OIL AND GAS:

Royalty-in-kind oversight problems costing millions in revenue -- GAO

Lax Interior Department controls over a major royalty collection program may be costing millions of dollars in forgone revenue, congressional investigators said today, findings a senior Democrat quickly said should bolster his proposal to kill the program.

The Government Accountability Office report says Interior's Minerals Management Service does not adequately track natural gas that industry is supposed to provide under the embattled royalty-in-kind program.

Interior estimates it is owed at least $21 million for past imbalances, or the difference between the amount of gas owed under the royalty-in-kind program and the amount received.

But the GAO report, the latest in a series of critical outside reviews of the program, says inadequate monitoring and data collection mean it is unknown how much the agency may be owed by producers. The report finds that Interior "lacks the information necessary to calculate the full amount of revenues due."

"Although Interior has made efforts to improve its management of royalties, continuing problems with identifying and collecting RIK [royalty in kind] gas imbalance have led to forgone revenues and uncertainty about how much gas the government is owed," the report states.

"While MMS has made recent progress to establish policies and procedures for charging interest on imbalances owed the government, these policies and procedures are incomplete and are leading to forgone revenues," it adds.

The program allows producers to provide Interior with oil and natural gas directly, which the government subsequently re-sells, instead of cash royalty payments. The program was started in the 1990s because Interior officials felt they could derive greater value than if they took all royalties as cash, GAO noted.

The report said that MMS believes the program is a way to avoid legal disputes with industry over the value of oil and natural gas that companies produce and that the agency can achieve better value for gas taken in kind because it can negotiate favorable transport and processing arrangements. Of the $12 billion in oil and gas royalties that MMS collected in fiscal 2008, it collected gas valued at $2.4 billion and oil valued at nearly $4.2 billion through the royalty-in-kind program.

But a series of reviews -- by GAO, Interior's inspector general and an outside panel that reviewed royalty programs -- in recent years have criticized both the adequacy of oversight and the ethics standards of the program.

House Natural Resources Chairman Nick Rahall (D-W.Va.) is holding hearings this week on a major federal lands energy bill, H.R. 3534, that would eliminate royalty in kind entirely.

"Today's GAO report is yet another in a long list of reports highlighting the urgent need to reform the federal royalty collection system," Rahall said in a statement today.

Among GAO's findings: MMS does not know how much it is due in imbalances because it does not verify all gas production data and also lacks information about how to price imbalances. MMS's information systems do not provide accurate and timely data on gas imbalances, and MMS doesn't have enough staff -- and provides inadequate training -- to reconcile imbalances, GAO said.

A July response from Ned Farquhar, who at the time was acting assistant secretary for land and minerals management, said Interior generally agrees with the findings and has actions under way to address the oversight problems. The department concurs or partially concurs with most of the recommendations for improved oversight.

But there was one notable exception. The report notes that MMS calculates the imbalances on a monthly basis, rather than daily. GAO alleges that this could allow producers to effectively reduce their obligations.

"[T]his leaves open the possibility that some companies that owe RIK gas could provide less gas to MMS on days when gas prices are relatively high and make up the difference by providing more gas on days when prices are relatively low," GAO said.

The report calls for monitoring daily imbalances to determine whether company practices result in lost revenues. If this is occuring, MMS should propose legislative changes that would require companies paying gas royalties in kind to make deliveries on a daily basis.

But the Interior rejects that approach.

"Changing the royalty obligation to a daily obligation is impractical and would be extremely costly and administratively burdensome to the Federal Government and to Federal oil and gas lease operators," Farquhar wrote.

More broadly, addressing the overall report, Farquhar also notes that imbalances do not always mean the government has received too little, noting that they can be either positive or negative depending whether an operator overdelivered or underdelivered.

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