[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
GETTING ROYALTIES RIGHT:
RECENT RECOMMENDATIONS
FOR IMPROVING THE FEDERAL
OIL AND GAS ROYALTY SYSTEM
=======================================================================
OVERSIGHT HEARING
before the
SUBCOMMITTEE ON ENERGY AND
MINERAL RESOURCES
of the
COMMITTEE ON NATURAL RESOURCES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
Tuesday, March 11, 2008
__________
Serial No. 110-64
__________
Printed for the use of the Committee on Natural Resources
Available via the World Wide Web: http://www.gpoaccess.gov/congress/
index.html
or
Committee address: http://resourcescommittee.house.gov
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COMMITTEE ON NATURAL RESOURCES
NICK J. RAHALL, II, West Virginia, Chairman
DON YOUNG, Alaska, Ranking Republican Member
Dale E. Kildee, Michigan Jim Saxton, New Jersey
Eni F.H. Faleomavaega, American Elton Gallegly, California
Samoa John J. Duncan, Jr., Tennessee
Neil Abercrombie, Hawaii Wayne T. Gilchrest, Maryland
Solomon P. Ortiz, Texas Chris Cannon, Utah
Frank Pallone, Jr., New Jersey Thomas G. Tancredo, Colorado
Donna M. Christensen, Virgin Jeff Flake, Arizona
Islands Stevan Pearce, New Mexico
Grace F. Napolitano, California Henry E. Brown, Jr., South
Rush D. Holt, New Jersey Carolina
Raul M. Grijalva, Arizona Luis G. Fortuno, Puerto Rico
Madeleine Z. Bordallo, Guam Cathy McMorris Rodgers, Washington
Jim Costa, California Louie Gohmert, Texas
Dan Boren, Oklahoma Tom Cole, Oklahoma
John P. Sarbanes, Maryland Rob Bishop, Utah
George Miller, California Bill Shuster, Pennsylvania
Edward J. Markey, Massachusetts Bill Sali, Idaho
Peter A. DeFazio, Oregon Doug Lamborn, Colorado
Maurice D. Hinchey, New York Mary Fallin, Oklahoma
Patrick J. Kennedy, Rhode Island Adrian Smith, Nebraska
Ron Kind, Wisconsin Robert J. Wittman, Virginia
Lois Capps, California
Jay Inslee, Washington
Mark Udall, Colorado
Joe Baca, California
Hilda L. Solis, California
Stephanie Herseth Sandlin, South
Dakota
Heath Shuler, North Carolina
James H. Zoia, Chief of Staff
Rick Healy, Chief Counsel
Christopher N. Fluhr, Republican Staff Director
Lisa Pittman, Republican Chief Counsel
------
SUBCOMMITTEE ON ENERGY AND MINERAL RESOURCES
JIM COSTA, California, Chairman
STEVAN PEARCE, New Mexico, Ranking Republican Member
Eni F.H. Faleomavaega, American Louie Gohmert, Texas
Samoa Bill Shuster, Pennsylvania
Solomon P. Ortiz, Texas Bill Sali, Idaho
Rush D. Holt, New Jersey Adrian Smith, Nebraska
Dan Boren, Oklahoma Don Young, Alaska, ex officio
Maurice D. Hinchey, New York
Patrick J. Kennedy, Rhode Island
Hilda L. Solis, California
Nick J. Rahall, II, West Virginia,
ex officio
------
CONTENTS
----------
Page
Hearing held on Tuesday, March 11, 2008.......................... 1
Statement of Members:
Costa, Hon. Jim, a Representative in Congress from the State
of California.............................................. 1
Prepared statement of.................................... 3
Pearce, Hon. Stevan, a Representative in Congress from the
State of New Mexico........................................ 4
Smith, Hon. Adrian, a Representative in Congress from the
State of Nebraska, Statement submitted for the record...... 90
Statement of Witnesses:
Allred, Hon. C. Stephen, Assistant Secretary, Land and
Minerals Management, U.S. Department of the Interior....... 53
Prepared statement of.................................... 57
Deal, David, Vice Chair, Royalty Policy Committee, U.S.
Department of the Interior................................. 12
Prepared statement of.................................... 15
Response to questions submitted for the record........... 21
Devaney, Earl, Inspector General, U.S. Department of the
Interior................................................... 6
Prepared statement of.................................... 9
Response to questions submitted for the record........... 10
Finfer, Larry, Deputy Director, Office of Policy Analysis,
U.S. Department of the Interior............................ 64
Response to questions submitted for the record........... 66
Luthi, Randall, Director, Minerals Management Service........ 55
Prepared statement of.................................... 57
Roller, Dennis, Audit Manager, North Dakota State Auditor's
Royalty Audit Section, Minerals Management Service......... 74
Prepared statement of.................................... 76
Response to questions submitted for the record........... 84
Rusco, Frank, Acting Director, Natural Resources and
Environment, U.S. Government Accountability Office......... 24
Prepared statement of.................................... 26
Response to questions submitted for the record........... 36
Stiff, Linda, Acting Commissioner, Internal Revenue Service.. 67
Prepared statement of.................................... 69
Response to questions submitted for the record........... 73
Additional materials supplied:
Brian, Danielle, Executive Director, Project On Government
Oversight, Washington, D.C., Statement submitted for the
record..................................................... 90
Kerrey, Hon. Bob, and Hon. Jake Garn, Co-Chairmen,
Subcommittee on Royalty Management, Statement submitted for
the record................................................. 19
OVERSIGHT HEARING ON GETTING ROYALTIES RIGHT: RECENT RECOMMENDATIONS
FOR IMPROVING THE FEDERAL OIL & GAS ROYALTY SYSTEM.
----------
Tuesday, March 11, 2008
U.S. House of Representatives
Subcommittee on Energy and Mineral Resources
Committee on Natural Resources
Washington, D.C.
----------
The Subcommittee met, pursuant to call, at 10:04 a.m. in
Room 1324, Longworth House Office Building, Hon. Jim Costa,
[Chairman of the Subcommittee] presiding.
Present: Representatives Costa, Pearce, Hinchey and Smith.
STATEMENT OF THE HONORABLE JIM COSTA, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF CALIFORNIA
Mr. Costa. The oversight hearing of the Subcommittee on
Energy and Mineral Resources will now come to order. The
Subcommittee is meeting today to hear testimony on recent
recommendations on the oil and gas royalty system, something
that has been the subject of this Subcommittee and the
Committee over on the Senate for some time now.
Under Rule 4[g], the Chairman and the Ranking Member may
make opening statements, and then if any other Members wish to
do the same, we will submit those statements into the record
under unanimous consent. Additionally, under Committee Rule
4[h] additional material for the record should be submitted by
Members or witnesses within 10 days.
That includes questions that Members may have but may not
have had the opportunity to ask during the hearing. We
obviously urge Members to submit those questions, and we ask
for the witnesses to provide a timely response on the answers
to the questions that have been submitted.
As Chairman, I spoke with the Ranking Member just a moment
ago. It is our intention to conclude this hearing by around
noontime. We have a number of votes, and we have other meetings
that we are compelled to participate in, and so we will try to
get as much work done as we can in the next two hours.
Let me just make a brief opening statement. I want to begin
by thanking the witnesses on Panel 1 and Panel 2 for your due
diligence and for your testimony. I know you will do your very
best to answer the questions that we have for you. We are
obviously here today, as I said earlier, to continue to focus
on how the government collects royalties for oil and gas that
is produced on Federal lands.
This is the third time that the Natural Resources Committee
has examined the issue in Congress, and my guess is it won't be
the last. In the past year and a half, there have been multiple
reports of the problems with royalty collections, some are less
significant, some I think are much more significant, and we
will endeavor to find from the witnesses your own take on how
we best do this job.
Three of the organizations involved in the reports that
have written about the success or the level of effectiveness
that the Minerals Management Service has done its job of
collecting royalties are here today. Representatives from the
Government Accountability Office, the Department of the
Interior's Inspector General and the Royalty Policy Committee
are first on our panel.
We look forward to hearing about the recommendations that
first came out in the Senate hearing, the 100 or so
recommendations that I understand the Minerals Management
Service is in the process of implementing. We also have
Assistant Secretary Stephen Allred and Director Randall Luthi
here today so that we can find out how some of these
recommendations are being implemented.
Dennis Roller from North Dakota is here to describe some of
the issues from the state and tribal standpoint that also
participate and are beneficiaries of the collection of these
royalties. In addition, probably a first for this committee, we
have a witness, you might be surprised, from the Internal
Revenue Service, Acting Director Linda Stiff.
I only asked her to come here today because I have some
questions about my own taxes. Not true. Of course, we have
invited the IRS here because one of the recent reports that was
done earlier discusses how the Internal Revenue Service could
act as a good model for our oil and gas royalty collection
system.
To the degree that there are comparisons, we would like to
learn whether or not those comparisons make sense or are
applicable in the case of the Minerals Management Service. I
also am glad because I think that frames the issue well, in
part, but the Internal Revenue Service, the IRS, of course can
be maligned. They are respected for their responsibility in
collecting money from the American taxpayer.
Meanwhile, the Minerals Management Service collects money
for the American taxpayer. One collects it from the American
taxpayer, the other collects it for the American taxpayer. I
think we seem to do very well in the first case. Some of my
constituents argue they do it too well.
I am not sure that we are doing quite as well in the second
category with regard to the royalty collection, and that is
obviously the purpose of today's hearing. The Minerals
Management Service brings in a staggering amount of money, last
year over $11 billion, as a source of income for our nation's
government, and it is expected to do more this year, in part
because of the rise in oil prices and natural gas.
The reports we are here to discuss show that, in fact,
honest folks believe the job could be done better. I believe
that we have a responsibility and need to ensure that we do the
best job possible for getting America's taxpayers' dollars, our
fair share, from our abundance of energy resources.
As I said, this won't be the last hearing on the subject. I
look forward to taking the testimony today, and not just as it
relates to the royalty program but how other efforts can be
improved, and the issue of in-kind versus royalty collection,
which is not a new discussion. Ranking Member Pearce and others
have opined as to their thoughts on what is the best way that
we can do this.
I think it is still an issue that we have to try to reach
some consensus on, and I know there are many differences of
opinion on that point. Let me conclude by saying that simply
because we have always done things this way doesn't necessarily
mean that it is the best way to do them.
Times change, technology changes. MMS is in the process of
trying to institute this $150 million new computerized program.
I keep getting mixed reports on the success of it. I think that
we need to make sure that we are adaptive to protect the
American interests of these resources.
I now would like to, with a great deal of pride, recognize
the Ranking Member, Mr. Pearce from New Mexico, for his opening
remarks.
[The prepared statement of Chairman Costa follows:]
Statement of The Honorable Jim Costa, Chairman,
Subcommittee on Energy and Mineral Resources
We are here today to discuss the way the federal government
collects royalties for oil and gas produced from federal lands. There
will be plenty of discussions about auditing and accounting and various
other financial complexities, but this is not some esoteric topic that
only a policy wonk could appreciate. This is about the one of the
largest sources of revenue for the federal government outside the tax
system, with over $11 billion brought in last year. Projections are
that revenues this year could top $15 billion. And let no one forget--
these are the natural resources that belong to the American people.
Royalties are not a gift that oil and gas companies give back to the
Treasury. They are the American people's fair share of the resources
that they are allowing to be extracted and sold. And this fair share
goes towards schools, it goes towards roads, it goes towards protecting
wilderness, restoring historic buildings, managing water projects, and
doing just about everything else that this country needs to do.
When an oil or gas company signs a federal lease, they're signing a
contract with the American people, and they're promising to provide
that fair share that the people rightfully deserve. But in order to get
that fair share, the American people have to put their trust in the
government. They have to trust that we will be good stewards of their
resources; that we will make sure to hold the oil and gas companies
accountable for that fair share. Anything less is a gross dereliction
of our duty.
Unfortunately, it appears that the government has not been as
diligent as it should. The past few years have seen one revelation
after another about the sorry state of our royalty collection system.
As the Inspector General of the Department of the Interior, Earl
Devaney, says in his testimony, ``the history here is rich and
disconcerting.'' The Government Accountability Office sums the issues
up in their testimony when they say, ``ultimately the system used by
Interior to ensure taxpayers receive appropriate value for oil and gas
produced from federal lands and waters is more of an honor system than
we are comfortable with.'' Certainly more than I am comfortable with as
well.
The most recent report comes from the Subcommittee on Royalty
Management, which was appointed by the Secretary of the Interior on
March 22, 2007, and came back with 110 recommendations to improve the
royalty system less than nine months later--that's about three
recommendations a week. Mr. David Deal, Vice-Chair of that
Subcommittee, is here to discuss some of these recommendations,
although I don't know if we'll have enough time to get through them
all.
But as I have already alluded to, that report is only the latest in
a line of serious concerns surrounding the royalty system. Inspector
General Earl Devaney, testifying here today, has completed three
reports in the past fifteen months, each one detailing serious
shortcomings in the Minerals Management Service. The audit of MMS'
increased use of compliance reviews talks of data reliability problems
and a lack of a proper strategy to identify which companies need to be
looked at more closely. The investigation of why price thresholds were
left off offshore leases in 1998 and 1999, which could cost the
government upwards of $9 billion, resulted in the discovery of a ``jaw-
dropping example of bureaucratic bunging.'' And the investigation of
cases filed by disgruntled auditors who claimed that MMS was not going
after royalties it was entitled to uncovered ``a band-aid approach to
holding together one of the Federal Government's largest revenue
producing operations,'' and a ``profound failure'' in the development
of a crucial computer system, one which MMS has spent $150 million on
already.
The Government Accountability Office has also uncovered numerous
fundamental problems with how the royalty program operates. Last year
they testified that MMS didn't have the data to accurately assess
whether the Royalty-in-Kind program, which has exploded in recent
years, was a better deal for the government than taking royalties the
traditional way, in value. Today, Mr. Frank Rusco of the GAO will
testify that MMS cannot even verify that they're getting the royalties
they should. Dennis Roller, an auditor with the State of North Dakota,
will testify about on-going problems that he sees from his position in
the trenches, where he fights to ensure that his state gets the share
of royalties that is rightfully theirs. No one from the Department of
Energy is here to testify to today, but earlier this year they reported
that MMS could not account for 30,000 barrels of royalty oil that were
supposed to be headed to the Strategic Petroleum Reserve--which is over
$3 million in today's prices.
There are far too many issues with the royalty program to address
today. This is just one in what will be a continuing series of hearings
this subcommittee will hold in order to get to bottom of these
problems, and figure out what needs to be done better. The entire
structure of the federal oil and gas leasing system is under scrutiny
here. I am not satisfied to maintain the dysfunctional status quo
simply because of historical factors or industry preference. I intend
to listen carefully to what our witnesses have to say, and start trying
to figure out what has to be done, by the Department of the Interior
and by Congress, to ensure that we don't come back here every few years
to hear the next list of 100 recommendations that need to be
implemented to make sure the American people get their fair share.
______
STATEMENT OF THE HONORABLE STEVAN PEARCE, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF NEW MEXICO
Mr. Pearce. Thank you, Mr. Chairman. The hearing today we
have titled ``Getting Royalties Right.'' If I recall, last year
we called it ``Royalties at Risk.'' I would say that as we get
into the hearing I would like to pause because the
misperceptions that are being created is that there are lost
royalties when real royalties are being lost because of the
energy policies that are originating from San Francisco-type
energy policies.
My question is when is the Subcommittee going to get
royalties right? The dollar value is falling, our economy is
slowing, the price of WTI Oil yesterday closed at a record
$107.87 per barrel, the spot price for natural gas closed at
$9.58 per TCF, the EIA is expected to forecast record high
gasoline prices for the summer and there is an outcry for
supply, but that outcry is falling on deaf ears.
This country keeps its potential revenue from royalties on
energy supply off limits. The majority keeps its off limits by
creating a misperception that we drill everywhere and all of
the time. Of the 262 million acres of BLM land, less than five
percent of that land is being used for oil and gas production.
The other 95 percent of BLM land has no oil and gas
production. The resources are there; we just don't produce it.
So when we talk about the lack of stewardship for the American
people, we should look in the mirror. Similarly, only 15
percent of the National Wildlife Refuge Systems has oil and gas
activities.
Furthermore, not a drop, zero percent, of our park lands
permit oil and gas activities. We learned last Congress that
less than three percent of our outer continental shelf is being
leased for oil and gas production, and this at a time when we
are seeing prices of gasoline moving toward $4 a gallon.
The majority keeps production off limits by convincing the
American people that we don't have enough energy here in the
U.S. To keep up the charade, they cut off two trillion barrels
of shale oil in Colorado and Utah last year in our omnibus
spending package. Two trillion barrels, that is double all of
the world's oil. Endless royalties are being now bypassed
because of a decision made by this Congress.
These are the royalties at risk if we continue to file
these Democratic energy policies that will continue to be at
risk. This hearing is a classic example of penny wise, pound
foolish. There are billions of dollars of Federal royalties
left on the table because more and more of our Federal lands,
where much of the energy is, remains off limits.
I am looking forward to the testimony. For instance, Mr.
Devaney says in his comments that four investigations remain
ongoing.
I am going to ask Mr. Devaney, and I hope he deals with the
question up front, what the Justice Department is telling him
about those investigations because I am concerned that if the
Justice Department doesn't see his reasons for continuing
investigations, I am concerned about how we are doing those
investigations.
Also, Mr. Rusco, I am interested, in your GAO report you
state that the Interior lacks adequate assurance that it is
receiving full compensation for oil and gas produced in Federal
lands, and yet, when I read this comprehensive report with
multiple qualified people on the panel that put that report
together I see that MMS is an effective steward of the minerals
revenue.
There is no middle ground between those statements. I am
diametrically opposed, and I am looking forward to the
testimony that is going to assure me that the GAO actually used
the same kind of qualified people that I can find on the list
here, so I will be asking about that in your testimony. How can
we come to diametrically opposed opinions from two different
oversight agencies?
So I am looking forward to the testimony today. Mr.
Chairman, I am aware of the criticism of royalties in kind. The
royalties in kind, every day the price of oil is different in a
different piece of the country. Price of oil is depending on
the quality of the amount that it is going to cost to produce
it, and we have to figure out every single area and every
single price in the country to see if we get our dollars.
Yet, if we simply did RIK, royalty in kind, we simply say
you made that many barrels, we get a percent and we will take
it here or we will take it there. Similarly, on gas, you just
read a meter. You don't have to do the complex calculations
with lawyers and auditors. In the way that we are processing
right now, the non-royalty-in-kind process attracts lawyers and
auditors like sharks to blood.
Again, I look forward to the testimony and discussion
today. I just ask that all things be put into perspective.
Welcome to you all. I appreciate your coming here for your
testimony, and we look forward to it. Thank you, Mr. Chairman.
Mr. Costa. Thank you, Mr. Pearce. I appreciate your
comments. I don't want to get in a debate with you at this
point, but I would indicate in meetings I had last week with
Shell folks who have done the most in oil shale in the areas
that you made reference to that they are probably 5 or 10 years
away even though they think there are tremendous prospects, as
you noted, in terms of their ability to get the technological
efforts to make it cost effective.
As it relates to energy offshore, you and I, I think, have
closer agreement than we have on others, but under the Clinton
administration with a Republican Congress record leases were
given in the late 1990s. Those leases have continued in the
Bush administration, and they are continuing to provide leases.
So we do have problems in states like Florida and
California, which I represent, where folks don't want to drill
offshore. It is a question, as you pointed out in your
testimony, of wanting to have it both ways. I might add that
those are not a circumstance of the majority or a minority
because in both those cases we had Republican Governors who in
Florida and California in a bipartisan Court chose not to seek
that exploration development.
It is a problem that we have to come together with as a
nation I think in a bipartisan fashion. I think I just want to
point out that we have witnesses here who will tell us what we
are doing and give us their opinion, and we will listen. Then
the good, sharp questioning that you are always a part of I
know will be a part of the record of this testimony, and I look
forward to it.
Mr. Earl Devaney is the Inspector General of the Department
of the Interior; Mr. David Deal is the Vice Chairman of the
Royalty Policy Committee within the Department of the Interior;
and Mr. Frank Rusco is the Acting Director of Natural Resources
and Environment for the General Accounting Office.
The timing lights, gentlemen, on the table, you are
familiar with I know, and I am sure you have properly focused
that you will be within that timeframe.
I would like to now recognize Mr. Devaney to testify for
five minutes, and we will go from there.
STATEMENT OF EARL DEVANEY, INSPECTOR GENERAL,
U.S. DEPARTMENT OF THE INTERIOR
Mr. Devaney. Thank you, Mr. Chairman. Mr. Chairman and
Ranking Member Pearce, I want to thank you for the opportunity
to appear before you today to discuss the recommendations
arising from some of my office's most recent work----
Mr. Costa. Could you bring the mic a little closer so we
could all hear you?
Mr. Devaney. Sure--in the oil and gas royalties collection
program and my thoughts about how this program might be
improved including a stepped up oversight effort on the part of
the Office of Inspector General.
Mr. Costa. I think you need to put that a little closer. We
really want to hear you, Mr. Devaney.
Mr. Devaney. The past two years, is that good?
Mr. Costa. Yes, that is better.
Mr. Devaney. OK. The past two years, the agency responsible
for royalty collections on behalf of the Federal Government,
the Minerals Management Service, has undergone intense scrutiny
by my office and GAO.
As you know, I testified on these issues before the House
Subcommittee on Energy and Resources in September of 2006, the
full House Committee on Natural Resources in February of 2007
and the Senate Committee on Energy and Natural Resources in
January of 2007.
The history here is both rich and disconcerting. Beginning
with our audit of MMS's compliance review process, we found
that while compliance reviews play a useful role in MMS's
Greater Compliance Asset Management Program they do not provide
the same level of detail or assurance that a traditional audit
provides, nor were they being utilized in the context of a
well-designed, risk-based compliance strategy.
Following this audit, we made recommendations for improving
data reliability, strengthening compliance review tools and
developing that missing risk-based strategy. This audit was
followed by a complex investigation into the failure of MMS to
include royalty price thresholds in offshore oil leases in the
Gulf of Mexico in 1998 and 1999.
After this investigation we recommended that all policy
decisions that significantly alter the terms and conditions of
the offshore/onshore oil and gas leases be memorialized in the
form of an internal memorandum compiled in one accessible
place, establish one person that is responsible for the entire
Notice of Sale document and prior to its final issuance, each
lease should be legally reviewed by the Solicitor's Office.
Even while this investigation was ongoing, Secretary
Kempthorne requested that we initiate another investigation
into the Minerals Revenue Management, a program within MMS that
had several qui tam cases filed by its own auditors. The
results of this investigation presented examples of a systemic
dilemma in MMS, that of the Bureau's conflicting roles and
relationships with the energy industry.
It also hinted of a profound failure in the development of
a critical IT system, it revealed a working environment with
poor communication compounded by an element of distrust, and it
demonstrated a band-aid approach to holding together one of the
Federal Government's largest revenue producing operations.
This report included recommendations to, among other
things, rescind the 1997 ``hardship'' guidance and develop
clear guidance to industry on interest calculations, develop a
strategy to eliminate the interest collection backlog on an
expedited basis, clarify guidance to the industry on sub-sea
transportation costs, foster better communications between
MMS's auditors and program people and to develop an enhanced
ethics program designed specifically for the RIK Program.
In addition, we discovered a number of other significant
issues worthy of separate investigations including ethical
lapses, such as DOI employees who were accepting gifts from oil
and gas industry representatives. We currently have four
investigations that remain ongoing. Because these four
investigations involve potential criminal violations, I am
currently precluded from discussing them in any detail.
Suffice it to say, Mr. Chairman, MMS has had more than its
share of royalty management problems and consumed more than its
share of my office's attention in the last two years. In
addition to his request for a qui tam investigation, Secretary
Kempthorne separately requested a study by the independent
bipartisan panel, co-chaired by Senators Bob Kerrey and Jake
Garn, which reported to the Royalty Policy Committee.
We shared with this panel a list of recommendations that
had emanated from our efforts. The final report presented to
the Royalty Policy Committee fundamentally incorporated all of
the 22 recommendations made by my office thus far. We expect to
build on these recommendations as our remaining investigations
come to their conclusion.
Given the work we have been doing in the royalties arena,
it might be reasonable to conclude that we drew on a corps of
subject-matter experts familiar with the intricacies and
nuances of royalty management. Rather, we grew our so-called
``experts'' from scratch and on the run. We recognized almost
immediately that our office would soon need to develop a
royalties oversight unit and build an expertise for the long
term.
We are in the process of doing just that. In the near term,
we are setting up a modest interspaced royalty oversight
office. This group will soon complete an evaluation of MMS's
Royalty-in-Kind Sales Program for oil, and then we will
undertake an audit of MMS's process for verifying volumes, most
importantly, oil destined for the Strategic Petroleum Reserve.
In the longer term, we intend to develop the capacity to
oversee all minerals-related activities managed by DOI from
initial leasing of Federal and Indian lands to the final
determination of those leases which would include the
management of those leases and the collection of royalty
payments.
Of course this vision is attached to a very real need for
continued funding, and I can assure the Committee that any
monies that we receive for that funding will be put to good
use. Mr. Chairman, I would be remise if I failed to acknowledge
the receptiveness and responsiveness of Secretary Kempthorne,
Assistant Secretary Allred and MMS Director Luthi to our
findings and recommendations.
The challenge, however, comes in the effective
implementation of the recommendations and in holding
accountable those responsible for MMS's many past failings.
This concludes my opening remarks, Mr. Chairman, and I will
answer any questions.
Mr. Costa. Thank you very much, Mr. Devaney. We do
appreciate your focus and due diligence as the Inspector
General. It is probably a good segue that we now go to our next
witness who was selected, in part, with some other folks,
Secretary Kempthorne, to really look at the problems associated
with the issue that we are attempting to deal with here today
and have been now for several years.
[The prepared statement of Mr. Devaney follows:]
Statement of The Honorable Earl E. Devaney, Inspector General,
U.S. Department of the Interior
Mr. Chairman, members of the subcommittee, I want to thank you for
the opportunity to appear before you today to discuss the
recommendations arising from some of my office's recent work in the oil
and gas royalties collection program, and my thoughts about how this
program might be improved, including a stepped up oversight effort on
the part of the Office of Inspector General (OIG).
For the past two years, the agency responsible for royalty
collections on behalf of the Federal Government, the Minerals
Management Service (MMS) of the Department of the Interior (DOI), has
undergone intense scrutiny by the OIG and GAO, following revelations of
systemic management and organizational failures. As you know, I
testified before the House Subcommittee on Energy and Resources in
September of 2006 and the full Committee on Natural Resources in
February 2007; I have done the same before the Senate Committee on
Energy and Natural Resources in January 2007. The history here is rich
and disconcerting. Beginning with our audit of MMS' compliance review
process, we found that while compliance reviews play a useful role in
MMS' greater Compliance and Asset Management Program, they do not
provide the same level of detail or assurance that a traditional audit
provides, nor have they been utilized in the context of a well-
designed, risk-based compliance strategy. Following this audit, we made
recommendations for improving systems data reliability, strengthening
the compliance review tools, and developing that missing risk-based
strategy.
This audit was followed by a complex investigation into the failure
of MMS to include royalty price thresholds in offshore oil leases in
the Gulf of Mexico in 1998 and 1999. From this investigation, we
recommended that all policy decisions that significantly alter the
terms and conditions of the offshore and onshore oil/gas leases be
memorialized in the form of an internal memorandum and compiled in one
accessible repository, establish one person that is responsible for the
entire Notice of Sale document, and prior to its final issuance, each
lease should be legally reviewed by the Solicitor's Office.
Even while this investigation was ongoing, Secretary Kempthorne
requested that we initiate another investigation into Minerals Revenue
Management (MRM), a program within MMS that had had several qui tam
cases filed against it by its own auditors. The results of this
investigation presented examples of a systemic dilemma in MMS--that of
the bureau's conflicting roles and relationships with the energy
industry. It also hinted of a profound failure in the development of a
critical MRM information technology (IT) system; it revealed a working
environment in which poor communication, or no communication,
compounded an already existing element of distrust; and it demonstrated
a band-aid approach to holding together one of the Federal Government's
largest revenue producing operations. This report included
recommendations to, among other things, rescind the 1977 ``hardship''
guidance and develop clear guidance to industry on interest
calculations, develop a strategy to eliminate the interest collection
backlog on an expedited basis, clarify guidance to industry on sub-sea
transportation costs, foster better communication between the MMS audit
and programmatic functions, and develop an enhanced ethics program
designed specifically for the RIK program.
In addition, we discovered a number of other significant issues
worthy of separate investigations, including ethics lapses, such as
accepting gifts from and fraternizing with industry, program
mismanagement and process failures. We currently have four
investigations that remain ongoing. Because these latter investigations
involve potential criminal violations, I am currently precluded from
discussing them in any detail. Suffice it to say, Mr. Chairman, MMS has
more than its share of royalty management issues, and has consumed more
than its share of the OIG's attention on these issues over the past two
years.
In addition to his request for the qui tam investigation, Secretary
Kempthorne separately requested a study by an independent bi-partisan
panel co-chaired by Senators Bob Kerrey and Jake Garn, which reported
to the Royalty Policy Committee. As our work regarding MMS concluded,
we shared with this panel a compilation of recommendations that
emanated from our efforts. The final report presented to the Royalty
Policy Committee fundamentally incorporated the 22 recommendations made
by the OIG thus far. We expect to build on these recommendations, as
our remaining investigations come to conclusion.
Given the amount of work we have been doing in the royalties'
arena, it might be reasonable to conclude that we drew on a corps of
subject-matter experts, familiar with the intricacies and nuances of
royalty management. Rather, we grew our so-called ``experts'' from
scratch and on the run. We recognized almost immediately, that the OIG
would need to develop a royalties' oversight unit, and build an
expertise for the long term.
In December, Congress passed the Omnibus Spending Bill for FY 2008.
Accompanying the bill was report language that instructed the OIG to
develop a permanent capability to oversee MMS' royalty function. We are
in the process of doing just that. In the near term, we are standing up
a modest Denver-based Royalty Oversight Office, consisting of six
employees--four of which have already been filled by current OIG Staff,
including the position of Director. The remaining two positions are
expected to be recruited and on-board by May 2008. The members of this
small office must first develop an understanding of royalties-related
activities in MMS; we are also identifying training opportunities to
cultivate their expertise, including observation and participation in
royalty audits conducted by States and Tribes. This group will soon
complete the on-going evaluation of MMS' Royalty-in-Kind (RIK) sales
program for oil, and will then undertake an audit of MMS' processes for
verifying volumes delivered as RIK, including, most importantly, oil
destined for the Strategic Petroleum Reserve. Eventually, this unit
would also verify that the recommendations we have made and those
issued by the Royalty Policy Committee have been appropriately
implemented.
In the longer term, we intend to develop the capacity to oversee
all minerals-related activities managed by DOI from initial leasing of
Federal and Indian lands to the final termination of those leases,
which would include the management of those leases and the collection
of royalty payments. Ultimately, we would like to expand our oversight
coverage beyond MMS to the energy and minerals programs at the Bureau
of Land Management and Indian Affairs, including oil, gas, and solid
minerals.
Of course, to this vision is attached the very real need for
continued funding to keep this unit operating, and to expand its
capacity as it develops. I am quite confident, however, that the
results that will be derived from this unit will more than pay for any
increase in appropriations that we receive.
Mr. Chairman, I would be remiss if I failed to acknowledge the
receptiveness and responsiveness of Secretary Kempthorne, Assistant
Secretary Allred and MMS Director, Randall Luthi to our findings and
recommendations. The challenge, however, comes in the effective
implementation of those recommendations and in holding accountable
those responsible for MMS' many past failings.
As we conclude the remaining investigations, I would be surprised
to see all of the involved DOI employees prosecuted. Any that are not,
however, will be forwarded to Assistant Secretary Allred for corrective
administrative action. This will be the accountability test, the
results of which, I am sure, the Subcommittee and I both await with
great expectation.
That concludes my prepared remarks, Mr. Chairman. I would be happy
to answer any questions you or the members of the Subcommittee might
have.
______
Response to questions submitted for the record by Earl Devaney.
Inspector General. U.S. Department of the Interior
1. Mr. Devaney, do you believe it is appropriate for MMS to be in
charge of analyzing the success of the Royalty-in-Kind Program?
It seems that they have a strong incentive to show how well it
is working, so would it be better to have someone outside of
MMS be doing this review? And if so, who might you suggest?
Answer: I believe any program in the Federal Government has an
obligation to critically assess its own performance, but I also
recognize the difficulty of being completely objective in doing so. An
additional challenge is to define ``success'' in a program that
generates considerable revenue for the Federal Government. An analysis
of the RIK program's success would probably be best conducted by an
independent oversight entity, like the GIG. If such an analysis were to
be undertaken, it would also be most effectively accomplished if a
definition of ``success'' were agreed upon in advance among the
program, Congress and the oversight entity.
2. Mr. Devaney, as an audit organization, would you state your
thoughts about any conflicts of interest that MMS might have
being both the agency in a contractual arrangement with oil and
gas companies and the agency responsible for auditing those
contracts and payments from those same companies?
Answer: The appearance of conflict of interest for MMS as an
organization cannot be ignored, since MMS enters into leases with the
oil and gas industries, collects the royalties and also audits industry
payments. However, it is important to note that MMS is a Federal
Government revenue collecting agency--similar to the Internal Revenue
Service (IRS) which also collects revenues and conducts audits.
3. Mr. Devaney, could you discuss your views of the usefulness of the
State and Tribal Royalty Audit Committee, or ``STRAC''? And do
you see any way to improve the relationship between STRAC and
MMS?
Answer: The states and tribes have a vested interest in the audit
and collection of royalty payments for the leases on their lands. As
such, the STRAC provides a forum for those states and tribes to share
information and communicate with MMS. I see this as a useful function.
STRAC is also useful for getting input from the states and tribes to
MMS on audit/oversight policies, procedures and regulations.
4. Mr. Devaney, I'm pleased to see your office is going to be opening
this office in Denver to perform a more active watchdog role.
Do you have enough funding to do what you think needs to be
done, and what else would you look at if you had additional
funding?
Answer: As I explained in my testimony, we received direction, as
well as funding from the Appropriations Committees of both the House
and Senate, to develop a permanent capability to oversee MMS royalties.
We have done that, and the unit is up and running.
Over the longer term, we would like to develop the capacity to
oversee all minerals-related activities managed by DOI Ultimately, we
would like to expand our oversight coverage beyond MMS to the energy
and minerals programs at the Bureau of Land Management and Indian
Affairs, including oil, gas, and solid minerals.
In order to see our longer term goals through, however, we will
have a very real need for continued funding to keep this unit
operating, and to expand its capacity as it develops.
5. Mr. Devaney, have you looked at any of the issues that were raised
in the Department of Energy's Inspector General report that
said that 30,000 barrels of oil headed for the strategic
petroleum reserve could not be accounted for?
Answer: We have reviewed the Department of Energy (DOE) OIG's
report and have discussed their findings with them. As a result, it
appears that there are weaknesses on the part of both DOI and DOE in
accounting for the volume intended for delivery to the strategic
petroleum reserve. As soon as our evaluation of the RIK oil sales
program is completed, we will be initiating an audit of oil volumes in
the RIK program, including oil designated for the Strategic petroleum
reserve.
Minority Questions for Earl Devaney, Inspector General. U.S. Department
of the Interior
1. Mr. Rusco from the Government Accountability Office referred to
Mineral Management Service's (MMS') internal controls in his
testimony. In your testimony you reference several qui tam
cases filed by MMS' own auditors. In our last hearing on this
subject we heard from Professor Pamela Bucy (an expert on False
Claims Act Laws) that these auditor actions were illegal and
that these plaintiffs should not have standing to file qui tam
lawsuits because they are using accounting information that
they received in the course and scope of their employment for
personal gain rather than the taxpayer's gain. Instead, these
plaintiffs should have reported their concerns to you, as
Inspector General, or internally within the Mineral Management
Service (MMS). Have you done anything to improve your internal
controls to make sure these cases are reported to you for
investigation rather than filed as qui tam cases?
Answer: Unfortunately, neither DOI nor OIG internal controls can
ensure that DOI employees properly report concerns to either the OIG or
Departmental management. The OIG has made efforts by way of outreach to
inform and educated DOI employees of their obligation to report fraud,
waste and mismanagement to the OIG; we have enhanced our ``hotline'' to
include Internet reporting; and have placed posters in most major DOI
facilities. MMS has also conducted some education and outreach in this
regard.
2. One [of] your criticisms of the MMS' administration of the Royalty-
In-Kind program is the initial lack of experience MMS employees
had in marketing the products they were taking in kind. You go
further to state that your office is setting up a Denver-based
Royalty Oversight Office and the members of this office need to
develop an understanding of royalty related activities within
MMS. That's a very complicated issue and based upon your
reasoning, it seems that this new office will have problems
because of lack of experience and knowledge of the issues they
have oversight responsibilities for. How useful will this
office be and would it not be a better investment to hire
additional people for MMS (Especially in light of the fact that
many of the criticisms levied against MMS are due to budgetary
constraints and the need for additional people to meet the
increasing workload)?
Answer: The OIG has been examining royalties' issues in various
arenas for over two years straight. When, in 1986--well before my time
as Inspector General--the royalty audit function was steered to MMS
rather than the OIG, our oversight, and thus our expertise, diminished.
When the present royalties' issues began to arise in January 2006, we
drew upon the limited royalties' experience that we had remaining in
the organization, but essentially were forced to grow our expertise
anew. With over two years behind us, however, we are well on our way in
building OIG expertise for the long term. The OIG Royalty Oversight
Office is already staffed with our two most knowledgeable royalties'
auditors, an auditor that we hired from MMS and an auditor from the
Department of Defense with extensive leasing and contracting
experience. We also have a strong pool of candidates with state and
tribal royalties audit experience who submitted their applications in
response to our vacancy announcements.
In addition, the first evaluation by this unit is being concluded,
and has developed some very good information that should be quite
useful to MMS management for improving the operations of the Royalty-
in-Kind program. I am already pleased with the work that this unit has
done, and expect that it will only improve with time and experience.
Finally, if the greater royalty audit function is to remain within
MMS, then our new unit will also provide vital audit oversight similar
to the oversight of the IRS' audit work provided by the Treasury
Inspector General for Tax Administration.
______
STATEMENT OF DAVID DEAL, VICE CHAIR, ROYALTY POLICY COMMITTEE,
U.S. DEPARTMENT OF THE INTERIOR
Mr. Costa. David Deal is the Vice Chair of the Royalty
Policy Committee, and has been part of the Commission that
Secretary Kempthorne put together to examine this carefully and
closely with their experience and to provide a set of
recommendations that was noted earlier, Getting Royalties
Right: The Recent Recommendations for Improving the Federal Oil
and Gas Royalty System.
So we with that introduction look forward to your
testimony, Mr. Deal.
Mr. Deal. Thank you, Mr. Chairman and Mr. Pearce. I
appreciate the opportunity to appear today at this important
and timely oversight hearing. As you requested, I will offer
you an abbreviated summary of my written statement already
submitted. I have over 30 years of experience on oil and gas
royalty management policy matters.
In the mid-1980s, I served on the Secretary of the
Interior's original Royalty Management Advisory Committee
formed in the wake of the 1982 Linowes Commission Report and
the landmark 1983 Federal Oil and Gas Royalty Management Act. I
have been involved in Federal royalty management matters,
legislation, rulemaking, litigation ever since.
I now serve as Vice Chair of the Department of the
Interior's Royalty Policy Committee. I also served as Vice
Chair of its Subcommittee on Royalty Management, whose December
2007 report you have received and brings me here today.
Our subcommittee, co-chaired by former Senators Bob Kerrey
and Jake Garn, was directed by the Secretary to undertake a
careful evaluation of the Royalty Management Program to ensure
that its procedures and processes were in order. The
subcommittee was initially charged with reviewing three areas:
reporting and accounting, audit compliance and review
procedures and royalty in kind.
Later, a fourth area for our review was added, namely
Secretary Kempthorne's February 2007 procedures to tighten
Department review of offshore lease packages, which include but
are not limited to, royalty provisions, such as price
thresholds.
I am pleased to say that the subcommittee's final December
2007 report was accepted by the multistakeholder Royalty Policy
Committee at its January 2008 meeting and without change
transmitted to Secretary Kempthorne. Overall, we concluded that
the Department's Royalty Management Program is not broken at
all but does need a major tune up.
Indeed, we identified 110 recommendations. Technical policy
as practical as possible, recommendations for change,
improvements plainly needed to restore public confidence and
ensure maximum value for the nation's taxpayers. As to our
specific recommendations, they are quite varied. There are 110
of them.
The executive summary includes a summary of major
recommendations. My co-chair's testimony before the Senate has
another angle of attack listing 10 areas which involve one or
more recommendations. Finally, many of the subcommittee's
recommendations reinforced thoughtful recommendations already
made by the Inspector General and the Government Accountability
Office.
What I would like to do today is rather than reiterate
those different listings, I would like to identify four
connecting themes which I think might further illuminate our
own recommendations, their underlying royalty issues and the
path ahead.
1) There are major differences in onshore and offshore
leases. Over 2,000 offshore leases, and over 20,000 onshore
leases now generate oil and gas royalties. The sheer numbers
and many other major differences described in my written
statement, vintage, location, Bureau of Management, contribute
to an asymmetrical regulatory picture and stretch staff
resources, especially onshore.
Chapter 3 of the subcommittee report offers 36 diverse
recommendations, many of which have an onshore tilt. Chapter 5,
which deals with intrabureau coordination, has 10 more
recommendations affecting onshore.
2) There are major differences in crude oil and natural
gas. Oil and gas exhibit fundamental differences in physical
properties, modes of transportation, end users and marketing,
price reporting and even government regulation outside the
Department of the Interior. These differences bear heavily on
the calculation of royalties.
My written statement describes two central aspects of the
calculation of royalties, allowances and marketable condition,
that reflect the complications that can arise somewhat
differently for oil and gas, but especially in connection with
gas, which today accounts for most disputes. These differences
and other matters are reflected in many of the measurement and
valuation recommendations of Chapters 3 and 4 of our report.
3) Improved intra-agency coordination is imperative. Table
13 at page 78 of our report is as good a snapshot as I have
seen of the different bureau responsibilities bearing on
royalty management. Our report offers 10 recommendations for
improving coordination, many of which address Indian lease
related matters.
4) Key elements of the Royalty Management Program need to
be implemented with more rigor, and more clarity. For example,
and I will offer just three, in the audits, compliance and
enforcement areas, that is Chapter 4 of our report, we include
26 recommendations, many of which are directed at clarifying
the strategy for choosing among the wide range of available
audit compliance and review options, most notably, audits
versus compliance reviews.
In so many words, the subcommittee concurred with the DOI
IG's December 2007 report, as you have already heard this
morning, which concluded that compliance reviews can be an
effective part of the MMS's CAM Program. It also concluded,
that we concur with as well, weaknesses related to management
information in the compliance review process and performance
measures may keep it from being maximized.
MMS's adoption of these recommendations should make MMS
audits compliance and enforcement efforts more cost effective,
adaptable to changing circumstances and more transparent for
review by Congress and other stakeholders. Our Chapter 4
recommendations notably also reflect the advice we sought
rather aggressively of the Internal Revenue Service, which
itself has adopted sophisticated risk-based models for choosing
among its audit, compliance and enforcement options.
A second just as important option, RIK. RIK, as we all
know, is an atypical government program with the MMS
functioning first as a regulator and then as a commercial
marketer. In this regard, in 2007 GAO expressed some concerns
about the RIK Program's rapid growth and posed questions about
the MMS's ability to adequately quantify and compare RIK and
RIV revenues and administrative costs as required by statute.
Here again, the subcommittee shared similar concerns
finding that the MMS had done a credible job managing the RIK
Program and that RIK offered great royalty management
advantages but that the RIK deserved, ``more intense oversight
and distinct program improvements.'' Chapter 6 of the
subcommittee report lists no less than 31 diverse
recommendations for clarifying and tightening RIK Program
management.
Here again, more rigor and clarity should make the Royalty
Management Program more cost effective and should enhance
program transparency for oversight by Congress and other
stakeholders. Last but not least, a final short but needless to
say important example of price thresholds.
In a similar vein, the process, procedure and training
recommendations of Chapter 7 of our report are centered on the
need for rigor to assure that OCS leases are issued fully
consistent with the law and policies of the department.
Mr. Chairman, as an Attachment B to my written statement, I
also mention that Attachment B is a simple, one page diagram
which it was my attempt to perhaps cut through some of the
complexity of the royalty revenue calculation process and
linking the different parts of the process to our report.
Hopefully this will illuminate our recommendations and the
underlying royalty issues.
Mr. Chairman, Mr. Pearce, that completes my remarks. I
would be glad to answer any questions that you might have.
Mr. Costa. Thank you very much, Mr. Deal. We appreciate
that concise and to the point testimony. Tune up, I like that.
Maybe we can come together in a fashion that will provide that
tune up. We all on occasion need a tune up.
[The prepared statement of Mr. Deal follows:]
Statement of David T. Deal, President, Deal Consulting & Dispute
Resolution, LLC, and Vice Chair, Royalty Policy Committee
Mr. Chairman and Members of the Subcommittee, I appreciate the
opportunity to appear today at this important and timely oversight
hearing.
I have over 30 years of experience on oil and gas royalty
management policy matters. In the mid-1980's I served on the Secretary
of the Interior's original Royalty Management Advisory Committee formed
shortly after publication of the Linowes Commission in 1982 and passage
of the landmark Federal Oil and Gas Royalty Management Act in 1983. I
have been involved in federal royalty management legislation,
rulemaking and litigation ever since.
I now serve as vice chair of the Department of the Interior's
Royalty Policy Committee (RPC), a federal advisory committee. I also
served as vice chair of its Subcommittee on Royalty Management,
established in November 2006, whose December 2007 report brings me here
today.
Prompted by criticism of the Department's royalty management
program from several quarters, Secretary Kempthorne and Assistant
Secretary Allred directed our Subcommittee to undertake a careful
evaluation of the program to ensure that its procedures and processes
were in order. The Subcommittee was initially charged with reviewing
three areas: reporting and accounting for Federal and Indian mineral
resources; audit, compliance and review procedures; and, royalty in
kind.
After our Subcommittee got underway in mid-2007, a fourth area for
our review was added: Secretary Kempthorne's February 2007 procedures
to tighten Department review of offshore lease packages to assure
consistency with all applicable law and policies. This fourth area was
prompted by the disturbing omission of royalty relief price thresholds
for Outer Continental Shelf leases issued in 1998 and 1999.
I am pleased to say that the Subcommittee's final December 2007
report, ``Mineral Revenue Collection from Federal and Indian Lands and
the Outer Continental Shelf,'' was accepted by the parent Royalty
Policy Committee at its January 17, 2008, and without change
transmitted to Secretary Kempthorne. I am also pleased to say that the
Department has energetically begun to address the 110 recommendations
of the Subcommittee's Report. Indeed, some of the simpler
recommendations have already been satisfied.
Character of the Subcommittee Report and Its Deliberative Process
As conceived by Secretary Kempthorne and Assistant Secretary
Allred, the Subcommittee's task was to be forward looking with a heavy
emphasis on process and procedures.
The Subcommittee was directed to address royalty bearing minerals,
although the heavy emphasis was oil and gas, which lay at the heart of
so much recent program criticism.
The Subcommittee was to be an independent panel. I served as vice
chair and the link to the Royalty Policy Committee, but the
Subcommittee's membership drew also on the skills of:
Bob Kerrey and Jake Garn, two former Senators who served
as co-chairs
Bob Wenzel, former deputy commissioner, Internal Revenue
Service
Perry Shirley, Assistant Director, Minerals Department,
Navajo Nation
Cynthia Lummis, former State Treasurer, State of Wyoming
Mario Reyes, Professor of Finance, University of Idaho.
Finally, from the outset Subcommittee members were advised that
nothing was off limits for our review. Moreover, the Subcommittee did
not limit itself to information within the Department but looked to
comparable programs outside the Department, most notably, the Internal
Revenue Service.
Key Recommendations
Overall, we concluded that the Department's royalty management
program is not broken but does need a major tune up. We concluded that
the Minerals Management Service is an effective steward of the Minerals
Revenue Management Program and that its seasoned, skilled staff was
eager to explore program improvements. And, as our Report makes clear,
many improvements are plainly needed to restore public confidence and
ensure maximum value for the nation's taxpayers.
At 160 pages in length and including 110 specific recommendations,
which address a mix of practical policy, management and technical
concerns, the Report does not read like a novel. To understand the
Subcommittee Report, our 110 recommendations can be sorted in several
ways.
For example, the Executive Summary to the Report itself includes a
Summary of Major Recommendations and separately identifies
recommendations that address major issues, some recommendations that
will require long-term support, other recommendations that can be
easily implemented, and a few that would need legislation.
In addition, Subcommittee co-chairs Bob Kerrey and Jake Garn, in
February 26, 2008, in a statement submitted to the Senate
Appropriations Committee, and included here as Attachment ``A,''
offered a more integrated approach by identifying ten key areas for
which Subcommittee recommendations were formulated.
Finally, many of the Subcommittee's recommendations reinforce
thoughtful recommendations made by the DOI Inspector General and the
Government Accountability Office.
Today, I will attempt no detailed analysis of the Report's many
recommendations. Nor will I reiterate the litany of major
recommendations in the Subcommittee Report or the key areas already
ably presented by my Subcommittee co-chairs. To complement that useful
information, I offer four basic themes that suffuse the Report and
might further illuminate the recommendations, their underlying royalty
issues and the path ahead. Toward this same end, I also offer a simple
one-page diagram, included here as Attachment ``B,'' that lays out the
basic royalty calculation formula with explanatory notes linking it to
the major portions of the Subcommittee Report.
Connecting Themes
1. Major differences in onshore and offshore leases. Whereas about
2,300 offshore oil and gas leases generate about $6.5 billion in
royalty revenues, about 23,000 onshore Federal leases generate about
$2.7 billion. Offshore leases are large, operated by large companies,
alone or in combination, and often far offshore. Typically, offshore
leases are relatively modern with highly concentrated production
facilities and linked to a small number of MMS planning region offices.
In contrast, onshore federal leases are far more diverse, including
many small properties often operated by small companies. Onshore leases
are often of old vintage, scattered around the countryside in several
states and linked with many BLM field offices. In addition, offshore
leases are regulated in all respects by the MMS whereas onshore federal
leases are regulated by the Bureau of Land Management (BLM) for site
security, production verification, but regulated by the MMS for audits,
compliance and enforcement.
These major differences contribute to an asymmetrical regulatory
picture and stretched staff resources, especially onshore, and are
reflected in Chapter 3 of the Subcommittee Report. Chapter 3 alone
accounts for 36 of the Report's 110 recommendations: requiring
electronic reporting; promoting remote data acquisition; upgrading gas
plant efficiency reporting and compliance review; examining BLM and MMS
staffing levels and training; and other matters.
2. Major differences in crude oil and natural gas. Under applicable
lease terms crude oil and natural gas produced on federal and Indian
leases generate royalty obligations. Moreover, crude oil and natural
gas can both be sold at the wellhead or downstream. But there the
similarities end.
These two commodities exhibit fundamental differences in physical
characteristics, modes of transportation, end users and marketing, the
reporting of prices, and government regulation. All of these bear
heavily on the calculation of royalties. Consider, for example, two
important elements in the calculation of oil and gas royalties,
allowances and marketable condition, complex issue areas which lie at
the heart of many royalty issues.
Allowances. Under federal mineral statutes, royalty is based on the
``value of production'' and producers are allowed to take deductions
for certain post-production costs to arrive at the proper base for
calculation of royalties. In arriving at this value of production for
the calculation of oil and gas royalties, MMS regulations do not allow
a producer to deduct the costs incurred for gathering production, or
satisfying ``marketable condition,'' or achieving any other marketing
purpose.
However, consistent with well-established oil and gas law, MMS
regulations do allow deductions for transportation costs. Consistent
with well-established oil and gas law, MMS regulations also allow a
producer to deduct certain processing costs, costs incurred to extract
after production trace amounts of natural gas liquids (NGLs) which, if
removed, are royalty bearing and therefore generate extra royalty
revenue for the U.S. Treasury.
Marketable condition. MMS regulations require that crude oil and
natural gas must be in ``marketable condition'' before being valued for
royalty purposes. For oil, this generally means simple elimination of
water and sediment before it is shipped and sold. For gas, much more is
required to satisfy pipeline specifications: acid gas removal to avert
pipeline corrosion, dehydration and compression. Complicating matters
here is that certain gas-related costs, otherwise not deductible, may
be deemed deductible (e.g., supplemental compression).
Given these differences, calculating gas royalties tends to be much
more complex and, not surprisingly, gas valuation continues to account
for most royalty disputes. These differences, and other matters, are
reflected in many of the measurement and valuation recommendations of
Chapters 3 and 4 of the Subcommittee Report: improving gas plant
efficiency information; upgrading gas measurement guidance; exploring
anew the use of indexing for gas valuation; addressing the issue of
cost-bundling to simply calculation of allowances; to name but a few.
3. Intra-agency coordination. In connection with Subcommittee's
four charges, the need for better coordination among the Department's
bureaus involved with royalty management (i.e., MMS, BLM and BIA)
commands a free-standing Chapter 5 of the Report. Table 13 at page 78
of the Report is a good snapshot of the different bureau
responsibilities bearing on royalty management.
While inter-bureau coordination, communication and information
sharing is not the kind of issue that generates royalty headlines, the
Subcommittee concluded early on that effective coordination is
imperative if the Department's sprawling, multi-stakeholder royalty
program is to operate efficiently and effectively. The Report's ten
recommendations include, for example: establishing an inter-bureau
Coordinating Committee; developing common data standards; and several
Indian lease-related matters.
4. Rigor and clarity. Stated most simply, the Department needs to
implement key elements of its royalty management program with more
rigor and clarity. For example, in connection with audits, compliance
and enforcement, the topic of Chapter 4 of the Report, the many of the
26 recommendations are directed at clarifying the strategy for choosing
among a wide range of available audit, compliance and review options.
In this regard, in his December 2007 report, the DOI Inspector General
concluded that ``compliance reviews,'' which are basically desk audits,
``can be an effective part of MMS' CAM Program,'' but recommended
strongly that several weaknesses be addressed to maximize the benefits
of compliance reviews. The Subcommittee concurred and we found that the
MMS had already adopted an Action Plan that seeks to implement
important corrective measures. Once adopted, these measures should make
MMS audit, compliance and enforcement efforts more cost-effective,
adaptable to changing circumstances, and more transparent for review by
Congress and other stakeholders.
In addition, the Report's Chapter 4 recommendations reflect the
Subcommittee's aggressive effort to seek the advice of the Internal
Revenue Service, which itself has adopted sophisticated risk-based
models for choosing among its audit, compliance and enforcement
options. My understanding here is that the MMS has already sought out
the IRS for further advice and consultation on best practices to
improve its royalty collection responsibilities.
Another key area where the Subcommittee concluded that more rigor
and clarity was needed is the MMS' Royalty-in-Kind (RIK) Program. RIK
is an option increasingly used in lieu of royalty in value (RIV) to
satisfy royalty obligations. When the MMS takes its royalty in kind, it
can bypass the complexities of valuation--which can be especially
difficult for non-arm's length transactions involving gas--and realize
substantial administrative cost savings. Through sales of the
production taken in kind MMS can then realize the dollar royalty
revenues it is owed and also generate extra revenues for the U.S.
Treasury. Crude oil taken in kind can also contribute to Strategic
Petroleum Reserve fills if the Administration sees fit; by statute,
crude oil or gas taken in kind can also be used to support any Federal
low income energy assistance program.
However, RIK is an atypical government program with the MMS
functioning first as a regulator and then as a commercial marketer. In
this regard, the Government Accountability Office (GAO) in 2004 made
recommendations that the Department has implemented and that have
improved RIK administration. However, in 2007 GAO expressed some
concerns about the RIK program's rapid growth and posed questions about
the MMS' ability to adequately quantify and compare RIK and RIV
revenues and administrative costs as required by statute.
The Subcommittee shared similar concerns, finding that RIK offered
great royalty management advantages but deserved ``more intense
oversight and distinct program improvements.'' Chapter 6 of the
Subcommittee Report lists 31 diverse recommendations for clarifying and
tightening RIK Program management: establishing an Royalty Policy
Committee RIK Subcommittee to address performance benchmarks, volume
verification and market positioning; publishing a guidebook of RIK
processes and procedures; establishing exploring alternative
organizational arrangements to optimize its performance in a commercial
environment; seeking reimbursement for costs incurred for Strategic
Petroleum Reserve transfers; discontinuing the small refiners' set
aside program and suspending the onshore crude oil RIK program;
publishing performance measures; maintaining a staff critical mass;
securing dedicated legal support; emulating sound business practices to
maintain a competitive marketing position; evaluating different auction
types; and many others.
Here again, more rigor and clarity should make the royalty
management program more cost-effective and should enhance program
transparency for oversight by Congress and other stakeholders. In a
similar vein, the process, procedure and training recommendations of
Chapter 7 are centered on the need for rigor to assure that OCS leases
are issued fully consistent with the law policies of the Department.
Mr. Chairman and members of the Subcommittee, I welcome any
questions or comments on my statement or the Subcommittee on Royalty
Management's Report that brings me before you today.
Attachment B
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Attachment A
Testimony of Senators Bob Kerrey and Jake Garn, Co-Chairmen,
Subcommittee on Royalty Management
The Subcommittee on Royalty Management was established by the
Secretary of the Interior, Dirk Kempthorne, in March 2007. It was
created as a consequence of concerns about lapses in ethical behavior
and inadequacies in lease issuance, royalty collection, and auditing.
These concerns have been expressed by the Congress and by the
Department's Inspector General who has investigated allegations of
ethical lapses of personnel in the royalty in kind (RIK) program.
As co-chairmen of this Subcommittee, we are pleased to provide this
statement on the Subcommittee's report entitled ``Mineral Revenue
Collection from Federal and Indian Lands and the Outer Continental
Shelf.'' The report was released on December 17, 2007, and is the
result of nine months of data gathering and analysis by the
Subcommittee. It presents a comprehensive analysis of the federal
mineral resource management program in the Department of the Interior.
The program is a major source of revenue to the U.S. Treasury, with
revenues in excess of $11 billion in 2007.
The Subcommittee members conducted an independent evaluation of the
revenue collection and royalty management program within the Department
of the Interior. In addition to ourselves, the Subcommittee includes an
impressive group of professionals: David Deal, our vice chairman, an
oil and gas expert, and a member of the Royalty Policy Committee to
whom the Subcommittee reports; Cynthia Lummis, a former Treasurer of
the State of Wyoming.; Mario Reyes, a professor of finance at the
University of Idaho; Perry Shirley, the Assistant Director for the
Minerals Department of the Navajo Nation; and Bob Wenzel, a former
Deputy Commissioner for the Internal Revenue Service (IRS).
The companies who lease the right to explore for and develop
minerals on federal lands and offshore waters pay royalties on the
minerals extracted from those lands and waters. Those royalties are
either paid in cash, which is know as royalty in value, or in product,
which is known as royalty in kind. The royalty in kind program has been
quite cost effective, especially for natural gas production, and the
program is expected to continue to grow. The Minerals Management
Service (MMS) does not stockpile product ``paid'' through the RIK
program. Rather, it sells the product through a closed bid auction
procedure. We believe the RIK program is an extremely important
component of the royalty management program and the RIK recommendations
in the report are geared toward ensuring the program's survival.
The Subcommittee's report makes over 100 recommendations for
improvements in the mineral resource management program. Most of these
recommendations can be implemented administratively. Many can be done
quickly. Some will require long term effort and continued vigilance. A
few of the recommendations depend upon legislative action. The Federal
employees who work in the mineral leasing and royalty collection
program are conscientious, hard working, and concerned about the
reputation of the program and of the Department of the Interior. We
believe that implementing the recommendations in this report will
greatly strengthen the management of the program, will restore public
confidence, and will ensure maximum value for the U.S. taxpayer.
We support all the Subcommittee's recommendations. However, for the
balance of this testimony, we focus on a limited number of
recommendations in 10 key areas that we believe are critical to ensure
continued improvements in the program. Most of the recommendations will
require some additional resources from the House and Senate Committees
on Appropriations. A relatively modest increase in appropriations
should yield increased revenues that more than offset the additional
funding.
1. Over the past few years, MMS has relied more heavily on
compliance reviews rather than full audits of industry royalty payments
for production on federal lands and offshore waters. It appears that
the increased reliance on compliance reviews has been based on funding
and personnel constraints rather than on documented data on benefits
and risks. MMS needs to establish an auditing and compliance program
that includes an appropriate balance of audits and compliance reviews,
and the program needs to be based on reliable data.
Specifically, MMS should implement a risk-based strategy for
identifying companies and properties for audits and compliance
reviews. This effort will require developing, testing, and
refining various strategies over the next several years. While
this will be an evolving process, and MMS is instituting a
pilot program in this area, MMS needs to take aggressive action
to establish an initial program over the short term. MMS should
work with the IRS to benefit from the lessons IRS has learned
in this area over the years.
2. We believe that one recommendation, which requires legislative
action, deserves very serious consideration by the Congress. We
recommend that MMS explore the feasibility of establishing an interest-
bearing trust fund within the Treasury. Interest from this fund could
be used to fund Department of the Interior activities; primarily, but
not necessarily limited to, royalty management activities.
3. The Department of the Interior should strengthen and emphasize
ethics training for all staff involved in royalty management. Training
should include guidance on appropriate interaction with the private
sector, prohibitions on the use of public office for private gain, and
the handling of official and proprietary information.
4. In addition to MMS, the Bureau of Land Management (BLM) and
the Bureau of Indian Affairs (BIA) play significant roles in onshore
royalty management. Program improvements in these bureaus are needed,
as is better coordination among MMS, BLM, and BIA. In particular,
improved communication and coordination among the various production
accountability staffs needs to be addressed. Further, data entry in BLM
and BIA, as well as compliance management information in MMS, should be
automated to eliminate manual data entry to the maximum extent
practicable.
5. BLM has difficulty recruiting and retaining Petroleum
Engineering Technicians and Petroleum Accountability Technicians. The
number of Mining Engineers is also inadequate. The salaries for these
positions need to be reviewed and training programs need to be
improved. Also, the total number of positions needed should be
determined based on workload in individual BLM field offices. For
example, production accountability reviews are critical for accurate
revenue collection. However, in 2006, BLM had only 20 Petroleum
Accountability Technicians (PATs) nationwide and nineteen of the
thirty-one BLM field offices with oil and gas responsibilities employed
no PATs.
Emphasis within BLM over the past several years has been on
increased funding for the ``front end'' of the program: namely,
additional leasing and processing of applications of permits to
drill. As the program has expanded, there has not been
sufficient attention to funding the workload associated with
the ``back end'' of the process: namely, increased collections,
production accountability, and auditing requirements.
6. The Indian oil valuation rule has been languishing within the
Department of the Interior for more than 10 years. Indian Tribes are
understandably frustrated by the delay. The Subcommittee believes that
the Department should immediately finalize its ``technical changes'' to
the Indian oil valuation rule and, by June 2008, MMS should propose a
rule that values Indian oil based on a market index as is done for
production from federal oil leases and from Indian gas leases.
7. Improved oversight of the mineral revenue collection program
is essential to ensure the problems that generated so much concern in
the past are not repeated and new problems in the future are avoided.
Therefore, we recommend the establishment of an RIK Subcommittee to the
Royalty Policy Committee. The RIK Subcommittee should address such
issues as performance benchmarks, volume verification, and market
positioning. We also recommend the establishment of a Coordinating
Committee, comprised of senior management officials in MMS, BLM, and
BIA, to ensure that recommended improvements are implemented in these
bureaus.
8. The skills necessary to administer the RIK program are not
typical for a government agency. RIK is basically an oil and gas
marketing operation. The Subcommittee recommends that issues associated
with hiring and maintaining staff with industry expertise and dedicated
legal support should be addressed in the RIK program. Also, MMS should
evaluate the benefits and costs of alternative auction types and should
develop a pilot program to test alternatives that could improve net
returns.
9. We recommend eliminating programs that are no longer cost
effective or large enough to support their continuation. These include
the onshore RIK crude oil program and the small refiners' set-aside RIK
program. Market conditions in the future may be conducive to
reinstating these programs but such is not the case today.
10. The Subcommittee's charter did not include a review of the
situation surrounding the offshore oil and gas leases in the Gulf of
Mexico issued in 1998 and 1999 without price thresholds. However,
towards the end of our review, we were asked by the Assistant Secretary
for Land and Minerals Management, Steven Allred, to comment on offshore
lease issuance procedures enumerated in a February 2007 memorandum to
him from Secretary Kempthorne.
Our recommendations are that the Department continue its
efforts to pursue voluntary royalty payment agreements with
holders of the leases; that Congress and the Secretary continue
to explore legislative options that would address the loss of
royalties without violating legitimately signed contracts; and
that MMS and the Office of the Solicitor develop procedures and
guidelines to ensure effective implementation of the 8
enumerated items in the memorandum within 60 days of release of
the Subcommittee's report.
Thank you for the opportunity to provide this testimony. We look
forward to working with you to improve this important program.
______
Response to questions submitted for the record
by David T. Deal
General Questions
1. Mr. Deal, did your subcommittee consider recommendations aimed at
instilling more independence in the audit function within MMS?
In our discussions of the audit function, the Subcommittee did not
address independence per se but did address aspects of the overall
audit process with an independence character. For example, Chapter 3
addresses several matters that would facilitate the verification of
production reporting that bear on the efficacy of audit and compliance
and the ``self-reporting'' concerns identified by the Government
Accountability Office in its March 11, 2008 testimony. Likewise,
Chapter 4 of the Subcommittee Report addresses the mechanics of the
audit and compliance review process, notably the choice of appropriate
review options.
The Subcommittee Report also includes a Royalty in Kind-related
Recommendation 6-16 to assure that RIK personnel have a solid
understanding of existing ethics guidelines and, perhaps most relevant,
a generic Recommendation 7-6 which addresses training, inclusive of
ethics training, for all staff involved in royalty management and
inclusive of ``guidance on public-private sector interactions, use of
official and/or proprietary data, and prohibitions on the use of public
office for private gain.''
2. Mr. Deal, could you discuss your views of the usefulness of the
State and Tribal Royalty Audit Committee, or ``STRAC''? And do
you see any way to improve the relationship between STRAC and
MMS?
As direct beneficiaries of onshore production in their
jurisdictions, States and Indian tribes are important stakeholders,
underscored by the fact that they have important roles in cooperation
with the MMS in the overall audit process. See 30 C.F.R. Parts 227-229.
While STRAC seems like a logical forum for States and Indian Tribes to
share issues of common concern, I have had no direct experience with
STRAC and the Subcommittee did not address MMS-STRAC relationships.
Therefore, I can offer no specific suggestions for improving STRAC-MMS
relationships.
3. Mr. Deal, in their testimony, Senators Kerrey and Garn discuss the
difference in the so-called ``front-end'' and ``back-end'' of
BLM's operations. Can you describe that in more detail?
To my knowledge, the ``front-end'' and ``back-end'' labels used in
the testimony of Senator Kerrey and Senator Garn are not terms of art
but are useful to explain BLM staffing challenges in the royalty
management arena.
As the Senators used these terms, ``front-end'' relates to tasks
associated with new leasing of onshore lands and the start up activity
that follows leasing, e.g., processing of drilling permit applications,
although the multiple-use character of BLM lands creates non-mineral
responsibilities as well. However, ``back-end'' relates to tasks
associated with leases once production has commenced, which embraces a
host of tasks, including, but not limited to, onshore royalty-related
production and accounting.
While the Subcommittee had neither the time nor the resources nor
the resources to undertake a careful assessment of BLM funding trends,
or the panoply of demands on BLM resources, our sense was that BLM
resources, in terms of staffing numbers and skill levels, fell short of
that needed to do the royalty-related ``back-end'' job completely and
competently, an area that is central to Chapter 3 of the Subcommittee
Report.
4. Mr. Deal and Mr. Finfer, could you provide more detail on the
difference between a ``royalty payor'' and an ``operating
rights owner'', and why it would be better for MMS to be able
to pursue the royalty payor (as per Recommendation 3-8). Please
provide an example to demonstrate the difficulty in the current
system.
Recommendation 3-8 of the Subcommittee Report suggests that the
Department of the Interior support Section 215 of H.R. 2337 introduced
in the 110th Congress, which would restore the MMS' ability to pursue a
designated payor for royalty debts, an option that was expressly
precluded by prior remedial royalty legislation, namely, the Royalty
Simplification and Fairness Act of 1996, Public Law 104-185 (RSFA). As
Chapter 3, page 23, of the Subcommittee Report notes, underlying this
recommendation, was the fact that the MMS does not have in place a
system for tracking operating rights owners, which can make enforcement
costly and cumbersome.
This recommendation is appropriately intended to simplify the
collection process and respond to the Debt Collection Improvement Act
of 1996-related compliance concerns identified in the course of a 2006
Inspector General audit. Upon reflection, however, my personal view is
that the Subcommittee Report or Recommendation 3-8 itself should have
included some caveats reflecting of some important legal and
operational concerns.
In oil and gas parlance, an ``operating interest'' or ``working
interest'' is the exclusive right to explore for, develop and produce
oil and gas on a lease. For example, as described in the BLM Manual
(excerpt attached), the owner of operating rights or a working interest
holds:
the interest or contractual obligation created out of a lease
(such as a sublease) authorizing the holder of that right to
enter the leased lands to conduct drilling and related
operations, including production, which may include as
consideration a share in revenues production. Operating rights
may or may not be transferred through an operating agreement;
however, transfer of operating rights on Federal leases must be
filed and approved on the official assignment form.
BLM Manual, H-3100-1, Oil and Gas Leasing, ``Glossary and
Abbreviations/Acronyms,'' at 1-14, September, 6, 1985.
In contrast, a ``royalty payor'' is a party making payments to the
royalty owner, in this case, the Federal Government. Although a royalty
payor can be a working interest owner, a royalty payor can be anyone
(e.g., an operator, a lessee, an accounting firm, etc.) so designated
by one or more working interest owners and, therefore, is not
necessarily linked to the underlying royalty obligation.
My recollection is that in the mid-1990's the MMS was already
concerned with collection closure times and advanced a ``designated
payor'' concept intended to simplify the compliance review process by
making any party designated as payor principally liable for any royalty
bills due. While industry did not oppose simplification, it balked at
the particular designated payor concept then under consideration by the
MMS, raising legal and fairness concerns.
At the heart of the industry concerns was the view that a
designated payor was not as a legal matter inherently a surrogate for
the working interest owners beyond the reporting of royalty information
and, did not bear the royalty obligation of the working interest owners
prescribed in the lease document, and should not be liable for the
working interest owner obligations of other parties.
When Congress took up RSFA in the mid-1990's, the designated payor
issue was one of several issues considered. While I was not privy to
the many stakeholder discussions on the pending legislation at that
time, there was widespread acceptance of the shortcomings of the MMS'
expanded designated payor approach. Enactment of RSFA in 1996
eliminated this liability ambiguity by amending the Federal Oil and Gas
Royalty Management Act to sharpen the 30 U.S.C. Sec. 1702 definition of
``lessee'' and amending 30 U.S.C. Sec. 1712(a) as follows:
(a) Liability for royalty payments
In order to increase receipts and achieve effective collections of
royalty and other payments, a lessee who is required to make any
royalty or other payment under a lease or under the mineral leasing
laws, shall make such payments in the time and manner as may be
specified by the Secretary or the applicable delegated State. A lessee
may designate a person to make all or part of the payments due under a
lease on the lessee's behalf and shall notify the Secretary or the
applicable delegated State in writing of such designation, in which
event said designated person may, in its own name, pay, offset or
credit monies, make adjustments, request and receive refunds and submit
reports with respect to payments required by the lessee.
Notwithstanding any other provision of this chapter to the contrary, a
designee shall not be liable for any payment obligation under the
lease. The person owning operating rights in a lease shall be primarily
liable for its pro rata share of payment obligations under the lease.
If the person owning the legal record title in a lease is other than
the operating rights owner, the person owning the legal record title
shall be secondarily liable for its pro rata share of such payment
obligations under the lease.
30 U.S.C. 1712 (a) (emphasis supplied).
Since passage of RSFA working interest owners and payors have
plainly relied on the bright line distinction between payor and working
interest owner royalty liability.
For examples of the problem MMS confronts when it pursues
collections from several working interest owners represented by a
designated payor, I believe the MMS itself is best positioned to offer
that information. I have no direct information on this matter. However,
I am confident that another oversight hearing witness, MMS Director
Randall Luthi, and his MMS Minerals Revenue Management staff can offer
examples to illuminate the collection process. Indeed, the agency may
be able to offer approaches to collection simplification, other than
its original designated payor approach, that could satisfy their
collection concerns without creating other problems in its place.
In sum, I am unaware of anyone opposed to simplification of the
collection process to reduce the MMS workload and better satisfy Debt
Collection Act requirements. However, if legislation akin to Section
215 of H.R. 2337 were enacted, the legislation and/or any ensuing MMS
regulation in fairness should apply prospectively only and eliminate
any ambiguities regarding the respective legal roles and
responsibilities of royalty payors and operating interest owners for
royalty collection in the future. In addition, because working interest
owners and designated payors have been able to rely on RSFA, they would
need an opportunity to consider realigning their payor arrangements and
respective responsibilities.
Minority Questions
5. In your opinion, what is the attitude of people working at MMS in
terms of their desire to fulfill their obligation to the
American public?
While my oversight hearing testimony observes that the federal
royalty management program needs many important improvements, I fully
subscribe to the Subcommittee's view:
In general, the Subcommittee concludes that the Minerals
Management Service is an effective steward of the Minerals
Revenue Management Program, and that MMS employees are
genuinely concerned with fostering continued program
improvements. The Subcommittee members unanimously agree that
MMS is the Federal agency best suited to fulfill the
stewardship responsibilities for Federal and Indian leases.
Subcommittee Report at ix.
In its Report the Subcommittee also observed that over the years
the MMS managed several rulemakings, stoutly defended its final rules
against court challenges, and generally prevailed. Subcommittee Report
at 12, citing, e.g., IPAA v. DeWitt, 279 F.3d 1036 (D.C. Cir. 2002)
(upholding categorical denial of deductibility of marketing costs,
except for firm demand charges, under 1997 gas valuation rule) and the
court's dismissal of industry's challenge of the 2000 oil valuation
rule.
Moreover, two more recent, cases not addressed in the Subcommittee
Report, illustrate MMS' aggressive advocacy. Both cases are non-
rulemaking, coalbed methane cases addressing application of the
``marketable condition'' rule: Amoco Production Company v. Rebecca
Watson, 410 F.3d 722 (D.C. Cir. 2005), cert. denied except for statute
of limitations issue, sub nom. BP America Production Company v. Watson,
126 S. Ct. 1768, 164 L. Ed. 2d 515, 2006 U.S. LEXIS 2851 (U.S., 2006)
(upholding Assistant Secretary's denial of deductions for the costs of
removing excess carbon dioxide from natural gas produced in the San
Juan Basin); and, Devon Energy Corp. v. Norton, No. 04-0821, appeal
pending, (D.D.C. Aug. 3, 2007) (upholding Assistant Secretary's denial
of deductions for many compression, dehydration, and transportation
costs).
Indeed, some courts have found that the MMS was overzealous in its
efforts to fulfill its obligation to the American public. See, e.g.,
the decisions in Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d
1159 (5th Cir. 1988) (holding that gas take-or-pay payments are not
royalty bearing) and Fina Oil and Chemical Company v. Norton, 332 F.3d
672 (rejecting MMS' use of gross proceeds to capture affiliate gas
resale proceeds even though affiliate was not ``marketing affiliate''
under MMS gas rule).
6. In the Energy Policy Act of 2005 we included a provision to
establish pilot offices in areas of increased oil & gas
exploration and development to ensure environmental compliance
and ensure timely processing of lease applications and
Applications for Permits to Drill--it seems that maybe we were
on to something and that this program should be expanded to
include other aspects of the Nation's oil & gas program,
including the collection of royalties. Do you believe this
would facilitate better communication between BLM, MMS and the
BIA?
Concentrating agency resources in areas of high activity makes
sense as a general matter. Whether it would facilitate BLM, MMS and BIA
communication, however, is unclear to me inasmuch as I have had little
contact with BLM and BIA staff over the years. However, I would observe
that further decentralizing BLM offices, especially without the
staffing and training recommendations of the Subcommittee, might not
improve BLM performance but deserves careful consideration. Moreover,
locating extra pilot offices in area of high exploration and
development activity might not address onshore problems that might be
associated with older, less active areas.
7. Can you describe your subcommittee's interactions with MMS and the
Department of the Interior while you were working on the
report? Was it truly independent from your perspective?
The Secretary of the Interior conceived of the Subcommittee as an
independent panel and the Subcommittee so operated.
At the very outset of the project, at the November 2006 Royalty
Policy meeting, and before the panel had been filled out, I was
personally assured by the former MMS Director, Johnnie Burton, that
``nothing was off limits'' for the Subcommittee's examination. Soon
thereafter, Assistant Secretary Allred confirmed that view. The
Subcommittee proceeded on that basis and encountered no barriers
whatsoever.
Once the Subcommittee panel was filled out in late March 2007 and
got underway, the Secretary appointed a small, non-MMS staff group to
support the Subcommittee. Given the geographic dispersion of the
Subcommittee members, and the need to collect large quantities of
information, set up meetings with cognizant MMS and BLM staff, access
to some basic policy analysis input, and administrative support, this
staff group was essential, but in no way interfered with Subcommittee
deliberations.
In the course of our deliberations, Subcommittee members met with
BLM and MMS staff via telephone or in person on many occasions,
especially during the Summer of 2007. My personal experience was that
on all occasions the MMS and BLM staff were open, prepared and
forthcoming in all respects. At no point, however, were MMS and BLM
royalty-oriented staff invited to comment on emerging Subcommittee
recommendations nor did they tender any such comments. Likewise, I am
not aware of any intervention at all by any Department political
appointee. Nor am I aware of any stakeholder (i.e., industry, state or
Indian) outside the Subcommittee seeking or being invited to opine on
any recommendation.
______
STATEMENT OF FRANKLIN RUSCO, ACTING DIRECTOR, NATURAL RESOURCES
AND ENVIRONMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE
Mr. Costa. Our next witness is, last but not least, Mr.
Frank Rusco, is that the way you pronounce it, who obviously
comes to the Committee with high recommendations. We look
forward to your testimony. Mr. Rusco, please begin.
Mr. Rusco. Thank you. Chairman Costa, Ranking Member Pearce
and members of this Subcommittee, I am pleased to be here to
discuss our ongoing work on royalty collections for oil and gas
produced on Federal lands and waters.
Mr. Costa. For the record, excuse me, Mr. Rusco, I did fail
to note you are the Director of Natural Resources and the
Environment within the General Accounting Office, and you
testify this morning with that imprimatur.
Mr. Rusco. Thank you. Interior's Minerals Management
Service collected almost $10 billion last year in such
royalties. MMS collects royalties in two forms, as a percentage
of oil and gas revenues paid in cash or royalties in value and
as a percentage of actual oil or gas royalties in kind. Oil and
gas production and royalty data are self-reported to MMS by oil
and gas production operators and/or royalty ``payors.''
Because of the large amount of money involved and the fact
that the basic data used to determine royalties owed are self-
reported, it is imperative that MMS have adequate IT and
management systems to: 1) prevent and detect errors and
omissions to production and royalty data; 2) ensure audit
capabilities can reliably identify and collect additional
royalties due as a result of errors or omissions; and 3) design
and implement appropriate performance measures for MMS's
overall programs.
Based on our work to date, we must conclude that MMS's IT
and management systems are inadequate on all three counts.
Therefore, we do not have assurance that royalties are
accurately collected. Until late 2004, MMS's IT and management
systems lacked the ability to reliably identify missing oil and
gas production reports.
As a result, MMS has identified a backlog of about 300,000
missing production reports which will now have to be
reconciled. Worse, the system still lacks the ability to
identify missing royalty reports, so MMS does not know if or
how many such reports are missing. Finally, companies are
allowed to go back in to MMS's data system and change royalty
data at any time for up to six years after an initial report is
filed.
There is no requirement for companies making such changes
to notify MMS, and the IT and management systems do not
systematically flag these changes for MMS review. As a result
of these and other deficiencies, MMS does not have reasonable
assurance that data entered into its system are complete or
accurate to begin with or that they remain so over time.
We have a number of concerns about MMS's audit capabilities
including: 1) the lack of systematic and complete collection
and evaluation of third-party production data and other
supporting documentation; and 2) increasing reliance on
compliance reviews, which compared to audits are less rigorous
checks of the reasonableness, accuracy and completeness of
royalty reports; and finally, the fact that there is too much
riding on audits and compliance reviews given that the primary
royalty data are so unreliable.
MMS is currently revising its audit and compliance review
process, and we will be evaluating these revisions in our
ongoing work. However, based on our work to date, we are
concerned about the ability of the audit and compliance review
process to adequately detect or deter missed reporting of
production and royalty data.
Finally, MMS lacks adequate performance measures for its
royalty-in-kind program. First, MMS does not check self-
reported royalty-in-kind gas volumes against third-party
production data. As a result, MMS does not have reasonable
assurance that it is even getting the correct volumes of gas,
which raises questions about MMS's claimed benefits of the
royalty-in-kind program.
Second, MMS's methodology for comparing the value of
royalty-in-kind oil and gas with what it would have received
had the royalties been paid in cash is subject to a lot of
unreported uncertainty. We found that even small changes in
assumptions about prices that royalty and value ``payors''
receive for their oil and gas leads to large swings in the
estimated benefits of the royalty-in-kind program and can even
make these estimates negative.
These and other problems raise serious questions about
MMS's reported measures of the benefits of the royalty-in-kind
program. I want to conclude by saying that we encountered
hardworking and knowledgeable staff in all Department of the
Interior offices we visited, and we have received great
cooperation in conducting our audit work.
However, we also found profound and persistent problems
with IT and management systems that are inadequately designed
and do not contain common sense checks that could assist staff
in: 1) detecting and correcting inaccurate or incomplete self-
reported production and royalty data; 2) conducting efficient
and effective audits and compliance reviews; and 3)
appropriately measuring program performance.
Upon completing our audit we will make recommendations that
will address these and other issues. This completes my oral
statement. My colleague, Jeanette Franzel, and I will be happy
to answer any questions you have. Thank you.
Mr. Costa. Thank you, Mr. Rusco.
[The prepared statement of Mr. Rusco follows:]
Statement of Frank Rusco, Acting Director, Natural Resources and
Environment, Accompanied by Jeanette Franzel, Director, Financial
Management and Assurance, U.S. Government Accountability Office
Mr. Chairman and Members of the Subcommittee:
We are pleased to participate in the subcommittee's hearing to
discuss the Department of the Interior's (Interior) oversight of the
collection of royalties paid on the production of oil and natural gas
(hereafter oil and gas) from federal lands and waters. In Fiscal Year
2007, Interior's Minerals Management Service (MMS) collected over $9
billion in oil and gas royalties and disbursed these funds to federal,
state, and tribal accounts. The federal portion of these royalties,
which totaled $6.7 billion in Fiscal Year 2007, represents one of the
country's largest nontax sources of revenue. At the same time, oil and
gas production on federal lands and waters represents a critical
component of the nation's energy portfolio, supplying roughly 35
percent of all the oil and 30 percent of all the gas produced in the
United States in 2006. The Department of Energy's (DOE) Energy
Information Administration projects that over the next 10 years the
portion of U.S. production from federal lands and waters will increase
to 47 percent for oil and 37 percent for gas. In Fiscal Year 2007, MMS
also transferred $322 million worth of oil to DOE as part of its
efforts to fill the nation's Strategic Petroleum Reserve (SPR). The SPR
currently holds nearly 700 million barrels of oil--equivalent to about
58 days of net oil imports--that can be released at the discretion of
the President in the event of an oil supply disruption. Recently, both
oil prices and the demand to drill for oil and gas on federal lands
have increased dramatically. For example, the price of West Texas
Intermediate--a commonly used benchmark crude oil--now exceeds $100 per
barrel, a price that, when adjusted for inflation, is the highest price
since 1980. Moreover, Interior's Bureau of Land Management (BLM) is
projecting substantially increased numbers of drilling permit
applications. It received 8,351 in 2005 and anticipates receiving
12,500 in 2008.
Companies that develop and produce federal oil and gas resources
from federal lands and waters do so under leases obtained and
administered by Interior--BLM for onshore leases and MMS's Offshore
Minerals Management (OMM) for offshore leases. Together, BLM and OMM
are responsible for overseeing oil and gas operations on more than
28,000 producing leases to help ensure that oil and gas companies
comply with applicable laws, regulations, and agency policies. Among
other things, BLM and OMM staff inspect producing leases to verify
whether oil and gas are accounted for as required by both the Federal
Oil and Gas Royalty Management Act of 1982 1 and agency
policies. As a condition of producing oil and gas under federal leases,
companies are required to self-report monthly production volumes to MMS
(as part of their monthly production reports). 2 In some
situations, several companies may be jointly involved in developing oil
and gas from a lease or a number of adjacent leases, in which case the
companies designate one of the companies to be the ``operator.'' The
operator has sole responsibility for submitting production reports for
all oil and gas produced from the leases.
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\1\ Federal Oil and Gas Royalty Management Act, Pub. L. No. 97-451,
Sec. 101(a) (1983).
\2\ Companies are required to self-report monthly production
volumes to MMS on an Oil and Gas Operations Report (OGOR) form.
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Companies, or lessees, compensate the government for producing
federal oil and gas resources either ``in value'' (royalty payments
made in cash), or ``in kind'' (royalty payments made in oil or gas). In
Fiscal Year 2006, 58 percent of the $9.74 billion in oil and gas
royalty payments were made in value, while 42 percent were made in
kind. Under the royalty-in-value program, lessees responsible for
paying cash royalties, also called ``payors,'' calculate the royalty
payment they owe to the federal government using the key variables
illustrated in the following equation:
Royalty payment = (sales volume x sales price - deductions) x royalty
rate 3
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\3\ The royalty rate varies somewhat but is typically in the range
of 12.5 to 18.75 percent. In other words, the federal government
typically receives between 12.5 and 18.75 percent of revenues less
allowable deductions for oil and gas produced on federal lands and
waters. Allowable deductions include payments to pipeline companies and
other shipping costs required to transport the commodity to a market
center, as well as adjustments made for the costs of processing natural
gas.
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Cash royalty payors are required to submit monthly royalty reports
to MMS specifying the royalty amount they owe the federal government
for the production and sale of oil and gas, and generally make the cash
payment via an electronic fund transfer to an account at the Department
of the Treasury (Treasury). 4 In many instances, because
leases are co-owned by multiple companies, multiple payors submit
individual royalty reports for a single lease. However, in these
situations a single company is designated the ``operator'' and is
responsible for submitting the production report for that entire lease.
As a result, MMS will often receive multiple royalty reports
corresponding to a single production report. Royalty reports include
the sales volume (amount sold), the sales revenue (the amount of
revenue received from the sale), and the royalty payment due to MMS
(royalty value less allowances taken for transportation and processing
the gas into a marketable condition), prorated based on the share owned
by each payor. Some of these data, as well as some of the deductible
transportation costs, are also available from third-party sources. For
example, individual royalty payor data on production and some
transportation costs can be acquired from pipeline statements, which
are essentially receipts from pipeline companies for shipping oil and
gas. In contrast, documentation of sales revenue data, as well as data
supporting allowable deductions, are generally available only from oil
and gas company records. Royalty payors submit their monthly royalty
reports through a Web-based portal. Once MMS reconciles the self-
reported royalty payment data from the monthly royalty reports with the
payments submitted to Treasury, MMS disburses the royalties from the
Treasury account to the appropriate federal, state, and tribal
accounts. The transaction information is recorded in MMS's financial
management system. 5
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\4\ Companies are required to self-report monthly royalty payments
to MMS on the Report of Sales and Royalty Remittance Form, Form 2014.
\5\ This system, also known as the Minerals Revenue Management
Support System, is designed to store and support the collection,
verification, and disbursement of royalty revenues from federal and
Indian mineral leases.
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As a check on the accuracy of the self-reported data the payors use
when determining cash royalty payments, among MMS's internal controls
are audits and compliance reviews. 6 Audits are an
assessment of the accuracy and completeness of the self-reported
production and royalty data compared against source documents, such as
sales contracts and oil and gas sales receipts from pipeline companies.
By contrast, compliance reviews deal with reasonableness--a quicker,
more limited check of the accuracy and completeness of a company's
self-reported data--and they do not include systematic examination of
underlying source documentation. In addition, some states and tribes
that receive a share of royalties collected by MMS have agreements with
MMS authorizing them to conduct both audits and compliance reviews on
federal and Indian producing leases within their jurisdictions.
7 MMS has an annual performance goal whereby it evaluates
the compliance group's performance on the basis of whether the group
has conducted compliance activities--either full audits or compliance
reviews--on a predetermined percentage of royalty payments.
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\6\ Internal controls are a series of management actions and
activities that occur throughout an entity's operations and include the
procedures used to meet agency objectives.
\7\ Eleven states--Alaska, California, Colorado, Louisiana,
Montana, New Mexico, North Dakota, Oklahoma, Texas, Utah, and Wyoming--
and seven tribes--Blackfeet Nation, Jicarilla Apache Tribe, Navajo
Nation, Shoshone and Arapaho Tribes, Southern Ute Indian Tribe, Ute
Mountain Ute Tribe, and the Ute Indian Tribe--conducted compliance work
under cooperative agreements with MMS in Fiscal Year 2007.
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In contrast to royalties in value, when paying royalties in kind, a
payor delivers a volume of oil or gas to MMS as determined by the
following equation:
Royalty volume = total production volume x royalty rate 8
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\8\ In some cases, there may be deductions to the royalty oil given
MMS as a result of costs incurred by the payor to transport the oil to
the point at which MMS takes possession. In addition, there may be
credits or deductions that adjust for different qualities of oil
transported on a pipeline.
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Once it receives the oil or gas, MMS may either sell it and
disburse the revenues received from the sales, or transfer it to
federal agencies for them to use. For example, MMS can transfer oil to
DOE and DOE, in turn, can trade this oil for other oil of specific
quality to fill the SPR. Under the Energy Policy Act of 2005,
9 MMS is charged with ensuring that the revenues it receives
when it sells oil and gas taken in-kind are at least as great as the
revenues it would have received had it taken the royalties in value.
Furthermore, MMS cannot sell oil and gas it takes in-kind for less than
market value. As required, MMS routinely compares the estimated
benefits of the in-kind program to the estimated benefits MMS would
have received if the royalties had been taken in cash and annually
reports these benefits to the Congress.
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\9\ Energy Policy Act of 2005, Pub. L. No. 109-58, Sec. 342 (2005).
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MMS estimates that from Fiscal Years 2004 through 2006 the royalty-
in-kind program generated about $87 million more in net value to the
government than MMS would have collected had it received royalties in
cash. Of this $87 million, MMS estimates that (1) $74 million came from
selling royalty-in-kind oil and gas for more than it would have
received in cash royalty payments, (2) $5 million came from interest
from receiving revenues from in-kind sales earlier than cash payments
are due, and (3) $8 million came from savings because the royalty-in-
kind program costs less to administer than the in-value program.
Our testimony today is based on two ongoing efforts. The first
focuses on MMS's royalty-in-value program and addresses (1) whether
Interior has adequate assurance that it is receiving full compensation
for oil and gas produced from federal lands and waters and (2) the
extent to which MMS's compliance efforts provide an adequate check on
industry's self-reported data. 10 The second, relating to
MMS's royalty-in-kind program, addresses (1) the extent to which MMS
has reasonable assurance that it is collecting the right amounts of
royalty-in-kind oil and gas and (2) the reliability of the benefits of
the royalty-in-kind program that MMS has reported. 11
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\10\ This work is being done at the request of Senator Bingaman and
Mr. Davis, Mr. Issa, Ms. Maloney, and Mr. Rahall, House of
Representatives.
\11\ This work is being done at the request of Senator Bingaman and
Senator Wyden, and Mr. Issa and Mr. Rahall, House of Representatives.
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In addressing these issues, we reviewed documentation on MMS
policies and procedures for collecting royalties; collected and
assessed information on the sales of royalty oil and gas; and reviewed
MMS procedures for preparing the administrative cost comparison between
the royalty-in-value and royalty-in-kind programs. We also interviewed
officials at offices selected from a nonprobability sample of five BLM
field offices and the associated BLM state offices--the offices were
selected based on the numbers of violations, oil and gas volume errors
identified, and geographic location. In addition, we interviewed
officials at MMS; toured oil and gas production facilities in Wyoming,
Colorado, and the Gulf of Mexico; sent questionnaires addressing
production and royalty data issues to the 11 state and 7 tribal members
of the State and Tribal Royalty Audit Committee, of which 9 states and
5 tribes responded. We assessed the reliability of the royalty-in-kind
sales and performance data by (1) reviewing the systems that MMS has in
place to help ensure that the data were entered and calculated
correctly, and (2) comparing the data to aggregate performance results
that MMS reported to the Congress for Fiscal Years 2004 through 2006.
We determined that the data were sufficiently reliable for the purposes
of this testimony. Our work is ongoing and we are continuing to assess
information related to the objectives and findings presented in this
testimony. We conducted this work from April 2007 to February 2008 in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.
In summary, regarding the royalty-in-value program, our work to
date has revealed the following:
Interior lacks adequate assurance that it is receiving
full compensation for oil and gas produced from federal lands and
waters. For example, neither BLM nor OMM is meeting statutory
obligations or agency targets for conducting inspections of meters and
other equipment used to measure oil and gas production, which raises
questions about the accuracy of oil and gas measurement. Further, MMS's
systems and processes for collecting and verifying royalty data are
inadequate and lack key internal controls. Specifically, MMS lacks an
automated process to routinely and systematically reconcile all
production data filed by payors (those responsible for paying the
royalties) with production data filed by operators (those responsible
for reporting production volumes).
MMS's compliance efforts do not consistently examine data
from third parties to verify whether self-reported industry payment
data are complete and accurate. Combined with the inadequacy of MMS's
systems and processes for collecting and verifying royalty data and the
lack of key internal controls, the absence of a consistent check on
self-reported data using third-party data raises further questions
about the accuracy of royalty payments.
Regarding the royalty-in-kind program, our work to date has
revealed the following:
MMS does not consistently check the accuracy of self-
reported gas collection data against available third-party data,
putting the accuracy of gas royalty collections at risk. MMS's ability
to detect gas production discrepancies is weaker than for oil because,
unlike in the case of oil, MMS does not use third-party gas metering
data to verify the operator-reported production numbers.
The methods and assumptions MMS uses to compare the revenues it
collects in kind with what it would have collected in cash do
not account for all costs and do not sufficiently deal with
uncertainties, raising significant questions about the reported
financial benefits of the in-kind program.
Interior's Oversight Does Not Provide Adequate Assurance That the
Government Is Being Fully Compensated for Oil and Gas
Production on Federal Lands and Waters
Interior lacks adequate assurance that it is receiving the full
royalties it is owed because (1) neither BLM nor OMM is fully
inspecting leases and meters as required by law and agency policies,
and (2) MMS lacks adequate management systems and sufficient internal
controls for verifying that royalty payment data are accurate and
complete. With regard to inspecting oil and gas production, BLM is
charged with inspecting approximately 20,000 producing onshore leases
annually to ensure that oil and gas volumes are accurately measured.
However, BLM's state Inspection and Enforcement Coordinators from
Colorado, Montana, New Mexico, Utah, and Wyoming told us that only 8 of
the 23 field offices in the 5 states completed both their (1) required
annual inspections of wells and leases that are high-producing and
those that have a history of violations and (2) inspections every third
year on all remaining leases. 12 According to the BLM state
Inspection and Enforcement Coordinators, the number of completed
production inspections varied greatly by field office. For example,
while BLM inspectors were able to complete all of the production
inspections in the Kemmerer, Wyoming, field office, inspectors in the
Glenwood Springs, Colorado, field office were able to complete only
about one-quarter of the required inspections. Officials in 3 of the 5
field offices in which we held detailed discussions with inspection
staff told us that they had not been able to complete the production
inspections because of competing priorities, 13 including
their focus on completing a growing number of drilling inspections for
new oil and gas wells, and high inspection staff turnover. However, BLM
officials from all 5 field offices told us that when they have
conducted production inspections they have identified a number of
violations. For example, BLM staff in 4 of the 5 field offices
identified errors in the amounts of oil and gas production volumes
reported by operators to MMS by comparing production reports with
third-party source documents. Additionally, BLM staff from 1 field
office we visited showed us a bypass built around a gas meter, allowing
gas to flow around the meter without being measured. BLM staff ordered
the company to remove the bypass. Staff from another field office told
us of a case in which individuals illegally tapped into a gas line and
routed gas to private residences. Finally, in one of the field offices
we visited, BLM officials told us of an instance in which a company
maintained two sets of conflicting production data--one used by the
company and another reported to MMS.
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\12\ We excluded production inspection results from three BLM field
offices where BLM state Inspection and Enforcement Coordinators could
not validate production inspection numbers because they felt the data
in BLM's Automated Fluid Minerals Support System (AFMSS), the database
used to track production inspections, were unreliable. We excluded one
additional BLM field office because it is implementing a pilot project
inspection program using different selection and prioritization
criteria; therefore it is not comparable with the other BLM field
offices.
\13\ To gain a balance of perspectives of how BLM field offices
conduct production inspections, we chose a nonprobability sample of
five field office locations--Meeker, Colorado; Vernal, Utah;
Farmington, New Mexico; Buffalo, Wyoming; and Pinedale, Wyoming. We
selected the field offices in each of these states through
consideration of a number of criteria, ensuring that we visited BLM
field offices that represented a range of BLM state office
jurisdictional policies. While this nonprobability sample allowed us to
learn about many important aspects of production inspections, it was
not designed to be representative of all the BLM field offices
production inspection activities. As such, the findings cannot be
generalized to sites we did not visit.
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Moreover, OMM, which is responsible for inspecting offshore
production facilities that include oil and gas meters, did not inspect
all oil and gas royalty meters, as required by its policy, in 2007. For
example, OMM officials responsible for meter inspections in the Gulf of
Mexico told us that they completed about half of the required 2,700
inspections, but that they met OMM's goal for witnessing oil and gas
meter calibrations. OMM officials told us that one reason they were
unable to complete all the meter inspections was their focus on the
remaining cleanup work from hurricanes Katrina and Rita. Meter
inspections are an important aspect of the offshore production
verification process because, according to officials, one of the most
common violations identified during inspections is missing or broken
meter seals. Meter seals are meant to prevent tampering with
measurement equipment. When seals are missing or broken, it is not
possible without closer inspection to determine whether the meter is
correctly measuring oil or gas production.
With regard to MMS's assurance that royalty data are being
accurately reported by companies, MMS's systems and processes for
collecting and verifying these data lack both capabilities and key
internal controls, including those focused on data accuracy, integrity,
and completeness. For example, MMS lacks an automated process to
routinely and systematically reconcile all production data filed by
payors (those responsible for paying the royalties) with production
data filed by operators (those responsible for reporting production
volumes). MMS officials told us that before they transitioned to the
current financial management system in 2001, their system included an
automated process that reconciled the production and royalty data on
all transactions within approximately 6 months of the initial entry
date. However, MMS's new system does not have that capability. As a
result, such comparisons are not performed on all properties.
Comparisons are made, if at all, 3 years or more after the initial
entry date by the MMS compliance group for those properties selected
for a compliance review or audit.
In addition, MMS lacks a process to routinely and systematically
reconcile production data included by payors on their royalty reports
or by operators on their production reports with production data
available from third-party sources. OMM does compare a large part of
the offshore operator-reported production data with third-party data
from pipeline operators through both its oil and gas verification
programs, but BLM compares only a relatively small percentage of
reported onshore oil and gas production data with third-party pipeline
data. When BLM and OMM do make comparisons and find discrepancies, they
forward the information to MMS, which then takes steps to reconcile and
correct these discrepancies by talking to operators. However, even when
discrepancies are corrected and the operator-reported data and pipeline
data have been reconciled, these newly reconciled data are not
automatically and systematically compared with the reported sales
volume in the royalty report, previously entered into the financial
management database, to ensure the accuracy of the royalty payment.
Such comparisons occur only if a royalty payor's property has been
selected for an audit or compliance review.
Furthermore, MMS's financial management system lacks internal
controls over the integrity and accuracy of production and royalty-in-
value data entered by companies. Companies may legally make changes to
both royalty and production data in MMS's financial management system
for up to 6 years after the reporting month, and these changes may
necessitate changes in the royalty payment. 14 However, when
companies retroactively change the data they previously entered, these
changes do not require prior approval by, or notification of, MMS. As a
result of the companies' ability to unilaterally make these retroactive
changes, the production data and required royalty payments can change
over time, further complicating efforts by agency officials to
reconcile production data and ensure that the proper amount of
royalties was paid. Compounding this data reliability concern, changes
made to the data do not necessarily trigger a review to determine their
reasonableness or whether additional royalties are due. According to
agency officials, these changes are not subject to review at the time a
change is made and would be evaluated only if selected for an audit or
compliance review. This is also problematic because companies may
change production and royalty data after an audit or compliance review
has been done, making it unclear whether these audited royalty payments
remain accurate after they have been reviewed. Further, MMS officials
recently examined data from September 2002 through July 2007 and
identified over 81,000 adjustments made to data outside the allowable
6-year time frame. MMS is working to modify the system to automatically
identify adjustments that have been made to data outside of the
allowable 6-year time frame, but this effort does not address the need
to identify adjustments made within the allowable time that might
necessitate further adjustments to production data and royalty payments
due.
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\14\ The Royalty Simplification and Fairness Act of 1996, Pub. L.
No. 104-185, Sec. 5(a) (1996), provides a 6 year adjustment window.
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Finally, MMS's financial management system could not reliably
detect when production data reports were missing until late 2004, and
the system continues to lack the ability to automatically detect
missing royalty reports. In 2004, MMS modified its financial management
system to automatically detect missing production reports. As a result,
MMS has identified a backlog of approximately 300,000 missing
production reports that must be investigated and resolved. It is
important that MMS have a complete set of accurate production reports
so that BLM can prioritize production inspections, and its compliance
group can easily reconcile royalty payments with production
information. Importantly, MMS's financial management system continues
to lack the ability to automatically detect cases in which an expected
royalty report has not been filed. While not filing a royalty report
may be justifiable under certain circumstances, such as when a company
sells its lease, MMS's inability to detect missing royalty reports
presents the risk that MMS will not identify instances in which it is
owed royalties that are simply not being paid. Officials told us they
are currently able to identify missing royalty reports in instances
when they have no royalty report to match with funds deposited to
Treasury. However, cases in which a company stops filing royalty
reports and stops paying royalties would not be detected unless the
payor or lease was selected for an audit or compliance review.
MMS's Compliance Efforts Do Not Consistently Use Third-Party Data to
Check Self-Reported Royalty-in-Value Payment Data
MMS's increasing use of compliance reviews, which are more limited
in scope than audits, has led to an inconsistent use of third-party
data to verify that self-reported royalty data are correct, thereby
placing accurate royalty collections at risk. Since 2001, MMS has
increasingly used compliance reviews to achieve its performance goals
of completing compliance activities--either full audits or compliance
reviews--on a predetermined percentage of royalty payments. According
to MMS, compliance reviews can be conducted much more quickly and
require fewer resources than audits, largely because they represent a
quicker, more limited reasonableness check of the accuracy and
completeness of a company's self-reported data, and do not include a
systematic examination of underlying source documentation. Audits, on
the other hand, are more time- and resource-intensive, and they include
the review of original source documents, such as sales revenue data,
transportation and gas processing costs, and production volumes, to
verify whether company-reported data are accurate and complete. When
third-party data are readily available from OMM, MMS may use them when
conducting a compliance review. For example, MMS may use available
third-party data on oil and gas production volumes collected by OMM in
its compliance reviews for offshore properties. In contrast, because
BLM collects only a limited amount of third-party data for onshore
production, and MMS does not request these data from the companies, MMS
does not systematically use third-party data when conducting onshore
compliance reviews. Despite conducting thousands of compliance reviews
since 2001, MMS has only recently evaluated their effectiveness. For
calendar year 2002, MMS compared the results of 100 of about 700
compliance reviews of offshore leases and companies with the results of
audits conducted on those same leases or companies. However, while the
compliance reviews covered, among other things, 12 months of production
volumes on all products--oil, gas, and retrograde, a liquid product
that condenses out of gas under certain conditions--the audits covered
only 1 month and one product. As a result of this evaluation comparing
the results of compliance reviews with those of audits, MMS now plans
to improve its compliance review process by, for example, ensuring that
it includes a step to check that royalties are paid on all royalty-
bearing products, including retrograde.
To achieve its annual performance goals, MMS began using the
compliance reviews along with audits. One of MMS's performance goals is
to complete compliance activities--either audits or compliance
reviews--on a specified percentage of royalty payments within 3 years
of the initial royalty payment. For example, in 2006 MMS reported that
it had achieved this goal by confirming reasonable compliance on 72.5
percent of all calendar year 2003 royalties. To help meet this goal,
MMS continues to rely heavily on compliance reviews, yet it is unable
to state the extent to which this performance goal is accomplished
through audits as opposed to compliance reviews. As a result, MMS does
not have information available to determine the percentage of the goal
that was achieved using third-party data and the percentage that did
not systematically rely on third-party data. Moreover, to help meet its
performance goal, MMS has historically conducted compliance reviews or
audits on leases and companies that have generated the most royalties,
with the result that the same leases and companies are reviewed year
after year. Accordingly, many leases and companies have gone for years
without ever having been reviewed or audited.
In 2006, Interior's Inspector General (IG) reviewed MMS's
compliance process and made a number of recommendations aimed at
strengthening it. The IG recommended, among other things, that MMS
examine 1 month of third-party source documentation as part of each
compliance review to provide greater assurance that both the production
and allowance data are accurate. The IG also recommended that MMS track
the percentage of the annual performance goal that was accomplished
through audits versus through compliance reviews, and that MMS move
toward a risk-based compliance program and away from reviewing or
auditing the same leases and companies each year. To address the IG's
recommendations, MMS has recently revised its compliance review
guidance to include suggested steps for reviewing third-party source
production data when available for both offshore and onshore oil and
gas, though the guidance falls short of making these steps a
requirement. MMS has also agreed to start tracking compliance activity
data in 2007 that will allow it to report the percentage of the
performance goal that was achieved through audits versus through
compliance reviews. Finally, MMS has initiated a risk-based compliance
pilot project, whereby leases and companies are selected for compliance
work according to MMS-defined risk criteria that include factors other
than whether the leases or companies generate high royalty payments.
According to MMS, during Fiscal Year 2008 it will further evaluate and
refine the pilot as it moves toward fuller implementation.
Finally, representatives from the states and tribes who are
responsible for conducting compliance work under agreements with MMS
have expressed concerns about the quality of self-reported production
and royalty data they use in their reviews. As part our work, we sent
questionnaires to all 11 states and seven tribes that conducted
compliance work for MMS in Fiscal Year 2007. Of the nine state and five
tribal representatives who responded, seven reported that they lack
confidence in the accuracy of the royalty data. For example, several
representatives reported that because of concerns with MMS's production
and royalty data, they routinely look to other sources of corroborating
data, such as production data from state oil and gas agencies and tax
agencies. Finally, several respondents noted that companies frequently
report production volumes to the wrong leases and that they must then
devote their limited resources to correcting these reporting problems
before beginning their compliance reviews and audits.
The MMS Royalty-in-Kind Program Is at Risk of Inaccurate Collection of
Natural Gas Royalties because of Inconsistent Oversight
Because MMS's royalty-in-kind program does not extend the same
production verification processes used by its oil program to its gas
program, it does not have adequate assurance that it is collecting the
gas royalties it is owed. As noted, under the royalty-in-kind program,
MMS collects royalties in the form of oil and gas and then sells these
commodities in competitive sales. To ensure that the government obtains
the fair value of these sales, MMS must make sure that it receives the
volumes to which it is entitled. Because prices of these commodities
fluctuate over time, it is also important that MMS receive the oil and
gas at the time it is entitled to them. As part of its royalty-in-kind
oversight effort, MMS identifies imbalances between the volume
operators owe the federal government in royalties and the volume
delivered and resolves these imbalances by adjusting future delivery
requirements or cash payments. The methods that MMS uses to identify
these imbalances differ for oil and gas.
For oil, MMS obtains pipeline meter data from OMM's
liquid verification system, which records oil volumes flowing through
numerous metering points in the Gulf of Mexico region. MMS calculates
its royalty share of oil by multiplying the total production volumes
provided in these pipeline statements by the royalty rates for a given
lease. MMS compares this calculation with the volume of royalty oil
that the operators delivered as reported by pipeline operators. When
the value of an imbalance cumulatively reaches $100,000, MMS conducts
further research to resolve the discrepancy. Using pipeline statements
to verify production volumes is a good check against companies' self-
reporting of royalties due the federal government because companies
have an incentive to not underreport their share of oil going into the
pipeline because that is the amount they will have to sell at the other
end of the pipeline.
For gas, MMS relies on information contained in two
operator-provided documents--monthly imbalance statements and
production reports. Imbalance statements include the operator's total
gas production for the month, the share of that production that the
government is entitled to, and any differences between what the
operator delivered and the government's royalty share. Production
reports contain a large number of data elements, including production
volumes for each gas well. MMS compares the production volumes
contained in the imbalance statements with those in the production
reports to verify production levels. MMS then calculates its royalty
share based on these production figures and compares its royalty share
with gas volumes the operators delivered as reported by pipeline
operators. When the value of an imbalance cumulatively reaches
$100,000, MMS conducts further research to resolve the discrepancy.
MMS's ability to detect gas imbalances is weaker than for oil
because it does not use third-party metering data to verify the
operator-reported production numbers. Since 2004, OMM has collected
data from gas pipeline companies through its gas verification system,
which is similar to its liquid verification system in that the system
records information from pipeline company-provided source documents.
Our review of data from this program shows that these data could be a
useful tool in verifying offshore gas production volumes. 15
Specifically, our analysis of these pipeline data showed that for the
months of January 2004, May 2005, July 2005, and June 2006, 25 percent
of the pipeline metering points had an outstanding discrepancy between
self-reported and pipeline data. 16 These discrepancies are
both positive and negative--that is, production volumes submitted to
MMS by operators are at times either under- or overreported.
---------------------------------------------------------------------------
\15\ Onshore gas properties accounted for less than 1 percent of
the revenue managed by the royalty-in-kind program from Fiscal Year
2004 through Fiscal Year 2006, but this area is expected to grow in the
future.
\16\ For purpose of this testimony, we used 4 months of data from
the gas verification system. We chose these months (January 2004, May
2005, July 2005, and June 2006) because these are the months for which
MMS has started to work to resolve the discrepancies identified between
the production reports and pipeline data.
---------------------------------------------------------------------------
Data from the gas verification system could be useful in validating
production volumes and reducing discrepancies. However, to fully
benefit from this opportunity, MMS needs to improve the timeliness and
reliability of these data. After examining this issue, in December
2007, the Subcommittee on Royalty Management, a panel appointed by the
Secretary of the Interior to examine MMS's royalty program, reported
that OMM is not adequately staffed to conduct sufficient review of data
from the gas verification system. 17 We have not yet, nor
has MMS, determined the net impact of these discrepancies on royalties
owed the federal government.
---------------------------------------------------------------------------
\17\ Subcommittee on Royalty Management, Royalty Policy Committee,
Report to the Royalty Policy Committee: Mineral Revenue Collection from
Federal and Indian Lands and the Outer Continental Shelf (2007).
---------------------------------------------------------------------------
Significant Questions and Uncertainties Exist Regarding the Reported
Financial Benefits of the Royalty-in-Kind Program
The methods and underlying assumptions MMS uses to compare the
revenues it collects in kind with what it would have collected in cash
do not account for all costs and do not sufficiently deal with
uncertainties, raising doubts about the claimed financial benefits of
the royalty-in-kind program. Specifically, MMS's calculation showing
that MMS sold the royalty oil and gas for $74 million more than MMS
would have received in cash payments did not appropriately account for
uncertainty in estimates of cash payments. In addition, MMS's
calculation that early royalty-in-kind payments yielded $5 million in
interest was based on assumptions about payment dates and interest
rates that could misstate the estimated interest benefit. Finally,
MMS's calculation that the royalty-in-kind program cost about $8
million less to administer than an in-value program did not include
significant costs that, if included, could change MMS's conclusions.
Sales Revenue
MMS sold the oil and gas it collected during the 3 Fiscal Years
2004 through 2006 for $8.15 billion and calculated that this amount
exceeded what MMS would have received in cash royalties by about $74
million--a net benefit of approximately 0.9 percent. MMS has recognized
that its estimates of what it would have received in cash payments are
subject to some degree of error but has not appropriately evaluated or
reported how sensitive the net benefit calculations are to this error.
18 This is important because even a 1 percent error in the
estimates of cash payments would change the estimated benefit of the
royalty-in-kind program from $74 million to anywhere from a loss of $6
million to a benefit of $155 million.
---------------------------------------------------------------------------
\18\ OMB Circular A-94, ``Guidelines and Discount Rates for
Benefit-Cost Analysis of Federal Programs,'' suggests that such
sensitivity analysis be done and reported.
---------------------------------------------------------------------------
Moreover, MMS's annual reports to the Congress present oil sales
data in aggregate and therefore do not reflect the fact that, in many
individual sales, MMS sold the oil it collected in kind for less than
it estimates it would have collected in cash. Specifically, MMS
estimates that, in Fiscal Year 2006, it sold 28 million barrels of oil,
or 64 percent of all the oil it collected in kind, for less than it
would have collected in cash. The government would have received an
additional $6 million in revenue if it had taken these royalties in
cash instead. These sales indicate that MMS has not always been able to
achieve one of its central goals: to select, based on systematic
economic analysis, which royalties to take in cash and which to take in
kind in a way that maximizes revenues to the government.
According to a senior MMS official, the federal government has
several advantages when selling gas that it does not have when selling
oil, a fact that helps to explain why MMS's gas sales have performed
better than its oil sales. For example, MMS can bundle the natural gas
production in the Gulf of Mexico from many different leases into large
volumes that MMS can use to negotiate discounts for transporting gas
from production sites to market centers. Because purchasers receive
these discounts when they buy gas from MMS, they may be willing to pay
more for gas from MMS than from the original owners. Opportunities for
bundling are less prevalent in the oil market. Because MMS generally
does not have this, or other, advantages when selling oil, purchasers
often pay MMS about what they would pay other producers for oil, and
sometimes less. Indeed, MMS's policies allow it to sell oil for up to
7.7 cents less per barrel than MMS estimates it would collect if it
took the royalties in cash. MMS told us that the other financial
benefits of the royalty-in-kind program, including interest payments
and reduced administrative costs, justify selling oil for less than the
estimated cash payments because once these additional revenues are
factored in, the net benefit to the government is still positive.
However, as discussed below, we have found that there are significant
questions and uncertainties about the other financial benefits as well.
Interest
Revenues from the sale of royalty-in-kind oil are due 10 days
earlier than cash payments, and revenues from the sale of in-kind gas
are due 5 days earlier. MMS calculates that the government earned about
$5 million in interest from Fiscal Years 2004 through 2006 from these
early payments that it would not have received had it taken royalties
in cash. 19 We found two weaknesses in the way MMS
calculates this interest. First, the payment dates used to calculate
the interest revenue have the potential to over- or underestimate its
value. MMS calculates the interest on the basis of the time between the
actual date that Treasury received a royalty-in-kind payment and the
theoretical latest date that Treasury would have received a cash
payment under the royalty-in-value program. However, MMS officials told
us that cash payments can, and sometimes do, arrive before their due
date. As a result, MMS might be overstating the value of the early
royalty-in-kind payments. Second, the interest rate used to calculate
the interest revenue may either over- or understate its value because
the rate is not linked to any market rate. From Fiscal Year 2004
through 2007, MMS used a 3 percent interest rate to calculate the time
value of these early payments. However, during this time, actual market
interest rates at which the federal government borrowed fluctuated. For
example, 4-week Treasury bill rates ranged from a low of 0.72 percent
to a high of 5.18 percent during this same period. Therefore, during
some fiscal years, MMS likely overstated or understated the value of
these early payments.
---------------------------------------------------------------------------
\19\ While MMS calls this value ``interest,'' it is not interest
per se because the money does not go into an interest-bearing account.
Rather, MMS argues that the government uses the early payments to cover
expenses that it would otherwise need to borrow money to pay for. The
interest, then, is the cost that the government avoids by deferring the
need to borrow.
---------------------------------------------------------------------------
Administrative Cost Savings
MMS has developed procedures to capture the administrative costs of
the royalty-in-kind and cash royalty programs and includes in its
administrative cost comparison primarily the variable costs for the
federal offshore oil and gas activities--that is, costs that fluctuate
based on the volume of oil or gas received by MMS, such as labor costs.
Although MMS also includes some department-level fixed costs, it
excludes some fixed costs that it does not incur on a predictable basis
(largely information technology [IT] costs). According to MMS, if it
included these IT and other such costs, there would be a high potential
of skewing the unit price used to determine the administrative cost
savings. However, by excluding such fixed costs from the administrative
cost comparison, MMS is not including all the necessary cost
information to evaluate the efficacy of the royalty-in-kind program.
MMS's administrative cost analysis compares a bundle of royalty-in-
kind program administrative costs divided by the number of barrels of
oil equivalent realized by the royalty-in-kind program during a year,
20 with a bundle of cash royalty program administrative
costs divided by the number of barrels of oil equivalent realized by
that program. The difference between these amounts represents the
difference in cost to administer a barrel of oil equivalent under each
program.
---------------------------------------------------------------------------
\20\ A barrel of oil equivalent is an amount of natural gas or
natural gas liquid that contains the same heating value as a barrel of
oil.
---------------------------------------------------------------------------
MMS then multiplies the difference in cost to administer a barrel
of oil equivalent under the two programs by the number of barrels of
oil equivalent realized by the royalty-in-kind program to determine the
administrative cost savings. However, MMS's calculations excluded some
fixed costs that are not incurred on a regular or predictable basis
from the analysis. For example, in Fiscal Year 2006, royalty-in-kind IT
costs of $3.4 million were excluded from the comparison. Moreover,
additional IT costs of approximately $29.4 million--some of which may
have been incurred for either the royalty-in-kind or the cash royalty
program--were also excluded. Including and assigning these IT costs to
the programs supported by those costs would provide a more complete
accounting of the respective costs of the royalty-in-kind and royalty-
in-value programs, and would likely impact the results of MMS's
administrative cost analysis.
Conclusions
Ultimately the system used by Interior to ensure taxpayers receive
appropriate value for oil and gas produced from federal lands and
waters is more of an honor system than we are comfortable with. Despite
the heavy scrutiny that Interior has faced in its oversight of royalty
management, we and others continue to identify persistent weaknesses in
royalty collections. Given both the long-term fiscal challenges the
government faces and the increased demand for the nation's oil and gas
resources, it is imperative that we have a royalty collection system
going forward that can assure the American public that the government
is receiving proper royalty payments. Our work on this issue is
continuing along several avenues, including comparing the royalties
taken in kind with the value of royalties taken in cash, assessing the
rate of oil and gas development on federal lands, comparing the amount
of money the U.S. government receives with what foreign countries
receive for allowing companies to develop and produce oil and gas, and
examining further the accuracy of MMS's production and royalty data. We
plan to make recommendations to address the weaknesses we identified in
our final reports on these issues.
We look forward to further work and to helping this subcommittee
and the Congress as a whole to exercise oversight on this important
issue. Mr. Chairman, this concludes our prepared statement. We would be
pleased to respond to any questions that you or other members of the
subcommittee may have at this time.
GAO Contact and Staff Acknowledgments
For further information about this testimony, please contact either
Frank Rusco, at 202-512-3841, or [email protected], or Jeanette Franzel,
at 202-512-9406, or [email protected]. Contact points for our
Congressional Relations and Public Affairs may be found on the last
page of this statement. Contributors to this testimony include Ron
Belak, Ben Bolitzer, Lisa Brownson, Melinda Cordero, Nancy Crothers,
Glenn C. Fischer, Cindy Gilbert, Tom Hackney, Chase Huntley, Heather
Hill, Barbara Kelly, Sandra Kerr, Paul Kinney, Jennifer Leone, Jon
Ludwigson, Tim Minelli, Michelle Munn, G. Greg Peterson, Barbara
Timmerman, and Mary Welch.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Response to questions submitted for the record by Dr. Rusco
Majority Question Responses
1. Mr. Rusco, do you believe it is appropriate for MMS to be in
charge of analyzing the success of the Royalty-in-Kind Program?
It seems that they have a strong incentive to show how well it
is working, so would it be better to have someone outside of
MMS be doing this review? And if so, who might you suggest?
Answer: Our review of the royalty-in-kind program raised
significant concerns about the assumptions and methods that MMS uses to
compare the revenues it collects in kind with what it would have
collected in cash payments. However, we believe that if MMS addresses
these concerns, MMS could produce reliable information on this key
aspect of program performance.
2. Mr. Rusco, did GAO identify any specific instances of a breakdown
in internal controls related to reporting?
Answer: We identified several instances where internal controls
were either absent or not working effectively. One instance of a
missing internal control we identified was the inability of MMS's
information technology (IT) system to effectively identify missing
royalty reports, a critical piece of data used by MMS to determine
whether royalties were paid. We also identified several instances where
internal controls were ineffective. For example, while MMS's IT system
now has the ability to identify missing production reports, it now has
a significant backlog of production data that staff are spending
considerable time and resources attempting to reconcile. Finally, MMS's
interest IT module, which is used to calculate and charge interest
payments to payors for late payments, never fully worked and is in the
process of being re-designed, subject to funding.
We also identified several weaknesses in MMS's system for measuring
and reporting the performance of the RIK program. Specifically, we
determined that MMS does not appropriately measure or report: (1) the
uncertainty of the benefits of taking royalties in kind or (2) the
interest accrued from receiving royalty-in-kind payments earlier than
cash payments. Further, we found that MMS's annual reports to Congress
have not fully reported all the costs of administering the RIK program.
These weaknesses make it unclear whether the benefits of taking
royalties in kind have exceeded what MMS would have received had it
taken royalties in cash instead.
3. Mr. Rusco, what is needed for MMS to better ensure the accurate
collection of royalties?
Answer: We plan on issuing a product related to the ongoing work
from which our testimony was drawn that will include recommendations on
how MMS can better ensure accurate collections of royalties. Those
recommendations will deal with improvements to help ensure the
completeness and accuracy of royalty data and the related collections.
Furthermore, we have additional ongoing work examining royalty
collections and will include recommendations in our reporting as
appropriate.
4. Mr. Rusco, it seems that MMS relies heavily on the audit and
compliance group to find errors in royalty and production
reporting. Is that more efficient than having the financial
management system be better controlled?
Answer: We did not directly address the issue of whether MMS's
financial management system with better controls would be more
efficient than relying on audits and compliance reviews. Our work did
identify that MMS currently uses both up-front edit checks to prevent
erroneous data from being initially entered into the financial system--
preventive controls--as well as after-the-fact audits and compliance
reviews to detect incorrect royalty payments--detection controls. An
effective internal control environment consists of both strong
preventive controls in addition to detection controls. An appropriate
balance between the two is also important in achieving effectiveness
and efficiency of internal controls. For example, where there is a high
volume of transactions, the lack of preventive controls significantly
increases the risk of errors and accordingly increases the need for
particularly sensitive detection controls. In the absence of preventive
controls, a high number of errors can render detection controls not
only inefficient but also ineffective in detecting and correcting
errors in a timely manner.
5. Mr. Rusco, in your testimony, you discuss what appear to be
significant lapses in key internal controls. Would GAO agree
that when controls are weak, particularly when surrounding a
``checkbook'' of billions of dollars, the risk of fraud goes up
dramatically?
Answer: While we did not perform specific tests that might have
uncovered potential fraud, it is true that the risk of fraud increases
in the absence of strong internal controls. However, internal controls,
even when operating optimally, will not provide a 100 percent guarantee
that someone cannot commit fraud. Because fraud is usually concealed,
material misstatements due to fraud are difficult to detect.
Nevertheless, certain events or conditions that indicate incentives or
pressures to perpetrate fraud, opportunities to carry out the fraud, or
attitudes and rationalizations to justify a fraudulent action may be
present at MMS. Such events or conditions are referred to as ``fraud
risk factors.'' Fraud risk factors do not necessarily indicate the
existence of fraud; however, they often are present in circumstances
where fraud exists. During the course of our work, we found that at
least two of the three key indicators of fraud--an incentive for
someone to misappropriate assets (for example cash or gas and oil in
this case), and the opportunity to do so (that is, a relatively low
risk of being caught)--may exist in MMS's environment of collecting the
federal government's fair share of royalties from oil and gas produced
on federal properties. However, we have not uncovered any fraud during
the course of our work so far.
6. Mr. Rusco, in response to a question at the hearing, Mr. Finfer
stated that one of the crucial elements to a risk-based
compliance strategy is good data. Do you believe that MMS
currently has data of sufficient quality to properly implement
an effective risk-based compliance strategy?
Answer: We agree that a crucial element of a risk-based compliance
strategy is good data upon which to base management's risk assessments
and judgments. We have previously reported on data accuracy problems in
limited sets of royalty data extracted from MMS's financial management
system. At this time, however, we are unable to comment on the full
extent of the reliability of the underlying data used to assign risk as
we did not assess many of the data elements that MMS has proposed to
use in ranking both properties and payors. We are in the process of
doing additional work in this area and will report out when that work
is completed.
7. Mr. Rusco, we constantly hear from MMS that the Royalty-in-Kind
Program is performing well. Your testimony indicates the
benefits are less certain. Do you think MMS's reports are
giving us the full story, and could you provide an example of
this?
Answer: MMS's annual reports are not providing the Congress with
the full picture regarding the performance of the royalty-in-kind
program. By presenting oil sales data aggregated by major sales
category, the reports do not reflect the fact that, in many individual
sales, MMS has sold the oil it collected in kind for less than it
estimates it would have collected in cash. For example, MMS estimates
that, in Fiscal Year 2006, it sold 64 percent of all the oil it
collected in kind, for less than it would have collected in cash.
8. Mr. Rusco, could you discuss your views of the usefulness of the
State and Tribal Royalty Audit Committee, or ``STRAC''? And do
you see any way to improve the relationship between STRAC and
MMS?
Answer: The State and Tribal Royalty Audit Committee (STRAC) works
under authority granted in the Federal Oil and Gas Royalty Management
Act. It performs compliance work through agreements with MMS and brings
jurisdictional expertise and staff to MMS's compliance activities. We
are aware that there are many written communications between STRAC and
MMS. However, we have not examined whether or how the relationship
between STRAC and MMS could be improved.
9. Mr. Rusco, in your testimony, you seem to say that if a company
gets a compliance review or an audit, it can make an adjustment
afterwards that MMS will never check? Is that true? Does the
MMS ``Adjustment Line Monitoring Initiative'' help with that?
Answer: A company can make adjustments to data after MMS has
completed either an audit or a compliance review, and MMS does not have
controls in place to assess the justification for each of those
adjustments. In commenting on our draft testimony, MMS stated that
staff are currently developing requirements for an IT initiative to be
completed in Fiscal Year 2008 that will assist in monitoring
adjustments. As of March 2008, MMS has not finalized the IT
specifications for this module, so we are unable to determine the
extent to which this would address our concerns. As planned, the new IT
system module would monitor adjustments made after the module went on-
line and would not address prior adjustments. Accordingly, unless MMS
goes back and reviews past data, we will not be confident that all past
adjustments have been warranted.
10. Mr. Rusco, in their testimony, Senators Kerrey and Garn discuss
the difference in the so-called ``front-end'' and ``back-end''
of BLM's operations, saying that increased funding has been
focused on additional leasing and processing of applications
for permits to drill, but ``there has not been sufficient
attention'' to collections, production accountability, and
auditing requirements. Has GAO seen evidence of this in recent
years?
Answer: BLM field office staff tell us that many resources are
dedicated to processing drilling permits. These staff and the official
BLM inspection strategy guidance, indicates that resources are
prioritized for ``front-end'' activities, such as drilling inspections
rather than ``back-end'' activities, such as production verification.
Furthermore, we reported in Oil and Gas Development: Increased
Permitting Activity Has Lessened BLM's Ability to Meet Its
Environmental Protection Responsibilities (GAO-05-418) that BLM's
ability to meet its environmental mitigation responsibilities for oil
and gas development has been lessened by a dramatic increase in oil and
gas operations on federal lands between 1999 and 2005. Since that time,
permitting activity has continued to increase.
11. Mr. Rusco, I understand that GAO is now looking at some of the
issues with the Accenture computing system that the Inspector
General brought up in September. Could you discuss your work on
this issue?
Answer: We agreed with the Department of the Interior's Inspector
General (IG) that we would examine key functionalities of the IT
system, whereas the IG would examine the contract Accenture had with
MMS to develop the IT system and determine whether the end product was
what the contract specified. Accordingly, we spoke with MMS staff and
STRAC users of the IT system and are doing further work to evaluate the
quality of the data managed in that system. We will report on the
results of this work when it is completed.
12. Mr. Rusco, the Subcommittee on Royalty Management's report says
that ``MMS's processes for evaluating the feasibility of RIK
vs. RIV appears to be rigorous and effective.'' Do you agree
with that statement?
Answer: Before MMS decides to take royalties from a particular
property or pipeline in kind, MMS compares the revenues it expects to
receive by taking the royalties in kind to what it currently receives
in cash. We did not evaluate the effectiveness of this prospective
analysis. Rather, we evaluated the methods that MMS uses to
retrospectively determine whether the benefits from taking royalties in
kind were, in fact, better than taking royalties in value. Our review
raised significant concerns about this retrospective analysis. MMS can
use its retrospective analysis to help inform prospective decisions
about which properties or portfolios to keep in the in-kind program.
For example, MMS placed one portfolio of natural gas leases back into
the in-value program after noticing that sales from these leases had
performed poorly. Our concerns about the retrospective analyses also
raise significant concerns about whether these analyses provide
reliable information regarding which leases to keep in the in-kind
program over time.
13. Mr. Rusco, a footnote in your testimony says that certain BLM
state officials believed the data in BLM's Automated Fluid
Minerals Support System (AFMSS) were unreliable. Have you
assessed the AFMSS and the reliability of its data?
Answer: We identified a number of discrepancies in the production
inspection data stored in BLM's Automated Fluid Minerals Support System
(AFMSS) and determined that it was not sufficiently reliable for our
reporting purposes. During the course of our work, we took a number of
steps to assess the reliability of the production inspection data.
These steps included requesting the Fiscal Year 2007 production
inspection data from AFMSS from BLM's AFMSS database manager for those
field offices that we included in our review. We then asked field staff
to validate the numbers we received from AFMSS. In several cases, field
office staff stated that the numbers were not correct and subsequently
revised the numbers in AFMSS. However, in two instances, BLM staff were
unable to validate the AFMSS production inspection numbers because they
lacked confidence in the data. Consequently, we were uncomfortable
reporting the actual production inspection numbers in our testimony. In
assessing the reliability of the data, we did not perform electronic
testing, nor did we compare records kept in BLM's paper files with data
in AFMSS.
14. Mr. Rusco, in your testimony you say that MMS lacks an automated
process to reconcile payor production data with production data
filed by operators. However, MMS reports that they have an
automated Compliance Process Tool (CPT) which makes those
reconciliations. How do these two statements square up, and how
does the CPT compare to MMS's old automated process?
Answer: MMS's prior IT system automatically compared all production
reports and royalty reports within 6 months without human intervention.
However, during the course of our work MMS officials told us that the
that the new system only compared a portion of the production reports
with the royalty reports through the compliance review process, which
generally is done 3 years after royalties are reported. Furthermore,
while this comparison is done via the Compliance Program Tool, it
requires an analyst to manipulate the menus and query tools to complete
the actual comparison. The need for staff to perform this comparison,
rather than its being done automatically, takes time away from other
compliance efforts. MMS recently told us that it is in the process of
changing its policies on comparing production and royalty reports.
However, we have not yet assessed this process.
15. Mr. Rusco, on page 8 of your testimony, you describe one instance
of a bypass built around a gas meter and one instance of a
company maintaining two sets of conflicting production data.
What action was taken by BLM in these instances, and did the
companies face any financial penalties?
Answer: In the instance of the bypass, BLM staff told us that they
issued the company an Incident of Non-Compliance. The company
subsequently removed the bypass. Because the company removed the bypass
within the allotted timeframe, the company was not issued a financial
fine.
In the other instance, according to BLM Petroleum Engineer
Technicians, the company kept two sets of books--the internal raw data
and the data reported to MMS on the Oil and Gas Operations Report
(OGOR). Although, the total volumes of oil and gas on those books were
the same, the company altered production amounts at the well level that
they reported to MMS on the OGOR. BLM subsequently asked the company to
correct and resubmit the OGORs and did not issue the company a
financial fine.
16. Mr. Rusco, please describe whether the findings and
recommendations of the Royalty Policy Committee report dated
December 17, 2007 are consistent with findings reported by GAO
in its testimony to the subcommittee on March 11, 2008, and
point out any major differences that exist between the two
reports.
Answer: The findings reported by GAO in its testimony to the
subcommittee on March 11, 2008 are generally consistent with the
findings and recommendations of the Royalty Policy Committee (RPC)
report dated December 17, 2007. This similarity is due to the fact that
both GAO's and RPC's objectives focused on two common objectives--(1)
to determine whether MMS collects the correct amount of federal and
Indian mineral royalties, and (2) to assess whether the federal
government is benefited by taking royalties in kind. To address these
objectives, both GAO and RPC reviewed management's oversight
activities, policies, procedures, systems and internal controls.
While RPC concluded that MMS is an effective steward for federal
and Indian mineral interests, it also found a number of management
activities requiring prompt, and in some cases, significant management
attention, to ensure public confidence. Over 100 detailed
recommendations to management were reported by RPC. For example,
several of these recommendations were directed at MMS and BLM to
improve production accountability and production measurement. GAO
shares this concern and believes that without improvement in
verification procedures, MMS cannot be assured that it is receiving
full compensation for oil and gas produced on federal and Indian
properties.
GAO and RPC also evaluated the RIK program and concluded that
improvements are needed to increase transparency of reporting and
clarity of management decision-making when determining whether to take
royalties in kind or in value. For example, RPC recommended, and GAO
suggested in its testimony, that MMS should report on the uncertainties
surrounding the benefits of taking royalties in kind. However, there
are a number of differences between the two reports with respect to the
RIK program. For example, RPC concluded that MMS should explore the
feasibility of establishing a trust fund, the interest from which could
be used to fund royalty management activities. The RPC also concluded
that MMS should study the use of various governance arrangements for
the RIK program. GAO has not explored these issues. Moreover, GAO was
not requested to examine outer continental shelf (OCS) royalty relief
as part of this testimony, whereas RPC was charged with reviewing the
Department's procedures established in response to the lack of price
thresholds for certain deep water leases in the Gulf of Mexico. This
additional examination by RPC resulted in six recommendations to
improve management in offshore leases.
17. Mr. Rusco, please describe to what extent GAO considered the
results of (1) audit reports issued by the Department of the
Interior's independent public accountants, KPMG, and (2) an
agreed upon procedures report issued by TCB&A, an independent
accounting firm engaged by Interior, to examine its RIK cost
methodology, in assessing and reporting on whether MMS's
oversight provides adequate assurance that full compensation is
being received from oil and gas produced on federal properties.
Answer: GAO reviewed and assessed these and other relevant
accountants' and auditors' reports (e.g. reports of Interior's OIG) in
planning the scope of our work. We also considered other auditors'
results during the course of developing our findings and conclusions in
reporting our work to the subcommittee. However, key differences
existed between our work and the scope of the work done by both KPMG
and TCB&A. In addition, key limitations in the scope of work done by
KPMG and TCB&A required us to perform additional test work to assess
MMS's oversight and controls over its royalty collections.
Specifically, with respect to KPMG's audit of Interior's financial
statements for 2007 and preceding years (a separate audit was not
completed for MMS's financial statements in 2007), KPMG's report
specifically stated that the audit of the financial statements was not
designed to provide an opinion on internal controls over financial
reporting or over reported performance information. Accordingly, GAO
performed additional procedures to assess these internal controls.
Similarly, GAO found that TCB&A's agreed-upon procedures report,
dated June 30, 2005, was limited to reviewing the RIK/RIV cost
comparison methodology and certain underlying fiscal 2004 data. While
the independent accountants reported MMS's methodology to be
reasonable, they also found that many underlying data were based on
undocumented estimates or were otherwise in error. Accordingly, GAO
further analyzed the underlying data, including expenses through fiscal
2006, and found that key expense elements--principally information
systems specifically used for the RIK program--had not been previously
assessed and had not been included in MMS's cost comparison. Therefore,
this earlier work supported GAO's conclusion that the RIK/RIV
methodology may be improved and reported results may be made more
transparent by including full and accurate costs.
18. Mr. Rusco, please describe the resources employed by GAO in its
audits of MMS that led to the findings in its testimony. How
many staff days and other resources were allocated and what
were the qualifications of GAO staff who worked on these
audits?
Answer: The findings included in our recent testimony on mineral
revenues were developed over the course of a year by GAO staff with a
wide range of qualifications, including staff with a juris doctorate,
doctorates in economics and social science, and master's degrees in
public administration, public affairs, environmental science, social
science and research methods, business administration, and geology.
Team members also hold certifications in public accounting, software
engineering project management, government financial management,
information system auditing, and management accounting.
19. Mr. Rusco, please describe and point out any major differences
between GAO's and MMS's estimates of potential losses resulting
from royalty relief in the Gulf of Mexico.
Answer: MMS's estimate for future losses from leases issued in the
deep waters of the Gulf of Mexico in 1998 and 1999 compare favorably
with scenarios that GAO developed to show the effect of different
production levels and prices. In February 2007, MMS estimated that
potential losses could be between $6.4 billion and $9.8 billion. In
April 2007, GAO developed and reported the results of scenarios that
showed the losses from these leases could range between $4.3 billion
and $10.5 billion. In June 2007, MMS revised its earlier estimate to
between $5.3 billion and $7.8 billion, based on oil and gas prices of
$60.78 per barrel of oil and gas prices of $7.52 per thousand cubic
feet. We plan to update our scenarios in the near-future.
GAO has not developed scenarios that illustrate potential losses
from leases issued in the deep waters of the Gulf of Mexico in 1996,
1997, and 2000. In October 2004, MMS estimated that forgone royalties
on these leases could be as high as $60 billion should price thresholds
not apply to these leases. While we reported in April 2007 that this
estimate was made in good faith, much had been learned since then and
we believed that MMS may have been overly optimistic about the amount
of oil and gas production that would occur over the lifetime of these
leases. MMS concurred and revised this estimate in February 2008 to
between $15.7 billion and $21.2 billion. We are currently reviewing
this estimate and plan to develop scenarios that illustrate the effect
of different production levels and prices.
Minority Question Response
1. In our experience, when Congress requests the Government
Accountability Office (GAO) to conduct a study or
investigation, we find that GAO often comes back to negotiate
the scope of the investigation. Oftentimes the reason
underlying the negotiation is a lack of resources needed for
the scope of the original request. In other words, GAO will try
to prioritize the salient aspects of the study that they feel
they can conduct within budgetary constraints. However, you
appear to be criticizing the MMS for prioritizing hurricane
recovery from the hurricanes that hit the Gulf in 2004 and
2005. Is that true? Wouldn't you agree that cleaning up after
several severe and unprecedented storms should have priority
over meter inspections? What MMS, Coast Guard, and the oil &
gas industry achieved during those storms and their aftermath
was remarkable. The fact that: (1) there were no major spills
even though many platforms were lost and (2) all oil field
personnel were safely evacuated--seems to be the bigger success
story rather than whether an internal best practices inspection
goal (that exceeds legal requirements) was met. Do you agree or
disagree?
Answer: One of the research objectives of our work was to determine
whether MMS was completing the required meter inspections as required
by agency policy and law. We did not consider or evaluate MMS's
prioritization methodologies for hurricane safety, recovery, or cleanup
activities. Therefore we cannot comment on the appropriateness of these
decisions. However, MMS officials did explain to us that one reason
they had not complied with their internal production inspection policy
was that their limited resources were devoted to hurricane recovery and
cleanup efforts, and we reported this in our testimony. An evaluation
of what the Coast Guard, MMS, and the oil and gas industry achieved
during and after Hurricanes Katrina and Rita was not within the scope
of our work on the accuracy of royalties or the royalty-in-kind
program.
______
Mr. Costa. Now, let us get to the questions. To all three
of you, does it make sense in looking at the track record of
the Royalty-in-Kind Program, it seems to indicate that given
the vagaries of the marketplace that there is incentive or
seemingly that it is working, but that maybe someone outside of
the Minerals Management Service should be doing the review.
Three of you, could you opine quickly on whether or not
they are in the appropriate place to make the review?
Mr. Deal. Let me take a----
Mr. Costa. Please use the mic.
Mr. Deal. I am sorry. Can you hear me?
Mr. Costa. Yes.
Mr. Deal. OK. Let me take a stab at that. My answer to that
is no, that it is not wise to export this program outside the
agency. That is an alluring possibility, but I really question
whether or not that solves any problems that might be
perceived, and all three of us have identified some
shortcomings in the program.
You have heard both of my colleagues at the table here talk
about the existing staff. They are energetic. More important
than that, they are very knowledgeable. Royalty management
involves not just strict accounting but a deep understanding
of----
Mr. Costa. I think you are responding to the entirety of
the program. I was talking about the analysis of the program.
Mr. Deal. OK. Maybe I don't understand the question. I am
sorry, sir.
Mr. Costa. Well, the point is that it is a complicated
area. I understand they have about 50 people that deal with the
review of this in kind program, and they are dealing in a very
complex marketplace in terms of trying to make these
determinations, and whether or not that analysis is most
properly done within that segment within the Minerals
Management Service was my question.
Mr. Deal. I see. Are you confining this to RIK?
Mr. Costa. Yes.
Mr. Deal. Yes, OK. Well, here again, I think my answer
would be the same, although I would recognize RIK has a
different character. MMS is still on the learning curve. They
would be the first to admit that. However, in the last several
years they have made great progress. The recommendations we
have made have been to several very discreet recommendations to
kind of better their game.
Mr. Costa. We will look at those recommendations. I want to
get the other response quickly. Mr. Devaney?
Mr. Deal. OK.
Mr. Devaney. Mr. Chairman, I think they can do it. I think
it is a matter of making sure that they have their policies and
procedures in place. When we first went in there, there weren't
too many written documents that described how the process was
supposed to work. Also, I think they need the right people
there, and I think they are making positive changes to make
that happen.
Mr. Costa. All right. Mr. Rusco?
Ms. Franzel. Hello, Mr. Chairman. I will answer on behalf
of GAO. Our findings with regard to the program, we did not
really detect any large governance issues that would cause us
to say that it needs to be taken outside of the current
environment, but rather internal control issues and data
reliability issues which really would reflect the major tune up
that Mr. Deal characterized as being needed.
Mr. Costa. All right. Thank you. Mr. Devaney, you indicated
that in your September 2007 report that other investigations
might be forthcoming, a result of what you found. Are you guys
moving ahead with those, and what are the topics?
Mr. Devaney. Yes. Those are the four cases, investigations,
I mentioned that involve potential criminal violations. That is
all we have left, and we are trying very hard to get those
closed.
Mr. Costa. All right. Mr. Deal, the whole panel talks about
the concerns in the report of the lack of price thresholds in
the infamous 1998-1999 lease sales which, combined with the
Kerr-McGee case, threaten to impact the Federal Government--
maybe to the tune of $30 billion or more. In your report, you
recommended to Congress and the Secretary to continue to
explore legislative options.
Do you have any suggestions on what we can do, particularly
if the case is lost?
Mr. Deal. Well, this is a very tough nut to crack. You have
heard testimony before from the Department, which I would agree
with. You know, a contract is a contract. We did exhort, as
other people have, the Department to continue to seek out
visional companies, as several companies already have, to
renegotiate their leases and take into account the price
thresholds.
This is tough, though. It poses a very tough legal problem.
The subcommittee did not spend a lot of time on that, not
because we were trivializing the issue but it had already been
studied at great length.
Mr. Costa. I think we understand it is difficult, and that
is why we are looking for recommendations.
Mr. Deal. Yes. Well, I wish I could shed more light on it.
You know, of course the Kerr-McGee case may moot the whole
issue if upheld, but it is on appeal so who knows what is going
to happen. So I wish I could illuminate it more, but I can't.
Mr. Costa. OK. Last question, quickly. Mr. Devaney, you
know, when we look at the situation over collections that your
office has brought in over $700 million in the last 10 years I
know the Justice Department now gets a small cut of the money
on the cases they win, three percent I think, do you have any
suggestion that a similar circumstance might apply in this
instance?
Mr. Devaney. Well, naturally I think I would like to see a
similar opportunity for any inspector general that investigates
in this area. I think there are about 11 inspector generals
that do qui tam work. I will speak for myself, we don't do as
much as I would like to do and it is a resource issue.
I think you get a big bang for your buck when you do these
cases, so I think it would be an interesting and fruitful idea
to try to put maybe one percent toward the investigative
efforts. I think the DOJ gets three percent.
Mr. Costa. Yes. All right. Thank you very much. My time has
expired. The gentleman from New Mexico is poised, waiting and
ready with his questions.
Mr. Pearce. Thank you, Mr. Chairman. Poised is never the
word that I have found used with me much. Unpoised maybe. Mr.
Rusco, if you remember the conversation in our office, we were
talking about government take and a report that is coming up. I
talked about the tendency of the reports coming from you all is
to maybe use hyperbole.
So if I can get my staffer to hold up--the government take
is, in your views, quite more simplistic, but government take
in Russia is definitely higher than it is here, but you can't
give a moral equivalence between the Russian system that allows
this kind of thing to go on and our country where these
cleanups occur. That is OK. Put it down. It is distracting even
me.
You draw rather harsh conclusions I think in your report,
and one of the things that you are critical of is that it
relies heavily on self-reporting. That is a curious thing
because what we did is compare it to IRS, and we even have IRS
people here. If I am not mistaken, IRS depends on self-
reporting, and so we find it OK with the mass of the public.
Always I am curious when people find other people's
behavior suspicious and their own behavior above reproach. So
when we say that the weakness of the system is self-reporting,
I don't find in your report where you mention that we actually
conduct 8.2 percent, where MMS examined 8.2 percent of the
properties and 25.9 percent of the payors. IRS only looks at
one percent.
I wonder if you had an IRS person on your team because this
big report that comes from Mr. Deal's committee, there were two
senators on that--by the way, I find people from state
treasurers, professor of finance, Deputy Assistant Director of
MMS, Bureau of Land Management economist--and I wonder if you
had this panel that was led by two senators to see that maybe
this report came out with less hyperbole and more facts, as we
are looking at a very complex thing there.
I wonder. I didn't see any list of people, and I had asked
for that in my opening statement. I would hope that you would
provide that for us at some point. Now, you are quick to say
that the methodology that is calculating financial benefit is
not good. I wonder in your own methodology, there is an
independent accountant report that says methodology as
reasonably and accurate, in your report, did you consider these
outside sources?
Mr. Rusco. Yes, we did.
Mr. Pearce. You did. And so we have this report that says
it is accurate, and your report says it is inaccurate. How many
weeks did you spend on your report versus this report here?
Mr. Rusco. Well, we have been auditing MMS on and off for
years, but this particular job we have been at for about a
year. On our team we have economists, accountants, data
analysts, specialists, licensed IT auditors, oil and gas
geologists, engineers and general auditor staff.
Mr. Pearce. Your report considers this but says that this
finding was inaccurate. We have independent accountants who
find that it is OK, and your team says it is not OK and you
were working for a year.
Now, I have the KPMG. KPMG is one of the big three if you
are going to get somebody to be an accountant. KPMG for three
years--three years--says we noted no deficiencies involving the
design of the internal control over the existence,
completeness, assertions related to any key performance
measures, and yet, you find the lack of key internal controls,
you spent a year on your report--was this the only report you
were working on during the year?
Mr. Rusco. No.
Mr. Pearce. How many reports were you working on during
this year period?
Mr. Rusco. Personally, I probably worked on seven or eight.
Mr. Pearce. OK, so you have seven or eight, so we can say
that roughly maybe two months dedicated time, unless you are
working overtime, and I am sure you did. Again, we go back to
the KPMG reports that find no deficiencies and you find that
there are lack of key internal controls.
I wonder if the discontinuity, I wonder if the hyperbole
that we found--lift that chart up over here one more time--if
the hyperbole and simplicity of what you have done is the same
simplicity that said we collect fewer royalties than Russia and
yet, that is Russia, that it is okay that exists and your
committee did not, your findings did not include any of that.
I wonder why you came up with different substantive
findings than people who audited for three years, two different
major accounting reports that found exactly the opposite of
what you found. Mr. Chairman, I will come back in my next
round.
Mr. Costa. Seems you were just getting warmed up.
Mr. Pearce. If you would extend some time, I would go on.
Mr. Costa. Well, I would be happy to do that except we have
other Members who obviously would like to get their questions
in as well. Mr. Hinchey, good to have you here this morning.
Mr. Hinchey. Thank you very much, Mr. Chairman.
Mr. Costa. You are up.
Mr. Hinchey. Nice to be here with you. Good morning.
Gentlemen, I just wanted to ask a couple of questions if I may.
With regard to those leases that go back to 1998 and 1999, have
you had a chance to look at the MMS cost estimates regarding
the amount of money that we stand to lose if that situation
isn't fixed?
Mr. Deal. Is your question directed to all of us?
Mr. Hinchey. Anyone who wants to take a crack at it. Mr.
Deal, you may do so if you want to. You probably know as much
as anyone.
Mr. Rusco. We issued a correspondence last year in which we
did an analysis ourselves of the expected costs of the lack of
price thresholds on those and royalty relief.
Mr. Hinchey. Could you speak a little louder?
Mr. Rusco. I am sorry. In our work looking at the royalty
relief we found similar dollar values to what MMS found in
their analysis.
Mr. Hinchey. Well, do you want to be more specific? What is
the number? Is the $21 billion estimate too low?
Mr. Rusco. We have not updated the analysis after the
recent Kerr-McGee ruling.
Mr. Hinchey. When do you expect to do that?
Mr. Rusco. Well, we have not yet been requested to do it.
We will do it at some point when requested.
Mr. Hinchey. Who are you expecting to request you to do it.
Mr. Rusco. That is not up to us.
Mr. Hinchey. Well, no, but who do you expect to request you
to do it?
Mr. Rusco. We will take a request from anyone in Congress
who is interested in that.
Mr. Hinchey. Would GAO accept this as a request to do it?
Mr. Rusco. If the request is sent to us, we will accept it
according to our usual protocol.
Mr. Hinchey. OK. We will send you a specific request and
ask you to do it because there is a lot of money at stake here.
You have a situation where the oil companies are making
record profits, where the price of oil has gone up to $109 a
barrel, the price of gasoline has gone up very dramatically,
and the fact of the matter is that property that is owned by
the people of this country is not being addressed accurately,
properly. They are not being paid properly.
Mr. Deal, I would like to ask you a question. You have a
lot of experience with the oil industry as a former person who
worked with the American Petroleum Institute, you were a
representative for that operation. As a member of the
Subcommittee on Royalty Management, one of your important
recommendations was that MMS should continue to renegotiate
those faulty 1998 and 1999 leases.
So are you also concerned that MMS has all but ceased
bringing these leaseholders back to the negotiating table?
Mr. Deal. Well, I have no information one way or the other
on that. I have no information about further efforts by the
Department.
Mr. Hinchey. Well, you know the negotiations are not going
on, right?
Mr. Deal. I am not aware of them. You know, the early
negotiations weren't very public either, so I am not privy to
them.
Mr. Hinchey. Do you believe that they have brought back to
negotiating table to talk about the amount of money that is at
stake here just in those two year leases?
Mr. Deal. I have no information to show that, so I really
don't know.
Mr. Hinchey. Do you intend to look into that, to acquire
information?
Mr. Deal. Would I or did I?
Mr. Hinchey. Do you intend to?
Mr. Deal. If directed, I will.
Mr. Hinchey. Pardon me?
Mr. Deal. If directed, I will. I would be glad to.
Mr. Hinchey. Who would you expect to direct you?
Mr. Deal. This committee.
Mr. Hinchey. Well, Mr. Chairman, would we ask him to do so?
Mr. Costa. I think that is appropriate. We could put
together a request in the form of a question to the Commission,
and we will work on that.
Mr. Hinchey. Good. I would like to help you with that.
Mr. Costa. OK.
Mr. Deal. Can I make one observation there?
Mr. Costa. Certainly. Please, Mr. Deal.
Mr. Deal. The Department is here today, and they can answer
your question directly. So I will be responsive to any question
posed to me, but the Department is here today.
Mr. Costa. I am sure that Mr. Hinchey will direct that
question to the Department.
Mr. Hinchey. Do I have any time left?
Mr. Costa. Yes.
Mr. Hinchey. Just let me ask you one last thing. You have a
lot of experience with the oil industry, so I am wondering if
you have any specific recommendations for the Congress on how
best to legislate the renegotiations that need to take place
with the oil industry in order to get this royalty situation
straightened out?
Mr. Deal. I don't have any suggestions. This question has
already been posed to me. I wish I could offer you a bright
line. This is a tough nut to crack. You know, there are
contracts on the table. Fortunately, you know, some companies
have been willing to renegotiate, others haven't as yet.
As far as legislation, you know, a few ideas have been
floated. They don't seem to have legs. I wish I could offer you
some great suggestion here, but I don't have one.
Mr. Hinchey. Well, I would think that the General
Accounting Office would have some input into this. I think that
we are all responsible to make sure that people who take public
property pay for it appropriately. Thanks to the initiative of
our Chairman here, we are overseeing this operation.
We would like very much for you to be more effectively
involved in it. Is there any likelihood that you intend to do
so?
Mr. Deal. Well, the subcommittee, which was formed that
resulted in the report you have, has been sunsetted. There is
nothing on the agenda for that subcommittee to do anything at
this point, but as before, you know, I am the Vice Chair of the
Royalty Policy Committee. We have been and will be, continue to
be responsive to the Secretary and respond accordingly. That is
about all I can say.
Mr. Hinchey. Well, that is fascinating because I can see
that there is no real initiatives being taken here. Nothing
really is being done effectively to try to straighten this mess
out.
Mr. Costa. The gentleman's time has expired, and we will
get a chance to go back.
Mr. Hinchey. Thank you.
Mr. Costa. Thank you. The next member of the Committee is
Mr. Smith from Nebraska, and you have five minutes.
Mr. Smith. Thank you, Mr. Chairman. I would like to ask Mr.
Rusco a couple of questions. In your testimony, you were
critical of MMS because it relies heavily on self-reporting and
honor system I guess, as described. Isn't it true that the IRS
relies on self-reporting. Is that accurate?
Mr. Rusco. It is accurate except that they also require
employers to submit W-2s or 1099s and other third-party
documentation.
Mr. Smith. OK, and so I guess furthermore, the IRS has
conducted audits of about one percent of the payors, and yet,
MMS examined 8.2 percent of the properties and 25.9 percent of
the payors, and was that included in your testimony?
Mr. Rusco. Not specifically, but we do agree that there is
an overreliance on compliance in audits in MMS, and that is
because the quality of the data coming into the system and the
integrity of that data are not up to par.
Mr. Smith. So the integrity of the data is lacking?
Mr. Rusco. If we could be sure that the self-reported data
were accurate, and if third-party data were collected in a
timely fashion and compared to those data and those problems
were fixed in the IT and management systems up front, that
would be a better way to do it than to rely more heavily on
your audit system.
Mr. Smith. And if we could meet the suggestions that you
are making what do you think the net result would be?
Mr. Rusco. I think the system would work much more
efficiently. I think part of what MMS is doing in trying to
implement a risk-based system is they are trying to touch fewer
properties but do it more efficiently and closer to the model
that the IRS uses.
Mr. Smith. Would the amount due increase?
Mr. Rusco. If the data could be assured of being accurate,
then we would know we had the accurate collection of royalties.
We don't know at this point, and we can't know because the data
are not reliable or accurate enough.
Mr. Smith. So maybe some folks are overpaying? Do I hear
you saying that?
Mr. Rusco. It is certainly possible. Likely? I can't
comment on that.
Mr. Smith. OK. Thank you. Mr. Deal, if we found the amount
payable on the amount due to increase what do you think would
be the impact in the marketplace?
Mr. Deal. Well, I guess it is kind of hard to say. Depends
on the impact. About the best way I could say it is the oil
companies try to be good corporate citizens, they pay what is
due. Sometimes they overpay and ask for a refund, sometimes
they underpay and need to pay with interest. What difference
would it have on the market?
I would say relative to existing oil prices and gas prices,
you know, my guess is that it is not likely to have a big
impact on the market, but, you know, we are kind of talking in
the abstract here. It depends on the amounts we are talking
about. There is no obvious big impact that tuning up the
Royalty Management Program would have.
Mr. Smith. OK. Thank you. I would yield the balance of my
time to Mr. Pearce. Thank you.
Mr. Costa. All right. Gentleman yields the balance of his
time to Mr. Pearce. Mr. Pearce has one minute and 20 seconds.
Mr. Pearce. Thank you. Mr. Deal, do the oil companies fill
out any reports every year about how much production that they
make and then how much they give? Are there any reports that
are filed?
Mr. Deal. Well, there are all kinds of annual reports, but
on a regular basis they have to submit, you know, every month--
--
Mr. Pearce. They have to submit something.
Mr. Deal. Yes.
Mr. Pearce. So when Mr. Rusco says there is a contrast
between what IRS does and what MMS does, IRS demands a W-2 from
every filer, and if I understand your testimony correctly, the
oil companies have to turn in some similar document saying we
produced this much and we pay this much, is that not accurate?
Mr. Deal. That is accurate.
Mr. Pearce. OK. Mr. Rusco, what was GAO saying the stakes
were last year in this 1998, 1999 lease, the offshore leases?
How much was going to be lost in the Kerr-McGee case?
Mr. Rusco. I am sorry, I don't remember the exact figure. I
will have to get back to you on that.
Mr. Pearce. If I gave you a number would you verify it?
Because I am going to give you a number. Sixty billion is what
the GAO said last year. Publicly they said $60 billion is at
stake. How much is at stake this year in your opinion?
Mr. Rusco. We have not updated that work since the recent
Kerr-McGee ruling.
Mr. Pearce. I am sorry, can you?
Mr. Rusco. I am sorry. We have not updated our----
Mr. Pearce. MMS is saying $20 billion this year after a
study, so you are 300 percent off, yet, you say these audit
reports that declare--and KPMG can't say this stuff. They can't
say that it is in conformity, and they do. They say it is in
conformity. I wonder if your GAO report is 300 percent off like
your estimate on the amount to be achieved.
Mr. Costa. All right. The gentleman's time has expired. Mr.
Rusco, this may be appropriate for you. In the Royalty-in-Kind
Program there is an industry practice that I have learned about
that is called swinging. My understanding is that when the
price is low, the industry provides more supply, and when the
price is high, they provide less. I guess that is the
definition more or less?
Do you think you could explain that practice and whether or
not you think that is a problem with the royalty-in-kind
payment?
Mr. Rusco. The process would exist if a royalty-in-kind,
and I will speak for gas producers in particular, because there
has been a case that MMS identified of that going on in natural
gas, this would be the case if MMS had contracted with someone
to provide natural gas, royalty-in-kind, and then sold that to
a buyer and then the deliveries would vary according to the
price of natural gas.
The deliveries would be lower if the prices were higher and
greater if the prices are lower. That is what swinging is. MMS
did identify some of that going on.
Mr. Costa. So you think it may be a problem?
Mr. Rusco. The extent of which the problem, we don't know,
but we do know that it has happened in the past. MMS has
identified it. You would have to ask them.
Mr. Costa. All right. OK. Before my time expires, Mr.
Devaney, you have expressed concerns about the culture in your
own testimony of the Royalty-in-Kind Program in the past,
especially as it relates to ethics or potential ethics
violations that are on.
Your investigations I know are now ongoing, and I know that
you can't speak specifically about that, but I would like to
get a general sense without talking about the specifics whether
or not we are talking about petty types of crime or whether we
are talking about wholesale criminal intent that could cost the
American Treasury significant amounts of money?
Mr. Devaney. I think the way I would like to answer that,
Mr. Chairman, is most of the continued investigations involve
personal behavior, at a minimum, ethical lapses with potential
criminal violations involved as well. I think that has stopped,
and I think the Department has made some personnel changes that
were very helpful.
I think at the end of the day if people are not prosecuted
we are going to turn this matter over to Assistant Secretary
Allred for administrative action, and I am confident that he
will take that action.
Mr. Costa. All right. Mr. Rusco and Mr. Devaney, there has
been a recommendation from the Royal Policy Committee that Mr.
Deal is dealing with that they establish a trust fund for MMS
operations. What do both of you think about that, quickly?
Mr. Deal. I will just say that I really don't have an
opinion on that.
Mr. Costa. Mr. Rusco?
Mr. Rusco. We have not addressed that either.
Mr. Costa. You haven't? OK. Mr. Rusco, you talked about the
focus of the Minerals Management Service on compliance review
versus audits, and I was inferring from your testimony that you
were suggesting that they perform greater focus on audits than
comparative compliance review. Would you like to speak a little
more in detail about the problems and why you think so?
Mr. Rusco. Yes. I think that in our work we found that the
data coming in to MMS are unreliable, that there aren't enough
controls on that data, there aren't enough verification with
third-party data, and, as a result of that, when MMS does
compliance reviews or audits they frequently find that
additional royalties are due.
We are concerned about the mix of compliance reviews and
audits because compliance reviews are less rigorous than
audits. However, we are not commenting on the precise mix
because we have not evaluated that.
Mr. Costa. Well, you know, when I talk to the Minerals
Management Service, and I talk about how many auditors they
have and whether or not they have the sufficient tools to do
the job, and I think about the companies that they are engaged
with and how sophisticated an operation it is, it just seems
like a lot of manual paper entries are taking place.
Why can't a lot of this data be automated and transferred
to the Minerals Management Service' computer with paper copies
being kept for independent reviews? It just seems to me like so
much of their effort, notwithstanding the $150 million
investment, has gone for naught. Quickly.
Mr. Rusco. We agree that the IT systems are inadequately
designed and there are many gaps that need to be filled.
Mr. Costa. OK. Good. My time has run out. Do either of you
have a quick comment on that? Do you concur? Disagree?
Mr. Devaney. I would concur. I think this IT system really
needs to be fixed.
Mr. Costa. All right. Very good. The gentleman from New
Mexico is up to the plate again for five minutes.
Mr. Pearce. Thank you, Mr. Chairman. Mr. Devaney, what is
your definition of timely? In other words, we asked for timely
responses back so if we have some questions today, what is
timely to get an answer back?
Mr. Devaney. I will get it back as soon as I possibly can.
Mr. Pearce. About how much?
Mr. Devaney. Two weeks.
Mr. Pearce. Two weeks. Be aware that we asked you last year
about why you excluded the letter from Carolina Calure out of
your report. You said there was no smoking guns to say that the
Clinton administration purposely left off, and so we brought
the smoking gun, and we gave it to you and you never really
responded to that.
So by your own definition, a couple of weeks, that is a
month and 12 months, 13 months. I really appreciate you getting
back with us on that, sir. In your testimony, you say that MMS
is not using risk-based strategies for compliance reviews. Mr.
Deal, did you find any evidence that risk-based strategies are
being used?
Mr. Deal. Well, we did.
Mr. Pearce. That is all. You did or you didn't. Yes, you
did. You did not?
Mr. Deal. No. We did, but found a need for more rigor and
clarity.
Mr. Pearce. Well, you found some use of risk-based
strategy?
Mr. Deal. Yes, yes.
Mr. Pearce. So, Mr. Devaney, your comments last year were
that there was no risk-based strategy in your comments. Did you
actually go to MMS and ask them if they had implemented?
Because in the report I find that we have implemented
significant risk-based strategies in the last 12 months. I
again wonder about your definition of timely. When is the last
time you went to talk to MMS about that?
Mr. Devaney. Well, Mr. Pearce, I think that, you know, when
we did that audit we didn't find that MMS was adequately using
a risk-based strategy. Today, I think they are.
Mr. Pearce. Yes, but your testimony today says they are not
doing it. I am wondering if you did any more--no, we didn't do
any more timely look on this than you did----
Mr. Devaney. I am sorry if you misunderstood my testimony.
I was characterizing my prior report.
Mr. Pearce. I understand you are characterizing your prior
report, but people are going to use your words in this hearing
today saying there is no risk-based strategy and come here
using loose words.
I just think that you really should be aware that people
are going to use your testimony today not to characterize what
you were wanting to characterize a year ago, they are going to
take your report today as if it were given today and as if you
actually did something in between last year and this year,
which you didn't answer my questions, and I have to assume, I
hope that you actually talked to MMS before you came here today
to make your assertions here that we are not doing our job when
I find really dedicated public servants that are wrestling with
a very complex issue.
Now, in your testimony last year you mentioned these four
investigations. Have you turned that over to DOJ? That is
pretty serious allegations of misconduct. Did you turn that
over to DOJ?
Mr. Devaney. Yes. We have been working with them all along.
Mr. Pearce. And so DOJ has had that information for 13
months?
Mr. Devaney. It is not a matter of turning the
investigation over. We have been working with DOJ for 13
months.
Mr. Pearce. But this is serious allegations you are making
in front of this Committee, and has DOJ decided to prosecute or
not?
Mr. Devaney. They have not made that decision yet.
Mr. Pearce. They haven't made a decision. They have had it
for 13 months, and, yet, you come here and you talk about--you
mentioned the qui tam cases.
Mr. Devaney. Right.
Mr. Pearce. We all remember Mr. Maxwell. He was in front of
this talking about this same thing. What happened to his case
in Court?
Mr. Devaney. I believe it was found in his favor in Court.
Mr. Pearce. It was found in his favor.
Mr. Devaney. Right.
Mr. Pearce. Can I check with staff? It was found not to
have standing. He was found not to have standing, and I wonder
about your internal processes when you write your report. He
took his case straight to the Courts, you mentioned that in
your testimony, and yet, he was thrown out of Court for not
having standing, and yet, you talk today about it as if it was
still a legitimate thing that he did, and Mr. Maxwell was
pitched out of Court because he did bypass all.
I wonder what your internal controls are doing about people
who will go outside the system to try to get personal gain.
Now, this is actually, Mr. Rusco, an actual document and
circumstance of somebody's behavior that would say we ought to
be suspicious, yet, we don't find that suspicion directed
there, we find the suspicious stuff directed--I have a very
complex report that states over and over that it is pretty
good.
Yes, we have 100 assertions that could be dealt with, but
overall, it is pretty good. Then I have Mr. Devaney's report,
and I have Mr. Rusco's report that says diametrically opposed.
I just wonder what facts were looked at. Thank you, Mr.
Chairman. I appreciate your indulgence.
Mr. Costa. Thank you, Mr. Pearce. We can agree to disagree,
but you are correct, the gentleman was found on the qui tam
case not to have standing because of the position he held. The
Court did find his allegations to be correct.
Mr. Smith, you are closing this panel.
Mr. Smith. I am----
Mr. Costa. OK. Very good. Well, then let us move on to the
next panel. Gentlemen, to be continued. I am sure that Mr.
Pearce, and I--and maybe other members of the Subcommittee--
will have questions that we will submit to you. We hope that
you will respond in a timely manner. I think Mr. Pearce is
correct.
If he didn't get an answer to last year's question, that is
inappropriate, and I would hope that would be corrected. So
with that understood, gentlemen, thank you, again, for your
testimony. We look forward to continuing this discussion as we
try to, as Mr. Deal said, tune up the deficiencies that exist
within the Minerals Management Service.
The next panel involves the following witnesses. The
Honorable Stephen Allred, who is the Assistant Secretary of
Land and Minerals Management with the U.S. Department of the
Interior. In addition, we have Mr. Dennis Roller, who is the
Audit Manager for the North Dakota State Auditor's Office that
will give us a state and tribal, a local perspective.
We also have Ms. Linda Stiff, who is also testifying, as I
noted before, the Acting Commissioner for the Internal Revenue
Service. Then the last two individuals that will testify are
Mr. Randall Luthi from the Minerals Management Service, and Mr.
Lawrence Finfer, who is the Deputy Director of the Office of
Policy Analysis within the Department of the Interior.
So lady and gentlemen, we would like you to be focused on
the five-minute rule.
Mr. Costa. Let us begin with The Honorable Stephen Allred,
Assistant Secretary for Land and Minerals Management within the
Department of the Interior. Mr. Allred. Yes. You need to keep
it close I think. Is it on?
STATEMENT OF THE HONORABLE C. STEPHEN ALLRED, ASSISTANT
SECRETARY, LAND AND MINERALS MANAGEMENT, U.S. DEPARTMENT OF THE
INTERIOR
Mr. Allred. Is it on now?
Mr. Costa. Now, you have it.
Mr. Allred. Mr. Chairman, Mr. Pearce, members of the
Committee, it is a pleasure to be here and to visit with you
about what is a very important program to the United States.
Our testimony, and we are going to kind of tag team this
between I and Director Luthi, but I am going to focus in early
on the subcommittee and why we asked it to do the report and a
little bit about the recommendations.
Mr. Luthi will talk a little bit later about what we are
doing about those recommendations and how we are implementing
them. As you know, we recently received the report that
contained the recommendations developed by the Subcommittee on
Royalty Management. What I would like to do very quickly is
tell you why the committee was formed and the claim we made to
ensure that it was an independent review.
As you know and as you have discussed here in the last
panel reports from the Office of the Inspector and others had
questions about the royalty program as to whether it was
adequate to ensure that the public received the royalties that
Congress had intended.
While at the time that I looked at this I concluded that
there were not major programs, and I visited all of the
Minerals Management Service's offices and talked to a lot of
people when I first came onboard, I felt that there were no
significant problems that threatened the viability of the
program, but I also recognized that with anything as complex as
the operations of the Minerals Management Service and the other
agencies within Interior, that there were probably lots of
opportunities for improvement.
I felt a comprehensive look across the board at those
issues was warranted. The Secretary agreed and determined that
a fully independent examination of the program was warranted,
both to restore credibility to this important revenue
generating program and to make sure that we were focused on the
changes that were needed.
On my recommendation in March of 2007, the Secretary
appointed the Subcommittee on Royalty Management to conduct
that independent examination. Mr. Deal has already identified
the three charges that we gave to the committee, so I won't
repeat those. We made it clear from the onset that the
Department would not direct, manage or influence the
subcommittee's work.
The subcommittee was comprised of seven distinguished
members, and while you have indicated already who those were, I
think it is important to reiterate it.
They were, as Co-Chairman, U.S. former Senator and Nebraska
Governor Bob Kerrey; and former U.S. Senator Jake Garn of Utah;
Cynthia Lummis, who is a former Wyoming official and State
Treasurer and who in that position had received, Wyoming
receives the largest amount of the royalties that we distribute
to the states; Mr. Perry Shirley, who is Director of the Navajo
Nation's Mineral Department and who has been involved in these
issues for some period of time; Mr. Robert Wenzel, who was from
1998 to 2003 the highest ranking career official in the
Internal Revenue Service and who brought a great amount of
expertise to this committee; Dr. Mario Reyes, who is Associate
Dean and Director of the Business Economics Program at the
University of Idaho; and David Deal, who has already testified
in front of you.
We provided staff out of our Department Office of Policy
Analysis and the co-chairs selected a staff member
independently of the Department to assure the independence of
the work that was being done for them. The Minerals Management
Service in that analysis played no role except to answer
questions.
I want to really express my appreciation and that of the
Department for the work that this committee did. They spent
many long hours, traveled extensively and we think prepared an
excellent report which was delivered to the Royalty Policy
Committee on December 17, 2007. That, incidentally, became a
public report while it laid before the Royalty Policy
Committee.
The subcommittee concluded that the Minerals Management
Service was an effective steward of the Minerals Revenue
Management Program and that the MMS employees were generally
concerned with fostering continuing program improvements. The
subcommittee members unanimously agreed that MMS was the
Federal agency best suited to fulfill the stewardship
responsibilities for Federal and Indian leases.
However, as we expected and as you indicated, the report
identified many areas that warrant management attention to
improve operations and ensure the public confidence. There were
110 recommendations. Thirty-five related to collections and
production accountability, 30 relate to the Royalty-in-Kind
Program, 27 to audit compliance enforcement, 10 to
coordination, and 5 to the OCS Royalty Relief Program.
We have developed an action plan that includes the three
bureaus within the Department. It is an extensive action plan
for those 110 recommendations. Most of those can be implemented
without additional legislation. Some cannot, and we will bring
back those recommendations to these committees. With that, Mr.
Chairman, I would be most happy to answer at the appropriate
time any questions you might have.
Mr. Costa. All right. Thank you very much, Mr. Allred. We
also want to thank you and the Department on behalf of the
committee for the submission of the breakdown of the Royalty
Policy Committee Report, and the recommendations by category
and the charts that you provided. I think they are helpful.
On your last point, as it relates to the legislative
changes, both Mr. Pearce and I are interested in looking at
those, and we will talk about them and confer with the
Department at the appropriate time.
Mr. Costa. So my understanding is Mr. Luthi is here to
provide back up, is that correct, or did you prepare testimony?
Mr. Luthi. Of course I prepared testimony, Mr. Chairman.
Mr. Costa. Well, we always like hearing from you. Mr.
Luthi, you have five minutes.
STATEMENT OF RANDALL LUTHI, DIRECTOR,
MINERALS MANAGEMENT SERVICE
Mr. Luthi. Thank you, Mr. Chairman. Our Royalty Management
Program today is not the same program as it was 15 years ago or
even two years ago. In the last seven months, I have learned
that the Royalty Management Program is the culmination of 26
years of ideas, findings and recommendations from many
partnerships with the best and brightest, both internal and
external, to our agency.
Our people are dynamic, resourceful and agile. We are ready
to change when necessary to keep pace with an ever challenging
business environment and changing legal mandates. Each month
approximately 2,100 companies report and pay royalties
associated with over 68,000 producing and nonproducing Federal
and Indian leases.
In Fiscal Year 2007 alone, the 537 employees of the
Minerals Management Program processed over 400,000 reports
containing 7.7 million lines of data, closed 304 audits,
completed 4,171 compliance reviews, held 10 RIK sales,
conducted 81 Indian outreach sessions, distributed $11.7
billion to the states, counties, Indian tribes, individual
mineral owners and other Federal agencies including the U.S.
Treasury, and that was before lunch.
Mr. Costa. Sounds like you have been busy.
Mr. Luthi. That represents the monitoring of approximately
5.7 trillion cubic feet of natural gas and 585 million barrels
of oil from Federal and Indian leases. Since 2003, we have
completed 59 internal control reviews, identified 713
recommendations for improvement and we have successfully
implemented 612. The Royalty Management Program has been
reviewed and analyzed by the GAO, OIG, annual CFO audits and
external independent peer reviews.
Since Fiscal Year 2003, 24 external reviews have resulted
in 195 recommendations of which at this time we have closed
124. Annual audits in our royalty management and financial
statements are conducted by an independent firm, KPMG, under
contract with the IG. We have received an unqualified, which is
a good, clean audit, for the past six years with some minor
findings.
We have worked to correct those findings to improve the
overall processing of our system and to make these reports more
useful to the public. In addition, the recent RPC subcommittee
report contains 110 recommendations spanning the three bureaus:
MMS, Bureau of Land Management and Bureau of Indian Affairs. Of
the 110, we are responsible for 73. Twenty-two of these
recommendations are going to require coordination.
As of February 11, 16 of the 110 are complete. Of the
remaining 94, 29 are already under way. We have developed a
Joint Action Plan with the other two agencies, and we have a
plan to implement or evaluate all of the subcommittee's
recommendations. Some of the recommendations we will need to
consult with the state, and tribal and other stakeholders as
well.
One of the common themes throughout the subcommittee's
report is the need for the three royalty management bureaus to
work as partners to make sure we are using the best practices
available, and we are doing that. Internally, we already
identified the need for better coordination and flow of
communication between our Offshore Minerals Program and
minerals royalty management.
Those efforts are under way. The stovepipes are being
breached and new connections are being forged. Our partnership
and communications with our external reviewing organizations do
not stop when we receive a report. Now, for example,
subcommittee member, Mr. Bob Wenzel, and the subcommittee's
efforts paved the way for us to establish an ongoing
relationship with the IRS to compare and contrast our risk-
based compliance approaches and to learn from their experience.
This last fall we met with the U.S. Attorney's Office and
the IG's office to strengthen our relationship regarding qui
tam cases. This group meets every month now to discuss joint
training on detecting and referring false claims and how best
to work with the U.S. Attorney's Office. It wasn't a surprise
to me when the RPC concluded that we are an effective steward
for the Minerals Management Program and that we are generally
concerned about its improvements.
I see this every day, but where much is given, much is
expected. Like the IRS, we have targeted high revenue producers
with compliance reviews and audits. As part of our evolution,
we are now developing an in place, a risk-based strategy for
compliance, that extends coverage to a greater number of
companies and properties.
The IG and the RPC recommended we develop this strategy,
and it will help us we believe in the future to help target
those properties and lessees where audits and compliance
reviews are warranted and where we need additional resources. I
am very pleased with those efforts but recognize there is more
work to be done. We will work quickly to implement the
remaining recommendations concerning the GAO draft report.
It seems very clear to me that this is still clearly a work
in progress and that the findings represented today may not be
complete. We stand ready with additional data and to work
closely with them to complete their analysis. In conclusion,
Mr. Chairman, a director can have no greater goal than to leave
an agency better when they arrived.
With the efforts of our MMS employees, you and your
Subcommittee's willingness to work with us, and the other
partnerships we have developed, that goal is clearly within
reach. Thank you for your time.
Mr. Costa. Thank you very much, Mr. Luthi.
[The prepared statement of Mr. Allred and Mr. Luthi
follows:]
Statement of C. Stephen Allred, Assistant Secretary Land and Minerals
Management, and Randall Luthi, Director, Minerals Management Service,
U.S. Department of the Interior
Mr. Chairman and Members of the Committee, we appreciate the
opportunity to testify today. This Committee has been instrumental in
shaping our domestic energy program, particularly with regard to the
sound development of our domestic oil and gas resources on the Outer
Continental Shelf (OCS) and onshore Federal and Indian lands, and the
management of mineral revenues from these lands. Our testimony will
focus on the recently issued report from the Royalty Policy Committee's
Subcommittee on Royalty Management and the Department of the Interior's
(Department) subsequent implementation efforts, and the status of the
Department's response to findings and implementation of the
recommendations contained in the previous reports and audits from the
Department's Office of Inspector General (OIG), the General
Accountability Office (GAO), and internal reviews. As we are all aware,
GAO is currently working on a similar analysis and report of the
Department's royalty management program. I anticipate that GAO's
findings will be similar to and support the findings and
recommendations of the Royalty Policy Committee (RPC) Subcommittee.
Background
The Department and its agencies serve the public through careful
stewardship of our Nation's natural resources. The Department also
plays a vital role in domestic energy development. Approximately one-
third of all energy produced in the United States comes from resources
managed by the Department of the Interior.
The Bureau of Land Management (BLM) is charged with managing 700
million acres of our Nation's onshore subsurface mineral estate. The
BLM issues onshore leases, establishes lease terms and conditions; and
conducts on-the-ground inspections to ensure that unnecessary
environmental impacts do not occur; that drilling operations are
completed in accordance with an approved drilling plan; that measuring
points for production of oil and gas are secure; and, that the onsite
physical infrastructure for transporting oil and gas from a lease is
secure so as to prevent theft of oil and gas. Furthermore, to
supplement the on-the ground inspections, production reviews are
performed to verify the production figures that operators have sent to
the Minerals Management Service (MMS).
MMS is responsible for managing off-shore mineral resources and
providing the American people with an accurate and transparent
accounting of revenue that production from all Federally-owned minerals
generates. In Fiscal Year 2007, MMS collected more than $11.4 billion
in revenues from Federal production, disbursing the revenue to states,
American Indians, and the U.S. Treasury as directed by various
statutes. Since its establishment in 1982, MMS has collected and
disbursed more than $176 billion in oil, natural gas and other mineral
revenues. I am happy to point out that for the past five years, as part
of its annual CFO audit, MMS consistently has received clean audit
opinions from the Office of the Inspector General's contracted
independent auditing firm.
In addition to the BLM and MMS roles, the Bureau of Indian Affairs
(BIA) maintains ownership information for Indian lands that determines
the distribution of revenue to tribes and individual Indians. Given
these shared responsibilities, the success of the royalty program
requires close coordination and sharing of information between these
three bureaus. The roles that BLM and BIA play in the process are
equally important and significantly impact the ability of MMS to
successfully achieve its mission.
As you know, the Secretary recently received a report that contains
recommendations developed by the Subcommittee on Royalty Management. We
would like to discuss how the Subcommittee came to be established, its
composition, areas of responsibility, and the current status of our
efforts to implement the recommendations contained in the report.
Establishment of the RPC Subcommittee
On March 22, 2007, upon my recommendation, Secretary Kempthorne
appointed the Subcommittee on Royalty Management (``the Subcommittee'')
to conduct an independent examination of the minerals revenue
management program. As you are aware, reports from the Department's OIG
and others questioned whether the Department's royalty programs were
adequate to assure that the public received the royalties that Congress
had intended. While I had concluded at the time that there were not
major problems in the royalty program, I felt that there needed to be a
comprehensive look at the royalty program and that there would be many
opportunities to improve those operations. As a result, the Secretary
determined that a fully independent examination of the program was
warranted, both to restore credibility to this important revenue-
generating program, and to focus on the improvements that were needed.
Specifically, we asked the Subcommittee to review:
the extent to which existing procedures and processes for
reporting and accounting for Federal and Indian mineral revenues are
sufficient to ensure MMS receives the correct amount;
MMS's audit, compliance and enforcement procedures and
processes to determine if they are adequate to ensure mineral companies
are complying with existing statutes, lease terms, and regulations as
they pertain to payment of royalties; and
the operations of the Royalty in Kind (RIK) Program to
ensure that adequate policies, procedures, and controls are in place to
ensure the decisions to take Federal oil and gas royalties in kind
result in net benefits to the Federal government.
Subsequently, the Subcommittee was also asked to review procedures
promulgated by the Department in response to the lack of price
thresholds in Gulf of Mexico deep water leases from 1998 and 1999 sales
to ensure that future leases with royalty suspension provisions include
price thresholds.
The panel was organized as a Subcommittee of the Royalty Policy
Committee (RPC), a Federal Advisory Committee Act (FACA) body that
advises the Secretary on matters related to mineral revenues, and was
comprised of seven distinguished members:
Former U.S. Senator and Nebraska Governor Bob Kerry and
former U.S. Senator Jake Garn, of Utah;
Cynthia Lummis, a former Wyoming official who served as
State Treasurer, and as a member of the Wyoming House and Senate,
concentrating on natural resource and taxation issues;
Perry Shirley, Assistant Director of the Navajo Nation's
Minerals Department, who serves as the Principal Investigator
responsible for administering a Cooperative Agreement between the
Navajo Nation and the Minerals Management Service;
Robert Wenzel, the highest ranking career official in the
Internal Revenue Service from 1998 to 2003, whose responsibilities
included the day-to-day operation and strategic management of the
United States tax administration system;
Dr. Mario Reyes, Associate Dean for Administrative
Affairs and Director of Business Economics Programs in the College of
Business and Economics at the University of Idaho; and
David Deal, who serves as the vice-chair of the full
Royalty Policy Committee, and served as the Royalty Policy Committee's
representative on the Subcommittee.
To ensure independence, the Subcommittee staff came primarily from
the Department's Office of Policy Analysis, but also included BLM staff
and an independent staff member, Loretta Beaumont, who was selected by
the co-chairs. MMS played no role in the Subcommittee's work beyond
responding to requests for information.
I want to express my deep appreciation to each member of the
Subcommittee and staff for their hard work in the preparation and
completion of this thorough report.
Royalty Policy Committee Report
The Subcommittee issued its report on December 17, 2007, as a
public document and in a public meeting on January 17, 2008, the RPC
voted to accept the Subcommittee's Report. By letter dated January 25,
2008, the RPC Chairman transmitted the Report to the Secretary.
The Subcommittee concluded that MMS is an effective steward of the
Minerals Revenue Management (MRM) Program, and that MMS employees are
genuinely concerned with fostering continued program improvements. The
Subcommittee members unanimously agreed that MMS is the Federal agency
best suited to account for and distribute royalties that are paid for
the production of oil and gas from Federal and Indian leases.
As we expected, however, the report identified many areas that
warranted management attention to ensure public confidence.
The report contains 110 recommendations, including 35
recommendations related to collections and production accountability
from both onshore and OCS operations; 30 regarding the royalty in-kind
(RIK) Program; 27 on audits compliance and enforcement; 10 related to
coordination, communication, and information sharing among MMS, BLM,
and BIA; and 5 on OCS royalty relief and ethics (See Attachment #1). At
least three of the recommendations would require legislative action.
Notably, the Report concluded, ``the advantages of including an RIK
approach among MMS asset management options are clear and MMS's process
for evaluating the feasibility of RIK versus royalty in-value (RIV)
appears to be rigorous and effective. Nevertheless, in order to ensure
the program's successful operation, a number of challenges must be
addressed.''
The Report's recommendations span the responsibilities of all three
Departmental Bureaus involved in royalty management--MMS, BLM, and BIA
(See Attachment #2). Examples of the roles of the three bureaus
include:
The results of Production Accountability Reviews
performed by BLM and the MMS Offshore program are sent to the MRM
program when there is a discrepancy of production reported to MRM and
what is actually discovered by the accountability review. MRM then
orders the operator to correct their production report and, if
necessary, also orders the payor to pay additional royalties.
BIA maintains ownership information for Indian lands that
determines the distribution of revenue to tribes and individual
Indians;
Land title maintained by BLM for federal lands, i.e.
classification of land, determines the distribution of revenue between
the Treasury, States, and other funds;
Lease terms and conditions established by BLM determine
the royalty rate and provisions for royalty rate reductions for onshore
leases;
Authorizations and regulations control drilling of wells
and construction of facilities, pipelines, and measurement equipment;
and
BLM inspections ensure the integrity of the facilities
and the protection of the environment.
Of the 110 recommendations, MMS is solely responsible for 73 and
BLM is solely responsible for 15. The remaining 22 recommendations
require coordination among the Bureaus. We are in the process of
establishing a Production Coordination Committee with representatives
from the BLM, MMS, and BIA whose task will be not only to coordinate
and implement the cross cutting recommendations contained in the
Report, but to also provide on-going coordination of issues related to
the management of Federal and Indian mineral leases as suggested by one
of the recommendations contained in the Report
Secretary Kempthorne and I are grateful to the Subcommittee for the
time and energy it devoted in its review. The Department is committed
to working with our stakeholders to implement the recommendations
contained in the Report. We agree with the statement of the
Subcommittee that implementing the recommendations in this report will
greatly strengthen the management of the program, restore public
confidence, and ensure maximum value for the U.S. taxpayer.
Randall Luthi, Director of the MMS, is here today to provide the
Subcommittee with an update on the work being done to implement the
findings and recommendations of the RPC Subcommittee and other previous
reviews.
The MMS's royalty management program of today is not the same
program of 25 years ago when it was in its infancy, or even 5 or 2
years ago. The MMS royalty management program of today is the
culmination of 26 years of ideas, findings and recommendations for
program enhancements from the best and the brightest, both internal and
external, to the agency. Since FY 2003, the MRM has completed 59
internal control reviews, identified 713 recommendations for
improvement, and successfully closed 612 of the recommendations. Since
FY 2003, 24 external reviews by the GAO and OIG, and annual CFO audits
and external peer reviews have resulted in 195 recommendations, of
which MMS has successfully closed 124.
Notably, many significant changes were identified through the
internal review process and were ultimately supported in the findings
and recommendations reported by the various external reviews. For
example, as part of the MRM program-wide Strategic Business Planning
process, the MMS royalty management program identified in June 2006 the
need for a risk-based compliance approach that expands compliance
coverage to a greater number of companies and properties. In its
December 2006 audit of MMS's compliance review process, the OIG also
recommended a risk-based compliance approach. MMS recently completed
the pilot project for this initiative. Additionally, in February 2006,
MMS identified the need for an automated adjustment line monitoring
tool to ensure that companies' royalty adjustments are made within the
allowed timeframes and in compliance with applicable laws and
regulations. Funding was appropriated for this initiative as part of
the FY 2008 budget. The royalty management program continues to make
improvements. For example, in June 2006, as part of its strategic
planning initiative, MMS began pursuing the development of a risk-based
strategy for compliance that expands compliance coverage to a greater
number of companies and properties. This strategy will allow us to rank
companies and properties according to particular risk identifiers, to
provide the detail needed to identify properties or payors where audits
or compliance reviews are warranted, and to identify when and where we
need additional resources. Also, MRM proposed to improve the timeliness
and efficiency of the interest assessment to companies by implementing
computer system enhancements. The President's Fiscal Year 2009 Budget
includes a request for an additional $3.7 million for these two
initiatives.
Implementation of Subcommittee Recommendations
I would like to turn your attention to our progress to implement
the RPC Subcommittee Report. In a memorandum dated January 14, 2008,
Secretary Kempthorne asked the Department to review the Report, develop
an action plan, and begin implementing the Subcommittee's
recommendations. I am pleased to report that as of February 11, 2008,
16 of the 110 recommendations are already complete (See Attachment #3).
Of the remaining 94 recommendations, 29 are underway. We have developed
a Joint Action Plan to address all of the Report's recommendations.
The Plan identifies by recommendation the responsible Bureau,
estimated timeframes for completion, and status. Points of contact are
designated within each Bureau to monitor implementation and report on
progress on a monthly basis. Many of the recommendations require
further evaluation, and to that end, teams are being formed to
determine appropriate actions and schedules. Likewise, many
recommendations will need to be explored further through consultations
with State and Tribal officials, and other organizations before they
can be adequately implemented. We have developed a tracking system and
have been and will continue to hold regular meetings to assess progress
on the implementation of each action item.
Examples of the major focus areas contained in our Joint Action
Plan include the following:
Completing Production Accountability Reviews at BLM and
MMS for producing leases to make certain that royalties are being paid
on the correct volume and quality of oil and gas from Federal and
Indian lands.
Improving the coordination, collaboration, communication,
and information sharing between BLM, MMS, and BIA.
Requiring more reporting of data electronically and
ensuring that bureaus have easy access to each other's systems.
Implementing a risk-based compliance strategy and
determining the extent to which a more flexible approach to audits,
similar to that used by the IRS, is feasible.
Ensuring the RIK program has the right personnel with the
right skills to get the job done.
Ensuring that all staff receives ethics training,
including training focusing on public-private sector interactions.
Ensuring that we have sufficient staff to support the
Department's onshore and offshore royalty management activities.
The BLM has already taken measures to strengthen its Production
Accountability Reviews by increasing funding in FY 2008 and FY 2009,
and, for FY 2009, BLM plans to hire an additional 15 Production
Accountability Technicians (PATs) to increase the number of reviews in
order to verify production reported to MMS by oil and gas operators. In
addition, as part of the Joint Action Plan, the BLM is examining issues
and recommendations to lower the thresholds for production of oil and
gas for which annual reviews will be given; revise its policy and
regulations on evaluating the quality of oil (API gravity) and gas (BTU
factor) when doing production verification, as inaccurate reporting of
these values will impact royalty collections; consolidate its policy on
oil and gas measurement and when gas can be used on a lease without
paying royalties on that gas; and update and consolidate policy across
the program for more effective implementation of the oil and gas
inspection program, including production accountability. The BLM is
also examining further increased staffing of Production Accountability
Technicians, ensuring PATs are properly trained, and developing
standardized position descriptions for PATs. Finally, BLM is working to
develop better communications with MMS, including scheduling annual
workshops on production accountability, and developing protocols for
operators who have been identified as underreporting production.
Recently, Assistant Secretary Allred sent to Chairman Costa and
Ranking Member Pearce, MMS's status update on the action MMS has taken
to address the findings of the OIG in two of its most recent reports. I
am pleased to report that as of February 29, 2008, MMS completed all of
the 23 items in the action plan associated with the December 2006 audit
report on MMS's compliance review process, and 12 of the 15 actions
associated with the September 2007 OIG report on false claims
allegations.
The OIG's December 2006 report on the compliance review process
represents the culmination of an audit that the OIG performed of MMS's
compliance review process. The objectives of the audit were to
determine (1) whether compliance reviews are an effective part of the
Compliance and Asset Management's (CAM) operation, and (2) whether MMS
is effectively managing the compliance review process.
The OIG concluded in its audit that compliance reviews can serve a
useful role as part of MMS's CAM program operations. The OIG further
reported that compliance reviews are a legitimate tool for evaluating
the reasonableness of company-reported royalties and allow a broader
coverage of royalties, while requiring fewer resources than audits.
While the OIG report concluded that compliance reviews are an effective
part of MMS's CAM program operations, it made recommendations to
strengthen policies and procedures to improve automated tracking and
verification systems and improve the compliance review process.
MMS administers a royalty Compliance and Asset Management operation
charged with ensuring that fair market value is received for the
mineral assets removed from Federal and Indian lands. MMS is committed
to the administration of a Federal and Indian mineral revenue
compliance program of the highest quality and integrity. Our efforts
are to ensure that Federal and Indian mineral revenues are timely and
correctly reported and paid by the minerals industry in compliance with
applicable laws, regulations and lease terms.
Our compliance strategies and activities are carried out through a
nation-wide MRM field audit structure and partnership through delegated
and cooperative audit agreements with 11 States and 7 Indian tribes.
This strategy effectively utilizes a combination of targeted and random
audits, compliance reviews, and royalty in kind property
reconciliations. The strategy calls for completion of the compliance
cycle within 3 years of the royalty due date. In Fiscal Year 2007, this
strategy ensured reasonable compliance on $5.8 billion in Federal and
Indian mineral lease revenues, 64.7 percent of total mineral revenues
paid for calendar year 2004 production. MMS's royalty compliance
activities have yielded over $3.4 billion in additional mineral
revenues since program inception in 1982. The cost benefit analysis of
compliance reviews and audits for Fiscal Years (FY) 2005 through 2007
shows that for every $1 spent on compliance reviews, MMS collected
$5.49. In August of 2007, MMS reached a $105.3 million settlement with
Burlington Resources, resulting from complex, multi-year audit work.
Without this anomaly being recorded in FY 2007, the cost benefit
analysis for audits shows that for every $1 spent on audits, MMS
collected $4.71 (See attachment #4). We agree with the OIG and the RPC
Subcommittee that compliance reviews are a valuable management tool.
Through the implementation of MMS's compliance action plan we have
taken steps to strengthen the compliance review process by establishing
and implementing a pilot project to further develop and begin
implementing risk-based compliance strategies, restoring MMS's access
to BLM's Automated Fluid Minerals Support System that was interrupted
by the Cobell litigation, amending production verification procedures,
and ensuring state and tribal auditors have access to compliance tools.
The OIG's September 2007 report on the false claims allegations
responded to Assistant Secretary Allred's request that they look into
the qui tam lawsuits that were filed by some MMS employees (relators)
against several energy companies alleging fraudulent activities. The
OIG report indicates that 1) the relators did not follow MMS
procedures, and 2) there was no evidence of retaliation by management
against employees. The report also identified a number of areas for
improvement that MMS embraced and moved aggressively to build upon.
As a result of this report, MMS analyzed its practices and, where
applicable, identified opportunities to implement policy and procedural
changes. These opportunities were outlined in the action plan
containing 15 items, 12 of which have been completed.
Significant accomplishments include eliminating the backlog in
interest billing; fully briefing decision makers on the interest
calculation policy; updating manuals and other guidance on safeguarding
proprietary and business confidential information and on procedures for
reporting suspected fraud; and establishing policies to ensure
mandatory training and performance management requirements are met. Of
special note, in FY 2007, MMS billed more than $66 million of interest
on late royalty payments and is now regularly billing the lessees for
any late payments on a monthly basis. The MMS will complete the
remaining three action items this spring.
In addition, in October 2007, MMS met with the U.S. Attorney's
Office (USAO) and the OIG to begin the process of strengthening our
relationships regarding the referral and investigation of false claims
cases. As a result of MMS's initiative, this group has begun meeting
every month to discuss joint training on detecting and referring false
claims and referral of potential royalty cases to the USAO.
Conclusion
Each month, approximately 2,100 companies report and pay royalties
associated with over 28,000 producing Federal and Indian leases. In FY
2007 alone, the 537 employees of the MRM program processed over 400,000
reports containing more than 7.7 million lines of data. The magnitude
and complexity of this program requires that the Federal government
work with all its partners to ensure the use of best practices, the
best technology, and the most efficient use of available resources. We
will continue to identify and respond to opportunities to improve our
efficiency and streamlining our processes, within the confines of
available resources. The Department's goal is to ensure that companies
are in compliance with applicable laws, regulations, and lease terms
and the Government is receiving fair market value. We are pleased with
the results of MMS's efforts thus far, but recognize that there is much
more work to be done. We can assure you that MMS will successfully
implement the remaining recommendations of the OIG and that the three
Bureaus will continue to work together to implement the RPC
Subcommittee's recommendations.
We welcome your input on all of these initiatives, and look forward
to working with the Committee as we strengthen and improve the royalty
management program.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
STATEMENT OF LAWRENCE FINFER, DEPUTY DIRECTOR, OFFICE OF POLICY
ANALYSIS, U.S. DEPARTMENT OF THE INTERIOR
Mr. Costa. We will now move on to the next witness, Mr.
Lawrence Finfer, is that correct? Mr. Finfer is the Deputy
Director of the Office of Policy Analysis for the Department of
the Interior. Mr. Finfer, please.
Mr. Finfer. Thank you, Mr. Chairman, Mr. Pearce. I am
Lawrence Finfer, Deputy Director of the Office of Policy
Analysis, but I was also Staff Director to the Subcommittee on
Royalty Management. As you know, our co-chairs, Senators Bob
Kerrey and Jake Garn, submitted a statement for the record. I
would like to briefly summarize that statement.
The subcommittee was formed in March 2007 to provide an
independent examination of the royalty program and its
proceeded over a nine month period. As mentioned, the
subcommittee concluded that overall MMS was an effective
steward of the royalty program.
The Senators, in particular, included the following
statement, both in their statement for the record and in the
announcement of the subcommittee's report, namely, ``that the
Federal employees who work in the mineral leasing and royalty
collection program are conscientious, hard working and
concerned about the reputation of the program and the
Department of the Interior.''
Nonetheless, the committee found many areas in which
improvements were needed, and some of those improvements need
to be substantial. Hence, the 110 recommendations provided by
the subcommittee. I would like to just highlight a number of
the ones that were included in the Senators' statements.
First, the subcommittee embraced the Inspector General's
recommendation that compliance reviews are an appropriate tool
but need to be used in conjunction with audits in a
comprehensive, well thought out strategy. This means
specifically the implementation of a risk-based approach.
In that light, the subcommittee consulted with what we
regarded as the pros, namely the IRS, which has decades of
experience in risk-based approaches, and we learned quite a
bit, which we included in our report. Further, we recommended
that MMS pursue an ongoing relationship with the IRS as it
implements a risk-based approach.
My understanding, that it is doing just that at this point.
That is absolutely critical to its success. Second, one
recommendation which has been touched on before is the
recommendation to establish a trust fund with royalty revenues.
The subcommittee's recommendation was made because a number of
these improvements will cost money, and a trust fund properly
invested will yield interest, a small portion of which could
help fund those improvements.
Third, building off of some of the recommendations of the
IG, the subcommittee recommended ethics training for all
employees involved in the royalty program, particularly the
Royalty-in-Kind Program.
Government employees do receive ethics training, but the
subcommittee believes that this particular ethics training
should be targeted to the particular issues and situations
faced by employees in this program so that they know what
interactions are appropriate and which ones are not.
Fourth, as noted, better coordination needs to occur
between BLM, and the MMS and the BIA in a variety of areas,
production accountability and otherwise. This is essential in a
variety of areas. We also made recommendations for improving
some of the reporting, such as the MMS 2014, to include BPU
values, and perhaps most important, to ensure that we go to an
all electronic reporting format as soon as possible.
Without an all electronic reporting format it will be
difficult to implement a risk-based approach. Also, as noted,
the subcommittee spotlighted some of the problems BLM has in
getting a sufficient number and a sufficiently well-trained
production technician workforce. This significantly affects
production accountability, and this is a situation that needs
to be addressed.
The onshore program has grown rapidly, and frankly, this
area needs some catch up work to ensure appropriate production
accountability. Finally, with respect to the Royalty-in-Kind
Program, the subcommittee concluded strongly that the RIK
Program is a valuable program and should be continued. However,
the program has grown rapidly from one that barely existed five
or six years ago to the point where it is not a major facet of
royalty collections.
That growth now needs to be accompanied by more structured
procedures and better oversight. We recommended the
establishment of a subcommittee on royalty in kind to the
Royalty Policy Committee, among other things, and much more
consistent application of procedures across the board, both in
terms of auction, performance measures and so on and so forth.
That combination will produce greater transparency, which
is essential for a program of this type. Simply put, the
program has grown so quickly it is now time to catch up and
give it the foundation that it needs and deserves. At the same
time, however, while concluding that the Royalty in Kind
Program was a valuable program there were certain areas we
recommended that be discontinued.
These include the Small Refiner Program and the Onshore Oil
Program. Mr. Chairman, this concludes my testimony, and I will
be pleased to take questions.
[The response to questions submitted for the record by Mr.
Finfer follows:]
Response to questions submitted for the record by Larry Finfer
Question 1: Mr. Finfer, you stated that one of the crucial elements to
a risk-based strategy is good data. Do you believe that MS
currently has data of sufficient quality to properly implement
an effective risk-based compliance strategy, given that both
Mr. Rusco and Mr. Roller testified that there were problems
with MMS data?
Answer: The issues raised with respect to the quality of MMS's data
do not necessarily bear upon whether data exist that are sufficient to
implement a risk-based approach. As the risk-based approach is
designed, those needs will be defined as will the systems support
needed to apply the data to implementation activities. That will also
inform the issue of whether existing systems can be readily adapted to
use data for risk-based activities or whether a new and more tailored
systems design effort is needed.
Question 2: Mr. Finfer, did the committee ask whether or not MMS had
enough staff to complete its audit and compliance tasks? They
currently have about 126 auditors, far less than the nearly 170
they had at the beginning of the decade? Is that enough?
Answer: The committee did review staffing issues and a number of
recommendations address those concerns. In general, although a portion
of the reduction is explicable given the efficiencies realized as a
result of the Royalty-In-Kind program, it appears that the some of the
reduction also reflected budget limitations as opposed to reduced
needs. Some of the committee recommendations address this issue. For
example, Recommendation 4-2 (Chapter 4, page 62 of the report)
recommends a systematic review of staffing and budgetary needs related
to anticipated compliance strategies. In particular, the development of
the risk-based approach should further inform the effort to define
appropriate staffing levels.
Question 3: Mr. Deal and Mr. Finfer, could you provide more detail on
the difference between a ``royalty payor'' and an ``operating
rights owner,'' and why it would be better for MMS to pursue
the royalty payor (as per Recommendation 3-8). Please provide
an example to demonstrate the difficulty in the current system.
Answer: The operating rights owner/working interest owner is
defined in BLM manuals as: ``The interest or contractual obligation
created out of a lease (such as a sublease) authorizing the holder of
that right to enter the leased lands to conduct drilling and related
obligations, including production, which may include as consideration a
share in revenues therefrom.'' The lessee of record title is the owner
of the lease, and there can be numerous lessees of a lease including
individuals who acquire an interest as a passive investment. The payor
can be the operator, purchaser, lessee, operating rights owner and the
accounting service hired by the owner to report on and pay the
royalties. There can be multiple payors on a given lease.
There are a number of problems with the current system that led to
the committee's recommendation. First, as noted in the report (Chapter
3, page 23), MMS does not have a system in place to track the identity
of operating rights owners. Enforcing an obligation against a lessee
could be costly and cumbersome and involve actions including hundreds
of entities. Added complications arise because when MMS pursues
nonpayments or underpayments against a payor, it must notify all
operating rights owners and lessees (which, as noted above, MMS is
currently unable to track). Further, under the Debt Collection
Improvement Act, MMS has only 180 days to collect payments. Given the
above circumstances, this has proved to be a near-impossible deadline.
Accordingly, the committee concluded that restoring pre-Royalty
Simplification and Fairness Act requirements was merited, and that is
reflected in Recommendation 3-8. However, if MMS received such
statutory authority, it would be important for it to work with industry
in the implementation phase to ensure requirements were imposed in a
reasonable and efficient manner.
______
Mr. Costa. Thank you very much. We appreciate a number of
the comments you made with regard to both risk assessment as
well as to the computerization program. I know a number of us
will have questions on a number of the points you raised.
STATEMENT OF LINDA STIFF, ACTING COMMISSIONER, INTERNAL REVENUE
SERVICE
Mr. Costa. Our next witness is Ms. Linda Stiff, the Acting
Commissioner for the Internal Revenue Service, is that correct?
Ms. Stiff. That is right.
Mr. Costa. Thank you, and we look forward to your
testimony.
Ms. Stiff. Good morning, Chairman Costa, Ranking Member
Pearce and members of the Subcommittee. Thank you for the
opportunity to appear before you today. I have served as the
acting Commissioner of the IRS since September. I am a career
IRS employee having started as a revenue agent more than 27
years ago.
Mr. Costa. Congratulations.
Ms. Stiff. While the IRS has no role relative to the
Federal Oil and Gas Royalty Program, it is my understanding
that you want me to review for the Subcommittee the IRS's
compliance procedures relative to the collection of Federal
income taxes.
My written statement provides a detailed overview of the
IRS compliance program, so what I would like to do this morning
is highlight what I think to be the most important aspects of a
strong compliance program. For the IRS, the most fundamental
premise of our compliance efforts involve balancing taxpayer
service with our enforcement programs.
Service is critical to sound tax administration because we
know that some portion of noncompliance results from taxpayers
failing to fully understand their tax obligations. The primary
goal of our service program is to assist taxpayers in complying
with their Federal tax responsibilities and to help them
navigate the complexities in the Tax Code.
To accomplish this, we provide extensive outreach and
education to individual and business taxpayers as well as to
tax practitioners. The IRS taxpayer services programs ensure
that taxpayers know their obligation, they understand how to
meet them and we provide assistance when appropriate.
Our service programs mitigate compliance problems due to
inadvertent errors and lack of understanding, particularly for
taxpayers who are inclined to comply. At the IRS we believe
that services with enforcement equals compliance. Enforcement
programs are critical to verify compliance as reported and to
ensure that all taxpayers can count on the system to be fair
and be a system that requires everyone to pay their share and
meet their tax requirements.
Additionally, our enforcement programs enable us to address
those instances where the noncompliance is willful and
intentional. The IRS employs a number of enforcement tools that
includes notices, matching of third-party information to
returns, audits and collection activities. In each of these
cases, we integrate risk-based strategies to select what work
will be done.
There are two critical factors that were actually mentioned
earlier by the first panel that assist us in ensuring
compliance with the tax laws. One is transparency. Simply put,
the more transparent a transaction is, the easier it is to
understand. Fostering greater transparency within this nation's
administration system enhances compliance with the tax laws.
The second critical factor to ensure compliance actually
flows from the transparency issue as well; it is third-party
information reporting. Research and compliance studies confirm
that compliance is greater in the presence of third-party
reporting. In fact, for the tax system, compliance exceeds 95
percent where third-party reporting exists.
Where income is not subject to either withholding or third-
party reporting requirements the misreporting percentage rises
to as high as 54 percent. We continue to seek means of
improving third-party reporting in transactions where it does
not now exist. Another critical component of our compliance
effort is balanced coverage or presence.
We know there is a ripple effect when we reach out and
interact with the taxpayer through our enforcement programs. It
is similar to the efforts of the police. They may not catch
every speeder, but if a motorist sees them they do tend to slow
down and abide by the law. Finally, from both a service and
enforcement perspective, we understand that we operate in an
environment where resources are limited.
We are challenged, just as our colleagues are, to find ways
to improve processes and increase productivity. We are doing
this by continuing to improve efficiency and productivity
through process changes and streamlined business practices, and
we are leveraging technology to deliver both increased services
and improve our enforcement efforts.
Mr. Chairman, I hope this overview has been helpful. I
thank you, again, for the opportunity to appear this morning
and will be happy to respond to any questions that you may
have.
Mr. Costa. Thank you. I appreciate your comments. How much
of that is applicable in this sense we will try to determine,
but we thank you for being here.
[The prepared statement of Ms. Stiff follows:]
Statement of Linda Stiff, Acting Commissioner of Internal Revenue
Chairman Costa, Ranking Member Pearce, and members of the
Subcommittee, thank you for the opportunity to appear before you today.
While the IRS has no role relative to the Federal oil and gas royalty
program, it is my understanding that you want me to review for the
Subcommittee IRS's compliance procedures relative to the collection of
Federal income taxes.
Background
The IRS administers America's tax laws and collects the revenue
that funds most federal government operations. Each year we collect
more than $2 trillion, or over 96 percent of the revenues that fund the
federal government each year. This revenue comes from over 144 million
Federal income tax returns filed by individuals and corporations
throughout the U.S. In many ways, the IRS and its employees represent
the face of U.S. government to more American citizens than any other
government agency.
What is perhaps most impressive about our Federal tax collection
system is that it is largely self-enforcing, and yet we collect what we
estimate to be approximately 85 percent of the taxes owed each year. We
are able to do this by maintaining a system that balances strong
taxpayer service with an equally strong compliance program.
Maintaining the Service and Enforcement Balance
Taxpayer Service
Research has shown us that the complexity of the U.S. tax code is
an important factor in the ability of many taxpayers to remain
compliant with tax laws. It is important for us to differentiate
between this type of noncompliance and willful noncompliance where the
taxpayer fully understands their obligations but refuses to pay the
taxes due. The primary goal of IRS service programs for individual
taxpayers is to facilitate compliance with federal tax obligations.
We attempt to assist taxpayers through three primary means: the
internet, the telephone and direct contact.
The Internet--One of the most frequently visited websites
in America is IRS.gov. In FY 2007 there were more than 215 million hits
on the web site, a 10-percent increase over the previous year. IRS.gov:
Provides taxpayers information on the economic stimulus
program enacted by Congress in February;
Assists taxpayers in determining whether they qualify for
the Earned Income Tax Credit (EITC);
Assists taxpayers in determining whether they are subject
to the Alternative Minimum Tax (AMT);
Allows more than 70 percent of taxpayers the option to
file their tax returns at no cost through the Free File program. Free
File is a public/private partnership that allows more than 97 million
taxpayers to file their returns at no cost. In 2007, approximately 4
million taxpayers took advantage of the Free File service.
Allows taxpayers who are expecting refunds to track the
status via the ``Where's My Refund?'' feature; and,
Allows taxpayers to calculate the amount of their
deduction for state sales taxes.
Telephone--Many Americans still prefer to pick up the
telephone to have their questions answered. In FY 2007 the IRS customer
assistance call centers answered 33.2 million assistor telephone calls
and maintained an 82.1 percent level of service on the telephone with
an accuracy rate of 91.2 percent on tax law questions. The agency
reached a 95 percent customer satisfaction rating for its toll-free
telephone service, up from 94 percent the year before.
Face to Face--While we attempt to direct taxpayers to
less costly, and in many ways more effective, means of assistance such
as the internet, we understand that there will always be a number of
people who prefer direct contact with an individual to have their
questions answered. We continue to meet that need through our 401
Taxpayer Assistance Centers (TACs). These TACs are scattered across the
country and act as walk-in sites for millions of Americans each year.
Another important element of our face-to-face contact with taxpayers is
the nearly 12,000 manned volunteer sites. These volunteer sites assist
in the preparation and submission of income tax returns, primarily for
low-income Americans. In FY 2007, over 76,000 volunteers prepared 2.63
million returns at these sites.
The overriding strategy that guides our taxpayer service program is
the Taxpayer Assistance Blueprint (TAB). This collaborative effort of
the IRS, the IRS Oversight Board, and the National Taxpayer Advocate
began in July 2005 in response to a Congressional mandate to develop a
five-year plan that outlines the steps we should take to improve
taxpayer services. This was in recognition of the critical role that
taxpayer service plays in improving compliance.
TAB represents a significant milestone in a decade-long history of
service enhancements by the IRS. During this period taxpayer
satisfaction with IRS services has grown significantly, due in large
part to the strength of our commitment to continual improvements.
Increases in electronic filing and on-line service transactions, high
levels of toll-free access and accuracy, extensive stakeholder
engagement, and increasingly diversified efforts to reach taxpayers
through local partners and community coalitions have all led to better
taxpayer understanding and participation in the tax system.
Another critical component of our compliance program is a strong
customer service focus toward the business community. A key component
of this has been our outreach program. In FY 2007, we:
Maintained relationships with business industry and tax-
professional organizations and coordinated or participated in events
across the country, sharing education and outreach messages and
information to better enable their members to comply with the law.
Engaged practitioners and payroll providers through
national and local chapters of prominent organizations such as the
American Institute of Certified Public Accountants (AICPA), American
Bar Association (ABA), the National Association of Enrolled Agents
(NAEA), the National Payroll Consortium (NPRC), and the Independent
Payroll Provider Association (IPPA).
Maintained a close working relationship with the Internal
Revenue Service Advisory Council (IRSAC) and the Information Returns
Program Advisory Committee (IRPAC) to address small business issues
through their Small Business/Self-Employed Sub-Working Group.
Currently, both groups are working to address issues to improve
voluntary compliance.
Enforcement
Through a renewed focus on improving our enforcement efforts, we
have been able to increase enforcement revenue from $33.8 billion in FY
2001 to $59.2 billion in FY 2007, an increase of 75 percent. This
represents a 5.6 to 1 return on investment for all IRS activities in FY
2007.
In FY 2007, both the levels of individual returns examined and
coverage rates have risen substantially. We conducted nearly 1.4
million examinations of individual tax returns in FY 2007, an 8 percent
increase over FY 2006. This is over three-quarters more than were
conducted in FY 2001, and reflects a steady and sustained increase
since that time. Similarly, the audit coverage rate has risen from 0.6
percent in FY 2001 to 1 percent in FY 2007.
While the growth in examinations of individual returns is visible
in all income categories, it is most visible in examinations of
individuals with incomes over $1 million. Audits of individuals with
incomes of $1 million or more increased from 17,015 during FY 2006 to
31,382 during FY 2007, an increase of 84 percent. One out of 11
individuals with incomes of $1 million or more faced an audit in 2007.
Their coverage rate has risen from 5 percent in FY 2004 to 9.25 percent
in FY 2007.
In looking at our audit numbers for individual taxpayers, it is
important to understand that we conduct two types of audits. The first
is the traditional field audit where an auditor actually meets with the
taxpayer to conduct an examination. The second is a correspondence
audit. These occur in instances where we are unable to match the
taxpayer's return with third-party documents that are filed with us.
For example, a taxpayer's return that does not report income that is
reported to us as part of an interest statement provided by the
taxpayer's bank would raise a red flag. We would send a letter to the
taxpayer assessing the additional tax as well as any interest and
penalties that may apply. The taxpayer is then provided an opportunity
to dispute this assessment if they desire or they can send the
corrected assessment directly to us.
In the business arena, we attempt to allocate resource to the areas
where we think they will be most effective. In FY 2007 for example, the
IRS continued efforts to review more returns of flow-through entities--
partnerships and S Corporations. Our business statistics reflect that
we have placed more emphasis in the growing area of these flow-through
returns. We also increased our focus on mid-market corporations--those
with assets between $10 million and $50 million.
Operating in an environment where resources are limited, we are
challenged to find ways to improve processes and increase productivity.
We are doing this by continuing to improve efficiency and productivity
through process changes and streamlined business practices.
A critical component in ensuring the most productive use of
compliance resources is a greater reliance on information technology
(IT) modernization. The IRS strategic vision includes IT systems that
would allow for identification of the cases to be worked, routing of
those cases to the most appropriate workstream, and the availability of
cost effective technology analytics to manage cases in the stream
optimally.
The National Research Project (NRP), which analyzed some 46,000
individual income tax returns from Tax Year (TY) 2001, has provided us
with significant data to help us facilitate the selection of the most
productive returns to examine. It is envisioned that the case selection
process will be further enhanced through automated classification
processes, including expert systems, electronic database analysis, and
leveraging e-filed data from corporations--efforts that are currently
underway. Technology enhancements are also on track for more effective
and efficient workload selection models within the non-filer
population.
The FY 2009 Budget for the IRS includes $51 million to expand our
commitment to quality enforcement research. This enforcement initiative
will support and expand ongoing research studies of filing, payment,
and reporting compliance to provide a comprehensive picture of the
overall taxpayer compliance level. Research allows the IRS to better
target specific areas of noncompliance, improve voluntary compliance,
and allocate resources more effectively to reduce the tax gap. Improved
research data will refine workload election models reducing audits of
compliant taxpayers.
We also use current audit information from ``issue management''
systems to improve case selection criteria and provide for immediate
identification of emerging issues. For collection programs, we are
using improved decision analytics to select cases and route them to the
most appropriate collection enforcement stream. For large corporate
returns, data is now available earlier due to the corporate e-file
mandate, and we are using data from returns filed electronically,
including the Schedule M-3, for risk assessment and issue
identification.
Delivery systems are also being modified to move audit work into
the system more effectively and efficiently. Return classification and
delivery will be more automated and digital, eliminating the manual
time-consuming and expensive process of ordering returns and sending
examiners out to Campus locations for classification details.
Additionally, the IRS will replace manual processes with electronic
case building and instant access to multi-year tax return information.
Automated systems are also being deployed to allow more batched
processing of high-volume examinations. Technology enhancements will
allow employees to work cases in an online environment, where returns
and case-related data can be downloaded, and actions can be tracked
electronically. We will continue to link multiple internal and external
databases to enhance overall effectiveness, allowing better
identification, management, and performance monitoring for compliance
workload. In utilizing these automated systems, IRS remains committed
to protecting taxpayer data from being accessed inappropriately.
The large corporate entities monitored by the IRS are highly
sophisticated, well-capitalized, well-organized, and adept at tax
planning. Particularly in the case of public companies, they are driven
to show high after-tax profitability to shareholders in a very
competitive and complex economic environment. They have the resources
and willingness to defend their reporting positions and contest
proposed adjustments aggressively.
However, these taxpayers also face significant changes in corporate
governance, including increased public disclosure and transparency. A
number of these changes have been the result of legislative or
administrative changes including:
New requirements were imposed on corporate officers and
directors by the Sarbanes-Oxley Act.
There was increased scrutiny of outside auditors by the
creation of the Public Corporation Accounting Oversight Board.
Increased requirements of disclosure were included in the
American Jobs Creation Act.
New SEC/FASB (FIN48) rules limit the discretion companies
can apply in determining their unresolved tax positions for financial
accounting purposes.
For some corporations, these changes have created a desire for
certainty regarding their tax liability as soon as possible. Tax
certainty--or lack thereof--can have a real effect on a company's share
price, because a more accurate picture of a company's finances is now
required and publicly available.
We recognized long ago that our traditional approach to corporate
tax administration, which centered on lengthy, detailed tax return
examinations, was no longer viable. As a result, we developed a
proactive approach to dealing with the challenges of effective tax
administration in a global environment with an increasingly complex tax
code. Overall, this strategy depends on making compliance checks, when
possible, on a real-time basis, remaining current in our examinations,
and having as much transparency to book-tax differences and other
indicators of risk as possible. To that end, we have initiated several
programs that foster transparency, currency, pre-filing compliance
opportunities, and improved efficiencies in issue and risk
identification.
First, to improve transparency on corporate tax returns, the IRS
introduced a new Schedule M-3. The Schedule M-3 provides transaction-
specific detail on book-tax differences, enabling the IRS to identify
and focus more quickly and precisely on those tax returns and issues
that present the highest potential compliance risk.
Second, our Large and Mid-Sized Business (LMSB) division has
introduced the Compliance Assurance Program (CAP). The CAP program is
designed to improve both currency and transparency. It is a real-time
approach to compliance review that allows LMSB, working in conjunction
with the taxpayer, to determine tax return accuracy prior to filing.
CAP is more efficient than a post-filing examination, as it provides
corporations certainty about their tax liability for a given year
within months, rather than years, of filing a tax return. CAP is a pre-
filing initiative designed to provide certainty for both the IRS and
the taxpayer, that a return (in its entirety) is substantially
complaint when it is filed. This win-win program greatly reduces
taxpayers' compliance burden and their need for contingent book tax
reserves, while increasing currency and allowing for more efficient use
of IRS resources.
Third, the IRS is continuing the Pre-Filing Agreement (PFA) program
to provide taxpayers an opportunity to request that revenue agents
examine and resolve potential issues before tax returns are filed. This
is distinguished from the CAP program as it provides certainty on a
single issue(s), as opposed to certainty of a tax return (in its
entirety). We continue to explore ways to improve and create additional
pre-filing compliance opportunities that may limit the number of issues
we need to examine in a post-filing examination.
Fourth, working with Treasury and Chief Counsel, LMSB identifies
emerging high-risk issues as early as possible, issuing guidance to
taxpayers and examiners on the proper treatment of these issues, and
efficiently and vigorously examining those returns where taxpayers
engage in that behavior.
Fifth, the IRS is mandating, in stages, the electronic filing of
corporate returns (E-Filing) in order to improve issue identification
and the selection for examination of high-risk returns. Large
corporations are required now to file their tax returns electronically
and this mandate will expand in future tax years. E-filing will provide
more consistent treatment and data analysis for efficient, near real
time identification of high-risk issues and taxpayers. E-filing and
Schedule M-3 together also allow us to identify and exclude more
efficiently lower-risk taxpayers from consideration for examination.
The approaches described above better position the IRS to address
the rapid change of business in the domestic and global arenas in a
timelier manner. The earlier we learn of emerging trends, the better
positioned we will be to adjust resources to address compliance risks
appropriately.
Increasing timeliness and reducing cycle time means that less time
is spent on each audit. This has allowed us to continue to show
improvement in enforcement results at the same time we are increasing
our coverage of these taxpayers. We believe that the more compliance
``touches'' that occur (even if that does not include a full audit in
the traditional sense), the better the direct and indirect enforcement
benefits will be.
Summary
Any agency with limited resources must make difficult decisions on
how to allocate those resources in the most effective way. It also must
be accountable for those decisions, and so appropriate metrics must be
established to measure the success or failure of the actions taken.
While we understand that we can still do some things better, we
believe that our approach, which balances service and enforcement in an
effort to improve compliance, is working effectively. We base that
conclusion on the metrics that show how enforcement--particularly
enforcement against high-income individuals and large corporations--
have grown substantially in the last five years without any diminution
in our taxpayer service levels.
Thank you for the opportunity to appear this morning, and I will be
happy to respond to any questions.
______
Response to questions submitted for the record by Linda Stiff,
Acting Commissioner of Internal Revenue
Questions for Ms. Linda Stiff, Acting Commissioner, Internal Revenue
Service
1. Commissioner Stiff, in a report issued last year by the Interior
Department's Inspector General, a manager at MMS says that when
companies file their royalty reports, they are allowed to take
deductions and it's up to MMS to figure out whether or not
those deductions are valid. Apparently, a company can never get
in trouble for filing a false deduction, since they're not
required to verify whether it is or isn't. Does the IRS operate
that way with individual taxpayers?
ANSWER: The IRS cannot comment on Mineral Management Services (MMS)
rules regarding royalty reporting requirements. However, with regard to
federal income tax returns, taxpayers are expected to maintain adequate
records (such as a check or a receipt) to substantiate any deduction on
their income tax return. Upon audit, a number of penalties--both civil
and criminal--can be applied if false deductions are claimed on an
income tax return. The IRS does not allow taxpayers to knowingly file
``false deductions.''
Individual taxpayers who receive royalty income normally receive a
Form 1099. The Form 1099 reports the gross royalty income received by
the taxpayer. Generally, the taxpayer may be entitled to deduct
depletion and production taxes from the income reported.
2. Commissioner Stiff, it seems to me that IRS would have similar
problems that MMS is having in terms of retaining a trained
workforce. You have highly trained accountants and tax experts
who are in demand in the private sector. Are you seeing high
turnover rates, and how do you attract and retain skilled
individuals?
ANSWER: The IRS takes a holistic approach to managing its human
capital. We ensure that planning, recruitment and hiring, employee
development, retention and the management of attrition are looked at as
a continuum and not as individual processes. We are fortunate that we
are not experiencing unusually high turnover rates among our Mission
Critical Occupations (MCO) at this time. However, with the potential
for increasing retirements, we are studying and implementing multiple
programs to ensure we meet hiring goals and have a well trained
workforce with the needed level of expertise. These programs include
targeted recruitment, marketing and advertising, as well as integrating
skills assessments into the hiring process. We are also expanding
strategic use of reemployed annuitants to enhance our training efforts
for newly hired MCO positions. Use of reemployed annuitants has proven
to be very successful. However, use of this program continues to
require special authority and/or legislative change to ensure there is
no impact on the annuitant's retirement income.
The IRS continuously reviews its programs to market itself as an
``employer of choice''. Relationships have been established with
veteran's organizations such as Military.com, Operation Warfights (DoD)
and the Department of Veterans Affairs ``Coming Home to Work Program''.
In addition, a Service-wide recruiter cadre participates in targeted
events at colleges and a video game-like tool is being developed to
target high school students for a possible career with the IRS. Work
life flexibilities, such as telework and alternate work schedules, are
also touted as tools to provide/ maintain a work life balance and
achieve business goals.
The IRS is currently challenged in the area of retaining some new
hires. New hires in MCO positions, such as Revenue Agents, are being
lost about one year ahead of the past trends. The trend is being
monitored and addressed through the use of: exit interviews; a
retention benefit index model; training and development studies; and
continued analysis of workforce drivers. The IRS has also adopted a
corporate incentive strategy that allows for recruitment, relocation
and retention payments for hard to fill positions.
In addition, we are focusing efforts on identifying and moving
employees into career paths for leadership. The IRS has established a
comprehensive Leadership Succession Review program that provides a
systematic approach to identify a leadership pipeline of high
performers early in their career. We expect that these efforts will
help us understand the causes of attrition and reduce the overall
impact on the organization.
Minority Question for Linda Stiff, Acting Commissioner, Internal
Revenue Service
1. Can the Internal Revenue Service please estimate the impact on the
federal treasury from corporate and personal income taxes over
the life of an oil and gas lease?
ANSWER: Perhaps the best approach to this request would be to
develop a profile of a ``typical'' oil and gas property, with estimates
of the costs incurred and revenues generated over the production life
of that property. Then a set of assumptions would be made regarding the
tax characteristics of the owner of that property and these
characteristics would interact with the revenue stream and costs
incurred to generate a set of estimates of income taxes due on the
earnings from that property.
Unfortunately, the income tax return of an investor in an oil and
gas property does not contain sufficient information for the Internal
Revenue Service to estimate the revenues, costs, and ultimately the
total amount of individual and corporate income taxes paid over the
life of an individual oil and gas property. The Department of Energy,
in conjunction with the Office of Tax Policy at the Department of
Treasury, is probably in the best position to answer a request along
these lines.
______
STATEMENT OF DENNIS ROLLER, ROYALTY AUDIT SECTION MANAGER,
OFFICE OF THE STATE AUDITOR, NORTH DAKOTA
Mr. Costa. Our last witness is Mr. Dennis Roller, who is
the Royalty Audit Section Manager for the Office of the State
of North Dakota. I assume that when you testify this morning,
Mr. Roller, that you also do so with the fact that you meet and
confer with other auditors from other states throughout the
country and with tribal groups, and that there is a general
sense of the challenges you face.
Mr. Roller. Yes, sir.
Mr. Costa. Yes, you do?
Mr. Roller. Yes, we do. Yes, I do.
Mr. Costa. You like my statement. OK.
Mr. Roller. It is not STRAC's voted upon view, but there is
general consensus, as I state, to my testimony and certain
areas that need review or need a tune up.
Mr. Costa. Thank you.
Mr. Roller. Mr. Chairman and members of the Committee,
thank you for the opportunity to comment and share my views
concerning the wide array of challenges faced by the Minerals
Management Service and state and tribal compliance delegations.
The first major challenge we are facing is a state of
misreporting of the oil and gas operations report, or OGOR, the
production reporting document, and the MMS 2014s, as a payment
reporting document. Many state and tribal delegations have
expressed their concerns over the lack of correct reporting and
additional compliance hours used because of the incorrect
reporting, as has the GAO earlier today.
This reporting issue goes to the core of having an
effective and efficient Royalty Management and Compliance
Program. Having complete and current OGOR data is one of the
first steps in having an efficient and effective compliance
system. The MMS does not have complete and current OGOR data.
The next step to have an effective Royalty Compliance
Program is having correct and complete 2014 data. The FBMS
states that overall, company 2014 reporting accuracy is around
97 percent, but that measure is based on the percentage of
lines processed through the MMS acceptance system the first
time.
This appears to be a good measure. The problem is that
there are very few edit checks in the acceptance system, so
very few lines are not accepted the first time. Because of the
lack of correct and complete 2014 reporting our audits now
entail a reconciliation of all 2014 payments made by a company
for the review period in order to determine what the company
intended to report and pay.
In my written testimony, I explained what is meant by
reconciling every single 2014 payment. In general, it means
that the lease number or agreement number was not reported
correctly, and we have to try to determine what the correct
lease number or agreement number is.
An IRS comparable scenario of this would be if I file my
taxes under Friend A's Social Security number and Friend A
files it under Friend B's Social Security number, et cetera.
You can see the mess that would present for Social Security
retirement benefits.
Comparing the OGOR data, what volume we expect to receive
royalties on, to what was actually received, 2014 payments, is
a must in order to have an effective and efficient compliance
program. Another area of concern that has been expressed to me
by several delegations is interest. The MMS reengineered system
did not have an interest module to bill late payment interest
until May 2003.
In a recent IG report, the MMS stated that interest will be
caught up by the end of Federal Fiscal Year 2007, but based on
the interest data the MMS has provided, there are many
compliance royalty collections and late paid royalties for
which interest has not been billed.
More importantly, we have determined that in many instances
when a company pays the royalties late the system doesn't bill
late paid interest and doesn't recoup the interest that was
paid to the company on their estimate. In essence, the company
is paid interest to pay their royalties late.
Another area of concern expressed by several delegations is
MMS's unwillingness to accept STRAC input or make a STRAC
suggested change. An example of this is STRAC's written request
on January 15, 2003, to then director, R.M. Johnnie Burton to
immediately withdraw the guidelines regarding statute of
limitations for demands, orders and appeal decisions for
Federal leases.
Under these guidelines, MMS required: 1) that the
prospective only statute of limitations enacted under RSFA be
applied retroactively to oil and gas production; and 2) that
RSFA statute of limitations apply to solid minerals, although
not covered under RSFA. The result of the guidelines was that
appeals were being lost, demands for payments were not issued,
audits were closed and royalties uncollected.
The dollars lost is unknown because MMS never evaluated the
impact of the guidelines before issuing them, making them
binding on the state delegations. In 2007, the U.S. District
Court for the District of Columbia, in a suit brought by the
California State Controller invalidated the guidelines as
arbitrary and capricious noting as grounds many of the
arguments STRAC made to MMS in 2003.
In November of 2007, the MMS director issued a memorandum
rescinding those guidelines, yet, MMS has done nothing to date
toward collection of royalties impacted by the guidelines.
Another area of concern, as expressed by several delegations,
states mainly, as it does not affect tribes, is the net receipt
sharing or the administrative provision which reduces by two
percent the state's share of the royalties from public domain
lands.
The two percent results in approximately a $40 million
decrease in royalty revenue to states from which the minerals
are produced. However, every U.S. citizen benefits from the
royalty revenue program because of the revenue generation of
the program. If every U.S. citizen benefits from the program,
then why is the cost of administering the program being
unfairly applied to only the states that produce the Federal
mineral.
The final area that I was asked to discuss is the RPC
report on MMS. I was asked as STRAC's chair to discuss STRAC's
opinion and views of the report. Unfortunately, due to the
timing of this hearing and the report, STRAC has not had an
opportunity to meet as a whole and discuss the report. However,
several STRAC delegations have provided comments to me upon
learning that Congress wanted STRAC's views of the report.
Those have been included in my written testimony. A general
summation of those comments, as the report highlights, many
important areas of concern, but STRAC delegations should have a
voice in how those concerns are addressed and corrected. In
closing, this is about giving the U.S. citizens what they
deserve: an effective and efficient Royalty Management Program
for their minerals.
Ultimately, it is about data management, and without good
data, the program cannot be effective and efficient. This
concludes my testimony. Thank you for the opportunity to appear
before the committee today. I will be happy to answer any
questions you may have and go into more details.
Mr. Costa. Thank you very much, Mr. Roller. We appreciate
your testimony.
[The prepared statement of Mr. Roller follows:]
Statement of Dennis Roller, Audit Manager for the North Dakota State
Auditor's Office--Royalty Audit Section, Minerals Management Service
Mr. Chairman and members of the committee, I want to thank you for
the opportunity for me to comment and share my views concerning the
wide array of challenges faced by the Minerals Management Service and
State and Tribal compliance delegations.
The North Dakota State Auditor's Office Royalty Audit Section (ND
delegation) was created in 1982 under the authority of section 205 of
the Federal Oil and Gas Royalty Management Act of 1982 (FOGRMA). For
the past 25 years the ND delegation has performed compliance work on
federal mineral royalties paid in North Dakota.
The ND delegation from 1982 through 2001 collected over $26.6
million. During that same period, the costs of the ND delegation were
less than $4.2 million. That's over $6 of revenue for every $1 spent.
For all States that had a 205 delegation for 1982 through 2001 the
total collections were over $296.5 million, while costs were under
$58.5 million.
Given the delegations success in the past, I would like to discuss
some of the challenges the MMS and the delegations are currently
facing.
Before I go into those challenges however, I would like to express
that my testimony is not being given without some trepidation. I'm
testifying in the hopes and beliefs that the royalty compliance program
will be improved for the benefit of all U.S. citizens. However, my
testimony about the challenges and ineffectiveness of the program may
be viewed differently by the Department of Interior, who is in control
of ND's delegation contract funding.
In fact, in October 2006, a now former high ranking MMS official
advised several STRAC delegation managers (including myself) to not
testify at the upcoming House and Natural Resources Subcommittee
hearing that eventually took place on March 28, 2007. This official
expressed to us that Congress only requests that you testify so you
aren't obligated to testify and that it is best to keep any problems in
house. I'm of the view that as a government employee we are to serve
the people and accountability to the people is a priority.
That said the first major challenge is the state of misreporting
for the MMS 2014s, payment reporting document, and the Oil and Gas
Operations Report (OGOR), production reporting document. Many State and
Tribal delegations have expressed their concerns to me and others over
the lack of correct reporting and the additional compliance hours used
because of the incorrect reporting.
With the re-engineered system that went into place on November 1,
2001, the MMS changed the property numbering system used by company's
to report the 2014s. The MMS also stopped doing any automated
comparison of the OGOR and the 2014. Without any automated check,
company reporting accuracy has drastically deteriorated.
This issue goes to the core of having an effective royalty
management program and an effective compliance program. Having correct
and current OGOR data is one of the first steps in having an efficient
and effective compliance system. Without complete and current OGOR
reporting, the MMS does not know what they should be being paid
royalties on. The ND delegation recently sent 48 different properties
to MMS for which OGOR reporting was at least six months behind and in
some cases OGORs had not been filed for over two, three or more years.
In one case, the property started production in February 2002 and no
OGORs had ever been filed. The ND delegation is aware there are even
more properties in ND for which the OGOR filings are late or never been
done, but has not had the time to complete this reporting project (the
known unreported OGORs in ND are for CY05 or later--a period for which
the ND Delegation has not done our automated comparison for--so when we
do that period these unreported OGOR issues will be addressed). Having
complete and current OGOR data is one of the first steps in having an
efficient and effective compliance system and the next step is having
correct and complete 2014 data.
Because of the lack of correct and complete 2014 reporting, our
audits now entail a reconciliation of every single 2014 payment made by
a company for the review period in order to determine what the company
intended to report and pay.
Here's an example of a recently worked ND delegation case depicting
this (with the well name, lease numbers and company name changed).
Federal well #1 is a lease well on lease A (meaning that 100% of the
wells production is attributable/payable to that lease). For January
2003 through July 2003, Company XYZ paid (2014 reporting) well #1's
sales incorrectly to communitization agreement #410, and allocated 75%
to lease A and 25% to lease B. For July 2003, Company XYZ paid 100% of
the sales to lease B. For August 2003 through June 2004, Company XYZ
again paid well #1's sales to communitization agreement #410, and
allocated 75% to the lease A and 25% to lease B. For July 2004, Company
XYZ paid 100% of well #1's sales to lease C. Finally, for August 2004
through December 2004, Company XYZ paid well #1's sales to unit #160,
and allocated 58% to lease A, 2% to lease C, 16% to lease D and 24% to
lease E. Net effect being that Company XYZ paid royalties on 100% of
the production from well #1, so no additional royalties are due, but it
was never once paid to the correct property on the 2014.
In this instance, the land types for all leases were the same
(acquired lands) and thus there was not a land type issue. If the
incorrect reporting crosses land types then the incorrect entity
receives the royalties, public domain lease is distributed 48% to the
State and 52% Federal Government, versus an acquired lease distribution
of 75% Federal Government and 25% to the county from which the mineral
was produced.
An IRS comparable scenario of this would be if I filed my tax
return using friend A's social security number, and friend A filed his
taxes under friend B, and so on. If you tried to file your taxes with
the wrong social security number electronically the IRS would not even
accept them, because the social security number did not match the name.
This ``reconciliation'' process (determining where the payments
made by the company actually belong) has added a tremendous amount of
hours and inefficiency to our audits. In order to combat this, the ND
delegation requested the authority to perform volume and royalty rate
automated verifications on October 1, 2005, as allowed for under the
Federal Oil and Gas Royalty Simplification and Fairness Act of 1996
(FOGRSFA). The ND delegation was denied that request on January 20,
2006. However, the ND delegation later was granted by MMS the ability
to perform limited scope compliance reviews using our comparison tool.
The ND delegation has been performing limited scope oil volume and
royalty rate compliance reviews (an automated comparison of the OGOR to
the 2014 for oil) since October 1, 2006 and have discovered countless
reporting issues, non payment issues, missing reporting documents
issues and two company's that just quit paying their federal royalty
obligation in ND. The ND delegation has taken on this comparison
process at a time when ND's delegation funding has went from 6 FTE to 4
FTE and the audits we perform have become complicated by the
misreporting, as already discussed.
The ND delegation efforts in this area for royalties paid for CY01
through CY02 resulted in identification of nearly $200,000 of
incorrectly paid royalties at a cost less than $30,000. The automated
comparison process that MMS used to perform was as successful too. Per
the 2001 Minerals Management Service budget justification document, the
last year such collection data was reported by the MMS, the AFS/PAAS
automated comparison process collected $56.2 million in additional FY98
paid royalties and per the 2000 budget justification document the AFS/
PAAS comparison collected $32.7 million for FY97 paid royalties.
Comparing the OGOR data (what volume we expect to receive royalties
on) to what was actually received (2014 payments) is a must in order to
have an effective and efficient compliance program.
This OGOR-2014 automated comparison process was a recommendation of
the Fiscal Accountability of the Nation's Energy Resources of January
1982, commonly referred to as the Linowes Commission, which was the
driving force for the creation of the MMS. Recommendation #5 of the
internal controls section (Chapter 3) of the Linowes Commission report
states ``That the Federal royalty managers incorporate production data
into the royalty management system in order to cross check the data
with sales and royalty data for all leases each payment period.''
(emphasis added) The MMS did this automated comparison for years,
commonly referred to as the AFS/PAAS comparison. However, since the
implementation (11/1/01) of the re-engineered system this is no longer
done.
Another area of concern that has been expressed to me by several
delegations is interest. The MMS re-engineered system (implemented 11/
1/01) did not have an interest module to bill late payment/collection
interest until May 2003. In a recent IG report the MMS stated that
interest will be caught up by the end of Federal Fiscal Year 2007 (9/
30/07). However, based on the interest data the MMS provided the ND
delegation through September 30, 2007 (the MMS has not yet provided any
interest data information beyond September 30, 2007) there are many
compliance royalty collections and late paid royalties for which
interest has not been billed as of September 30, 2007.
In addition and more importantly, the ND delegation has determined
that in many instances when a company pays their royalties late the
system doesn't bill late paid interest and doesn't recoup the interest
that was paid to the company on their estimate. An estimate is like a
security deposit. It stays with the MMS until the company is no longer
the payor and it allows the company to pay the royalties for the lease
one month later than originally due.
For example, Company A has a $10,000 estimate for lease 55555.
Company A pays $10,500 for January royalties on April 1, one day late
since the January royalties are due the last day of February but
because of the estimate they are due the last day of March. Because no
royalties were paid by the due date (March 31) the system assumes no
royalties are due and automatically calculates and pays interest to
Company A for the entire month of March on the company's $10,000
estimate. On April 1st, the system should determine that the January
royalties of $10,500 was paid late and bill Company A interest for 1
day on $10,500 and also bill Company A interest on $10,000 for the
Month of March (recoup the interest paid on the estimate because the
system assumed no royalties were due when in fact there were royalties
due that were just paid late). The ND delegation has discovered that
the calculation and billing of this interest often doesn't occur. In
essence, Company A was paid interest to pay their royalties late.
Specific examples of this can be provided by me upon request.
Another area of concern expressed by several delegations is MMS'
unwillingness to accept STRAC input or make a STRAC suggested change. A
good example of this is MMS' Government Performance Results Act (GPRA)
goals. MMS set the goals based on dollars voluntarily paid by the
company (2014 payments). The delegations for years argued that is not a
good way to set goals (what about the property for which nothing is
paid on but there should be royalties paid--one that compliance work
should be done on--but you accomplish $0 toward the GPRA goals because
$0 was paid on the property--it moves the compliance efforts away from
severely under paid properties because less of the goal is
accomplished). MMS refused to change the goals until a recent Inspector
General report stated the goals should be revised.
An even better example of this is STRAC's written request to then-
Director R.M. ``Johnnie'' Burton to immediately withdraw the
``Guidelines Regarding Statute of Limitations for Demand, Orders and
Appeals Decisions for Federal Leases'', which was approved on October
15, 2002. Under these Guidelines, MMS required: (1) that the
prospective only statute of limitations, enacted under the Royalty
Simplification and Fairness Act (RSFA), be applied retroactively to oil
and gas production, and (2) that the RSFA statute of limitations apply
to solid mineral royalties, although not covered under RSFA.
The result of the Guidelines was that appeals were deemed lost and
royalties uncollected, although MMS could claim a reduction in the
number of outstanding appeals. Also, demands for payments were not
issued and audits were closed. The dollars lost is unknown because MMS
never evaluated the impact of the Guidelines before issuing them and
making them binding on the State delegations.
On January 15, 2003, STRAC warned MMS that the Guidelines were of
doubtful legality and that they would most likely result in an
unnecessary litigation, but STRAC's concerns were dismissed. In 2007,
the U.S. District Court for the District of Columbia, in a suit brought
by the California State Controller, invalidated the Guidelines as
arbitrary and capricious, noting as grounds many of the arguments STRAC
made to MMS in 2003.
On November 17, 2007, MMS Director Randall Luthi issued a
memorandum rescinding the Guidelines. Yet, MMS has done nothing to date
towards collection of royalties impacted by the Guidelines.
A final example of MMS not willing to accept input from STRAC is in
the development of the recent Compliance Program Tool (CPT). CPT is a
new MMS tool (STRAC delegations were provided training on the tool in
mid CY07) used by MMS to perform their compliance reviews. In this
instance, the MMS didn't even ask STRAC for input, even though they
profess STRAC to be their partner. They developed the tool and they
want all the delegations to use it, but unfortunately the tool is
ineffective because the tool was built backwards. Instead of starting
with production data (OGOR) and then comparing that to 2014 data, MMS
used their GPRA philosophy of starting with dollars voluntarily paid
(2104 payments) and then compared those to the OGOR. What this means,
is that for all the OGORs that no payments were received (the ones that
compliance should be looking at), the CPT tool doesn't show a
difference (because there was no 2014 and thus there is no starting
point). I refer you back to the earlier example of lease well #1's
royalties being attributed 100% to lease A--but no payment was made as
a lease well to lease A so the CPT would not show a difference. If MMS
would have asked STRAC for input, this fatal tool error could have been
avoided.
An IRS comparable scenario of this would be me not filing my taxes
and the IRS never catching that I didn't file any taxes because there
were no taxes filed by me in the universe that they looked at (taxes
paid), even though the State of ND files with the IRS a w-2 showing
that they paid me a salary.
Another area of concern as expressed by several delegations (States
as it does not affect Tribes) is the net receipts sharing or the
administrative provision which reduces by 2% the States share of the
royalties from public domain lands as established under the Minerals
Leasing Act. This was passed as part of the Federal Fiscal Year 2008
Interior Appropriation Bill (HR2764) and is again included in the
Presidents Budget for Federal Fiscal Year 2009. The 2% results in
approximately a $40 million decrease in Mineral Leasing Act royalty
revenue to the States from which the minerals are produced. However,
every U.S. citizen benefits from the royalty revenue program because of
the revenue generation of the program. If every State benefits from the
program, then why is the cost of administering the program (2%
reduction of States share) being unfairly applied to only the States
that produce the Federal Mineral? Plus, it's applied by the States with
the most production shouldering the most administrative costs. Why
should the States that produce the Federal Mineral, for the benefit of
every U.S. citizen, solely bore the costs of administering that
program?
Should the State of Montana bore most of the Core of Engineers
costs associated with administering the dams on the Missouri River just
because the majority of the water was originally produced from the
mountains of Montana? No, the whole country benefits from those dams
through electricity generation, barge traffic, water supply for cities,
etc., so the cost should be bore by the country as a whole (Federal
Government), not mostly by the State of Montana.
Should the State of Florida or Arizona pay more of the
administration cost of the Social Security Benefit Program because they
have more retirees in those states?
Secondly, the 50% State share as provided for originally under the
Minerals Leasing Act was provided to the States because the States and
Counties within the States were incurring large infrastructure and
maintenance costs (road building, maintenance of roads costs, etc.)
from development of the minerals on Federal Lands. However, the States
and Counties did not receive any revenues from those lands (through
taxation, royalties, agricultural use, etc.). So the Mineral Leasing
Act provided the States 50% of the royalties to compensate for the loss
of revenues from the Federal Lands (Bankhead Jones Act provided 25% to
the Counties for acquired lands). Today the lack of revenue generation
(other that the sharing of the royalties as provided for by the Mineral
Leasing Act and the Bankhead Jones Act) from those Federal Lands is
still the case, so why should the State's share to compensate for the
lack of revenue be reduced by 2%?
The final area that I was asked to discuss is the Royalty Policy
Committee (RPC) report on MMS. I was asked as STRACs chair to discuss
STRAC's opinion and views of the report. Unfortunately, do to the
timing of this hearing and the report, STRAC has not had an opportunity
to meet as a whole and discuss the report. However, several STRAC
delegations have provided comments to me upon learning that Congress
wanted STRAC's views of the report. See attachment 2 for a summary of
those comments about the recommendations. Note that these are not STRAC
views as a whole, just a summation of views as presented by several
STRAC delegations to myself.
I would sum up the comments on the RPC report to be that the report
highlights many important areas of concern, but STRAC delegations
should have a voice in how those concerns are corrected and addressed.
In closing, the STRAC delegations have been very successful in the
past at collecting additional royalties owed from Federal Lands.
However, the MMS has consistently shown over the last several years
that they are not interested in accepting STRAC's opinion or more
recently even willing to ask for STRAC's opinion, despite the fact that
they profess STRAC to be their partner. With the increase in oil and
gas prices over the last two years bringing on a flurry of activity
that hasn't been seen for over twenty years, now is not the time to be
reducing audits and compliance activities and resisting improving a
system that has many problem areas.
This concludes my formal testimony. Thank you for the opportunity
to appear before the Committee today. I will be happy to answer any
questions you may have and to go into more detail surrounding these
issues.
______
Attachment 1
State and Tribal Royalty Audit Committee
State of Alaska Blackfeet Nation State of California
State of Colorado Crow Tribe Fort Peck
Tribes Jicarilla Apache Tribe State of Louisiana
State of Montana Navajo Nation State of New
Mexico State of North Dakota State of Oklahoma
Shoshone & Arapaho Tribes Southern Ute Indian Tribe
State of Texas State of Utah Ute Indian
Tribe Ute Mountain Ute Tribe State of Wyoming
,-- ,
Jay Norman, Chairman (505) 827-0986 Former Ex Officio:
Harold St. Goddard, 1st Vice Chair (435) Ellwood V. Soderlind
722-5141 (307) 777-6467
lnge-Lise Goss, 2nd Vice Chair (801) 297-
4608
January 15, 2003
R. M. "Johnnie" Burton, Director
Minerals Revenue Management
Minerals Management Service
1849 "C" Street NW. Room 4212
Washington, D.C. 20240
Dear Ms. Burton:
On behalf of the State and Tribal Royalty Audit Committee (STRAC),
we are writing to request that you immediately withdraw the
``Guidelines Regarding Statute of Limitations for Demands, Orders and
Appeals Decisions for Federal Leases,'' which were approved by you on
October 15, 2002. With all due respect, the ``Guidelines'' cannot be
considered legally binding upon pending appeals and audits involving
any minerals produced from Federal lands prior to September 1996. The
``Guidelines'' are inconsistent with the Royalty Simplification and
Fairness Act (RSFA) and its legislative history.
Under RSFA, Congress set a 7 year statute of limitations on
judicial actions and demands relating to oil and gas produced from
Federal leases after August 1996. 30 U.S.C. '1724(b)(l). Under the
``Guideline'' the preclusive reach of '1724(b)(l) would be expanded, as
a matter of MMS policy, to include the following additional categories
of royalty matters:
Orders to perform issued both before and after the
'1724(b)(l) effective date;
Pending administrative appeals of demands for royalties
owed on oil and gas produced before the '1724(b)(l) effective date;
Pending audits of royalties on oil and gas produced
before the '1724(b)(l) effective date, including outstanding issue
letters, draft demands or demand letters resulting from such audits;
Audits, demands, orders to perform and appeals, related
to minerals other than oil and gas produced from Federal lands either
before or after the '1724(b)(l) effective date.
Under the terms of the ``Guidelines,'' the Minerals Revenue
Management and Appeals Division staff, as well as auditors under RSFA
Section 205 audit agreements, are required to implement this guidance
effective immediately. In short, through this policy statement, MMS has
legislated its own 7 year statute of limitations applicable to audits,
orders, demands and appeals not covered by RSFA '1724(b)(l).
As set out in the ``Guidelines,'' the only way that an audit
program can avoid application of this binding norm \1\ to the royalty
matters listed above is through retroactive application, often post-
audit, of a fact bound campelling circumstance standard that has no
known statutory origin. While MMS staff has informed us that all of the
factual circumstances that may be considered compelling, are not set
forth in the Guidelines, both that standard and the 7 year norm
substantially limit audit judgment and discretion. \2\ Moreover, the
``Guidelines'' are currently being applied by MRM/Lakewood to reduce
State drafted demand orders without the benefit of any standards on
what will be considered a compelling circumstance, other than the
``Guideline'' examples. \3\
The only legal justification for the policy set forth in the
``Guidelines,'' is the legislative intent of RSFA not to pursue claims
for royalties due more than 7 years before a demand or order to pay or
to perform restructured accounting.(p.2) With regard to this
justification, STRAC briefly notes the following:
Through Section 11 of RSFA, Pub. L. 104-185, 30 U.S.C.
Sec.1701 note, Congress provided that RSFA amendments shall apply with
respect to production of oil and gas after the first day of the month
following the date of the enactment of this Act [August 13, 1996],
unless a particular provision specified otherwise. RSFA, including the
7year limitation period, was intended to be applied prospectively only.
The statute of limitations established here [RSFA] is prospective only,
meaning that obligations arising from production of oil or gas from
Federal leases prior to enactment of this bill are not affected, House
Report 104-667, p. 18, reprinted in 1996 USCAN 1442, 1447-1448
[emphasis supplied]. Instead of being supported by RSFA's legislative
intent, the policy set forth in the ``Guidelines'' is directly contrary
to Congress's expressed intent under RSFA and contrary to standard
principles of statutory construction. See e.g., 73 Am. Jur. 2d Statutes
'245 (even where congress is silent, the presumption is that a statute
is prospective only); Chevron USA, Inc., v. NRDC, 467 US. 837, 842-843
(1984) (agency must give effect to the unambiguously expressed intent
of Congress).
Under its plain language, RSFA's 7 year limitations
period does not apply to orders to perform restructured accounting,
whether those orders are issued before or after August 1996. Instead,
RSFA's 7 year limitations period applies only to a judicial proceeding
or demand. 30 U.S.C. '1 724(b)(l). A demand, as defined in RSFA Section
1, 30 U.S.C. '1 701 (22), includes only orders to pay, not any and all
Administrative orders as stated in the ``Guidelines"(p.l). Applying the
7 year limitation to orders to perform is inconsistent with the fact
that the statute of limitations, if one exists, is tolled once audit is
initiated \4\; limiting the scope to seven years prior to the date of
such an order does not give the public credit for the tolled period.
The expansion of the 7 year limitation to the categories
of appeals, demands and audits listed above does not comport with the
statute of limitations case law applicable to such matters.
Representatives of the Solicitor's Office have repeatedly and publicly
stated that the Department has not acquiesced in the decision in OXY
USA, Inc. v. Babbitt, 268 F. 3d 1001 (10th Cir. 2001). \5\ Even to the
extent that the decision is controlling, however, it does not preclude
all means of collection of royalty debts; it applies only to judicial
actions initiated by the Department to collect royalty debts. As the 10
Circuit emphasized, 28 U.S.C. '2415 includes two narrowly drafted
exceptions to the time-bar, permitting the government to defensively
assert time-barred claims by way of offset or counter claim. 268 F.3dat
1106. Moreover, application of the statute of limitations, if any, is
not an issue subject to administrative resolution. E.g. Marathon Oil
Co., 149 IBLA at 290-291.
Under RSFA 30 U.S.C. '1735 and its predecessor, any standards
applicable to delegated state audits are required to be promulgated by
rule, not agency proclamation. Cf: IPAA v. Babbit, 92 F.3d 1248, 1256
(D.C. Cir. 1996) nothing in DOI's procedures vest authority in the
Associate Director of MMS..., or even the Director to issue
proclamations binding on the agency. RSFA also requires that standards
be designed and implemented only after consultation with State
authorities. E.g., 30 U.S.C. 7 735(d). The ``Guidelines'' were issued
without notice to or consultation with States, and, thus, in this
respect too, are directly contrary to congressional intent.
While MMS may have some enforcement flexibility with regard to
individual royalty cases, it does not have unfettered enforcement
discretion. See e.g., cases cited supra footnote 2. In fact, Interior
shall give priority to those lease accounts identified by States and
Tribes as having significant potential for underpayment. 30 US. C.
'1711 (c)(l). This mandatory language limits any arguable power of MMS
to unilaterally discriminate among issues or cases it will pursue.
Heckler v. Chaney, 470 U.S. 821, 833 (1991).
In sum, the ``Guidelines'' are simply another instance of an
advance MMS policy statement that, as in the past, will only serve to
complicate and confuse the audit and collection process, and lead to
unnecessary litigation. There is no identification of any statutory
authorization and, to our knowledge, no Solicitor's or other legal
opinion, government regulation or case law supporting what is, in
essence, a waiver of royalty debts. Cf American Central Gas Companies,
Inc., 156 IBLA 367, 371 (2002) (MMS has no authority to waive
interest). Indeed, according to MMS staff, these guidelines were issued
without any analysis of the potential revenue loss, either in terms of
royalty income or wasted audit resources. \7\
What is even more unfortunate, in STRAC's view, is what the
``Guidelines'' suggest about Interior's current attitude toward State
and Tribal participation in the royalty audit program. State and Tribal
audit programs are not a subdivision of the Federal bureaucracy.
Instead, each STRAC jurisdiction represents an independent and
sovereign government. While there has always been some disagreements in
the relationship between the MMS and STRAC jurisdictions, it is a
working relationship that Congress sanctioned first in FOGRMA and then
in RSFA by requiring MMS to, in effect give these jurisdictions a full
seat at the table. Because of their expertise and more direct financial
interest (and because of Federal mis-steps), Congress wanted the States
and Tribes to be active participants and watchdogs over the federal
collection of revenues owed to their jurisdictions, not passive
subordinates of a Federal bureau or hapless recipients of whatever MMS
determines. The issuance of the ``Guidelines'' was not only
inconsistent with Secretary Norton's public commitment to Consultation,
Communication and Cooperation, it was also a serious step backwards in
over 20 years of slow but steady progress in forging mutually
acceptable compromises and an amicable working relationship on royalty
matters. It is particularly disheartening to see the legacy of
Secretary James Watt being casually disregarded by today's Department.
The next STRAC/MMS meeting is scheduled for February 4-5, 2003 in
Sacramento, California. We understand that you are currently scheduled
to attend that meeting. Our hope is that you will have withdrawn the
``Guidelines'' before that meeting. If not, we request that you or
someone designated by you, be prepared to respond in detail to the
legal and administrative issues out lined above. We also ask that MMS
disclose for STRAC's review all of the Departmental documentation that
would explain the genesis of the ``Guidelines''. We trust that Interior
is open to providing such information voluntarily, but nonetheless, as
a formality, we will submit a request under the Freedom of Information
Act.
If you have questions regarding this letter or the issues, please
feel free to call me at 505-827-0986.
Sincerely,
Jay Norman STRAC
Chairman
State of New Mexico
Taxation and Revenue Department
Oil & Gas Bureau
1200 S. St. Francis Drive
Santa Fe, NM 87509
[email protected]
_______________________________________________________________________
\1\ Cf. American Business Assoc. v. US., 627 F.2d 525,529 (D. C.
Cir. 1980)
\2\ Compare Shell Oil Ca. v. EPA, 950 F. 26 741, 763-764 (D. C.
cir. 1991; Alliance for Billntegrity v. Shalala, 11 6 F. Supp. 2d 166,
171 (D.C. Cir. 7P97Xenforcement Discretion limited to decisions in
individual cases; does not extend to broader policies imposed on
categories of agency matter).
\3\ The example set forth in the ``Guidelines'' (p-2) misstate the
reality of MMS's pre-1996 audit program and enforcement practice. For
example, prior to 1996, MMS and the Solicitor's Office simply refused
to use its subpoena power, despite State/Tribal requests and lessee
refusal to turn over documents. Indeed, according to MMS staff, there
are no outstanding subpoenas relating to the pre-1996 time period.
Moreover, MMS does not conduct fraud audits and never has. Thus the
examples of compelling circumstances listed in the ``Guidelines'' are
essentially administratively meaningless.
\4\ E.g. Phillips Petroleum v. Lujan, 963 F.2d 1380 (lojh Cir.
1992).
\5\ E.g. Marathon Oil Co., 149IBLA 287, 291 (1999); Amoco
Production Co., 144 IBLA 135, 140)1998)(lntQrior is not obligated to
follow decisions of federal courts, especially if contrary decisions
exist or are likely).
\6\ Cf. Opinion of Office of Legal Counsel, US. DOJ (July 28,
1998).
\7\ It was also disturbing to learn from MMS staff that, while
issued under your and the Associate Director's signatures, the
Guidelines were actually a product of a decision made elsewhere in the
Department and with little, if any, input by MMS itself.
______
Attachment 2
RPC Report Comments/Key Recommendations
Report was released without any STRAC involvement or comments. As
stakeholders we should have some say.
Report recommendations 4-1, 4-4, 4-5 and 4-9 which identify
development of Risked Based audit and compliance strategies, tools and
pilot projects. States and Tribes should be directly involved in this
development as each State and Tribe is unique in nature as it relates
to oil and gas production and valuation.
Recommendation 4-16 which identifies that the DOI should improve
processes and procedures associated with calculating interest on
royalty payments. This recommendation should go even further. DOI
should work with Congress in deleting the requirement that the federal
government pay interest on overpayments.
Recommendations 3-16 and 3-17 which identifies that the DOI/MMS
should implement gas plant studies and periodic reporting. This
recommendation, if implemented would strengthen the audit and
compliance functions and would support recommendations 3-15 and 3-27.
Recommendations 3-15 and 3-27 which identifies development and
implementation of new software to perform accounting comparisons
between Production and Royalty reporting and enforcement of accurate
reporting via written orders and civil penalties. If implemented, it
also would support validating incorrect reporting and would ensure that
the audit and compliance functions are working from accurate data.
Recommendation 5-5, 5-6 and 5-7 which identifies that the BLM/MMS
should coordinate onshore production issues in conjunction with royalty
reporting. This implementation should go beyond the Federal Government
entities and incorporate shareholders from States and Indian Nations.
On page 57, E. Royalty Collections As a Result of Audit and
Compliance Activities: It reinforces how good compliance reviews are
because of the large increase in collections as summarized in Table 9
on page 58. Are there any new compliance review collections that
wouldn't have existed through exception processing (automated), which
includes AFS/PAAS comparisons ($56 million in 1999), AFS exceptions
($12 million in 1999) and allowance exceptions ($101,000 in 1999)?
Recommendation 4-27 for revising regulations and guidance for
calculating solid minerals prices especially for non-arms-length
transactions. This has been discussed on numerous occasions at the RPC
Coal Subcommittee. If MMS implements this recommendation it will
enhance our solid minerals audits.
______
Response to questions submitted for the record by Dennis Roller, Audit
Manager for the North Dakota State Auditor's Office--Royalty Audit
Section for the Minerals Management Service
Mr. Chairman, I want to thank you for the opportunity to provide
testimony at the hearing and the opportunity to provide further clarity
and information for your additional questions.
Question 1:
Mr. Roller, if a company has an estimated payment on file, and they
don't report their royalties by the due date, the system assumes that
they didn't owe any royalties and pays them interest on the entire
estimated payment?
Answer 1:
Yes, that is correct. The system does not do a check of the
production report (Oil and Gas Operations Report - OGOR) to determine
if there were actual sales that royalties have not been paid on. It
just automatically pays interest on the estimate. Of course, with my
testimony about the state of misreporting, the check I just mentioned
would not be useful since the MMS doesn't have complete and accurate
OGOR data. It all hinges on having complete and accurate data.
Question 2:
Mr. Roller, about two years ago, the House adopted an amendment to
the Interior Appropriations bill that would have increased STRAC
funding by $1 million. It had bipartisan support, and showed our
interest in making sure that STRAC was adequately funded. Has STRAC
seen any additional funding recently?
Answer 2:
STRAC did see an increase of $500,000 in the total STRAC FFY07
budgets--per MMS. I nor does any one STRAC delegation have all
delegations budget levels to know that the total STRAC delegations
budgets were increased. The reason STRAC was given by MMS that the
increase was only $500,000 rather than $1 million is because of how MMS
views the budget. MMS feels that the base budget for STRAC at that time
was $6.9 million--which is based on the 1996 DOI budget justification
document (page 134). In the 1996 DOI budget justification document,
$6.9 million was requested as STRAC funding. Since 1996, MMS does not
mention total STRAC funding in their budget justification document.
Instead, the MMS tells STRAC that the base funding is $6.9 million and
any additional funding the MMS gives STRAC is out of the MMS budget. So
for FFY06, the MMS funded STRAC at $8.6 million ($6.9 million base and
then $1.7 million out of the MMS budget). Then in FFY07 (the year
Congress adopted an amendment for $1 million more funding for STRAC),
the MMS funded STRAC at $9.1 million ($6.9 million base, $1 million
amendment, and $1.2 million out of the MMS budget).
Question 3:
Mr. Roller, I understand you have an example where a company
reported a negative royalty by accident and got paid interest on that.
Could you explain that situation?
Answer 3:
Because of the proprietary nature of the company 2014 reporting I
will change the company name when I explain the situation. See Exhibit
I for the detailed 2014 and interest lines and see below for a written
explanation.
For the October 2001 oil sales on lease 2550898320, due November
30, 2001 (the company did not have an estimate), XYZ Company in May
2002 paid on document # ROY100011534 a negative $928.11. The MMS paid
XYZ company interest in the amount of $22.41 (interest invoice
#INT100015538)--interest calculated from the due date of November 30,
2001 until the paid date in May 2002. The interest was paid as the
system assumed it was an over payment (since it was negative payment).
Then in June 2002 on document #ROY100014923, XYZ Company paid $928.11
making the royalty royalties paid for October 2001 to be $0. The MMS
then billed interest of $3.56 (interest invoice #INT100036045) for the
late paid royalties. I have no clue how the interest was calculated as
it should have been calculated from the due date of November 30, 2001
to June 2002 when paid--but that would be more than what was originally
paid to XYZ of $22.41. In fact one month's interest at the 6% rate
applicable at the time on $928.11 is over $4.50, so I'm puzzled how the
amount billed is only $3.56. Finally, in May 2007 the company paid over
$7,300 (based on a ND OGOR to 2014 comparison finding) for the October
2001 royalties on document #ROY100154907. No interest to date has been
billed on this collection (latest interest information MMS has provided
is through December 2007). Although, today (3/27/08) in a conference
call with States and Tribes the MMS director, Randall Luthi, assured us
that interest billing was current. Net effect is that the company has
been paid $18.85 ($22.41 paid to XYZ less $3.56 billed to XYZ) to
borrow money from the MMS for a month and to pay their $7,300 of
royalties owed over 5 years late.
I hope these additional answers and explanations help you to better
understand my testimony and the challenges the delegations have and are
currently facing.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Mr. Costa. Director Luthi, in reference to the comments
that Mr. Roller made, last year, as you know, a Federal Court
ruled that the Minerals Management Service's guidelines about
not pursuing certain unpaid royalties were unlawful.
About a week and a half ago I sent you a letter that was
signed by some of my colleagues asking for details on how you
were planning to follow up on the cases that you stopped
because of the, as the Court said, unlawful guidelines. Can you
provide any information yet, and what the follow-up is on these
cases that were dropped?
Mr. Luthi. Thank you, Mr. Chairman. I did receive your
letter. We put it into our system, and I had asked to get a
response as soon as possible. I would like to wait until that
written response is available so I know it is accurate.
Mr. Costa. All right. Well, speaking of your system, I
understand that Accenture, the computer company or the company
that was contracted with, received $150 million on a program
that it seems, based on the testimony here this morning, isn't
working, at least to the expectation levels. Some have said it
is a failure. Some said that, in part, because a new contract
was awarded last fall.
When you awarded the new contract last fall, did you factor
in the shortcomings of the previous contract, and are we going
to be able to get beyond this, what I would refer to as green
eye shade approach of accounting that the Department seems to
be plagued with?
Mr. Luthi. Mr. Chairman, appreciate the question. Accenture
was the contractor that put together this system. As you might
guess, this isn't an off the shelf system, and now, frankly, it
has been a challenge to make it work. The award that you
mentioned last fall is currently under review one more time
because one of the other contractors asked some questions, and
we are going back and looking at the award.
I think in general the answer to your question is it is a
system that has not been perfect, we have had to go in and make
several changes to it, but it is to the point now where it is
working and it is working I would say for the most part
effectively. We are going to continue to work with it. I think
it is going to make more financial sense to stay with the
current program rather than try to throw it out and start all
over again.
Again, it is not a system that you normally see. It has to
be a system that can calculate interest, which was difficult
for it to do, it has got to recognize different production
values----
Mr. Costa. I appreciate the complexity, but this is
something that we will continue to follow obviously. It seems
to frustrate a lot of us. Mr. Finfer, could you describe a
little more detail what MMS could learn about how the Internal
Revenue Service handles its compliance activities?
Mr. Finfer. Yes, sir. We consulted with the IRS on the
risk-based approach. Again, they have 40 years more experience
in this.
Obviously they are dealing with a much more complex
universe, many more industries, many more layers and so on, but
in meeting with a wide variety of their senior managers, and I
must say IRS was very generous about affording us the time with
them, one of the key things that came out was you have to have
a very strong data support system and underlay.
Without good data, without reliable data and data system
support it is very hard to implement a risk-based approach.
Another thing was that you are never in a situation where you
can set it and forget it. Your work is never done. What is
today's big risk may not be a big risk tomorrow and vice versa,
so you have to constantly evolve the system through constant
evaluation, feedback, retooling and so on.
Third, that a fundamental objective of a risk-based
approach isn't necessarily increasing collections, per se, but
it is identifying behaviors which might not necessarily be
costing the taxpayers a lot of money now but if they
proliferated would cost a lot of money and getting on those
quickly so that you don't create problems. Those were among the
many key insights.
Mr. Costa. No, and there were a lot of recommendations. My
time is quickly going. I am really intrigued with this further
development. I was talking with the Ranking Member on risk
assessment versus risk management because, frankly, I think
there is a lot to be gained in that area. I also believe,
whether we are talking about in this instance or whether we are
talking about health and safety, it is one of the areas that we
in government generally perform poorly.
That is my opinion. Quickly, your reports mention the
possibility of an alternative government structure for the
Royalty-in-Kind Program. Could you describe what those are?
Mr. Finfer. Yes. Royalty in kind involves the government
operating an enterprise pure and simple. Unless one is opposed
to that, and some are, but if you are not opposed to that then
obviously the goal needs to be to enable it to operate
effectively as a business to get the greatest net returns for
the taxpayers.
So we recommended a cost benefit analysis of potential
alternative governance structures. This might include, for
example, something comparable to what is called an FFRDC,
Federally funded research and development center, like the
National Labs. Those sorts of entities are tied to the
respective departments, in that case, DOE, and in this case it
would be tied to Interior and MMS.
The advantage of that structure is that they would be freed
from some of the strictures that inhibit the ability of the
program to operate like an enterprise. For example, some of the
personnel requirements they would be free from so that they
could compete to get high quality personnel, there wouldn't be
any question about whether they had followed contracting
procedures that other programs might have to follow.
However, we said at the same time that if an alternative
governance structure is proposed to the legislation it would
need to be balanced by heightened oversight. There is a trade
off here. If you are going to get more freedom to operate, you
also need to have heightened oversight.
In that case, we recommended the establishment of an
independent oversight board which would have the power to make
recommendations to the Secretary which the Secretary would have
to respond to with a published finding as to why he or she
accepted, modified or rejected the board's recommendations.
Mr. Costa. All right. I have gone beyond my time, but I
would like to ask unanimous consent that a statement from the
Project on Government Oversight be entered into the record.
Without objection.
Mr. Pearce will be the last questioner. With his
indulgence, though, if you could give me a quick response, Mr.
Roller, do you see any positive changes as a result of the
recommendations MMS has already implemented? Quickly, because I
have exceeded my time.
Mr. Roller. To be honest, I haven't had any experience in
knowing what recommendations have been implemented that weren't
discussed with STRAC or anyone.
Mr. Costa. Well, obviously you can answer it very quickly
then. I may follow up with you then on that question. The
gentleman from New Mexico has his time, and when he completes
his questioning we will conclude this hearing.
Mr. Pearce. Well, we may not complete my questioning until
2:00 or 3:00 then. I am sorry to hear the gentleman say that.
Mr. Costa. I won't be here until 2:00 or 3:00.
Mr. Pearce. OK, thank you, Mr. Chairman.
Mr. Costa. Godspeed.
Mr. Pearce. Mr. Luthi you heard the testimony of Mr. Rusco
feeling like all the oil and gas operators are out there to
cheat the American government and the American people. What
would it take to cheat on your royalties? Beginning at what
level to be significant?
Mr. Luthi. Thank you, Mr. Chairman.
Mr. Pearce. Scoot it closer, if you would, and push the
button. There we go.
Mr. Luthi. There we go. To paraphrase your question a
little bit, what would it take to cheat on the royalties? It
takes quite a complicated process as far as I can understand
because your royalty is developed upon a basic formula of
volume, value and the royalty that is set. The only set
standard there is the royalty amount, rather, the 18 and three-
quarters percent, 12.5 percent, whatever that is.
So then you go back and you look at the volume and the
value of either the gas or the oil. The volume is normally run
through at least one, if not several, meters, so there is an
opportunity to----
Mr. Pearce. So you would have to have meters that don't
work that have been jimmied with, and then you would have to
have complicity up and down. In other words, if the guy at the
top, the CEO, says cheat, you have to have the mid-level say
cheat, and then he has got to have a guy at the field level say
cheat and they all have to kind of agree, but then you have
different operators at the well.
So if I can get this guy over here on the ground that
actually pumps and works that well to cheat, I have to also get
every single guy out there at field level. CEO, you could get
one guy that issues the instructions, then you get different
mid-level people, but you have individuals on the ground.
If one of them says I am not going to do that, I am going
to report, isn't that--I just find that absurd that we have a
GAO report that begins to say that we have that sort of--have
you all stumbled on any kind of complicity like that throughout
the nation?
Mr. Luthi. No, we haven't, Congressman.
Mr. Pearce. OK. All right. The document that came out,
actually, as we looked through it, it came up with a lot of
findings and about 100 or more recommendations, but at the
beginning it says the process is working well, but, yes, it
could be tuned up a lot. How many of those findings had you
already started implementing even maybe before the findings
were given or since you have seen the report?
Tell me a little bit about the contrast of MMS today versus
maybe the MMS of the Clinton years?
Mr. Luthi. That is going back a few years, but, yes, many
of the findings, especially those 16 that I referenced in my
testimony, we actually had underway. A good example of that--or
they were the easy ones to fix--one of those was the Indian Oil
Valuation Rule. That particular one wasn't an easy fix.
It is a very complex rule, it is an important rule. What it
does is help clarify how we value Indian oil. That is out, it
is on the street, it is out there now. Other things that we
did, we did recommend, and it has been done, we have the
subcommittee now dedicated to RIK. We have increased some
security, the easy stuff, on the computers, the passwords.
The coordination was a big factor, which I thought the
subcommittee did an excellent job of identifying, and we have
broken down some barriers. It is amazing to me, as coming from
a small, you know, Wyoming I would say bureaucracy and a
legislature, to see how we do get on our own stovepipe area.
We don't have a chance for those that are actually
monitoring the meters, seeing the producers on a daily basis
don't always have that coordination with those that are
actually requesting the money be paid. We have broken that
down. We are very pleased with the progress----
Mr. Pearce. Well, I think that is an important piece to
know from this hearing today. One report says that you are
doing fairly well and you are even implementing many of the
findings before and during. By the way, you can go out to New
Mexico. They spent almost $200 million.
I was on the Appropriating Committee trying to work out
this thing or trying to figure out the royalty payments, and
New Mexico's budget at that time was maybe $2 billion and we
spent $200 million, so you can imagine kind of how trying that
was because it is very complex.
Mr. Finfer, if it is that complex to figure out the
royalties because the wellhead prices are different every day,
you have a floating price, and then you got people that got all
these partners, and subpartners, and unit operators and unit
members, tell me a little bit about the Royalty-in-Kind
Program.
I continue to see it to be a fairly simple operation
compared to the other operation that we spent billions, or
millions, or whatever. Tell me a little bit about the RIK.
Mr. Finfer. RIK isn't foolproof, but, yes, it is simpler.
It is a more cut and dried process. One of the ways in which it
has an advantage is, as you know, there have been many disputes
about valuation over the years. Just simply writing the
valuation rules took 10 years or so. In the Royalty in Value
Program there are many disputes about valuations, deductions
and so forth that can take quite a bit of time to resolve.
Royalty in Kind has less of that sort of a problem, and so
there is a significant advantage in that regard.
Mr. Pearce. So, if I understand you correctly, it is not
foolproof, but it might be damn foolproof, so, if you get it
narrowed down. OK. Mr. Chairman, I see my time is up. We have
come within one minute of your expectations of a noontime
adjournment, so I would thank you for your indulgence all day
long. I appreciate it.
Mr. Costa. Thank you, Mr. Pearce, the gentleman from New
Mexico. We will continue to work with the various parties on
this issue, and we will look at the recommendations and see if
we can figure out a way in a collaborative fashion that we can
peruse those as I think Mr. Deal said tune up. I kind of like
that term. Every once in a while I need a tune up.
So I want to thank all the witnesses for your testimony and
your patience. We look forward to continuing to work with you.
I have some comments I need to make here. We want to note for
the members of the Subcommittee that if they have additional
questions for witnesses, we will ask you to respond to these in
writing.
The hearing record will be held open for 10 days to allow
those responses to be submitted. If there is no further
business before the Subcommittee, once again, I want to thank
the members of the Subcommittee, and the staff and all those
who worked to put this hearing together. The Subcommittee now
is adjourned.
[Whereupon, at 12:03 p.m., the Subcommittee was adjourned.]
[Additional material submitted for the record follows:]
[A statement submitted for the record by The Honorable
Adrian Smith, a Representative in Congress from the State of
Nebraska, follows:]
Statement of The Honorable Adrian Smith, a Representative in Congress
from the State of Nebraska
Good morning. There are a number of challenges facing domestic oil
and gas production, and I thank you, Chairman, for holding this hearing
today on the ``Recent Recommendations for Improving the Federal Oil and
Gas Royalty System.''
As Congress continues to examine our energy needs, we must
encourage and promote the development and utilization of domestic oil
and gas production. We can sustain this goal while ensuring federal
management practices meet the highest standards.
While oil and gas production on federal lands generates revenue
from royalty payments, all domestic oil and gas production generates
revenue from corporate and personal income taxes. As my home state of
Nebraska has seen an increase in production on non-federal land, I am
very interested in how this also contributes to the federal treasury.
I appreciate the Subcommittee for holding this hearing today on the
recommendations for improving the Minerals Management Service. I look
forward to hearing from the Department of the Interior, the Government
Accountability Office, the Inspector General's office, the Internal
Revenue Service, and all of our witnesses. What we learn here today
will play a critical role for achieving the greatest possible benefit
from our vital, irreplaceable natural resources.
Chairman, I look forward to working with you. Thank you.
______
[A statement submitted for the record by Danielle Brian,
Executive Director, Project On Government Oversight,
Washington, D.C., follows:]
Statement of Danielle Brian, Executive Director,
The Project On Government Oversight
The Project on Government Oversight (POGO) has long worked for
accountability and honesty within the federal government. By that
standard, we applaud the Royalty Policy Committee's report shedding
light on the many problems inherent within the royalty collection
systems at the Department of Interior's Minerals Management Service
(MMS) and encouraging reform, oversight, and transparency. However,
much of what we know about the agency from its own Inspector's General
reports, press reports, Congressional oversight, state and tribal
auditors, and whistleblowers leads us to believe that the Committee's
report does not go far enough.
Rather than depicting MMS as ``an effective steward'' 1
of the nation's oil and gas royalty collection program, the report is a
damning picture of the inability of the program to effectively collect
the taxpayers' money. Combined with a recent report by the Department
of Interior's Inspector General that found that the agency was
collecting the largest share of non-tax revenue within the government
using a ``band-aid'' approach, it is easy to conclude that MMS and its
revenue collection agency, Minerals Revenue Management (MRM), are
failing to effectively collect taxpayer money. 2
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\1\ Report to the Royalty Policy Committee, Mineral Revenue
Collections from Federal and Indian Lands and the Outer Continental
Shelf, Submitted by: the Subcommittee on Royalty Management, with staff
support from the Department of Interior, Office of Policy Analysis
(Office of the Secretary) and the Bureau of Land Management, December
17, 2007, page ix. (Referred to as Report to the Royalty Policy
Committee from this point forward.)
\2\ Department of Interior. Memorandum from Earl E. Devaney,
Inspector General, to Secretary Kempthorne and C. Stephen Allred,
Assistant Secretary, Land and Minerals Management, September 19, 2007,
page 1.
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Despite having spent close to $150 million over the last several
years on information technology, the report finds that MMS' technology
systems, as well as MMS strategies for using those systems are failing
in a multitude of areas. 3 It is critical the agency have an
effective strategy for determining which companies to audit.
4 It is also critical that the agency have information
technology systems that collect the appropriate information.
5 It is critical that the agency know for certain how much
royalty is owed to the government. 6
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\3\ United States Department of Interior, Office of Inspector
General, ``Minerals Management Service: False Claims Allegations,''
Transmitted on September 19, 2007, page 38.
\4\ Report to the Royalty Policy Committee, Recommendations 4-1, 4-
9, 4-19.
\5\ Report to the Royalty Policy Committee, Recommendations 3-6, 3-
10, 4-10, 4-16, 4-17, 4-18, 4-22.
\6\ Report to the Royalty Policy Committee, Recommendations 3-1, 3-
14, 3-15.
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The Committee's report recommends 110 ways that improvements should
be made. Many of the Committee's recommendations are straightforward
common sense strategies for good management. It is easy for POGO to
support making manuals and procedures available to the public,
increasing communication among agencies, enhancing performance
measures, conducting more studies, and ensuring better reporting for
all endeavors at the agency. For instance, mandatory electronic
reporting for all lessees would reduce manual entry errors, speed up
calculation, and ease auditing and compliance reviews. 7
Additionally, POGO always supports systems that encourage
whistleblowers. We urge adoption of a whistleblower hotline combined
with incentives to encourage whistleblowers to come forward.
8
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\7\ Report to the Royalty Policy Committee, Recommendations 3-7, 3-
11, 3-13, 3-16, 4-8, 4-21, 4-22.
\8\ Report to the Royalty Policy Committee, Recommendations 4-6.
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While these nuts and bolts recommendations are key to begin
reforming the ailing systems within the agency, they fail to address
important questions of independence, oversight, and transparency. The
Committee was charged with determining if royalty collection and audit,
compliance, and enforcement systems and procedures are adequate, as
well as reviewing the operations of the program to take royalties in
the form of product, rather than cash. While they may have discovered
110 ways to improve these systems, avoiding reforms that target larger
systemic problems will only lead to continued skepticism of the
agency's ability to effectively steward the program.
Following are the four larger issues connected to reforming the
agency we believe the Congress should address, as well as two areas
raised by the Committee to which we are vigorously opposed.
Additional Reforms:
1. Presidential appointment and Congressional confirmation for the
Director of the Minerals Management Service would provide additional
oversight and scrutiny of the agency, as well as elevate the status of
one of the largest non-tax revenue operations within the federal
government.
2. Moving the compliance and audit function out of MMS is a
critical step to improving the independence of the agency from oil and
gas companies and reducing conflict of interest within the agency. The
same people responsible for working with companies to see that federal
lands are used to their greatest leasing potential and working in
partnership with those companies to sell royalty oil should not also be
in charge of auditing those companies.
3. Transparency of MMS leases, contracts, documents, and
procedures is paramount to reducing opportunities for fraud and
increasing public confidence in the agency.
4. An independent and public study of the royalty in kind program
and its use to fill the nation's Strategic Petroleum Reserve should be
commissioned to determine if this is in the best interest of the
taxpayers. While this program may have many benefits, evidence is
mounting that it compromises the integrity of the agency and squanders
taxpayer money through inefficiencies.
Areas of Concern:
1. POGO urges the Congress to reject the Committee's
recommendation that a trust fund be established and the interest used
to fund audit and compliance activities without Congressional approval.
9 Rather we urge the Congress to reign in all spending
activities outside the annual Congressional appropriations process.
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\9\ Report to the Royalty Policy Committee, Recommendation 6-6.
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2. POGO urges that any consideration of moving to market indices
for gas valuation, whether for affiliated transactions or not, be
carefully considered in light of continuing court cases proving
manipulation by oil and gas companies. 10
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\10\ Report to the Royalty Policy Committee, Recommendation 4-26.
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While this list is by no means exhaustive, it represents
significant opportunities to reform the agency by taking an expansive
view on what it means to be an effective steward of federal lands and
funds. We are preparing in-depth comments on our primary policy
objectives and concern as well as on individual chapters of the Royalty
Policy Committee report, and will supply the document to the Committee
when it is complete. We appreciate the Chairman's interest in this
critically important area and trust you will find our comments helpful.
We would like to sincerely thank the Royalty Policy Committee for
its thoughtful and expansive work on this critical issue. We believe
this report, combined with others generated in the recent past, are an
urgent call for reform of the royalty system. We hope that this report
will be used to springboard the agency into action so that the
taxpayers are assured of receiving their fair share from the nation's
mineral rich lands.