[House Report 104-858]
[From the U.S. Government Publishing Office]




                                                 Union Calendar No. 465

104th Congress, 2nd Session -  -  -  -  -  -  -  - House Report 104-858

 
  CRUDE OIL UNDERVALUATION: THE INEFFECTIVE RESPONSE OF THE MINERALS 
                           MANAGEMENT SERVICE

                               __________

                           SEVENTEENTH REPORT

                                 by the

                        COMMITTEE ON GOVERNMENT
                          REFORM AND OVERSIGHT


                                     


                                     

 September 27, 1996.--Committed to the Committee of the Whole House on 
            the State of the Union and ordered to be printed


              COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT

       WILLIAM F. CLINGER, Jr., Pennsylvania, Chairman
CARDISS COLLINS, Illinois            BENJAMIN A. GILMAN, New York
HENRY A. WAXMAN, California          DAN BURTON, Indiana
TOM LANTOS, California               J. DENNIS HASTERT, Illinois
ROBERT E. WISE, Jr., West Virginia   CONSTANCE A. MORELLA, Maryland
MAJOR R. OWENS, New York             CHRISTOPHER SHAYS, Connecticut
EDOLPHUS TOWNS, New York             STEVEN SCHIFF, New Mexico
JOHN M. SPRATT, Jr., South Carolina  ILEANA ROS-LEHTINEN, Florida
LOUISE McINTOSH SLAUGHTER, New York  WILLIAM H. ZELIFF, Jr., New 
PAUL E. KANJORSKI, Pennsylvania      Hampshire
GARY A. CONDIT, California           JOHN M. McHUGH, New York
COLLIN C. PETERSON, Minnesota        STEPHEN HORN, California
KAREN L. THURMAN, Florida            JOHN L. MICA, Florida
CAROLYN B. MALONEY, New York         PETER BLUTE, Massachusetts
THOMAS M. BARRETT, Wisconsin         THOMAS M. DAVIS, Virginia
BARBARA-ROSE COLLINS, Michigan       DAVID M. McINTOSH, Indiana
ELEANOR HOLMES NORTON, District of ColumbiaTATE, Washington
JAMES P. MORAN, Virginia             DICK CHRYSLER, Michigan
GENE GREEN, Texas                    GIL GUTKNECHT, Minnesota
CARRIE P. MEEK, Florida              MARK E. SOUDER, Indiana
CHAKA FATTAH, Pennsylvania           WILLIAM J. MARTINI, New Jersey
BILL BREWSTER, Oklahoma              JOE SCARBOROUGH, Florida
TIM HOLDEN, Pennsylvania             JOHN B. SHADEGG, Arizona
ELIJAH CUMMINGS, Maryland            MICHAEL PATRICK FLANAGAN, Illinois
            ------                   CHARLES F. BASS, New Hampshire
BERNARD SANDERS, Vermont (Independent)TEVEN C. LaTOURETTE, Ohio
                                     MARSHALL ``MARK'' SANFORD, South 
                                     Carolina
                                     ROBERT L. EHRLICH, Jr., Maryland
                                     SCOTT L. KLUG, Wisconsin

  James L. Clarke, Staff Director
  Kevin M. Sabo, General Counsel
     Judith McCoy, Chief Clerk
Bud Myers, Minority Staff Director
                                 ______

   Subcommittee on Government Management, Information, and Technology

STEPHEN HORN, California, Chairman
CAROLYN B. MALONEY, New York         MICHAEL PATRICK FLANAGAN, Illinois
MAJOR R. OWENS, New York             PETER BLUTE, Massachusetts
JOHN M. SPRATT, Jr., South Carolina  THOMAS M. DAVIS, Virginia
PAUL E. KANJORSKI, Pennsylvania      RANDY TATE, Washington
COLLIN PETERSON, Minnesota           JOE SCARBOROUGH, Florida
TIM HOLDEN, Pennsylvania             CHARLES F. BASS, New Hampshire
                                     SCOTT KLUG, Wisconsin

                               Ex Officio

CARDISS COLLINS, Illinois            WILLIAM F. CLINGER, Jr., 
                                     Pennsylvania
J. Russell George, Staff Director/
              Counsel
 Mark Brasher, Professional Staff
     Mark Stevenson, Minority 
        Professional Staff


                         LETTER OF TRANSMITTAL

                              ----------                              

                                  House of Representatives,
                                Washington, DC, September 27, 1996.
Hon. Newt Gingrich,
Speaker of the House of Representatives,
Washington, DC.
    Dear Mr. Speaker: By direction of the Committee on 
Government Reform and Oversight, I submit herewith the 
committee's seventeenth report to the 104th Congress.
                                 William F. Clinger, Jr., Chairman.

                                     


                            C O N T E N T S

                               __________
                                                                   Page
 I. Summary of oversight findings and recommendations.................1
        A. Introduction..........................................     1
        B. Summary of findings and recommendations...............     2
        C. Background............................................     3
        D. Proceedings of the Subcommittee on Government 
            Management, Information, and Technology..............     5
        E. Findings..............................................    11
        F. Recommendations.......................................    13
        G. Conclusion............................................    15

  
                                                 Union Calendar No. 465
104th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES

 2nd Session                                                    104-858
_______________________________________________________________________

  CRUDE OIL UNDERVALUATION: THE INEFFECTIVE RESPONSE OF THE MINERALS 
                           MANAGEMENT SERVICE

                                _______
                                

 September 27, 1996.--Committed to the Committee of the Whole House on 
            the State of the Union and ordered to be printed

_______________________________________________________________________


  Mr. Clinger, from the Committee on Government Reform and Oversight, 
                        submitted the following

                           SEVENTEENTH REPORT

    On September 24, 1996, the Committee on Government Reform 
and Oversight approved and adopted a report entitled ``Crude 
Oil Undervaluation: The Ineffective Response of the Minerals 
Management Service.'' The chairman was directed to transmit a 
copy to the Speaker of the House.

          I. Summary of Oversight Findings and Recommendations

                            A. INTRODUCTION

    The Committee on Government Reform and Oversight (``the 
committee'') has primary legislative and oversight jurisdiction 
with respect to the ``overall economy, efficiency and 
management of Government operations and activities, including 
Federal procurement.'' It also has primary oversight 
responsibility to ``review and study, on a continuing basis, 
the operation of Government activities at all levels with a 
view to determining their economy and efficiency.'' \1\ In 
addition to its other oversight responsibilities:
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    \1\ Rules of the House of Representatives, 104th Congress, X, 
1(g)(6) and (12) and X, 2(b)(2).

          [T]he Committee on Government Reform and Oversight 
        may at any time conduct investigations of any matter 
        without regard to the provisions . . . conferring 
        jurisdiction over such matter upon another standing 
        committee. The committee's findings and recommendations 
        in any such investigation shall be made available to 
        the other standing committee or committees having 
        jurisdiction over the matter involved. . . .\2\
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    \2\ Rules of the House of Representatives, 104th Congress, X, 
4(c)(2).

    Pursuant to this authority, Subcommittee on Government 
Management, Information, and Technology of the Committee on 
Government Reform and Oversight convened an oversight hearing 
on June 17, 1996 to examine whether companies under agreements 
to extract oil from Federal lands in California undervalued the 
oil and as a result, underpaid royalties to the Federal 
Government. The subcommittee also reviewed the management of 
this program by the Minerals Management Service of the 
Department of the Interior.

               B. SUMMARY OF FINDINGS AND RECOMMENDATIONS

    Between 1978 and 1993, oil companies did not pay sufficient 
royalty on crude oil drilled on Federal lands in California and 
elsewhere. These amounts may reach as high as $2 billion 
nationwide. This is a serious problem that the Department of 
the Interior's Minerals Management Service has failed to 
seriously address.

                           Findings in Brief

    1. There is an undervaluation problem, where crude oil 
royalties received by the Federal Government have been below 
fair market value.
    2. The Minerals Management Service has delayed collecting 
crude oil royalty revenues due to these undervaluations.
    3. Global settlements between the Federal Government and 
major oil companies have not protected the financial interests 
of the U.S. Government and its taxpayers.
    4. The crude oil undervaluation problem is not limited to 
California; it exists in other oil-producing States.
    5. Royalty-in-kind transactions may have left Federal 
financial interests unprotected.
    6. Pipelines which cross Federal lands harm Federal 
interests by depressing oil royalty revenues and preventing an 
efficient oil market through the monopolistic distortion caused 
by proprietary pipelines.

                        Recommendations in Brief

    1. The Minerals Management Service must prepare a timetable 
for collecting royalty underpayments.
    2. The Minerals Management Service needs to consider 
outside audit assistance to supplement its existing audit 
staff.
    3. The Minerals Management Service, together with the 
Department of Justice, should review existing global 
settlements to determine whether Federal financial interests 
can be salvaged and prevent future problems with global 
settlements which reduce the potential for royalty collections 
by the Federal Government.
    4. The Department of the Interior should immediately 
proceed to examine whether other underpayments have occurred in 
States other than California.
    5. The Department of the Interior should examine royalty-
in-kind payments to determine whether these amounts also 
suffered from undervaluation, and whether the royalties can be 
recovered.
    6. The Department of the Interior should enforce the 
administration's stated policy on oil pipelines, and discuss 
the issue with officials in the State of California to ensure 
that all pipelines in California promote an efficient oil 
market and protect Federal financial interests.

                             C. BACKGROUND

    California is the fourth largest oil-producing State in the 
United States.\3\ During 1994, California's crude-oil 
production totaled about 345 million barrels of oil, or just 
under 1 million barrels a day.\4\ This includes a large amount 
of oil produced on Federal lands in California. In 1975, the 
State of California and the city of Long Beach initiated 
litigation against seven major oil companies operating in 
California alleging that the companies conspired to keep posted 
oil prices low.\5\ The city and State claimed they had been 
damaged because their oil revenues depended on posted prices 
and the royalty thereon.\6\ If the posted price is below fair 
market value, the Federal Government loses royalty revenue.
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    \3\ California Department of Conservation homepage, Internet 
address http://www.consrv.ca.gov/dog/facts.html.
    \4\ Ibid.
    \5\ U.S. Department of the Interior, History of the California 
Pricing Issue, undated document released with the Final Interagency 
Report on the Valuation of Oil Produced from Federal Leases in 
California, May 16, 1996. The oil companies involved in the suit 
included ARCO, Shell, Chevron, Mobil, Texaco, Unocal, and Exxon.
    \6\ Ibid. Posted prices are the announced prices at which crude oil 
purchasers, generally major refiners, will purchase crude oil from 
producers at the wellhead.
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    In 1986, the Minerals Management Service (MMS) of the 
Department of the Interior contacted State officials in 
California to assess the appropriateness of posted prices as 
the royalty value basis.\7\ MMS concluded that the system of 
posted prices existing at the time fairly represented market 
value. Weighing heavily in the MMS decision was the fact that 
the State of California and the city of Long Beach had been 
unsuccessful with their antitrust claims in court.\8\ The 
Department of Justice looked into the issue and chose not to 
pursue an investigation.\9\
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    \7\ Ibid.
    \8\ Ibid. The State of California and the city of Long Beach had 
attempted to show collusion between the oil companies to keep posted 
prices low. The State and city's demonstration of underpricing of crude 
oil have been more convincing than the charge of collusion, as the 
collusion/antitrust claim is more difficult to prove.
    \9\ Ibid. In the mid-1980's, MMS, the General Accounting Office and 
the Internal Revenue Service independently analyzed the issue, but the 
information available to them at the time was inconclusive in proving 
that Federal oil was undervalued at posted prices. For example, see 
U.S. General Accounting Office, California Crude Oil: An Analysis of 
Posted Prices and Fair Market Value, GAO/GGD 88-114, September 8, 1988.
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    In 1991, six of the companies involved (ARCO, Shell, 
Chevron, Mobil, Texaco, and Unocal) reached settlements 
totaling $345 million to end the court actions by the State and 
city alleging undervaluation.\10\ A seventh defendant, Exxon, 
went to trial and was exonerated on the antitrust charges 
relating to State oil leases. That decision was appealed, and 
Exxon won the appeal in January 1995.\11\ A separate appeal 
covering a different time period is still pending.
---------------------------------------------------------------------------
    \10\ U.S. Department of the Interior, Final Interagency Report on 
the Valuation of Oil Produced from Federal Leases in California, May 
16, 1996, page 1 of the Executive Summary.
    \11\ Ibid.
---------------------------------------------------------------------------
    In light of the 1991 settlement relating to undervaluation 
of State crude oil leases, MMS performed a scoping exercise to 
estimate the size of any potential royalty underpayments 
relating to Federal lands.\12\ However, since the MMS scoping 
exercise lacked crucial information relating to the Long Beach 
cases such as internal oil company records, the State of 
California urged the Department of the Interior to begin a more 
formal investigation.\13\ MMS responded by creating an 
interagency task force in 1994.\14\ The task force consisted of 
representatives from MMS, the Office of the Solicitor in the 
Department of the Interior, the Department of Commerce, the 
Department of Energy and the Department of Justice.
---------------------------------------------------------------------------
    \12\ Ibid, page 15.
    \13\ Ibid, page 15.
    \14\ Ibid, page 2. The Department of Justice subsequently resigned 
from the team, citing the move away from the interagency team from 
investigating antitrust violations and more focus on undervaluation of 
royalty payments.
---------------------------------------------------------------------------
    The State of California assisted the Federal team in 
obtaining court records from the earlier litigation. These 
documents were instrumental in demonstrating the undervaluation 
of crude oil to the Federal interagency team. In May of 1996, 
the Federal interagency team released its report, which 
concluded that companies often received gross proceeds higher 
than their posted prices.\15\ The bulk of crude oil in 
California was not sold in competitive markets with competing 
economic interests. Rather, it was moved through intracompany 
transfers; straight exchanges (where one oil company trades oil 
at one location with another company which has oil at another 
location; this allows both to avoid or reduce transportation 
costs); and buy/sell contracts (which include other costs in 
addition to the value of the crude oil, including 
transportation costs or other considerations).\16\ In the 
absence of vigorous competition amongst competing economic 
interests, it is difficult to determine a proxy for the market 
value of oil. Correspondingly, it is easy for oil companies to 
hide the true value of the crude oil in complicated contracts 
with separate charges for transportation.\17\
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    \15\ Ibid, page 44.
    \16\ Ibid, page 50.
    \17\ Summit Resource Management, Inc., Crude Oil Royalty Payment 
Analysis, February 21, 1995, page 5. The Summit report compares lease 
pricing methods with trade pricing methods and concludes that the 
``sales price at the lease has absolutely no bearing on the actual 
price received for the sale of the oil.''
---------------------------------------------------------------------------
    The interagency report estimates that Federal revenues from 
oil royalties on California leases alone are between zero and 
$856 million for the period between 1978 and 1993. The report 
recommended:
     that MMS focus collection efforts on those 
companies (about 10) that produce 90 percent of Federal crude 
oil in California;
     that for the period beginning March 1, 1988, 
Federal royalties be computed by the premium paid on 
competitive arm's-length contracts for oil produced from the 
same field or area;
     that the Assistant Secretary of the Interior issue 
a royalty payor letter ordering targeted oil companies to 
submit all arm's-length contract records for the periods in 
question so as to minimize audit expenses;
     that the Federal Government submit a bill for 1989 
and 1993 to Texaco, since MMS audited those records;
     that MMS's oil royalty valuation regulations be 
revised to consider alternatives to reliance on posted prices 
and improve clarity; and
     that a method be chosen to determine royalties 
owed. The team was split on which approach to take for the 
period before March 1, 1988. The team was split as follows:

          (1) the Commerce and Energy Departments recommended 
        using Alaska North Slope oil market prices as the basis 
        for valuing Federal crude oil in California for 
        purposes of determining royalties (this is less audit 
        intensive, but potentially open to legal challenges) 
        and that MMS pursue underpayments from 1980 forward; 
        while
          (2) the MMS/Solicitor's office recommended using the 
        same procedures before 1988 as after 1988 (these 
        procedures require labor-intensive audits, but closely 
        conform to established precedent), and that MMS and the 
        Solicitor's office determine how far back to pursue 
        royalty underpayments.\18\
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    \18\ U.S. Department of the Interior, Final Interagency Report on 
the Valuation of Oil Produced from Federal Leases in California, May 
16, 1996, pages 54-87.

    Subsequently, MMS announced that it would accept part of 
the task force's recommendations and attempt to collect 
approximately $440 million.\19\ The $856 million figure was 
reduced due to global settlements between the oil companies and 
the Department of the Interior, payments-in-kind of the 
royalty, and other factors. However, this does not include 
potential underpayments from States other than California. It 
is limited solely to Federal crude oil coming from lands in 
California.\20\
---------------------------------------------------------------------------
    \19\ Press Release, U.S. Department of the Interior, MMS Pursues 
California Undervaluation Royalties, July 18, 1996.
    \20\ Ibid.
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    In August of 1996, a draft report of the inspector general 
of the Department of the Interior was obtained by various press 
sources.\21\ The draft report criticized the Department for 
improper procedures during negotiations with oil companies. 
During these negotiations, the Department reduced the estimated 
value of items to be negotiated by more than $350 million--
without documentation.\22\ The draft report is dated November 
1995; it has not yet been released, having been delayed for 
nearly 1 year.
---------------------------------------------------------------------------
    \21\ Wall Street Journal, U.S. May Have Lost Out on Vast Oil 
Royalties, August 15, 1996, section A, page 3.
    \22\ U.S. Department of the Interior, Office of Inspector General, 
Draft Audit Report, Negotiated Royalty Settlements, November 1995, 
pages 5-6.
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     D. PROCEEDINGS OF THE SUBCOMMITTEE ON GOVERNMENT MANAGEMENT, 
                      INFORMATION, AND TECHNOLOGY

    On June 17, 1996, the subcommittee convened a hearing 
examining whether the Federal Government was receiving the oil 
royalties that are due it. Subcommittee Chairman Horn opened 
the hearing noting that the recently enacted Debt Collection 
Improvement Act provided to agencies the tools they need to 
collect delinquent debts owed to the Federal Government, and 
the great interest of Congress in general, and the Committee on 
Government Reform and Oversight in particular, in collecting 
these amounts.\23\ Ranking member Representative Carolyn 
Maloney noted her interest in seeing that oil royalties are 
collected. Mrs. Maloney advocated using the market price of 
Alaska North Slope crude as a proxy for fair market value of 
California crude oil rather than auditing each Federal mineral 
lease contract.\24\
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    \23\ Opening statement of Subcommittee Chairman Stephen Horn before 
a hearing of the Subcommittee on Government Management, Information, 
and Technology, House Committee on Government Reform and Oversight, 
Valuation of Federal Oil--Is the U.S. Getting the Royalties it is Owed? 
June 17, 1996.
    \24\ Opening statement of Representative Carolyn Maloney before a 
hearing of the Subcommittee on Government Management, Information, and 
Technology, House Committee on Government Reform and Oversight, 
Valuation of Federal Oil--Is the U.S. Getting the Royalties it is Owed? 
June 17, 1996.
---------------------------------------------------------------------------
    Representative Ken Calvert, chairman of the Subcommittee on 
Energy and Mineral Resources of the Committee on Resources, 
reviewed his committee's activities regarding the royalty 
management program: ``The Federal Government runs an 
inefficient, complicated, and burdensome system for royalty 
collection and accounting which has resulted in enormous 
amounts of litigation over the years.'' \25\ Mr. Calvert 
advocated the passage of H.R. 1975, the Federal Oil and Gas 
Royalty Simplification and Fairness Act, to help solve the 
problem.\26\ The cornerstone of the bill is expanded authority 
for State governments to manage the royalties from Federal 
lands located in the State. Mr. Calvert noted that half of the 
revenues from onshore crude oil production go to the State from 
which they are derived. The legislation will assist in solving 
the royalty underpayment problem in the future, but will not 
give any directions on how the Minerals Management Service 
should pursue past underpayments.\27\
---------------------------------------------------------------------------
    \25\ Statement of Representative Ken Calvert before a hearing of 
the Subcommittee on Government Management, Information, and Technology, 
House Committee on Government Reform and Oversight, Valuation of 
Federal Oil--Is the U.S. Getting the Royalties it is Owed? June 17, 
1996.
    \26\ H.R. 1975 passed the House of Representatives on July 16, 1996 
under suspension of the rules and passed the Senate on August 2, 1996. 
President Clinton subsequently signed the Federal Oil and Gas Royalty 
Simplification and Fairness Act on August 13, 1996. It became Public 
Law No. 104-185.
    \27\ Statement of Representative Ken Calvert, during debate on H.R. 
1975, the Federal Oil and Gas Royalty Simplification and Fairness Act, 
Congressional Record, page H7606.
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    Director of the Minerals Management Service Cynthia 
Quarterman testified that in 1993, the Office of Policy 
Analysis at the Department of the Interior asked MMS to review 
the undervaluation issue in light of the 1991 settlement in the 
Long Beach litigation.\28\ Director Quarterman described the 
timing of events surrounding the crude oil undervaluation 
issue. A scoping exercise in 1993 and 1994 confirmed that the 
underpayment issue should be pursued using an interagency task 
force employing representatives from MMS and the Solicitor's 
office in the Department of the Interior, and the Departments 
of Commerce, Energy and Justice. The Federal employees were 
supplemented by consultants.\29\ Abraham E. Haspel, Chief 
Economist at the Department of Energy, described the role of 
the Department of Energy in the interagency task force and 
summarized some of the conclusions which the task force 
generated.
---------------------------------------------------------------------------
    \28\ Oral testimony of Director Cynthia Quarterman, Director, 
Minerals Management Service, U.S. Department of the Interior before a 
hearing of the Subcommittee on Government Management, Information, and 
Technology, House Committee on Government Reform and Oversight, 
Valuation of Federal Oil--Is the U.S. Getting the Royalties it is Owed? 
June 17, 1996.
    \29\ U.S. Department of the Interior, Final Interagency Report on 
the Valuation of Oil Produced from Federal Leases in California, page 
29. The contract was with Innovation and Information Consultants, Inc., 
which had assisted the State of California in analyzing oil sales 
contracts for the Long Beach litigation.
---------------------------------------------------------------------------
    In the question period, Subcommittee Chairman Horn quoted a 
1993 memorandum in which Robert Berman, an economist in 
Interior's Office of Policy Analysis, suggested that the 
Department should ``[p]roceed immediately to ascertain the 
amount of additional royalties due and initiate collection 
procedures.'' \30\ Adding that this was the same conclusion 
reached by the interagency team after a 3-year delay, 
Subcommittee Chairman Horn placed in the record a 1994 
electronic mail message from the interagency team leader David 
Hubbard, expressing his concern about the timetable for 
completing the interagency report and his feeling that he has 
``stalled on this issue long enough.'' \31\ In the hearing, 
Director Quarterman responded that the agency was not engaging 
in a pattern of delay and stressed that auditing oil company 
records was a time-consuming process.\32\
---------------------------------------------------------------------------
    \30\ U.S. Department of the Interior, memorandum from Bob Berman to 
Brooks Yeager, California Common Carrier and Crude Valuation, August 6, 
1993.
    \31\ U.S. Department of the Interior, electronic mail message from 
David Hubbard, MMS Denver, CO, to James W. Shaw, MMS Denver, CO.
    \32\ Testimony of Director Quarterman, June 17, 1996.
---------------------------------------------------------------------------
    Mrs. Maloney noted her belief that MMS should attempt to 
collect underpayments which occurred during the period 1980-85, 
since nearly three-fourths of all underpayments occurred in 
that time period. Director Quarterman declined to commit to 
that request, noting that there were other factors at work, 
including competing demands for time and staff which might 
involve greater dollar figures. Mrs. Maloney repeated her wish 
that the prices for crude oil from the Alaska North Slope (ANS) 
be used as a proxy for market value in California. Again, 
Director Quarterman would not commit MMS to this course of 
action, despite the use of ANS prices as market value in 
California by the task force and by major oil companies.\33\
---------------------------------------------------------------------------
    \33\ Ibid.
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    Subcommittee Chairman Horn asked what would be an 
appropriate gauge of market value of crude oil. Mr. Berman 
indicated that a market price, such as the price of crude oil 
on the New York Mercantile Exchange, or, on the west coast, ANS 
prices, provide the best benchmark for economic value. 
Subcommittee Chairman Horn inquired whether adjustments needed 
to be made for transportation costs. Mr. Berman believed that 
could be easily done by using the spot market for a given 
commodity in a given location. He added that it is easy for the 
owner of a pipeline to disguise a premium on crude oil.\34\
---------------------------------------------------------------------------
    \34\ Oral testimony of Robert Berman, Office of Policy Analysis, 
U.S. Department of the Interior before a hearing of the Subcommittee on 
Government Management, Information, and Technology, House Committee on 
Government Reform and Oversight, Valuation of Federal Oil--Is the U.S. 
Getting the Royalties it is Owed? June 17, 1996.
---------------------------------------------------------------------------
    Director Quarterman described the changing resource levels 
devoted to the royalty management program, and the recent 
addition of $4 million above the President's request by the 
House Committee on Appropriations for the audit division.\35\
---------------------------------------------------------------------------
    \35\ Testimony of Director Quarterman, June 17, 1996.
---------------------------------------------------------------------------
    Mrs. Maloney reviewed the chronology of MMS's actions with 
respect to crude oil undervaluation. She pointed out that MMS 
entered into a global settlement with Exxon and Chevron after 
an internal memorandum noted that perhaps $422 million was owed 
in underpayments.\36\ Director Quarterman replied that the 
Exxon agreement included a provision that would allow MMS to 
collect in the case of fraud, malfeasance, concealment or 
misrepresentation of fact. Director Quarterman agreed not to 
proceed with additional global settlements without an exclusion 
relating to crude oil valuation.\37\
---------------------------------------------------------------------------
    \36\ Statement of Representative Carolyn Maloney, June 17, 1996.
    \37\ Testimony of Director Quarterman, June 17, 1996.
---------------------------------------------------------------------------
    Mrs. Maloney quoted the task force conclusion that 
pipelines owned by a vertically integrated oil company--through 
which oil may be required to go--contribute to the 
undervaluation problem. Director Quarterman asserted that the 
Department of the Interior did not have jurisdiction over the 
pipelines in California since they do not traverse Federal land 
or raise interstate commerce issues by going through another 
State.\38\
---------------------------------------------------------------------------
    \38\ Ibid.
---------------------------------------------------------------------------
    Subcommittee Chairman Horn noted the task force 
recommendation that bills be sent immediately to oil companies 
which were subjected to audits by the task force. Director 
Quarterman testified that she did not anticipate sending bills, 
to avoid a piecemeal approach to collecting underpayments.\39\
---------------------------------------------------------------------------
    \39\ Ibid.
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    Mrs. Maloney asked whether Mr. Berman had sent a memorandum 
warning MMS of the potential loss of Federal revenue if the 
undervaluation issue was included as a part of the global 
settlements being negotiated with certain oil companies. Mr. 
Berman said that he had sent this memorandum to Brooks Yeager, 
the Director of the Office of Policy Analysis, and discussed 
the matter with Yeager and Ted Heintz, Berman's immediate 
supervisor.
    Mr. Berman testified that he had initiated an investigation 
to determine whether posted prices reflect market value outside 
of California. According to Mr. Berman, the initial 
investigations indicate that posted prices are below market 
value outside of California. Subcommittee Chairman Horn asked 
the amount by which posted prices understated value. Mr. Berman 
replied that posted prices might have been between 3 and 10 
percent below the market value of the crude oil.\40\
---------------------------------------------------------------------------
    \40\ Testimony of Mr. Berman, June 17, 1996.
---------------------------------------------------------------------------
    Assistant Secretary of the Interior for Land and Minerals 
Management Robert Armstrong was asked by Subcommittee Chairman 
Horn for a timetable of when bills would be sent to Texaco, 
which was the subject of an audit during the task force 
deliberation. Mr. Armstrong responded that in 4 to 6 weeks, a 
bill would be sent.\41\
---------------------------------------------------------------------------
    \41\ Oral testimony of Assistant Secretary for Land and Minerals 
Management, U.S. Department of the Interior, Robert Armstrong, before a 
hearing of the Subcommittee on Government Management, Information, and 
Technology, House Committee on Government Reform and Oversight, 
Valuation of Federal Oil--Is the U.S. Getting the Royalties it is Owed? 
June 17, 1996. Mr. Armstrong's testimony contradicted that of Director 
Quarterman, who indicated that bills for these audits would not be sent 
out in a ``piecemeal fashion.'' A bill has not yet been sent.
---------------------------------------------------------------------------
    Subcommittee Chairman Horn asked Mr. Berman whether the 
appropriate market gauge for fair market value for crude oil is 
the ANS price. Mr. Berman noted that a common benchmark should 
be used. In California, this benchmark is the ANS price, while 
outside of California there are other, more useful market 
benchmarks such as the price on the New York Mercantile 
Exchange, Cushing, and St. James. Mr. Horn urged that a market 
price be used in determining fair market value.
    Mrs. Maloney asked Robert Speir, an economist at the 
Department of Energy and a member of the interagency task 
force, why the task force opinion diverged on whether to use 
ANS crude oil prices as a proxy for market value. Mr. Speir 
indicated that the divergence resulted from different opinions 
on how to value crude oil accurately.\42\ Mr. Speir explained 
that since ANS represents fair market value, that was the 
determinant in his belief in the appropriateness of using an 
ANS benchmark. Mr. Speir also noted that oil companies used an 
ANS benchmark to determine value and that he had reviewed oil 
company documents that indicated that posted prices did not 
represent fair market value.\43\
---------------------------------------------------------------------------
    \42\ Mr. Speir indicates that he and the Department of Commerce 
representative prefer a market-based valuation for fair market value, 
while the Department of Interior personnel from MMS and the Solicitor's 
office appear to be more interested in consistency and performing the 
task of valuation as it has always been done.
    \43\ Oral testimony of Robert Speir, U.S. Department of Energy 
before a hearing of the Subcommittee on Government Management, 
Information, and Technology, House Committee on Government Reform and 
Oversight, Valuation of Federal Oil--Is the U.S. Getting the Royalties 
it is Owed? June 17, 1996.
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    Mrs. Maloney asked Mr. Armstrong, Mr. Haspel, Mr. Berman 
and Mr. Speir the number of heated oil pipelines which crossed 
Federal lands in California. There was agreement that there was 
only one pipeline, Mobil's M-70, that crossed Federal land. Mr. 
Haspel noted that it is the policy of the Department of Energy 
that pipelines operate as common carriers.\44\
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    \44\ Oral testimony of Brian McMahon, Hoecker and McMahon, before a 
hearing of the Subcommittee on Government Management, Information, and 
Technology, House Committee on Government Reform and Oversight, 
Valuation of Federal Oil--Is the U.S. Getting the Royalties it is Owed? 
June 17, 1996. Mr. McMahon refers to a letter from William Weitzel of 
Texaco, Inc. to the Federal Trade Commission referring to Texaco's 
acquisition of Getty Oil. The letter refers to a Consent Order 
requiring Texaco to sell oil at posted price and characterizes this 
action as ``inappropriate and unfair'' since ``posted prices are 
currently lower than market.'' Page 9.
---------------------------------------------------------------------------
    Brian McMahon, an attorney with Hoecker and McMahon, 
represented the city of Long Beach and the State of California 
in litigation regarding crude oil undervaluation. Mr. McMahon 
testified that periodic oil selloffs by the Federal Government 
at Elk Hills in California, or by the State of California or 
the city of Long Beach would typically yield premia over posted 
prices.\45\ McMahon also noted Texaco's assertion, in an 
official document to the Federal Trade Commission, that posted 
prices were lower than market value.\46\ Mr. McMahon noted that 
there was a problem with the pipelines in California and their 
continuing usage of posted prices:
---------------------------------------------------------------------------
    \45\ Ibid. The premia is present where the price obtained through a 
market sale was higher than a price obtained through the use of a 
posted price, with the premium being the difference between the two 
prices, and premia being the plural of premium.
    \46\ Testimony of Mr. Speir, June 17, 1996.

          To my knowledge, there is only one heated pipeline 
        coming out of the San Joaquin Valley to Los Angeles, 
        and that is the pipeline identified as the M-70 of 
        Mobil. That goes through the Angeles National Forest, 
        and we know that the Mobil Co. received an MLA permit, 
        it is called, a Mineral Leasing Act permit, in order to 
        pass through Federal lands. That permit required Mobil 
        to dedicate its pipeline as a common carrier. In fact 
        Mobil does not dedicate its pipeline as a common 
        carrier, and crude oil producers in the San Joaquin 
        Valley must sell their crude at the price Mobil sets 
        for its crude oil, and that price is the posted 
        price.\47\
---------------------------------------------------------------------------
    \47\ Testimony of Mr. McMahon, June 17, 1996.

    Mr. McMahon described an instance where the production unit 
of Union Oil Co. was faced with a situation where the posted 
price was lower than the price of production.\48\ The company 
affirmed that the posted price did not represent market 
value.\49\ In response to this situation, the production arm 
suggested that it should share in the value of the refined 
value of the crude oil, much like what the State of California 
has suggested that the oil companies should do in correcting 
undervaluation of crude oil.
---------------------------------------------------------------------------
    \48\ Often, oil companies are vertically integrated, with the same 
firm owning or controlling the drilling, transportation, refining and 
marketing of petroleum products. These various units are sometimes made 
into a subsidiary corporation for favorable legal purposes.
    \49\ Ibid.
---------------------------------------------------------------------------
    In response to questioning by Mrs. Maloney, Mr. McMahon 
indicated that the documents relating to the Long Beach 
undervaluation cases contain very sensitive information 
evidencing underpricing.\50\ Robert Shannon, assistant city 
attorney for the city of Long Beach, testified that the 
competitors of the oil companies had seen the documents, and 
that this mooted the question of commercial sensitivity.\51\
---------------------------------------------------------------------------
    \50\ Ibid.
    \51\ Oral testimony of Robert Shannon, assistant city attorney, 
city of Long Beach, CA, before a hearing of the Subcommittee on 
Government Management, Information, and Technology, House Committee on 
Government Reform and Oversight, Valuation of Federal Oil--Is the U.S. 
Getting the Royalties it is Owed? June 17, 1996.
---------------------------------------------------------------------------
    Mr. McMahon also described the difficulty of determining 
what is an arm's-length transaction. For example, Mr. McMahon 
characterized shadow transactions which had the effect of 
disguising market value:

          Suppose that I am tired of [California] earthquakes 
        and my friend in Hartford, CT, is tired of snow, so we 
        decide I am going to move to Hartford and he is going 
        to move to California. And we both have a Ford Taurus, 
        and he has a car that is 1 year younger than mine, and 
        it is worth $2,000 more. We say why should we drive 
        both cars cross country. Let's just sell it to each 
        other. Then I say that I will price yours at $22,000 
        and you price mine at $20,000, and we will write checks 
        for that amount. So he says, ``Wait a minute! If we do 
        that, we are going to have to pay a lot of tax on this. 
        Let's price my car at $3,000 and your car at $1,000.'' 
        This preserves the $2,000 real difference in price, but 
        we paid much less in taxes. And that is what the oil 
        companies are doing with the posted prices.\52\
---------------------------------------------------------------------------
    \52\ Testimony of Mr. McMahon, June 17, 1996.

Mr. McMahon further elaborated on the issue, comparing the 
pipeline distribution system to other transportation 
bottlenecks, such as the railroads in the 19th century.\53\
---------------------------------------------------------------------------
    \53\ Ibid. The bottleneck theory of antitrust holds that monopolies 
can flow from dominating either production, distribution or 
transportation hubs through which a particular product must pass. In 
the 19th century, railroads were a necessity to get many products to 
market. The differential prices which railroads charged different 
customers allowed trusts, such as the Standard Oil Trust, to dominate 
the market.
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                              E. FINDINGS

    The committee finds the following:

The Minerals Management Service has delayed collecting royalty 
        undervaluations

    In the hearing held by the committee on June 17, 1996, 
members expressed concern over delays in collecting 
underpayments. MMS has engaged in tactics to delay the release 
of the interagency report, as evidenced by an electronic 
message to his supervisor in 1994, David Hubbard, the 
interagency task force leader, in requesting additional audit 
resources, stated that he has ``stalled long enough.''
    Once MMS disclosed that it would attempt to collect $440 
million, it did not include a timetable for the completion of 
this task. MMS will not simply send the oil companies a bill 
using Alaska North Slope crude prices as a proxy for the market 
price of oil. Instead, MMS will audit each and every contract. 
Given that MMS will have to use scarce audit resources, it will 
likely take many years to complete this task. This is 
especially true because the MMS audit division is not committed 
to collecting these revenues. Unpublished Department of the 
Interior notes quote the head of the MMS audit division 
dismissing the interagency task force report in November 1995 
as ``a piece of [expletive deleted].'' Giving control of the 
audit process to staff who vehemently disagree with the results 
provides MMS management with further opportunities to delay 
implementation of sensible policies.
    The MMS announcement does not outline any interim steps the 
agency will take. The interagency task force audited Shell's 
contracts in California for 1984 and Texaco for 1989 and 
1993.\54\ As recommended in the report, bills should 
immediately be sent to those companies for those years. During 
the June 17 hearing on this issue, Assistant Secretary of the 
Interior for Land and Minerals Management Robert Armstrong 
stated that bills would be sent out within 4 to 6 weeks. As of 
the date of this report, 9 weeks have passed since the date of 
the hearing, and no action has occurred.
---------------------------------------------------------------------------
    \54\ U.S. Department of the Interior, Final Interagency Report on 
the Valuation of Oil Produced from Federal Leases in California, pages 
63-64.
---------------------------------------------------------------------------

Global settlements may not have protected U.S. financial interests

    MMS engaged in global settlements (i.e., a settlement 
agreement between the Federal Government and an oil company 
which covers a number of issues and claims in one fell swoop) 
which allowed two oil companies with large underpayments to 
avoid payment with the full knowledge that there were 
substantial problems with underpayments in California in this 
program. These agreements may have extinguished the claim of 
the Federal Government to collect the amounts owed. Apparently, 
the inspector general also recognized that these agreements did 
not demonstrate that the best interests of the United States 
were protected.\55\ In a draft report, the inspector general 
noted that the royalty settlements were not conducted in 
accordance with ``Minerals Management Service Settlement 
Negotiation Procedures.'' The report faults MMS for including 
``no documentation for the estimated values of the issues 
concerning the underpayment of royalties to be negotiated. . . 
.'' \56\ In addition, the report faults MMS for writing down 
amounts owed for no apparent reason:
---------------------------------------------------------------------------
    \55\ U.S. Department of the Interior, Office of Inspector General, 
Draft Audit Report, Negotiated Royalty Settlements, November 1995, page 
1.
    \56\ Ibid, page 4.

          Prior to negotiations, one of the Service's Royalty 
        Management Program divisions estimated the value of a 
        particular issue to be negotiated in a global 
        settlement to be about $439 million. However, the list 
        of issues and values prepared by the negotiation team 
        prior to negotiations estimated that the same issue was 
        valued at $78 million. Documentation in the settlement 
        file was insufficient to explain the $360.4 million 
        difference in the estimated values of this issue.\57\
---------------------------------------------------------------------------
    \57\ Ibid, pages 5-6.

    These are serious charges. It would be helpful for MMS to 
realize that the problem that we have with the Federal budget 
deficit means that we must protect the taxpayers of this 
country through better financial management. MMS's poor 
management and slow response reflect poorly on the 
administration's record. During testimony in a hearing on this 
topic on June 17, Robert Berman, an economist in the Office of 
Policy Analysis of the Department of the Interior testified 
that he issued a memorandum expressing his concern that MMS was 
entering into global settlements with no consideration given to 
the underpayment issue.\58\ This memorandum was issued prior to 
the global settlements, but apparently went unheeded.
---------------------------------------------------------------------------
    \58\ Testimony of Mr. Berman, June 17, 1996.
---------------------------------------------------------------------------

The California undervaluation problem exists in other States

    During the June 17 committee hearing, Robert Berman also 
testified that the amount of the undervaluation of oil 
extracted from Federal lands may amount to between 3 and 10 
percent for States other than California. This may amount to 
more than $1.3 billion if the higher range is used.\59\
---------------------------------------------------------------------------
    \59\ Testimony of Mr. Berman, June 17, 1996 and press release by 
the Project on Government Oversight, August 5, 1996. Berman testified 
that the undervaluation of crude oil was probably between 3 and 10 
percent. Using this information, the Project on Government Oversight 
estimated that applying this percentage to crude oil royalties outside 
of California would yield $1.3 billion.
---------------------------------------------------------------------------

Royalty-in-kind transactions may have left U.S. financial interests 
        unprotected

    The May 1996 interagency task force report acknowledged 
that the team had not ``investigated recoupment of additional 
revenues on royalty-in-kind crude oil that might have been 
undervalued.'' The report recommends that the ``Department [of 
the Interior] should consider the effects of RIK [royalty-in-
kind] volumes in its decisionmaking, including potential 
collections where these volumes were undervalued.'' \60\
---------------------------------------------------------------------------
    \60\ U.S. Department of the Interior, Final Interagency Report on 
the Valuation of Oil Produced from Federal Leases in California, page 
40, footnote 16.
---------------------------------------------------------------------------
    In concept, royalty-in-kind oil is taken by the Department 
of the Interior and sold directly to a refiner. In practice, 
the Department relied on the Federal leaseholder and the 
refiner-purchaser to arrange the terms of sale and transfer to 
the refiner's facility. The Federal Government then received 
payment from the refiner. Typically, this was the posted price, 
which has been determined to be undervalued. It is possible 
that royalty-in-kind purchasers were effectively forced to pay, 
through excessive transportation charges, more for their 
Federal crude oil than the Federal Government received (i.e., 
the Federal Government may not have received all of the fair 
market value of the crude oil which it was due since some of 
the value may have been retained by the leaseholder through 
excessive transportation charges).\61\
---------------------------------------------------------------------------
    \61\ See note 17.
---------------------------------------------------------------------------
    To the extent that royalty-in-kind purchasers were forced 
to exchange their royalty-in-kind crude oil with the Federal 
leaseholder because the purchaser could not gain access to 
proprietary pipelines, the purchasers may have had to pay a 
premium due to lack of access to transportation assets.

Pipelines which cross Federal lands harm Federal interests by 
        depressing royalty revenues and preventing an efficient oil 
        market

    The problem of proprietary pipelines was well understood by 
the task force. As the task force notes:

          The market restrictions imposed by proprietary 
        pipelines operated by the major oil refiners had two 
        critical effects. First, it greatly restricted open-
        market trading in California crude oil; second, it 
        segregated the crude oil markets of the San Joaquin 
        Valley and Ventura Basin from the refining centers in 
        San Francisco and Los Angeles. The reports [of two 
        consultants employed by the task force] concluded that 
        the pipeline situation contributed to postings 
        substantially understating California crude oil 
        values.\62\
---------------------------------------------------------------------------
    \62\ U.S. Department of the Interior, Final Interagency Report on 
the Valuation of Oil Produced from Federal Leases in California, page 
47.

The Department of Energy also recognizes this problem. The 
Department of Energy has indicated that the administration's 
Domestic Natural Gas and Oil Initiative included a pipeline 
reform plank.\63\ The Department of Energy requested that the 
Department of the Interior require pipelines that cross Federal 
lands operate as common carriers. The Department of the 
Interior has not taken any action on the issue, allowing a 
continued distortion of the California oil market.
---------------------------------------------------------------------------
    \63\ Letter from Deputy Secretary of Energy Bill White to Secretary 
of the Interior Bruce Babbitt, dated March 29, 1994.
---------------------------------------------------------------------------

                           F. RECOMMENDATIONS

    The committee urges that the Secretary of the Interior: (1) 
begin collecting amounts relating to royalty underpayments in 
California which are well established; (2) begin assessing and 
collecting amounts relating to royalty underpayments in other 
States; and (3) ensure that any global settlement sensibly 
values the possibility of these collections. There is an 
unwillingness to address issues relating to the undervaluation 
of crude oil at the Minerals Management Service. Leadership is 
required to address these problems.
    With these goals in mind, the committee urges action in the 
following areas:

Timetable for collections

    The MMS and the Department of the Interior should develop a 
timetable to collect these amounts, including specific dates by 
which to achieve specific goals. This would assist Congress in 
providing oversight of this essential task, and commit the 
administration to a realistic schedule of collecting these 
debts.

Audit resources

    There is some question as to whether MMS's audit staff can 
perform the task of implementing the interagency task force 
report without prejudice. If the audit staff is unwilling to 
support program goals determined by the Administration, then 
MMS should contract with a professional firm of certified 
public accountants. In depending on a private law firm, the 
State of California took a similar approach, which resulted in 
a $345 million settlement. California now contracts with a 
professional firm of certified public accountants to manage its 
oil sales.\64\ If MMS is experiencing internal resistance in 
key functions to collecting these underpayments, then MMS 
should seek outside assistance to expedite collections.
---------------------------------------------------------------------------
    \64\ Staff conversation with Brian McMahon.
---------------------------------------------------------------------------

Review global settlements

    The question of whether the global settlements will prevent 
recoveries of underpayments needs to be addressed. The 
Department of the Interior should request that the Department 
of Justice prepare an opinion certifying that these amounts 
have been negotiated away by MMS.
    Also, the Department of the Interior needs to review its 
compromise procedures, which are more sweeping than almost any 
other Federal agency. Agencies which compromise debts are 
limited in their authority to do so. Under existing Federal 
law, Federal agencies may:

          Compromise a claim of the Government of not more than 
        $100,000 (excluding interest) or such higher amount as 
        the Attorney General may from time to time prescribe 
        that has not been referred to another executive or 
        legislative agency for further collection action.\65\
---------------------------------------------------------------------------
    \65\ Title 31, United States Code, Section 3711(a)(2).

The Department of the Interior, in connection with the Office 
of Management and Budget and the Department of Justice, should 
examine whether the persistent mismanagement at MMS requires a 
threshold for global settlements which would trigger the 
involvement of the Department of Justice.

Collecting underpayments in States other than California

    The Department of the Interior should develop a strategy to 
address this issue and advise the committee of its plan. If 
there is an underpayment problem in California, it is highly 
likely that the same problem exists elsewhere.

Royalty-in-kind transactions

    The May 1996 interagency task force report recommends that 
the Department of the Interior should consider potential 
collections where crude oil royalties which were taken in-kind 
were undervalued. This should be done.

Common carrier pipelines

    The Department of the Interior should alter its policy to 
comport with the administration's recommendations regarding the 
Domestic Natural Gas and Oil Initiative. In addition, the 
Department should contact officials from the State of 
California and demonstrate the problem of proprietary 
pipelines, and the harm which unregulated pipelines can bring 
to consumers, crude producers and royalty owners such as the 
State of California and the Federal Government.

                             G. CONCLUSION

    The Minerals Management Service needs to review its 
operations to ensure that the amounts which are owed to the 
Federal Government are collected in a timely fashion. For 
years, oil companies were able to use complex transactions to 
disguise premia on crude oil from Federal regulators. Now that 
the Federal Government has determined that there are hundreds 
of millions of dollars of additional payments owed, MMS must 
aggressively pursue this problem to protect Federal financial 
interests. MMS has failed to do so. There is still time to 
accomplish this task. Until that happens, the crude oil 
undervaluation issue is a serious hole in the Federal budget 
deficit that amounts to perhaps $2 billion nationwide for crude 
oil leasing. This is a problem that is preventable, and 
requires the attention of senior management in the 
administration.

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