[Audit Report on the Stripper Oil Well Property Royalty Rate Reduction Program, Bureau of Land Management]
[From the U.S. Government Printing Office, www.gpo.gov]
Report No. 01-I-297
Title: Audit Report on the Stripper Oil Well Property Royalty Rate
Reduction Program, Bureau of Land Management
Date: March 30, 2001
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C-IN-MOA-001-98(B)-D
March 30, 2001
Memorandum
To: Director, Bureau of Land Management
From: Roger La Rouche
Assistant Inspector General for Audits
Subject: Audit Report on the Stripper Oil Well Property Royalty Rate
Reduction Program, Bureau of Land Management (No. 01-I-297)
This report presents the results of our audit of the Stripper Oil Well Property Royalty Rate
Reduction Program. This is the third report that we are issuing on the Program.
In accordance with the Departmental Manual (360 DM 5.3), we are requesting a written
response to this report by April 16, 2001. The response should include the information
requested in Appendix 6.
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.
cc: Director, Minerals Management Service
U.S. Department of the Interior Office of Inspector General
EXECUTIVE SUMMARY
Stripper Oil Well Property Royalty Rate Reduction Program,
Bureau of Land Management
Report No. 01-I-297
March 2001
The Stripper Oil Well Property Royalty Rate Reduction Program, initiated by the Bureau of
Land Management (BLM), became effective on October 1, 1992. The Program was to
provide an economic incentive for operators to maintain or restart production of marginal or
uneconomic oil wells on Federal onshore leases by drilling new wells, by reworking existing
wells, and/or by implementing enhanced oil recovery projects. The Secretary of the Interior
is required by Program regulations to evaluate the effectiveness of the Program, and this
provision allows the Secretary to terminate any or all royalty rate reductions granted under
the Program upon a 6-month notice any time after September 10, 1997.
On February 18, 1998, the Department of the Interior extended the Program for an indefinite
period.
The operators of the properties included in the Program are allowed to pay Federal royalty
rates ranging from 0.5 to 11.7 percent of the value of a barrel of oil. These rates are below
the standard onshore rate of 12.5 percent. As of September 30, 1999, approximately 850
operators and 4,100 properties were participating in the Program. Royalty rate reductions
during the period of October 1, 1992 through December 31, 1998 totaled more than $139
million.
We concluded that the goal of BLM's Stripper Oil Well Property Royalty Rate Reduction
Program of increasing or restarting oil production on marginal or uneconomical wells on
Federal leases has merit. Specifically, we believe that property operators who have already
implemented enhanced or secondary recovery techniques but who were unable to produce
economic quantities of oil and for whom reserves were near depletion could be encouraged
to continue production by obtaining the Program's reduced royalty rates. BLM, however,
did not determine whether all properties participating in the Program needed the reduced
royalty rates to economically maintain or increase production. In addition, BLM's
evaluation supporting the decision to extend the Program was limited in scope and did not
adequately consider comments from BLM's field offices and the Minerals Management
Service (MMS). Further, BLM did not consider a property's economic viability in
connection with Program eligibility and did not provide for an increase in royalty rates if the
property subsequently became economically viable. As a result, we believe that the
Government is losing royalty revenues from Program properties which do not require
reduced royalties to maximize production or promote development.
We also noted that BLM did not include a provision in the Program regulations for
recovering costs of the Program from participating operators. MMS, which is responsible
for confirming the reduced royalty rates authorized under the Program, estimated that it costs
an average of $180,000 annually to process Program notifications and to maintain an
automated royalty rate exception processing routine, which is used to monitor royalty rates
paid by royalty payors. We believe that the $180,000 annual cost should be recovered from
the operators.
We recommended that BLM reevaluate the Program and make changes as appropriate and
that it develop and implement a cost recovery fee for processing Program notifications.
AUDITEE COMMENTS AND OFFICE OF INSPECTOR GENERAL EVALUATION
BLM stated, "In the light of the policy focus on minerals and the change of Administration
. . . . [i]t is our intention to present a full range of policy options from status quo to
discontinuing the program to the new Assistant Secretary for Land and Minerals
Management." BLM also stated that the recommendation to implement a cost recovery fee
will be included in the policy options.
Because the response did not express specific concurrence or nonconcurrence with the
report's two recommendations, the recommendations are considered unresolved.
CONTENTS
Page
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . .5
BACKGROUND. . . . . . . . . . . . . . . . . . . . . . . .5
OBJECTIVE AND SCOPE . . . . . . . . . . . . . . . . . . .7
PRIOR AUDIT COVERAGE. . . . . . . . . . . . . . . . . . .8
FINDINGS AND RECOMMENDATIONS . . . . . . . . . . . . . . . .9
A. PROGRAM OPERATIONS. . . . . . . . . . . . . . . . . .9
B. RECOVERING PROCESSING COSTS . . . . . . . . . . . . 16
APPENDICES
1. OFFICES AND SITES VISITED AND/OR CONTACTED. . . . 18
2. SCHEDULE OF ROYALTY RATE REDUCTIONS . . . . . . . 19
3. SCHEDULE OF ESTIMATED ANNUAL STRIPPER
OIL WELL PROPERTY ROYALTY RATE REDUCTIONS
PROVIDED BY STATE . . . . . . . . . . . . . . . . 20
4. SCHEDULE OF STRIPPER OIL WELL PROPERTIES WITH
THE HIGHEST ESTIMATED ROYALTY SAVINGS
FOR CALENDAR YEAR 1997 . . . . . . . . . . . . . 21
5. BUREAU OF LAND MANAGEMENT RESPONSE. . . . . . . . 24
6. STATUS OF AUDIT REPORT RECOMMENDATIONS. . . . . . 26
INTRODUCTION
BACKGROUND
The Secretary of the Interior is required by the Federal Oil and Gas Royalty Management Act
of 1982 (30 U.S.C. 1711) 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."
The Mineral Leasing Act of 1920 (30 U.S.C. 209) allows the Secretary to adjust royalty
rates on Federal onshore leases to encourage the maximum amount of oil or gas to be
removed. Further, to promote development on leases that cannot be operated economically
under the existing lease terms, the Secretary may waive, suspend, or reduce the royalty on
all or any portion of the leasehold.
The Stripper Oil Well Property Royalty Rate Reduction Program, initiated by the Bureau
of Land Management (BLM), became effective on October 1, 1992. The Program was to
provide an economic incentive for operators to restart production of marginal or uneconomic
oil wells and to increase production on Federal onshore leases by drilling new wells, by
reworking existing wells, and/or by implementing enhanced or secondary oil recovery
projects. The Secretary is required by 43 CFR 3103.4-2(b)(5) to evaluate the effectiveness
of the Program and is allowed, at any time after September 10, 1997, to terminate any or all
royalty reductions granted under the Program upon 6 months notice. On February 18, 1998,
the Department of the Interior extended the Program for an indefinite period.
To qualify for the Program, eligible wells must either produce oil or serve as injection wells
for any period of time during the initial 12-month qualifying period, a preceding period, or
a subsequent 12-month period. The qualifying period is used to determine the average daily
production and the royalty rate that would be effective on or after October 1, 1992. In
calculating the royalty rate, operators are required to use either the initial qualifying period,
which was August 1, 1990 through July 31, 1991, or if shut-in during this period, the
12-month production period immediately prior to the shut-in. Further, properties not
qualifying during or prior to the initial qualifying period are required to use the first
consecutive 12-month qualifying period beginning after August 31, 1990. In addition,
participating operators can submit notifications for further reduced royalty rates subsequent
to their initial participating rate if production levels continue to decline (these subsequent
periods are referred to as outyears). After the first outyear notification is filed, a notification
is required thereafter for each subsequent 12-month period, or the royalty rate reverts to the
initial reduced royalty rate. Each outyear notification is due within 60 calendar days after
the applicable 12-month period.
The operator is required to submit a notification of Program participation on the "Stripper
Royalty Rate Reduction Notification" (Form MMS-4377), which includes the operator's
lease or agreement number, qualifying period, and reduced royalty rate. The operator is
required to calculate the reduced royalty rate using production and injection information
reported on the "Monthly Report of Operations" (Form MMS-3160). The operator
calculates the average production of oil per well per day by dividing the total oil production
produced from eligible wells during the qualifying period by the total number of producing
or injecting well days. The resultant average is rounded down to the nearest whole barrel
regardless of the amount. The reduced royalty rate becomes effective on the first day of the
month after the Minerals Management Service receives the notification. The operators of
the properties included in the Program are allowed to pay Federal royalty rates ranging from
0.5 to 11.7 percent of the value of a barrel of oil (see Appendix 2). These rates are below the
standard onshore rate of 12.5 percent.
BLM has overall responsibility for the Program, including promulgating the Program
regulations; establishing policies and procedures for the Program; conducting all on-the-
ground inspections to verify producing volumes and producing days; and reviewing
production anomalies that are identified by MMS, which are unexplained differences
between reported production from the operator's monthly reports and the notification. MMS
is responsible for confirming the reduced royalty rate information provided by the operator
on the notification forms. The information confirmed by MMS includes the following: the
Federal mineral interest in the property, the identification and the proper description of the
property, and the operator's status as the current operator of the property. MMS also
confirms that wells meet the Program's definition of a producing oil or injection well, that
reported production is complete, and that the corresponding reduced royalty rate is accurate.
Upon completion of this review, MMS notifies the operator that the calculated rate has been
confirmed, adjusted, or disqualified.
As of September 30, 1999, approximately 850 operators and 4,100 properties were
participating in the Program. Royalty rate reductions during the period of October 1, 1992
through December 31, 1998 totaled more than $139 million (see Appendix 3). Stripper oil
properties included single leases, communitization agreements, and units and ranged in size
from a single well to more than 1,300 wells per property.
OBJECTIVE AND SCOPE
The objective of the audit was to determine whether BLM used accurate and effective data
and appropriate methodology to identify Program benefits and costs to justify the Program's
indefinite extension.
Our audit fieldwork was conducted at MMS s Royalty Management Program office in
Lakewood, Colorado, and BLM's Fluid Minerals Office in Washington, D.C. In addition,
we contacted or visited BLM, Department of Energy, and state government officials at the
offices listed in Appendix 1. To meet our audit objective, we examined data relative to
BLM's evaluation study of the Stripper Well Property Royalty Rate Reduction Program and
BLM and MMS records pertaining to individual operators participating in the Program.
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 to accomplish our objective.
We also reviewed the Department of the Interior's Accountability Report for fiscal year
1998, which includes information required by the Federal Managers' Financial Integrity Act
of 1982, and BLM's annual assurance statement on management controls to determine
whether any reported weaknesses were within the objective and scope of our audit. Neither
the Accountability Report nor the assurance statement addressed BLM's involvement in the
Program. In addition, we evaluated BLM's system of internal controls related to the
Program. The internal control weaknesses we found are discussed in the Findings and
Recommendations section of this report. Our recommendations, if implemented, should
improve internal controls in these areas.
PRIOR AUDIT COVERAGE
During the past 5 years, the General Accounting Office has not issued any audit reports on
this Program. However, the Office of Inspector General has issued two audit reports on the
Stripper Oil Well Property Royalty Rate Reduction Program.
In August 1999, we issued the audit report entitled "Processing Notifications for the Stripper
Oil Well Property Royalty Rate Reduction Program, Minerals Management Service"
(No. 99-I-782). The report stated that MMS did not timely confirm notifications it received
and did not timely input the confirmed reduced royalty rates or review differences in the
royalty rates confirmed with the royalty rates paid for properties participating in the Stripper
Oil Well Property Royalty Rate Reduction Program. We recommended that MMS develop
and implement a plan (1) to eliminate the Stripper Oil Well Property Royalty Rate Reduction
Program notification processing and data entry backlogs and to approve future notifications
in a timely manner and (2) to review Program exceptions generated by the automated
matching process and collect underpaid royalties from operators. Based on MMS's response
to the two recommendations, we considered one recommendation resolved and implemented
and the other recommendation resolved but not implemented.
In March 2000, we issued the audit report entitled "Supporting Documentation for Operators
Participating in the Stripper Oil Well Property Royalty Rate Reduction Program, Bureau of
Land Management and Minerals Management Service" (No. 00-I-300). The report stated
that BLM (1) did not provide sufficient oversight of operators to ensure that information on
the production and injection days was correct and (2) did not establish Program policies and
procedures to enable participating operators to accurately compute their reduced royalty rates
and for MMS Program staff to accurately review and confirm the reduced royalty rates
provided by the operators. As a result, royalties may have been underpaid by as much as
$43 million since inception of the Program through December 31, 1998. The report
recommended that BLM and MMS (1) develop and implement a plan which ensures that the
largest benefiting stripper oil well properties are audited, (2) develop a policy for
participating Program operators that do not have records for periods prior to 1993 which
support their qualifying information on their "Monthly Reports of Operations," (3) develop
Program policy and procedures which address qualifying production and wells, and
(4) develop and implement a procedure to review supporting records for future Program
notifications submitted by operators and existing notifications that MMS has not confirmed.
Based on BLM's and MMS's responses to the four recommendations and subsequent
information, we considered two recommendations resolved and implemented and two
recommendations resolved but not implemented.
FINDINGS AND RECOMMENDATIONS
A. PROGRAM OPERATIONS
The goal of BLM's Stripper Oil Well Property Royalty Rate Reduction Program of
increasing or restarting oil production on marginal or uneconomical wells on Federal leases
has merit. Specifically, we believe that property operators who have already implemented
enhanced or secondary recovery techniques but who were unable to produce economic
quantities of oil and for whom reserves were near depletion could be encouraged to continue
production by obtaining the Program's reduced royalty rates. BLM, however, did not
determine whether all properties participating in the Program needed the reduced royalty
rates to economically maintain or increase production. The Mineral Leasing Act of 1920
(30 U.S.C. 209) permits the Secretary to reduce royalty rates in order to encourage
maximum production and to promote development on leases that cannot be operated
economically. The Code of Federal Regulations (43 CFR 3103.4-2) requires that the
Program be evaluated for effectiveness after 5 years, at which time any or all royalty rate
reductions granted under the Program could be terminated upon 6 months' notice. However,
BLM's evaluation supporting the decision to extend the Program was limited in scope and
did not adequately consider critical comments from BLM's field offices and MMS. Also,
BLM did not consider a property's economic viability in connection with Program eligibility
and did not provide for an increase in royalty rates if the property subsequently became
economically viable. As a result, we believe that the Government is losing royalty revenues
from Program properties which do not require reduced royalties to maximize production or
promote development.
Program Extension
The Department of the Interior approved the indefinite extension of the Stripper Oil Well
Property Royalty Rate Reduction Program on February 18, 1998. BLM recommended
indefinite extension based on the results of a joint study conducted by officials from BLM,
MMS, and the Department of Energy. The study's methodology consisted of (1) running a
computer model that compared actual production on selected New Mexico Program
properties with model estimates of production which might have occurred had the royalty
rate remained at 12.5percent, (2) soliciting public and private sector comments, and
(3) reviewing BLM and MMS production data relative to Program properties in other
oil-producing states.
As discussed in the sections that follow, we believe that the scope of this study was
insufficient to support BLM's recommendation for approving an indefinite extension of the
Program without modification. In addition, BLM and MMS officials raised significant
concerns about the adequacy of the study that were not resolved before the recommendation
to extend the Program was made to the Assistant Secretary for Land and Minerals
Management.
Scope of Study. The study did not determine why incremental production increased
on existing wells or why new wells were completed on existing producing properties. In
addition, the number and the locations of the properties used in the computer modeling were
insufficient for results to be projected to the entire Program. These issues are discussed as
follows:
- The recommendation to extend the Program relied primarily on the results of a
Department of Energy computer model (Tertiary Oil Recovery Information System, or
TORIS) that estimated incremental production from 603 sample Program properties in the
State of New Mexico during the period of October 1992 through December 1996. As a result
of the modeling, Department of Energy officials estimated that incremental production from
the existing wells increased by 4.27 million barrels from October 1992 through December
1996 and was attributable to the royalty rate reduction. However, we questioned this
attribution because in calendar year 1997, 88 percent of the production from the top 100
Program-benefiting properties was from properties that had enhanced or secondary recovery
projects. According to industry, BLM, and MMS officials, operator decisions on these types
of projects are based on economic factors such as estimated reserves, oil prices, production
volumes, and production costs. The Department of Energy officials who participated in the
model agreed that incremental production from enhanced or secondary recovery projects
should not have been attributed only to reduced royalty rates when any of these other
economic factors could have been the primary reason the enhanced recovery project was
initiated.
- The Department of Energy sampled 603 Federal properties in New Mexico;
however, its February 9, 1998, report stated that "to more fully assess the effectiveness of
the royalty relief Program, the analysis should be expanded to include Federal lands in other
states." In addition, the Department of Energy also noted that its evaluation did not consider
the impact of oil price changes and "highly recommended that future analysis considers the
impact of the oil price change once the 1997 and 1998 data become available."
- According to MMS comments on the study, 40 percent of the 6,807 stripper
notifications received and logged involved New Mexico properties and 39 percent involved
Wyoming properties. According to MMS, while the study showed an increase in production
from New Mexico, Wyoming experienced a decline in production. MMS also said that
Wyoming was more representative of a stripper oil state and New Mexico is more
representative of a marginal gas state. According to MMS, many of the New Mexico wells
that qualified under the Stripper Program were actually low-producing gas wells rather than
oil wells. Except for the States of California, Colorado, Kentucky, and New Mexico,
production volumes overall decreased on the stripper oil properties, according to MMS,
when 1992 was used as the base year. MMS also stated that the losses in royalty dollars
attributable to the Program were more than $89 million through 1996. According to MMS,
this estimated royalty loss reflected the "worse case scenario of royalty losses" attributable
to the Program and was based on the assumption that every barrel would have been produced
in the absence of the Program. MMS acknowledged that the estimated royalty loss did not
take into consideration incremental production and the economic impact attributable to
shut-in wells if the Program had not been an effect.
Comments on the Program. The study's methodology also solicited comments and
data from the public, industry, BLM, and MMS. Public and industry comments were
received primarily from oil and gas organizations and operators that had properties
participating in the Program. Respondents from the oil and gas industry favored continuing
the Program and cited Program benefits such as extended life of industry's properties,
consideration of secondary recovery processes, ability to drill new wells, and positive impact
on local economies. However, none of the claims by oil property operators or oil producer
associations relative to program benefits on individual properties or industrywide statistics
were verified by BLM.
Fourteen BLM offices (seven state and seven field offices) and MMS's Royalty Management
Program Office made specific comments about Program benefits and the need for continuing
the Program. Although these comments were made by personnel connected with the
Program, the final study report omitted the comments from BLM's field offices and
attributed MMS's comments to "one respondent." In written responses, only 1 (a Colorado
field office) of the 14 responding BLM offices attributed increased production to royalty rate
reductions. Of the remaining 13 offices, 5 offices stated that increased production was not
attributable to royalty rate reduction, 6 offices had no comments on the reasons for the
increased production, and 2 offices did not identify increased production. In regard to
continuation of the Program, four offices recommended termination, nine offices did not
comment on Program extension, and the remaining office recommended specific Program
modifications.
In its comments, MMS suggested that BLM consider evaluating the economics of the
higher-producing properties to determine whether or not a royalty rate reduction was
warranted. MMS agreed that the lower producing properties could benefit from continuation
of the Program and also recognized that some of the higher producing properties may have
had operating costs that would warrant some type of royalty reduction. However, MMS said
that the loss of royalties is greatest with the higher volume producing properties. MMS
suggested that BLM consider narrowing the scope of properties that could continue to
receive a royalty rate reduction. MMS recommended that BLM consider a production cap
under which properties could benefit from a royalty rate reduction and suggested that BLM
consider redefining a stripper property as one that has an average daily production volume
lower than the fewer than 15 barrels of oil per eligible well per well day cited in the
regulation.
Economic Viability
According to 43 CFR 3103.4-2, operators of properties that produce an average of fewer
than15 barrels of oil per eligible well per day may pay reduced royalties. The Code does not
address situations in which properties are profitable or become profitable and do not need
the reduced royalty subsidy in order to maximize production or promote development. Once
a reduced royalty rate is approved for a property, the rate does not go up, even if production
increases, but the rate can go down if production decreases. Stripper regulations allow many
properties that have current production volumes well above BLM's qualifying level of 15
barrels per day to pay reduced royalty rates based on the qualifying period.
Average Production per Well. Operators of many of the largest benefiting Program
properties have drilled new wells, reworked existing wells, or initiated enhanced recovery
projects since qualifying for the Program and have increased production volumes well above
the qualifying maximum level of an average of fewer than 15 barrels of oil per well per day.
Of the top 100 benefiting properties in calender year 1997, 43 properties had increased
production above 15 barrels of oil per day (see Appendix 4), and these properties accounted
for $11.2 million, or about 36 percent, of the total reduced royalty allowed for 1997 of
$31.1 million.
We selected 19 of the 43 properties with average production volumes above 15 barrels for
review of income and expenditures. The 19 properties were selected based mainly on the
availability of property enhancement information submitted to BLM by the operators. This
information pertained to investments in the property that would require BLM approval, such
as reworking or recompleting a well, drilling new wells, plugging old wells, or changing well
status. We examined BLM and MMS records to determine the amount of revenues from oil
sales, royalty rate reductions claimed, and total operator investment in improvements to
increase production from the initial date the reduced royalty rate was claimed through
September 1998. Because we did not have cost information on operator activities not
requiring BLM approval, such as routine maintenance or normal operating expenses, we
were unable to calculate a rate of return on capital investments or determine whether these
properties needed a royalty rate reduction to operate economically. We believe that the
operators of these properties would have invested in the improvements to increase production
even if Program incentives were not available because of how quickly capital costs were
recovered. The potential profitability of these properties is presented as follows:
- A property in New Mexico with one producing oil well and average daily
production of three barrels of oil per day qualified for a reduction of its royalty rate to
2.9 percent in October 1993. In July 1995, the operator recompleted the well into a different
producing formation at an estimated cost of $45,000. In calender year 1997, the property had
increased average daily production to 109 barrels of oil per day. From October 1993 through
September 1998, the property produced more than 137,000 barrels of oil with a sales value
of more than $2.7 million, and the property's operator had received a reduction in its royalty
payments of almost $260,000 (paying a 2.9 percent reduced royalty rate versus the standard
rate of 12.5 percent).
- A property in Wyoming with four producing oil wells and three injection wells and
an average daily production of six barrels of oil per day qualified for a reduction of its
royalty rate to 5.3 percent in October 1992. BLM records show that since qualifying for the
reduced royalty rate, the operator made no investments in the property to enhance
production. In calender year 1997, the property had increased average daily production to
more than 22 barrels of oil per day. From October 1992 through March 1998, the property
produced more than 272,000 barrels of oil with a sales value of more than $5.2 million, and
the property's operator had received a reduction in its royalties of more than $378,000
(paying a 5.3 percent reduced royalty rate versus the standard rate of 12.5 percent).
- A property in California with 376 producing oil wells and 12 injection wells and an
average daily production of 2 barrels of oil per day qualified for a reduction of its royalties
to 2.1 percent in October 1992. Since qualifying for the reduced royalty rate, the operator
drilled 79 new wells and received BLM approval of 309 notices for additional investments
in operations at an estimated cost of about $27 million. In calender year 1997, the property
had an average daily production of more than 31 barrels of oil per day. From October 1992
through September 1998, the property produced more than 4.5 million barrels of oil with a
sales value of more than $86 million, and the property's operator received a reduction in its
royalties of almost $9 million (paying a 2.1 percent reduced royalty rate versus the standard
rate of 12.5 percent).
Although increasing oil production of stripper oil well properties was a goal of the Program,
we believe that operators of those properties which significantly increased production above
the qualifying levels may have invested in the property without the Program incentives of
reduced royalty rates. Accordingly, unless operators can justify, with specific economic
data, that continued reduced royalty rates are required to maximize production or further
promote development, we believe that Program benefits should be reduced or eliminated as
production increases beyond qualifying levels.
Cumulative Production per Property. Properties are permitted by 43 CFR
3103.4-2 to qualify for reduced royalty rates based on average production per well, but the
regulation does not distinguish between a small property with a few wells and low
cumulative production and a large property with many wells and high cumulative production.
During our audit, we found that 72 of the top 100 benefiting properties in calender year 1997
were enhanced or secondary recovery projects. The production from these 72 properties
came from 7,200 wells and totaled 19.6 million barrels, resulting in royalty savings of
approximately $19.4 million (81 percent of the reduced royalty allowed for 1997). In our
opinion, the cumulative amount of production (these 72 properties averaged almost
273,000 barrels of oil each during 1997) provided the economic incentive to keep these
properties producing, and the reduced royalty rate did not significantly affect the operators'
decision to continue production on these properties. In 1997, MMS's Royalty Management
Program and BLM State Offices in Wyoming and Utah provided written comments
regarding the extension of the Program that raised concerns about allowing reduced royalty
rates for secondary recovery properties. The comments from MMS and BLM are as follows:
- MMS expressed concern about qualifying properties that produced large quantities
of oil, noting that the greatest loss in royalty dollars was incurred from these higher
producing properties. MMS conducted a study of the Program's largest qualifying property,
a water flood project in Wyoming that had more than 1,900 wells and produced more than
2 million barrels of oil per year. MMS records showed that the property's operator saved
more than $3.4 million in royalties during calendar year 1997. In its comments, MMS
further stated:
We make the case that this property would have continued [without the
reduced royalty rate] to produce high [oil] volumes because the water flood
project has been in existence for many years. In addition, having the existing
infrastructure and operations at economies of scale would almost guarantee
that the property would continue to produce as long as the price of oil was not
such that it made production uneconomical.
- BLM's Wyoming State Office stated that the economic significance of a royalty
rate reduction was small when compared with the investments in enhanced and secondary
recovery systems. The State Office recommended that these properties be analyzed on their
individual merits for continued royalty rate reduction. The State Office further stated:
An enhanced recovery unit project usually begins with an oil field that has
produced oil through primary recovery that is at or near its economic limit.
At this point in the life of the field, a RRR [royalty rate reduction] may have
[been] obtained as the property continues to produce under primary recovery.
Once the enhanced recovery unit is approved and enhanced recovery
operations commence, the benefits of enhanced or secondary recovery result
in oil wells that can produce at rates many times more than when they were
under primary recovery [sometimes at higher rates than when the well was
initially completed for primary reserves].
- Written comments from BLM's Utah State Office identified secondary recovery
properties that had received reduced royalty rates with production of 2.5 million barrels of
crude oil. However, the State Office also noted that other secondary recovery properties in
the same area were undergoing similar development without the benefit of reduced royalty
rates. The State Office further stated, "We feel the results would have been the same if the
stripper policy was not in place."
BLM's Montana State Office stated in its written response:
Overall, we do not believe the royalty rate reduction has served to extend the
productive life of federal leases. It appears that most operators did not take
action to drill new wells, work over existing wells, or attempt new
technologies [horizontal drilling is considered to be a standard completion
technique for many fields in North Dakota and eastern Montana]. We do not
recommend renewal of the royalty rate reduction regulations.
We found that during calender year 1997, about 800 operators that had about 3,600 stripper
oil well properties received about $31 million in royalty rate reductions (see Appendix 3).
During this period, operators of five individual properties (less than 1 percent) received
almost $11 million (35 percent) of the royalty rate reductions allowed (see Appendix 3). In
addition, operators of the top 100 benefiting properties (less than 3 percent) received more
than $24 million (77 percent) of the royalty rate reductions provided by the Program. While
these large properties should not be excluded automatically from the Program based on their
total production levels, we believe that these large properties may be profitable without the
benefit of a reduced royalty rate and that taxpayers should not subsidize such operations. If
large producing properties are allowed to be considered for the Program, we believe that the
operators should be required to submit sufficient information to demonstrate that economic
incentives are required to maximize production or promote development.
The Program has been in operation since October 1992. To ensure that only properly
qualified properties receive program benefits, we believe that BLM should perform a more
comprehensive evaluation that addresses the issues and concerns discussed in this report.
For example, the uncertainties in the Department of Energy's modeling and the concerns of
MMS and many of the BLM field offices need to be fully considered. In addition, BLM was
not aware of the extent of operator misreporting, as noted in our audit report titled
"Supporting Documentation for Operators Participating in the Stripper Oil Well Property
Royalty Rate Reduction Program, Bureau of Land Management and Minerals Management
Service" (see Prior Audit Coverage). The report stated that production reports, which are
used to calculate reduced royalty rates, were improperly completed by the operators, which
resulted in many operators receiving a royalty rate lower than the rate to which they were
entitled. Of the 20 properties reviewed, 17 were found to be either improperly calculated or
unsupported, and royalties may have been underpaid by as much as $43 million. We believe
that the concerns noted in that report, along with the issues raised in this report, should be
considered in a reevaluation of the Program. Finally, the recent increases in oil prices (the
price per barrel increased from about $10 in February 1999 to about $31 in March 2000)
have substantially increased the profitability of many of the Program properties and have
also increased the royalty losses attributable to the Program.
Recommendation
We recommend that the Director, BLM, reevaluate the Stripper Oil Well Property Royalty
Rate Reduction Program and make changes as appropriate. In the new evaluation, BLM
should analyze production changes and the reasons for the production changes, such as
enhanced or secondary recovery and the impact of oil price variations during the period
reviewed, on a representative sample of properties participating in the Program; establish
production ceilings for stripper oil properties above which operators would not receive
reduced royalty rates unless they submitted sufficient economic data to demonstrate that they
needed the reduction to maximize production or promote development; and establish
guidelines for reduction of Program benefits when production levels on an average per well
basis increase beyond an established level.
BLM Response and Office of Inspector General Reply
In the March 26, 2001 response (Appendix 5) to the draft report from the Acting Director,
BLM, BLM stated, "It is our intention to present a full range of policy options from status
quo to discontinuing the program to the new Assistant Secretary for Land and Minerals
Management." Based on the response, we request that BLM specifically respond to the
recommendation, which is unresolved (see Appendix 6).
B. RECOVERING PROCESSING COSTS
MMS did not recover its costs for processing notifications for the Stripper Oil Well Property
Royalty Rate Reduction Program. The authority for Federal agencies to recover costs of
providing services to beneficiaries is contained in the Independent Offices Appropriations
Act of 1952. In addition, the Department of the Interior Manual and Office of Management
and Budget Circular A-25, "User Charges," provide guidance on carrying out the authority
contained in the Act. However, when BLM promulgated the Program regulations, it did not
include a provision for recovering costs of the Program from participating operators. MMS
officials estimated that it cost an average of $180,000 annually to process Program
notifications and to maintain the automated royalty rate exception processing routine, which
is used to identify exceptions in the royalty rates paid by royalty payors. During fiscal years
1995 through 1998, MMS received from 400 to 800 notifications annually. Based on these
estimates, we determined that the average cost to process one notification would be from
about $225 to $450. In addition, MMS estimated that it would cost about $145,000 to
eliminate the notification processing backlog (see Prior Audit Coverage). As noted in our
August 1999 audit report, MMS has not allocated the resources necessary to properly
monitor this Program, primarily because of higher priorities and limited resources.
The Department of the Interior Manual (Part 346, "Cost Recovery") states that unless
otherwise prohibited or limited by statute or authority, a fee that recovers costs should be
imposed for services that provide special benefits or privileges to a non-Federal recipient.
Circular A-25 requires that a user charge be "assessed against each identifiable recipient for
special benefits derived from Federal activities beyond those received by the general public."
Circular A-25 further states that a special benefit will be considered to accrue and a user
charge will be imposed when a Government service "is performed at the request of or for the
convenience of the recipient, and is beyond the services regularly received by other members
of the same industry or group or by the general public." In addition, MMS regulations for
offshore royalty relief contained in 30 CFR 203.56 require an application processing fee as
follows:
When you submit an application for royalty relief, you must include a
payment to reimburse MMS for the costs it incurs in processing your
application. The MMS will establish in a Notice to Lessees a schedule that
will specify the fees that must be paid for each of the different types of
royalty relief applications.
We believe that since the reduced royalty rate does not automatically apply to all producers,
it is a special benefit to certain operators and meets this cost recovery criterion. Furthermore,
since the regulations governing the Program are BLM regulations, we believe that the
processing fees should be required by BLM but should be collected by MMS.
BLM has several options for determining how to recover costs associated with processing
stripper notifications. For example, BLM could base fee amounts on the number of wells
included in the notification. In that regard, some properties had only a single well, and MMS
personnel said that the information on a single well notification takes only 1 to 2 hours to
confirm. Therefore, billing an operator for the cost to review a single well notification might
not be productive; thus, smaller operators could be exempt from the payment. However,
billing an operator for reviewing data on multiple-well notifications, such as 10 or more
wells, should be considered, since the amount of the reduced royalties would be significant
and the operator would be less likely to end participation in the Program. BLM officials
have expressed concerns that charging a processing fee for notifications could cause some
of the smaller marginal operators to end their participation in the Program. Our review,
however, found that since smaller operators typically had smaller properties, they had fewer
wells.
Recommendation
We recommend that the Director, BLM, revise Program regulations to require a cost
recovery fee for processing Program notifications.
BLM Response and Office of Inspector General Reply
In the March 26, 2001 response (Appendix 5) to the draft report, the Acting Director, BLM,
did not express specific concurrence or nonconcurrence with the recommendation. BLM
said that it would incorporate the recommendation into the policy options when the new
Assistant Secretary arrives. Based on the response, we request that BLM specifically
respond to the recommendation, which is unresolved (see Appendix 6).