing 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 $9 billion 
in revenue per year over the past 5 years, representing one of the 
largest sources of non-tax revenue to the Federal Government. (In 
fiscal year 2006, $12.6 billion was collected and $12.8 billion was 
disbursed, 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 5 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
    Last month, 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 that 
allowed 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 3-year period could look 
like. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    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). 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    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 fiscal year 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 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 activities on $5.8 billion in Federal 
and Indian mineral lease revenues, which represents 72.5 percent of 
total mineral revenues paid for calendar year 2003. As a result of the 
December 6, 2006 Office of the Inspector General report, MMS will be 
developing a new risk strategy and performance targets that reflect the 
number of companies and/or leases covered, not total royalties. In 
addition, as RIK gas volumes expand, MMS expects offshore compliance 
workloads to decrease, freeing up resources to be redirected toward 
highest risk, but smaller-dollar onshore Federal properties.
    In recent years, MMS has completed an increased number of audits, 
doubling the number of audits in the most recent 4-year period over the 
previous 4 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 
during the 1998-2001 period of numerous lawsuits on undervaluation of 
crude oil and natural gas in previous years 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 fiscal year 2003 through fiscal year 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 fiscal year 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 under-delivered 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 voluntary compliance. 
We measure success in having higher levels of upfront compliance so 
that companies make correct payments the first time. Audits act as a 
deterrent, but we hope that audits will reveal fewer problems as 
companies become more proficient in calculating and paying the 
royalties they owe accurately.
    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.
  --Royalty-In-Kind (RIK).--MMS is receiving an increasing percentage 
        of revenues through its RIK program and has eliminated many 
        valuation issues for the RIK volumes. During fiscal year 2006, 
        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. As noted earlier, 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 6-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.
                      strategic petroleum reserve
    During the State of the Union Address, President Bush announced 
plans to double our nation's Strategic Petroleum Reserve (SPR) to 1.5 
billion barrels of oil. Also announced was a directive to fill the SPR 
to its current capacity of 727 million barrels. MMS will provide 
royalty in kind oil starting in July 2007 to accomplish this mandate. 
This policy decision will provide an additional layer of protection for 
our nation's energy security.
              fiscal year 2008 president's budget request
    For fiscal year 2008, MMS has submitted a budget request of $297 
million in current appropriations and offsetting receipts which is an 
overall increase of $5 million from the fiscal year 2007 President's 
Budget (an additional $16 million relative to the 2007 Continuing 
Resolution that is currently in place). The additional funds requested 
in the President's Budget will improve MMS' ability to: implement the 
5-Year Oil & Gas Leasing Program (2007-2012); provide oversight of 
increasing ultra-deepwater offshore development; hire specialized staff 
to address well abandonment and pollution prevention issues in the Gulf 
of Mexico region; and fully fund projected fixed cost increases for 
personnel-related costs and rent.
    In addition to the items listed above, the President's Budget also 
includes additional funding for two systems changes that are designed 
to enhance compliance and enforcement efforts in the management of 
mineral revenues. The budget includes $940,000 for an adjustment line 
monitoring initiative for MRM Support System modifications to ensure 
that company reporting adjustments are made only within allowable 
timeframes. The budget also includes $1.45 million for the first year 
of a two-year interactive payment reconciliation and billing 
initiative, which will allow MMS to automate the interface with its 
customer base on numerous activities. Both of these proposals provide a 
strong return on investment and will provide MMS with the resources 
necessary to continue to improve its robust audit and compliance 
program.
                               conclusion
    In the four 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, in early 
January 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.
    Chairman Feinstein, this concludes my remarks. I would be happy to 
answer any questions you have.

                       1998 AND 1999 LEASE SALES

    Senator Feinstein. Thank you very much, Mr. Allred.
    We will have 5-minute rounds. If the staff could begin the 
clock running that would be appreciated.
    I am going to go rapidly through a series of questions just 
to establish a record if I might, and if you could answer them 
briefly I would appreciate it.
    First, how much revenue was lost from 1998 to 2006 as a 
result of the failure of MMS to specify price thresholds in the 
1998 and 1999 lease sale contracts?
    Mr. Allred. Madam Chairman, we believe that that is 
approximately $900 million.
    Senator Feinstein. Thank you very much, Mr. Allred.
    How much more does the Government stand to lose from these 
leases?
    Mr. Allred. Madam Chairman, we have to make a lot of 
assumptions in doing this, but in making the assumptions based 
upon what we believe will be producing leases, we believe that 
is about $9 billion.
    Senator Feinstein. For a total then of $10 billion?
    Mr. Allred. Approximately $10 billion, yes.
    Senator Feinstein. Thank you.
    Some of the companies have agreed to begin paying royalties 
effective October 2006. Are they agreeing to pay royalties on 
sales prior to last October?
    Mr. Allred. Madam Chairman, in the contract amendment that 
I negotiated we reserved that issue. We did not deal with it.
    Senator Feinstein. So the answer is no, is that correct?
    Mr. Allred. In the current signed agreements, they do not 
require them to pay prior to October 1. But that is not a 
resolved issue.
    Senator Feinstein. Thank you.
    Are the companies that voluntarily comply paying the same 
royalty rates as the other leaseholders who entered into leases 
since 1999?
    Mr. Allred. Madam Chairman, yes, they are. Those threshold 
rates are the same adjusted for inflation forward.
    Senator Feinstein. Thank you.
    For the record, which companies are participating and which 
are not?
    Mr. Allred. Madam Chairman, I am going to have to do this 
from memory, but it is BP, Shell, Marathon----
    Senator Feinstein. ConocoPhillips?
    Mr. Allred. ConocoPhillips, and two companies of the 
Walters Group, two separate companies.
    Senator Feinstein. The holdouts are?
    Mr. Allred. There are a number of them. If I could put up 
another chart it probably would be easy to illustrate.
    Senator Feinstein. I would just like, if you could, a 
listing of the companies that are holdouts.
    Mr. Allred. The major companies are ExxonMobil, which has a 
small amount, Chevron-UNOCAL, Devon, Anadarko-Kerr McGee, 
Dominion Exploration and Production, Marabeni, which is out of 
Italy, Total, which is Norwegian. Then there are 32 other 
companies that have each, have small amounts each, but they 
total 29 percent of the estimated production.
    Senator Feinstein. Thank you. Thank you. This is very 
helpful.
    Are foreign companies responsible for about 20 percent of 
deep water oil and gas production?
    Mr. Allred. Madam Chairman, the companies--one of the 
things that you have to do is to have a U.S. subsidiary in 
order to hold leases. But those companies which do not 
otherwise operate in the United States comprise about 20 
percent.
    Senator Feinstein. Thank you.
    Would legislation to extend the duration of the 1998-1999 
leases be an incentive to the holdouts to start paying 
royalties?
    Mr. Allred. Madam Chairman, I believe that it would. In my 
discussions--and this has not been with all of them, but just 
speaking about the issue generally--I believe that that would 
favorably move us forward on changing the agreements. Without 
specific language, as you are aware, it is hard to get a 
commitment. But I believe that that would be viewed favorably.
    Senator Feinstein. Well, we are working on specific 
language and we would look forward to going over that with you 
if we might. That would be an extent of the leases in exchange 
for a payment of the back royalties.
    Mr. Allred. We look forward to working with you on it.
    Senator Feinstein. Thank you very much.
    My time has just about expired. I have got 6 seconds to 
spare. In order of arrival, the Senators are Senator Alexander, 
Senator Reed, and then Senator Domenici. Senator Alexander.

                  STATEMENT OF SENATOR LAMAR ALEXANDER

    Senator Alexander. Thank you, Madam Chairman.
    I am glad to see Senator Domenici here because I want to 
talk about him. I would like to talk about a little different 
subject, but it has the outer continental shelf leasing in 
mind. It is something we have begun to call the Domenici one-
eighth, and I wanted to ask about the Land and Water 
Conservation Fund as it relates to the legislation Congress 
passed at the end of the last session, which allows for 
additional drilling in what we call lease 181. Within that 
there is a provision that $1 out of $8 that come in--that is 
the Domenici one-eighth--would go to fund the State side of the 
Land and Water Conservation Fund.
    I want to talk about that and ask you a couple questions 
about it. The history on this is the following. In 1965 
Congress created the Land and Water Conservation Fund and 
authorized funding of $450 million for the State side and $450 
million for the Federal side. This was very helpful to States 
and cities. The chairman is a former mayor. I am a former 
Governor. We use this money for city parks, State parks, 
recreation areas, usually matching it with private funds and 
other funds.
    The original funding for this was to come from sales of 
surplus Federal real property, motorboat fuel taxes, and fees 
for recreation use, but that did not amount to much, and so 
Congress added a different source. In 1968 an additional source 
of funding for the Land and Water Conservation Fund was to be 
revenues from the outer continental shelf development. It was 
to be a sort of conservation royalty. States get royalties when 
you drill onshore. It goes to the State. The idea would be if 
we do some drilling and we have an environmental burden maybe 
we will have an environmental benefit.
    In 1985 a commission which I chaired and President Reagan 
appointed, called the President's Commission on Americans 
Outdoors, recommended that we fully fund the Land and Water 
Conservation Fund from receipts from the outer continental 
shelf. That has never really happened and in the last few years 
funding for the State side of the Land and Water Conservation 
Fund and the Federal side has been very low.
    So in light of two developments, one of which the Senator 
from California was talking about and one is the Domenici one-
eighth, I am looking to see if maybe we can--and perhaps 
through this subcommittee, Madam Chairman, would be a good 
place to begin a discussion--move toward full funding of the 
Federal side as well as the State side of the Land and Water 
Conservation Fund.
    So my questions would be two. One would be, do you know yet 
how much money would be allocated to the State side of the Land 
and Water Conservation Fund as a result of the Domenici one-
eighth, the conservation royalty that Congress enacted last 
year? Second, have you considered the possibility that as we 
negotiate, as you negotiate or Congress makes some decisions 
about this up to $9 billion of money that should be owed to the 
taxpayers, have you considered whether some of that money could 
appropriately be used for the conservation royalty so that we 
could see full funding of the Land and Water Conservation Fund? 
Those are my two questions.
    Mr. Allred. Senator, with regard to the first question, let 
me ask my staff if we have a forecast. I am not aware of one.
    Senator Alexander. If I do not today, could you supply the 
committee with an answer to that question?
    Mr. Allred. Senator Alexander, I would be glad to do that. 
I think rather than giving you a number that I am not sure of, 
I would just rather get it to the committee.
    [The information follows:]
          Gulf of Mexico Energy Security Act (GOMESA) of 2006
    GOMESA authorizes 12.5 percent of certain OCS receipts (subject to 
a cap in later years) to be deposited into the LWCF and made available 
in the following year for the National Park Service State LWCF grant 
program. Receipt projections are as follows:

                                            [In millions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                              2007     2008     2009     2010     2011     2012
----------------------------------------------------------------------------------------------------------------
GOMESA receipts for LWCF..................................  .......      6.4     10.9      0.9      0.4      0.4
NPS LWCF Grants disbursements.............................  .......  .......      6.4     10.9      0.9      0.4
----------------------------------------------------------------------------------------------------------------


    Senator Alexander. My understanding was that it would be a 
low number in the early years, but it might grow to be a number 
that could be as high as $80 to $100 million a year. As you 
consider your answer, will you also consider, I believe 181 had 
two parts to it. There was a Lease 181 and then there is some 
other area which we know less about, and that might be an even 
larger amount of funding that could come to the Land and Water 
Conservation Fund.
    What about the possibility of using this up to $9 billion, 
some of that money to appropriately fund the Land and Water 
Conservation Fund, as has been anticipated by Congress since 
1968 and recommended by President Reagan's commission?
    Mr. Allred. Senator, as you can imagine, that $9 billion 
has attracted a lot of attention up here on the Hill, and we 
are prepared to put it wherever you choose to put it.
    Senator Alexander. Thank you, Madam Chairman.
    Senator Feinstein. Thank you.
    Senator Alexander. Madam Chairman, I would hope that--I 
know of your long interest in these issues and I would hope 
that we might have more discussions at some time about the Land 
and Water Conservation Fund.
    Senator Feinstein. I would look forward to that, Senator. 
Thank you very much.
    Senator Reed.

                       1998 AND 1999 LEASE SALES

    Senator Reed. Thank you very much, Madam Chairman.
    Thank you, Mr. Allred, for your testimony. The Secretary is 
in negotiations now with these leaseholders to correct the 
problem because of the contract. What leverage does he have in 
that negotiation and what leverage, additional leverage, might 
he use?
    Mr. Allred. Senator Reed, up until this point in time I 
think the leverage we have is that of the goodwill of the 
companies themselves and the public pressure that they 
obviously are under with regard to this issue. That is why when 
asked in the Energy Committee hearing what other tools I would 
need that I suggested that it would be very helpful if we had 
the ability to offer these companies, based on due diligence 
upon a particular lease, an extension of 3 years. I believe in 
my discussions, again in very general terms, that that would 
attract many of the companies.
    Senator Reed. Has there been any consideration to barring 
these companies from further lease activity if they fail to 
negotiate?
    Mr. Allred. Senator, we do not have the ability to do that.
    Senator Reed. That would require legislation?
    Mr. Allred. That would require legislation. What I am 
concerned about, though, is the curves that I showed you 
previously, that that would have to be done I think very 
carefully so that we were not enjoined from issuing further 
leases. That is my concern as to how we do that.

                         KERR-MC GEE LITIGATION

    Senator Reed. Kerr-McGee is involved in litigation which 
could result, according to some reports, for up to a $60 
billion loss to the Treasury over 25 years. What is the 
administration doing to respond to the litigation, both in 
terms of trying to prevail, I presume, but also if that happens 
what is the fallback position?
    Mr. Allred. Senator, that issue has to do with whether or 
not the act passed by Congress authorized us to put price 
thresholds on. It covers a period from 1995 to 2000. So it 
would have a big effect. GAO has estimated that that is like 
$60 billion if they were to prevail.
    We feel--our Solicitor's Office tells me and the Department 
of Justice they are confident in our position. However, you and 
I know judges do sometimes surprising things. We have been in 
mediation in an attempt to find a way to solve it. Of course, 
Kerr-McGee has been bought by Anadarko. I believe Anadarko 
would like to find a way to solve this issue. At this point in 
time we have not been able to do so. If we are unable to reach 
any agreement, my understanding is that on March 1 the court 
will then have to decide how to go forward and schedule the 
court proceedings.
    It is a concern to us because, again, while we feel good 
about our position, courts can find however they find on these 
issues dealing with authorities under legislation.

           ROYALTY RATES ON DEEP WATER GULF OF MEXICO LEASES

    Senator Reed. Mr. Allred, the President's budget proposes 
to increase royalty rates on deep water Gulf of Mexico leases 
starting in 2007 and to repeal certain provisions on deep water 
gas and oil drilling. Has the Department taken a comprehensive 
evaluation to determine whether the existing or proposed 
royalty provisions reflect changing market conditions? 
Specifically, how do they compare with rates charges by States 
on State land and private landowners who are similarly selling 
the same thing? Are they getting the same return on their 
property?
    Mr. Allred. Senator Reed, one of the reasons we changed it 
was that we felt that the activities on the shelf had matured 
to the point that we did not need as much incentive to get 
people out there. When you looked at the early days of drilling 
on the OCS, outer continental shelf, there was a high degree of 
risk. No one had done it before. Fifty years ago, it was very 
difficult to drill in 10 feet of water. Now we are drilling in 
10,000 feet of water.
    But we think there has been enough experience and enough 
technology development that the lower rates are no longer 
necessary. Now, as we have looked at comparing our processes 
with those on State lands, State lands are--sometimes they 
mimic what we do and sometimes they are more or less. But there 
is a significant difference, particularly with regard to the 
OCS, in that when you can drive a rig up on dry land and drill 
a hole, you still have the risk of whether the resource is 
there or not, but you do not have all the other risks that are 
involved. That is one of the reasons why, for example, we did 
not increase it in Alaska, because there still is too much 
technology and too much risk there, we think, to raise that 
royalty rate in those areas.
    So we look at this. We try to make judgments based on 
market conditions and then make a decision as to how to go 
forward.
    Senator Reed. Thank you, sir.
    Thank you.
    Senator Feinstein. Senator Craig, the ranking member, has 
arrived. Senator, if you would like to make a brief statement, 
then we will go to Senator Domenici if that is agreeable.
    Senator Craig. Thank you very much, Madam Chairman, for 
that courtesy. I wanted to get here to ask Mr. Allred a couple 
of questions, but at least for the time now let me congratulate 
you on becoming the chairman of this very important 
subcommittee, a tremendously important subcommittee for 
California, for the State of Idaho when we look at our land 
masses.
    But now we are off, obviously, on an area that remains 
extremely important to both of us and that is energy 
production, done appropriately, in the outer reaches of our 
country and the difficulties involved and the complications 
that we know are there, both in contract and in the 
environmental realities.
    Again, thank you and congratulations, and I look forward to 
working with you.
    Senator Feinstein. Thank you very much. I do as well.
    Senator Domenici.

                 STATEMENT OF SENATOR PETE V. DOMENICI

    Senator Domenici. Thank you very much, Madam Chairman. I am 
delighted to serve on your committee. I have been active 
heretofore and hope to continue.
    We have a hearing now in the Energy Committee with three 
eminent scholars talking about climate change. So there are 
three hearings in the Congress today. I figure when those 
hearings are finished we will have solved the problem. Maybe 
tonight or tomorrow morning we will have it all solved.
    Senator Craig. The ice storm will be over and it will be 
warm again.
    Senator Domenici. In the meantime, let me just make sure 
that I state for the record what I know about this situation. 
Frankly, the Clinton administration and bidders set about to 
procure some leases in 1998 and 1999 and they were signed 
without any royalties. Neither side, neither the administration 
or the bidders, claim that anything was amiss. They just did 
not think royalties had to be in the leases or forgot or made a 
mistake, but just did not put them in.
    Now, some run around saying that we are being cheated out 
of all this money. The truth of the matter is that it is a very 
legal situation. It was done in a legal manner. But it is 
probably a mistake.
    I think, Madam Chairperson, we have to try to resolve this 
issue in a way that will bring these oil companies to the table 
and talk good sense and suggest that indeed they ought to pay 
it as if it was in their leases and then actually change the 
leases to reflect that.
    I want to ask you, have you asked the Solicitor whether 
there is any doctrine, any legal doctrine, which would permit 
the two parties to make a change here? Is there a mistake 
doctrine that would permit two contracting parties who made a 
mistake to come back and amicably adjust the mistake, sir?
    Mr. Allred. Senator Domenici, we have looked at that issue 
a number of times and, while we always maintain our options 
based upon a set of facts that are before us, I think the 
report of the Inspector General makes it very difficult to 
claim the mistake. What the Inspector General has laid out is 
that in the preparation of the 1998 leases, and consequently 
the 1999 leases, there was a definitive decision and the person 
who wrote them was instructed to remove the price thresholds 
from those leases.
    What is not clear is why or who gave that instruction. But 
given that information from the Inspector General, I believe 
that, and I am so advised by our Solicitor, that it would 
probably be very difficult to win an argument of mistake.
    Senator Domenici. Well, I want to suggest, Madam 
Chairperson, that we use this committee and your leadership to 
get the oil companies in and have a talk, serious talk about 
getting this resolved. There are people here who want to do all 
kinds of things as a result of this where they lay blame and 
say therefore we want to take away the future of these oil 
companies. They do not deserve to be denied any future 
drilling. They did nothing wrong.
    But we look at it and say, why should you get away with 
none for that year when you really should be paying. It is not 
like we could enforce it. We cannot go to court and get the 
money. I hope everybody understands that. If they could they 
would go there.
    So I think these oil companies ought to know that to stay 
on the good side of Congress as we proceed with further royalty 
situations--and we will have a lot of them; we did that one big 
bill which you are aware of, that is going to open up a lot of 
bidding. These people are going to have to be out there bidding 
because they want to make money. We ought to see if we cannot 
get them in and say, the best thing for you would be to pay up.
    I thank you for letting me mouth off here. I was not able 
to do it, but I was not in the right position, and I would help 
you in anything you would like to do.
    Senator Feinstein. Thank you very much, and I am very 
heartened by your comments and we will all work together toward 
that end.
    Senator Craig, would you like a first round and then we 
will go to a second round.

                      MODIFYING COMPANY CONTRACTS

    Senator Craig. Let me pick up where Senator Domenici left 
off, because this is obviously an important issue. It is a big 
dollar issue. It is also a very complicated legal issue that I 
know you are trying to sort yourself through, Mr. Assistant 
Secretary Allred. Can you discuss the potential impact to the 
marketplace if statutory language was passed that coerced 
companies into modifying their contracts? Have you thought 
about that?
    Mr. Allred. Senator Craig, it is always a pleasure to be in 
a hearing with you.
    I have thought about that and, as you are aware, much of my 
career was in private business, where as a senior executive 
officer I had to make decisions about investments. So that 
colors my thoughts a little bit about how we deal with this 
issue.
    Companies are willing to invest a certain amount of money. 
In deciding how to invest that amount of money, in order to 
reach their fiscal objectives, they are going to look at a 
number of things. One of them is risk. That will be either 
technological risk or political risk. I think it is interesting 
to look at what happens elsewhere where the political risks 
become so great that they choose either not to invest or they 
choose to only invest in the most lucrative projects.
    So, if our concern is to develop as much domestically 
controlled oil as we can, I think if we were to develop an 
atmosphere here that would raise those risks to a company 
seeking to invest, it would be detrimental to our efforts to 
develop that oil. So I think again, just as I have concerns 
about the unintended consequences of what we do, I think our 
decisions have to be well thought out from the standpoint of 
business going forward and encouraging people to use private 
resources to develop these oil sources that we need.
    Senator Craig. Well, we all know that where we are today in 
deep water is, while there has been some successes, it still is 
on the margin, and there is a margin out there. You call it 
risk. It is also an oil company not becoming a partner or a 
direct participant anymore with foreign resources, but simply 
becoming a service company that ultimately develops them for a 
foreign country. I do not think oil companies want that either.
    So I have always felt that in correcting this--and I am not 
objecting in any way to its being corrected. I tend to agree 
with Senator Domenici that this needs to get solved. But it is 
important we do it in the context of the broader picture and 
what it may or may not do.
    For example, would oil companies potentially pay less in 
bonus bids for the right to lease offshore if this kind of 
uncertainty over the sanctity of contracts is introduced into 
the marketplace?
    Mr. Allred. Senator, I believe that they would. When you 
look at what a company decides to bid on a lease, they will 
apportion that among a number of things. For example, one of 
them will be bonuses; one of them will be royalty payments and 
rental payments; the other one will be the risk I talked about. 
If that risk number goes up, obviously the bonus number will go 
down.
    Senator Craig. Well, there are other questions for me to 
ask. I am bouncing back and forth between a couple of 
committees. I think it is important, Madam Chairman, that we 
solve this problem and work cooperatively with the agency to 
get it done in a way that maintains the sanctity of a 
government contract, a government relationship with the private 
sector. We have phenomenal resources out there. We ourselves 
are not in the business of developing them. We are in the 
business of developing relationships with the private sector as 
they develop them. We have had a good reputation to date in 
doing so. As we sort through who did not do what, when, and the 
impact it has, I think the issue at hand is getting it over 
with, getting it done right, and maintaining a relationship 
between the private sector and the government that is a 
reputable one.
    Senator Feinstein. I agree with you, Senator. Thank you 
very much.

                INSPECTOR GENERAL REPORT ON LEASE SALES

    I would like if I might to begin a second round. Mr. 
Allred, I want to just clear up something that you just 
testified to by reading directly from the IG report on the 
subject: ``We found that shortly after the inception of the 
Outer Continental Shelf Deep Water Royalty Act in 1995, MMS 
made the policy decision to include price thresholds in the 
leases between 1995 and 2000. Field personnel initially 
attached addenda to the leases containing price threshold 
language, but it stopped for 2 years and instead cited a 
regulation that they thought contained threshold language when 
in fact it did not. MMS' review process, which included the 
Solicitor, simply failed to identify this discrepancy.''
    Is that an accurate statement of the facts?
    Mr. Allred. Madam Chairman, that is what the Inspector 
General believes to be the overall impact. In the detailed 
report you will find e-mails and other information from the 
person who actually prepared it, where he was told to exclude 
it. I have asked this question several times as to who told him 
that. The conclusion that the Inspector General came to, was 
that it was probably a lack of coordination where rules were 
being developed and leases were being written and the two were 
never reconciled. That is his conclusion based upon what he saw 
out there.
    I have no reason to dispute that. There just is no 
information as to--and I have asked several times if he could 
get more information. He has told me that it is just not 
available. So I think that is probably as good a 
characterization that could be made.
    I think it was a definitive decision to not put them in. 
Why that decision or whether anybody realized the impact of not 
putting them in I think are two different things.
    Senator Feinstein. Well, the report then goes on to say: 
``We found that the omission was first brought to the attention 
of the former associate director for offshore minerals 
management in 2000. She chose not to inform the former MMS 
director, preferring to work out a solution within OMM.''
    That it seems to me was a big mistake. I mean, to see that 
this happened and not bring it to the attention of the director 
is certainly a major error in judgment, to say the least.
    Mr. Allred. Madam Chairman, in fact there is a letter that 
resulted I believe from the incident you are talking about--it 
is not in the report, but it is available. The associate 
director at that point in time wrote a letter to the oil 
companies saying that they should not misinterpret the lack of 
price thresholds being in the leases as the authority not to 
include them because the Secretary had the prerogative at that 
point in time whether or not to include them. So there was a 
response to the oil companies. It is a little bit hard from 
that letter to understand exactly what they were saying about 
the lack of price thresholds in the companies----
    Senator Feinstein. May we receive a copy of the letter for 
the record, please?
    Mr. Allred. Madam Chairman, I believe that your staff 
already has that.
    Senator Feinstein. We will check. Thank you. Thank you very 
much.
    [The information follows:]
                              Mariner Energy, Inc.,
                                       Westlake Park Blvd.,
                                  Houston, Texas, January 12, 2001.
U.S. Department of the Interior,
Minerals Management Service, Gulf of Mexico OCS Region, New Orleans, 
        LA.
Attn: Mr. Chris C. Oynes, Regional Director
Re: Deep Water Royalty Relief Act Price Triggers

    Gentlemen: The Deep Water Royalty Relief Act (``the Act'') 
authorized, among other things, royalty suspension volumes for certain 
deep water leases in the Gulf of Mexico. When applicable, certain price 
triggers eliminate royalty suspension volumes for the year in which the 
price of oil or gas exceeds a specified threshold. The Act does not 
expressly authorize the Minerals Management Service (MMS) to apply the 
price triggers to ``post-Act leases.''
    Mariner Energy, Inc., was recently informally notified by your 
office that the MMS intends to collect royalty on some post-Act leases 
by virtue of a price trigger provision included as an addendum to those 
leases. This letter is to outline Mariner's position objecting to 
collection of royalty on these leases and to request a meeting where 
these issues can be more completely discussed.
                               background
    In 1995, Congress passed the Outer Continental Shelf Deep Water 
Royalty Relief Act, codified at 43 U.S.C.A. 1337. Among other things, 
the Act authorized royalty relief for certain deep water leases in the 
Gulf of Mexico. Specifically, Congress required the automatic 
suspension of royalties on all eligible leases purchased in the five 
years following the date of enactment, so-called ``post-Act leases.''
    The Act also allows qualifying leases in existence on the date of 
the Act, so-called ``pre-Act leases,'' to apply for royalty relief. If, 
however, oil or gas prices reach a certain ceiling in a given year, the 
Act requires the payment of royalties on pre-Act leases. Significantly, 
Congress did not include price triggers for post-Act leases. The MMS 
implementing regulations, 30 C.F.R. Part 260, also do not contain price 
triggers for new leases.
    Although not authorized either by statute or agency regulation, the 
MMS lease form used for the first four post-Act offshore lease sales 
(Sale 157, Sale 161, Sale 166, and Sale 168) contained an addendum with 
price triggers. The MMS removed the price trigger language from lease 
forms and notices of sale for subsequent sales.
    Mariner Energy, Inc., is lessee under several post-Act leases that 
contain price trigger language. Three of those leases, Garden Banks 179 
and 367, and Ewing Banks 966 had natural gas sales in the year 2000.
                               discussion
    When enacting the Deep Water Royalty Relief Act, Congress expressly 
conditioned royalty relief for pre-Act leases on oil and gas prices 
remaining below a certain threshold. Congress placed no such 
limitation, however, on the automatic minimum royalty suspension 
volumes given to post-Act leases.
    We contend that Congress intentionally chose not to apply price 
triggers to post-Act leases. Post-Act leases were offered for sale with 
the promise of minimum royalty suspension volumes to increase leasing 
activity in the Gulf and, as a result, bonus bids at post-Act sales 
increased significantly. On the other hand, because pre-Act lessees had 
already purchased their leases without royalty relief incentives, it 
was reasonable to impose a suspension of relief thereafter granted by 
the Act when oil and gas prices are high.
    Further, while the Act specifically instructs the Secretary to 
promulgate implementing regulations, he chose not to include price 
triggers in the regulations applicable to post-Act leases. The only 
price triggers are found in 30 C.F.R. Sec. 203.78 which applies to pre-
Act leases. By comparison, MMS's recent proposal to extend royalty 
relief for future leases by administrative means contains express price 
trigger language.
    Finally, the fact that MMS removed the price trigger language from 
the lease forms and notices of sale after the fourth post-Act sale 
indicates the agency's recognition that it was not authorized to 
include the price triggers in post-Act leases.
    In summary, it is Mariner's position that price trigger provisions 
included in post-Act leases are without statutory or regulatory 
authority and are therefore unenforceable.
    Mariner Energy wishes to thank you in advance for your 
consideration in this matter, and we will be pleased to meet, at your 
convenience, to more fully discuss the issues.
            Regards,
                                      Mariner Energy, Inc.,
                                 Tom E. Young, Vice President-Land.
                                 ______
                                 
                   U.S. Department of the Interior,
                               Minerals Management Service,
                                 Washington, DC, February 14, 2001.
Mr. Tom E. Young,
Vice President-Land, Mariner Energy, Inc., Houston, Texas.
    Dear Mr. Young: This letter responds to your letter of January 12, 
2001, to the Regional Director, Gulf of Mexico Region, on the subject 
of ``Deepwater Royalty Relief Act Price Triggers.'' Therein, you 
objected to our intent to collect royalties on certain deepwater leases 
and requested to meet with us. We will comment on your specific points 
below. After reading our response, if you should still want to have a 
meeting, we will be happy to do so. Simply call my office, or that of 
the Regional Director so we can arrange a site and time.
    As you know, the Deep Water Royalty Relief Act (DWRRA) of 1995 
provided for suspension of royalties for specified volumes of 
production for both active deepwater leases issued before passage of 
the Act and for new leases. As accurately noted in your letter, the Act 
also specified certain price thresholds that can rescind the royalty 
suspension volumes for years in which oil or gas prices exceed the 
thresholds. This past year is the first time the price threshold 
provisions have been triggered. The average price for natural gas in 
2000 is 13.5 percent higher than the threshold. As gas prices were 
rising dramatically throughout the year, we published on our web site 
the implications of rising prices on royalty suspension leases. We also 
spoke to representatives of your company on numerous occasions about 
this emerging energy situation and its potential effect on suspended 
royalties. This was to ensure that the effect of higher prices would 
not be a surprise to your company.
    As you know, the Minerals Management Service alerts bidders in our 
proposed OCS lease sale notices about the terms of the deepwater leases 
offered for sale on which they bid. The Secretary under U.S.C. 1337 and 
30 CFR 260 may set and vary the terms and conditions thereof for each 
OCS lease sale. For your leases in question, the price threshold 
requirement was noted in the proposed and final Notices of Sale, and 
more importantly, in the lease documents that you and any joint owner 
signed. Accordingly, we expect that bidders are aware of the price 
threshold condition on the royalty incentive before acquiring a 
deepwater lease and factor the chance of the royalty suspension being 
unavailable under higher prices when formulating their bonus bid 
amounts for deepwater leases. Thus, while lease terms may change upon 
mutual agreement in certain situations, we think that a change now 
would, among other things, provide a windfall to those who bid on the 
value of the tracts in the presence of a price threshold. Hence, we 
cannot re-consider this lease term as a result of the contractual 
condition now being triggered by rising gas prices.
    Despite the price threshold terms in your leases, you now contend 
that MMS did not have the authority to impose this condition because 
Congress explicitly specified price threshold language under DWRRA only 
for pre-Act leases. However, when offering leases with royalty 
suspensions, the Secretary under the OCS Lands Act (OCSLA), acting 
through MMS, does have authority to propose various terms and 
conditions on OCS leases, and hence to apply price threshold conditions 
for this royalty relief to post-Act deepwater leases as well, as 
discussed below.
    Section 302 of the DWRRA provides a rather elaborate framework for 
evaluating requests for royalty relief from lessees holding certain 
deepwater tracts acquired prior to passage of the Act. Within this 
framework is a provision in Sections 302(v-vii) for a specific type of 
price threshold to apply. It stipulated, inter alia, that in any 
calendar year in which actual oil or gas prices exceeded its associated 
threshold price (as adjusted for inflation), royalties would be due on 
the relevant production for that calendar year even if such production 
were subject to an otherwise-approved suspension in royalties. 
Moreover, the relevant production in that year would be counted against 
any remaining royalty suspension volumes.
    In contrast, no such elaborate framework was provided in Section 
304 of the DWRRA addressing suspension volumes for newly offered 
deepwater leases. Rather, Section 304 referred back to Section 302 and 
simply set suspension volumes for leases issued in the 1996-2000 period 
at levels equivalent to those specified for pre-Act leases. For 
designing the bidding system and specific terms of sale for these 
deepwater leases, Section 304 requires MMS to use section 8(a)(1)(H) of 
the OCSLA, as amended by Section 303 of the DWRRA. The amendment in 
Section 303 not only provides us the general authority to utilize 
royalty volume suspensions in future OCS sales, but also states that 
the ``suspensions may vary based on the price of production from the 
lease.''
    Thus, the DWRRA actually provided MMS with even broader authority 
to specify or tie the amount of royalty suspension volume to price 
conditions for new leases. In practice, MMS chose to use the same price 
threshold for new leases as Congress mandated for active ones. This was 
partly to ensure administrative efficiencies when leases are unitized. 
Congress did not mean to omit specific price trigger language for new 
leases because it didn't want MMS to use them. Instead, Congress 
provided broader authority for MMS to use or not use price triggers in 
a form we determined would be appropriate and consistent with the 
objectives of the Act. This observation is also true for other terms 
and conditions of sales held during the 1996-2000 period.
    You have also stated that certain actions by MMS in promulgating 
the implementing regulations and lease notices indicate that MMS 
recognizes that it lacks authority to include price triggers for post-
Act leases, but this is not the case. For interim regulations 
immediately following passage of the Act, MMS addressed price 
thresholds for active leases because Congress had mandated the specific 
elements. In contrast, because Congress did not mandate the specific 
elements for terms of new leases, we did not address it in regulation. 
Rather, we determined that the specific form of certain elements such 
as price triggers, would be best determined at the time of sale to 
allow more flexibility on the application and form.
    For Notices of Sales held in 1998 and 1999, the price trigger 
language was left out of the notices and lease documents. This was 
within the discretion of MMS and the Secretary. Moreover, the threshold 
was reintroduced in subsequent sales. Therefore, it is incorrect for 
you to conclude that the omission of price threshold language from an 
earlier version of MMS's regulations or certain lease sale documents is 
germane to the question of MMS's authority in include price triggers 
with royalty suspension for post-Act leases.
    We can understand that lessees are not anxious to have royalties 
due when price thresholds are actually exceeded. However, the intent of 
DWRRA, and MMS policies implementing it, were understood similarly by 
all stakeholders from the outset--i.e., to provide sufficient financial 
incentives to promote deepwater activity under certain conditions, with 
oil and gas prices being an explicit consideration. We believe Congress 
included references to product prices and specific price thresholds in 
the Act to protect interests of the Treasury for those years when 
prices rise to levels where the royalty incentive in no longer needed 
or appropriate, and in instances where MMS's authority to set terms and 
conditions unilaterally, i.e., for active leases, is less flexible than 
for new leases.
    In general, when oil or gas prices rise significantly relative to 
historic trends or price expectations, the profit gains to the lessee 
far outweigh any royalties due the government as a result of the price 
threshold terms. It is reasonable that the nation, as owner of the 
mineral resources, should participate in the revenue benefits of the 
price gain, as it was willing to provide the financial incentive when 
needed to promote the development of the resource at lower prices.
    We appreciate your interest in our program and your willingness to 
share your concerns with us. But, we see no reason at this time to 
change our position concerning the application of price threshold terms 
in post-Act deepwater leases.
            Sincerely,
                                       Carolita U. Kallaur,
               Associate Director for Offshore Minerals Management.

    Senator Feinstein. So then is there any information that 
the Secretary would have known that these were not included?
    Mr. Allred. Madam Chairman, as I understand from the 
Inspector General, there are no records and he has been unable 
to determine whether anybody above that level at that point in 
time understood that they were not in there.
    Senator Feinstein. Thank you.

                        COMPLIANCE AND AUDITING

    Let me proceed with my questions then. Now, the Inspector 
General reported that compliance reviews are an important part 
of the compliance and asset management program, but are no 
substitute for full audits. How do those reviews differ from 
royalty audits?
    Mr. Allred. Madam Chairman, first a little bit about what 
is due the U.S. Government in order perhaps to explain what 
occurs. Oil or gas is produced. It is metered through a meter 
that the Mineral Management Service supervises. So we know 
through both the meters and then subsequent production reports 
from the companies how much is being produced out of a well.
    Then that oil or gas has to be transported to a place of 
collection or a place of use and it generally has to be 
processed to remove water or to separate oil and gas or 
whatever the process might be. When we look at Federal revenues 
and Federal royalties, it is the amount of oil or gas produced 
at the well, which we know, with certain costs subtracted, and 
those costs that are subtracted are the allowable costs for 
that transportation and the allowable costs for that 
production.
    That is where the problems develop. It is just like 
deductions on income tax. You get arguments about what is a 
proper deduction and what is not. That is where the questions 
arise when we talk about these audits. It is not generally 
about how much was produced. It is a question of how much was 
deducted from the value of that which was produced.
    We do two processes. The first is a full audit, where we go 
in and look at the costs of those companies, which either 
sometimes they are owned by the producing company, sometimes 
they are vendors, but to look at those total costs and to 
determine whether those deductions are proper or not under our 
rules.
    There are a lot of situations. For example, as I indicated, 
some of those pipelines may be owned by, in part by the 
producer, or they may be owned by someone else. We have to 
determine which case that is and to what extent it is.
    When we do a compliance audit, rather than a full audit, 
what we do is we compare----
    Senator Feinstein. Is that different from a compliance 
review?
    Mr. Allred. That is different from a compliance review. The 
full audits----
    Senator Feinstein. Yes, what are the criteria for an audit?
    Mr. Allred. It would be--a good many times they are 
triggered either by a compliance review or a periodic audit of 
that particular----
    Senator Feinstein. But my understanding is there is no 
criteria for an audit in the MMS.
    Mr. Allred. Madam Chairman, no, we have criteria. If we 
have any reason to believe, either through records or other 
sources of information, that we are not being paid the full 
amount, we can audit. Keep in mind that there are two other 
audit functions here in addition to the Federal Government. 
There are the States and there are the Indian tribes which also 
receive these revenues, and they are part of the audit program, 
too.
    But we have a number of criteria, which obviously we keep 
rather quiet as to what triggers an audit. But those audits are 
also very expensive and require lots of manpower. As the work 
load is increased--and it has increased significantly as we 
have new production--we have also added a second tier, and 
those are the compliance reviews. Those compliance reviews 
include information that we have. Keep in mind that we know 
what is being produced from the meters we supervise and from 
the reports that are supplied by the producer and also by 
reports that are supplied by the buyer. We then look, based 
upon our own information as to what transportation costs are or 
what processing costs are, do a review of what we are being 
paid. That will trigger questions in our minds. Sometimes it is 
obvious we have been underpaid and we bill the companies. They 
can challenge it, but we bill the companies.
    In those cases where we have big questions about whether 
they have paid, it will trigger a full audit. Now, what the 
Inspector General recommended that we do is that we better 
develop the risk criteria by which we do those compliance 
reviews, and we are in the process of doing that. We have them, 
but he felt they needed to be more formalized.
    I would also indicate that, again going back to my 
experience as a corporate executive, if you look at the facts 
which are in the audit of our royalty management, I was not 
necessarily surprised by what is in there. Those are the kinds 
of things you normally would see in a review of operations. 
Anything, as I indicated in my testimony, anything that is as 
large and as complex as royalty management is, there an outside 
audit will find lots of opportunities to improve it. That is 
why we periodically do these. It is important to have that 
outside review, and MMS has accepted most of those 
recommendations, those that it is capable of accepting, and we 
will implement those improvements.

                            CLOSING REMARKS

    Senator Feinstein. Thank you very much, Mr. Allred.
    I think you heard the questions from members of the 
committee and, as you probably know, we discussed this issue 
last year at an Appropriations Subcommittee--excuse me, at the 
full Appropriations Committee, and I moved some language which 
was included in the appropriations bill, which of course is now 
the product of the CR.
    But I want you to know that it is my intention to work with 
Senators Domenici, Craig, and members on this side as well as 
the other side, to include specific legislation in this bill 
which will in fact recover the money due to the taxpayers. I 
feel it very, very strongly. These companies have reaped record 
profits. I think one of them has reaped quarterly the greatest 
profits ever reaped by any American corporation. I believe they 
deserve to repay the taxpayers for the loss of this money.
    So we look forward to working with you on the how-to part 
of it and I think there are a couple of good ideas that you 
have mentioned and we will explore those more fully.

                         CONCLUSION OF HEARING

    Do you have any further comments you might like to make at 
this time? If not, I will recess the hearing.
    Mr. Allred. Madam Chairman, we look forward to working with 
you and to help solve this problem.
    Senator Feinstein. Thank you very much.
    [Whereupon, at 10:54 a.m., Tuesday, February 13, the 
hearing was concluded, and the subcommittee was recessed, to 
reconvene subject to the call of the Chair].

                                   - 
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