[Advisory Report on Royalty-in-Kind Demonstration Pilots, Minerals Management Service]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 99-i-371

Title: Advisory Report on Royalty-in-Kind Demonstration Pilots,
       Minerals Management Service

Date:  March 29, 1999



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





ADVISORY REPORT


ROYALTY-IN-KIND DEMONSTRATION PILOTS,
MINERALS MANAGEMENT SERVICE


REPORT NO. 99-I-371

MARCH 1999






MEMORANDUM
            TO:  The Secretary

          FROM:  Robert J. Williams
                 Acting Inspector General

SUBJECT SUMMARY: Final Advisory Report - "Royalty-in-Kind
                 Demonstration Pilots, Minerals Management
                 Service" (No. 99-i-371)

Attached for your information is a copy of the subject final
advisory report.  The objective of our audit was to determine
whether the Minerals Management Service's royalty-in-kind pilots
will result in an adequate feasibility test of the
royalty-in-kind concept.

We concluded that the pilots in the Gulf of Mexico to test gas
and in Wyoming to test oil will provide the Service with the
knowledge and practical experience to implement a permanent
royalty-in-kind system for those particular regions and products.
However, because the United States oil and gas industry operates
in distinct regions, we believe that the limited geographic
coverage and products included under the pilot program will not
provide a conclusive royalty-in-kind feasibility assessment for
all Federal oil and gas production.  The pilot program is limited
because the Service's strategy is to conduct pilots in those
areas where the Service expects to maintain or exceed the
revenues collected under the royalty-in-value system.  Service
officials said that this strategy was consistent with the
recommendations contained in the Service's "1997 Royalty In Kind
Feasibility Study" and that resources were not available to
expand the planned pilot program.  As a result of the Service's
decision to limit the scope of its pilots, we believe that any
conclusions concerning the feasibility of a royalty-in-kind
program will apply solely to the geographic regions and products
specifically studied and should not be used to evaluate the
concept on a nationwide basis. While we believe that the
Service's strategy to maintain or exceed prior revenue collection
levels for the pilot leases has merit, we also believe that
additional factors warrant consideration.  We view the pilots as
an opportunity to gain knowledge through operational experience
of how a royalty-in-kind program should be managed, as well as to
demonstrate whether any advantages exist over the in-value
system.  We believe that by including leases in the pilots which
are not anticipated to yield the desired revenues, the Service
may obtain valuable information and learn methods to maximize the
collections.  Accordingly, we made  suggestions that we believe
will enhance the effectiveness of the pilot program if they are
implemented.

If you have any questions concerning this matter, please contact
me at (202) 208-4252.


Attachment






MARCH 1999                                 C-IN-MMS-002-98-R



ADVISORY REPORT

Memorandum

     To:  Director, Minerals Management Service

   From:  Robert J. Williams
          Assistant Inspector General for Audits

Subject:  Advisory Report on Royalty-in-Kind Demonstration
          Pilots, Minerals Management Service (No. 99-i-371)

INTRODUCTION

This report presents the results of our audit of the Minerals
Management Service's royalty-in-kind demonstration pilots.  This
audit was performed as part of our biennial audit requirement of
the Federal Royalty Management System for fiscal years 1998 and
1999.  The objective of our audit was to determine whether the
royalty-in-kind pilots will result in an adequate feasibility
test of the royalty-in-kind concept.  A second report will
contain the results of our audit of the oil royalty-in-kind
program for small refiners.

BACKGROUND

Under the terms of Federal oil and gas leases,[1] the Federal
Government may choose to receive its royalty share of oil and gas
production either in-kind (receiving a physical share of the
production) or in-value (receiving a cash payment).  This
authority is established in the Mineral Leasing Act of 1920 and
the Outer Continental Shelf Lands Act of 1953.  Historically, the
Minerals Management Service has chosen to receive cash payments.
Since the 1980s, however, the Service and the oil and gas
industry have frequently disagreed on the appropriate value to
use in computing royalty payments under the royalty-in-value
system.  Consequently, oil and gas industry officials are
advocating that the Service take its royalties in-kind.  Industry
officials state that a royalty-in-kind system would eliminate
valuation disputes and appeals, increase revenue collections for
the Government, require less audit verification, and reduce
administrative costs for both the Government and industry.  The
oil and gas industry supports proposed legislation[2] that would
require that the Federal Government establish a royalty-in-kind
system for all Federal leases, with only limited exceptions.
Conversely, the Service maintains that a mandatory
royalty-in-kind program would result in reduced revenue
collections, and it therefore believes that the Government should
retain its flexibility to choose between royalty-in-kind or
royalty-in-value collections on a lease-by-lease basis to
maximize overall revenue collections.

In an effort to determine whether a royalty-in-kind system might
eliminate disputes and improve the royalty collection process,
the Service conducted a demonstration pilot in 1995,  known as
the Royalty Gas Marketing Pilot.  During the Pilot, natural gas
was taken in-kind from 79 leases in the Gulf of Mexico, which
represented 6 percent of the royalty gas volume in the Gulf.  The
Service concluded, in its September 1996 report "Minerals
Management Service Royalty Gas Marketing Pilot," that the Pilot
was an operational success but that the amount of royalties
collected was 6.5 percent less than what would have been
collected under the in-value system.  When projected to the Gulf
of Mexico lease universe, the Service estimated that a royalty
loss of $82 million would have resulted for the year.

Following the 1995 demonstration pilot, the Service continued to
examine the royalty-in-kind concept.   In its August 1997 report
"1997 Royalty In Kind Feasibility Study," the Service concluded
that when managed correctly, royalty collections under a
royalty-in-kind system could maintain or exceed the amounts
collected under the in-value system and that the Service and
industry could realize administrative efficiencies.  The report
recommended that pilots be conducted in areas considered to have
the greatest potential for success, primarily the Gulf of Mexico
for gas and the State of Wyoming for oil.

In accordance with the feasibility study, the Service plans to
implement a royalty-in-kind program consisting of three
demonstration pilots.  The program, which was scheduled to begin
in October 1998 and last for up to 6 years (September 2004), will
take oil volumes in-kind in Wyoming and gas volumes in-kind from
two offshore areas in the Gulf of Mexico.  The Service
anticipates that the three pilots will provide it with
operational experience in managing a royalty-in-kind program and
in evaluating the feasibility of a permanent royalty-in-kind
program.

SCOPE

We reviewed the Minerals Management Service's royalty-in-kind
activities conducted since the Service's 1995 Royalty Gas
Marketing Pilot.  The audit was performed from April through
October 1998 at the Service's Royalty Management Program offices
in Lakewood, Colorado.  To accomplish the audit objective, we
interviewed Service officials who were involved in planning and
administering the pilots.  We interviewed other Service officials
and officials from the state governments of Texas and Wyoming and
the oil and gas industry who were knowledgeable of the pilots or
of the royalty-in-kind concept.  We also reviewed reports and
other documents that the Service used to support the planning and
implementation of the pilots.

The audit was conducted, as applicable, in accordance with the
"Government Auditing Standards," issued by the Comptroller
General of the United States.  Accordingly, we included such
tests of records and other auditing procedures that were
considered necessary under the circumstances.  As part of the
audit, we reviewed the internal controls to the extent considered
necessary to accomplish our audit objective.  We also reviewed
the Secretary's Annual Statements and Reports to the President
and the Congress for fiscal years 1993 through 1995, which are
required by the Federal Managers' Financial Integrity Act; the
Departmental Reports on Accountability for fiscal years 1996 and
1997, which include information required by the Act; and the
Service's annual assurance statement on management controls for
fiscal year 1997.  We determined that none of the reported
weaknesses were directly related to the objective and scope of
this audit.

PRIOR AUDIT COVERAGE

The General Accounting Office has issued one report on
royalty-in-kind activities of the Service during the past 5
years.  The report "Federal Oil Valuation, Efforts to Revise
Regulations and an Analysis of Royalties in Kind" (No.
GAO/RCED-98-242) was issued in August 1998 in response to a
Congressional request to address the following: "(1) the
information used by MMS [the Minerals Management Service] to
justify the need for revising its oil valuation regulations; (2)
how MMS has addressed concerns expressed by the oil industry and
states in developing these regulations; and (3) the feasibility
of the federal government's taking its oil and gas royalties in
kind, as indicated by existing studies and programs."  The report
stated that the Service (1) "relied heavily" on an interagency
task force report to justify revising its oil valuation
regulations and (2) solicited public comments on its proposed
regulations in five "Federal Register" notices and revised its
proposed regulations three times in response to the comments
received.  The report further stated that available information
"indicates that it would not be feasible for the federal
government to take its oil and gas royalties in kind except under
certain conditions.  These conditions include having relatively
easy access to pipelines to transport the oil and gas, leases
that produce relatively large volumes of oil and gas, competitive
arrangements for processing gas, and expertise in marketing oil
and gas.  However, these conditions are currently lacking for the
federal government and for most federal leases."  The report
contained no recommendations.

The Office of Inspector General has issued one audit report
during the past 5 years on royalty-in-kind activities.  The
report "Royalty Gas Marketing Pilot, Minerals Management Service"
(96-I-786), issued in May 1996, stated that the Service
effectively administered the 1995 Royalty Gas Marketing Pilot and
had demonstrated the feasibility of taking gas royalties in-kind
as an alternative to the royalty-in-value system.  However, the
report noted that there were weaknesses in the areas of pilot
design, revenue collections, marketing strategies, and
administrative controls.  We also concluded that the 1995 pilot
was too limited in scope to accurately represent gas operations
in the Gulf of Mexico.  Although the report contained no
recommendations, it did contain suggestions for the Service to
consider in the design of future royalty-in-kind pilots, such as
conducting larger scale pilots with mandatory lease holder
participation.

**FOOTNOTES**

[1]:An exception applies to leases issued under Section 6 of the
Outer Continental Shelf Lands Act.  For these leases, the lessee
has the option to pay its royalties in-kind.  Section 6 leases
account for less than 3 percent of total Federal production.

[2]:The Royalty Enhancement Act of 1998 was introduced in the
second session of the 105th Congress in both the House of
Representatives (H.R. 3334) and the Senate (S. 1930).

DISCUSSION

We found that the Minerals Management Service's royalty-in-kind
pilots in the Gulf of Mexico to test gas and in Wyoming to test
oil will provide the Service with the knowledge and practical
experience to implement a permanent royalty-in-kind system for
those particular regions and products.  However, because the
United States oil and gas industry operates in distinct regions,
we believe that the limited geographic coverage and products
included under the pilot program will not provide a conclusive
royalty-in-kind feasibility assessment for all Federal oil and
gas production.  The pilot program is limited because the
Service's strategy is to conduct pilots in those areas where the
Service expects to maintain or exceed the revenues collected
under the royalty-in-value system.  Service officials said that
this strategy was consistent with the recommendations contained
in the Service's "1997 Royalty In Kind Feasibility Study" and
that resources were not available to expand the planned pilot
program.  As a result of the Service's decision to limit the
scope of its pilots, we believe that any conclusions concerning
the feasibility of a royalty-in-kind program will apply solely to
the geographic regions and products specifically studied and
should not be used to evaluate the concept on a nationwide basis.

While we believe that the Service's strategy to maintain or
exceed prior revenue collection levels for the pilot leases has
merit, we also believe that additional factors warrant
consideration.  We view the pilots as an opportunity to gain
knowledge through operational experience of how a royalty-in-kind
program should be managed, as well as to demonstrate whether any
advantages exist over the in-value system.  We believe that by
including leases in the pilots which are not anticipated to yield
the desired revenues, the Service may obtain valuable information
and learn methods to maximize the collections.  This would be
consistent with the Service's objectives of the pilots, which are
"to test the propriety of the [royalty-in-kind] concept for
collecting federal . . . royalties."  Further, we believe that
the Service should be prepared to effectively implement a
permanent royalty-in-kind program for Federal leases in
anticipation of the proposed legislation becoming law.  Our
conclusions and suggestions to enhance the effectiveness of the
pilot program are discussed in the paragraphs that follow.

Pilot Program Progress Update

The Service was successfully managing the pilot program at the
time of our review.  The pilot team was making satisfactory
progress to ensure that the pilots will begin on schedule, a
representative sample of leases in each tested area will be
selected, the sampled leases will have a smooth transition from
the royalty-in-value system to the royalty-in-kind system, and
the pilot results will be evaluated.  The team coordinated the
Wyoming crude oil pilot with appropriate officials from the State
of Wyoming and held public meetings to explain the proposed oil
royalty-in-kind program.  Additionally, the Service incorporated
into its pilot program certain comments and suggestions that were
contained in our audit report of the 1995 pilot.  For example,
the current pilot program will consist of larger scale pilots
with mandatory participation by lease holders and will improve
the marketing strategies by using longer contract periods and
include various production volume sizes in the bids.  These
improvements should increase revenue collections and the
information and data obtained by the Service.

In preparing for the Wyoming pilot, the team conducted a survey
analysis of the crude oil market and consulted with industry
experts to select a representative sample of Federal oil leases
in the State.  The team structured the Wyoming pilot in two
phases: one phase that will test the royalty-in-kind values by
holding a sealed lease bid sale and a second phase that will
involve a contract marketing agent to maximize royalty revenues.
The team received bids on 182 properties representing 621 leases
in Wyoming and accepted bids on 97 of the properties representing
315 leases.  According to the team, the bids on the other 85
properties affecting 306 leases were rejected because the
anticipated revenues would not equal or exceed those expected
under the royalty-in-value system.

The team was also preparing for the start of the two gas pilots
in the Gulf of Mexico.  For example, the Service and the state
government of Texas entered into a cooperative agreement that
details the responsibilities and expectations for the pilot to be
conducted offshore Texas.  A public meeting was also held to
discuss the details of the pilot.

Industry Position

Under an in-kind system, the Service would assume sole
responsibility for selling the Federal Government's royalty share
of production.  As such, the valuation method used to determine
the Government's share of production, which is a major factor in
determining royalty payments under the royalty-in-value system,
would not apply.  The royalty-in-kind concept has received
widespread support from the oil and gas industry.  Based on our
review, we confirmed that the industry officials we contacted
strongly supported the proposed legislation, which would mandate
a royalty-in-kind system for Federal leases.  The officials we
contacted, representing individual oil and gas companies and
industry trade associations, told us that an in-kind system would
more efficiently collect royalties from Federal leases.  For
example, under the in-value system, the Service may audit prior
year collections from a company and determine that additional
royalties are owed because the company had not paid on the market
value of the oil or gas.  If the company disagrees with the
Service's determination, an expensive and time-consuming process
of formal appeals and litigation to resolve the dispute may
ensue.  According to industry officials, a royalty-in-kind
program would avoid these valuation disputes by introducing
"certainty"[3] into Federal royalty payment determinations.
Overall, the industry, in meetings and through correspondence,
has urged the Service to forego the pilot program and adopt a
nationwide royalty-in-kind system without delay.

Scope of Pilot Program

In our opinion, the Service's pilot program will not provide
sufficient information and data to determine whether a
royalty-in-kind system would be appropriate for all Federal
leases because of the limited coverage of individual oil and gas
producing regions.  The oil and gas industry and the Service
recognize three distinct oil-producing regions or markets (see
Appendix 1) in the United States as follows:  the States of
California and Alaska; the six "Rocky Mountain Area" States of
Colorado, Montana, North Dakota, South Dakota, Utah, and Wyoming;
and the remaining states and the Gulf of Mexico.  The Service
identified the three producing regions during its efforts in 1998
to revise the oil valuation regulations, which was affirmed by
written comments received from industry representatives.
Similarly,  the natural gas market is not generally considered to
operate uniformly in each producing area of the country (see
Appendix 2).  For example, the availability and ownership of
processing plants and the relative access to a pipeline for
transporting the gas to a final market can affect sales prices in
a specific production area.

We believe that the Service will not obtain sufficient
information and data to implement a mandatory nationwide
royalty-in-kind program if the proposed legislation is enacted
because the royalty-in-kind pilots will not adequately test each
of the distinct regions.  Specifically, we found the following:

- The royalty-in-kind concept for crude oil will not be fully
tested.  The only pilot scheduled for oil will be conducted in
Wyoming.  While Wyoming represents a major oil-producing state,
accounting for 8.5 percent of total Federal oil production in
fiscal years 1994 through 1996, the Gulf of Mexico accounted for
65.1 percent and California/Alaska (onshore and offshore)
accounted for 16.8 percent (see Appendix 1).  Consequently, the
Service will not be able to determine the feasibility of taking
royalties in-kind in those regions that produce most of the oil
involving royalties to the Federal Government.[4]  We suggest
that the Service consider including additional geographic areas
in the pilot program.

- The royalty-in-kind concept for natural gas also will not be
fully tested.  The two pilots scheduled in the Gulf of Mexico,
which accounted for 72 percent of Federal gas production in
fiscal years 1994 through 1996, will enable the Service to
determine the feasibility of taking royalties in-kind for most
Federal gas (see Appendix 2).  However, a pilot is not scheduled
for Federal onshore gas, which accounted for about 27 percent of
the production.  Consequently, the Service will not be able to
determine the feasibility of taking royalties in-kind for onshore
gas production.  We suggest that the Service continue to pursue
conducting pilots in New Mexico[5] and/or Wyoming.  New Mexico
accounted for about 15 percent and Wyoming accounted for about 7
percent of Federal gas production.

We believe that unless the pilot program is expanded, the Service
will not obtain the information and data needed to operate a
royalty-in-kind program for oil produced in California/Alaska or
the Gulf of Mexico or for gas produced onshore.  As currently
designed, the results of the pilot will provide information and
data for the Service to learn how to operate a royalty-in-kind
program only for those regions and products specifically tested.
Consequently, we do not believe that the results of the pilots,
such as an increase or a decrease in Federal royalty revenues,
should be extrapolated or extended to the universe of Federal
leases.  Accordingly, we suggest that the Service consider
conducting pilots in each region for both oil and gas.

Other Pilot Program Issues

In addition to considering whether to perform additional pilots
in each market area, we believe that the Service should also
consider the following issues when it determines specific areas
and products to include in future pilots:

- The pilots will not test the taking of both oil and gas from
the same lease.  Since pending royalty-in-kind legislation (see
footnote 2) in the U.S. Congress would require both products to
be taken simultaneously, we suggest that the Service take both
products simultaneously to identify whether any problem areas or
special considerations exist.

- In our opinion, the time frames for completing the pilots
should be shortened.  By the time the last pilot is completed in
fiscal year 2004, the Service will have spent 10 years studying
the royalty-in-kind concept and the program may become mandated
prior to that date.  While we recognize that personnel resources
are limited and that the pilot team members are maximizing their
efforts, we suggest that the Service develop alternatives to
shorten the time frames by, for example, operating the separate
phases of the Wyoming pilot concurrently instead of in
succession.  Also, the Gulf of Mexico pilot could be shortened
from the 5 years currently planned.

- We believe that the Service should consider the possible cost
savings to the Federal Government and to industry associated with
a reduction in the number of appeal and litigation cases filed
and the reduction in the Service's costs (approximately $34
million in fiscal year 1997) to administer the mineral revenue
compliance program.

We agree with the Service's position that the royalty-in-kind
concept needs to be studied carefully before full implementation
is considered.  The Federal lease universe consists of almost
22,000 leases capable of production distributed among 30 states,
the Gulf of Mexico, and offshore Alaska and California.  Federal
leases represent about 25 percent of the oil and 35 percent of
the gas produced domestically in the United States.  These leases
are connected to a vast and complex infrastructure consisting of
pipelines and other transportation systems, oil refineries, gas
processing plants, and market centers.  Moreover, the Service
collects about $3.3 billion each year in royalties from Federal
leases, with about $500 million of this amount distributed to
state governments.  Therefore, considering the complexities of
the oil and gas business, the monetary significance of Federal
lease revenues, the proposed legislation that would mandate a
royalty-in-kind program, and the Service's limited experience in
collecting royalties in-kind, we believe that the Service should
proceed expeditiously to obtain information and data on how an
in-kind program should be designed and managed and to determine
whether the presumed efficiencies over the in-value system exist.

Minerals Management Service Response and Office of Inspector
General Reply

In the February 16, 1999, response (see Appendix 3) to the draft
report from the Director, Minerals Management Service, the
Service generally agreed with the report's findings and
conclusions.  In the response, the Service included additional
comments regarding the royalty-in-kind pilot program.  These
comments and our replies to these comments are provided in the
paragraphs that follow.

Minerals Management Service Comment.  The Service said that the
report incorrectly assumed that the Service established the pilot
program to gain experience in  case  a royalty-in-kind program
became mandatory through legislation.  The Service stated that
instead, the purpose of the pilot program was "to test the RIK
[royalty-in-kind] concept in several strategic areas within
existing staff resources to determine whether and under what
conditions taking RIK is a prudent method of managing public
resources."

The Service said that it "agree[d] with the report's conclusion
that the . . . financial results" of the three pilots "cannot be
extrapolated" to the universe of Federal leases.  However, the
Service said that  experience gained in administrating the pilots
will provide the agency with certain basic operational
information for implementing royalty-in-kind systems in other
market areas of the country.  Additionally, the Service said that
the pilots will sufficiently evaluate each of the three study
areas.  Specifically, the response stated that the pilots are
designed to "test the RIK concept across all reasonable lease,
transportation, and sales types."  Additionally, the Service
stated, "Because we [the Service] reject bids resulting in lower
royalties than would be received in value, we maintain or
increase revenues at the same time as receiving valuable data on
all types of leases."

The Service said that it agreed with the report's statement that
expanding the pilot program to each producing region "would
increase" the overall knowledge acquired regarding the
feasibility of the royalty-in-kind concept.  However, the Service
reiterated that resources were unavailable to conduct additional
pilots.

The Service stated that the Office of Inspector General "may wish
to update" the references in the report concerning the
legislation that would make a royalty-in-kind system mandatory
because, according to the Service, the oil and gas industry
"changed [its] view on a mandatory, comprehensive RIK program"
and "is no longer actively lobbying for passage" of this
legislation.

The Service acknowledged the report's suggestion to complete the
pilot program within a shorter time frame, stating,  "We would
also like to complete the  pilots and make decisions on their
results as soon as possible.  However, it is our view that a
robust, defensible test of RIK concepts needs to be conducted
over several business cycles to avoid the effects of short-term
market distortions."  The Service further stated that "it is
possible that the pilot results will be clear enough in a shorter
time frame to base decisions on project termination or broader
application."

Office of Inspector General Reply.  We believe the Service's
response did not accurately reflect our understanding of the
Service's objectives for the pilot program.  In the Discussion
section of the report, we quoted the Service's written objectives
as published on its Web site (http://www.rmp.mms.gov/rikweb) for
the pilot program.  Although the Service stated that we assumed
that the pilots were developed as a result of the proposed
royalty-in-kind legislation, our discussion regarding proposed
legislation was included solely for the complete disclosure of
current events involving the royalty-in-kind matter.  Further, we
believe that the extent of the proposed legislation warrants the
Service's continued attention to review the royalty-in-kind
concept on a nationwide basis.

We agree the pilot program will adequately test the various
leases contained in each area tested by the three pilots, and
the report clearly states that the pilots were properly designed.
However, our discussion regarding adequate scope coverage was
directed to evaluating the feasibility of implementing a
royalty-in-kind system on a nationwide basis.  Therefore, in our
view, a complete analysis must consist of a pilot being conducted
in each of the major producing regions in the country.

Finally, the oil and gas industry was promoting the proposed
royalty-in-kind legislation at the end of our fieldwork in
October 1998.  However, to gain support for the proposed
royalty-in-kind legislation, the bills' sponsors had made
modifications to the legislation such as eliminating the
mandatory in-kind provisions for certain marginally producing
wells and for Alaska leases.  Although the bills were not passed
in the 105th Congress, we believe that the strong support for a
mandatory royalty-in-kind system expressed by the oil and gas
industry during our audit exists and that industry will continue
to promote such legislation.

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

The legislation, as amended, creating the Office of Inspector
General requires semiannual reporting to the Congress on all
audit reports issued, actions taken to implement audit
recommendations, and identification of each significant
recommendation on which corrective action has not been taken.

We appreciate the assistance of Service personnel in the conduct
of our review.

**FOOTNOTES**

[3]:"Certainty" means that the value of oil and gas for royalty
payments would be established at the time of production with no
subsequent audit adjustments.

[4]:An oil royalty-in-kind program, which the Federal Government
has operated for the benefit of small and independent refiners,
has provided the Minerals Management Service with experience in
collecting royalties in-kind; however, the objective of the
program is to ensure a steady supply of oil for the eligible
refiners regardless of the amount of royalties collected.  The
program was not designed to explore different concepts in
collecting royalty payments or to make any comparisons to the
revenues that would have been received under the royalty-in-value
system.  In short, the program does not evaluate the feasibility
of an in-kind system.

[5]:At the time of our review, the State of New Mexico had not
accepted the Service's proposal to conduct a royalty-in-kind
pilot in that state.



                                                       APPENDIX 1


        FEDERAL OIL SALES VOLUMES1
        3-YEAR AVERAGE
        (1994-1996)


Offshore         Onshore
Total
Sales   Percent  Sales
Percent   SalesVolumeof
TotalVolumeof
TotalVolumePercent
(Barrels)
Offshore(Barrels)
Onshore(Barrels)of Total

GEOGRAPHIC PRODUCING REGIONS

California/Alaska   65,429,368   16.123,132,006  19.1
88,561,374  16.8

Rocky Mountain Area2         0      064,115,820  53.1
64,115,820  12.2

All Other States, including
Gulf of Mexico3  340,021,626   83.933,536,254
27.8373,557,880  71.0

Total      405,450,994
100.0120,784,080100.0526,235,074 100.0

____________________

1 Data obtained from "Mineral Revenues 1996, Report on Receipts
From Federal And Indian Leases," published by the Minerals
Management Service.

2 Consists of Colorado (1.3%), Montana (.5%), North Dakota and
South Dakota (1.1%), Utah (.8%), and Wyoming (8.5%).

3 All other states consist of Alabama, Arkansas, Florida,
Illinois, Kansas, Kentucky, Louisiana, Michigan, Mississippi,
Nebraska, Nevada, New Mexico, Ohio, Oklahoma, Pennsylvania,
Texas, and West Virginia (5.9% in total) and the Gulf of Mexico
(65.1%).

                                                       APPENDIX 2

FEDERAL GAS SALES VOLUMES1
3-YEAR AVERAGE
(1994-1996)

Sales Volume Percent
(Mcf)2 of Total
OFFSHORE PRODUCTION

Gulf of Mexico
Alabama                           107,679,995
1.6
Louisiana                       3,675,569,617
55.7
Mississippi                         4,145,058
.1
Texas                             965,199,315
14.6

Total Gulf of Mexico           4,752,593,985
72.0

California                            38,642,502
.6

Total Offshore3                4,791,236,487
72.6


ONSHORE PRODUCTION

New Mexico                         1,001,806,371
15.2
Wyoming                              475,552,092
7.2
All Other States                     331,563,468
5.0

Total Onshore                  1,808,921,931
27.4

Total                        6,600,158,418
100.0
_____________________

1  Data obtained from "Mineral Revenues 1996, Report on Receipts
From Federal and Indian Leases," published by the Minerals
Management Service.

2  Thousand cubic feet.  The standard unit for measuring the
volume
of natural gas.

3  The five states listed for offshore production also had
onshore
production of 103,516,660 Mcf, or 1.6 percent of total
production.  The onshore production for these five states was
included in the Onshore Production - All Other States category.






ILLEGAL OR WASTEFUL ACTIVITIES SHOULD BE REPORTED
TO THE OFFICE OF INSPECTOR GENERAL BY:
Sending written documents to:



Within the Continental United States

U.S. Department of the Interior
Office of Inspector General
1849 C Street,N.W.
Mail Stop 5341
Washington, D.C. 20240

Calling:

Our 24 hour
Telephone HOTLINE
1-800-424-5081 or
(202) 208-5300

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(202) 208-2420 or
1-800-354-0996



Outside the Continental United States


Caribbean Region

U.S. Department of the Interior
Office of Inspector General
Eastern Division- Investigations
1550 Wilson Boulevard
Suite 410
Arlington, Virginia 22209

Calling:
(703) 235-9221


North Pacific Region

U.S. Department of the Interior
Office of Inspector General
North Pacific Region
238 Archbishop F.C. F'lores Street
Suite 807, PDN Building
Agana, Guam 96910


Calling:
(700) 550-7428 or
COMM 9-011-671-472-7279