[Audit Report on the Small Refiners Program, Minerals Management Service]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 00-I-279

Title: Audit Report on the Small Refiners Program, Minerals Management
       Service  

   
  Date: March 27, 2000
  
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  U.S. Department of the Interior
  Office of Inspector General
  
  
  
  EXECUTIVE SUMMARY
  
  Small Refiners Program,
  Minerals Management Service, 
  Report No. 00-I-279
  March 2000                     
  
  BACKGROUND
  
  An estimated 50 small refining companies operate in the United States and account for about
  11 percent of the Nation's crude oil refining capacity.  Small refiners produce a variety of
  products, such as motor gasolines, diesel and jet fuels, and asphalt for road construction. 
  However, because small refiners generally are independent companies that do not have their
  own oil production capabilities, the potential exists for these refiners to face economic
  adversity, including possible shutdowns of operations, when oil supplies are low or oil prices
  are high.  To assist small refiners, the Department of the Interior takes a portion of the
  Federal Government's royalties "in-kind" from oil companies and sells the oil to eligible
  refiners to ensure that they have a constant supply.  The Minerals Leasing Act of 1920 and
  the Outer Continental Shelf Lands Act of 1953 govern the sale of royalty-in-kind oil
  originating from onshore leases and offshore leases, respectively.  
  
  The Small Refiners Program is administered by the Royalty-in-Kind Section, within the
  Accounting and Reports Division of the Minerals Management Service's Royalty
  Management Program.  The Small Refiners Program costs about $1.2 million to operate each
  year, and the Section has seven full-time positions.  In administrating the Program, the
  Service conducts periodic sales of Government royalty oil and negotiates contracts with the
  participating small refiners for the purchase of the oil, which generally run for a period of
  3 years.  Prior to a royalty oil sale, Program regulations require the Service to conduct a study
  (known as a Determination of Need) to determine whether small refiners would benefit from
  the sale.  The Service's  regulations also require that the costs of operating the Program be
  recovered through administrative fees assessed on the participating refiners.
  
  OBJECTIVE
  
  The objective of our audit was to determine whether the Service had an effective strategy to
  correct deficiencies in the Small Refiners Program that were identified by Service, state
  government, and industry officials in a formal study completed in 1997.
  
  RESULTS IN BRIEF
  
  We concluded that the Minerals Management Service had made satisfactory progress in
  correcting the deficiencies in the Small Refiners Program that were identified in a formal
  study conducted by Service, state government, and industry officials.  For example, the
  Service improved the process for determining the value of royalty oil and was redesigning
  the Program to ensure that refiners paid royalties for oil volumes received.  We found,
  however, that the Program had weaknesses that had not been addressed.  Specifically, the
  Service did not address the anticipated increase in demand for oil from the refiners, did not
  conduct royalty oil sales on a frequent or regular basis, and did not recover the full costs of
  administrating the Program.  Program regulations (30 CFR 208.4) require that the Service
  conduct an analysis of the crude oil market prior to a royalty oil sale to determine whether
  small refiners have adequate access to supplies of oil at equitable prices.  In addition, 30 CFR
  208.4(b)(4) and Office of Management and Budget Circular No. A-25, "User Charges," 
  require that the Service recover the full administrative costs of the Program.  The identified
  weaknesses occurred because the Service's crude oil market analysis did not include
  potential oil available to small refiners under the 20 percent set-aside provision in offshore
  leases and because Program officials, in attempting to reduce the financial impact on the
  refiners, recovered only a portion of the administrative costs incurred to operate the Program. 
  We found that the Service had not recovered administrative costs of about $1.9 million since
  fiscal year 1997.
  
  RECOMMENDATIONS
  
  We recommended that the Minerals Management Service require Small Refiners Program
  officials to ensure that the Determination of Need considers all sources of oil available to the
  small refiners and to conduct the Determination of Need on a regular and more frequent
  basis.  We further recommended that the Service ensure that it recovers the full costs of
  administrating the Program from the small refiners.
  
  AUDITEE COMMENTS AND OIG EVALUATION
  
  The Service concurred with the recommendation to conduct the Determination of Need on
  a regular and more frequent basis but did not concur with the recommendations to consider
  all sources of available oil when conducting the Determination and to recover all costs of
  administrating the Program.  As to the Determination, the Service indicated that its failure
  to consider the 20 percent set-aside provision was not relevant to the process.  We believe, 
  however, that the Determination cannot be valid if this potentially significant source of oil
  is disregarded.   Although the Service held  a  sale in October 1999, which resulted in smaller
  than expected volumes of oil sold, we do not believe that the small refiners necessarily
  exhibited a reduced interest in Government royalty oil.  Rather, the manner in which the sale
  was conducted may have resulted in fewer small refiners participating, in that the
  "established reasonable price thresholds" were greater than expected for prospective small
  refiners.  Regarding cost recovery, the Service stated that it was recovering costs in
  accordance with Program regulations and that it should recover only the costs of
  administrating leases active in the Program.  We believe that the Service should recover the
  full administrative costs associated with both active and terminated leases.  Accordingly, the
  Service was requested to reconsider its responses to the report's remaining two
  recommendations, which are unresolved.   C-IN-MMS-001-99-R
  
  
  
  
  
  
  
  March 27, 2000
  AUDIT REPORT
  
  Memorandum
  
  To:  Director, Minerals Management Service
  
  From:  Robert J. Williams
  Assistant Inspector General for Audits
  
  Subject:  Audit Report on the Small Refiners Program, Minerals Management Service 
  (No. 00-I-279)
  
  INTRODUCTION
  
  This report presents the results of our audit of the Small Refiners Program of the Minerals
  Management Service.  We initiated this audit as part of our audit workplan for fiscal year
  1998.  However, at the request of the Service, we agreed to reschedule the audit for fiscal
  year 1999 to allow the Service sufficient time to complete certain Program improvements. 
  The objective of our audit was to determine whether the Service had an effective strategy to
  correct deficiencies in the Small Refiners Program that were identified by Service, state
  government, and industry officials in a formal study completed in 1997.
  
  BACKGROUND
  
  An estimated 50 small refining companies operate in the United States and account for about
  11 percent of the Nation's crude oil refining capacity.  Small refiners produce a variety of
  refined products, such as motor gasolines, diesel and jet fuels, and asphalt for road
  construction.  However, because small refiners generally are independent companies that
  do not have their own oil production capabilities, the potential exists for these refiners to face
  economic adversity, including a possible shutdown of operations, when oil supplies are low
  or oil prices are high.  In that regard, the Energy Information Administration of the
  Department of Energy reported on its Web site (http://www.eia.doe.gov/emeu/cabs/usa.html)
  in May 1999 that "[t]he United States has experienced a steep decline in refining capacity
  since 1981."  The report further stated that in the 1980s, the number of operating refineries
  decreased from 324 to 204 and that "[s]ince 1992, about 34 additional, mainly small U.S.
  refineries have shut down."
  
  To assist small refiners, the Department of the Interior takes a portion of the Federal
  Government's oil royalties "in-kind" and sells the portion  to eligible refiners to ensure that
  they have a constant oil supply.  The Minerals Leasing Act of 1920, as amended, and the
  Outer Continental Shelf Lands Act of 1953, as amended, govern the sale of royalty-in-kind
  oil originating from onshore leases and offshore leases, respectively.  The implementing
  regulations for the Small Refiners Program are contained in the Code of Federal Regulations
  (30 CFR 208).
  
  In administrating the Small Refiners Program, the Service conducts periodic sales of
  Government royalty oil and negotiates contracts with the participating small refiners for the
  purchase of the oil.  The contracts are generally for a period of 3 years.  The number of
  refiners participating in the Program, along with the associated values and quantities of oil
  since fiscal year 1997, is shown in Table 1.
  
  
  Table 1.  Program Summary Data
    
  FISCAL YEARS
    
  1997
  
  1998
  
  1999
    
  Participating small refiners at start of year
  
    11
  
    6
  
    5
    
  Number of purchase contracts at start of year
  
    13
  
    8
  
    6
  
  
           

 Contracts covering offshore leases
  
    9
  
    6
  
    6
  
   Contracts covering onshore leases
  
    4
  
    2
  
    0
  
  Number of leases at start of year
  
    549
  
    212
  
    148
  
  
  Volumes of oil sold under the Program
            (Millions of barrels)
  
    26.8
                              
   17.4
                              
    12.7 *
                              
                              
   Value of oil sold under the Program
    (Millions of dollars)
                              
     $483.4
  
    $237.6
  
   $151.4*
  
  
  Estimated percentage of Federal 
   royalty oil production
  
     32%
                              
    22%
                              
    16% *

  *Amounts projected based on actual data from October 1998 through August 1999.
  
  
  The reduction in the size of the Program was caused in part by refiners leaving the Program
  for market-related reasons, such as the availability of oil from non-Federal sources.  In
  addition, the size of the Program was also reduced because, according to some refiners, the
  Service did not manage the sale and valuation of the royalty oil in a manner consistent with
  normal industry trade practices.
  
  In September 1996, the Service initiated a formal study to address the deficiencies in the
  Program that were identified by the Royalty Policy Committee, which is composed of
  Service, state government, and industry officials.  These deficiencies consisted of
  discrepancies between the oil volumes reported by the lease operator and the volumes
  delivered to the refiner, inconsistent oil measurement points for offshore leases, uncertainty
  in the valuation of the royalty-in-kind oil, and a 1-month delay in the Service's receiving
  payment from the refiner compared with receiving payments on  royalty-in-value leases.  In
  the report issued by the Service in September 1997 on the results of the formal study, the
  Service made three recommendations to correct the problems identified and established a
  strategy to test the planned corrective actions in a demonstration pilot.  The pilot was
  conducted in 1998, and the Service concluded in its preliminary draft report on the results
  of the pilot, issued in May 1999, that the recommendations in the September 1997 report
  should be implemented. Service officials said that they expected to implement the
  improvements to the Program in time for the next sale of royalty oil to the refiners, which
  was scheduled for October 1999.
  
  The Small Refiners Program is administered by the Royalty-in-Kind Section, within the
  Accounting and Reports Division of the Service's Royalty Management Program.  The Small
  Refiners Program costs about $1.2 million to operate each year, and the Section has seven
  full-time positions.  The Service requires, under its regulations (30 CFR 208), that the costs
  of operating the Program be recovered by administrative fees assessed on the participating
  refiners.
  
  SCOPE OF AUDIT
  
  Our audit scope consisted of a review of the Service's Program activities conducted from
  October 1996 through August 1999.  The audit fieldwork was conducted primarily at the
  Service's Royalty Management Program offices in Lakewood, Colorado, where we
  interviewed cognizant Program officials and examined relevant records.  We also
  interviewed cognizant officials at the Service's Policy and Management Improvement offices
  in Lakewood.  We visited or contacted 13 small refiner companies: the 5 refiners currently
  in the Small Refiners Program, 5 former Program participants, and 3 small refiners that had
  not previously participated in the Program.  Additionally, we visited or contacted the Service
  offices, state government offices, oil companies, and oil industry trade organizations listed
  in Appendix 2.
  
  Our audit was conducted in accordance with the "Government Auditing Standards," issued
  by the Comptroller General of the United States.  Accordingly, we included such tests of
  records and other auditing procedures that were considered necessary under the
  circumstances.  As part of the audit, we reviewed the internal controls to the extent
  considered necessary to accomplish our audit objective.  We also reviewed the Secretary's
  Annual Statements and Reports to the President and the Congress for fiscal years 1993
  through 1995, which were required by the Federal Managers' Financial Integrity Act; the
  Departmental Reports on Accountability for fiscal years 1996, 1997, and 1998, which
  include information required by the Act; and the Service's annual assurance statements on
  management controls for fiscal years 1996, 1997, and 1998.  We determined that none of the
  reported weaknesses were directly related to the objective and scope of this audit.
  
  PRIOR AUDIT COVERAGE
  
  Neither the Office of Inspector General nor the General Accounting Office has issued any
  audit reports during the past 5 years concerning the Small Refiners Program.  However,
  during this period, the Office of Inspector General has issued two reports and the General
  Accounting Office has issued one report that related to the royalty-in-kind concept of
  collecting Federal oil and gas royalties as follows:
  
  - In May 1996, the Office of Inspector General issued the report "Royalty Gas Marketing
  Pilot, Minerals Management Service" (No. 96-I-786), which stated that the Service had
  effectively administered the 1995 Royalty Gas Marketing Pilot and had demonstrated the
  feasibility of taking gas royalties in-kind as an alternative to the royalty-in-value system.  The
  report noted, however,  that there were weaknesses in the areas of pilot design, revenue
  collections, marketing strategies, and administrative controls.  We also concluded that the
  1995 pilot was too limited in scope to accurately represent gas operations in the Gulf of
  Mexico.  Although the report contained no recommendations, it did contain suggestions for
  the Service to consider in the design of future royalty-in-kind pilots, such as conducting
  larger scale pilots with mandatory lease holder participation.
  
  - In March 1999, the Office of Inspector General issued the report "Royalty-in-Kind
  Demonstration Pilots, Minerals Management Service" (No. 99-I-371), which stated that the
  Service was successfully managing the three royalty-in-kind pilots.  However, we determined
  that the limited geographic coverage and products examined by the pilots would not  result
  in a conclusive in-kind feasibility assessment for all Federal oil and gas production.  The
  report contained no recommendations but made suggestions that we believe will enhance the
  effectiveness of the pilot program,  such as that the Service should  expand the scope of the
  pilots to cover additional oil- and gas-producing regions and take both oil and gas from the
  same leases.
  
  - In August 1998, the General Accounting Office issued the report "Federal Oil Valuation,
  Efforts to Revise Regulations and an Analysis of Royalties in Kind" (No. GAO/RCED-98-
  242) in response to a Congressional request to address the following: "(1) the information
  used by MMS [the Minerals Management Service] to justify the need for revising its oil
  valuation regulations; (2) how MMS has addressed concerns expressed by the oil industry
  and states in developing these regulations; and (3) the feasibility of the federal government's
  taking its oil and gas royalties in kind, as indicated by existing studies and programs."  The
  report stated that the Service (1) "relied heavily" on an interagency task force report to justify
  revising its oil valuation regulations and (2) solicited public comments    o
  n its proposed regulations in five "Federal Register" notices and revised its proposed
  regulations three times in response to the comments received.  The report further stated that
  available information
  
  . . . indicates that it would not be feasible for the federal government to take its oil and
  gas royalties in kind except under certain conditions.  These conditions include having
  relatively easy access to pipelines to transport the oil and gas, leases that produce
  relatively large volumes of oil and gas, competitive arrangements for processing gas, and
  expertise in marketing oil and gas.  However, these conditions are currently lacking for
  the federal government and for most federal leases.
  
  The report did not contain any recommendations.
  
  RESULTS OF AUDIT
  
  We concluded that the Minerals Management Service had made satisfactory progress in
  correcting the deficiencies in the Small Refiners Program that were identified in a formal
  study conducted by Service, state government, and industry officials.  For example, the
  Service improved the process for determining the value of royalty oil and was redesigning
  the Program to ensure that refiners pay royalties for oil volumes received.  We found,
  however, that the Program had weaknesses that not been addressed.  Specifically, the Service
  did not address the anticipated increase in demand for oil from the refiners, did not conduct
  royalty oil sales on a frequent or regular basis, and did not recover the full costs of
  administrating the Program.  Program regulations (30 CFR 208.4) require that the Service
  conduct an analysis of the crude oil market prior to a royalty oil sale to determine whether
  small refiners have adequate access to supplies of oil at equitable prices.  In addition, 30 CFR
  208.4(b)(4) and Office of Management and Budget Circular No. A-25, "User Charges,"
  require that the Service recover the full administrative costs of the Program.  The weaknesses
  identified occurred because the Service's crude oil market analysis did not include potential
  oil available to small refiners under the 20 percent set-aside lease provision and because
  Program officials, in attempting to reduce the financial impact on the refiners, recovered only
  a portion of the administrative costs.  Because the Service did not conduct a complete
  analysis of the oil market, the oil volumes in the next royalty sale will not likely be sufficient
  to satisfy the expected increase in demand from the small refiners.  Further, the Service has
  not recovered administrative costs of about $1.9 million since fiscal year 1997 (see
  Appendix 1).
  
  Program Improvements Completed or In Progress
  
  We concluded that the Service was making progress in correcting the deficiencies in the
  Small Refiners Program identified by the formal study.  As part of this effort, the Service has
  held discussions with Program participants since 1996 to create what they consider to be a
  commercially oriented Program that operates more efficiently and is more responsive to the
  oil industry.  The small refiners that we contacted generally agreed that this objective was
  being achieved and indicated that they were interested in purchasing the royalty oil. 
  Although they attributed this interest in part to the fact that the Program represented a rare
  source of supply that can be secured for long-term periods at reasonable prices, the refiners
  also credited the Service with improving the Program significantly over the past 2 years.
  
  The specific deficiencies and the actions that were implemented or were being considered
  to correct the deficiencies were as follows:
  
  - Before fiscal year 1998, the small refiners' oil purchase contracts authorized the Service
  to review the validity of the valuation methodologies used for royalty payments and, if
  warranted, assess additional royalties up to 7 years after the initial payment.  As a result,
  time-consuming and expensive disputes with the refiners occurred concerning the proper
  valuation of the oil.  The Service, however,  corrected this Program deficiency in fiscal year
  1998 by negotiating price formulas into the oil purchase contracts, an action that prohibits
  any redetermination of the values.  We believe that the price formulas provide the refiners
  with a simple methodology to value the royalty oil, and compliance is readily verifiable by
  the Service.  Service officials said that they were satisfied that this approach did not result
  in reduced royalty collections and that they intended to negotiate price formulas into future
  contracts with the small refiners.
  
  - The Service has not adopted the standard industry practice of basing payments on the
  volume of oil delivered by the lease operator.  Instead, the Program requires that royalty
  payments be based on the volume of oil that the refiner is contractually entitled to receive
  from the operator.  As a result, small refiners paid royalties for undelivered oil.  To illustrate,
  the volume of oil delivered to the refiner for a given month is based on an estimated
  production amount.  However, the lease operator regularly produces a volume different from
  the estimate, creating an "imbalance."  Because royalties are due on the volume of oil
  produced (the entitlement volume), the refiner may pay royalties on an oil volume that it did
  not receive.  Service officials said that they bill the refiners based on entitlement volumes
  because these volumes "in theory" should equal delivered volumes.  Although the lease
  operator corrects imbalances by overdelivering or underdelivering oil in future months or by
  making cash payments as necessary, this creates a burden for the small refiners that do not
  have sufficient financial resources.  For example, one refiner stated that it had paid more than
  $1 million of royalties for oil which had not been delivered and that after more than 1 year,
  the volume imbalance had not been fully corrected.  At the time of our audit, the Service was
  reviewing options that would base royalty payments on delivered volumes. Service officials
  stated that this Program deficiency would be corrected before the October 1999 Government
  royalty oil sale to small refiners.
  
  - The small refiners have been critical of the Program because it requires surety instruments
  to be posted for what they consider to be excessive periods of time.  Program regulations (30
  CFR 208.11) require a refiner to provide a surety at the beginning of a contract covering an
  amount estimated to be equal to a 99-day purchase of royalty oil and require the surety to be
  enforceable for 9 months after the contract terminates.  We found that these time periods
  were longer than the industry standard of 50 to 60 days and resulted in less money available
  for refinery operations.  The refiners stated that the Government did not benefit from its
  surety policy because the extra costs incurred by the refiners were passed on to the
  Government through lower prices offered for the oil.  However, Service officials said that
  the Government should be fully insured against possible loss if a refiner does not pay for
  royalty oil and that the 99-day period for the surety represents the minimum time frame for
  the Service to terminate deliveries of oil under a purchase contract in the event of
  nonpayment by the small refiner.  At the time of our audit, however, Service officials said
  that they might shorten the surety period to 60 days for future royalty oil sales.
  
  Based on the actions implemented or under consideration, we believe that the Service has
  demonstrated that it can successfully manage a royalty-in-kind system with small refiners.
  
  Program Improvements Needed
  
  During our audit, we found that the Service had not adequately addressed the issues of oil
  volumes and the recovery of administrative costs, as discussed in the paragraphs that follow.
  
  Oil Volumes.  We found that the volume of royalty oil the Service plans to market in the
  October 1999 sale is not likely to be sufficient to meet the demands from the small refiners. 
  The small refiners contacted said that they anticipate a decline in oil supplies in the open
  market and that they therefore are increasingly interested in obtaining Government royalty
  oil.  For example, all 13 small refiners that we contacted supported continuation of the
  Program, and 3 of the 5 refiners in the Program said that they would like to purchase larger
  volumes of royalty oil.  Additionally, Service officials said that they expect at least
  20 refiners to participate in the October 1999 royalty oil sale, or at least four times the
  number currently in the Program.  The Service, however, may be unable to substantially
  increase the amount of royalty oil in the sale because most of the remaining royalty oil that
  has not been dedicated to the Program has been committed to refilling the Strategic
  Petroleum Reserve.
  
  We found that the demand for royalty oil could exceed 136,000 barrels per day (based on
  6,826 average barrels per day purchased by the five participants during fiscal year 1999
  multiplied by the Service's estimate of at least 20 refiners), a number that is significantly
  more than the maximum of 80,000 barrels per day from the Gulf of Mexico that the Service
  plans to sell in October 1999.  Consequently, the Service may have to reduce the volume of
  oil to each refiner and/or exclude some refiners from the sale.  However, we found that the
  Service had not considered that substantial oil volumes are potentially available for sale to
  small refiners under the "20 percent set-aside" provision contained in many offshore leases. 
  Program regulations (30 CFR 208.4) require the Service, prior to a royalty oil sale, to
  conduct a study (known as a  Determination of Need) to determine whether small refiners
  will benefit from the sale.  Accordingly, the Service solicited comments from the oil industry
  and relevant Governmental agencies in fiscal year 1999 to determine whether small refiners
  had adequate access to crude oil supplies at equitable prices.  The Service's Accounting and
  Reports Division issued an analysis paper in April 1999 that concluded that small refiners
  had difficulty in obtaining crude oil supplies at fair market prices and recommended that the
  Service continue the Program and hold another sale of royalty oil "as soon as possible."
  
  The Outer Continental Shelf Lands Act (43 U.S.C. ï¿½1337(b)(7)) provides that each offshore
  lease will contain a provision requiring the lessee to offer 20 percent of the oil production
  for sale to small or independent refiners.  Our analysis of crude oil production data provided
  by the Service's Offshore Minerals Management regional offices in New Orleans, Louisiana,
  and Camarillo, California, disclosed that as of January 1999, approximately 160,000 barrels
  of oil subject to the provision were produced each day, consisting of 150,550 barrels per day
  from the Gulf of Mexico Region and 8,950 barrels per day from the Pacific Region.
  
  While the Service does not monitor compliance or keep records concerning the amount of
  set-aside oil purchased by small refiners, cognizant Service officials stated that "few" small
  refiners acquired the oil.  Our analysis disclosed that this oil supply was not fully accessed
  for various reasons, such as the set-aside provision was not well known in the oil industry,
  small refiners and lessees may have had difficulty in agreeing on the logistics for delivering
  the oil, and insufficient guidance existed on the implementation of the set-aside lease
  provision.  Further, because the Service considers the provision to be "self-executing," it has
  not developed regulations or procedures for implementation except for a Notice of
  Interpretation issued in the "Federal Register" in 1983.
  
  In our opinion and consistent with Program regulations, the Service should consider the
  volume of oil that is available to refiners under the 20 percent set-aside provision and
  coordinate this information with the requirements of the Small Refiners Program.  We
  estimate that the combined oil from these two sources should provide about 240,000 barrels
  per day (160,000 barrels from the 20 percent set-aside provision plus a minimum of 80,000
  barrels from the Program) for the small refiners.
  
  Frequency of Sales.  The Service has conducted royalty oil sales on an infrequent and
  irregular basis, which impairs the ability of small refiners to rely on this supply source for
  planning purposes.  Specifically, the most recent sales were held in 1983, 1987, and 1994,
  with the next sale scheduled for October 1999.  Thus, the time frame between sales averaged
  about 5 years, which, in our opinion, is too long considering the dynamic and cyclical nature
  of the oil industry.  Further, regulations (30 CFR 208) for the Program do not clearly specify
  when oil sales should be conducted, stating only that the crude oil market may be evaluated
  "from time to time."  The Service has routinely extended the periods of the existing purchase
  contracts with the refiners because of the absence of regular oil sales.  However, refiners said
  that they would prefer that sales be held more frequently and regularly.  We believe that the
  Service should accommodate the refiners by establishing a regular schedule of sales every
  2 or 3 years.  The Service should also consider conducting an interim sale between the
  scheduled sales, as allowed by Program regulations (30 CFR 208.4(d)), if sufficient volumes
  of royalty oil become available to attract competitive bids.
  
  Recovery of Administrative Costs.  The Service has not recovered the full amount of the
  Program's administrative costs, as required by applicable regulations.  Regulations (30 CFR
  208.4(b)(4)) for the Program require administrative costs to be allocated to the refiners on
  the basis of the "total number of leases under contract" (that is, active leases).  Therefore, if
  total administrative costs remain constant but the number of leases in the Program decreases,
  the monthly administrative fee should increase because the same amount of costs will be
  distributed over a smaller base.  However, since March 1997, the Service has documented
  the full cost of administrating the Program but has charged only the fee associated with
  leases active in the Program.  According to Service officials, the lower fee assessment was
  charged because certain refiners had terminated leases from the Program and the remaining
  refiners objected that the resultant increase in the monthly fee from $180 to $450 (150
  percent) would have forced them to resign from the Program.  Consequently, the Service did
  not raise the monthly fee, and the refiners were assessed only about one-third of the
  administrative costs.  However, 30 CFR 208.4(b)(4) provides that the Service "will recover
  the administrative costs of the RIK [royalty-in-kind] Program through the collection of
  administrative fees."  Although Service officials said that they interpreted the regulations to
  support the collection of costs associated only with active leases, we believe that the
  regulations require the Service to collect the full administrative costs of the Program. 
  Additionally, Office of Management and Budget Circular No. A-25, which provides
  guidance for the implementation of Title V of the Independent Offices Appropriations Act
  of 1952 (the User Charge Statute), states that agencies should assess user charges to recover
  the full costs of Federal activities provided to recipients of special benefits.
  
  Because of its interpretation, the Service has not recovered administrative costs totaling
  about $1.9 million for the period of March 1997 through September 1999 and will not
  recover costs of approximately $813,000 for each additional year that this matter remains
  uncorrected.  Further, state governments will be adversely impacted if the Service conducts
  a sale of royalty oil for onshore leases because, under the net receipts sharing process, a
  portion of the unrecovered costs will be passed on to the states through reductions in their
  monthly royalty distributions.
  
  Recommendations
  
  We recommend that the Director, Minerals Management Service, require Small Refiners
  Program officials to:
  
  1.  Ensure that the Determination of Need considers all sources of oil available to the small
  refiners, including the 20 percent set-aside lease provision.
  
  2.  Conduct the Determination of Need on a regular basis and increase the frequency of the
  analyses, such as every 2 or 3 years.  The Service should also consider conducting interim
  Government royalty oil sales if the need for the oil is established and sufficient volumes of
  oil become available to attract competitive bids.
  
  3.  Ensure that the Service recovers the full costs of administrating the Program from the
  small refiners, as required by  30 CFR 208.4(b)(4) and Office of Management and Budget
  Circular No. A-25.
  
  Minerals Management Service Response and Office of Inspector General
  Reply
  
  In the January 5, 2000, response (see Appendix 3) to the draft report from the Director,
  Minerals Management Service, the Service concurred with Recommendation 2 but did not
  concur with Recommendations 1 and 3.  Based on the response, we consider
  Recommendation 2 resolved but not implemented.  Accordingly, the unimplemented
  recommendation will be referred to the Assistant Secretary for Policy, Management and
  Budget for tracking of implementation, and the Service is requested to reconsider its
  responses to Recommendations 1 and 3, which are unresolved.
  
  Recommendation 1.  Nonconcurrence.
  
  Minerals Management Service Response.  The Service stated that it would "consider all
  relevant information" when conducting a  Determination of Need for future royalty oil sales
  and that "the failure to use the 20 percent set aside does not preclude a determination that
  there is a need to sell royalty oil to the small refiner."  The Service further stated that it does
  "not believe it would be appropriate to implement" the recommendation.
  
  The Service also disagreed with the report's statement that the volume of royalty oil the
  Service planned to market in the October 1999 sale would likely be insufficient to meet the
  demands from the small refiners.  The Service further stated that in the October 1999 sale,
  which was held after the issuance of our preliminary draft report, the Service accepted bids
  for 16,600 of the 22,000 barrels of royalty oil from the Pacific Region but that "no acceptable
  bids" were received for the 80,0000 barrels of oil from the Gulf of Mexico Region because
  none of the bids met the Service's "established reasonable price thresholds."  The Service 
  stated that small refiners may have adequate access to sufficient amounts of oil from non-
  Federal sources.
  
  Office of Inspector General Reply.  Although the Service stated that it would "consider all
  relevant information" when conducting a Determination of Need for future royalty oil sales,
  the Service did not specifically affirm that an analysis of oil available under the 20 percent
  set-aside lease provision would be performed.  To the contrary, the Service indicated that the
  20 percent set-aside was not relevant to the Determination of Need process.   We believe,
  however, that the results of a Determination of Need cannot be valid if this potentially
  significant source of oil available to small refiners is disregarded.
  
  Regarding the Service's comments on the results of the October 1999 sale, we believe that
  the Service should not interpret the relatively small volume of royalty oil awarded as a lack
  of demand for oil by the small refiners.  In our opinion, the fact that the bids did not meet the
  Service's "established reasonable price thresholds" could indicate that the small refiners have
  a different opinion of what constitutes a reasonable price.  Our analysis, based in part on
  contacts with the small refiner companies and industry trade associations, disclosed a strong
  interest among small refiners to purchase Government royalty oil.  The Service's own
  Determination of Need also reached this conclusion.  Therefore, the results of the
  October 1999 sale should not be the basis to conclude that small refiners have sufficient
  access to oil from non-Federal sources.
  
  Recommendation 3.  Nonconcurrence.
  
  Minerals Management Service Response.  The Service stated that it was "properly
  recovering the costs of administering the program, as required by 30 CFR 208.4."  The
  Service stated that it should  recover only the costs of administrating leases active in the
  Program, stating that it "cannot support" our "contention that the costs attributable to
  terminated contracts should be borne by the current RIK [royalty-in-kind] program
  participants." The Service further stated that the Program regulations provide flexibility in
  determining the costs that may be recovered.
  
  Office of Inspector General Reply.  We disagree that the Service should  recover only the
  administrative costs associated with the leases active in the Program.  In our opinion, the
  Program regulations (30 CFR 208.4(b)(4)) provide for the recovery of total administrative
  costs.  Moreover, as stated in the report, Office of Management and Budget Circular No. A-
  25 requires that agencies assess user charges to recover the full costs of Federal activities
  provided to recipients of special benefits.  The Circular (Section 6) further requires that
  agencies choosing to make an exception to recovering full costs submit a request to the
  Director of the Office of Management and Budget.  The Service has not requested such an
  exception, and without approval of such an exception, the Service should recover the full
  costs of administrative activities.
  
  In addition, the Service should recognize that administrative costs, such as post-contract
  costs, are routine activities associated with both refiners that have terminated their contracts
  as well as refiners that have completed contractual obligations.  As such, these costs are
  incurred for all small refiners participating in the Program.  Accordingly, to recover the costs
  in compliance with the Circular, the Service should base the monthly administrative fee on
  the full $1.2 million cost of operating the Program. 
  
  Other Matters
  
  The eligibility of a company to qualify as a small refiner depends on whether the royalty oil
  originates from offshore leases or onshore leases.  This situation exists because the laws that
  authorize the Program for onshore lease sales (Mineral Leasing Act, as amended in 1946)
  and for offshore lease sales (Outer Continental Shelf Lands Act, as amended in 1978) contain
  different eligibility criteria.  For example, the eligible small refiner for onshore lease sales
  must not have total refinery capacity of more than 175,000 barrels per day, while the offshore
  eligible small refiner must not have total refinery capacity of more than 75,000 barrels per
  day.  As a result, if royalty oil produced from both offshore and onshore leases becomes
  available for sale, the Service must conduct separate royalty oil sales.  We did not locate, nor
  did the Service provide, documentation supporting the different qualification criteria. 
  Although Service officials stated that amending the applicable laws would be time
  consuming, we believe that a single eligibility criterion would result in more efficient royalty
  oil sales.
  
  In accordance with the Departmental Manual (360 DM 5.3), we are requesting a written
  response to this report by May 8, 2000.  The response should include the information
  requested in Appendix 4.
  
  Section 5(a) of the Inspector General Act (5 U.S.C. app. 3) requires the Office of Inspector
  General to list this report in its semiannual report to the Congress.  In addition, the Office of
  Inspector General provides audit reports to the Congress.