Oil and Gas Royalties: The Federal System for Collecting Oil and 
Gas Revenues Needs Comprehensive Reassessment (03-SEP-08,	 
GAO-08-691).							 
                                                                 
In fiscal year 2007, domestic and foreign companies received over
$75 billion from the sale of oil and gas produced from federal	 
lands and waters, according to the Department of the Interior	 
(Interior), and these companies paid the federal government about
$9 billion in royalties for this oil and gas production. The	 
government also collects other revenues in rents, taxes, and	 
other fees, and the sum of all revenues received is referred to  
as the "government take." The terms and conditions under which	 
the government collects these revenues are referred to as the	 
"oil and gas fiscal system." This report (1) evaluates government
take and the attractiveness for investors of the federal oil and 
gas fiscal system, (2) evaluates how the absence of flexibility  
in this system has led to large foregone revenues from oil and	 
gas production on federal lands and waters, and (3) assesses what
Interior has done to monitor the performance and appropriateness 
of the federal oil and gas fiscal system. To address these	 
issues, we reviewed expert studies and interviewed government and
industry officials.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-691 					        
    ACCNO:   A83959						        
  TITLE:     Oil and Gas Royalties: The Federal System for Collecting 
Oil and Gas Revenues Needs Comprehensive Reassessment		 
     DATE:   09/03/2008 
  SUBJECT:   Evaluation methods 				 
	     Federal legislation				 
	     Financial analysis 				 
	     Foreign investments in US				 
	     Gas leases 					 
	     Gas resources					 
	     Intergovernmental fiscal relations 		 
	     Land resources					 
	     Monitoring 					 
	     Natural resource management			 
	     Natural resources					 
	     Oil leases 					 
	     Oil resources					 
	     Performance measures				 
	     Petroleum industry 				 
	     Policy evaluation					 
	     Rates						 
	     Revenue sharing					 
	     Royalty payments					 
	     Systems evaluation 				 
	     Program evaluation 				 
	     Financial management				 

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GAO-08-691

   

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Report to Congressional Requesters: 

United States Government Accountability Office: 
GAO: 

September 2008: 

Oil And Gas Royalties: 

The Federal System for Collecting Oil and Gas Revenues Needs 
Comprehensive Reassessment: 

GAO-08-691: 

GAO Highlights: 

Highlights of GAO-08-691, a report to congressional requesters. 

Why GAO Did This Study: 

In fiscal year 2007, domestic and foreign companies received over $75 
billion from the sale of oil and gas produced from federal lands and 
waters, according to the Department of the Interior (Interior), and 
these companies paid the federal government about $9 billion in 
royalties for this oil and gas development. The government also 
collects other revenues in rents, taxes, and other fees, and the sum of 
all revenues received is referred to as the ï¿½government take.ï¿½ The 
terms and conditions under which the government collects these revenues 
are referred to as the ï¿½oil and gas fiscal system.ï¿½ This report (1) 
evaluates government take and the attractiveness for investors of the 
federal oil and gas fiscal system, (2) evaluates how the absence of 
flexibility in this system has led to large foregone revenues from oil 
and gas production on federal lands and waters, and (3) assesses what 
Interior has done to monitor the performance and appropriateness of the 
federal oil and gas fiscal system. To address these issues, we reviewed 
expert studies and interviewed government and industry officials. 

What GAO Found: 

In addition to having a low government take, the deep water Gulf of 
Mexico and other U.S. regions are attractive targets for investment 
because they have large remaining oil and gas reserves and the U.S. is 
generally a good place to do business compared to many other countries 
with comparable oil and gas resources. Multiple studies completed as 
early as 1994 and as recently as June 2007 indicate that the U.S. 
government take in the Gulf of Mexico is lower than that of most other 
fiscal systems. For example, data GAO evaluated from a June 2007 
industry consulting firm report indicated that the government take in 
the deep water U.S. Gulf of Mexico ranked 93rd lowest of 104 oil and 
gas fiscal systems evaluated. Generally, other measures indicate that 
the United States is an attractive target for oil and gas investment. 

The lack of price flexibility in royalty ratesï¿½automatic adjustment of 
these rates to changes in oil and gas prices or other market 
conditionsï¿½and the inability to change fiscal terms on existing leases 
have put pressure on Interior and the Congress to change royalty rates 
in the past on an ad hoc basis with consequences that could amount to 
billions of dollars of foregone revenue. For example, royalty relief 
granted on leases issued in the deep water areas of the Gulf of Mexico 
between 1996 and 2000ï¿½a period when oil and gas prices and industry 
profits were much lower than they are todayï¿½could cost the federal 
government between $21 billion and $53 billion, depending on the 
outcome of ongoing litigation challenging the authority of Interior to 
place price thresholds that would remove the royalty relief offered on 
certain leases. Further, royalty rate increases in 2007 are expected to 
generate modest increases in federal revenues from future leases 
offered in the Gulf of Mexico. However, in choosing to increase royalty 
rates, Interior did not evaluate the entire oil and gas fiscal system 
to determine whether or not these increases strike the proper balance 
between the attractiveness of federal leases for investment and 
appropriate returns to the federal government for oil and gas 
resources. 

Interior does not routinely evaluate the federal oil and gas fiscal 
system, monitor what other governments or resource owners are receiving 
for their energy resources, or evaluate and compare the attractiveness 
of federal lands and waters for oil and gas investment with that of 
other oil and gas regions. As a result, Interior cannot assess whether 
or not there is a proper balance between the attractiveness of federal 
leases for investment and appropriate returns to the federal government 
for oil and gas resources. Specifically, Interior does not have 
procedures in place for evaluating the ranking of (1) the federal oil 
and gas fiscal system or (2) industry rates of return on federal leases 
against other resource owners. Interior also does not have the 
authority to alter tax components of the oil and gas fiscal system. All 
these factors are essential to inform decisions about whether or how to 
alter the federal oil and gas fiscal system in response to changing 
market conditions. 

What GAO Recommends: 

Interior did not fully agree with the recommendations in our draft 
report, stating that an ongoing Interior study covered many of the 
issues we recommended they study. GAO maintains that a more 
comprehensive review is necessary and suggest that Congress consider 
directing Interior to (1) convene an independent panel to conduct such 
a review of the federal oil and gas fiscal system, and (2) establish 
procedures to periodically evaluate the state of the fiscal system. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-691]. For more 
information, contact Frank Rusco at (202) 512-3841 or [email protected]. 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

The Gulf of Mexico Has a Relatively Low U.S. Government Take and the 
United States Is an Attractive Place to Invest in Oil and Gas 
Development: 

The Inflexibility of Royalty Rates to Changing Oil and Gas Prices Has 
Cost the Federal Government Billions of Dollars in Foregone Revenues: 

Interior Does Not Have a System in Place to Evaluate Whether the 
Federal Fiscal System Is in Need of Reassessment: 

Conclusions: 

Matter for Congressional Consideration: 

Agency Comments and Our Evaluation: 

Appendix I: Scope and Methodology: 

Appendix II: Companies Receiving Royalty Relief In The Gulf Of Mexico: 

Appendix III: Comments from Department of Interior: 

GAO Comments: 

Appendix IV: GAO Contact and Staff Acknowledgments40: 

Tables: 

Table 1: Summary of Four 2007 Studies Comparing Government Take 
Percentages: 

Table 2: Amounts of Royalty Relief Received by Companies: 

Abbreviations: 

BLM: Bureau of Land Management: 

DWRRA: Deep Water Royalty Relief Act of 1995: 

EIA: Energy Information Administration: 

FLPMA: Federal Land Policy and Management Act: 

FRS: Financial Reporting System: 

Interior: Department of the Interior: 

MMS: Minerals and Management Service: 

OCSLA: Outer Continental Shelf Lands Act: 

S&P: Standard & Poor's: 

[End of section] 

United States Government Accountability Office:
Washington, DC 20548: 

September 3, 2008: 

The Honorable Jeff Bingaman: 
Chairman, Committee on Energy and Natural Resources: 
United States Senate: 

The Honorable Nick J. Rahall II: 
Chairman, Committee on Natural Resources: 
House of Representatives: 

The Honorable Steven Pearce: 
Ranking Member, Subcommittee on Energy and Mineral Resources: 
Committee on Natural Resources: 
House of Representatives: 

The Honorable Mary L. Landrieu: 
United States Senate: 

In fiscal year 2007, domestic and foreign companies received over $75 
billion from the sale of oil and gas produced from federal lands and 
waters, according to the Department of the Interior's (Interior) 
Minerals Management Service (MMS). The agency further reported that 
these companies paid the federal government about $9 billion in 
royalties for such oil and gas development. Clearly, such large and 
financially significant resources must be carefully developed and 
managed so that the nation's rising energy needs are met while at the 
same time the American people are assured of receiving a fair return on 
publicly owned resources. In May 2007, we reported that, based on 
studies by industry experts, the amount of money that the U.S. 
government receives from production of oil and gas on federal lands and 
waters--the so-called "government take"--was among the lowest in the 
world. The government take that accrues to any government resource 
owner is largely determined by the government's oil and gas fiscal 
system--the precise mix and total amount of payments made to the 
government for the rights to explore, develop, and sell oil and gas 
resources. We also noted that several factors needed to be considered 
to determine whether adjustments to an oil and gas fiscal system are 
warranted, including the size and availability of the oil and gas 
resources in place; the costs of finding and developing these 
resources, including labor costs and the costs of complying with 
environmental regulations; and the stability of both the oil and gas 
fiscal system and the country in general.[Footnote 1] Conceptually, a 
fair government take would strike a balance between encouraging private 
companies to invest in the development of oil and gas resources on 
federal lands and waters while maintaining the public's interest in 
collecting the appropriate level of revenues from the sale of the 
public's resources. 

Governments and companies negotiate the exploration and development of 
oil and gas resources under terms of leases or contracts granted by 
governments. The terms and conditions of such arrangements are 
established by law and policy, or are negotiated on a case-by-case 
basis. An important aspect of these arrangements is the oil and gas 
fiscal system, which defines all applicable payments from the companies 
to the government resource owners.[Footnote 2] Oil and gas fiscal 
systems vary widely across different resource owners, reflecting 
differences in the mix and weight of the various payments. U.S. federal 
oil and gas leases operate under a system in which the government 
transfers title to the oil and gas produced to a company for a period 
of time, generally in exchange for a lump-sum payment called a bonus 
bid. The company is then typically subject to the payment of rental 
rates, royalties, and taxes for any oil and gas that is eventually 
produced on the lease. In other oil and gas fiscal systems, such as 
"production sharing" or "profit sharing" systems, the host country and 
production company enter into a contract to apportion the production or 
profits between them rather than or in addition to royalty payments. 

In recent years, and in response to increasing industry profits and 
other changing market conditions, many countries have re-evaluated or 
are re-evaluating their oil and gas fiscal systems. A number of 
countries have significantly increased their overall government take 
while others--typically those with marginal or less certain levels of 
oil and gas resources--have reduced their government take. According to 
Wood Mackenzie, an energy consulting firm that recently performed a 
comprehensive study of government take and other measures that 
determine the attractiveness of different countries to oil and gas 
investors, the most prominent trend in changing oil and gas fiscal 
systems has been the imposition of windfall profits taxes or other 
mechanisms to increase the resource owners' shares of oil and gas 
revenues from existing projects. Wood Mackenzie estimates that these 
changes will ultimately result in these countries' collecting 
additional oil and gas revenues of between $118 billion and $400 
billion, depending on future oil and gas prices.[Footnote 3] For 
example, the state of Alaska recently increased its government take and 
changed the terms of contracts to give Alaska larger shares of revenues 
as oil and gas prices increase. A second trend in changing oil and gas 
fiscal systems has been an increase in governmental control of 
resources. For example, Algeria, Russia, and Venezuela have rich 
resource reserves and have increased the state control over these 
resources, while increasing their government takes. Other trends 
include increasing variation of fiscal terms across and within 
countries to reflect differences in the value of the resources and 
other factors that affect the attractiveness of these resources to 
investors. For example, Papua New Guinea and Vietnam are offering terms 
to encourage production that reflect these countries' status as 
frontier areas for exploration, while Norway has provided incentives 
for exploration and continued production on fields with declining 
production. 

A considerable body of legislation governs Interior's authority and 
obligations to manage resources on federal lands and within federal 
waters. For example, the Outer Continental Shelf Lands Act (OCSLA) and 
the Federal Land Policy and Management Act (FLPMA) direct Interior to 
ensure the United States receives fair market value on the development 
of its oil and gas resources. In 1976, an Interior report concluded 
that the government receives "fair market value" when lessees receive 
no more than a "normal" rate of return. In 1982--the last time Interior 
convened a task force to comprehensively review its "fair market value" 
procedures, the task force indicated that fair market value was not the 
value of the oil and gas eventually discovered or produced; instead it 
is the value of "the right" to explore and, if there is a discovery, to 
develop and produce the energy resource. In general, for offshore, 
Interior has the authority to change most components of the federal oil 
and gas fiscal system so long as no more than one component is set on 
automatically adjusting or "flexible" terms, and so long as the 
Congress does not disapprove the change--pass a resolution of 
disapproval--within 30 days of receiving notice of Interior's bidding 
system. However, only the Congress may change the tax components of the 
oil and gas fiscal system. 

To provide more information to the Congress about the nature of the 
federal oil and gas fiscal system and the attractiveness of the United 
States as a place in which to invest in oil and gas development, we 
agreed to build on the information in our May 1, 2007, report, which 
compared the U.S. government's take with the government takes of other 
resource owners throughout the world, by reviewing new studies on the 
subject and adding and updating other information. Specifically, this 
report (1) evaluates the government take and the attractiveness for 
investors in the federal oil and gas fiscal system for the Gulf of 
Mexico and the United States in general, (2) evaluates how the absence 
of flexibility in this system has led to large foregone revenues from 
oil and gas production on federal lands and waters as oil and gas 
prices have risen, and (3) assesses what Interior has done to monitor 
the performance and appropriateness of the federal oil and gas fiscal 
system in light of changing market conditions. 

To evaluate the attractiveness of the United States for oil and gas 
investment, we reviewed the results of a study we procured from Wood 
Mackenzie, a leading industry consultant. In using this study, we 
reviewed the methodology and controls used by Wood Mackenzie to ensure 
the accuracy of the data used and the study results. We found the study 
results and the data that accompanied the study to be sufficiently 
reliable to meet the objectives of this report.[Footnote 4] We also 
evaluated the results of various studies conducted by other industry 
experts and by MMS, the agency responsible for collecting oil and gas 
royalties from federal lands and waters. To evaluate the study results, 
we interviewed study authors and other industry experts to determine 
the studies' methodologies and the appropriate interpretation of the 
results. Based on these interviews and our review of the results of the 
studies, we believe the general approaches taken by the authors of the 
studies was reasonable and that results of the studies are credible. 
However, with the exception of the Wood Mackenzie study, we did not 
fully evaluate each study's methodology or the underlying data used to 
make the government take estimates. We also purchased and evaluated 
data from a leading financial firm and evaluated data and information 
published by the Department of Energy's Energy Information 
Administration (EIA), the American Petroleum Institute, and other 
sources. We assessed these data for reliability and deemed them 
reliable for the purposes of this report. We reviewed academic and 
government studies that investigated the costs and benefits of various 
oil and gas fiscal systems, and we interviewed and gathered information 
from officials from MMS, other governments, and the oil and gas 
industry. To evaluate how the absence of flexibility in the federal oil 
and gas fiscal system has led to large foregone revenues from oil and 
gas production on federal lands and waters as oil and gas prices have 
risen, we relied on past work evaluating changes in federal oil and gas 
fiscal terms in the deep water regions of the U.S. Gulf of Mexico. We 
also evaluated Interior analyses that accompanied recent increases in 
royalty rates in the U.S. Gulf of Mexico. In addition, we reviewed the 
Wood Mackenzie study and accompanying data. We also interviewed company 
officials and industry experts to obtain information on their 
preferences regarding oil and gas fiscal system characteristics. To 
assess what Interior has done to monitor the performance and 
appropriateness of the federal oil and gas fiscal system in light of 
changing market conditions, we evaluated the extent to which Interior 
had collected the types of information and done the analysis needed to 
determine whether or not the oil and gas fiscal system should be 
changed in light of the recent changes in oil and gas market 
conditions. To do this, we reviewed Interior studies, policies, and 
guidance and interviewed officials from MMS; interviewed and collected 
views from oil and gas companies and industry groups; and evaluated 
analyses of oil and gas fiscal systems. We neither assessed Interior's 
overall management of the federal system, both on and offshore, nor did 
we attempt to evaluate the costs and benefits of any of Interior's 
specific changes to the system over time. We conducted this performance 
audit from May 2007 to September 2008 in accordance with generally 
accepted government auditing standards. Those standards require that we 
plan and perform the audit to obtain sufficient, appropriate evidence 
to provide a reasonable basis for our findings and conclusions based on 
our audit objectives. We believe that the evidence obtained provides a 
reasonable basis for our findings and conclusions based on our audit 
objectives. 

Results in Brief: 

In addition to having a low government take, the U.S. Gulf of Mexico 
and other U.S. regions are attractive targets for investment because 
they have large remaining oil and gas reserves and the United States is 
generally a good place to do business compared to many other countries 
with comparable oil and gas resources. Multiple studies completed as 
early as 1994 and as recently as June 2007 indicate that the U.S. 
government take in the Gulf of Mexico is lower than that of most other 
oil and gas fiscal systems. For example, data we evaluated from a June 
2007 Wood Mackenzie report indicate that the government take in the 
deep water U.S. Gulf of Mexico ranked as 93rd lowest of 104 oil and gas 
fiscal systems evaluated. More broadly, other measures indicate that 
the United States as a whole is an attractive target for oil and gas 
investment. First, the deep water U.S. Gulf of Mexico and other U.S. 
oil and gas regions rank high in terms of remaining oil and gas 
reserves among countries that allow private oil and gas companies to 
operate on their lands and waters. Second, since 2002 as oil prices 
have risen and gas prices have remained high by historical standards, 
the number of oil and gas drilling rigs operating in U.S. lands and 
waters has increased much faster than in the rest of the world. 
Specifically, the number of rigs in use globally outside the United 
States increased by about 18 percent from an annual average of 998 in 
2002 to 1,180 through the first 4 months of 2008, while the number of 
rigs operating in the United States increased by about 113 percent, 
from an annual average of 831 in 2002 to 1,829 rigs in April 2008. 
Finally, the United States ranks high among almost all other 
governments in terms of its general attractiveness for doing business. 
For example, the World Bank ranked the United States as the third most 
favorable place to conduct business of 178 countries analyzed in a 2007 
study. 

The lack of price flexibility in royalty rates and the inability to 
change fiscal terms for existing leases have put pressure on Interior 
and the Congress to change royalty rates on future leases in an ad hoc 
basis with consequences that could amount to billions of dollars of 
foregone revenue. For example, 1995 legislation granted royalty relief 
on certain leases issued in the deep water areas of the U.S. Gulf of 
Mexico between 1996 and 2000--a period when oil and gas prices and 
industry profits were much lower than they are today--could cost the 
federal government between $21 billion and $53 billion, depending on 
the outcome of ongoing litigation concerning the authority of Interior 
to place price thresholds that would remove the royalty relief offered 
on certain leases. A royalty relief provision also was included in the 
Energy Policy Act of 2005 on leases issued during the 5-year period 
beginning on the date of enactment of this act. Further, two royalty 
rate increases affecting future U.S. Gulf of Mexico leases were 
announced by Interior in 2007. These royalty rate increases are 
expected to generate modest increases in federal revenues from future 
leases offered in the U.S. Gulf of Mexico. However, in choosing to 
increase royalty rates Interior did not evaluate the entire oil and gas 
fiscal system to determine whether or not these increases strike the 
proper balance between the attractiveness of federal leases for 
investment and appropriate returns to the federal government for oil 
and gas resources. As a result, and because the new royalty rates are 
not flexible with respect to oil and gas prices, Interior and the 
Congress may again be under pressure from industry or the public to 
further change royalty rates if and when oil and gas prices either fall 
or continue rising. Finally, these royalty changes only affect U.S. 
Gulf of Mexico leases and do not address onshore leases at all, which 
should also be considered in light of the increases in oil and gas 
prices. Wood Mackenzie reports that the deep water U.S. Gulf of Mexico 
ranked in the bottom half of oil and gas fiscal systems in terms of 
stability based on recent changes to fiscal terms and on the relative 
lack of built-in flexibility that would allow the fiscal terms to 
adjust to market conditions. Oil and gas companies we communicated with 
stated a clear preference for stable fiscal terms, other things being 
equal. In general, while companies prefer lower government take, it is 
reasonable to expect that these companies would be willing to pay a 
higher share of revenues in return for greater assurance that the 
fiscal terms will not induce balancing changes when market conditions 
change, such as the windfall profits charges that a number of countries 
have recently imposed. 

Interior does not routinely evaluate the federal oil and gas fiscal 
system as a whole, monitor what other governments or resource owners 
worldwide are receiving for their energy resources, or evaluate and 
compare the attractiveness of the United States for oil and gas 
investment with that of other oil and gas regions. As a result, 
Interior cannot assess whether or not there is a proper balance between 
the attractiveness of federal lands and waters for oil and gas 
investment and a reasonable assurance that the public is getting an 
appropriate share of revenues from this investment. Specifically, 
Interior does not have procedures in place for routinely evaluating the 
ranking of (1) the federal oil and gas fiscal system or (2) industry 
rates of return on federal leases against other resource owners. 
Further, Interior does not have the authority to alter the tax 
components of the oil and gas fiscal system. All these factors should 
inform any decisions about whether or how to alter the federal oil and 
gas fiscal system in response to changing market conditions. While 
Interior has made many specific changes to components of the oil and 
gas fiscal system over the years to adjust to changing market 
conditions, these changes were generally not done as part of a 
comprehensive review of the system that took into account the relative 
ranking of the U.S. government take or other comparisons with other 
countries or regions. In fact, the last time Interior conducted a 
comprehensive evaluation of the federal oil and gas fiscal system was 
over 25 years ago. Finally, the lack of a comprehensive re-evaluation 
of the federal oil and gas fiscal system stands in contrast to the 
actions of many other governments that have recently re-evaluated or 
are currently re-evaluating their systems in light of rising oil and 
gas prices and higher industry profits and rates of return. 

Recent large increases in oil and gas prices and industry profits raise 
obvious questions about whether the public share of oil and gas 
revenues is appropriate. The fact that the recent studies show that the 
government take in the deep water U.S. Gulf of Mexico is relatively low 
and U.S. federal oil and gas regions are attractive places to invest 
also indicates that the federal oil and gas fiscal system may not 
strike a proper balance between maintaining competitive investment 
conditions and providing an appropriate share of revenues to the public 
from oil and gas sold on public lands and waters. Finally, because 
Interior has not comprehensively re-evaluated the federal oil and gas 
fiscal systems for over 25 years, such a comprehensive evaluation of 
the systems, both on-and offshore, is overdue. Comparing oil and gas 
fiscal systems and attractiveness for investment is inherently complex 
and Interior has not collected information needed to perform such a 
comprehensive review. In the draft report we sent to Interior for 
comment, we made recommendations to address these issues. In its 
response, Interior stated that it did not fully concur with our 
recommendations because it had already contracted for a study that will 
address many of the issues we raise. However, because Interior's 
ongoing study is limited in scope and is limited to a specific region 
in the Gulf of Mexico, rather than a review of the entire federal oil 
and gas fiscal system as we recommended, we do not find the agency's 
stated rationale for not agreeing fully with our recommendations to be 
convincing. Therefore, we believe that Congress may wish to consider 
directing the Secretary of the Interior to to convene an independent 
panel to perform a comprehensive review of the federal oil and gas 
fiscal system. Further, in order to keep abreast of potentially 
changing market conditions going forward, the Congress may wish to 
consider directing the Secretary of the Interior to direct the Minerals 
Management Service and other relevant agencies within Interior to 
establish procedures for periodically collecting data and information 
and conducting analyses to determine how the federal government take 
and the attractiveness for oil and gas investors in each federal oil 
and gas region compare to those of other resource owners and report 
this information to the Congress. 

Background: 

Interior, created by the Congress in 1849, oversees and manages the 
nation's publicly owned natural resources, including parks, wildlife 
habitats, and minerals, including crude oil and natural gas resources, 
on over 260 million surface acres and 700 million subsurface acres 
onshore and in the waters of the Outer Continental Shelf. In this 
capacity, Interior is authorized to lease federal oil and gas resources 
and to collect the royalties associated with their production, 
Interior's Bureau of Land Management (BLM) is responsible for leasing 
federal oil and natural gas resources on land, whereas offshore-- 
including the U.S. Gulf of Mexico--Minerals Management Service (MMS) 
has the leasing authority. To lease U.S. Gulf of Mexico waters for oil 
and gas exploration, companies generally must first pay the federal 
government a sum of money that is determined through a competitive 
auction and evaluated by Interior against departmental economic and 
geologic models. This money is called a bonus bid. Companies are 
required to submit one-fifth of any bid for a lease tract up front at 
time of bid, and pay the remaining four-fifths balance of their bonus 
payment and their first year rental payment after acquiring a lease. 
After the lease is awarded and production begins, the companies must 
also pay royalties to MMS based on a percentage of the cash value of 
the oil and gas produced and sold or "in kind," as a percentage of the 
actual oil or gas produced. Royalty rates for onshore leases are 
generally 12.5 percent. Royalty rates for leases in the U.S. Gulf of 
Mexico, prior to 2007, ranged from 12.5 percent for water depths of 400 
meters or deeper (referred to as deepwater) to 16-2/3 percent for water 
depths less than 400 meters (referred to as shallow). In 2007, the 
Secretary of Interior twice increased the royalty rate for future U.S. 
Gulf of Mexico leases--in January, the rate for deep water leases was 
raised to 16-2/3 percent and in October, the rate for all future 
leases, included those issued in 2008, was raised to 18-3/4 percent. 

A considerable body of legislation has been enacted pertaining to the 
management of resources on federal and Indian trust lands and within 
federal waters. This legislation includes the Mining Law of 1872, 
Mineral Lands Leasing Act of 1920, 1947 Mineral Leasing Act for 
Acquired Lands, Outer Continental Shelf Lands Act of 1953, Federal Land 
Policy and Management Act of 1976, the Outer Continental Shelf Lands 
Act Amendments of 1978, Federal Oil and Gas Royalty Management Act of 
1982, as well as the Federal Onshore Oil and Gas Leasing Reform Act of 
1987, the Outer Continental Shelf Deep Water Royalty Relief Act of 
1995, and the Energy Policy Act of 2005. The Outer Continental Shelf 
Lands Act, as amended (OCSLA) is, among other things, intended to 
ensure the public "a fair and equitable return" on the resources of the 
shelf. The law directs the Secretary of Interior to conduct leasing 
activities to assure receipt of fair market value for the lands leased 
and the rights conveyed by the federal government. In addition, the 
Federal Land Policy and Management Act indicated that, unless otherwise 
provided by statute, it is the policy of the United States to receive 
"fair market value" for the use of the public lands and their 
resources. In 1982, Interior's MMS convened a task force to review its 
fair market value procedures. Upon completion of the task force's work, 
the Secretary of Interior informed the Congress by letter in March 1983 
that the Department had completed its analysis and validation of the 
process by which it will assure a fair return to the American people. 
The Secretary indicated in that letter that the process in place will 
assure the American people a full and fair return as it pertains to 
bonuses, rentals, royalties, and taxes. The 1983 Interior task force 
report also provided some clarity regarding a fair return, or fair 
market value. The report indicated that the market value of a lease is 
not the market value of the oil and gas eventually discovered or 
produced. Instead, it is the value of the right to explore and, if 
there is a discovery, develop and produce the energy resource. 

Currently Interior has the legal authority to change most aspects of 
the oil and gas fiscal system. Specifically, Interior is allowed by 
statute to change bid terms for offshore leases including the royalty 
rate, the bonus bid structure, rental terms, and even the minimum 12.5 
percent royalty rate, so long as there is only one variable or 
"flexible" term--such as a royalty rate that adjusts upwards or 
downwards with oil and gas prices--in the resulting system, and so long 
as Congress does not pass a resolution of disapproval within 30 days of 
Interior's changes to the system.[Footnote 5] With regard to onshore 
leases, Interior is generally allowed by statute to change bid terms 
including the royalty rate, the bonus bid structure, rental terms, and 
the minimum royalty rate so long as the bid structure meets certain bid 
terms,[Footnote 6] but with certain additional limits on flexibility 
than the offshore leases. Over the past 25 years, Interior has 
implemented several programs that adjusted royalty rates or other 
system components. Such programs included the net profit share leases, 
which were for offshore leases that based royalties on a percentage of 
net profits derived from production; sliding scale royalty rates, which 
was an onshore royalty rate system based on changing production levels; 
and royalty rate reduction for stripper wells and lower-grade, more 
viscous crude oil, where onshore oil wells producing less than 15 
barrels of oil per day were eligible for royalty rate reductions. 
Interior officials told us they also "experimented" with a variety of 
flexible royalty rate and profit sharing systems in the early 1980s, 
but found them difficult to administer and validate the amount of 
payments due to MMS, which in Interior's estimation more than offset 
any enhanced flexibility associated with a variable royalty rate. 

The Gulf of Mexico Has a Relatively Low U.S. Government Take and the 
United States Is an Attractive Place to Invest in Oil and Gas 
Development: 

Multiple studies completed as early as 1994 and as recently as June 
2007 all indicate that the U.S. government take in the Gulf of Mexico 
is lower than most other oil and gas fiscal systems. Four recent 
studies by private consultants or resource owners indicate that the 
U.S. government take in the Gulf of Mexico is relatively low. For 
example, data we evaluated from a June 2007 report by Wood Mackenzie 
reported that the government take in the deep water U.S. Gulf of Mexico 
ranked as the 93rd lowest out of 104 oil and gas fiscal systems 
evaluated in the study. Other U.S. oil and gas regions are also listed 
in the Wood Mackenzie study and some but not all other studies. 
However, these regions are not uniquely under federal jurisdiction, so 
a direct comparison of the government take in these other regions 
cannot be used to isolate the federal oil and gas fiscal system. The 
results of the four studies are summarized below in table 1. 

Table 1: Summary of Four 2007 Studies Comparing Government Take 
Percentages: 

Study: Our Fair Share: Report of the Alberta Royalty Review Panel, 
Sept. 18, 2007 (analysis done by the Alberta Department of Energy); 
Rank (from highest to lowest) of Gulf of Mexico U.S. government take 
among oil and gas fiscal systems reviewed in each study: 16/19; 
Government take percentages: Highest: 77.00; 
Government take percentages: Lowest: 39.00; 
Government take percentages: Gulf of Mexico: 47.50. 

Study: Cambridge Energy Research Associates: 2002 vs. 2007; 
Rank (from highest to lowest) of Gulf of Mexico U.S. government take 
among oil and gas fiscal systems reviewed in each study: 17/17; 
Government take percentages: Highest: 95.00; 
Government take percentages: Lowest: 49.00; 
Government take percentages: Gulf of Mexico: 49.00. 

Study: Van Meurs Corporation: Comparative Analysis of Fiscal Terms for 
Alberta Oil Sands and International Heavy and Conventional Oils, May 
17, 2007; 
Rank (from highest to lowest) of Gulf of Mexico U.S. government take 
among oil and gas fiscal systems reviewed in each study: 25/28; 
Government take percentages: Highest: 92.00; 
Government take percentages: Lowest: 25.00; 
Government take percentages: Gulf of Mexico: 47.00. 

Study: Wood Mackenzie: Government Take: Comparing the Attractiveness 
and Stability of Global Fiscal Systems, Wood Mackenzie, June 2007; 
Rank (from highest to lowest) of Gulf of Mexico U.S. government take 
among oil and gas fiscal systems reviewed in each study: 93/104; 
Government take percentages: Highest: 98.04; 
Government take percentages: Lowest: 18.05; 
Government take percentages: Gulf of Mexico: 44.09. 

Source: GAO analysis of four calendar year 2007 government take 
studies. 

[End of table] 

As we reported in May 2007, the results of five other studies completed 
between 1994 and 2006 had similar findings. The information reported by 
Wood Mackenzie and other such expert studies are used by resource 
owners and oil and gas companies alike to aid in making investment or 
policy decisions and these studies represent the best data on 
government take available. However, we recognize there are limitations 
with the government take studies and the relative ranking of government 
take alone is not sufficient to determine whether the federal 
government is receiving its fair share of oil and gas revenues. A 
number of other factors that are not part of the government take 
determine company decisions of where and how much to invest and how 
much to pay for access to oil and gas resources. These factors include 
the relative size of oil and gas resource bases in different regions 
and the relative costs of developing these resources. Thus government 
take is a major, but not sole factor in determining the attractiveness 
of a fiscal system for oil and gas development. 

When other factors are taken into consideration, the U.S. Gulf of 
Mexico is an attractive target for investment because it has large 
remaining oil and gas reserves and the United States is generally a 
good place to do business compared to many other countries with 
comparable oil and gas resources. For example, once reserves that are 
entirely owned by governments are removed from the analysis, of the 104 
remaining fiscal regimes ranked by Wood Mackenzie that allow some 
participation by international oil companies and that have remaining 
oil and gas reserves, the deep water U.S. Gulf of Mexico ranked 18th 
highest in terms of remaining oil and gas reserves. Three other U.S. 
regions were ranked in the top 18 in terms of reserves. These were the 
U.S. Rocky Mountains (8th), Alaska (14th), and U.S. Gulf Coast (15th), 
but these regions are not uniquely covered by the federal fiscal 
regimes, as state and private resource owners may also exist. 

Wood Mackenzie also ranked oil and gas fiscal regimes in terms of their 
attractiveness for investment. Wood Mackenzie's measure of oil and gas 
fiscal attractiveness took into account both reward associated with 
factors such as resource size; and risk, including the extent to which 
government take includes bonuses. With respect to reward, Wood 
Mackenzie compared the levels of government take with the size of oil 
and gas fields governed by the various oil and gas fiscal systems. The 
risk ranking reflected whether or not the system included bonus 
payments, which increase the risk to investors because they must be 
paid whether or not economic volumes of oil and gas are eventually 
found on an oil and gas tract.[Footnote 7] Risk also included a measure 
of the extent to which and the way in which the resource owner held an 
equity share in the resources being developed. The impact of the fiscal 
terms on the rewards and risks associated with a wide range of 
hypothetical new investments were assessed under the terms of each of 
the 103 oil and gas fiscal systems included in this section of the 
study. Based on these assessments, Wood Mackenzie ranked the deep water 
U.S. Gulf of Mexico fiscal system as more attractive for investment 
than 60 (about 58 percent) of the 103 fiscal systems ranked. 

More broadly, other measures indicate that the United States is an 
attractive place to invest in oil and gas production. For example, 
since 2002 as oil prices have risen and gas prices have remained high 
by historical standards, the number of oil and gas drilling rigs 
operating in the United States has increased much faster than in the 
rest of the world, which indicates companies in recent years have 
continued to find the United States a conducive place to invest in oil 
and gas production. Specifically, according to data on crude oil rig 
counts from Baker Hughes, the number of rigs in use globally excluding 
the United States increased by about 18 percent from an annual average 
in 2002 of 998 to 1,180 through the first 4 months of 2008, while the 
number of rigs operating in the United States increased about 113 
percent, from 831 rigs in 2002 to 1,768 rigs in 2007 and 1,829 rigs in 
April 2008. These increases coincided with the increase in oil and gas 
prices over the same period and indicate that the United States has 
remained an attractive place to invest in oil and gas as prices have 
risen. 

While rig counts can reasonably be associated with the attractiveness 
of a region for development and production, they do not tell the whole 
story. For example, according to Baker Hughes, the Gulf of Mexico rig 
count fluctuated over the longer term and has decreased in recent 
years. Specifically, from 1973 to 1981, rig counts in the Gulf of 
Mexico increased, from 80 to 231, before generally decreasing to 45 in 
1992. They then generally rose again until 2001. From 2001 to April 
2008, the annual rig count in the Gulf of Mexico decreased from 148 to 
58. This decline has occurred despite the Gulf of Mexico being 
generally considered an attractive target for investment, both from the 
perspective of the government take and because of the potential for 
significant oil and gas resources. 

Other analyses report the oil and gas industry appears to have 
performed favorably in recent years compared with other industries. 

* The Energy Information Administration reported in December 2007 that 
from 2000 through 2006, the return on equity, which compares a 
company's profit with the value of the shares held by the company's 
owners, for the major energy producers, referred to as Financial 
Reporting System (FRS) companies, averaged 7 percentage points higher 
than that of the U.S. Census Bureau's "All Manufacturing Companies." 
[Footnote 8] According to the report, this reversed a trend where the 
return on equity for the major energy producers averaged 2 percentage 
points lower than All Manufacturing Companies from 1985 to 1999. 

* The American Petroleum Institute, in a 2007 study, showed that from 
2000 to 2005, the average return on investment for oil and gas 
production was about 61 percent higher than for the Standard & Poor's 
(S&P) industries.[Footnote 9] However, the average return on investment 
for the industry has matched or exceeded the returns for the S&P 
industrials only in recent years; over the 25-year period from 1980 to 
2005, the average return on investment for oil and gas production was 
about 18 percent lower than for the S&P industries. 

* A GAO analysis found that the "upstream," or exploration and 
production segments, of the domestic oil and gas production companies 
also received higher rates of return than companies operating in other 
U.S. manufacturing industries from 2002 through 2006. We analyzed 
financial data from S&P's Compustat and EIA's FRS. From 2002 through 
2006, the upstream segments of the domestic oil and gas production 
companies have averaged a 17.4 percent return on investment,[Footnote 
10] compared with 15.2 percent for all other manufacturing companies. 
[Footnote 11] When both upstream and "downstream" the refining and 
marketing segments are included in the analysis, the oil and gas 
industry return on investment averaged over 20 percent during this 
period. This short term picture, however, contrasts with a longer-term 
analysis, which shows the oil and gas industry receiving a return on 
investment that is comparable, or slightly lower, than that received by 
other manufacturing industries over the past 30 years. Our analysis 
found that during this period, upstream oil and gas production has 
averaged 11.2 percent return on investment with the entire oil and gas 
industry receiving an average 13.7 percent return on investment. All 
other manufacturing companies have averaged 12.3 percent return on 
investment during this period. This recent improvement in financial 
performance from 2000 through 2006 coincided with rising oil and gas 
prices. Further, since 2006, oil and gas prices have risen even higher, 
while EIA's most recent projections to 2030 are for oil and gas prices 
to remain much higher than they were for most of the period 1985 
through 1999. 

In addition, the United States is also generally ranked favorably as a 
place to conduct business by the World Bank and by business media 
sources, including The Economist, and AM Best. For example, the World 
Bank ranked the United States as the third most favorable place to 
conduct business of 178 countries analyzed in a 2007 study.[Footnote 
12] The Economist in October 2007 ranked the United States as the ninth 
highest of 82 countries analyzed for projected favorability of business 
environment from 2008 to 2012. Finally, as of February 2008, the United 
States remained in the top tier--of five possible tiers--on AM Best's 
countries for business risk index, meaning the United States generally 
posed the least risk for investors of the five possible levels 
assigned. 

The Inflexibility of Royalty Rates to Changing Oil and Gas Prices Has 
Cost the Federal Government Billions of Dollars in Foregone Revenues: 

The lack of price flexibility in royalty rates and the inability to 
change fiscal terms for existing leases have put pressure on Interior 
and the Congress to change royalty rates in the past on future leases 
on an ad hoc basis. For example, in 1980, a time when oil prices were 
comparable in inflation-adjusted terms to today's prices, Congress 
passed a windfall profit tax, which amounted to an excise tax per 
barrel of oil produced in the United States. Congress repealed that tax 
in 1988 at time when oil prices had fallen significantly from their 
1980 level. The tax attempted to recoup for the federal government much 
of the revenue that would have otherwise gone to the oil industry as a 
result of the decontrol of oil prices. 

Further, in 1995--a period with relatively low oil and gas prices--the 
federal government enacted the Outer Continental Shelf Deep Water 
Royalty Relief Act (DWRRA). In implementing the DWRRA for leases sold 
in 1996, 1997, and 2000, MMS specified that royalty relief would be 
applicable only if oil and gas prices were below certain levels, known 
as "price thresholds," with the intention of protecting the 
government's royalty interests if oil and gas prices increased 
significantly. MMS did not include these same price thresholds for 
leases it issued in 1998 and 1999. In addition, the Kerr-McGee 
Corporation--which was active in the Gulf of Mexico and is now owned by 
Anadarko Petroleum Corporation--filed suit challenging Interior's 
authority to include price thresholds in DWRRA leases issued from 1996 
through 2000. Recently, the U.S. District Court for the Western 
District of Louisiana granted summary judgment in favor of Kerr-McGee 
concerning the application of price thresholds to those leases and this 
ruling is currently under appeal.[Footnote 13] In our June 2008 report 
on the potential foregone revenues at stake in the Kerr-McGee 
litigation, we found that the value of future forgone royalties is 
highly dependent upon oil and gas prices, and on production levels. 
[Footnote 14] Assuming that the District Court's ruling is upheld, 
future foregone royalties from all the DWRRA leases issued from 1996 
through 2000 could range widely--from a low of about $21 billion to a 
high of $53 billion,[Footnote 15] depending on the outcome of ongoing 
litigation concerning the authority of Interior to place price 
thresholds that would remove the royalty relief offered on certain 
leases. The $21 billion figure assumes relatively low production levels 
and oil and gas prices that average $70 per barrel and $6.50 per 
thousand cubic feet over the lives of the leases. The $53 billion 
figure assumes relatively high production levels and oil and gas prices 
that average $100 per barrel and $8 per thousand cubic feet over the 
lives of the leases. A royalty relief provision was also included in 
the Energy Policy Act of 2005 on leases issued during the 5-year period 
beginning on August 8, 2005. 

In 2007, the Secretary of the Interior twice increased the royalty rate 
for future Gulf of Mexico leases--in January, the rate for deep water 
leases was raised to 16-2/3 percent and in October, the rate for all 
future leases in the Gulf, including those issued in 2008, was raised 
to 18-3/4 percent. Interior estimated these actions will increase 
federal oil and gas revenues by $8.8 billion over the next 30 years. 
The January 2007 increase applied only to deep water Gulf of Mexico 
leases; the October 2007 increase applied to all water depths in the 
Gulf of Mexico. These royalty rate increases appear to be a response by 
Interior to the high prices of oil and gas that have led to record 
industry profits and raised questions about whether the existing 
federal oil and gas fiscal system gives the public an appropriate share 
of revenues from oil and gas produced on federal lands and waters. 
However, the royalty rate increases do not address these record 
industry profits from existing leases at all and high profits will 
likely remain as long as the existing leases produce oil and gas or 
until oil and gas prices fall. In addition, in choosing to increase 
royalty rates, Interior did not evaluate the entire oil and gas fiscal 
system to determine whether or not these increases were sufficient to 
balance investment attractiveness and appropriate returns to the 
federal government for oil and gas resources. On the other hand, 
according to Interior, it did consider factors such as industry costs 
for outer continental shelf exploration and development, tax rates, 
rental rates, and expected bonus bids. Further, because the new royalty 
rates are not flexible with respect to oil and gas prices, Interior and 
the Congress may again be under pressure from industry or the public to 
further change the royalty rates if and when oil and gas prices either 
fall or continue rising. Finally, these royalty changes only affect 
Gulf of Mexico leases and do not address onshore leases at all, which 
should also be considered in light of the increases in oil and gas 
prices. 

In addition, Wood Mackenzie reports that the deep water U.S. Gulf of 
Mexico ranked in the bottom half of countries in terms of oil and gas 
fiscal system stability based on repeated changes to fiscal terms for 
future leases and on the relative lack of built-in flexibility that 
would allow the fiscal terms to adjust to market conditions. 
Specifically, the Wood Mackenzie study ranked the deep water U.S. Gulf 
of Mexico fiscal terms as lower than 71 (about 72 percent) of the 103 
oil and gas fiscal systems. In contrast, among the key trends among 
governments in recent years has been to make fiscal terms more 
responsive to market conditions. By adding such progressive features to 
oil and gas fiscal systems including royalty rates that increase with 
oil and gas prices, these other entities are making their systems more 
stable over time by reducing incentives for industry or the public to 
push for ad hoc changes in fiscal terms as future prices change. Wood 
Mackenzie's measure of fiscal stability combines two criteria: recent 
history of changes to fiscal terms and built-in flexibility. As 
discussed previously in this report, changes to royalty rates occurred 
in the Gulf of Mexico three times since 1995, with the royalty relief 
in the mid 1990s and the two increases in royalty rates in 2007. 
However, as noted above, the study was conducted before the second 2007 
increase in royalty rates, so the government take would likely have 
increased but the U.S. stability rating could have fallen in the 
intervening period. Built-in flexibility reflects the relative degree 
to which a fiscal system is regressive or progressive, with more 
progressive systems being more flexible. A flexible system does not 
mean changing the fiscal terms of existing contracts but having a 
system in place that automatically adjusts to changing economic and 
market conditions. 

Oil and gas companies we communicated with stated a clear preference 
for stable fiscal terms, other things being equal. Overall, oil and gas 
companies may be more willing to invest in flexible systems, given that 
they tend to be inherently more stable and therefore are less likely to 
be arbitrarily changed on a recurring basis. Oil and gas companies and 
industry trade associations we contacted provided us a range of views 
on the advantages and disadvantages of various oil and gas fiscal 
systems, and generally indicated that one of the most important 
features of any system is its stability and predictability. Stability 
of fiscal terms is important because oil and gas companies are making 
very long-term investments and uncertainty about whether or not the 
resource owner will change the fiscal terms during the lifetime of the 
investment adds to the investment risk. The respondents also said that 
the terms of the oil and gas fiscal system should consider industry 
exploration and development costs, the likelihood of discovery, and 
political and economic risks. While companies surely prefer lower 
government take, all else constant, to the extent that stability is 
also preferred, a more stable system may be able to remain competitive 
for investment while resulting in a higher government take than a less 
stable system. In particular, companies may be willing to pay a larger 
average share of oil and gas revenues if they believe that oil and gas 
fiscal systems will not change when market conditions change, such as 
the windfall profits charges that a number of countries have recently 
imposed. Such willingness to accept lower expected profits in exchange 
for lower risk is a common feature of investment markets. 

In addition to the potential trade-off between oil and gas fiscal 
system stability and government take, companies may be willing to pay 
higher average shares of revenues if governments bear some of the risk 
that companies take on when they purchase the rights to explore for oil 
and gas. For example, in the United States as well as for a number of 
other governments, leases are awarded through a bidding process that 
requires companies to pay bonus bids for the rights to explore and 
develop leases. With regard to bonus bids, there are advantages to 
requiring such bids. First, when companies have to compete with one 
another to win a lease, the lease is more likely to be awarded to a 
company with the expertise and resources to properly explore and 
develop the resources on the lease than if leases are awarded using 
some other rationing mechanism that does not take into account how much 
companies are willing to pay for the lease. In addition, it guarantees 
the public some revenue early on in the exploration and development 
process, which can take a number of years to complete. However, the use 
of bonus bids pushes a great deal of risk onto oil and gas companies 
and requires them to estimate many uncertain factors, including the 
amounts of oil and gas that will ultimately be produced on the lease, 
the costs of that production, and the prices of gas and oil over the 
entire working life of the lease. In general, by increasing the risk 
that companies bear, these companies will have to expect to receive a 
higher rate of return to be willing to take on the project. In fiscal 
systems requiring bonus bids or other up-front payments, the companies 
bear the risk that leases will not generate economically significant 
oil and gas production. In fact, in the United States, a large 
proportion of leases that companies have paid for do not generate 
economic levels of production and the companies, after purchasing the 
lease, and paying rent for the duration of the initial term of the 
lease and whatever resources they spent on exploring for oil and gas, 
simply let the lease revert back to the government when the initial 
term expires. 

Some oil and gas fiscal systems mitigate the risk associated with up- 
front company expenditures by allowing the companies to recover 
exploration and development costs prior to starting higher royalty 
payments. For example, Alberta, Canada, has used such fiscal terms. 
Other fiscal systems share risk with companies by more strongly linking 
government take to company profits. In such oil and gas fiscal systems, 
government take is low in early years of a lease, when exploration and 
early development are being undertaken, but increases if production 
increases or if oil and gas prices increase once production begins. The 
state of Alaska has recently changed its fiscal terms to increase its 
government take and to increase the linkage between government take and 
company profits. Both Alberta and the state of Alaska have higher 
government takes than the U.S. Gulf of Mexico according to the Wood 
Mackenzie study. 

Interior Does Not Have a System in Place to Evaluate Whether the 
Federal Fiscal System Is in Need of Reassessment: 

Interior does not routinely evaluate the federal oil and gas fiscal 
system as a whole, monitor what other resource owners worldwide are 
receiving for their energy resources, or evaluate and compare the 
attractiveness of the United States for oil and gas investment with 
that of other oil and gas regions. As a result, Interior cannot assess 
whether or not there is a proper balance between the attractiveness of 
federal lands and waters for oil and gas investment and a reasonable 
assurance that the public is getting an appropriate share of revenues 
from this investment. This is true of the U.S. Gulf of Mexico as well 
as other federal oil and gas producing regions. Interior does not have 
procedures in place for routinely evaluating the ranking of (1) the 
federal oil and gas fiscal system against other resource owners or (2) 
industry rates of return on federal leases compared to other U.S. 
industries which could factor into any decisions about whether or how 
to alter the fiscal systems in response to changing market conditions. 
Interior officials told us that they have a "bid adequacy review 
process" for offshore leases that determines whether the bonus bid 
meets criteria designed to ensure fair market value of the leased tract 
but that onshore leases do not have a similar bid adequacy provision. 
Moreover, Interior maintains it has been responsive to changes in 
market conditions through revisions to lease terms, including changes 
in minimum bonus bid levels, fluctuating royalty rates, and price 
thresholds. However, as we have discussed previously in this report, 
bonus bids have both positive and negative sides with respect to their 
likely impact on overall government take. Further, frequent adjustments 
to fiscal terms are not looked on favorably by industry, especially 
when they involve increases in royalty rates or other charges. Interior 
indicated, in commenting on the report draft, that it is in the process 
of evaluating other fiscal approaches such as sliding scale royalties 
for some oil and gas leases. 

We did not evaluate the effectiveness of the bid adequacy review 
process in terms of its intended goal of ensuring bonus bids on 
offshore federal leases are competitive. However, even assuming that 
these bids are competitive, we do not think that this is sufficient to 
ensure that the other elements of the system are appropriately 
balancing the interests of taxpayers and oil and gas companies. In 
light of the complexity of oil and gas fiscal systems, the great deal 
of uncertainty surrounding the volumes and future prices of oil and 
gas, and the costs of producing it, oil and gas companies cannot be 
expected to accurately forecast all the factors that will ultimately 
determine the value of a lease at the time that lease is sold. As a 
result, oil and gas company profits have tended to rise and fall over 
time with oil and gas prices, putting pressure on Interior to alter 
fiscal terms in a reactive rather than a strategic way. Further, the 
fact that Interior does not apply the same or a similar bid adequacy 
process for onshore leases raises questions about how Interior, 
overall, is providing reasonable assurance that even the bonus bids it 
receives are competitively determined in all publicly owned oil and gas 
producing regions. 

While Interior has made many specific changes to components of the 
federal oil and gas fiscal system over the years to adjust to changing 
market conditions, these changes were generally not done as part of a 
comprehensive review of the fiscal system that took into account the 
relative ranking of the U.S. government take or other comparisons with 
other countries or regions. The last time Interior conducted a 
comprehensive evaluation of the oil and gas fiscal system was over 25 
years ago. The lack of a recent comprehensive re-evaluation of the U.S. 
federal fiscal system stands in contrast to the actions of many other 
governments that have recently reevaluated or are currently re- 
evaluating their fiscal systems in light of rising oil and gas prices 
and higher industry profits and rates of return. For example, as 
previously discussed in this report, a number of countries have 
recently imposed windfall profits taxes or other mechanisms to increase 
the resource owners' shares of oil and gas revenues from existing 
projects. Wood Mackenzie estimates that these changes will ultimately 
result in these countries' collecting additional oil and gas revenues 
of between $118 billion and $400 billion, depending on future oil and 
gas prices. 

In evaluating an oil and gas fiscal system, all components of the 
system, including bonus bids, land rental rates, royalties, and oil and 
gas company taxes, must be considered. However, while Interior has a 
great deal of expertise and data from years of administering and 
collecting revenues from oil and gas leases on federal lands and waters 
that would be essential for any review of the federal oil and gas 
fiscal system, they do not have the authority to change taxes and, 
therefore, cannot fully revise the system without legislative action by 
the Congress. Further, it is essential to keep federal leases 
competitive with other potential investments governed by different 
fiscal systems. Therefore, in addition to input from Interior, oil and 
gas industry experts must also be consulted in any comprehensive review 
of the federal oil and gas fiscal system. For example, when Alberta 
recently reviewed its oil and gas fiscal system, it convened a panel 
that included experts from academia, energy research and consulting 
firms, and the energy industry and also hired a consultant to evaluate 
the system and make specific recommendations. Following this review, 
Alberta increased some elements of the oil and gas fiscal system. 
However, prior to this review, Canadian government corporate taxes were 
reduced, which made Alberta more attractive for investors. In any 
comprehensive review of the U.S. oil and gas fiscal system, taxes may 
need to be part of the discussion. Therefore, congressional action may 
be needed to change the federal oil and gas fiscal system, if changes 
are ultimately determined to be appropriate. 

Conclusions: 

Oil prices have increased in recent years to levels not seen since the 
late 1970s and early 1980s when adjusted for inflation. Natural gas 
prices have also been high by historical standards in recent years. 
These high prices have coincided with rising oil company profits. 
Moreover, the EIA's long-term outlook projects these prices to remain 
much higher than what they had been for much of the past 25 years. Our 
work indicates that federal oil and gas leases in the deep water U.S. 
Gulf of Mexico and other U.S. regions are attractive investments and 
that the government take in the U.S. Gulf of Mexico ranks among the 
lowest across a large number of other oil and gas fiscal systems. Our 
work further indicates that other measures, including fiscal 
attractiveness and rates of return, indicate the U.S. Gulf of Mexico 
and other U.S. oil and gas producing regions are attractive places to 
invest. However, the regressive nature of the U.S. federal fiscal 
systems and other factors have caused these fiscal systems to be 
unstable over time and this adds risk to oil and gas investments and 
may reduce the amount oil and gas companies are willing to pay in total 
for the rights to explore and develop federal leases. Because of these 
facts and because Interior has not re-evaluated its oil and gas fiscal 
system in over 25 years, a comprehensive re-evaluation is called for. 
While Interior could collect data and commission studies to re-evaluate 
the federal fiscal system, the agency does not currently have the 
information to fully compare the federal fiscal system with those of 
other governments, including states or foreign countries. In addition, 
Interior does not have the authority to make changes to all elements of 
federal fiscal system if such changes were found to be desirable. 
Finally, because of the complexity of evaluating oil and gas fiscal 
systems and the importance of striking a balance between remaining an 
attractive place for investment and providing revenue to the federal 
government, it is important that independent experts also be consulted 
as well as representatives from the oil and gas industry. 

Matter for Congressional Consideration: 

In the draft report we sent to Interior for comment, we made 
recommendations to address these issues. In its response, Interior 
stated that it did not fully concur with our recommendations because it 
had already contracted for a study that will address many of the issues 
we raise. However, because Interior's ongoing study is limited in scope 
and is limited to a specific region in the Gulf of Mexico, rather than 
a review of the entire federal oil and gas fiscal system as we 
recommended, we do not find the agency's stated rationale for not 
agreeing fully with our recommendations to be convincing. Therefore, we 
believe that Congress may wish to consider directing the Secretary of 
the Interior to convene an independent panel to perform a comprehensive 
review of the federal oil and gas fiscal system. 

Further, in order to keep abreast of potentially changing market 
conditions going forward, the Congress may wish to consider directing 
the Secretary of the Interior to direct the Minerals Management Service 
and other relevant agencies within Interior to establish procedures for 
periodically collecting data and information and conducting analyses to 
determine how the federal government take and the attractiveness for 
oil and gas investors in each federal oil and gas region compare to 
those of other resource owners and report this information to the 
Congress. 

Agency Comments and Our Evaluation: 

The Department of the Interior provided us comments on a draft of the 
report. Overall, the department agreed that it is important to reassess 
the federal oil and gas fiscal system but did not fully concur with 
either of our two recommendations to (1) perform a comprehensive review 
of the system using an independent panel and (2) adopt policies and 
procedures to keep abreast of important changes in the oil and gas 
market and in other countries' efforts to adjust their oil and gas 
management practices in light of these changes. We disagree with 
Interior's rationale for its lack of full concurrence with our 
recommendations and have, therefore, elected to reframe the 
recommendations into Matters for Congressional Consideration in the 
final report. 

In response to our first recommendation, Interior indicated that it 
would be premature and duplicative for the department to undertake such 
a review because it had recently contracted with an outside party to 
conduct a 2-year study of the policies affecting the pace of area-wide 
leasing and revenues in the Central and Western Gulf of Mexico. We 
disagree that our recommended review is either premature or duplicative 
with this Interior study effort. First, a comprehensive review is 
overdue, given that Interior has not performed a comprehensive 
evaluation of the oil and gas fiscal system in over 25 years and in 
light of the dramatic increases in oil and gas prices and industry 
profits in recent years. Further, as documented in this report, many 
other oil and gas owners have been re-evaluating and changing their oil 
and gas fiscal systems in response to these recent market conditions. 
The Congress and the public are justifiably concerned about whether the 
federal government is getting a fair return for its energy resources as 
oil and gas company profits have reached record levels. In addition, 
our recommended review would not be duplicative with Interior's ongoing 
study, which is geographically limited to only two sections of the Gulf 
of Mexico. In contrast, we recommended that Interior review all its oil 
and gas fiscal systems, both onshore and offshore. Nor does Interior's 
ongoing study cover the full scope of review that we recommended, 
including looking at how other resource owners are managing their oil 
and gas fiscal systems. Further, Interior's ongoing study does not 
explicitly look at the stability of the system as we recommended and 
this appears to be a critical factor influencing changes to oil and gas 
fiscal systems globally. Finally, Interior's ongoing effort does not 
utilize an independent panel. We believe it is essential to empanel an 
independent body, representative of major stakeholders, including those 
representing the interests of industry and the public, in order to 
develop recommendations that strike an appropriate balance between 
remaining and attractive place for investment and providing revenue to 
the federal government. 

In response to our second recommendation, Interior implied that such an 
effort was unnecessary because Interior agencies that lease federal 
minerals already keep abreast of current literature on fiscal systems 
of other resource owners. During our work, we identified only one 
Interior study done over the past 25 years that provided information on 
the U.S. government take compared to other fiscal systems. While that 
one Interior study issued in 2006 showed, similar to our work, that the 
U.S. government take was low compared to other fiscal systems, it is 
also worth noting that the study itself relied on dated 1994 government-
take information. Therefore, we do not believe that Interior has 
adequately kept abreast of important trends in oil and gas management, 
especially as it relates to how other resource owners are managing 
these resources. In addition, our recommendation went further than 
simply keeping abreast of current literature. In particular, our 
recommendation sought to have Interior monitor and report on how the 
federal government's fiscal terms for oil and gas development compare 
with the terms of other resource owners worldwide. 

Interior's full letter commenting on the draft report is printed as 
appendix III, and our detailed response follows. In addition, Interior 
made technical comments that we have addressed as appropriate. 

As agreed with your offices, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from the date of this report. At that time, we will send copies 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 [hyperlink, 
http://www.gao.gov]. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-3841 on [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 report are listed in appendix IV. 

Signed by: 

Frank W. Rusco: 
Acting Director, Natural Resources and Environment: 

[End of section] 

Appendix I: Scope and Methodology: 

We performed our work at the Department of Interior's (Interior), 
Bureau of Land Management's (BLM), and Minerals Management Service's 
(MMS) offices and in Washington, D.C. from May 2007 to September 2008 
in accordance with generally accepted government auditing standards. We 
focused our analysis of government take and industry rates of return on 
the U.S. Gulf of Mexico because it represents approximately 79 percent 
of oil and 50 percent of gas production on federal leases, and because 
there are complicating factors for onshore oil and gas leases, such as 
state and local taxes or fees that may differ by locality, which the 
available studies do not fully address. We did evaluate information 
that applied more broadly to the United States, specifically with 
respect to overall measures of the attractiveness of the United States 
for oil and gas investment. However, we cannot infer from our review of 
the Gulf of Mexico federal oil and gas leases how the data on federal 
government take or industry returns to investment are applicable to 
federal onshore leases. In general, the results of this review can 
compare the federal system associated with the U.S. Gulf of Mexico to 
that of other oil and gas fiscal systems but cannot provide specific 
prescriptive recommendations for how to change the federal fiscal 
system to achieve a fair return for the public from sale of oil and gas 
on public lands and waters. We also compared the federal oil and gas 
fiscal system to all types of fiscal systems around the world to 
encompass the range of choices that oil and gas companies are faced 
with when deciding where to invest. 

To determine the degree to which the federal government is receiving a 
fair return, our work included reviewing various pieces of energy 
resource management legislation enacted over the last several decades. 
This included, among others, the Outer Continental Shelf Lands Act of 
1953 (OCSLA) and its amendments and the Federal Land Policy and 
Management Act of 1976 (FLPMA) and its amendments. We also collected 
and analyzed various pieces of Interior energy resource policy and 
management information. To evaluate how the U.S. government take 
compares to those in other countries, we reviewed the results of a 
study procured from Wood Mackenzie, a leading industry consultant, and 
recent studies conducted by other private consultants or resource 
owners. We also collected and analyzed various studies generated by 
MMS, the agency responsible for collecting oil and gas royalties from 
federal lands and waters and interviewed private consulting firm 
officials. In evaluating the study results, we conducted interviews 
with study authors and an industry expert to discuss the study 
methodologies and the appropriate interpretation of the results. Based 
on these interviews and our review of study results, we believe the 
general approach that these study authors took was reasonable and that 
the results of the studies are credible. However, we did not fully 
evaluate each study's methodology or the underlying data used to make 
the government take estimates. Overall, because all the studies came to 
similar conclusions with regard to the relative ranking of the U.S. 
federal government, and because such studies are used by oil and gas 
industry companies and governments alike for the purposes of evaluating 
the relative competitiveness of specific oil and gas fiscal systems, we 
are confident that the broad conclusions of the studies are valid. To 
assess the extent to which the United States' oil and gas fiscal system 
is able to remain stable as market conditions change, we relied heavily 
on the study and data we obtained from Wood Mackenzie. We interviewed 
industry experts and gathered information regarding the types of fiscal 
systems and the relative stability offered with each. We interviewed 
company officials and industry experts to obtain information on their 
preferences regarding fiscal system characteristics. 

We also purchased data from Compustat and analyzed that data and data 
published by the Energy Information Administration. The financial data 
we procured are widely used by private companies and governments for 
purposes of comparing company and industry rate of return over time, 
because Interior in the past used rate of return as a credible measure 
to evaluate the profitability of the Gulf of Mexico for firms 
conducting oil and gas exploration there versus the relative 
profitability of other manufacturing firms operating in the United 
States. We also evaluated data reported by the American Petroleum 
Institute and other sources. Further, we reviewed various reports 
prepared over the last 2 years by private sources on the profitability 
of oil and gas companies operating in the U.S. versus operating 
elsewhere in the world. We also spoke to industry officials regarding 
aspects of the various fiscal systems in which they operate. Finally, 
we discussed the issue of a "fair return" with various Interior, BLM, 
and MMS officials, as well as members of the oil and gas industry. To 
determine what steps Interior takes to get reasonable assurance that 
the federal government take provides a fair return to the public, we 
reviewed Interior studies and procedures, and interviewed officials 
from MMS. 

We conducted this performance audit from May 2007 to September 2008, in 
accordance with generally accepted government auditing standards. Those 
standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe that 
the evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives. 

[End of section] 

Appendix II: Companies Receiving Royalty Relief in the U.S. Gulf of 
Mexico: 

According to Interior, companies operating in the U.S. Gulf of Mexico 
had received more than $1.3 billion in royalty relief through September 
30, 2007. Table 2 lists the companies that have received royalty relief 
under DWWRA and the amounts of that relief. Six companies had signed 
agreements with Interior, allowing thresholds to be placed for 
royalties to be paid in the future. Those companies are BP Exploration 
and Production; ConocoPhillips & Burlington Resources Offshore, Inc.; 
Marathon; Shell; Walter Hydrocarbons; and Walter Oil and Gas. According 
to Interior information dated February 4, 2008, ConocoPhillips & 
Burlington Resources Offshore, Inc., had not received royalty relief. 

Table 2: Amounts of Royalty Relief Received by Companies: 

Company: ATP Oil & Gas Corporation; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 7,080,958; 
Signed agreement with Interior to include price thresholds: No. 

Company: BHPBilliton; 
Ownership: Public - Australia; 
Royalty Relief Received to Date: 6,480,679; 
Signed agreement with Interior to include price thresholds: No. 

Company: BP Exploration & Production; 
Ownership: Public - United Kingdom; 
Royalty Relief Received to Date: 172,508,633; 
Signed agreement with Interior to include price thresholds: Yes. 

Company: Chevron USA/Texaco/Union Oil; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 4,003,495; 
Signed agreement with Interior to include price thresholds: No. 

Company: Devon Energy Corporation/Ocean/Santa Fe; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 143,808,801; 
Signed agreement with Interior to include price thresholds: No. 

Company: Dominion Exploration; 
Ownership: Public - Italy; 
Royalty Relief Received to Date: 126,504,055; 
Signed agreement with Interior to include price thresholds: No. 

Company: EnCana Gulf of Mexico; 
Ownership: Public - Canada; 
Royalty Relief Received to Date: 43,908; 
Signed agreement with Interior to include price thresholds: No. 

Company: ENI Deepwater; 
Ownership: Public - Italy; 
Royalty Relief Received to Date: 27,176,887; 
Signed agreement with Interior to include price thresholds: No. 

Company: Howell Group; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 46,867; 
Signed agreement with Interior to include price thresholds: No. 

Company: Anadarko Petroleum Corporation/Kerr McGee/Offshore Shelf/ 
Westport; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 142,406,788; 
Signed agreement with Interior to include price thresholds: No. 

Company: Marathon Oil Corporation; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 1,393,586; 
Signed agreement with Interior to include price thresholds: Yes. 

Company: Mariner Energy, Inc.; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 44,050,427; 
Signed agreement with Interior to include price thresholds: No. 

Company: Marubeni; 
Ownership: Public - Japan; 
Royalty Relief Received to Date: 26,477,247; 
Signed agreement with Interior to include price thresholds: No. 

Company: Newfield Exploration Corp.; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 10,338,890; 
Signed agreement with Interior to include price thresholds: No. 

Company: Nexen Inc.; 
Ownership: Public - Canada; 
Royalty Relief Received to Date: 129,518,866; 
Signed agreement with Interior to include price thresholds: No. 

Company: NI Energy Venture; 
Ownership: Public - Japan; 
Royalty Relief Received to Date: 406,747; 
Signed agreement with Interior to include price thresholds: No. 

Company: Nippon Oil Exploration; 
Ownership: Public - Japan; 
Royalty Relief Received to Date: 22,897,836; 
Signed agreement with Interior to include price thresholds: No. 

Company: Noble Corp.; 
Ownership: Public - Cayman Islands; 
Royalty Relief Received to Date: 1,137,105; 
Signed agreement with Interior to include price thresholds: No. 

Company: Occidental Petroleum Corp.; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 109,653,662; 
Signed agreement with Interior to include price thresholds: No. 

Company: Petrobras America; 
Ownership: Semipublic - Brazil; 
Royalty Relief Received to Date: 13,354,061; 
Signed agreement with Interior to include price thresholds: No. 

Company: Pioneer Natural Resources Co.; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 128,068,000; 
Signed agreement with Interior to include price thresholds: No. 

Company: Pogo Producing Co.; 
Ownership: Public - United States; 
Royalty Relief Received to Date: 7,414,106; 
Signed agreement with Interior to include price thresholds: No. 

Company: Royal Dutch Shell; 
Ownership: Public - Netherlands; 
Royalty Relief Received to Date: 27,399,688; 
Signed agreement with Interior to include price thresholds: Yes. 

Company: Total E&P 
Ownership: Public - France; 
Royalty Relief Received to Date: 171,648,800; 
Signed agreement with Interior to include price thresholds: No. 

Company: Walter Oil & Gas Corp./Walter Hydrocarbons; 
Ownership: Private - United States; 
Royalty Relief Received to Date: 1,286,768; 
Signed agreement with Interior to include price thresholds: Yes. 

Total: 
Royalty Relief Received to Date: 1,325,106,861. 

Source: GAO analysis of Interior data dated February 4, 2008. 

Note: Numbers do not add exactly due to rounding. 

[End of table] 

Appendix III: Comments from Department of the Interior: 

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

United States Department of the Interior: 
Office Of The Secretary: 
Washington, D.C. 20240: 

August 8, 2008: 

The Honorable Frank Rusco: 
Director, Government Accountability Office: 
441 G Street, NW: 
Washington, D.C. 20548: 

Dear Mr. Rusco: 

Thank you for the opportunity to review and comment on the Government 
Accountability Office draft report "Oil and Gas Royalties: The Federal 
System for Collecting Oil and Gas Revenues Needs Comprehensive 
Reassessment" (GAO-08-691). We appreciate the efforts of the GAO and 
have consistently worked closely with the GAO on this and previous 
reports over the years. We agree that it is important to review the 
Federal oil and gas fiscal system, but we do not fully concur with the 
recommendations in your draft report. The GAO's recommendations to 
conduct more reviews attest to the complexity of evaluating the Federal 
oil and gas fiscal system. 

Background: 

In June 2006, Congress asked the GAO to review royalties on Federal oil 
and gas production and provide advice on what changes if any should be 
made to ensure that the public is receiving fair value. The GAO lists 
three objectives in its draft report: 1) evaluate the attractiveness 
for oil and gas investors of the Federal oil and gas fiscal system; 2) 
evaluate how the absence of flexibility in this system has led to large 
forgone revenues from oil and gas production on Federal lands and 
waters; and 3) assess what the Department of the Interior (Interior) 
has done to monitor the performance and appropriateness of the Federal 
oil and gas fiscal system. As noted in the draft report, comparing 
fiscal systems for oil and gas is inherently complex. The Minerals 
Management Service agrees with the implications of the GAO report that 
we should evaluate fiscal system designs that are responsive to market 
conditions and keep informed of what other countries are doing in their 
fiscal systems; however, we have concerns with other findings and 
statements in the GAO draft report, which are discussed below. 

Areas of Concern: 

In addressing the first objective noted above, the GAO draft report 
relies heavily on measures of Government take, but does not clarify the 
link between Government take and investment attractiveness to 
investors, nor does the draft report relate the significance of 
Government take to the purposes of the Outer Continental Shelf Lands 
Act and the Federal Land Policy and Management Act. [See comment 1] 

The second objective of the GAO study appears to lead to a 
predetermined conclusion. The report's conclusion that inflexibility in 
the system is responsible for significant reductions in Federal 
receipts is not supported by the GAO's analysis presented in the draft 
report. The example cited by the GAO concerns the deep water leases 
issued in 1998 and 1999. At the time, the MMS was implementing the 
special requirements of the Deep Water Royalty Relief Act. The MMS 
acted in a flexible and creative way to set the elements of the fiscal 
terms of its leases in a manner consistent with anticipated technical, 
as well as market, conditions at time of sale. The GAO also states that 
the MMS did not evaluate the entire oil and gas fiscal system to 
determine whether or not the two royalty increases provided the proper 
balance between the attractiveness of Federal leases for investment and 
appropriate returns to the Federal Government. Interior did evaluate 
components of the Federal leasing system, including tax and production 
losses from imposing the resulting royalty increases that, in large 
part, were a prudent and incremental response to emerging market 
conditions. [See comment 2] 

The GAO does not credit the MMS for efforts related to the third 
objective, which is monitoring the performance of the Federal fiscal 
system. Even though Interior may not have conducted a "comprehensive 
evaluation" of the Federal oil and gas fiscal system as defined by the 
GAO, the MMS evaluates the expected OCS resources and market conditions 
in light of our organic statutes and tax laws when setting the fiscal 
terms for each lease sale and analyzing the results following each 
sale. [See comment 3] 

Onshore Federal royalty issues, while not directly addressed by the GAO 
in this report, differ from offshore due to the intermingling of 
Federal, State, Indian, and private lands. The Federal take is severely 
limited by the revenue split with States. Bonus money paid for onshore 
leasing is, by law, the result of competitive bidding with a minimum 
acceptable bid set by Congress of not less than $2.00 per acre. 
Multiple bids received at onshore lease auctions are an indication of 
market value, with the high bidder generally being awarded the lease. 
The price of natural gas is set by the domestic market, and, generally, 
higher royalty rates will be passed on to consumers as higher gas 
prices. [See comment 4] 

Senior Departmental officials have consistently interpreted the 
mandates of the OCSLA as receipt of fair market value, expeditious 
exploration and development, encouragement of competition, protection 
of human health and the environment, resource conservation, etc.-not 
maximization of Government receipts as the GAO implies. We believe 
Interior bureaus have succeeded in achieving the purposes of the OCSLA 
and FLPMA. In its oversight role, Congress should hold Interior to the 
standards encompassed in existing statutes. Maximizing Federal mineral 
revenues or achieving some worldwide ranking of government take are not 
purposes in the existing laws guiding Federal oil and gas programs. 
[See comment 5] 

The MMS analyzes fiscal terms before each lease sale and reviews the 
results of each sale. The analysis includes the level and extent of 
bidding activity to determine if fiscal terms are operating as 
intended. Studies and literature are reviewed related to fiscal terms 
and potential economic, fiscal, and geologic outcomes in different 
countries and regions operating under different fiscal terms. The two 
recent Gulf of Mexico royalty rate increases were made by the MMS 
incrementally in response to expected oil and gas prices. These royalty 
rate increases are consistent with the statutory objective to achieve 
fair market value. Additionally, both the MMS and the Bureau of Land 
Management are investigating sliding royalty options for future oil and 
gas leasing. The BLM is focusing on a variable royalty structure for 
onshore oil shale and the MMS is analyzing additional variable royalty 
and rental structures for the Federal OCS. [See comment 6] 

The MMS recently contracted with a panel of academic oil and gas 
industry experts to conduct a 2-year study on issues that, to a large 
extent, overlap those being recommended by the GAO for a comprehensive 
study and independent panel. Entitled "Policies to Affect the Pace of 
Leasing and Revenues in the Gulf of Mexico," the study is analyzing a 
variety of fiscal arrangements, including fixed and sliding royalty 
terms much like those discussed or implied in the GAO report. A 
considerable part of this study is designed to cover important fiscal 
issues now being raised by the GAO. Interior believes it is premature 
and duplicative to conduct another comprehensive study of fiscal terms 
and convene another panel of experts until the recommendations of this 
panel are reviewed and evaluated. [See comment 7] 

We agree that total revenue allocated to the Government (Government 
take) varies greatly among countries and resource owners. In many of 
the fiscal systems that rank higher in Government take in the studies 
cited in the GAO report, governments own and produce the resource. It 
is important to point out that global companies have choices where they 
make capital investments. Their investment choices are affected by many 
variables, including the fiscal system of rents, royalties, and bonus 
bids, as well as the cost of capital, risk, and the attractiveness of 
alternative investments. An increase in Government take through higher 
royalties, taxes, or other aspects of the fiscal system may result in 
less domestic oil and gas production than would occur at more favorable 
economic terms. Thus any increases in Federal revenues through higher 
fiscal terms must be carefully weighed. The public receives significant 
direct, indirect, and induced economic benefits from domestic oil and 
gas leasing and development in the form of jobs and economic growth, as 
well as less dependency on foreign energy sources. [See comment 8] 

We disagree with the GAO assertion that Interior cannot properly and 
effectively conduct the mineral leasing programs without explicitly 
ranking Federal mineral leasing systems and assessing industry rates of 
return compared to leasing systems employed worldwide. While Government 
take rankings may be a comparison measure, Interior operates under a 
management and leasing policy defined by Congress in the OCSLA and 
FLPMA. Through the evaluation of varied fiscal terms, the MMS has made 
changes within the authority granted to the Secretary under the OCSLA 
and in response to subsequent legislative requirements. The OCSLA in 
particular describes the purposes of the offshore oil and gas program, 
which include expeditious exploration and development, encouraging 
competition, receipt of fair market value, etc. [See comment 9] 

Interior notes that the report does not mention the deep water royalty 
relief mandated by Congress in the Energy Policy Act of 2005. The 
Administration has actively sought repeal of this provision. Since the 
GAO's findings for leasing in the OCS focus almost entirely on deep 
water leases in the Gulf of Mexico, the impact of the law should have 
been taken into consideration. [See comment 10] 

Conclusion: 

The Department of the Interior does not fully concur with the two 
recommendations made to the Secretary of the Interior. While we agree 
that it is important to review the Department's oil and gas lease 
terms, Interior's existing procedures are adequate to evaluate 
alternative fiscal terms and systems in the context of the stated 
purposes, goals, and objectives of the statutory requirements. Many of 
the fiscal systems used by other countries are not allowed in the 
United States. [See comment 11] 

The first recommendation, with which we do not fully concur, is that 
the Secretary of the Interior direct the MMS, the BLM, and other 
relevant agencies within Interior to conduct a comprehensive review of 
the Federal oil and gas fiscal system using an independent panel that 
includes private sector experts and oil and gas industry 
representatives to collect and evaluate the necessary information to 
make informed conclusions. Recently the MMS commissioned an outside, 
independent group of energy industry experts from the University of 
Rhode Island to conduct a related 2-year study entitled, "Policies to 
Affect the Pace of Leasing and Revenues in the Gulf of Mexico." 
Accordingly, it would be premature and duplicative for the MMS to 
undertake another comprehensive study, and convene another group of 
experts prior to completion of the current study. On any study, the 
Secretary will involve partners, as appropriate. The MMS and the BLM 
will continue to evaluate program requirements and analyze options for 
determining the most appropriate mineral leasing fiscal systems subject 
to the authorizing legislation. [See comment 12] 

The second recommendation, with which we do not fully concur, is for 
the Secretary of the Interior to direct the MMS, the BLM, and other 
relevant agencies within Interior to establish procedures to 
periodically evaluate the Federal oil and gas fiscal system in relation 
to those of other resource owners and report the findings to Congress. 
Interior would respond to any Congressional request. The MMS and the 
BLM have conducted internal control reviews of key components of their 
fluid minerals management programs. The MMS evaluates the fiscal terms 
before each OCS lease sale and will continue to balance the 
requirements of the OCSLA and continues to respond to emerging market 
conditions. Interior agencies that lease Federal minerals already keep 
abreast of current literature on fiscal systems of other resource 
owners. Therefore, we believe that what other resource owners may do is 
useful to know, but what they do is not the most important factor to 
consider in designing appropriate fiscal terms for mineral leases 
issued by the Department of the Interior. [See comment 13] 

Through our leasing program, we continually update, evaluate, and 
review the fiscal terms of leases. We are always open to suggestions to 
clarify procedures in order to assure their effectiveness. We will 
closely examine those procedures internally. 

Technical comments are enclosed. If you have any questions, please 
contact Andrea Nygren, MMS Audit Liaison Officer, at (202) 208-4343. 

Sincerely: 

Signed by: 

C. Stephen Allred: 
Assistant Secretary: 

Enclosure: 

The following are GAO's comments on the Department of the Interior's 
letter dated August 8, 2008. 

GAO Comments: 

1. Regarding Interior's statements that (1) the draft report relies 
heavily on measures of government take but does not clarify the link 
between government take and investment attractiveness, and (2) the 
draft report does not relate the significance of the OCSLA and FLPMA 
laws, we disagree. The report on page 1 states that several factors 
need to be considered, including the size of availability of the oil 
and gas resources in place; the cost of finding and developing these 
resources, and the stability of other the oil and gas fiscal systems 
and the country in general. Also on page 2, we note that a fair 
government take would strike a balance between encouraging private 
companies to invest in the development of oil and as resources on 
federal lands and waters while maintaining the public's interest in 
collecting the appropriate level of revenues from the sale of the 
public's resources. Further, we devote a significant portion of our 
discussion of objective one to how the attractiveness of the U.S. oil 
and gas fiscal system compares with those of other resource owners, and 
concludes that U.S Gulf of Mexico and other U.S. places are attractive 
places to invest. With regard to the significance of the OCSLA and 
FLPMA laws, on page 3 of the report we discuss the provisions of the 
OCSLA and FLPMA laws and how they relate to the management of the 
federal oil and gas fiscal system. 

2. Interior commented that the report's conclusion that inflexibility 
in the federal oil and gas fiscal system is responsible for significant 
reductions in the federal fiscal take is not supported. We maintain 
that the inherent inflexibility of the federal fiscal system means that 
government receipts from the production of oil and gas on federal lands 
and waters have not tracked with the prices of oil and gas. This lack 
of flexibility explains, in part, why the Congress enacted the Deep 
Water Royalty Relief Act in 1995, a time when oil and gas prices were 
much lower than they are today. The lack of flexibility of the royalty 
rates for some of the leases issued under this Act, as implemented by 
Interior, will end up costing the public billions of dollars in 
foregone revenues. Further, the recent increases to royalty rates that 
Interior references in its comments do nothing to address the bulk of 
leases already held and for which industry profits have increased as 
high as they have precisely because neither the royalty rates, nor 
other components of the oil and gas fiscal system were sufficiently 
flexible to allow federal revenues to increase automatically when oil 
and gas prices and industry profits increased. Overall, Interior should 
strive to achieve fair market value over time, not simply evaluate 
market conditions at the time leases are issued. 

3. With regard to Interior's comments that although it has not 
conducted a comprehensive evaluation of the federal oil and gas fiscal 
system, it has evaluated expected resources and conditions on the Outer 
Continental Shelf (offshore) tracts, we agree that Interior takes some 
steps to evaluate offshore leases but the objective addresses a broader 
evaluation of how Interior monitors the performance and appropriateness 
of the entire federal oil and gas fiscal system, including offshore and 
onshore, and also including assessing performance over time rather than 
at the time a lease is sold. Interior officials told us they evaluate 
offshore tracts before the issuance of a lease for prospectivity of the 
lease and use such measures to determine an adequate minimum bid for 
the lease. However, as Interior makes note in its own comments, 
Interior officials have not systematically reviewed the bid outcomes of 
offshore tracts. 

4. We agree that onshore and offshore leases can be very different and 
for the reasons stated in Interior's comments. That is why we 
recommended a comprehensive review of the entire federal oil and gas 
fiscal system, including onshore and offshore. We also recommended that 
the results of this comprehensive review be presented to the Congress 
so that it can act appropriately in the event any existing laws or 
regulations that govern the leasing and collection of revenues from 
federal oil and gas leases could be improved in light of the 
recommendations of the independent panel. 

5. Interior states that the report implies that Interior maximizes 
government receipts from oil and gas leases. We disagree that the 
report implies this and can find no place in the report where we 
believe a reader would make such an inference. 

6. We disagree with Interior's statement that it "analyzes fiscal terms 
before each lease sale and reviews the results of each sale." 
Interior's analysis of prospective leases is for offshore leases only 
and, according to Interior officials, is an analysis of the 
prospectivity of the offshore tract, designed to set minimum adequate 
bids. It is not a review of "fiscal terms," as Interior states in its 
comments. With regard to the two recent royalty rate increases for 
future oil and gas leases in the Gulf of Mexico, these increases do not 
resolve fair market value for past leases issued with inflexible fiscal 
terms and are themselves inflexible. Therefore, if future oil and gas 
prices turn out to be different than what Interior expected when they 
made the changes, the resulting outcome will again not reflect a fair 
return and could be too high or too low, depending on what happens in 
the oil and gas markets. 

7. With regard to Interior's comment that it recently contracted with a 
panel of academic oil and gas industry experts to conduct a study of 
fiscal arrangements including fixed and sliding royalty terms, please 
see our general response to Interior's comments on page 24. 

8. We agree with the statements Interior makes in this paragraph, and 
note that these concepts are also well represented in our report. For 
example, we note that investment choices are affected by many 
variables, including the fiscal system of rents, royalties, and bonus 
bids, as well as the cost of capital, risk, and the attractiveness of 
investments; indeed, we designed the job to discuss the first range of 
issues in our first objective, and the second range of issues in the 
second objective. We conclude, and Interior agrees, that any increases 
in federal revenues through higher fiscal terms must be carefully 
weighed; however, Interior has not done this "careful weighing" in 
making its royalty rate increases. That is why we recommended a 
comprehensive review of the federal oil and gas fiscal system. 

9. With regard to Interior's comment that it operates under a 
management and leasing policy defined by the Congress in the OCSLA and 
FLPMA, we agree and this is reflected on page 3 of the draft report. 
However, Interior cannot effectively conduct the mineral leasing 
programs without evaluating federal mineral leasing systems and 
assessing industry rates of return and other factors discussed in this 
report. Interior must keep abreast of these issues and developments in 
fiscal regimes elsewhere, and advise Congress on developments in the 
competitiveness of the federal oil and gas fiscal system versus those 
employed by other resource owners. Further, our audit work shows that 
Interior has responded to oil and gas market changes in a reactive, 
rather than strategic and forward-looking manner, and we believe the 
Congress needs to be kept abreast of changes affecting federal oil and 
gas leasing and revenue generation. 

10. Interior comments that the draft report does not mention the 
royalty relief mandated by the Congress in the Energy Policy Act of 
2005, and its decision to seek repeal of this provision, and that the 
impact of the law should have been taken into consideration. We agree 
that the draft report did not discuss the 2005 law explicitly but note 
that the results we report do implicitly take this law into 
consideration. Our results on the government take and attractiveness of 
investment in the deep water Gulf of Mexico derive largely from a 2007 
study done by Wood Mackenzie that took into account the impact of the 
existing laws at the time of the study. We have added language to make 
explicit acknowledgement of the Energy Policy Act of 2005: 

11. See our general response to Interior's comments on page 24-25 of 
this report. 

12. See our general response to Interior's comments on page 24-25 of 
this report. 

13. See our general response to Interior's comments on page 24-25 of 
this report. 

[End of section] 

Appendix IV: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Frank Rusco, (202) 512-3841 or [email protected]: 

Staff Acknowledgments: 

In additional to the individual named above, Jon Ludwigson (Assistant 
Director), Robert Baney, Ron Belak, Nancy Crothers, Glenn Fischer, 
Michael Kendix, Carol Kolarik, Michelle Munn, Daniel Novillo, Ellery 
Scott, Rebecca Shea, Dawn Shorey, Barbara Timmerman, and Maria Vargas 
made key contributions to this report. 

[End of section] 

Footnotes: 

[1] GAO, Oil and Gas Royalties: A Comparison of the Share of Revenue 
Received from Oil and Gas Production by the Federal Government and 
Other Resource Owners, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-07-676R] (Washington, D.C.: May 1, 2007). 

[2] In general, each country has at least one oil and gas fiscal 
system. Certain countries--for example, Canada and the United States-- 
have a number of different oil and gas fiscal systems: a federal system 
that governs resource development on federal lands and other systems 
that govern resource development on provincial lands in Canada and 
state lands in the United States. 

[3] The estimated additional revenues are the estimated reduction in 
the companies' share of remaining value of existing assets, when 
comparing fiscal systems in place at the start of 2002 and those in 
place in mid-2007, under a high-price scenario of $75 per barrel of 
crude oil. 

[4] In the Wood Mackenzie study, "Gulf of Mexico" results refer only to 
deep water areas of 400 meters or greater depth; Wood Mackenzie 
currently does not have a comparable database for shallower Gulf 
waters. 

[5] 43 U.S.C. ï¿½ 1337. 

[6] With regard to onshore leasing, there are both competitive and 
noncompetitive leases. For competitive leases, 30 U.S.C. Section 226 
stipulates that a national minimum acceptable bid of $2 an acre be met 
and a royalty payment of not less than 12.5 percent be met, although 
Section 209 of the law allows the Secretary to waive or reduce rental 
rates or minimum royalty rates when he deems this is necessary to 
promote development or if the leases cannot be successfully operated 
under the terms provided; Section 226 of the law allows the Secretary 
to increase the $2 an acre minimum bid, so long as he notifies the 
House and Senate Committees on Natural Resources 90 days before doing 
so. For noncompetitive leases, if there are no bonus bids made at an 
auction, or if all bids are less than the national minimum, the land is 
offered noncompetitively, with some exceptions. 

[7] Wood Mackenzie's evaluation of risk did not compare the likely 
resource risk from future drilling activities or include a risk 
comparison of technical and/or resource risks; it evaluated the risk to 
companies for conducting business under the specific fiscal system 
being evaluated. 

[8] Energy Information Administration, Performance Profiles of Major 
Energy Producers: 2006, December 2007. A return of equity is another 
measure of company and industry profitability. A return on equity is 
net income divided by shareholders' equity. 

[9] American Petroleum Institute, America's Oil and Gas Industry: 
Putting Earnings into Perspective, 2007. 

[10] Return on investment is calculated by dividing net income by net 
investment in place. 

[11] Our analysis differs from the other studies cited in this report 
because we examined return on investment for exploration and production 
only, instead of oil and gas industry-wide return on investment or 
return on equity. Additionally, our analysis of the manufacturing 
industry includes the universe of companies identified as manufacturers 
by Standard Industrial Classification code (excluding oil and gas 
companies) instead of an industry index as was used by the American 
Petroleum Institute and EIA studies. As a result, our return on 
investment differs from the other studies. 

[12] World Bank, Doing Business 2008: Comparing Regulation in 178 
Economies, Washington, D.C., 2007. 

[13] Six of the 25 companies that have received royalty relief to date 
have signed agreements with Interior to allow the inclusion of price 
thresholds for leases signed in 1998 and 1999. A list of U.S. and 
international companies that currently receive royalty relief, and who 
may be affected by the outcome of the legal challenge, is presented in 
app. II. 

[14] GAO, Oil and Gas Royalties: Litigation over Royalty Relief Could 
Cost the Federal Government Billions of Dollars, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-08-792R] (Washington, D.C., June 
5, 2008). 

[15] By foregone revenue, we mean the royalty revenue that would have 
accrued to the federal government had there been no royalty relief 
under the DWRRA. 

[End of section] 

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