Mineral Revenues: Progress Has Been Slow in Verifying Offshore Oil and Gas Production

Published by the Government Accountability Office on 1990-08-31.

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

                      United   States   General   Accounting   Office       .

                      Report to the Chairman, Committee on
                      Energy and Natural Resources, U.S.

August   1990
                      Progress Has Been
                      Slow in Verifying
                      Offshore Oil and, Gas

                                  ---    -
GAO/RCED-90-    193
.. :
                   United States

GAO                General Account@    Office
                   Washington, D.C. 20644

                   Resources, Community,           and
                   Economic Development            Division


                   August 31, 1990

                   The Honorable J. Bennett Johnston
                   Chairman, Committee on Energy
                     and Natural Resources
                   United States Senate

                   Dear Mr. Chairman:

                   This report responds to your request that we review the Department of
                   the Interior’s actions to (1) verify the accuracy of reported offshore oil1
                   and gas production and (2) annually inspect certain offshore lease sites.
                   The Federal Oil and Gas Royalty Management Act of 1982 (KJGRMA)(30
                   U.S.C. 1701 et seq.) requires Interior to establish a comprehensive
                   system, including annual inspections of certain lease sites, to determine
                   oil and gas royalties.

                   The federal government receives royalties from offshore oil and gas
                   leases on the basis of the volume and price of the oil and gas production
                   sold and the royalty rate. Therefore, it is essential that these elements
                   be verified and that inspections be conducted to help ensure accurate
                   determination of oil and gas royalties.2

                   Seven years after passage of FWRMA, Interior does not have a fully oper-
Results in Brief   ational program for verifying that all oil and gas production is accu-
                   rately reported for royalty determination purposes. However, its
                   Minerals Management Service (MMS)recently initiated two programs
                   intended to verify the accuracy of reported oil and gas production.
                   Although neither program is fully implemented, results for the fit 6
                   months indicate that the volume of oil produced, for the most part, has
                   been accurately reported. Preliminary results of the pilot gas production
                   verification program found minor volume discrepancies.

                   Although FW~RMA   requires annual inspections of lease sites that have
                   significant production or a history of noncompliance with applicable
                   laws or regulations, MMShas not defined the terms and consequently has
                   not determined which lease sites are subject to this inspection mandate.

                   ‘For purposes of this report, we use the tern “oil” to represent the liquid hy dmcarbon substances of
                   oil and condensate.
                   *For information on onshore production verification, see Mineral Revenues:Shortcomings in Onshore
                   Federal Oil and Gas production Verification (GAO/R-W,            June 26,199O).

                   P8ge 1                                                        GAO/ECED8@193 Itfinerd Revenuea

             While in 1989 MMS inspected over 98 percent of the locations where oil is
             measured, it inspected only about one-third of the meters where gas is
             measured. Because M M Shas not determined which lease sites have sig-
             nificant production or a history of noncompliance and it maintains
             records by measurement point rather than lease site (a lease site may or
             may not have a measurement point), it has not demonstrated that it is
             meeting the FDGRMA  inspection mandate.

             MMS, through its four regional offices and its Royalty Management Pro-
Background   gram in Lakewood, Colorado, is responsible for managing federal off-
             shore oil and gas operations, including exploration, production,
             inspections, and revenue collection. From 1982 through 1989, reported
             production from federal offshore leases was 2.8 billion barrels of oil,
             valued at $64.7 billion, and 34.1 trillion cubic feet of gas, valued at
             $80.9 billion, This reported production earned the federal government
             $23.8 billion in royalties.

             Only M M SGulf
                         ’ of Mexico and Pacific regions have producing offshore
             leases. In 1989 production in the Gulf region accounted for 91 percent of
             oil royalties and 99 percent of gas royalties, while the Pacific region
             accounted for the remaining royalties. Gas royalties represent an
             increasing share of royalties from offshore production, rising from 54
             percent in 1982 to 61 percent in 1989.

             The amount of royalty is determined on the basis of the volume and
             price of oil and gas sold and the applicable royalty rate. For royalty pur-
             poses, the volume of oil and gas produced is measured by one or more
             meters at MMs-approvedfacility measurement points (FM%),usually
             located at an offshore lease site. A single FMPcan serve one or many
             leases. As of December 31, 1989, M M SGulf
                                                      ’ of Mexico region had 386 oil
             FMPSand 1,074 gas F’MPS. The Pacific region had 10 oil FMPSand 9 gas
             FMPS. Run tickets are used to record the volume of oil that passes
             through a meter. Gas production is generally recorded on charts that
             graphically record temperature and pressure readings which are used to
             calculate the volume that passes through a meter. Each day’s gas pro-
             duction is summarized on a gas volume statement.

             M M Sregulations require that oil meters be tested (proven) monthly and
             gas meters be tested (calibrated) at least every 46 days to ensure the

             Page 2                                        GAo,%CElNWl93
                                                                      Mineral    Revenues

accuracy of the meters used to measure production.3 The lease operator
is responsible for testing the oil and gas meters. This testing is per-
formed by the operator, the transmission pipeline company, or a third
MMS  regulations require offshore lease operators to submit oil run tickets
and meter-proving reports to the appropriate MMS regional office. The
run tickets and meter-proving reports are used to arrive at net
volume-the volume on which royalties are determined Offshore gas
lease operators are not required to submit similar documents to regional
offices, but must retain calibration reports.

In addition, operators submit montNy oil and gas production reports to
the Royalty Management Program which identify the production volume
and disposition (e.g., sales, storage) of the oil and gas. These reports are
input to M M S Production Accounting and Auditing System (PAAS). Not all
production is subject to royalties. For example, in some cases, gas can
legally be flared (burned off) without payment of royalties. Royalty
payors submit monthly sales and royalty data to the Royalty Manage
ment Program which are input to M M SAuditing
                                           ’        and Financial System
(AFS).M M Suses these automated systems to compare reported produc-
tion sold with reported sales volume to identify potential royalty
underpayment. This comparison does not verify production sold; the
same correct or incorrect number can be reported to both systems.

In January 1982 the Commission on Fiscal Accountability of the
Nation’s Energy Resources (the Linowes Commission) reported that
effective internal controls for the management of oil and gas royalties
must include verification of production, sales, and royalties reported by
companies. To verify production, the Commission recommended that
federal royalty managers periodically obtain run tickets and other data
on a sample basis and use them to cross-check production reports.

In January 1983 the Congress passed FDGRMA,      which requires that Inte-
rior establish a comprehensive inspection, collection and fiscal and pro-
duction accounting and auditing system to accurately determine oil and
gas royalties. M M Sstated that part of its comprehensive system consists
of verifying reported offshore oil and gas production and conducting

When an oil meter is proven, a meter factor is d&ennined that shows the relationship between the
true volume of oil passing through a meter and the volume indicated by the meter. The meter factor is
used to mathematically adjust the production indicated by the meter. When calibrating a gas meter, a
che&ismadet.oassurethattheprernnuP andtemperatwerecordingdeviceaarerecord@

P8ge 3                                                       GAO/?WEMWl93         Mineral Revenoen

                  production measurement and site security inspections. Although FDGRMA
                  does not specifically require that Interior establish a production verifi-
                  cation program, the act did, according to the MMS Director, provide
                  “more urgency” to establishing a viable production verification program
                  to ensure proper reporting of production volumes to PAAS.

                  In addition, FOGRMA requires annual inspections of each lease site that
                  (1) produces or is expected to produce significant quantities of oil or gas
                  in any one year or (2) has a history of noncompliance with applicable
                  laws or regulations. The MM.9 Director noted that, to comply with the
                  FQGRMA   mandate, MMS conducts inspections of oil and gas meter facilities
                  to ensure meter accuracy and site security requirements. FDGRMA defines
                  a lease site as the land identified in the lease contract. A producing lease
                  may or may not have an mp-production          from some leases flows to
                  another location where it is measured, whereas production from other
                  leases is measured at a meter on the lease site.

                  MMS conducts production measurement and site security inspections at
                  FMPS. The oil production measurement inspections involve such things as
                  examining components of the sales meter facility and sampling devices
                  and examining how meter factors are determined. The production mea-
                  surement part of a gas inspection involves checking the calibration fre
                  quency and flow rate of gas meters. The site security part of an
                  inspection involves such items as examining seals that are placed on
                  meters to preclude tampering and determining that no unapproved
                  bypasses exist. MMS published regulations regarding site security for off-
                  shore operations in April 1988. In March 1990, MMS published proposed
                  regulations clarifying that site security applies to gas as well as oil pro-
                  duction. MMSexpects to finalize these regulations by the end of 1990.

                  Interior has been slow in implementing a program to verify offshore oil
ProgressSlow in   and gas production sold. In April 1984, we found that Interior had no
Moving Toward     assurance that oil produced from federal offshore leases was accurately
Production        measured for royalty determination purposes4 We recommended that
                  MMSimplement plans for improved receipt and review of meter-proving
Verification      reports and match these reports with run tickets on a selective basis. We
                  also recommended that after PAA~ and AFSbecame fully operational, MMS
                  use the meter-proving and run ticket data in conjunction with PAAS to
                  verify that reported sales volumes are accurate.

                  ‘Improvements Needed in the De     nt of the Interior’s Measurement of Offshore Oil for Royalty
                  Purpose (GAO-78,            Ap%984).

                  Page 4                                                     GAO/‘BCEMW192      Mined    Revenues

In October 1984 the Director, MMS, established a task force to compare
run ticket net volumes with reported sales volumes. The study covered 8
months of production for 22 FMPSin the Gulf of Mexico region and 9
months of production for 1 FMP in the Pacific region. The task force
found that there were discrepancies between the net volume on the run
tickets and what was reported to MMSas having been sold and that there
was a net underreporting of sales volumes. In December 1984 the task
force recommended that, to ensure accurate royalty payments, run
tickets for every offshore oil meter be compared with sales reported to
AESon a monthly basis.

MMS’ Gulf of Mexico region conducted an extension of the 1984 study
and looked at 111 oil FMPSfor a 6-month period in 1985. The study com-
pared reported sales volumes with run ticket net volumes. The study
noted that underreported and overreported production totaled almost
1.4 million barrels, about 2 percent of the total net volume shown on the
run tickets reviewed. The June 1986 report summarizing the study rec-
ommended that MMS develop an automated program, using run tickets,
to verify volumes of oil on which royalty is due. This study served as
the pilot for MMS’ current oil verification program.

For the period January 1986 through March 1988, MMS' Pacific region
manually calculated run ticket net volumes and compared them with
production volumes reported to PAAS According to regional officials
most volume differences were due to rounding when making various cal-
culations or to operators’ bookkeeping errors. This effort was discon-
tinued due to a staffing reassignment.

In a 1987 audit report, Interior’s Office of Inspector General (IG) found
that the MMSGulf of Mexico regional office had not verified the accuracy
of oil production volumes reported by lease operators, and neither the
Gulf nor the Pacific regional office had verified volumes of natural gas
produced and sold. The IG recommended that MMS implement (1) an auto-
mated process to verify oil production reported to PAAS and (2) a plan to
randomly verify gas production reported to PAAS In January 1987 MMS
established a task force to develop procedures for verifying gas produc-
tion. In its April 1988 final report, the task force recommended that gas
production verification efforts be concentrated on validating quantities
and qualities reported to MMSas sales.

 P8ge5                                       GAO/RCEIMW193   Mineral Revenues

                             initiated two programs intended to verify production from offshore
Programs Underway       MMS
                        leases-one for oil and one for gas. As of July 1, 1990, the automated oil
to Verify Oil and Gas   verification program included all FMPS in the Gulf region and none in the
Production              Pacific region due to computer problems. The gas verification pro-
                        gram-a pilot program- is being conducted in the Gulf only. M M S plans
                        to summarize the results of the gas program by October 1, 1990.

Oil Verification        The results of M M Soil
                                            ’ verification program in the Gulf for the first 6
                        months indicate that the volume of oil produced, for the most part, is
                        being accurately reported.

                        In the Gulf of Mexico regional office, MMS inputs run ticket and meter-
                        proving report data to a computer to derive a run ticket net volume that
                        is compared with monthly production reports. Differences in volumes
                        are forwarded to the Royalty Management Program for resolution. The
                        Gulf region’s first submission to the Royalty Management Program was
                        in September 1989 with a review of May 1989 production data and
                        included 37 FMPS.  The program expanded to cover 303 FMPS    beginning
                        with October 1989 production data. As of July 1,1990, the Gulf
                        included all FMPS.

                        The first 6 months of production data that MMS reviewed (May-Oct.
                        1989) identified 90 volume discrepancies.5Preliminary results,
                        according to M M Sofficials, indicate that these discrepancies were gener-
                        ally the result of bookkeeping errors or late reporting of data. For
                        example, M M Sfound that a company’s underreporting for one FMP was
                        offset by the same company’s corresponding overreporting of produc-
                        tion for another FMP.MMS believes that oniy three discrepancies resulted
                        in actual underreported production and estimated that an additional
                        $26,000 in royalties may be due. M M Sis in the process of working with
                        the companies involved to resolve these discrepancies.

                        M M SPacific
                              ’      regional office initiated its automated oil verification pro-
                        gram covering all 10 F+MPB  with January 1989 production data. However,
                        the low tolerance level established by the region-a difference of more
                        than 10 barrels-made the automated system very sensitive to small
                        differences. The region decided, as an interim measure, to manually cal-
                        culate run ticket net volumes as it had done in the past and compare
                        them with volumes on production reports.

                        “A discrepancy in the Gulf of Mexico region is a difference of at least 1,000 barrels and 5 percent of
                        the production reported.

                        P8ge 6                                                         GAO,fECED~193         Mineral Revenues

Gas Verification       MMS’  Gulf of Mexico regional office is conducting a pilot program to
                       verify reported gas production. This program is being conducted on 48
                       FMPS(containing 106 of the Gulfs 1,814 gas meters) through which flow
                       about one-third of Gulf gas production.

                       Because MMSregulations do not require gas operators to submit produc-
                       tion documentation to the regional offices, the Gulf regional office, in
                       order to conduct the pilot gas verification program, requested data from
                       operators. In April 1989 MMSrequested 6 months (Oct. 1988Mar. 1989)
                       of production documentation, including gas volume statements, for the
                       48 FMPS. MMScompared the volumes on the gas volume statements with
                       the production reports sent to the Royalty Management Program. Pre-
                       liminary results of the pilot gas program have found minor volume

                       FWRMArequires annual inspections of each lease site that produces or is
MMS Needsto            expected to produce significant quantities of oil or gas or has a history
Determine Which        of noncompliance with applicable laws or regulations. These phrases are
LeaseSites Should Be   not defined in the act, and MMShas not defined what constitutes signifi-
                       cant production or a history of noncompliance. Although MMShas con-
Inspected Under        ducted inspections at some FMPSand/or meters, MMShas not
FOGRMA                 demonstrated that it is meeting the FOGRMAinspection mandate.

                       MMSmaintains inspection records by FWPand/or meter rather than lease
                       site. An FWPcan measure the production coming from more than one
                       lease site or it can measure production from a single lease site. During
                       calendar year 1989, the MMS Gulf region inspected almost all of the oil
                       FMPS(379 of 386). However, it inspected less than one-third of the gas
                       meters (678 of 1,814)-eIn the Pacific region, MMSconducted production
                       measurement and site security inspections at all 10 of the oil FWS and 8
                       of the 9 gas FMPS.

                       According to MMSGulf regional officials, the region inspected gas meters
                       only if they were co-located with oil meters. These gas meters were not
                       necessarily those through which passed the greatest amounts of produc-
                       tion or those which had a history of noncompliance.

                       6MM8 records indicate the number of gas meters inspected. Although MMS inspected 678 @S meters,
                       some of these meters may have been inspected more than once. Hence the estimate that MM.‘3
                       inspected about onethird of the gas meters may be overstated.

                       Page 7                                                     GAO/ECEDS@l93       bfinerd   Itevenues

                      Effective internal controls for the management of oil and gas royalties
Conclusions           must include verification of production volumes reported by companies.
                      We believe that oil and gas verification serves as a deterrent to inaccu-
                      rate reporting of production. In addition, such verification is needed
                      before PAASdata can reliably be compared with AFS data. As currently
                      used, this comparison does not verify production; the same correct or
                      incorrect number can be reported to both systems.

                      M M Shas begun two production verification programs-one for oil and
                      one for gas. We believe the steps M M Sis taking regarding oil production
                      verification-calculating   net production volume from run tickets and
                      meter-proving reports and comparing the results with operators’
                      monthly production reports-are appropriate. M M Sexpects to complete
                      its pilot gas production verification program by October 1990.

                      FQGRMA   mandates that Interior annually inspect lease sites producing or
                      expected to produce significant quantities of oil or gas or sites that have
                      a history of noncompliance with laws or regulations. The M M S Director
                      identified production measurement and site security inspections as
                      those satisfying the FWRMA inspection mandate. MMS conducted such
                      inspections at some, but not all, oil and gas F’M Pand/or
                                                                         S      meters, concen-
                      trating primarily on oil locations.

                      Because gas royalties represent the largest and a growing share of roy-
                      alties from offshore production, we believe that it is increasingly impor-
                      tant for M M Sto perform production measurement and site security
                      inspections at gas lease sites with significant production or a history of
                      noncompliance. Further, because oil and gas lease sites with significant
                      production or a history of noncompliance pose a greater potential roy-
                      alty loss than other lease sites, it is important that MMS identify those
                      lease sites so that appropriate priority can be given to ensuring that, as
                      a minimum, those lease sites are inspected. This is especially important
                      when resources are not sufficient to inspect all lease sites in a given

                      Because of the need to ensure that the volume of oil and gas produced
Recommendations       from federal leases is accurately reported for purposes of determining
                      royalties, we recommend that the Secretary of the Interior direct the
                      Director, M M !~,to take the following actions:

                  l   Include the FMPSin the Pacific region in the automated oil verification

                      Page 8                                        GAO/BcED~192   Minerd Revenues

l   Complete the gas verification pilot program and move quickly to imple-
    ment an ongoing pIWdUCtiOn verification  program     At a minimum,       MMS

    should verify gas volumes for all high-producing leases and leases with
    a history of noncompliance, as well as randomly verify production from
    a sample of the remaining leases.
l   Define the terms “significant quantities of oil or gas” and “history of
    noncompliance” and ensure that lease sites meeting these criteria are
    annually inspected as required by IWRMA.

    We obtained information for this report from officials in MMSregional
    offices in New Orleans, Louisiana, and Los Angeles, California; in the
    MMSVentura, California, district office; in MMS’Royalty Management
    Program in Lakewood, Colorado; in the headquarters offices of MMSand
    the Office of the Solicitor in Washington, DC. We reviewed offshore pro-
    duction documents, inspection reports, and agency pilot studies and ana-
    lyzed computer statistics. In addition, we sent a letter of inquiry to MMS
    about its production verification and inspection responsibilities. After
    receiving the MMSresponse, we met with numerous MMS officials to
    clarify information in the response. We conducted our review from
    August 1989 through August 1990 in accordance with generally
    accepted government auditing standards. Our review did not address
    sales price and royalty rate which, together with production sold, is ver-
    ified through Interior’s royalty compliance audits.

    As requested, we did not obtain official agency comments on this report.
    However, we discussed the factual information in a draft of this report
    with MMSheadquarters officials. Although the MMSDirector noted in a
    March 16,1990, letter to us that MMSconducted production measure-
    ment and site security inspections to satisfy FKGRMA,the MMSheadquar-
    ters officials said that FQGRMA   imposes no additional inspection
    requirements on MMS.These officials said that under the Outer Conti-
    nental Shelf Lands Act Amendments of 1978 (43 U.S.C. 1348) (OCSLAA),
    MMSis conducting annual inspections of all offshore facilities for safety
    and environmental purposes and that these inspections would also iden-
    tify gross site security violations. They believe that these inspections
    also satisfy the KIGRMAinspection mandate. According to these officials,
    it is not necessary for MMSto identify the lease sites with high produc-
    tion or a history of noncompliance because the safety and environ-
    mental inspections are conducted at all facilities.

    We believe that FYINXMAdoes impose additional inspection responsibili-
    ties on MMS.While we believe that production measurement and site

    P8ge 9                                             GAO/BCEBO&lBZ3 Mind   Revenuea

security could be performed in conjunction with the annual safety and
environmental inspections that are done to satisfy KSLAA requirements,
the specific production measurement and site security inspection items
identified by MMSare not covered in the annual safety and environ-
mental inspections.

Unless you publicly announce the contents of the report earlier, we plan
no further distribution until 30 days from the date of this letter. At that
time, we will send copies to interested parties and make copies available
to others upon request.

This work was performed under the direction of James Duffus III,
Director, Natural Resources Management Issues, who can be reached at
(202) 276-7766. Other major contributors to this report are listed in
appendix I.

Sincerely yours,

J. Dexter Peach
Assistant Comptroller General

Page 11   GAO/BCED9@193
                    M ined Revenues
Appendix I

Major Contdbutors to This &port

                        Robert W. Wilson, Assistant Director
Resources,              Rosellen McCarthy, Assignment Manager
Community, and          Ronald J. Johnson, Evaluator-in-Charge
Development Division,
Washington, DC.

                        Page 12                                  GAO/llCED~l93   Mineral Revenues

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