[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).