oversight

Mineral Revenues: A More Systematic Evaluation of the Royalty-in-Kind Pilots Is Needed

Published by the Government Accountability Office on 2003-01-09.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to Congressional Requesters




January 2003
               MINERAL REVENUES

               A More Systematic
               Evaluation of the
               Royalty-in-Kind Pilots
               Is Needed




GAO-03-296
                                               January 2003


                                               MINERAL REVENUES
                                               A More Systematic Evaluation of the
Highlights of GAO-03-296, a report to
Representative Nick J. Rahall, Ranking
                                               Royalty-in-Kind Pilots Is Needed
Minority Member, House Committee on
Resources, and Representative Carolyn
B. Maloney




In fiscal year 2001, the federal               From January 1995 through September 2001, the Minerals Management
government collected $7.5 billion in           Service (MMS) took, in kind, 178 million barrels of oil and 213 billion
royalties from the sale of oil and             cubic feet of gas, or 32 percent of the federal government’s royalty share
gas produced on federal lands.
Although most oil and gas
                                               of all oil and 3 percent of the federal government’s royalty share of all gas
companies pay royalties in cash,               produced on federal lands. MMS sold the majority of this oil—143
the Department of the Interior’s               million barrels—to small refiners in accordance with long-standing
Minerals Management Service                    legislation. MMS also took 29 million barrels of federal royalty oil to fill
(MMS) has the option to take a                 the Strategic Petroleum Reserve. MMS took the remaining 6 million
percentage of the oil and gas                  barrels of oil in kind and all the gas in kind under a series of pilot
produced and either transfer this              projects to evaluate whether there are additional circumstances under
percentage to other federal
agencies or to sell this percentage
                                               which taking royalties in kind is in the best interest of the federal
itself—known as “taking royalties              government.
in kind.” GAO reviewed the extent
to which MMS has taken royalties               MMS personnel have made progress in implementing some components of
in kind since 1995, the reasons for            management control for its Royalty-in-Kind Program, such as addressing the
taking royalties in kind, and MMS’s            risks associated with oil and gas sales and developing written procedures.
progress in implementing                       However, MMS does not plan to complete and implement all management
management control over its                    controls until 2004, when it will consider the Royalty-in-Kind pilots to have
Royalty-in-Kind Program.                       changed from a pilot stage to a fully operational stage and when it will have
                                               acquired additional systems support. To date, MMS has not developed clear
                                               strategic objectives linked to statutory requirements nor collected the
                                               necessary information to effectively monitor and evaluate the Royalty-in-
                                               Kind Program. Without clear objectives linked to statutory requirements and
GAO recommends that MMS clarify                the collection of necessary information, MMS cannot systematically assess
its strategic objectives for the               whether Royalty-in-Kind sales are administratively less costly, whether they
Royalty-in-Kind Program and link               generate fair market value or at least as much revenue as traditional cash
these objectives to statutory                  royalty payments, and thus whether MMS should expand or contract the
requirements. GAO also                         Royalty-in-Kind Program.
recommends that MMS gather key
information to monitor and
                                               Estimated Value of Federal Royalty Oil and Gas Taken in Kind by Purpose, Calendar Years
evaluate the program prior to                  1995 through 2001 and January through July 2002.
further expansion of the program.
In commenting on the draft report,
the Department of the Interior
generally agreed with GAO’s
observations and recommendations
and emphasized MMS’s future
plans to improve management
control over the Royalty-in-Kind
Program.


www.gao.gov/cgi-bin/getrpt?GAO-03-296.

To view the full report, including the scope
and methodology, click on the link above.
For more information, contact Jim Wells at
(202) 512-6877 or wellsj@gao.gov.
Contents


Letter                                                                                  1
               Results in Brief                                                         2
               Background                                                               3
               MMS Has Taken Increasing Amounts of Royalties in Kind Since
                 1995 to Meet Several Objectives                                        5
               MMS Takes Oil in Kind and Sells It to Small Refiners                     5
               MMS Takes Oil in Kind to Fill the Strategic Petroleum Reserve            8
               MMS Is Studying the Increased Use of Royalties in Kind                   9
               MMS Has Established Some Management Control over Its RIK
                 Program, but Additional Efforts Are Needed                            12
               Conclusions                                                             19
               Recommendations for Executive Action                                    20
               Agency Comments and Our Evaluation                                      20
               Scope and Methodology                                                   20

Appendix I     Comments from the Department of the Interior                            22



Appendix II    Objectives, Scope, and Methodology                                      36



Appendix III   GAO Contacts and Staff Acknowledgments                                  38



Figures
               Figure 1: Estimated Percentage of Federal Royalty Oil Taken in
                        Kind by Purpose, Calendar Years 1995 through 2000 and
                        January through September 2001                                  6
               Figure 2: Estimated Value of Federal Royalty Oil Taken in Kind by
                        Purpose, Calendar Years 1995 through 2001 and January
                        through July 2002                                               7
               Figure 3: Estimated Percentage of Total Federal Royalty Gas Taken
                        in Kind by Purpose, Calendar Years 1995 through 2000 and
                        January through September 2001                                 11
               Figure 4: Revenues Reportedly Collected from the Sale of Federal
                        Royalty Gas Taken in Kind, Calendar Years 1995 through
                        2001 and January through July 2002                             11




               Page i                                         GAO-03-296 Mineral Revenues
Abbreviations

DOE         Department of Energy
GAO         General Accounting Office
MMS         Minerals Mangement Service
RIK         Royalty-in-Kind
SPR         Strategic Petroleum Reserve




Page ii                                   GAO-03-296 Mineral Revenues
United States General Accounting Office
Washington, DC 20548




                                   January 9, 2003

                                   The Honorable Nick J. Rahall
                                   Ranking Minority Member
                                   Committee on Resources
                                   House of Representatives

                                   The Honorable Carolyn B. Maloney
                                   House of Representatives

                                   Federal lands supply about one-third of the oil and gas produced in the
                                   United States. Companies that lease these lands traditionally pay royalties
                                   to the Department of the Interior’s Minerals Management Service (MMS)
                                   based on a percentage of the value of the oil and gas that the companies
                                   produce. In fiscal year 2001, oil and gas royalties to MMS totaled about
                                   $7.5 billion. Determining proper royalty payments, however, has been
                                   costly and administratively difficult for both the companies that lease
                                   federal lands and MMS. The value of the oil and gas, in particular, is often
                                   a source of dispute. For example, during MMS’s recently completed 4-1/2
                                   year process of promulgating new regulations for valuing oil, the oil
                                   industry strongly opposed these regulations primarily because they would
                                   increase the industry’s royalty payments and increase their administrative
                                   burden. In commenting on the regulations, industry officials suggested
                                   that instead of accepting cash royalty payments, MMS should accept a
                                   percentage of the actual oil and gas produced and sell this percentage
                                   itself—known as “taking royalties in kind.”

                                   The Mineral Leasing Act of 1920 and the Outer Continental Shelf Lands Act
                                   of 1953 authorize taking royalties in kind and require that the government
                                   obtain at least fair market value for royalty oil and gas it sells. Under this
                                   authority, MMS has taken federal oil in kind, mainly to fulfill congressional
                                   and executive directives. Specifically, the Congress has directed taking oil
                                   in kind for the Small Refiners Program, whose objective is to supply crude
                                   oil to small refiners that do not have an adequate supply of their own. In
                                   more recent years, the President has directed the taking of oil in kind to
                                   fill the Strategic Petroleum Reserve as a safeguard against disruptions to
                                   the national supply of crude oil. However, in 1995, MMS began to study
                                   whether there are additional circumstances under which taking oil and gas
                                   in kind is in the best interest of the federal government. MMS’s efforts
                                   were encouraged by the Congress as a means of avoiding disputes
                                   between MMS and the oil and gas industry over the value of the oil and gas
                                   produced as well as a way to simplify royalty administration. To this end,


                                   Page 1                                             GAO-03-296 Mineral Revenues
                   MMS established Royalty-in-Kind (RIK) pilots and is developing
                   management controls for its RIK Program—a newly created program
                   under which MMS manages all its RIK activities. Management control is an
                   integral component of an organization’s management that, if effective, can
                   provide for the effectiveness and the efficiency of operations, the
                   reliability of financial reporting, and compliance with applicable laws and
                   regulations. Key management controls include (1) identifying and
                   mitigating the risks that could prevent an agency from achieving its
                   objectives, (2) developing written procedures, and (3) monitoring and
                   evaluating program performance. In the 2001 and 2002 Appropriations
                   Acts for Interior and Related Agencies, the Congress provided additional
                   direction that MMS collect at least as much revenue from its RIK pilots as
                   it would have collected in cash royalty payments.

                   As a part of your interest in MMS’s stewardship over federal oil and gas
                   royalties, you asked us to (1) determine the extent to which MMS has
                   taken oil and gas in kind since 1995 and the reasons for doing so and (2)
                   report on the status of MMS’s efforts to implement management controls
                   for its RIK Program.


                   From January 1995 through September 2001, the Minerals Management
Results in Brief   Service took 178 million barrels of oil and 213 billion cubic feet of gas in
                   kind, or about 32 percent of the federal government’s royalty share of all
                   oil and 3 percent of the federal government’s royalty share of all gas
                   produced on federal lands, and used these quantities for various purposes.
                   Of the 178 million barrels, MMS sold about 143 million barrels to small
                   refiners under the Small Refiners Program. MMS also complied with
                   presidential directives to use federal royalty oil to fill the nation’s Strategic
                   Petroleum Reserve at various times, transferring about 29 million barrels
                   to the Strategic Petroleum Reserve from 1999 through 2000. In addition,
                   MMS selectively took federal oil and gas in kind with the intent of
                   improving the stewardship of federal resources. Specifically, MMS took
                   both oil and gas in kind to evaluate whether there are additional
                   circumstances under which taking oil and gas in kind is in the best interest
                   of the federal government. The amount of oil that MMS took in kind for
                   these pilot purposes was small from October 1998 through September
                   2001. However, over the following 6 months, we estimate that the amount
                   may have approached 20 percent of the federal government’s royalty share
                   of all oil produced on federal lands. Similarly, the amount of gas that MMS
                   took in kind beginning in 1998 was small until 2000 and has averaged
                   about 10 percent of the federal government’s royalty share of all gas
                   produced on federal lands from January 2000 through September 2001.


                   Page 2                                               GAO-03-296 Mineral Revenues
             MMS personnel have made progress in implementing some components of
             management control, such as mitigating the risks associated with the sale
             of oil and gas and developing written procedures. However, MMS does not
             plan to complete and implement all management controls until 2004, when
             it will consider the Royalty-in-Kind pilots to have changed from a pilot
             stage to a fully operational stage and when it will have acquired additional
             systems support. To date, MMS has not developed clear strategic
             objectives linked to statutory requirements or collected the necessary
             information to effectively monitor and evaluate the Royalty-in-Kind
             Program. Without clear objectives linked to statutory requirements and the
             collection of necessary information, MMS cannot systematically evaluate
             to what extent Royalty-in-Kind sales should continue.

             We are making recommendations to improve the management of the
             Royalty-in-Kind Program. These recommendations include clarifying
             strategic objectives and obtaining the necessary information to more
             effectively monitor and evaluate the Royalty-in-Kind Program. We
             provided the Department of the Interior with a draft of this report for
             comment.


             In fiscal year 2001, the latest period for which data are available, the
Background   Minerals Management Service reported that it collected about $5.2 billion
             in gas royalties and about $2.3 billion in oil royalties. There are more than
             20,000 producing federal leases located in the continental United States
             and Alaska and more than 2,000 producing federal leases in the waters off
             the shores of the United States. Despite the larger number of onshore
             leases, offshore leases (most of which are in the Gulf of Mexico) account
             for 81 percent of all federal oil and gas royalty payments. In general,
             royalty rates for onshore leases are 12-1/2 percent of the value of the oil
             and gas produced, whereas royalty rates for most offshore leases are 16-
             2/3 percent. The government generally distributes about half of the royalty
             payments collected onshore back to the states in which the leases are
             located. The government also shares with the coastal states a smaller
             portion of the royalty payments collected from offshore leases located
             within 3 miles of the coast, known as the 8(g) zone. However, the
             government does not share royalties from offshore leases beyond the 8(g)
             zone, where the majority of offshore oil and gas is produced.

             The collecting, reporting, and auditing of cash royalty payments have been
             challenging for MMS. MMS relies upon royalty payors to self-report the
             amount of oil and gas they produce, the value of this oil and gas, and the
             cost of transportation and processing that they deduct from royalty


             Page 3                                            GAO-03-296 Mineral Revenues
payments. There are concerns about the accuracy and reliability of these
data. Although MMS is responsible for auditing these data, with more than
22,000 producing leases and often several companies paying royalties on
each lease each month, the auditing becomes a formidable task. In
addition, there has been considerable disagreement between industry and
MMS over the value of the oil and gas produced and the cost of
transportation and processing deductions, leading to time-consuming and
costly appeals and litigation.

While most companies that lease federal lands pay their royalties in cash,
the federal government can instead take a portion of the oil and gas that
these companies produce—known as “taking royalties in kind.” The
Congress authorized royalties in kind under the Mineral Leasing Act of
1920 and under the Outer Continental Shelf Lands Act of 1953. Standard
leases for the exploration of oil and gas on federal properties reserve the
right for the federal government to take its royalties in kind.

The Federal Managers’ Financial Integrity Act of 1982 directed federal
agencies to develop management control for safeguarding resources and
required GAO to prescribe standards for agencies to follow in establishing
management control. 1 Management control plays a significant role in
helping managers achieve strategic and annual performance goals that are
required under the Government Performance and Results Act of 1993.
Management control consists of several components: (1) an environment
that sets a positive and supportive attitude toward management control
and conscientious management (control environment); (2) an assessment
of the risks that an organization faces from both external and internal
sources (risk assessment); (3) procedures, techniques, and mechanisms
that enforce management’s directives (management control activities); (4)
recording and communicating information to management and to others
that need it within the organization (information and communication); and
(5) monitoring the quality of performance over time (monitoring).




1
 Management control is synonymous with internal control, which is the term used in the
Federal Managers’ Financial Integrity Act of 1982. The standards that GAO were required
to establish under the act appear within the report entitled Standards for Internal Control
in the Federal Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: November 1999).




Page 4                                                      GAO-03-296 Mineral Revenues
                       From January 1995 through September 2001, MMS took 178 million barrels
MMS Has Taken          of oil and 213 billion cubic feet of gas in kind primarily for three purposes:
Increasing Amounts     (1) to provide small refiners with a stable source of crude oil, (2) to fill the
of Royalties in Kind   Strategic Petroleum Reserve (SPR), and (3) to study alternatives to the
                       traditional system of cash royalty payments.2 MMS sold the majority of the
Since 1995 to Meet     oil that it took in kind to small refineries under the Small Refiners
Several Objectives     Program—a long-standing program designed to assist small refiners that
                       are having difficulty obtaining an adequate supply of crude oil. MMS also
                       transferred substantial quantities of federal royalty oil to the SPR as a
                       safeguard against disruptions in the nation’s supply of crude oil. MMS
                       takes lesser quantities of oil and gas in kind under a series of pilot sales in
                       Wyoming and the Gulf of Mexico to study alternatives to the traditional
                       system of cash royalty payments. In doing so, MMS has been testing
                       whether it can improve the administrative efficiency of royalty collections
                       and whether it can sell the federal royalty oil and gas for at least as much
                       as it would have collected from traditional cash royalty payments.


                       From January 1995 through September 2001, MMS sold to small refiners
MMS Takes Oil in       about 143 million barrels of oil, or about 25 percent of the federal
Kind and Sells It to   government’s royalty share of all oil produced on federal lands during this
                       time period. The amounts of oil taken in kind each year for small refiners
Small Refiners         have ranged from about 10 to 40 percent of the total federal royalty oil, as
                       shown in figure 1. These amounts were worth from $138 million to $588
                       million, as shown in figure 2.3 The majority of federal royalty oil sold to
                       small refiners since 1995 was produced in the Gulf of Mexico. Other
                       purposes for which MMS took oil in kind, such as for the Wyoming and
                       Gulf pilots and the SPR, are also shown in figures 1 and 2.




                       2
                         For the purpose of this report, 1 cubic foot of gas has a heating value of 1,000 British
                       thermal units. When MMS reported federal royalty gas as having a heating value greater
                       than 1,000 British thermal units per cubic foot, we adjusted the volume to compensate for
                       this difference.
                       3
                         MMS personnel within the RIK Program supplied data on revenues collected from the sale
                       of oil taken in kind from January 1995 through July 2002. However, MMS personnel were
                       unable to supply data on total federal oil royalty revenues (from both RIK sales and cash
                       royalty payments) or the total amount of oil produced on federal lands that were more
                       current than September 2001. They attributed their inability to obtain these data, in part, on
                       a court-ordered shutdown of the system that lasted from December 2001 through March
                       2002.




                       Page 5                                                       GAO-03-296 Mineral Revenues
Figure 1: Estimated Percentage of Federal Royalty Oil Taken in Kind by Purpose,
Calendar Years 1995 through 2000 and January through September 2001




Page 6                                               GAO-03-296 Mineral Revenues
Figure 2: Estimated Value of Federal Royalty Oil Taken in Kind by Purpose,
Calendar Years 1995 through 2001 and January through July 2002




Under the Mineral Leasing Act, as amended by P.L. 79-506, if the Secretary
of the Interior determines that there are insufficient supplies of crude oil
available on the open market to refiners that do not have their own supply,
the Secretary is required to give preference to these small refiners in
selling federal royalty oil. Accordingly, the Secretary provides small
refiners with a stable source of crude oil at equitable prices so that these
small refiners can compete in areas dominated by integrated oil companies
and large refiners. Although the Secretary has long held this authority, the
Secretary conducted few sales prior to 1970 because of little interest from
small refiners. The Secretary delegated the responsibility to administer
small refiner sales to MMS shortly after its formation in 1982. After MMS
assesses small refiners’ needs for crude oil, MMS identifies federal royalty
oil to meet these needs, and then conducts sales. Often, more than one
small refiner wanted to purchase the same oil, so MMS in recent years
conducted a lottery to determine the purchaser.



Page 7                                                GAO-03-296 Mineral Revenues
                      Prior to 2000, MMS relied upon the producer of the oil to report its sales
                      value and subsequently billed the small refiner this amount plus an
                      administrative fee to cover the costs of running the program. After billing
                      the small refiners, however, MMS determined that the producers had
                      understated the value of the oil, so MMS sent additional bills to the small
                      refiners. These bills often surprised the small refiners, and in some cases,
                      large bills threatened their financial solvency. Because small refiners were
                      dropping out of the program owing to the uncertainty over the value of the
                      oil, MMS changed its small refiner sales in 2000 from lottery-based sales to
                      competitive auction-based sales. The bidders and MMS now agree to the
                      price before receiving the oil, just as they do in sales of other federal
                      royalty oil.


                      The Congress established the Strategic Petroleum Reserve to provide
MMS Takes Oil in      emergency oil in the event of a disruption in petroleum supplies. The SPR
Kind to Fill the      consists of a series of underground salt caverns along the coastline of the
                      Gulf of Mexico that can store up to 700 million barrels of oil. It is managed
Strategic Petroleum   and maintained by the Department of Energy (DOE). Largely to reduce the
Reserve               federal deficit, the federal government withdrew and sold oil from the SPR
                      in fiscal years 1996 and 1997.

                      To replace the amounts withdrawn from the SPR, MMS assisted with the
                      transfer of about 29 million barrels of federal royalty oil from the Gulf of
                      Mexico to DOE in 1999 and 2000. This amount represented about 17
                      percent of the federal government’s royalty share of all oil produced on
                      federal lands in each of these 2 years, as shown in figure 1. By filling the
                      SPR, the federal government had forgone the receipt of royalty revenues
                      that it would have otherwise collected in cash. The Office of Management
                      and Budget in February 1999 estimated that the total cost of filling the SPR
                      would be $370 million, but oil prices rose since then, and the total cost
                      was probably higher. Refilling stopped in December 2000 but commenced
                      again in April 2002 under presidential directive and is expected to continue
                      into 2005. From April through July 2002, MMS assisted in transferring to
                      DOE about 7.5 million barrels of oil, worth about $169 million. MMS plans
                      to increase deliveries to DOE from 63,000 barrels per day in July 2002 to
                      about 130,000 barrels per day in 2003.




                      Page 8                                            GAO-03-296 Mineral Revenues
                      MMS began studying the use of federal royalty oil as an alternative to cash
MMS Is Studying the   royalty payments through a series of pilot sales in Wyoming. Through nine
Increased Use of      consecutive sales that began in October 1998, MMS and the state of
                      Wyoming collectively sold federal and state royalty oil.4 In doing so, MMS
Royalties in Kind     acquired information on how to group properties for sale and how to
                      establish a price basis for bidding. Although the federal portion of these
                      volumes far exceeded the state portion, we estimate that the federal oil
                      that MMS sold during the 3-year period from October 1998 through
                      September 2001 accounted for about 1 percent of the federal government’s
                      royalty share of all oil produced on federal lands. MMS expanded its study
                      of royalty oil to the Gulf of Mexico with two competitive sales, the first of
                      which delivered oil to purchasers starting in November 2000. Unlike the
                      pilots in Wyoming, the amount of federal royalty oil that MMS sold in the
                      Gulf of Mexico reached significant quantities during the second pilot
                      sale—about 32 times the amount of oil sold in Wyoming during the same 6-
                      month period. We estimate that the federal royalty oil that MMS sold
                      during this second sale, which commenced in October 2001 and ended in
                      March 2002, might have accounted for about 20 percent of the federal
                      government’s royalty share of all oil produced on federal lands during the
                      term of the sale.

                      MMS first began studying the taking of gas in kind by conducting a gas
                      pilot in 1995. This pilot assessed the administrative efficiency and revenue
                      impacts of taking gas in kind relative to cash royalty payments. MMS
                      accepted about 6 percent of the federal royalty gas in the Gulf of Mexico
                      and sold it through auctions for about $72.6 million. Although this pilot
                      showed that MMS could execute the sale of royalty gas, MMS estimated
                      that these sales resulted in about 6 percent less revenue than MMS would
                      have received in cash royalty payments, or more than a $4 million loss.
                      MMS attributed this loss primarily to unforeseen problems in securing
                      transportation of the gas through pipelines and to industry’s volunteering
                      the royalty gas for sale, rather than to MMS’s selecting this gas. MMS
                      continued studying RIK and issued a report in 1997 that concluded that
                      RIK sales could be administratively more efficient and could generate at
                      least as much revenue as traditional cash royalty payments. MMS began
                      testing these conclusions with a series of pilot sales in the Gulf of Mexico
                      that began in December 1998. The gas that MMS sold during these pilot


                      4
                       In these sales, MMS and the state of Wyoming sold oil from specified properties for 6-
                      month periods. The buyer would receive the federal and state royalty share of oil from
                      those properties for a period of 6 months following the sale. Wyoming participated in all
                      but the first sale.




                      Page 9                                                      GAO-03-296 Mineral Revenues
sales averaged about 10 percent of the federal government’s royalty share
of all gas produced on federal lands from January 2000 through September
2001, as shown in figure 3. The annual revenues that MMS reported
collecting from the sale of this federal royalty gas are illustrated in figure
4.5 MMS studied various methods of selling this royalty gas, including
negotiating the sales price, paying gas marketers to aggregate smaller
volumes of gas into larger volumes, and auctioning the gas. As a result of
these pilot studies, MMS decided to sell federal royalty gas through
auctions open to all buyers meeting minimum standards of credit
worthiness.6




5
 MMS personnel within the RIK Program supplied data on revenues collected from the sale
of gas taken in kind from January 1995 through July 2002. However, MMS personnel were
unable to supply data on total federal gas royalty revenues (from both RIK sales and cash
royalty payments) or the total amount of gas produced on federal lands that were more
current than September 2001. They attributed their inability to obtain these data, in part, on
a court-ordered shutdown of the system that lasted from December 2001 through March
2002.
6
 In these auctions, MMS sells gas from selected properties for specified periods of time.
The buyer receives the federal royalty share of gas for a period of 5, 7, or 12 months
following the sale. MMS initially sold this gas for 1-month periods but discontinued this
process because it was administratively more efficient to conduct sales for greater periods
of time.




Page 10                                                      GAO-03-296 Mineral Revenues
Figure 3: Estimated Percentage of Total Federal Royalty Gas Taken in Kind by
Purpose, Calendar Years 1995 through 2000 and January through September 2001




Figure 4: Revenues Reportedly Collected from the Sale of Federal Royalty Gas
Taken in Kind, Calendar Years 1995 through 2001 and January through July 2002




Page 11                                             GAO-03-296 Mineral Revenues
                          Management control is a necessary safeguard to protect against the risks
MMS Has Established       of fraud, waste, abuse, and mismanagement. MMS has made progress in
Some Management           establishing some components of management control over its RIK
Control over Its RIK      Program, such as (1) identifying and mitigating the risks associated with
                          oil and gas sales and (2) developing written procedures for these sales and
Program, but              for collecting and reporting revenues. However, MMS has yet to develop
Additional Efforts Are    several key management control activities and does not plan to develop
                          them until 2004, when it will consider the RIK Program to have changed
Needed                    from a pilot status to a fully operational status. Specifically, MMS has not
                          clearly defined its strategic objectives, linked performance measures to
                          these objectives, and collected the necessary information to monitor and
                          evaluate the RIK Program.

Management Control Is a   The Federal Managers’ Financial Integrity Act of 1982 directs federal
Necessary Safeguard       agencies to develop management control for safeguarding resources
                          against the risks of fraud, waste, abuse, and mismanagement. Management
                          control is critical to ensure that revenues and expenditures from agency
                          operations are recorded and accounted for properly and that financial and
                          statistical reports are reliable. The act also directs us to issue standards
                          for management control within the federal government. These standards
                          provide broad criteria for agencies to use, in conjunction with guidance
                          issued by the Office of Management and Budget. Management control
                          includes (1) developing strategic objectives, (2) linking performance
                          measures to these objectives, (3) collecting the necessary information to
                          monitor and evaluate performance, (4) identifying and mitigating risks,
                          and (5) developing written procedures and documenting compliance with
                          these procedures.

                          Management control also plays an important role in helping managers
                          comply with the Government Performance and Results Act of 1993
                          (Results Act), which requires federal agencies to establish strategic goals,
                          measure performance, and report on accomplishments. The Results Act
                          shifts the focus of federal agencies away from traditional concerns, such
                          as staffing and reporting on activities, toward achieving results. There is
                          no more important element in results-oriented management than an
                          agency’s strategic-planning process, and establishing formal strategic
                          objectives can help clarify what the agency seeks to accomplish and can
                          help unify the agency’s staff in achieving its goals.




                          Page 12                                           GAO-03-296 Mineral Revenues
MMS Has Begun to       MMS has begun to establish management control over its RIK Program by
Establish Management   addressing the risk that oil and gas sales will be unsuccessful, addressing
Control                inherent risks associated with the sale of oil and gas, and developing
                       written procedures for various activities within the Royalty-in-Kind
                       Program. These activities include conducting RIK sales, collecting
                       revenues, and reporting on revenues. MMS also has made progress in
                       documenting the results of its RIK sales.

                       MMS has addressed the risk that RIK sales will be unsuccessful by
                       ensuring that prior to these sales, certain conditions exist for the
                       properties from which MMS will sell royalty oil and gas. In 1998, we
                       identified the conditions necessary for successful oil and gas sales by
                       surveying state governments, universities, and the Province of Alberta,
                       which, at various times, had programs that took oil and gas in kind.7 We
                       identified several conditions that made these programs feasible. In
                       particular, these programs seemed successful if these entities had (1)
                       relatively easy access to pipelines, (2) properties that produce relatively
                       large volumes of oil or gas, (3) favorable arrangements for processing gas,
                       and (4) expertise in marketing oil and gas. MMS has considered these
                       conditions in addressing risk. Specifically, MMS’s practice of negotiating
                       the cost of transporting gas through pipelines helps to secure relatively
                       easy access to pipelines. Similarly, MMS’s practice of grouping the
                       properties that produce royalty oil or gas according to the pipelines to
                       which they are connected helps ensure that properties produce relatively
                       large volumes of oil or gas. MMS has also arranged for the processing of
                       natural gas and has increased its knowledge of oil and gas marketing by
                       hiring consultants and interviewing oil and gas marketers and
                       representatives of pipeline companies in Wyoming and the Gulf Coast.

                       MMS has also developed procedures to manage the inherent risks, or
                       uncertainties, in the selling of oil and gas. Such risks include fluctuating oil
                       and gas prices, the varying amount of oil and gas that wells produce, and
                       the credit worthiness of purchasers. To manage the risk associated with
                       fluctuating prices, for example, MMS does not try to maximize revenues by
                       guessing which way the market will move but, instead, accepts bids
                       relative to the fluctuating market prices. Thus, MMS avoids substantial
                       losses that could result from wrong guesses. MMS also manages the risk
                       due to the inability of properties to deliver consistent quantities of gas,



                       7
                        See Federal Oil Valuation: Efforts to Revise Regulations and an Analysis of Royalties
                       in Kind, GAO/RCED-98-242 (Washington, D.C.: Aug. 19, 1998).




                       Page 13                                                  GAO-03-296 Mineral Revenues
                        which could require that MMS purchase or supply more costly alternative
                        gas in the event of a shortfall. MMS manages this risk by guaranteeing that
                        it will deliver only a portion of the gas (base volume) at a stable price and
                        offering the other portion (swing volume), without guarantee, at published
                        prices that vary daily. MMS has also developed procedures to monitor the
                        credit worthiness of oil and gas purchasers and can terminate their sales
                        contract or demand additional credit guarantees, if necessary. These
                        procedures led MMS to promptly cancel its contract with Enron, thereby
                        limiting losses to 1 month’s worth of gas production from the Enron
                        contract.

                        MMS has developed written procedures for conducting RIK sales
                        activities, collecting revenues from these sales, and reporting on these
                        revenues. Sales activities include identifying properties from which to take
                        oil and gas in kind, announcing the oil and gas for sale, determining a
                        minimum acceptable bid, analyzing bids, and awarding contracts. We
                        examined documents for sales that MMS conducted from October 1998
                        through October 2002 and found documentation of these activities in all
                        sales in which they were appropriate. However, we did not determine the
                        adequacy of MMS’s procedures for collecting and reporting on revenues,
                        nor did we assess the degree to which MMS complied with these
                        procedures.8


MMS Has Not Developed   MMS developed the following seven strategic objectives for the RIK
Clear Objectives and    Program:
Linked Performance
                        •   Implement RIK where applicable and when it is an improvement over
Measures to These           traditional cash royalty payments (royalty in value).
Objectives              •   Leverage MMS’s position as an asset holder.
                        •   Take advantage of potential interagency synergies.
                        •   Minimize the cost of royalty administration.
                        •   Reduce business cycle time (the time to collect, disburse, audit, and
                            reconcile revenues).



                        8
                          The Department of the Interior’s Inspector General recently reported a problem in
                        collecting all revenues due from the sale of royalty gas. MMS had not resolved in a
                        reasonable time frame the commonly occurring discrepancies between amounts paid and
                        owed due to uncertainties in the gas volumes delivered (referred to as “gas imbalances”).
                        See Department of the Interior, Office of Inspector General, Evaluation of Vulnerabilities
                        to Underreporting: Royalty-in-Value versus Royalty-in-Kind, Report No. 2002-I-0044
                        (Washington, D.C.: August 2002).




                        Page 14                                                    GAO-03-296 Mineral Revenues
•   Accelerate timing of revenue collections.
•   Adopt energy industry business practices and controls wherever
    feasible.

Overall, none of the seven objectives address the revenue impacts of the
RIK sales. The seven objectives do not address requirements in the law
that MMS (1) collect at least as much revenue from the RIK pilots as it
would have from traditional cash royalty payments and (2) obtain fair
market value. The Congress directed MMS in the fiscal years 2001 and
2002 Appropriations Acts for Interior and Related Agencies to collect at
least as much revenue from the sale of royalties in kind as MMS would
have collected from traditional cash royalty payments. Moreover, the
Congress had previously directed the Secretary of the Interior in the
Mineral Leasing Act of 1920 and the Outer Continental Shelf Lands Act of
1953 to obtain fair market value for oil and gas taken in kind.9 The
Congress defined “fair market value” in the Outer Continental Shelf Lands
Act as the average unit price for the mineral sold either from the same
lease or, if such sales did not occur, in the same geographic area.

Furthermore, the first three objectives are not expressed in either a
quantitative or measurable form. The last four objectives, although being
quantitative, address administrative efficiency only. Without objectives to
guide agency staff in the quantitative evaluation of the revenue impacts of
RIK sales, MMS will be unable to determine whether RIK sales generate
more or less revenue than traditional cash royalty payments; whether
MMS obtains fair market value; and hence, whether it should convert the
RIK pilots to an operational status.

MMS has also not developed any performance measures that it linked to
the seven strategic objectives for its RIK Program. However, MMS has
developed two performance measures—(1) confirm and reconcile, within
90 days, all production royalties taken in kind and (2) accelerate the timing
of revenue receipt by 5 days over traditional cash royalty payments
(royalty in value)—that are linked to the broader agency-wide objective of
“collecting royalties in the shortest time possible.” In addition to
supporting the broad agency-wide objective, these two performance
measures support RIK Program objectives that are designed to improve



9
  The Mineral Leasing Act uses the term “market price” not “fair market value,” and the
requirement to obtain market price does not cover competitive sales, which, by their very
nature, provide some protection to the federal government.




Page 15                                                    GAO-03-296 Mineral Revenues
                           administrative efficiency. MMS officials told us that they intend to develop
                           performance measures that are specific to the RIK Program in 2004, when
                           the RIK Program changes from the pilot status to a fully operational status
                           and they acquire and fully implement new information systems that can
                           better measure performance.


MMS Has Not Obtained the   After 5 years of conducting pilot programs and completing 24 oil and gas
Necessary Information to   pilot sales, MMS’s ability to effectively and efficiently monitor and
Monitor and Evaluate the   evaluate its RIK Program is limited because it has not obtained the
                           necessary information to do so. This information includes the
RIK Program                administrative costs of the RIK Program, the savings from avoiding
                           potential litigation and appeals, the savings in auditing properties, and the
                           revenue impacts of all sales. MMS lacks information largely because it has
                           not developed an information systems infrastructure to rapidly and
                           efficiently collect this information. Without quantitative costs, savings, and
                           revenue information, MMS is unable to determine the program’s overall
                           cost and effectiveness, whether RIK generates at least as much revenue as
                           traditional cash royalty payments, and whether the RIK Program should be
                           expanded or contracted.


MMS Has Not Quantified     MMS has not quantified the costs of administering the RIK Program. Such
Anticipated Costs and      costs, which MMS incurs when selling RIK but does not incur when
Savings from               collecting traditional cash royalty payments, result from identifying
                           properties from which to sell oil and gas, calculating minimum acceptable
Implementing the RIK       bids, analyzing bids, awarding and monitoring contracts, billing
Program                    purchasers, negotiating transportation rates, reconciling discrepancies in
                           volume, and comparing RIK revenues with traditional cash royalty
                           payments. MMS has not quantified these costs because its current
                           personnel, payroll, and budgeting systems do not capture data in sufficient
                           detail. Although MMS tracks employees’ time charges with these systems,
                           MMS does not distinguish between time charges that support only the RIK
                           Program and time charges that support both the RIK Program and the
                           traditional system of collecting cash royalties. Similarly, MMS has not
                           decided how to assign the cost of MMS’s financial system and other
                           significant overhead costs to the RIK Program and to the traditional cash
                           royalty system. MMS officials told us, however, that they plan to
                           implement an activity-based cost-accounting system in fiscal year 2003
                           that will assist in resolving these issues.

                           MMS also has not quantified anticipated savings from avoiding potential
                           appeals and litigation by selling oil and gas in kind. MMS officials


                           Page 16                                            GAO-03-296 Mineral Revenues
                         explained that MMS anticipates that it can avoid substantial costs
                         associated with appeals and litigation involving primarily the valuation of
                         natural gas and the transportation of both oil and gas. MMS officials have
                         not estimated the costs of appeals because of problems with implementing
                         the information system that tracks these costs and because of their
                         uncertainty that these costs are recorded in a consistent manner. In
                         addition, the Office of the Solicitor within the Department of the Interior,
                         which is responsible for litigation concerning MMS’s activities, does not
                         have an automated system to track litigation costs.

                         Although MMS anticipates that the cost of auditing revenues will decrease
                         because of taking RIK, MMS has not quantified these savings. MMS
                         anticipates substantial savings because verifying the value of oil and gas is
                         much easier when taking RIK because the purchaser and MMS agree to the
                         sales price before the sale occurs. Similarly, when MMS negotiates
                         transportation costs itself, it knows the exact transportation rate that
                         companies can charge MMS, unlike when companies pay royalties in cash.
                         In addition, MMS does not need to audit transportation costs when MMS
                         sells royalty oil or gas at the location of the lease because there are no
                         transportation costs, since the buyer assumes the responsibility for
                         transportation. Although MMS has projected decreases in the number of
                         staff auditors as a result of future RIK sales, MMS has not finalized these
                         estimated savings because MMS is uncertain of how much oil and gas it
                         will take in kind in the future. MMS officials also question the reliability of
                         the time that auditors have charged to the RIK Program in the past—
                         information that formed the baseline for their projections.


MMS Has Not Fully        MMS also has not fully quantified the revenue impacts of all the royalty oil
Determined the Revenue   and gas that it sold, preventing a comprehensive comparison between RIK
Impacts of RIK Sales     sales revenues and the revenues that MMS would have received under the
                         traditional cash royalty system. MMS does analyze factors that affect the
                         revenues of upcoming RIK sales, including current oil and gas prices;
                         anticipated market conditions; and transportation and processing, if
                         applicable. However, MMS does not systematically compare RIK sales
                         revenues with what it would have received in traditional cash royalties
                         after these gas sales are completed. Of the 15.8 million barrels of federal
                         royalty oil sold in pilot sales from October 1998 through July 2002, MMS
                         quantified the revenue impacts of about 9 percent. Of the approximately
                         241 billion cubic feet of federal royalty gas that MMS sold from December
                         1998 through March 2002, we estimate that MMS quantified, either in
                         whole or in part, the revenue impacts resulting from the sale of about 44
                         percent of this gas. Although MMS analyzed revenue impacts from 44


                         Page 17                                            GAO-03-296 Mineral Revenues
percent of the federal royalty gas it sold, almost none of this analysis was
done in a timely manner, thereby precluding the use of this information to
improve or modify subsequent sales. For example, MMS did not complete
the evaluation of the gas that it sold competitively each month over a 19-
month period until after it had discontinued selling gas in this manner.
Similarly, MMS did not evaluate the revenue impacts of using a gas
marketer to aggregate gas volumes until 1 year after it terminated these
sales. If MMS had evaluated these aggregated sales earlier, it might have
discontinued this method of selling royalty gas because it would have
confirmed employees’ suspicions during the initial sale that the manner in
which gas was being sold was disadvantageous to MMS. Instead, MMS let
another three contracts with similar terms, resulting in an overpayment of
almost $3 million on transportation valued at about $13 million.

MMS’s information systems hinder the timely monitoring and evaluation of
the RIK Program and the evaluation of the revenue impacts from
individual sales. The RIK Program’s current system for managing RIK sales
revenues consists of a series of unlinked computer spreadsheets into
which personnel manually enter RIK data. Such a manual system is prone
to errors, which could lead to inaccurate information. Prior to September
2002, RIK Program personnel did not compile basic monthly reports on
revenues collected and royalty volumes sold, which could have been used
to monitor the RIK Program on a periodic basis. Also, limitations of MMS’s
agency-wide financial system—the system that generates agency-wide
accounting reports and maintains and manages all royalty data—currently
hamper the timely comparison of RIK sales revenues with cash royalty
payments. MMS personnel were unable to use the financial system to
produce summary data that were more current than 1-year old. As of
October 2002, for example, MMS personnel were unable to use the
financial system to determine how much total revenue MMS collected and
how much oil and gas had been produced from federal lands since
September 2001. MMS personnel also said that because of missing or
erroneous data in the agency-wide financial system, data extracted from
this system cannot be used in revenue comparisons without time-
consuming checks for accuracy and reasonableness. Furthermore, it will
be more difficult to use RIK gas data in this system to calculate revenue
impacts because MMS personnel do not enter these data at the lease
level.10 Lastly, RIK Program personnel said that because they have to


10
  When sales involve the federal offshore leases whose royalties must be shared with
adjacent states, MMS officials said that they record the transactions for each lease
separately. This facilitates the disbursement of royalty revenue to the adjacent states.



Page 18                                                      GAO-03-296 Mineral Revenues
              manually acquire data to evaluate federal properties for prospective sales,
              the growth of the RIK Program has slowed.

              MMS officials also said that they have not evaluated the revenue impacts
              from the sales of all royalty oil and gas largely because they have delayed
              the development of performance measures for the RIK Program until 2004.
              These performance measures will incorporate benchmarks against which
              to compare RIK sales revenues. MMS personnel said that MMS has
              generally encountered difficulty in establishing benchmarks against which
              to measure the revenue impacts of RIK oil and gas sales because once it
              takes all federal royalty oil or gas in kind in a specific area, it no longer
              receives any traditional cash royalty payments for comparison. However,
              MMS officials explained that by 2004, MMS expects to acquire and fully
              implement two additional information systems dedicated to the RIK
              Program that will automate the acquisition of necessary information for
              attempting revenue comparisons. MMS personnel said that they had not
              acquired these automated systems earlier because they believed that they
              first needed to process a large number of transactions and sell a large
              volume of oil and gas before they could justify the expense of acquiring
              these systems.


              MMS has begun to establish management control over its RIK Program. It
Conclusions   has initiated positive steps to address the risks that affect its oil and gas
              sales and has developed written procedures for various activities within
              the RIK Program. MMS has also made progress in documenting the results
              of its RIK sales. However, MMS has not established clear objectives for the
              program that are linked to statutory requirements. MMS’s current
              objectives for its RIK Program are not clearly linked to requirements in the
              law that MMS (1) collect at least as much during pilot sales as it would
              have collected in cash royalty payments and (2) obtain fair market value.

              In addition to the lack of objectives linked to statutory requirements, MMS
              is not systematically collecting the necessary information to monitor and
              evaluate the RIK program. Such information includes the administrative
              costs of the RIK program, anticipated savings from reductions in audit
              efforts and from avoiding appeals and litigation, and the revenue impacts
              of all sales. Without clear objectives and the systematic collection of
              evaluative information, MMS cannot assess and ultimately determine
              whether it should expand or contract the use of royalty in kind sales.




              Page 19                                           GAO-03-296 Mineral Revenues
                      To continue the further development of management control for the
Recommendations for   Minerals Management Service’s Royalty-in-Kind Program, we recommend
Executive Action      that the Secretary of the Interior instruct the appropriate managers within
                      the Minerals Management Service to do the following:

                      •   Clarify the Royalty-in-Kind Program’s strategic objectives to explicitly
                          state that goals of the Royalty-in-Kind pilots include obtaining fair
                          market value and collecting at least as much revenue as MMS would
                          have collected in cash royalty payments.

                      •   Prior to expanding the Royalty-in-Kind Program, identify and acquire
                          key information needed to monitor and evaluate performance. Such
                          information, as identified by the Minerals Management Service, should
                          include the revenue impacts of all Royalty-in-Kind sales, administrative
                          costs of the Royalty-in-Kind Program, estimates of savings in avoiding
                          potential litigation, and expected savings in auditing revenues.


                      We provided the Department of the Interior with a draft of this report for
Agency Comments       review and comment. Interior fundamentally agreed with our observations
and Our Evaluation    and recommendations and emphasized MMS’s future plans for improving
                      management control over the RIK Program. Where appropriate, we have
                      included additional references to the activities that Interior mentions in its
                      comments. Interior’s comments and our response to these comments are
                      reproduced in appendix I.


                      In reviewing MMS’s RIK Program, we reviewed congressional directives in
Scope and             pertinent legislation; standards for the development of management
Methodology           control issued by us and the Office of Management and Budget; and prior
                      reports and documentation on the Small Refiners Program, Strategic
                      Petroleum Reserve, and RIK pilots. We also obtained statistical
                      information from MMS on oil and gas volumes taken in kind and the
                      revenue that MMS generated by selling these volumes. In addition, we
                      reviewed documentation pertaining to management control and
                      interviewed MMS personnel about their efforts to establish management
                      control over the RIK Program.

                      We conducted our work from January to November 2002 in accordance
                      with generally accepted government auditing standards. For a more
                      detailed discussion of the scope and methodology of our review, see
                      appendix II.



                      Page 20                                            GAO-03-296 Mineral Revenues
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 7 days from the
date of this letter. At that time, we will send copies of this report to the
Secretary of the Interior; the Director, Office of Management and Budget;
and other interested parties. We will also make copies available to others
upon request. This report will be available at no charge on GAO’s Web site
at http://www.gao.gov.

If you have any questions about this report, please call Mark Gaffigan or
me at (202) 512-3841. Key contributors to this report are listed in appendix
III.




Jim Wells
Director, Natural Resources
 and Environment




Page 21                                           GAO-03-296 Mineral Revenues
                              Appendix I: Comments from the Department
Appendix I: Comments from the Department
                              of the Interior



of the Interior


Note: GAO’s comments
supplementing those in
the report’s text appear at
the end of this appendix.




                              Page 22                                    GAO-03-296 Mineral Revenues
Appendix I: Comments from the Department
of the Interior




Page 23                                    GAO-03-296 Mineral Revenues
Appendix I: Comments from the Department
of the Interior




Page 24                                    GAO-03-296 Mineral Revenues
                              Appendix I: Comments from the Department
                              of the Interior




See comment 1.




See comment 1.




Note: Page numbers in
the draft report may differ
from those in the report.
See comment 1.




                              Page 25                                    GAO-03-296 Mineral Revenues
                 Appendix I: Comments from the Department
                 of the Interior




See comment 2.




See comment 1.




See comment 1.




See comment 3.




See comment 1.




                 Page 26                                    GAO-03-296 Mineral Revenues
                 Appendix I: Comments from the Department
                 of the Interior




See comment 1.




See comment 1.




See comment 1.




                 Page 27                                    GAO-03-296 Mineral Revenues
                 Appendix I: Comments from the Department
                 of the Interior




See comment 4.




See comment 5.




                 Page 28                                    GAO-03-296 Mineral Revenues
                 Appendix I: Comments from the Department
                 of the Interior




See comment 5.




                 Page 29                                    GAO-03-296 Mineral Revenues
Appendix I: Comments from the Department
of the Interior




Page 30                                    GAO-03-296 Mineral Revenues
                 Appendix I: Comments from the Department
                 of the Interior




See comment 5.




                 Page 31                                    GAO-03-296 Mineral Revenues
                 Appendix I: Comments from the Department
                 of the Interior




See comment 6.




See comment 7.




See comment 7.




                 Page 32                                    GAO-03-296 Mineral Revenues
                 Appendix I: Comments from the Department
                 of the Interior




                 The following are GAO’s comments on the Department of the Interior’s
                 letter dated December 13, 2002.

                 1. We clarified our report to reflect these comments.
GAO’s Comments
                 2. We acknowledge that the Mineral’s Management Service’s (MMS)
                 difficulties in obtaining royalty data from its financial system may be due,
                 in part, to the court-ordered shutdown of this financial system in
                 December 2001. However, 9 months had passed since operation of the
                 financial system was restored on March 23, 2002. Additionally, MMS
                 personnel said that the statistical subsystem designed to generate routine
                 summary data that we requested for October 2001 through July 2002 had
                 not yet been deployed and was not expected to be deployed until April
                 2003 at the earliest.

                 3. We expressed Royalty-in-Kind (RIK) volumes as a percentage of total
                 federal royalty oil and gas volumes to show the overall significance of
                 taking royalties in kind compared with receiving cash royalty payments.
                 Using percentages also made it easier to show that large percentages of oil
                 were taken in kind for the Strategic Petroleum Reserve (SPR) and for the
                 Small Refiners Program relative to the small percentages taken for pilot
                 purposes. In expressing RIK volumes as percentages, we used actual RIK
                 sales volumes supplied by MMS but had to estimate the total federal
                 royalty volumes because MMS does not maintain these data.

                 4. In this report, we state that MMS’s strategic objectives do not address
                 the requirements in the law because nowhere in the seven strategic
                 objectives is there reference to the terms “fair market value” or “collecting
                 at least as much revenue as would have been collected in cash royalty
                 payments.” In its response, Interior states that it has intended to
                 accomplish these legislative mandates, and Interior apparently believes
                 that these intentions are implied by the strategic objective stating that
                 MMS will implement RIK “when it is an improvement over traditional cash
                 royalty payments.” In light of Interior’s agreeing with us that the objectives
                 for the RIK Program should include achieving fair market value and
                 collecting revenues at least equal to what MMS would have collected in
                 cash royalty payments, we continue to recommend that MMS clarify the
                 language in its strategic objectives to reflect these intentions.

                 5. We acknowledge that MMS performs substantial analysis prior to
                 converting leases from traditional cash royalty status to RIK. For oil sales,
                 MMS generally calculated a minimum acceptable bid that bidders had to
                 exceed before MMS made an award. For gas sales, MMS relied upon gas


                 Page 33                                             GAO-03-296 Mineral Revenues
Appendix I: Comments from the Department
of the Interior




indexes to assess bids. While relying on minimum acceptable bids and gas
indexes prior to a sale is a first step in ensuring that RIK revenues will
equal or exceed cash royalty payments, MMS cannot determine actual
revenue impacts until after the sales are completed. To effectively monitor
and evaluate the performance of the RIK pilot sales, MMS should calculate
revenue impacts in a timely manner after sales are completed and adjust
future sales on the basis of these results.

Relying on codified valuation regulations as an indicator of what MMS
would have collected in cash royalty payments is not as straightforward as
Interior implies, and the application of valuation regulations is often a
source of dispute between MMS and industry. For example, MMS often
does not know which provision of the valuation regulations will apply to
future royalty collections from a given lease until after the sale. Also,
MMS’s market analyses suggests that many of the provisions for valuing oil
and gas sold to affiliated companies may no longer reflect the manner in
which many companies buy and sell oil and gas today. To compensate for
these uncertainties, MMS must use considerable judgment in estimating
revenue impacts prior to RIK sales.

While MMS has evaluated the revenue impacts after some completed sales,
MMS has not evaluated the revenue impacts of all sales. We point out in
this report that MMS evaluated the revenue impacts, either in whole or in
part, of about 9 percent of the oil sold in kind and about 44 percent of the
gas sold in kind. With regards to the Wyoming oil pilots and the Texas 8(g)
gas pilots that Interior mentions in commenting on this report, MMS
evaluated and published the results of 3 of the 8 completed pilot sales in
Wyoming and 19 of the 29 monthly Texas 8(g) sales. Furthermore, only a
few of MMS’s analyses were done in a timely manner, precluding MMS
from using this information to modify subsequent sales. For example,
MMS did not analyze the revenue impacts of the Texas 8(g) monthly sales
or its aggregated gas sales until after it had discontinued selling gas by
these methods. However, we encourage MMS to analyze the revenue
impacts of its Gulf of Mexico oil pilots despite these sales’ current
suspension because the oil from these properties is being transferred to
the SPR. The results of such a study could be useful, should MMS continue
the Gulf of Mexico oil pilots in the future.

6. MMS supplied us with the estimated loss of about $3 million on the
aggregation contracts. We calculated that transportation was worth about
$13 million on the basis of transportation costs and volumes supplied by
MMS. MMS reported that the total value of royalty payments on the
aggregated gas was about $363 million.


Page 34                                           GAO-03-296 Mineral Revenues
Appendix I: Comments from the Department
of the Interior




7. Our assessment that MMS has difficulty obtaining royalty information
from its financial system is based largely on MMS personnel, who have
used these data to estimate the revenue impacts of RIK sales and told us
that they could not use these data without first performing time-
consuming checks for accuracy and reasonableness. At our request, these
personnel supplied us with royalty data from nine Wyoming oil properties
that we estimate accounted for about 50 percent of the oil sold during the
Wyoming pilots. Although we did not find widespread systemic problems
with this small data set, we confirmed that a small amount of missing,
incomplete, and inaccurate data, in addition to numerous modifications of
data entries by payors (adjustments), precluded using these data for
calculating revenue impacts without first inspecting these data for
accuracy and reasonableness. We confirmed that the manual inspection of
these data was time-consuming. In addition, MMS personnel told us that
RIK gas data are not entered into the system at the lease level, and we
believe this will complicate comparing RIK revenues with cash royalty
payments.




Page 35                                          GAO-03-296 Mineral Revenues
               Appendix II: Objectives, Scope, and
Appendix II: Objectives, Scope, and
               Methodology



Methodology

               In this report, we discuss (1) the extent to which the Minerals
               Management Service has taken federal royalties in kind since 1995 and the
               reasons for doing so and (2) the status of MMS’s efforts to implement
               management controls for its RIK program.

               To determine the extent to which and the purposes for which MMS has
               taken RIK since 1995, we reviewed legislative directives concerning RIK in
               the Mineral Leasing Act of 1920, the Outer Continental Shelf Lands Act of
               1953, and the Appropriations Acts for the Interior and Related Agencies
               for fiscal years 1995 though 2002. We also reviewed presidential directives
               for using federal royalty oil to fill the SPR. We reviewed prior reports and
               other documentation on the Small Refiners Program, the SPR, and the RIK
               pilots in Wyoming and the Gulf of Mexico. We then asked MMS personnel
               to supply data on the amount and values of federal royalty oil and gas
               taken in kind and of total oil and gas royalties from January 1995 through
               July 2002. Although MMS personnel within the RIK Program could supply
               data on RIK revenues and volumes taken in kind during this time period,
               they could not supply data on total royalty revenues and the total amount
               of oil and gas produced on federal lands that were more current than
               September 2001. We did not review the accuracy of these figures.

               To review the status of MMS’s efforts to implement management control
               over its RIK Program, we reviewed the Federal Managers’ Financial
               Integrity Act of 1982, the standards for management control that we issued
               entitled Standards for Internal Control in the Federal Government
               (GAO/AIMD-00-21.3.1, November 1999), and the implementation guidance
               issued by the Office of Management and Budget in OMB Circular A-123.
               We also reviewed our tool for assessing an agency’s management controls
               entitled Internal Control Management and Evaluation Tool (GAO-01-
               1008G, August 2001) and our guide for assessing an agency’s strategic plan
               entitled Agencies’ Strategic Plans Under GPRA: Key Questions to
               Facilitate Congressional Review (GAO/GGD-10.1.16, May 1997).
               Standards for Internal Control in the Federal Government establishes
               the criteria that agencies must meet in developing and maintaining
               management control, which is not one event but a series of actions and
               activities that occur throughout an agency’s operations on an ongoing
               basis. Our review focused on MMS’s efforts to address risks that could
               affect the RIK Program and on some management control activities that
               we identified as being critical to MMS’s implementation and management
               of the program. These management control activities are (1) developing
               strategic objectives, (2) linking performance measures to these objectives,
               (3) obtaining the necessary data for making management decisions and for
               monitoring and evaluating the RIK Program, and (4) developing written


               Page 36                                           GAO-03-296 Mineral Revenues
Appendix II: Objectives, Scope, and
Methodology




procedures and documenting compliance with these procedures. We
assessed MMS’s efforts to establish these management control activities
by reviewing relevant documentation and interviewing MMS personnel.

We reviewed MMS’s efforts to mitigate the risks associated with
differences in the properties that produce federal oil and gas, fluctuating
oil and gas prices, disruptions in production, and credit worthiness. In
assessing strategic objectives and linked performance measures, we
reviewed these objectives and measures for their results-orientation,
clarity, specificity, ability to be expressed quantitatively or in a measurable
form, and consistency with congressional directives. In reviewing the
availability of key data for management decisions and monitoring and
evaluating the RIK Program, we assessed the extent to which MMS had
determined the revenue impacts of all RIK sales, the administrative cost of
operating the RIK Program relative to collecting cash royalties, and the
expected savings from avoiding litigation and appeals and simplifying
auditing. We also examined whether MMS had compared revenue impacts
from each RIK sale with expected revenues from traditional cash royalty
payments or other benchmarks and assessed whether MMS had collected
monthly RIK revenues and sales volumes for monitoring purposes. In
reviewing MMS’s efforts to develop written procedures, we determined if
written procedures existed as of January 1, 2002, for conducting sales
activities, collecting revenues, and reporting on these revenues. We
determined major sales activities to be the selection of properties from
which to sell RIK, the announcement of the sale, the calculation of a
minimum acceptable bid, the evaluation of bids, and the determination of
the winning bidders. For each sale completed as of October 2002, we also
reviewed whether MMS documented these major activities. However, we
did not assess the adequacy of written procedures to collect and report on
revenues, nor did we assess MMS’s compliance with these procedures.
Because at the time of our review, MMS had not implemented an
automated system to support the RIK Program, we reviewed its current
manual system and its efforts to acquire automated systems.




Page 37                                            GAO-03-296 Mineral Revenues
                  Appendix III: GAO Contacts and Staff
Appendix III: GAO Contacts and Staff
                  Acknowledgments



Acknowledgments

                  Jim Wells (202) 512-3841
GAO Contacts      Mark Gaffigan (202) 512-3168


                  In addition to those named above, Letha Angelo, Ronald Belak, Robert
Acknowledgments   Crystal, Cynthia Norris, Frank Rusco, Dawn Shorey, Jamelyn Smith, and
                  Maria Vargas made key contributions to this report.




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                  Page 38                                       GAO-03-296 Mineral Revenues
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