Royalty Revenues: Total Revenues Have Not Increased at the Same  
Pace as Rising Oil and Natural Gas Prices due to Decreasing	 
Production Sold (21-JUN-06, GAO-06-786R).			 
                                                                 
In fiscal year 2005, federal and Native American lands supplied  
about 35 percent of the oil and 26 percent of the natural gas	 
produced in the United States. Companies that lease these lands  
to produce oil and natural gas pay royalties to the Department of
the Interior's Minerals Management Service (MMS) based on a	 
percentage (the royalty rate) of the cash value of the oil and	 
natural gas produced and sold. As an alternative to collecting	 
cash royalty payments, MMS has the option to take a percentage of
the actual oil and natural gas produced (referred to as "taking  
royalties in kind") and selling it themselves or using it for	 
other purposes, such as filling the nation's Strategic Petroleum 
Reserve (SPR). MMS reported collecting $7.4 billion in fiscal	 
year 2001 and $8 billion in fiscal year 2005 in cash royalty	 
payments and in revenue from its own royalty-in-kind sales of oil
and natural gas. While these total royalty revenues increased by 
about 8 percent from 2001 to 2005, oil and natural gas prices	 
rose substantially more--about 90 percent for oil and 30 percent 
for natural gas. Consequently, Congress asked us why oil and	 
natural gas royalty revenues did not increase at the same pace as
the increase in oil and natural gas prices.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-786R					        
    ACCNO:   A55848						        
  TITLE:     Royalty Revenues: Total Revenues Have Not Increased at   
the Same Pace as Rising Oil and Natural Gas Prices due to	 
Decreasing Production Sold					 
     DATE:   06/21/2006 
  SUBJECT:   Comparative analysis				 
	     Crude oil						 
	     Indian lands					 
	     Natural gas					 
	     Prices and pricing 				 
	     Royalty payments					 
	     Strategic Petroleum Reserve			 

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GAO-06-786R

     

     * Falling Natural Gas Production Volumes Have Largely Offset R
     * Declining Oil Sales Have Largely Offset Rising Oil Prices
     * Agency Comments

June 21, 2006

Congressional Requesters:

Subject: Royalty Revenues: Total Revenues Have Not Increased at the Same
Pace as Rising Oil and Natural Gas Prices due to Decreasing Production
Sold

In fiscal year 2005, federal and Native American lands supplied about 35
percent of the oil and 26 percent of the natural gas produced in the
United States. Companies that lease these lands to produce oil and natural
gas pay royalties to the Department of the Interior's Minerals Management
Service (MMS) based on a percentage (the royalty rate) of the cash value
of the oil and natural gas produced and sold. As an alternative to
collecting cash royalty payments, MMS has the option to take a percentage
of the actual oil and natural gas produced (referred to as "taking
royalties in kind") and selling it themselves or using it for other
purposes, such as filling the nation's Strategic Petroleum Reserve (SPR).
MMS reported collecting $7.4 billion in fiscal year 2001 and $8 billion in
fiscal year 2005 in cash royalty payments and in revenue from its own
royalty-in-kind sales of oil and natural gas. While these total royalty
revenues increased by about 8 percent from 2001 to 2005, oil and natural
gas prices rose substantially more-about 90 percent for oil and 30 percent
for natural gas. Consequently, you asked us why oil and natural gas
royalty revenues did not increase at the same pace as the increase in oil
and natural gas prices.

In summary, federal and Native American royalty revenues did not increase
at the same pace as oil and natural gas prices between 2001 and 2005
principally because the volumes upon which royalties are based declined
substantially during this time. In assessing changes in royalty revenues,
it is important to understand the three key variables of volume, price,
and royalty rate that make up total royalty revenues. When reporting and
paying royalties to MMS, companies must collect and report various data,
including the volume of oil or natural gas sold, the sales price received
less allowable deductions-such as transportation-to get the resource to
market, and the royalty rate to be paid as specified in the oil and
natural gas lease. Companies can calculate the royalty revenue they owe to
the federal government using the three key variables illustrated in the
following equation:

  Royalty revenue = volume sold x sales price less deductions x royalty rate1

As summarized in table 1 and table 2, the volume of natural gas and oil
that was sold decreased significantly between 2001 and 2005, largely
offsetting the impact of increased sales prices on total royalty revenues.

Table 1: Natural Gas Royalty Statistics for Federal and Native American
Lands

Fiscal Total volume sold   Average sales price      Average  Total royalty 
year                             received (per royalty rate       revenues 
              (thousands of thousand cubic feet)a        (less 
                cubic feet)                        deductions) 
2001       6,912,002,366                 $5.05     0.145124 $5,062,170,355 
2005       5,864,705,117                 $6.59     0.137267 $5,304,520,628 

Source: MMS.

aAverage sale price rounded to nearest cent.

Table 2: Oil Royalty Statistics for Federal and Native American Lands

Fiscal   Total volume   Average sales price Average royalty  Total royalty 
year   sold (barrels)         received (per      rate (less       revenues 
                                      barrel)a     deductions) 
2001      699,346,399                $25.27        0.134703 $2,380,264,986 
2005      434,142,391                $47.96        0.128498 $2,675,676,653 

Source: MMS.

aAverage sales price rounded to nearest cent.

In conducting our work, it was not possible with the available data to
precisely determine how much of the change in total royalty revenues was
due to a change in any one variable, as all three variables were changing
over time at varying rates. For example, during any given month in which
royalties are collected, each of the variables may either rise or fall
compared to the previous month. For our analysis, however, we estimated a
variable's contribution to the total dollar change in royalty revenues for
oil and natural gas by assuming that the other two variables changed at a
constant rate. Under this assumption, the total change in that variable
from 2001 to 2005 closely approximated the actual change over the period.
We also examined the effects of specific factors, such as hurricanes, on
total volumes sold and average royalty rates. We obtained oil and natural
gas data from MMS's financial system for fiscal years 2001 and 2005 to
conduct our independent analysis to more fully explain the change in both
natural gas and oil royalty revenues. We also interviewed MMS officials at
their Lakewood, Colorado, office to solicit their views on why oil and
natural gas royalty revenues did not increase at the same rate as prices
between 2001 and 2005. The comparison of royalty revenues between 2001 and
2005 does not include natural gas or oil production that is subject to
royalty relief. Legislation and regulations exempt some production from
certain leases in the Gulf of Mexico from royalties, and therefore these
production volumes do not appear in the royalty revenue statistics. 2
Although the volumes subject to royalty relief were small, they are
expected to grow in the future. We have ongoing work and plan a future
report on royalty-relief policies and MMS efforts to estimate the impact
of royalty relief on future royalty revenues. We coordinated and worked
with the Department of the Interior's Office of Inspector General on this
review. A detailed description of our methodology appears in enclosure I.
We conducted our review from February through April 2006 in accordance
with generally accepted government auditing standards.

1Companies report to MMS on Form MMS-2014 the volume sold (sales volume),
the amount of revenue received from this sale (sales value), and the
royalty revenue due to MMS (royalty value less allowances). The average
sales price is calculated by dividing sales value by sales volume. The
average royalty rate net of allowances is calculated by dividing royalty
value less allowances by sales value.

 Falling Natural Gas Production Volumes Have Largely Offset Rising Natural Gas
                                     Prices

As summarized in table 1, decreases in the volume of natural gas produced
and sold between 2001 and 2005 have largely offset the impact of increased
sales prices on total royalty revenues. Natural gas production volumes
from federal and Native American lands decreased because of natural
declines in older wells. In addition, hurricanes in 2005 contributed to a
decline in natural gas production volumes by forcing companies to
temporarily suspend natural gas production from wells in the Gulf of
Mexico. Finally, the volume of gas upon which royalties are based in a
given year is decreased by the amount of gas that is exempt from paying
royalties under federal royalty-relief provisions. Natural gas volumes
subject to royalty relief did grow between 2001 and 2005. In 2001, MMS
reported about 5 billion cubic feet of natural gas were exempt from
royalties under royalty-relief provisions. In 2005, MMS reported that
these volumes increased to over 246 billion cubic feet of natural gas,
with a total estimated royalty value of about $226 million. Volumes of
natural gas subject to royalty relief are expected to grow in the future.
We have ongoing work to examine royalty-relief policies and efforts to
estimate the impact of royalty relief on future royalty revenues.

In addition to reduced production volumes, the average royalty rates on
natural gas production from federal and Native American lands decreased
from 2001 to 2005, contributing to the drop in royalty revenues. Royalty
rates can vary depending on where the natural gas is produced. In general,
average royalty rates for natural gas have decreased as production has
declined in areas with higher royalty rates (such as shallow waters in the
Gulf of Mexico where the royalty rate is 16.67 percent) and increased in
areas with lower royalty rates (such as deep waters in the Gulf of Mexico
where the royalty rate is 12.5 percent). Because the comparison of royalty
revenues between years does not include production that is subject to
royalty relief, the average royalty rate is not affected by production
that is subject to royalty relief.

From fiscal years 2001 to 2005, total natural gas royalty revenues from
federal and Native American lands increased by about $242 million (see
table 1). We estimate that the rise in natural gas prices between 2001 and
2005 would have increased

2Certain leases issued in 1998 and 1999 did not contain price thresholds,
resulting in additional royalty-free volumes which do not appear in the
royalty revenue statistics.

royalty revenues by $1,392 million. Natural gas prices have risen since
2001 because demand for natural gas has expanded faster than supply. The
domestic gas industry has been producing at near capacity, and the
nation's ability to increase imports has reached its limits. Tight
supplies have also made the market susceptible to extreme price spikes
when either demand or supply changes unexpectedly, such as when hurricanes
hit the Gulf Coast in late 2005. However, we estimate that a decline in
the total natural gas volume sold resulted in a decrease of about $860
million in potential royalty revenues. In addition, a decline in the
average royalty rate decreased potential royalty revenues by an additional
$292 million. The relationship between the changes in natural gas royalty
revenues due to an increase in the price of natural gas, decrease in
volumes sold, and decrease in average royalty rate is illustrated in
figure 1.

Figure 1: Estimated Effects of Volume, Price, and Royalty Rate on Federal
and Native American Natural Gas Royalty Revenues, Fiscal Years 2001 to
2005

Note: Changes attributed to individual variables account for 99 percent
instead of 100 percent of the actual change in total royalty revenues due
to limitations in the methodology. See enclosure I for more details.

A significant portion of the $860 million decrease in potential royalty
revenues associated with declining sales volumes appears to be the result
of a decrease in natural gas production caused by the normal depletion of
natural gas wells in shallow waters (i.e., waters less than 400 meters
deep) of the Gulf of Mexico. MMS's Gulf of Mexico Offshore Region reported
a precipitous decline in natural gas production in shallow waters of the
Gulf starting in 1997. This decline continued from 2001 to 2005. MMS
reported that natural gas production from shallow waters dropped from
about 4.2 trillion cubic feet in 2001 to about 2.4 trillion cubic feet in
2005, while production

from deep waters (i.e., waters over 400 meters deep) remained relatively
stable.3 However, since companies are reporting the discovery of oil and
natural gas fields in increasingly deeper water, MMS anticipates that
production from deep water will increase in the future.

While older natural gas wells onshore also experienced declining
production, these declines were overshadowed by an increase in natural gas
production from new onshore wells. Onshore total natural gas volumes sold
actually increased by about 17 percent from 2001 to 2005, according to MMS
statistics. Had this onshore increase not occurred, the $860 million
decrease in potential royalty revenues associated with declining sales
volumes would have been greater. We have previously reported the increase
in oil and natural gas activities on federal onshore lands managed by the
Bureau of Land Management.4 Permits issued to drill wells on these lands
more than tripled from fiscal years 1999 to 2004, with much of the
increase occurring in the Rocky Mountain states of Montana, Wyoming,
Colorado, Utah, and New Mexico.

Hurricanes in the Gulf of Mexico also contributed to the decline in
natural gas sales volume from 2001 to 2005 by forcing companies to
temporarily suspend production. MMS reported that, during August and
September 2005, total cumulative shut-in natural gas production was
196,481 million cubic feet, or about 5 percent of the annual natural gas
production in the Gulf of Mexico. We estimate that this production could
have resulted in royalty revenues of about $208 million, although it is
unclear what portion of this production was subject to royalties.

In addition to the declining natural gas sales volumes, a declining
average royalty rate also reduced total royalty revenues. From 2001 to
2005, the average royalty rate dropped from about 14.5 percent to about
13.7 percent, resulting in a decrease of about $292 million in potential
royalty revenues. This decrease appears to have resulted largely from the
decline in natural gas production in shallow waters of the Gulf of Mexico.
Shallow water leases have royalty rates of 16.67 percent, while deeper
water leases carry royalty rates of 12.5 percent. The increase in onshore
production, where leases also carry a 12.5 percent royalty rate, has also
contributed to the decline in the average royalty rate.

           Declining Oil Sales Have Largely Offset Rising Oil Prices

As summarized in table 2, decreases in the volumes of oil produced and
sold between 2001 and 2005 have largely offset the impact of increased
sales prices on total royalty revenues. The oil volumes sold from federal
and Native American lands declined principally because MMS took
substantial volumes in kind and used these volumes to fill the SPR,
instead of receiving cash royalty payments or selling the oil and

3Not all volumes produced are subject to royalties. The Outer Continental
Shelf Deep Water Royalty Relief Act of 1995 exempts certain volumes from
royalties. Hence, total volumes sold reported in tables 1 and 2 reflect
volumes on which royalties wee paid, and as a result are less than total
volumes actually produced for a given year.

4GAO, Oil and Gas Development: Increased Permitting Activity Has Lessened
BLM's Ability to Meet Its Environmental Protection Responsibilities,
GAO-05-418 (Washington, D.C.: June 17, 2005).

collecting revenue from royalty-in-kind sales. As with natural gas,
hurricanes in 2005 also contributed to a decline in oil

production volumes by forcing companies to temporarily suspend production
from wells in the Gulf of Mexico. Also, the volume of oil upon which
royalties are based in a given year is decreased by the amount of oil that
is exempt from paying royalties under federal royalty-relief provisions.
Although the comparison of royalty revenues between 2001 and 2005 does not
include oil production that is subject to royalty relief, the volumes
subject to royalty relief did grow between 2001 and 2005. In 2001, MMS
reported about 2.6 million barrels of oil were exempt from royalties under
royalty-relief provisions. In 2005, MMS reported that these volumes
increased to about 29 million barrels of oil, with a total estimated
royalty value of about $175 million. The oil volumes subject to royalty
relief are expected to grow further, and we have work currently under way
to examine royalty-relief policies and estimates of the impact on future
royalty revenues. In addition to the declining oil sales volumes, a
declining average royalty rate for oil also contributed to reduced total
royalty revenues.

From fiscal years 2001 to 2005, total oil royalty revenues from federal
and Native American lands increased by about $295 million (see table 2).
We estimate that the rise in crude oil prices between 2001 and 2005
increased potential royalty revenues by $1,693 million. Crude oil prices
rose during this period primarily because the growth in world oil demand
has not been accompanied by a similar growth in crude oil supplies. Demand
has increased, particularly in the United States, China, and India, while
production has been voluntarily restricted by members of the Organization
of Petroleum Exporting Countries or otherwise disrupted by events in
Nigeria, Iraq, and Venezuela. In addition, hurricanes in the Gulf Coast in
late 2005 disrupted the flow of oil into the United States and damaged oil
facilities, leading to increased prices at that time. However, a decline
in the total oil volume sold during this same period resulted in a
decrease of about $1,278 million in potential royalty revenues. In
addition, a drop in the average royalty rate caused another $129 million
decrease in potential royalty revenues. The relationship between the
changes in oil royalty revenues due to an increase in the price of crude
oil, decrease in volumes sold, and decrease in average royalty rate is
illustrated in figure 2.

Figure 2: Estimated Effects of Volume, Price, and Royalty Rate on Federal
and Native American Oil Royalty Revenues, Fiscal Years 2001 to 2005

Note: Changes attributed to individual variables account for 97 percent
instead of 100 percent of the actual change in total royalty revenues due
to limitations in the methodology. See enclosure I for more details.

Most of the $1,278 million decrease in potential royalty revenues
associated with declining sales volumes appears to be the result of
transfers of royalty oil to the SPR. The Congress created the SPR to
provide emergency oil in the event of a disruption in petroleum supplies.
Managed by the Department of Energy (DOE), the SPR is a series of
underground salt caverns along the coastline of the Gulf of Mexico that
can store up to 700 million barrels of oil. MMS assists DOE in
transferring oil into the SPR. Under royalty in kind, instead of receiving
cash royalty payments, MMS takes the federal government's royalty share in
oil. MMS can then sell the oil and collect revenue from the
royalty-in-kind sales or use it for other purposes. In fact, MMS was
directed to transfer the oil to the SPR. Since the oil was transferred and
not sold, no cash royalty revenues were collected from a sale. MMS began
assisting DOE with the transfer of royalty oil to the SPR in April 2002,
after having stopped filling the SPR in December 2000. In 2005, MMS
reported that it had assisted in transferring about 213 million barrels of
oil to the SPR. This amount represents about 80 percent of the decrease in
total oil volume sold from 2001 to 2005.

Hurricanes in the Gulf of Mexico also contributed to the decline in oil
sales volumes from 2001 to 2005 by forcing companies to shut-in wells. MMS
reported that during August and September 2005, total cumulative shut-in
oil production was 40,828,134 barrels, or about 15 percent of the decline
in total oil volumes sold from 2001 to 2005. We estimate that this shut-in
production could have produced royalty revenues of at

least $270 million, although it is unclear what portion of this production
was royalty-bearing and at what price the oil would have been sold. In
addition, oil volumes sold from onshore federal and Native American lands
decreased by 8 million barrels, or about 3 percent of the decrease in
total oil volumes sold from 2001 to 2005.

In addition to the declining oil sales volumes, a declining average
royalty rate also helped offset the increase in total royalty revenues due
to increasing crude oil prices. From 2001 to 2005, the average royalty
rate dropped from about 13.5 percent to about 12.8 percent, resulting in a
decrease of about $129 million in potential oil royalty revenues. As with
natural gas, this decrease appears to have resulted from an increase in
the proportion of oil produced from deep waters in the Gulf of Mexico,
where royalty rates are lower.

                                Agency Comments

We provided a draft of this report to the Department of the Interior for
review and comment. The Minerals Management Service provided written
comments, which are presented in enclosure II. MMS agreed with our
observations and emphasized our conclusion that federal oil and gas
royalty collections from 2001 through 2005 have not kept pace with rising
oil and natural gas prices because of a decrease in the volumes of oil and
natural gas sold during this period. MMS also provided comments to improve
the report's technical accuracy, which we incorporated as appropriate.

                                   - - - - -

As agreed with your offices, unless you publicly announce the contents of
this report, we plan no further distribution until 30 days from the date
of this letter. At that time we will send copies of this report to
appropriate congressional committees, the Secretary of the Interior, the
Director of MMS, the Director of the Office of Management and Budget, and
other interested parties. We will also make copies available to others
upon request. In addition, the report will be available at no charge on
GAO's Web site at http://www.gao.gov .

If you or your staff have any questions about this report, please contact
me at (202) 512-3841 or [email protected]. Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last page
of this report. GAO staff who made major contributions to this letter
include Ron Belak, Glenn C. Fischer, Mark Gaffigan, and Frank Rusco.

Jim Wells

Director, Natural Resources

and Environment

Enclosures

List of Addressees

The Honorable Jeff Bingaman

Ranking Minority Member

Committee on Energy and Natural Resources

United States Senate

The Honorable Norm Coleman

Chairman, Permanent Subcommittee on Investigations

Committee on Homeland Security and Governmental Affairs

United States Senate

The Honorable Carl Levin

Ranking Minority Member

Permanent Subcommittee on Investigations

Committee on Homeland Security and Governmental Affairs

United States Senate

The Honorable Daniel K. Akaka

United States Senate

The Honorable Maria Cantwell

United States Senate

The Honorable Thomas R. Carper

United States Senate

The Honorable Mark Dayton

United States Senate

The Honorable Byron L. Dorgan

United States Senate

The Honorable Richard J. Durbin

United States Senate

The Honorable Russell D. Feingold

United States Senate

The Honorable Dianne Feinstein

United States Senate

The Honorable Tim Johnson

United States Senate

The Honorable John F. Kerry

United States Senate

The Honorable Frank R. Lautenberg

United States Senate

The Honorable Robert Menendez

United States Senate

The Honorable Barbara A. Mikulski

United States Senate

The Honorable Patty Murray

United States Senate

The Honorable Barack Obama

United States Senate

The Honorable Jack Reed

United States Senate

The Honorable Ken Salazar

United States Senate

The Honorable Charles E. Schumer

United States Senate

The Honorable Ron Wyden

United States Senate

The Honorable Darrel E. Issa

Chairman

Subcommittee on Energy and Resources

Committee on Government Reform

House of Representatives

The Honorable Carolyn B. Maloney

House of Representatives

Enclosure I

                             Scope and Methodology

To determine why oil and natural gas royalty revenues have not kept pace
with rising oil and natural gas prices from fiscal years 2001 to 2005, we
first interviewed Minerals Management Service (MMS) officials in Lakewood,
Colorado. MMS presented their briefing entitled "Management of the
Nation's Natural Gas Royalty Revenues: The Department of the Interior's
Response to the NY Times, February 2006." MMS issued this document in
response to an article published in The New York Times on January 23,
2006, that questioned why natural gas royalty revenues in 2005 did not
increase at the same rate as prices increased. We reviewed extensive
documentation supporting the information in MMS's presentation and agreed
with the reasons MMS cited as to why natural gas royalty revenues have not
kept pace with rising natural gas prices. We also generally agreed with
MMS's portrayal of the impact these reasons had on royalty revenues. We
also discussed with MMS officials the reasons that oil revenues had not
kept pace with rising prices from 2001 to 2005.

Because summary royalty data published on MMS's Web site do not solely
represent transactions that occurred during the reported fiscal year, but
include transactions from previous years as well, we obtained oil and
natural gas data from MMS's financial system for fiscal years 2001 and
2005.5 We obtained data that were posted to the appropriate fiscal year,
including the sum of sales values, sum of sales volumes, and sum of
royalty values less allowances for each payor aggregated by product type
(oil or natural gas) for transactions that consisted largely of cash
royalty payments, royalty in kind, compensatory royalties, transportation
allowances, natural gas processing allowances, and profitable
profit-sharing arrangements. We tested these aggregate data for
reasonableness because we were aware of possible data errors. We corrected
a 1.19 trillion cubic-foot error in the volume of natural gas sold during
fiscal year 2001. However, we did not test or validate the estimated 6
million transactions of which the 2001 and 2005 data are comprised. We
have tested individual oil and natural gas transactions from MMS's
financial database in the past and have found that, when transactions were
aggregated to lesser levels, between 1.9 and 6.0 percent of the data was
erroneous or missing.6 We found that about 8.5 percent of the aggregated
data for 2001 and 2005 that we analyzed for this report is anomalous.
Anomalous data include data that are outside of a reasonable range for
royalty rates, outside of a reasonable range for expected prices, contain
negative or missing values for sales volumes or royalties when cash
royalties are due, and consist of a positive value when allowances are
reported. We then estimated the financial impact that these anomalous data
had on royalties reported and sales volumes reported. Because only a small
number of these anomalies exceeded 0.01 percent of the total annual
royalty revenues or volumes sold, our analysis suggests that these
anomalous data did not significantly impact royalty statistics reported in
table 1 and

5Transactions from previous fiscal years are called adjustments, and they
are a standard industry practice caused by, among other things,
rebalancing of volumes sold and corrections to unit allocations. Fiscal
years 2001 and 2005 contain adjustments only for their respective years
that are current as of January 6, 2006, and exclude reported sales of
nitrogen.

6GAO, Mineral Revenues: Cost and Revenue Information Needed to Compare
Different Approaches for Collecting Federal Oil and Gas Royalties,
GAO-04-448 (Washington, D.C.: Apr. 16, 2004), app. I.

table 2. We concluded that these data are sufficiently reliable for the
broad nature of our analysis.

We decided to pursue an approach that was different from MMS's approach in
quantifying the individual impact of changes in prices, volumes, and
royalty rates on total royalty revenues and to assess why total royalty
revenues had not kept pace with rising prices. MMS estimated the impact of
these variables by determining what royalties would have been if
individual variables had not declined or if specific events, like
hurricanes, had not occurred. While mathematically sound, this methodology
has some limitations-for instance, it does not consider that all the
variables are changing over time. In addition, the sum of estimated
individual changes using this methodology significantly exceeds the actual
change in total royalty revenues, and this could be misinterpreted. In
contrast, we estimated the effects of each individual variable on total
royalty revenues by multiplying the change in that variable from 2001 to
2005 by the average values of the other variables during that period. This
methodology assumes that all the variables were changing at a constant
rate from 2001 to 2005. We examined the raw data and found that this
assumption was generally reasonable for natural gas volumes sold, average
natural gas prices, and net natural gas royalty rates, except for the
average natural gas price in fiscal year 2002. It also appears to be
reasonable for net oil royalty rates and average oil prices, except for
fiscal year 2002. The one main exception is that the drop in oil volumes
sold was not changing at a constant rate-oil volumes sold dropped
substantially between 2002 and 2003 when the federal government started to
transfer significant quantities of oil to the SPR. Under our methodology,
nonetheless, the sum of the estimated individual impacts on total royalty
revenues was close to the actual total change in royalty revenues.

Enclosure II

                  Comments from the Department of the Interior

(360676)

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