[Audit Report on Oil and Gas Transportation  Allowances and Gas Processing Allowances,  Minerals Management Service]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 00-i-290

Title: Audit Report on Oil and Gas Transportation  Allowances and
       Gas Processing Allowances,  Minerals Management Service

Date:  March 27, 2000


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U.S. Department of the Interior
Office of Inspector General



AUDIT REPORT
OIL AND GAS TRANSPORTATION ALLOWANCES 
AND GAS PROCESSING ALLOWANCES,
MINERALS MANAGEMENT SERVICE


REPORT NO. 00-I-290

MARCH  2000



EXECUTIVE SUMMARY

Oil and Gas Transportation Allowances and Gas Processing
Allowances, Minerals Management Service (No. 00-i-290)


BACKGROUND

The Minerals Management Service (MMS) is responsible for
collecting and accounting for rental and royalty payments
received under all Federal and Indian oil and gas leases and
determining whether royalties received for products represent
fair and equitable value.  To fulfill these obligations, MMS
promulgates regulations concerning the sales and payment of
royalties on crude oil, natural gas, and liquid products from
Federal and Indian leases.  The Code of Federal Regulations (30
CFR 202 and 206) contains regulations that pertain to MMS's
transportation and gas processing allowances.  The regulations
allow royalty payors to reduce royalties by claiming deductions
for reasonable and actual costs of transporting oil and gas and
processing gas on allowance reports.

MMS's automated allowance tracking system is used to monitor
transportation and processing allowances to determine whether
deductions exceed regulatory limits on allowances.  The system
identifies those leases for which the allowance deduction exceeds
a specified maximum percentage of the oil or gas value at the
point of sale.  This system also identifies and bills payors for
additional royalties when allowances have been deducted from
royalties due and the required forms to deduct the allowances
have not been filed.  MMS officials said that the tracking and
billing program portion of the system was terminated in 1994
because the system required too many resources and generated too
many errors.

During calendar years 1996 through 1998, MMS collected revenues
of more than $17.8 billion from approximately 25,471 Federal and
Indian mineral leases, of which $11.4 billion was for oil and gas
royalties.  Royalty payors deducted about $222.5 million in oil
and gas transportation allowances and $111 million in gas
processing allowances from royalty payments for the 3-year
period.  For calendar years 1996 through 1998, MMS oversaw
collections of royalties of $331 million on approximately 3,723
Indian leases with gas ($203 million) and oil ($128 million)
production.  

OBJECTIVE

The objective of the audit was to determine whether MMS
satisfactorily implemented the recommendations made in our 1994
report and ensured that royalty payors deducted only the
appropriate amount of oil and gas transportation allowances from
royalties due.

RESULTS IN BRIEF

We found that two of the three prior recommendations in our
August 1994 report were no longer valid for Federal leases or
Indian gas leases after December 31, 1999, because of  revisions
to the valuation regulations and that MMS had implemented the
remaining  recommendation.  In addition, based on our limited
audit of both offshore and onshore transportation allowances and
offshore gas processing allowances on selected leases, we found
that royalty payors had deducted the appropriate amount of oil
and gas transportation and processing allowances from royalties
due.  However, MMS was not maintaining an accurate filing system
for tracking allowance reports for oil production on Indian
leases.  We believe that MMS should maintain a filing system so
that it can provide information from the allowance reports,
copies of the arm's-length contracts, or actual cost information
to the tribes when requested by tribal officials.  At a State and
Tribal Royalty Audit Committee meeting, MMS presented steps it
will take for filing, tracking, and distributing data and forms
for Indian leases.  The steps were accepted by Committee members.

RECOMMENDATIONS

The report did not contain any recommendations.

AUDITEE COMMENTS

In our March 9, 2000, exit conference with officials from MMS
headquarters and the Royalty Management Program, the officials
agreed with the conclusions presented in a draft of this report.



                                                C-IN-MMS-003-99-D
AUDIT REPORT

Memorandum

     To:  Director, Minerals Management Service

   From:  Roger La Rouche
          Acting Assistant Inspector General for Audits

Subject:  Audit Report on Oil and Gas Transportation 
          Allowances and Gas Processing Allowances, 
          Minerals Management Service (No. 00-i-290)

INTRODUCTION

This report presents the results of our followup review of
recommendations contained in our August 1994 audit report
entitled "Transportation and Processing Allowance Deductions,
Minerals Management Service" (No. 94-I-1110).  The objective of
the followup review was to determine whether the Minerals
Management Service (MMS) satisfactorily implemented the
recommendations made in our 1994 report and ensured that royalty
payors deducted only the appropriate amount of oil and gas
transportation allowances from royalties due.

BACKGROUND

According to the Federal Oil and Gas Royalty Management Act of
1982 (30 U.S.C. *1711(a)), the Secretary of the Interior is
required to "establish a comprehensive inspection, collection and
fiscal and production accounting and auditing system to provide
the capability to accurately determine oil and gas royalties,
interest, fines, penalties, fees, deposits, and other payments
owed, and to collect and account for such amounts in a timely
manner."  

MMS is composed of two specialized programs: the Royalty
Management Program and the Offshore Minerals Management Program.
All mineral revenue functions are centralized within the Royalty
Management Program, which collects, accounts for, and distributes
revenues generated from Federal and Indian lands and the Outer
Continental Shelf.  MMS's Offshore Minerals Management Program
conducts leasing activities for and provides oversight of mineral
operations on the Nation's Outer Continental Shelf.  MMS is
responsible for collecting and accounting for rental and royalty
payments received under all Federal and Indian oil and gas leases
and determining whether royalties received for products represent
fair and equitable value.  To fulfill these obligations, MMS
promulgates regulations concerning the sales and payment of
royalties on crude oil, natural gas, and liquid products from
Federal and Indian leases.  The Code of Federal Regulations (30
CFR 202 and 206) contains regulations that pertain to MMS's
transportation and gas processing allowances.  The regulations
allow royalty payors to reduce royalties by claiming deductions
for reasonable and actual costs of transporting oil and gas and
processing gas on allowance reports (Form MMS-4110, "Oil
Transportation Allowance Report"; Form MMS-4295, "Gas
Transportation Allowance Report"; or Form 4109, "Gas Processing
Allowance Report").  Payors are required to file Form MMS-2014,
"Report of Sales and Royalty Remittance," which identifies
royalties due and deductions for these allowances.

MMS's automated allowance tracking system is used to monitor
transportation and processing allowances to determine whether
deductions exceed regulatory limits on allowances.  The system
identifies those leases for which the allowance deduction exceeds
a specified maximum percentage (50 percent for oil and gas
transportation and 66.7 percent for gas processing) of the oil or
gas value at the point of sale.  This system also identifies and
bills payors for additional royalties when allowances have been
deducted from royalties due and the required forms to deduct the
allowances have not been filed.  MMS officials said that the
tracking and billing program portion of the system was terminated
in 1994 because the system required too many resources and
generated too many errors.

During calendar years 1996 through 1998, MMS collected revenues
of more than $17.8 billion from approximately 25,471 Federal and
Indian mineral leases, of which $11.4 billion was for oil and gas
royalties.  Royalty payors deducted about $222.5 million in oil
and gas transportation allowances and $111 million in gas
processing allowances from royalty payments for the 3-year
period.  For calendar years 1996 through 1998, MMS oversaw
collections of royalties of $331 million on approximately 3,723
Indian leases with gas ($203 million) and oil ($128 million)
production.  

SCOPE OF AUDIT

The scope of this self-initiated audit was to follow up on the
actions MMS had taken to implement the three recommendations made
in our August 1994 report and to determine whether  MMS has
ensured that royalty payors deducted only the appropriate amount
of oil and gas transportation allowances and gas processing
allowances from royalties due.  To accomplish our objective, we
performed audit work at MMS's Royalty Management Program in
Lakewood, Colorado, and the offshore operations in Santa Maria,
California.  We also visited the offices of Chevron Oil Company
in San Ramon, California; Marathon Oil Company in Findlay, Ohio;
and Yates Petroleum Corporation in Artesia, New Mexico.

In performing our audit, we reviewed MMS's allowance limit
exception processing system; examined selected lease data and
transportation allowances for both onshore and offshore
operations for calendar year 1997; interviewed MMS officials
regarding implementation of our prior recommendations; and
reviewed Indian annual allowance forms for calendar years 1996,
1997, and 1998 for 14 judgementally selected leases based on
leases that had a significant amount of royalties.

Our audit was made 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 our audit, we evaluated the system of
internal controls to the extent we considered necessary.  We also
reviewed the Departmental Report on Accountability for fiscal
year 1998, which includes information required by the Federal
Managers' Financial Integrity Act of 1982, and MMS's annual
assurance statement on management controls for fiscal year 1998
to determine whether any reported weaknesses were within the
objective and scope of our audit.  Neither the Accountability
Report nor the assurance statement addressed oil or gas
transportation allowances.

PRIOR AUDIT COVERAGE

The General Accounting Office has not issued any audit reports
during the past 5 years on MMS's oil and gas transportation
allowances or gas processing allowances.  Our August 1994 report
"Transportation and Processing Allowance Deductions, Minerals
Management Service" (No. 94-I-1110) contained three
recommendations to the MMS Director.  We recommended that MMS
monitor transportation and processing allowances deducted by
royalty payors; notify royalty payors of any allowance reporting
differences and request that they explain the allowance
differences; and  implement an allowance limit exception
processing enhancement to the automated allowance tracking
system.  MMS concurred with the report's three recommendations.

RESULTS OF AUDIT

We found that two of the three prior recommendations in our
August 1994 report were no longer valid for Federal leases or
Indian gas leases after December 31, 1999, because of  revisions
to the valuation regulations and that MMS had implemented the
remaining  recommendation.  In addition, based on our limited
audit of both offshore and onshore transportation allowances and
offshore gas processing allowances on selected leases, we found
that royalty payors had deducted the appropriate amount of oil
and gas transportation and processing allowances from royalties
due.  However, we found that MMS was not maintaining an accurate
filing system for tracking allowance reports for oil production
on Indian leases.  We believe that MMS should maintain a filing
system so that it can provide information from the allowance
reports, copies of the arm's-length contracts, or actual cost
information to the tribes when requested by tribal officials.

Prior Audit Report Recommendations

Recommendation 1.  Monitor the transportation and processing
allowances deducted by royalty payors to determine whether the
deductions exceeded the actual allowance costs reported to the
Service.

Recommendation 2.  Notify royalty payors of the allowance
reporting differences and request that they explain the allowance
differences and correct the allowance reports or pay additional
royalties. 

We found that Recommendations 1 and 2 from our 1994 audit report
(No. 94-I-1110) were no longer applicable to Federal leases as of
March 1996 and do not apply to Indian gas leases after December
31, 1999.  MMS's "Revision of Valuation Regulations Governing Oil
and Gas Transportation and Processing Allowances, and Coal
Washing and Transportation Allowances," effective on March 1,
1996, and "Amendments to Gas Valuation Regulations for Indian
Leases" effective on January 1, 2000, eliminated  the requirement
of submitting allowance reports[1] that estimated deductions to
royalties due.  However, payors that report actual  allowances
for Indian gas leases based on an arm's-length contract will be
required  to file a copy of the contract with MMS within 2 months
of the date the payor deducts the allowance on Form MMS-2014.
Payors of Indian leases that do not have arm's-length
contracts[2] are required by 30 CFR * 206 to submit actual cost
information to support the allowance on Form MMS-4295, "Gas
Transportation Allowance Report," within 3 months after the end
of the 12-month period to which the allowance applies.  As a
result, MMS will receive allowance information on some Indian
leases and will need to maintain that data for use by tribal
officials. 

MMS published the final rule titled "Amendments to Gas Valuation
Regulations for Indian Leases" in the "Federal Register" (64 FR
43506, dated August 10, 1999), which became effective on January
1, 2000.  This new rule shifted the emphasis from estimated
allowances to actual allowances for gas transportation and gas
processing allowances.  Payors that report the value of gas to
MMS using index-based values, majority prices, or the alternative
methodology for dual accounting include a 10 percent factor for
transportation that does not require additional support to be
submitted by the payor.  Changes in requirements for filing forms
are summarized in the Appendix.

To implement the new rule, an MMS official told us that the
document entitled "Strategy on Implementation of the Indian Gas
Rule," which included the steps for filing, tracking, and
distributing data and forms under the new regulations, was
presented to and accepted by the State and Tribal Royalty Audit
Committee at a meeting held in January 2000.  These steps
included the establishment of a database to identify leases, fund
codes, effective dates, and payor codes.  MMS's State and Indian
Compliance Division will file and track letters for
transportation, valuation notices, and arm's-length
transportation and processing contracts, and it will distribute
these documents to Indian tribes if requested.

Recommendation 3.  Implement the allowance limit exception
processing enhancement for the automated allowance tracking
system to identify allowance deductions that exceeded the
regulatory limitations without the required approval from the
Service and to identify allowance deductions that equaled or
exceeded 100 percent of the royalty value.  Also, royalty payors
should be required to pay additional royalties and interest where
applicable.

The Allowance Limit Exception Processing enhancement was
implemented in November 1997.  We obtained a data base of onshore
royalty payments for calendar year 1997 and reviewed oil and gas
transportation allowance and gas processing allowance deductions
to determine whether the enhancement prevented payors from
taking allowances that exceeded 99 percent of the royalty values.
We found that no allowances exceeded 99 percent of the royalty
value.  In addition, we performed limited testing to determine
whether allowances in excess of regulatory limitations were
deducted by payors without an approved payor allowance limit
request.  We found no instances of allowances taken in excess of
regulatory limitations for which a request had not been approved.
In addition, we found, for the  allowances reviewed of $20.7
million for calendar year 1997, which consisted of $19.8 million
from offshore operations and $.9 million from onshore operations,
that the payors were able to support the allowances claimed.

In our March 9, 2000, exit conference with officials from MMS
headquarters and the Royalty Management Program, the officials
agreed with the conclusions presented in a draft of this report.    

Since this report does not contain any recommendations, a
response is not required.

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.

**FOOTNOTES**

[1]:Prior to March 1, 1996, all royalty payors had to file an
initial allowance report based on estimated or actual costs if
known at the time of submission before any allowance could be
deducted on Form MMS-2014.  Effective in March 1996, the
"Revision of Valuation Regulations Governing Oil and Gas
Transportation and Processing Allowances, and Coal Washing and
Transportation Allowance" eliminated the requirement for filing
annual allowance reports for Federal leases.  However, payors are
still required to submit annual allowance reports and report
differences based on actual costs to MMS for Indian oil leases.

[2]:The Code of Federal Regulations (30 CFR * 206.151) describes
an arm's-length contract as "a contract or agreement that has
been arrived at in the marketplace between independent,
nonaffiliated persons with opposing economic interests regarding
that contract."

APPENDIX 

CHANGES IN REQUIREMENTS FOR 
FILING ALLOWANCE REPORTS
-----------------------------------------------------------
| Period    |Oil        |  Gas      |  Oil      |  Gas    |
|           |(Federal)  |(Federal)  |(Indian)   |(Indian) |
-----------------------------------------------------------
|March 1988 |Allowance  |Allowance  |Allowance  |Allowance|
|   to      |forms      |forms      |forms      |forms    |
|March 1996 |required   |required   |required   |required |
|           |to be      |to be      |to be      |to be    |
|           |filed      |filed      |filed      |filed    |
|           |prior to   |prior to   |prior to   |prior to |
|           |taking     |taking     |taking     |taking   |
|           |allowance. |allowance. |allowance. |allowance.|
-----------------------------------------------------------
|           |No form    |No form    |Allowance  |Allowance|
|March 1996 |filing     |filing     |forms      |forms    |
|   to      |requirements|requirements|required |required |
|January    |unless     |unless     |to be      |to be    |
|  2000     |over       |over       |filed      |filed    |
|           |regulatory |regulatory |prior to   |prior to |
|           |maximums.  |maximums.  |taking     |taking   |
|           |           |           |allowance. |allowance.|
-----------------------------------------------------------
|           |No form    |No form    |Allowance  |For arm's-|
|After      |filing     |filing     |forms      |length   |
|January    |requirements|requirements|required |contracts,|
|  2000     |unless     |unless     |to be      |copies of|
|           |over       |over       |filed in   |the      |
|           |regulatory |regulatory |advance of |contracts|
|           |maximums.  |maximums.  |taking     |to be    |
|           |           |           |allowance. |filed    |
|           |           |           |           |within 2 |
|           |           |           |           |months of|
|           |           |           |           |taking   |
|           |           |           |           |allowance.|
|           |           |           |           |         |
|           |           |           |           |For non- |
|           |           |           |           |arm's-   |
|           |           |           |           |length   |
|           |           |           |           |contracts,|
|           |           |           |           |allowance|
|           |           |           |           |forms to |
|           |           |           |           |be filed |
|           |           |           |           |within 3 |
|           |           |           |           |months   |
|           |           |           |           |after end|
|           |           |           |           |of period*|
|           |           |           |           |based on |
|           |           |           |           |actual   |
|           |           |           |           |cost     |
|           |           |           |           |information.|
-----------------------------------------------------------

* In compliance with MMS's "Amendments to Gas Valuation
Regulations for Indian Leases," payors may choose the actual or
the alternative method of dual accounting (dual accounting refers
to the requirement to pay royalty based on a value that is the
higher of the value of gas prior to processing less any
applicable allowances as compared with the combined value of drip
condensate, residue gas, and gas plant products after processing
less applicable allowances).  If the alternative method is used,
royalty payments and allowance deductions are based on a formula
predetermined by MMS.  In addition, payors in a designated index
zone (index zone is an area with an active spot market and
published indices applicable to that field or area that are
acceptable to MMS) report under MMS's formula.  In these
situations, contracts or other supporting documentation does not
have to be filed.  




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