Mineral Revenues: A More Systematic Evaluation of the		 
Royalty-in-Kind Pilots Is Needed (09-JAN-03, GAO-03-296).	 
                                                                 
In fiscal year 2001, the federal government collected $7.5	 
billion in royalties from the sale of oil and gas produced on	 
federal lands. Although most oil and gas companies pay royalties 
in cash, the Department of the Interior's Minerals Management	 
Service (MMS) has the option to take a percentage of the oil and 
gas produced and either transfer this percentage to other federal
agencies or to sell this percentage itself--known as "taking	 
royalties in kind." GAO reviewed the extent to which MMS has	 
taken royalties in kind since 1995, the reasons for taking	 
royalties in kind, and MMS's progress in implementing management 
control over its Royalty-in-Kind Program.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-296 					        
    ACCNO:   A05813						        
  TITLE:     Mineral Revenues: A More Systematic Evaluation of the    
Royalty-in-Kind Pilots Is Needed				 
     DATE:   01/09/2003 
  SUBJECT:   Crude oil						 
	     Internal controls					 
	     Program evaluation 				 
	     Royalty payments					 
	     Gas resources					 
	     Oil resources					 
	     Strategic planning 				 
	     MMS Royalty-in-Kind Program			 

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GAO-03-296

Report to Congressional Requesters

United States General Accounting Office

GAO

January 2003 MINERAL REVENUES A More Systematic Evaluation of the Royalty-
in- Kind Pilots Is Needed

GAO- 03- 296

From January 1995 through September 2001, the Minerals Management Service
(MMS) took, in kind, 178 million barrels of oil and 213 billion cubic feet
of gas, or 32 percent of the federal government*s royalty share of all oil
and 3 percent of the federal government*s royalty share of all gas
produced on federal lands. MMS sold the majority of this oil* 143 million
barrels* to small refiners in accordance with long- standing legislation.
MMS also took 29 million barrels of federal royalty oil to fill the
Strategic Petroleum Reserve. MMS took the remaining 6 million barrels of
oil in kind and all the gas in kind under a series of pilot projects to
evaluate whether there are additional circumstances under which taking
royalties in kind is in the best interest of the federal government.

MMS personnel have made progress in implementing some components of
management control for its Royalty- in- Kind Program, such as addressing
the risks associated with oil and gas sales and developing written
procedures. However, MMS does not plan to complete and implement all
management controls until 2004, when it will consider the Royalty- in-
Kind pilots to have changed from a pilot stage to a fully operational
stage and when it will have acquired additional systems support. To date,
MMS has not developed clear strategic objectives linked to statutory
requirements nor collected the necessary information to effectively
monitor and evaluate the Royalty- inKind Program. Without clear objectives
linked to statutory requirements and the collection of necessary
information, MMS cannot systematically assess whether Royalty- in- Kind
sales are administratively less costly, whether they generate fair market
value or at least as much revenue as traditional cash royalty payments,
and thus whether MMS should expand or contract the Royalty- in- Kind
Program.

Estimated Value of Federal Royalty Oil and Gas Taken in Kind by Purpose,
Calendar Years 1995 through 2001 and January through July 2002.

MINERAL REVENUES

A More Systematic Evaluation of the Royalty- in- Kind Pilots Is Needed

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 296. To view the full report,
including the scope and methodology, click on the link above. For more
information, contact Jim Wells at (202) 512- 6877 or wellsj@ gao. gov.

Highlights of GAO- 03- 296, a report to Representative Nick J. Rahall,
Ranking Minority Member, House Committee on Resources, and Representative
Carolyn B. Maloney

January 2003

In fiscal year 2001, the federal government collected $7. 5 billion in
royalties from the sale of oil and gas produced on federal lands. Although
most oil and gas companies pay royalties in cash, the Department of the
Interior*s Minerals Management Service (MMS) has the option to take a
percentage of the oil and gas produced and either transfer this percentage
to other federal agencies or to sell this percentage itself* known as
*taking royalties in kind.* GAO reviewed the extent to which MMS has taken
royalties in kind since 1995, the reasons for taking royalties in kind,
and MMS*s progress in implementing management control over its Royalty-
in- Kind Program.

GAO recommends that MMS clarify its strategic objectives for the Royalty-
in- Kind Program and link these objectives to statutory requirements. GAO
also recommends that MMS gather key information to monitor and evaluate
the program prior to further expansion of the program. In commenting on
the draft report, the Department of the Interior generally agreed with
GAO*s observations and recommendations and emphasized MMS*s future plans
to improve management control over the Royalty- in- Kind Program.

Page i GAO- 03- 296 Mineral Revenues Letter 1

Results in Brief 2 Background 3 MMS Has Taken Increasing Amounts of
Royalties in Kind Since

1995 to Meet Several Objectives 5 MMS Takes Oil in Kind and Sells It to
Small Refiners 5 MMS Takes Oil in Kind to Fill the Strategic Petroleum
Reserve 8 MMS Is Studying the Increased Use of Royalties in Kind 9 MMS Has
Established Some Management Control over Its RIK

Program, but Additional Efforts Are Needed 12 Conclusions 19
Recommendations for Executive Action 20 Agency Comments and Our Evaluation
20 Scope and Methodology 20

Appendix I Comments from the Department of the Interior 22

Appendix II Objectives, Scope, and Methodology 36

Appendix III GAO Contacts and Staff Acknowledgments 38

Figures

Figure 1: Estimated Percentage of Federal Royalty Oil Taken in Kind by
Purpose, Calendar Years 1995 through 2000 and January through September
2001 6 Figure 2: Estimated Value of Federal Royalty Oil Taken in Kind by

Purpose, Calendar Years 1995 through 2001 and January through July 2002 7
Figure 3: Estimated Percentage of Total Federal Royalty Gas Taken

in Kind by Purpose, Calendar Years 1995 through 2000 and January through
September 2001 11 Figure 4: Revenues Reportedly Collected from the Sale of
Federal

Royalty Gas Taken in Kind, Calendar Years 1995 through 2001 and January
through July 2002 11 Contents

Page ii GAO- 03- 296 Mineral Revenues Abbreviations

DOE Department of Energy GAO General Accounting Office MMS Minerals
Mangement Service RIK Royalty- in- Kind SPR Strategic Petroleum Reserve

Page 1 GAO- 03- 296 Mineral Revenues

January 9, 2003 The Honorable Nick J. Rahall Ranking Minority Member
Committee on Resources House of Representatives

The Honorable Carolyn B. Maloney House of Representatives

Federal lands supply about one- third of the oil and gas produced in the
United States. Companies that lease these lands traditionally pay
royalties to the Department of the Interior*s Minerals Management Service
(MMS) based on a percentage of the value of the oil and gas that the
companies produce. In fiscal year 2001, oil and gas royalties to MMS
totaled about $7.5 billion. Determining proper royalty payments, however,
has been costly and administratively difficult for both the companies that
lease federal lands and MMS. The value of the oil and gas, in particular,
is often a source of dispute. For example, during MMS*s recently completed
4- 1/ 2 year process of promulgating new regulations for valuing oil, the
oil industry strongly opposed these regulations primarily because they
would increase the industry*s royalty payments and increase their
administrative burden. In commenting on the regulations, industry
officials suggested that instead of accepting cash royalty payments, MMS
should accept a percentage of the actual oil and gas produced and sell
this percentage itself* known as *taking royalties in kind.*

The Mineral Leasing Act of 1920 and the Outer Continental Shelf Lands Act
of 1953 authorize taking royalties in kind and require that the government
obtain at least fair market value for royalty oil and gas it sells. Under
this authority, MMS has taken federal oil in kind, mainly to fulfill
congressional and executive directives. Specifically, the Congress has
directed taking oil in kind for the Small Refiners Program, whose
objective is to supply crude oil to small refiners that do not have an
adequate supply of their own. In more recent years, the President has
directed the taking of oil in kind to fill the Strategic Petroleum Reserve
as a safeguard against disruptions to the national supply of crude oil.
However, in 1995, MMS began to study whether there are additional
circumstances under which taking oil and gas in kind is in the best
interest of the federal government. MMS*s efforts were encouraged by the
Congress as a means of avoiding disputes between MMS and the oil and gas
industry over the value of the oil and gas produced as well as a way to
simplify royalty administration. To this end,

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 03- 296 Mineral Revenues

MMS established Royalty- in- Kind (RIK) pilots and is developing
management controls for its RIK Program* a newly created program under
which MMS manages all its RIK activities. Management control is an
integral component of an organization*s management that, if effective, can
provide for the effectiveness and the efficiency of operations, the
reliability of financial reporting, and compliance with applicable laws
and regulations. Key management controls include (1) identifying and
mitigating the risks that could prevent an agency from achieving its
objectives, (2) developing written procedures, and (3) monitoring and
evaluating program performance. In the 2001 and 2002 Appropriations Acts
for Interior and Related Agencies, the Congress provided additional
direction that MMS collect at least as much revenue from its RIK pilots as
it would have collected in cash royalty payments.

As a part of your interest in MMS*s stewardship over federal oil and gas
royalties, you asked us to (1) determine the extent to which MMS has taken
oil and gas in kind since 1995 and the reasons for doing so and (2) report
on the status of MMS*s efforts to implement management controls for its
RIK Program.

From January 1995 through September 2001, the Minerals Management Service
took 178 million barrels of oil and 213 billion cubic feet of gas in kind,
or about 32 percent of the federal government*s royalty share of all oil
and 3 percent of the federal government*s royalty share of all gas
produced on federal lands, and used these quantities for various purposes.
Of the 178 million barrels, MMS sold about 143 million barrels to small
refiners under the Small Refiners Program. MMS also complied with
presidential directives to use federal royalty oil to fill the nation*s
Strategic Petroleum Reserve at various times, transferring about 29
million barrels to the Strategic Petroleum Reserve from 1999 through 2000.
In addition, MMS selectively took federal oil and gas in kind with the
intent of improving the stewardship of federal resources. Specifically,
MMS took both oil and gas in kind to evaluate whether there are additional
circumstances under which taking oil and gas in kind is in the best
interest of the federal government. The amount of oil that MMS took in
kind for these pilot purposes was small from October 1998 through
September 2001. However, over the following 6 months, we estimate that the
amount may have approached 20 percent of the federal government*s royalty
share of all oil produced on federal lands. Similarly, the amount of gas
that MMS took in kind beginning in 1998 was small until 2000 and has
averaged about 10 percent of the federal government*s royalty share of all
gas produced on federal lands from January 2000 through September 2001.
Results in Brief

Page 3 GAO- 03- 296 Mineral Revenues

MMS personnel have made progress in implementing some components of
management control, such as mitigating the risks associated with the sale
of oil and gas and developing written procedures. However, MMS does not
plan to complete and implement all management controls until 2004, when it
will consider the Royalty- in- Kind pilots to have changed from a pilot
stage to a fully operational stage and when it will have acquired
additional systems support. To date, MMS has not developed clear strategic
objectives linked to statutory requirements or collected the necessary
information to effectively monitor and evaluate the Royalty- in- Kind
Program. Without clear objectives linked to statutory requirements and the
collection of necessary information, MMS cannot systematically evaluate to
what extent Royalty- in- Kind sales should continue.

We are making recommendations to improve the management of the Royalty-
in- Kind Program. These recommendations include clarifying strategic
objectives and obtaining the necessary information to more effectively
monitor and evaluate the Royalty- in- Kind Program. We provided the
Department of the Interior with a draft of this report for comment.

In fiscal year 2001, the latest period for which data are available, the
Minerals Management Service reported that it collected about $5. 2 billion
in gas royalties and about $2.3 billion in oil royalties. There are more
than 20,000 producing federal leases located in the continental United
States and Alaska and more than 2,000 producing federal leases in the
waters off the shores of the United States. Despite the larger number of
onshore leases, offshore leases (most of which are in the Gulf of Mexico)
account for 81 percent of all federal oil and gas royalty payments. In
general, royalty rates for onshore leases are 12- 1/ 2 percent of the
value of the oil and gas produced, whereas royalty rates for most offshore
leases are 162/ 3 percent. The government generally distributes about half
of the royalty payments collected onshore back to the states in which the
leases are located. The government also shares with the coastal states a
smaller portion of the royalty payments collected from offshore leases
located within 3 miles of the coast, known as the 8( g) zone. However, the
government does not share royalties from offshore leases beyond the 8( g)
zone, where the majority of offshore oil and gas is produced.

The collecting, reporting, and auditing of cash royalty payments have been
challenging for MMS. MMS relies upon royalty payors to self- report the
amount of oil and gas they produce, the value of this oil and gas, and the
cost of transportation and processing that they deduct from royalty
Background

Page 4 GAO- 03- 296 Mineral Revenues

payments. There are concerns about the accuracy and reliability of these
data. Although MMS is responsible for auditing these data, with more than
22,000 producing leases and often several companies paying royalties on
each lease each month, the auditing becomes a formidable task. In
addition, there has been considerable disagreement between industry and
MMS over the value of the oil and gas produced and the cost of
transportation and processing deductions, leading to time- consuming and
costly appeals and litigation.

While most companies that lease federal lands pay their royalties in cash,
the federal government can instead take a portion of the oil and gas that
these companies produce* known as *taking royalties in kind.* The Congress
authorized royalties in kind under the Mineral Leasing Act of 1920 and
under the Outer Continental Shelf Lands Act of 1953. Standard leases for
the exploration of oil and gas on federal properties reserve the right for
the federal government to take its royalties in kind.

The Federal Managers* Financial Integrity Act of 1982 directed federal
agencies to develop management control for safeguarding resources and
required GAO to prescribe standards for agencies to follow in establishing
management control. 1 Management control plays a significant role in
helping managers achieve strategic and annual performance goals that are
required under the Government Performance and Results Act of 1993.
Management control consists of several components: (1) an environment that
sets a positive and supportive attitude toward management control and
conscientious management (control environment); (2) an assessment of the
risks that an organization faces from both external and internal sources
(risk assessment); (3) procedures, techniques, and mechanisms that enforce
management*s directives (management control activities); (4) recording and
communicating information to management and to others that need it within
the organization (information and communication); and (5) monitoring the
quality of performance over time (monitoring).

1 Management control is synonymous with internal control, which is the
term used in the Federal Managers* Financial Integrity Act of 1982. The
standards that GAO were required to establish under the act appear within
the report entitled Standards for Internal Control in the Federal
Government, GAO/ AIMD- 00- 21. 3. 1 (Washington, D. C.: November 1999).

Page 5 GAO- 03- 296 Mineral Revenues

From January 1995 through September 2001, MMS took 178 million barrels of
oil and 213 billion cubic feet of gas in kind primarily for three
purposes: (1) to provide small refiners with a stable source of crude oil,
(2) to fill the Strategic Petroleum Reserve (SPR), and (3) to study
alternatives to the traditional system of cash royalty payments. 2 MMS
sold the majority of the oil that it took in kind to small refineries
under the Small Refiners Program* a long- standing program designed to
assist small refiners that are having difficulty obtaining an adequate
supply of crude oil. MMS also transferred substantial quantities of
federal royalty oil to the SPR as a safeguard against disruptions in the
nation*s supply of crude oil. MMS takes lesser quantities of oil and gas
in kind under a series of pilot sales in Wyoming and the Gulf of Mexico to
study alternatives to the traditional system of cash royalty payments. In
doing so, MMS has been testing whether it can improve the administrative
efficiency of royalty collections and whether it can sell the federal
royalty oil and gas for at least as much as it would have collected from
traditional cash royalty payments.

From January 1995 through September 2001, MMS sold to small refiners about
143 million barrels of oil, or about 25 percent of the federal
government*s royalty share of all oil produced on federal lands during
this time period. The amounts of oil taken in kind each year for small
refiners have ranged from about 10 to 40 percent of the total federal
royalty oil, as shown in figure 1. These amounts were worth from $138
million to $588 million, as shown in figure 2. 3 The majority of federal
royalty oil sold to small refiners since 1995 was produced in the Gulf of
Mexico. Other purposes for which MMS took oil in kind, such as for the
Wyoming and Gulf pilots and the SPR, are also shown in figures 1 and 2.

2 For the purpose of this report, 1 cubic foot of gas has a heating value
of 1,000 British thermal units. When MMS reported federal royalty gas as
having a heating value greater than 1, 000 British thermal units per cubic
foot, we adjusted the volume to compensate for this difference. 3 MMS
personnel within the RIK Program supplied data on revenues collected from
the sale of oil taken in kind from January 1995 through July 2002.
However, MMS personnel were unable to supply data on total federal oil
royalty revenues (from both RIK sales and cash royalty payments) or the
total amount of oil produced on federal lands that were more current than
September 2001. They attributed their inability to obtain these data, in
part, on a court- ordered shutdown of the system that lasted from December
2001 through March 2002. MMS Has Taken

Increasing Amounts of Royalties in Kind Since 1995 to Meet Several
Objectives

MMS Takes Oil in Kind and Sells It to Small Refiners

Page 6 GAO- 03- 296 Mineral Revenues

Figure 1: Estimated Percentage of Federal Royalty Oil Taken in Kind by
Purpose, Calendar Years 1995 through 2000 and January through September
2001

Page 7 GAO- 03- 296 Mineral Revenues

Figure 2: Estimated Value of Federal Royalty Oil Taken in Kind by Purpose,
Calendar Years 1995 through 2001 and January through July 2002

Under the Mineral Leasing Act, as amended by P. L. 79- 506, if the
Secretary of the Interior determines that there are insufficient supplies
of crude oil available on the open market to refiners that do not have
their own supply, the Secretary is required to give preference to these
small refiners in selling federal royalty oil. Accordingly, the Secretary
provides small refiners with a stable source of crude oil at equitable
prices so that these small refiners can compete in areas dominated by
integrated oil companies and large refiners. Although the Secretary has
long held this authority, the Secretary conducted few sales prior to 1970
because of little interest from small refiners. The Secretary delegated
the responsibility to administer small refiner sales to MMS shortly after
its formation in 1982. After MMS assesses small refiners* needs for crude
oil, MMS identifies federal royalty oil to meet these needs, and then
conducts sales. Often, more than one small refiner wanted to purchase the
same oil, so MMS in recent years conducted a lottery to determine the
purchaser.

Page 8 GAO- 03- 296 Mineral Revenues

Prior to 2000, MMS relied upon the producer of the oil to report its sales
value and subsequently billed the small refiner this amount plus an
administrative fee to cover the costs of running the program. After
billing the small refiners, however, MMS determined that the producers had
understated the value of the oil, so MMS sent additional bills to the
small refiners. These bills often surprised the small refiners, and in
some cases, large bills threatened their financial solvency. Because small
refiners were dropping out of the program owing to the uncertainty over
the value of the oil, MMS changed its small refiner sales in 2000 from
lottery- based sales to competitive auction- based sales. The bidders and
MMS now agree to the price before receiving the oil, just as they do in
sales of other federal royalty oil.

The Congress established the Strategic Petroleum Reserve to provide
emergency oil in the event of a disruption in petroleum supplies. The SPR
consists of a series of underground salt caverns along the coastline of
the Gulf of Mexico that can store up to 700 million barrels of oil. It is
managed and maintained by the Department of Energy (DOE). Largely to
reduce the federal deficit, the federal government withdrew and sold oil
from the SPR in fiscal years 1996 and 1997.

To replace the amounts withdrawn from the SPR, MMS assisted with the
transfer of about 29 million barrels of federal royalty oil from the Gulf
of Mexico to DOE in 1999 and 2000. This amount represented about 17
percent of the federal government*s royalty share of all oil produced on
federal lands in each of these 2 years, as shown in figure 1. By filling
the SPR, the federal government had forgone the receipt of royalty
revenues that it would have otherwise collected in cash. The Office of
Management and Budget in February 1999 estimated that the total cost of
filling the SPR would be $370 million, but oil prices rose since then, and
the total cost was probably higher. Refilling stopped in December 2000 but
commenced again in April 2002 under presidential directive and is expected
to continue into 2005. From April through July 2002, MMS assisted in
transferring to DOE about 7.5 million barrels of oil, worth about $169
million. MMS plans to increase deliveries to DOE from 63,000 barrels per
day in July 2002 to about 130, 000 barrels per day in 2003. MMS Takes Oil
in

Kind to Fill the Strategic Petroleum Reserve

Page 9 GAO- 03- 296 Mineral Revenues

MMS began studying the use of federal royalty oil as an alternative to
cash royalty payments through a series of pilot sales in Wyoming. Through
nine consecutive sales that began in October 1998, MMS and the state of
Wyoming collectively sold federal and state royalty oil. 4 In doing so,
MMS acquired information on how to group properties for sale and how to
establish a price basis for bidding. Although the federal portion of these
volumes far exceeded the state portion, we estimate that the federal oil
that MMS sold during the 3- year period from October 1998 through
September 2001 accounted for about 1 percent of the federal government*s
royalty share of all oil produced on federal lands. MMS expanded its study
of royalty oil to the Gulf of Mexico with two competitive sales, the first
of which delivered oil to purchasers starting in November 2000. Unlike the
pilots in Wyoming, the amount of federal royalty oil that MMS sold in the
Gulf of Mexico reached significant quantities during the second pilot
sale* about 32 times the amount of oil sold in Wyoming during the same
6month period. We estimate that the federal royalty oil that MMS sold
during this second sale, which commenced in October 2001 and ended in
March 2002, might have accounted for about 20 percent of the federal
government*s royalty share of all oil produced on federal lands during the
term of the sale.

MMS first began studying the taking of gas in kind by conducting a gas
pilot in 1995. This pilot assessed the administrative efficiency and
revenue impacts of taking gas in kind relative to cash royalty payments.
MMS accepted about 6 percent of the federal royalty gas in the Gulf of
Mexico and sold it through auctions for about $72. 6 million. Although
this pilot showed that MMS could execute the sale of royalty gas, MMS
estimated that these sales resulted in about 6 percent less revenue than
MMS would have received in cash royalty payments, or more than a $4
million loss. MMS attributed this loss primarily to unforeseen problems in
securing transportation of the gas through pipelines and to industry*s
volunteering the royalty gas for sale, rather than to MMS*s selecting this
gas. MMS continued studying RIK and issued a report in 1997 that concluded
that RIK sales could be administratively more efficient and could generate
at least as much revenue as traditional cash royalty payments. MMS began
testing these conclusions with a series of pilot sales in the Gulf of
Mexico that began in December 1998. The gas that MMS sold during these
pilot

4 In these sales, MMS and the state of Wyoming sold oil from specified
properties for 6- month periods. The buyer would receive the federal and
state royalty share of oil from those properties for a period of 6 months
following the sale. Wyoming participated in all but the first sale. MMS Is
Studying the

Increased Use of Royalties in Kind

Page 10 GAO- 03- 296 Mineral Revenues

sales averaged about 10 percent of the federal government*s royalty share
of all gas produced on federal lands from January 2000 through September
2001, as shown in figure 3. The annual revenues that MMS reported
collecting from the sale of this federal royalty gas are illustrated in
figure 4. 5 MMS studied various methods of selling this royalty gas,
including negotiating the sales price, paying gas marketers to aggregate
smaller volumes of gas into larger volumes, and auctioning the gas. As a
result of these pilot studies, MMS decided to sell federal royalty gas
through auctions open to all buyers meeting minimum standards of credit
worthiness. 6

5 MMS personnel within the RIK Program supplied data on revenues collected
from the sale of gas taken in kind from January 1995 through July 2002.
However, MMS personnel were unable to supply data on total federal gas
royalty revenues (from both RIK sales and cash royalty payments) or the
total amount of gas produced on federal lands that were more current than
September 2001. They attributed their inability to obtain these data, in
part, on a court- ordered shutdown of the system that lasted from December
2001 through March 2002. 6 In these auctions, MMS sells gas from selected
properties for specified periods of time. The buyer receives the federal
royalty share of gas for a period of 5, 7, or 12 months following the
sale. MMS initially sold this gas for 1- month periods but discontinued
this process because it was administratively more efficient to conduct
sales for greater periods of time.

Page 11 GAO- 03- 296 Mineral Revenues

Figure 3: Estimated Percentage of Total Federal Royalty Gas Taken in Kind
by Purpose, Calendar Years 1995 through 2000 and January through September
2001

Figure 4: Revenues Reportedly Collected from the Sale of Federal Royalty
Gas Taken in Kind, Calendar Years 1995 through 2001 and January through
July 2002

Page 12 GAO- 03- 296 Mineral Revenues

Management control is a necessary safeguard to protect against the risks
of fraud, waste, abuse, and mismanagement. MMS has made progress in
establishing some components of management control over its RIK Program,
such as (1) identifying and mitigating the risks associated with oil and
gas sales and (2) developing written procedures for these sales and for
collecting and reporting revenues. However, MMS has yet to develop several
key management control activities and does not plan to develop them until
2004, when it will consider the RIK Program to have changed from a pilot
status to a fully operational status. Specifically, MMS has not clearly
defined its strategic objectives, linked performance measures to these
objectives, and collected the necessary information to monitor and
evaluate the RIK Program.

The Federal Managers* Financial Integrity Act of 1982 directs federal
agencies to develop management control for safeguarding resources against
the risks of fraud, waste, abuse, and mismanagement. Management control is
critical to ensure that revenues and expenditures from agency operations
are recorded and accounted for properly and that financial and statistical
reports are reliable. The act also directs us to issue standards for
management control within the federal government. These standards provide
broad criteria for agencies to use, in conjunction with guidance issued by
the Office of Management and Budget. Management control includes (1)
developing strategic objectives, (2) linking performance measures to these
objectives, (3) collecting the necessary information to monitor and
evaluate performance, (4) identifying and mitigating risks, and (5)
developing written procedures and documenting compliance with these
procedures.

Management control also plays an important role in helping managers comply
with the Government Performance and Results Act of 1993 (Results Act),
which requires federal agencies to establish strategic goals, measure
performance, and report on accomplishments. The Results Act shifts the
focus of federal agencies away from traditional concerns, such as staffing
and reporting on activities, toward achieving results. There is no more
important element in results- oriented management than an agency*s
strategic- planning process, and establishing formal strategic objectives
can help clarify what the agency seeks to accomplish and can help unify
the agency*s staff in achieving its goals. MMS Has Established

Some Management Control over Its RIK Program, but Additional Efforts Are
Needed

Management Control Is a Necessary Safeguard

Page 13 GAO- 03- 296 Mineral Revenues

MMS has begun to establish management control over its RIK Program by
addressing the risk that oil and gas sales will be unsuccessful,
addressing inherent risks associated with the sale of oil and gas, and
developing written procedures for various activities within the Royalty-
in- Kind Program. These activities include conducting RIK sales,
collecting revenues, and reporting on revenues. MMS also has made progress
in documenting the results of its RIK sales.

MMS has addressed the risk that RIK sales will be unsuccessful by ensuring
that prior to these sales, certain conditions exist for the properties
from which MMS will sell royalty oil and gas. In 1998, we identified the
conditions necessary for successful oil and gas sales by surveying state
governments, universities, and the Province of Alberta, which, at various
times, had programs that took oil and gas in kind. 7 We identified several
conditions that made these programs feasible. In particular, these
programs seemed successful if these entities had (1) relatively easy
access to pipelines, (2) properties that produce relatively large volumes
of oil or gas, (3) favorable arrangements for processing gas, and (4)
expertise in marketing oil and gas. MMS has considered these conditions in
addressing risk. Specifically, MMS*s practice of negotiating the cost of
transporting gas through pipelines helps to secure relatively easy access
to pipelines. Similarly, MMS*s practice of grouping the properties that
produce royalty oil or gas according to the pipelines to which they are
connected helps ensure that properties produce relatively large volumes of
oil or gas. MMS has also arranged for the processing of natural gas and
has increased its knowledge of oil and gas marketing by hiring consultants
and interviewing oil and gas marketers and representatives of pipeline
companies in Wyoming and the Gulf Coast.

MMS has also developed procedures to manage the inherent risks, or
uncertainties, in the selling of oil and gas. Such risks include
fluctuating oil and gas prices, the varying amount of oil and gas that
wells produce, and the credit worthiness of purchasers. To manage the risk
associated with fluctuating prices, for example, MMS does not try to
maximize revenues by guessing which way the market will move but, instead,
accepts bids relative to the fluctuating market prices. Thus, MMS avoids
substantial losses that could result from wrong guesses. MMS also manages
the risk due to the inability of properties to deliver consistent
quantities of gas,

7 See Federal Oil Valuation: Efforts to Revise Regulations and an Analysis
of Royalties in Kind, GAO/ RCED- 98- 242 (Washington, D. C.: Aug. 19,
1998). MMS Has Begun to

Establish Management Control

Page 14 GAO- 03- 296 Mineral Revenues

which could require that MMS purchase or supply more costly alternative
gas in the event of a shortfall. MMS manages this risk by guaranteeing
that it will deliver only a portion of the gas (base volume) at a stable
price and offering the other portion (swing volume), without guarantee, at
published prices that vary daily. MMS has also developed procedures to
monitor the credit worthiness of oil and gas purchasers and can terminate
their sales contract or demand additional credit guarantees, if necessary.
These procedures led MMS to promptly cancel its contract with Enron,
thereby limiting losses to 1 month*s worth of gas production from the
Enron contract.

MMS has developed written procedures for conducting RIK sales activities,
collecting revenues from these sales, and reporting on these revenues.
Sales activities include identifying properties from which to take oil and
gas in kind, announcing the oil and gas for sale, determining a minimum
acceptable bid, analyzing bids, and awarding contracts. We examined
documents for sales that MMS conducted from October 1998 through October
2002 and found documentation of these activities in all sales in which
they were appropriate. However, we did not determine the adequacy of MMS*s
procedures for collecting and reporting on revenues, nor did we assess the
degree to which MMS complied with these procedures. 8

MMS developed the following seven strategic objectives for the RIK
Program:

 Implement RIK where applicable and when it is an improvement over
traditional cash royalty payments (royalty in value).

 Leverage MMS*s position as an asset holder.

 Take advantage of potential interagency synergies.

 Minimize the cost of royalty administration.

 Reduce business cycle time (the time to collect, disburse, audit, and
reconcile revenues).

8 The Department of the Interior*s Inspector General recently reported a
problem in collecting all revenues due from the sale of royalty gas. MMS
had not resolved in a reasonable time frame the commonly occurring
discrepancies between amounts paid and owed due to uncertainties in the
gas volumes delivered (referred to as *gas imbalances*). See Department of
the Interior, Office of Inspector General, Evaluation of Vulnerabilities
to Underreporting: Royalty- in- Value versus Royalty- in- Kind, Report No.
2002- I- 0044 (Washington, D. C.: August 2002). MMS Has Not Developed

Clear Objectives and Linked Performance Measures to These Objectives

Page 15 GAO- 03- 296 Mineral Revenues

 Accelerate timing of revenue collections.

 Adopt energy industry business practices and controls wherever feasible.

Overall, none of the seven objectives address the revenue impacts of the
RIK sales. The seven objectives do not address requirements in the law
that MMS (1) collect at least as much revenue from the RIK pilots as it
would have from traditional cash royalty payments and (2) obtain fair
market value. The Congress directed MMS in the fiscal years 2001 and 2002
Appropriations Acts for Interior and Related Agencies to collect at least
as much revenue from the sale of royalties in kind as MMS would have
collected from traditional cash royalty payments. Moreover, the Congress
had previously directed the Secretary of the Interior in the Mineral
Leasing Act of 1920 and the Outer Continental Shelf Lands Act of 1953 to
obtain fair market value for oil and gas taken in kind. 9 The Congress
defined *fair market value* in the Outer Continental Shelf Lands Act as
the average unit price for the mineral sold either from the same lease or,
if such sales did not occur, in the same geographic area.

Furthermore, the first three objectives are not expressed in either a
quantitative or measurable form. The last four objectives, although being
quantitative, address administrative efficiency only. Without objectives
to guide agency staff in the quantitative evaluation of the revenue
impacts of RIK sales, MMS will be unable to determine whether RIK sales
generate more or less revenue than traditional cash royalty payments;
whether MMS obtains fair market value; and hence, whether it should
convert the RIK pilots to an operational status.

MMS has also not developed any performance measures that it linked to the
seven strategic objectives for its RIK Program. However, MMS has developed
two performance measures*( 1) confirm and reconcile, within 90 days, all
production royalties taken in kind and (2) accelerate the timing of
revenue receipt by 5 days over traditional cash royalty payments (royalty
in value)* that are linked to the broader agency- wide objective of

*collecting royalties in the shortest time possible.* In addition to
supporting the broad agency- wide objective, these two performance
measures support RIK Program objectives that are designed to improve

9 The Mineral Leasing Act uses the term *market price* not *fair market
value,* and the requirement to obtain market price does not cover
competitive sales, which, by their very nature, provide some protection to
the federal government.

Page 16 GAO- 03- 296 Mineral Revenues

administrative efficiency. MMS officials told us that they intend to
develop performance measures that are specific to the RIK Program in 2004,
when the RIK Program changes from the pilot status to a fully operational
status and they acquire and fully implement new information systems that
can better measure performance.

After 5 years of conducting pilot programs and completing 24 oil and gas
pilot sales, MMS*s ability to effectively and efficiently monitor and
evaluate its RIK Program is limited because it has not obtained the
necessary information to do so. This information includes the
administrative costs of the RIK Program, the savings from avoiding
potential litigation and appeals, the savings in auditing properties, and
the revenue impacts of all sales. MMS lacks information largely because it
has not developed an information systems infrastructure to rapidly and
efficiently collect this information. Without quantitative costs, savings,
and revenue information, MMS is unable to determine the program*s overall
cost and effectiveness, whether RIK generates at least as much revenue as
traditional cash royalty payments, and whether the RIK Program should be
expanded or contracted.

MMS has not quantified the costs of administering the RIK Program. Such
costs, which MMS incurs when selling RIK but does not incur when
collecting traditional cash royalty payments, result from identifying
properties from which to sell oil and gas, calculating minimum acceptable
bids, analyzing bids, awarding and monitoring contracts, billing
purchasers, negotiating transportation rates, reconciling discrepancies in
volume, and comparing RIK revenues with traditional cash royalty payments.
MMS has not quantified these costs because its current personnel, payroll,
and budgeting systems do not capture data in sufficient detail. Although
MMS tracks employees* time charges with these systems, MMS does not
distinguish between time charges that support only the RIK Program and
time charges that support both the RIK Program and the traditional system
of collecting cash royalties. Similarly, MMS has not decided how to assign
the cost of MMS*s financial system and other significant overhead costs to
the RIK Program and to the traditional cash royalty system. MMS officials
told us, however, that they plan to implement an activity- based cost-
accounting system in fiscal year 2003 that will assist in resolving these
issues.

MMS also has not quantified anticipated savings from avoiding potential
appeals and litigation by selling oil and gas in kind. MMS officials MMS
Has Not Obtained the

Necessary Information to Monitor and Evaluate the RIK Program

MMS Has Not Quantified Anticipated Costs and Savings from Implementing the
RIK Program

Page 17 GAO- 03- 296 Mineral Revenues

explained that MMS anticipates that it can avoid substantial costs
associated with appeals and litigation involving primarily the valuation
of natural gas and the transportation of both oil and gas. MMS officials
have not estimated the costs of appeals because of problems with
implementing the information system that tracks these costs and because of
their uncertainty that these costs are recorded in a consistent manner. In
addition, the Office of the Solicitor within the Department of the
Interior, which is responsible for litigation concerning MMS*s activities,
does not have an automated system to track litigation costs.

Although MMS anticipates that the cost of auditing revenues will decrease
because of taking RIK, MMS has not quantified these savings. MMS
anticipates substantial savings because verifying the value of oil and gas
is much easier when taking RIK because the purchaser and MMS agree to the
sales price before the sale occurs. Similarly, when MMS negotiates
transportation costs itself, it knows the exact transportation rate that
companies can charge MMS, unlike when companies pay royalties in cash. In
addition, MMS does not need to audit transportation costs when MMS sells
royalty oil or gas at the location of the lease because there are no
transportation costs, since the buyer assumes the responsibility for
transportation. Although MMS has projected decreases in the number of
staff auditors as a result of future RIK sales, MMS has not finalized
these estimated savings because MMS is uncertain of how much oil and gas
it will take in kind in the future. MMS officials also question the
reliability of the time that auditors have charged to the RIK Program in
the past* information that formed the baseline for their projections.

MMS also has not fully quantified the revenue impacts of all the royalty
oil and gas that it sold, preventing a comprehensive comparison between
RIK sales revenues and the revenues that MMS would have received under the
traditional cash royalty system. MMS does analyze factors that affect the
revenues of upcoming RIK sales, including current oil and gas prices;
anticipated market conditions; and transportation and processing, if
applicable. However, MMS does not systematically compare RIK sales
revenues with what it would have received in traditional cash royalties
after these gas sales are completed. Of the 15. 8 million barrels of
federal royalty oil sold in pilot sales from October 1998 through July
2002, MMS quantified the revenue impacts of about 9 percent. Of the
approximately 241 billion cubic feet of federal royalty gas that MMS sold
from December 1998 through March 2002, we estimate that MMS quantified,
either in whole or in part, the revenue impacts resulting from the sale of
about 44 percent of this gas. Although MMS analyzed revenue impacts from
44 MMS Has Not Fully

Determined the Revenue Impacts of RIK Sales

Page 18 GAO- 03- 296 Mineral Revenues

percent of the federal royalty gas it sold, almost none of this analysis
was done in a timely manner, thereby precluding the use of this
information to improve or modify subsequent sales. For example, MMS did
not complete the evaluation of the gas that it sold competitively each
month over a 19- month period until after it had discontinued selling gas
in this manner. Similarly, MMS did not evaluate the revenue impacts of
using a gas marketer to aggregate gas volumes until 1 year after it
terminated these sales. If MMS had evaluated these aggregated sales
earlier, it might have discontinued this method of selling royalty gas
because it would have confirmed employees* suspicions during the initial
sale that the manner in which gas was being sold was disadvantageous to
MMS. Instead, MMS let another three contracts with similar terms,
resulting in an overpayment of almost $3 million on transportation valued
at about $13 million.

MMS*s information systems hinder the timely monitoring and evaluation of
the RIK Program and the evaluation of the revenue impacts from individual
sales. The RIK Program*s current system for managing RIK sales revenues
consists of a series of unlinked computer spreadsheets into which
personnel manually enter RIK data. Such a manual system is prone to
errors, which could lead to inaccurate information. Prior to September
2002, RIK Program personnel did not compile basic monthly reports on
revenues collected and royalty volumes sold, which could have been used to
monitor the RIK Program on a periodic basis. Also, limitations of MMS*s
agency- wide financial system* the system that generates agency- wide
accounting reports and maintains and manages all royalty data* currently
hamper the timely comparison of RIK sales revenues with cash royalty
payments. MMS personnel were unable to use the financial system to produce
summary data that were more current than 1- year old. As of October 2002,
for example, MMS personnel were unable to use the financial system to
determine how much total revenue MMS collected and how much oil and gas
had been produced from federal lands since September 2001. MMS personnel
also said that because of missing or erroneous data in the agency- wide
financial system, data extracted from this system cannot be used in
revenue comparisons without timeconsuming checks for accuracy and
reasonableness. Furthermore, it will be more difficult to use RIK gas data
in this system to calculate revenue impacts because MMS personnel do not
enter these data at the lease level. 10 Lastly, RIK Program personnel said
that because they have to

10 When sales involve the federal offshore leases whose royalties must be
shared with adjacent states, MMS officials said that they record the
transactions for each lease separately. This facilitates the disbursement
of royalty revenue to the adjacent states.

Page 19 GAO- 03- 296 Mineral Revenues

manually acquire data to evaluate federal properties for prospective
sales, the growth of the RIK Program has slowed.

MMS officials also said that they have not evaluated the revenue impacts
from the sales of all royalty oil and gas largely because they have
delayed the development of performance measures for the RIK Program until
2004. These performance measures will incorporate benchmarks against which
to compare RIK sales revenues. MMS personnel said that MMS has generally
encountered difficulty in establishing benchmarks against which to measure
the revenue impacts of RIK oil and gas sales because once it takes all
federal royalty oil or gas in kind in a specific area, it no longer
receives any traditional cash royalty payments for comparison. However,
MMS officials explained that by 2004, MMS expects to acquire and fully
implement two additional information systems dedicated to the RIK Program
that will automate the acquisition of necessary information for attempting
revenue comparisons. MMS personnel said that they had not acquired these
automated systems earlier because they believed that they first needed to
process a large number of transactions and sell a large volume of oil and
gas before they could justify the expense of acquiring these systems.

MMS has begun to establish management control over its RIK Program. It has
initiated positive steps to address the risks that affect its oil and gas
sales and has developed written procedures for various activities within
the RIK Program. MMS has also made progress in documenting the results of
its RIK sales. However, MMS has not established clear objectives for the
program that are linked to statutory requirements. MMS*s current
objectives for its RIK Program are not clearly linked to requirements in
the law that MMS (1) collect at least as much during pilot sales as it
would have collected in cash royalty payments and (2) obtain fair market
value.

In addition to the lack of objectives linked to statutory requirements,
MMS is not systematically collecting the necessary information to monitor
and evaluate the RIK program. Such information includes the administrative
costs of the RIK program, anticipated savings from reductions in audit
efforts and from avoiding appeals and litigation, and the revenue impacts
of all sales. Without clear objectives and the systematic collection of
evaluative information, MMS cannot assess and ultimately determine whether
it should expand or contract the use of royalty in kind sales. Conclusions

Page 20 GAO- 03- 296 Mineral Revenues

To continue the further development of management control for the Minerals
Management Service*s Royalty- in- Kind Program, we recommend that the
Secretary of the Interior instruct the appropriate managers within the
Minerals Management Service to do the following:

 Clarify the Royalty- in- Kind Program*s strategic objectives to
explicitly state that goals of the Royalty- in- Kind pilots include
obtaining fair market value and collecting at least as much revenue as MMS
would have collected in cash royalty payments.

 Prior to expanding the Royalty- in- Kind Program, identify and acquire
key information needed to monitor and evaluate performance. Such
information, as identified by the Minerals Management Service, should
include the revenue impacts of all Royalty- in- Kind sales, administrative
costs of the Royalty- in- Kind Program, estimates of savings in avoiding
potential litigation, and expected savings in auditing revenues.

We provided the Department of the Interior with a draft of this report for
review and comment. Interior fundamentally agreed with our observations
and recommendations and emphasized MMS*s future plans for improving
management control over the RIK Program. Where appropriate, we have
included additional references to the activities that Interior mentions in
its comments. Interior*s comments and our response to these comments are
reproduced in appendix I.

In reviewing MMS*s RIK Program, we reviewed congressional directives in
pertinent legislation; standards for the development of management control
issued by us and the Office of Management and Budget; and prior reports
and documentation on the Small Refiners Program, Strategic Petroleum
Reserve, and RIK pilots. We also obtained statistical information from MMS
on oil and gas volumes taken in kind and the revenue that MMS generated by
selling these volumes. In addition, we reviewed documentation pertaining
to management control and interviewed MMS personnel about their efforts to
establish management control over the RIK Program.

We conducted our work from January to November 2002 in accordance with
generally accepted government auditing standards. For a more detailed
discussion of the scope and methodology of our review, see appendix II.
Recommendations for

Executive Action Agency Comments and Our Evaluation

Scope and Methodology

Page 21 GAO- 03- 296 Mineral Revenues

As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 7 days from
the date of this letter. At that time, we will send copies of this report
to the Secretary of the Interior; the Director, Office of Management and
Budget; and other interested parties. We will also make copies available
to others upon request. This report will be available at no charge on
GAO*s Web site at http:// www. gao. gov.

If you have any questions about this report, please call Mark Gaffigan or
me at (202) 512- 3841. Key contributors to this report are listed in
appendix III.

Jim Wells Director, Natural Resources

and Environment

Appendix I: Comments from the Department of the Interior

Page 22 GAO- 03- 296 Mineral Revenues

Appendix I: Comments from the Department of the Interior

Note: GAO*s comments supplementing those in the report*s text appear at
the end of this appendix.

Appendix I: Comments from the Department of the Interior

Page 23 GAO- 03- 296 Mineral Revenues

Appendix I: Comments from the Department of the Interior

Page 24 GAO- 03- 296 Mineral Revenues

Appendix I: Comments from the Department of the Interior

Page 25 GAO- 03- 296 Mineral Revenues

See comment 1. Note: Page numbers in

the draft report may differ from those in the report. See comment 1.

See comment 1.

Appendix I: Comments from the Department of the Interior

Page 26 GAO- 03- 296 Mineral Revenues

See comment 1. See comment 3.

See comment 1. See comment 1. See comment 2.

Appendix I: Comments from the Department of the Interior

Page 27 GAO- 03- 296 Mineral Revenues

See comment 1. See comment 1.

See comment 1.

Appendix I: Comments from the Department of the Interior

Page 28 GAO- 03- 296 Mineral Revenues

See comment 5. See comment 4.

Appendix I: Comments from the Department of the Interior

Page 29 GAO- 03- 296 Mineral Revenues

See comment 5.

Appendix I: Comments from the Department of the Interior

Page 30 GAO- 03- 296 Mineral Revenues

Appendix I: Comments from the Department of the Interior

Page 31 GAO- 03- 296 Mineral Revenues

See comment 5.

Appendix I: Comments from the Department of the Interior

Page 32 GAO- 03- 296 Mineral Revenues

See comment 7. See comment 7.

See comment 6.

Appendix I: Comments from the Department of the Interior

Page 33 GAO- 03- 296 Mineral Revenues

The following are GAO*s comments on the Department of the Interior*s
letter dated December 13, 2002.

1. We clarified our report to reflect these comments. 2. We acknowledge
that the Mineral*s Management Service*s (MMS) difficulties in obtaining
royalty data from its financial system may be due, in part, to the court-
ordered shutdown of this financial system in December 2001. However, 9
months had passed since operation of the financial system was restored on
March 23, 2002. Additionally, MMS personnel said that the statistical
subsystem designed to generate routine summary data that we requested for
October 2001 through July 2002 had not yet been deployed and was not
expected to be deployed until April 2003 at the earliest.

3. We expressed Royalty- in- Kind (RIK) volumes as a percentage of total
federal royalty oil and gas volumes to show the overall significance of
taking royalties in kind compared with receiving cash royalty payments.
Using percentages also made it easier to show that large percentages of
oil were taken in kind for the Strategic Petroleum Reserve (SPR) and for
the Small Refiners Program relative to the small percentages taken for
pilot purposes. In expressing RIK volumes as percentages, we used actual
RIK sales volumes supplied by MMS but had to estimate the total federal
royalty volumes because MMS does not maintain these data.

4. In this report, we state that MMS*s strategic objectives do not address
the requirements in the law because nowhere in the seven strategic
objectives is there reference to the terms *fair market value* or
*collecting

at least as much revenue as would have been collected in cash royalty
payments.* In its response, Interior states that it has intended to
accomplish these legislative mandates, and Interior apparently believes
that these intentions are implied by the strategic objective stating that
MMS will implement RIK *when it is an improvement over traditional cash
royalty payments.* In light of Interior*s agreeing with us that the
objectives for the RIK Program should include achieving fair market value
and collecting revenues at least equal to what MMS would have collected in
cash royalty payments, we continue to recommend that MMS clarify the
language in its strategic objectives to reflect these intentions.

5. We acknowledge that MMS performs substantial analysis prior to
converting leases from traditional cash royalty status to RIK. For oil
sales, MMS generally calculated a minimum acceptable bid that bidders had
to exceed before MMS made an award. For gas sales, MMS relied upon gas
GAO*s Comments

Appendix I: Comments from the Department of the Interior

Page 34 GAO- 03- 296 Mineral Revenues

indexes to assess bids. While relying on minimum acceptable bids and gas
indexes prior to a sale is a first step in ensuring that RIK revenues will
equal or exceed cash royalty payments, MMS cannot determine actual revenue
impacts until after the sales are completed. To effectively monitor and
evaluate the performance of the RIK pilot sales, MMS should calculate
revenue impacts in a timely manner after sales are completed and adjust
future sales on the basis of these results.

Relying on codified valuation regulations as an indicator of what MMS
would have collected in cash royalty payments is not as straightforward as
Interior implies, and the application of valuation regulations is often a
source of dispute between MMS and industry. For example, MMS often does
not know which provision of the valuation regulations will apply to future
royalty collections from a given lease until after the sale. Also, MMS*s
market analyses suggests that many of the provisions for valuing oil and
gas sold to affiliated companies may no longer reflect the manner in which
many companies buy and sell oil and gas today. To compensate for these
uncertainties, MMS must use considerable judgment in estimating revenue
impacts prior to RIK sales.

While MMS has evaluated the revenue impacts after some completed sales,
MMS has not evaluated the revenue impacts of all sales. We point out in
this report that MMS evaluated the revenue impacts, either in whole or in
part, of about 9 percent of the oil sold in kind and about 44 percent of
the gas sold in kind. With regards to the Wyoming oil pilots and the Texas
8( g) gas pilots that Interior mentions in commenting on this report, MMS
evaluated and published the results of 3 of the 8 completed pilot sales in
Wyoming and 19 of the 29 monthly Texas 8( g) sales. Furthermore, only a
few of MMS*s analyses were done in a timely manner, precluding MMS from
using this information to modify subsequent sales. For example, MMS did
not analyze the revenue impacts of the Texas 8( g) monthly sales or its
aggregated gas sales until after it had discontinued selling gas by these
methods. However, we encourage MMS to analyze the revenue impacts of its
Gulf of Mexico oil pilots despite these sales* current suspension because
the oil from these properties is being transferred to the SPR. The results
of such a study could be useful, should MMS continue the Gulf of Mexico
oil pilots in the future.

6. MMS supplied us with the estimated loss of about $3 million on the
aggregation contracts. We calculated that transportation was worth about
$13 million on the basis of transportation costs and volumes supplied by
MMS. MMS reported that the total value of royalty payments on the
aggregated gas was about $363 million.

Appendix I: Comments from the Department of the Interior

Page 35 GAO- 03- 296 Mineral Revenues

7. Our assessment that MMS has difficulty obtaining royalty information
from its financial system is based largely on MMS personnel, who have used
these data to estimate the revenue impacts of RIK sales and told us that
they could not use these data without first performing timeconsuming
checks for accuracy and reasonableness. At our request, these personnel
supplied us with royalty data from nine Wyoming oil properties that we
estimate accounted for about 50 percent of the oil sold during the Wyoming
pilots. Although we did not find widespread systemic problems with this
small data set, we confirmed that a small amount of missing, incomplete,
and inaccurate data, in addition to numerous modifications of data entries
by payors (adjustments), precluded using these data for calculating
revenue impacts without first inspecting these data for accuracy and
reasonableness. We confirmed that the manual inspection of these data was
time- consuming. In addition, MMS personnel told us that RIK gas data are
not entered into the system at the lease level, and we believe this will
complicate comparing RIK revenues with cash royalty payments.

Appendix II: Objectives, Scope, and Methodology

Page 36 GAO- 03- 296 Mineral Revenues

In this report, we discuss (1) the extent to which the Minerals Management
Service has taken federal royalties in kind since 1995 and the reasons for
doing so and (2) the status of MMS*s efforts to implement management
controls for its RIK program.

To determine the extent to which and the purposes for which MMS has taken
RIK since 1995, we reviewed legislative directives concerning RIK in the
Mineral Leasing Act of 1920, the Outer Continental Shelf Lands Act of
1953, and the Appropriations Acts for the Interior and Related Agencies
for fiscal years 1995 though 2002. We also reviewed presidential
directives for using federal royalty oil to fill the SPR. We reviewed
prior reports and other documentation on the Small Refiners Program, the
SPR, and the RIK pilots in Wyoming and the Gulf of Mexico. We then asked
MMS personnel to supply data on the amount and values of federal royalty
oil and gas taken in kind and of total oil and gas royalties from January
1995 through July 2002. Although MMS personnel within the RIK Program
could supply data on RIK revenues and volumes taken in kind during this
time period, they could not supply data on total royalty revenues and the
total amount of oil and gas produced on federal lands that were more
current than September 2001. We did not review the accuracy of these
figures.

To review the status of MMS*s efforts to implement management control over
its RIK Program, we reviewed the Federal Managers* Financial Integrity Act
of 1982, the standards for management control that we issued entitled
Standards for Internal Control in the Federal Government

(GAO/ AIMD- 00- 21. 3. 1, November 1999), and the implementation guidance
issued by the Office of Management and Budget in OMB Circular A- 123. We
also reviewed our tool for assessing an agency*s management controls
entitled Internal Control Management and Evaluation Tool (GAO- 011008G,
August 2001) and our guide for assessing an agency*s strategic plan
entitled Agencies* Strategic Plans Under GPRA: Key Questions to Facilitate
Congressional Review (GAO/ GGD- 10. 1. 16, May 1997).

Standards for Internal Control in the Federal Government establishes the
criteria that agencies must meet in developing and maintaining management
control, which is not one event but a series of actions and activities
that occur throughout an agency*s operations on an ongoing basis. Our
review focused on MMS*s efforts to address risks that could affect the RIK
Program and on some management control activities that we identified as
being critical to MMS*s implementation and management of the program.
These management control activities are (1) developing strategic
objectives, (2) linking performance measures to these objectives, (3)
obtaining the necessary data for making management decisions and for
monitoring and evaluating the RIK Program, and (4) developing written
Appendix II: Objectives, Scope, and

Methodology

Appendix II: Objectives, Scope, and Methodology

Page 37 GAO- 03- 296 Mineral Revenues

procedures and documenting compliance with these procedures. We assessed
MMS*s efforts to establish these management control activities by
reviewing relevant documentation and interviewing MMS personnel.

We reviewed MMS*s efforts to mitigate the risks associated with
differences in the properties that produce federal oil and gas,
fluctuating oil and gas prices, disruptions in production, and credit
worthiness. In assessing strategic objectives and linked performance
measures, we reviewed these objectives and measures for their results-
orientation, clarity, specificity, ability to be expressed quantitatively
or in a measurable form, and consistency with congressional directives. In
reviewing the availability of key data for management decisions and
monitoring and evaluating the RIK Program, we assessed the extent to which
MMS had determined the revenue impacts of all RIK sales, the
administrative cost of operating the RIK Program relative to collecting
cash royalties, and the expected savings from avoiding litigation and
appeals and simplifying auditing. We also examined whether MMS had
compared revenue impacts from each RIK sale with expected revenues from
traditional cash royalty payments or other benchmarks and assessed whether
MMS had collected monthly RIK revenues and sales volumes for monitoring
purposes. In reviewing MMS*s efforts to develop written procedures, we
determined if written procedures existed as of January 1, 2002, for
conducting sales activities, collecting revenues, and reporting on these
revenues. We determined major sales activities to be the selection of
properties from which to sell RIK, the announcement of the sale, the
calculation of a minimum acceptable bid, the evaluation of bids, and the
determination of the winning bidders. For each sale completed as of
October 2002, we also reviewed whether MMS documented these major
activities. However, we did not assess the adequacy of written procedures
to collect and report on revenues, nor did we assess MMS*s compliance with
these procedures. Because at the time of our review, MMS had not
implemented an automated system to support the RIK Program, we reviewed
its current manual system and its efforts to acquire automated systems.

Appendix III: GAO Contacts and Staff Acknowledgments

Page 38 GAO- 03- 296 Mineral Revenues

Jim Wells (202) 512- 3841 Mark Gaffigan (202) 512- 3168

In addition to those named above, Letha Angelo, Ronald Belak, Robert
Crystal, Cynthia Norris, Frank Rusco, Dawn Shorey, Jamelyn Smith, and
Maria Vargas made key contributions to this report. Appendix III: GAO
Contacts and Staff

Acknowledgments GAO Contacts Acknowledgments

(360167)

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