Date:  December 5, 2006


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Department of the Interior
Office of Inspector General


                           AUDIT REPORT

MINERALS MANAGEMENT SERVICES COMPLIANCE REVIEW PROCESS (No. C-IN-MMS-0006-2006)


This report contained information that was redacted pursuant to 5 U.S.C.  552(b)(2) (high) and (low) and (b)(6) of the Freedom of Information Act.


EXECUTIVE SUMMARY


(Text inside of text box - left side of page) WHY WE DID THIS AUDIT

We conducted this audit at the request of the U.S. Senate Committee on Energy and Natural Resources.  The audit addresses concerns raised by the news media and the State and Tribal Royalty Audit Committee (STRAC) about MMS increasing use of compliance reviews as part of its CAM Program.     

Historically, MMS has relied on audits to verify companies reported royalties.  In the late 1990s, MMS began reengineering its royalty verification processes, which included the establishment of the compliance review process.  A compliance review is less intensive than an audit and is designed to determine the reasonableness of reported royalties without obtaining detailed source documentation or conducting site visits.    


AUDIT OBJECTIVES

Our objectives were to determine (1) whether compliance reviews are an effective part of the CAM Program and (2) whether MMS is effectively managing the compliance review process.


(Text outside of text box - right side of the page) WHAT WE FOUND

Compliance reviews can serve a useful role as part of the Minerals Management Services (MMS) Compliance and Asset Management (CAM) Program.  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.  However, compliance reviews do not provide the same level of assurance as an audit and therefore should only be used in conjunction with audits in a coordinated compliance strategy.  

While we concluded that compliance reviews can be an effective part of MMS CAM Program, our audit disclosed weaknesses that may prevent MMS from maximizing the benefits of the compliance reviews.  These weaknesses related to management information, the compliance review process, and the performance measures used to evaluate the CAM Programs effectiveness.  

Management Information


MMS lacks reliable information for managing the CAM Program.  Audit and compliance review data are maintained in multiple information systems that we found to be inaccurate and incomplete.  As a result, MMS cannot:

> effectively use existing systems for day-to-day management and reporting purposes;

> develop an effective strategy for deploying personnel and other resources between audits and compliance reviews;

> provide accurate information on CAM Program operations and results to stakeholders, including the Congress and state and tribal audit organizations; and
determine the true cost and benefits of compliance reviews and audits.

> determine the true cost and benefits of compliance reviews and audits.


Compliance Review Process

We found that MMS developed extensive policies and procedures for conducting compliance reviews and that MMS generally followed the guidance.  Our audit disclosed some areas where the compliance review process should be strengthened.  For example:

> Compliance reviews do not adequately evaluate company-reported volume and allowance data.  This increases the risk that MMS may not detect underpaid royalties.

> MMS does not always inform companies when compliance reviews begin.  Standard notices would give greater visibility to the CAM Program and deter inaccurate reporting.

> MMS methodology for establishing threshold amounts for pursuing potential underpayments is not consistent and could result in uncollected royalties.

> MMS does not have detailed guidance identifying when compliance reviews should be referred to audits. 

> MMS selection process to identify properties for compliance reviews or audits does not take into account which companies have the highest risk for underpaying royalties.

> The ability of state and tribal auditors to conduct effective compliance reviews is hindered because they do not have full access to MMS automated tools. proper amount of royalties, should be eliminated because it is computed with incomplete data.  


Performance Measures

We found that MMS should reassess the CAM Programs  Government Performance and Results Act performance measures.      

> The compliance index, which attempts to assess whether companies are paying the proper amount of royalties, should be eliminated because it is computed with incomplete data.  

> The compliance coverage measure inappropriately treats audits, compliance reviews, and royalty-in-kind analyses equally.  Also, the measures focus on dollar coverage results in many of the same companies and properties being reviewed year after year.  MMS should revise this measure to report separately on each activity and should modify its CAM strategy to expand the coverage of companies and properties subjected to  review.

> MMS should also develop new measures that address the efficiency of its operations. 

We made three recommendations to the Director of MMS.  The Directors response to the draft report, included as Appendix 2, expressed general concurrence with the findings and recommendations and provided the actions in process for implementing the recommendations.  MMS stated that it will provide a final action plan within 30 days after receipt of the final Office of Inspector General (OIG) report.  The Directors response included several areas of disagreement.  We agreed with managements comments in three areas and revised the recommendations contained in our draft report concerning activity-based costing and source document review; we corrected our recommendation concerning collections to reflect the correct entity within MMS which holds responsibility for that function.

Concurrent with conducting this audit we also compiled information to answer additional questions posed by the U.S. Senate Committee on Energy and Natural Resources.  These questions related to MMS auditor positions, the number of royalty audits initiated by MMS, the adequacy of MMS resources, and the funding for state and tribal audit organizations.  We did not evaluate the substance of the audits or audit work conducted.  Our answers are presented in Appendices 4 and 5.  As noted above, MMS has data reliability issues related to audit and compliance review information.  Accordingly, our answers are based on the best available data.


CONTENTS

Introduction............................................1

Results of Audit........................................3

MMS Lacks Reliable Management Information...............4

Compliance Review Process Does Not Maximize Outcomes....7

Performance Measures Need Revision......................10

Recommendations.........................................13

Appendices

1  Scope and Methodology...............................16

2  MMS Response to Draft Report.......................18 

3  Status of Recommendations...........................31

4  OIG Response to Questions Posed By the U.S.
   Senate Committee on Energy and Natural Resources....32

5  State and Tribal Audit Organization Funding.........36

6  Related Reviews.....................................47

7  Acronyms and Abbreviations..........................50



INTRODUCTION

AUDIT OBJECTIVES

Our audit objectives were to determine:   

> Are compliance reviews an effective part of the Minerals Management Services (MMS) Compliance and Asset Management (CAM) Program?

> Is MMS effectively managing the compliance review process?


BACKGROUND

MMS is responsible for collecting, accounting for, and distributing royalties paid by companies that extract oil, gas, and other minerals from leased federal and Indian properties.  MMS collected $9.9 billion in royalties in FY2005.  About 2,600 companies1 reported and paid royalties from approximately 27,800 producing leases.     

MMS CAM Program is responsible for ensuring that companies are accurately reporting and paying royalties in compliance with applicable laws, regulations, and lease terms.  This is accomplished by conducting audits and compliance reviews.  The CAM Program is divided into four components: 

 Onshore Oil and Gas
 Offshore Oil and Gas
 Indian Oil and Gas
 Solids & Geothermal  

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A royalty is the landowners share of the mineral production.  MMS collects royalties either in cash (royalty-in-value) or in product (royalty-in-kind).  

Royalties collected from federal properties are distributed to other Department of the Interior bureaus, the Department of the Treasury, and other federal agencies.  Additionally, state governments receive a portion of royalties from minerals produced within their state borders. 

Royalties collected from Indian-owned properties are distributed to the applicable tribal governments or individual Indian owners.  


The CAM Program had a FY2006 budget of $42.7 million and employs approximately 380 personnel.  To assist in verifying royalties, MMS has cooperative agreements with audit organizations representing 11 state and 7 tribal governments.  MMS reimburses these organizations for all of their costs to conduct compliance work.  The tribes retain 100 percent of collections resulting from their compliance work, and the states retain a portion of collections as statutorily allowed, which is generally 50 percent.  The State and Tribal Royalty Audit Committee (STRAC) represents the state and tribal audit organizations in its coordination with MMS.


MMS began a reengineering initiative in the late 1990s to establish a more efficient and effective process for verifying royalty payments.  As part of this reengineering effort, MMS developed the compliance review process to complement traditional audits and accomplish a broader coverage of reported royalties.  MMS began using compliance reviews in 2000.  

A compliance review is an analysis that determines the reasonableness of company reported royalty and production data.  An analyst compares the company reported data to MMS expected values.  If the reported data are not within a reasonable range, the variance is pursued with the company.  Unlike audits, compliance reviews are not conducted in accordance with the Government Auditing Standards.  Compliance reviews generally do not obtain and review company source records, review company systems or internal controls, or result in formal reports.  Additionally, compliance review procedures do not include issuing engagement letters or conducting entrance and exit conferences.  In fact, MMS may not contact companies at all when compliance reviews are conducted unless discrepancies are found.  


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THE ROYALTY EQUATION
To determine whether royalties have been accurately paid, MMS reviews the four elements of the royalty equation: 

Volume: 	Amount of minerals produced and sold.
Value:  	Sales price of minerals produced and sold.
Allowances:  	Deductions for transportation and processing.
Royalty rate:  	Landowners share of minerals produced and sold.


Compliance reviews and audits are generally conducted for royalties paid in-value.  For royalties paid in-kind, the Royalty-in-Kind (RIK) Program is responsible for verifying that the producing company delivered the correct volume and the buyer paid the correct contract price.   In the mid-1990s, MMS began exploring the potential for expanding the RIK program and in recent years, has increased the royalties taken in-kind rather than in-value.  In its FY2005 report on the RIK Program, MMS reported that the value of RIK gas and oil was $3.7 billion.  

In January 2006, a New York Times article criticized the effectiveness of the CAM Program and asserted that MMS undercollected approximately $700 million in gas royalties in FY2005.  Subsequently, the Times raised concerns expressed by STRAC members about MMS increasing use of compliance reviews instead of audits.  The U.S. Senate Committee on Energy and Natural Resources (Committee) requested that our office and the Government Accountability Office (GAO) look into these issues.  This report responds to the Committees request for us to look at the effectiveness of MMS compliance reviews.  The Committee also requested that we provide answers to specific questions concerning the number of audits that were initiated since 2000 and the levels of staffing and funding for those years.  Our answers to those questions are addressed in Appendices 4 and 5.  GAO addressed the Committees questions regarding the alleged underpayments of royalties in its June 2006 report Royalty Revenues: Total Revenues Have Not Increased at the Same Pace as Rising Oil and Natural Gas Prices due to Decreasing Production Sold.

Appendix 1 contains information on the audit scope and methodology and Appendix 6 lists prior reviews that were related to our audit.


RESULTS OF AUDIT

Compliance reviews can serve a useful role as part of the CAM Program.  Our research showed that other federal and private sector entities use similar procedures to verify reasonableness of reported information.  The Internal Revenue Service (IRS), for example, extensively uses automated procedures to analyze tax returns and has established compliance checks to determine whether taxpayers adhere to recordkeeping and reporting requirements.  When properly designed and implemented, compliance reviews can effectively evaluate the reasonableness of company-reported royalties.  For example, one compliance review recovered $4.5 million in underpaid gas royalties for an offshore property.  Compliance reviews also allow greater coverage of the royalty universe while requiring fewer resources than audits because MMS can:

> complete compliance reviews in less time and usually cover more reporting months than audits, 

> complete compliance reviews without traveling to company locations, and 

> coordinate audits and compliance reviews to use its resources more efficiently.    

However, compliance reviews are only a test of the reasonableness of royalties paid and do not provide the same level of royalty verification as an audit.  To a large extent, compliance reviews rely on company-reported information instead of source documentation.  For example, MMS may consult general industry pricing publications rather than the companys specific sales contract to help assess the reasonableness of the companys reported value.  A compliance review should not be used as a substitute for an audit, but rather, as one part of a comprehensive compliance strategy that incorporates both activities.

Our audit disclosed weaknesses in MMS management of compliance reviews and its overall CAM Program.  Specifically: 

> MMS lacks reliable management information to adequately develop a compliance strategy, monitor progress, and assess results of its CAM Program.

> MMS needs to improve its compliance review process to maximize outcomes. 

> MMS performance measures are inadequate and need to be revised.   
 

MMS LACKS RELIABLE MANAGEMENT INFORMATION
MMS lacks the information it needs to adequately manage compliance reviews and its overall CAM Program.  Audit and compliance review data are maintained in multiple information systems that we found to be inaccurate and incomplete.  Specifically, we found errors in data relating to audit and compliance review tracking and the costs and benefits of the CAM Program.

CAM PROGRAM DATA ARE NOT ADEQUATELY TRACKED

MMS maintains management information on the CAM Program primarily in its Compliance Information Management (CIM) system and in four separate databases maintained by the CAM components to accumulate data for Government Performance and Results Act (GPRA) reporting.  However, we found that these systems do not maintain certain basic information that could aid CAM Program managers in monitoring the day-to-day operations and assessing results.  We found the following problems:

> Incomplete and Inconsistent Compliance Review Data in CIM:  The CAM components were inconsistent in their tracking of compliance reviews in CIM.  Two CAM components did not have complete information on all compliance reviews because data is only entered if the reviews result in monetary findings.  The other two components recorded all compliance reviews in CIM.  This practice prevents MMS management from accurately tracking and reporting on all compliance reviews.   

> Lack of Status Information on Compliance Work in Progress:  The current status of each compliance review is not tracked within CIM.  Supervisors oversee multiple concurrent compliance reviews and some supervisors were managing over 100 reviews at a time.  We found that the information systems do not provide sufficient information to allow supervisors to adequately track the progress of compliance reviews and manage their workloads.  For example, supervisors do not have automated access to information such as phase of reviews, anticipated completion dates, status of potential issues, and status of communications with companies on identified potential underpayments.  We found that CIM also lacks status information for audits.

> Original Monetary Findings Not Tracked:  CIM contains data fields to record the original monetary findings from audits and compliance reviews and the subsequent collections from companies for underpayments.  However, we found that MMS process for recording collections resulted in the inappropriate substitution of the collected amount into the original monetary finding field.  This results in the amount of the monetary finding equaling collections.  MMS should retain data on the original monetary findings so that it can assess the effectiveness of audits and compliance reviews by determining the recovery rates.   

> Inaccurate Data on Completion of Audits and Compliance Reviews:  MMS could not accurately count the number of audits and compliance reviews that were completed each fiscal year.  We attempted to independently determine the statistics on audit and compliance review completions; however, we found that data fields needed to perform these analyses were often not used.  For example, the audit report issuance field in CIM was frequently not populated.  We also found that the GPRA databases did not always indicate whether the compliance activity had been conducted as an audit or as a compliance review. 

> Offshore GPRA Database Contains Inaccurate and Incomplete Information:  We found that the Offshore GPRA database contained inaccurate or incomplete information that prevented MMS from accurately reporting on performance.  This database is designed to accumulate data on compliance coverage on properties.  We found that some properties were identified as having completed compliance reviews when those reviews had not been completed.  We selected for review five properties identified in the GPRA database as having completed compliance reviews.  MMS had not completed a review for three of those five properties.  In fact, one of the reviews had not even been started.  MMS detected the same issue during an internal control review performed in 2006.  However, we found that MMS corrective action plan was not sufficient to ensure the accuracy of the data.  Instead of requiring that the data be validated, the plan called for the Compliance Review Manual procedures to be communicated to all supervisors.


COSTS AND BENEFITS OF AUDIT AND COMPLIANCE REVIEWS ARE UNKNOWN

MMS cannot effectively evaluate the costs and benefits of compliance reviews.  A valid cost and benefit analysis would demonstrate the value of compliance reviews to stakeholders.  STRAC, which represents the state and tribal audit organizations, has expressed skepticism that compliance reviews are a wise use of limited resources.

MMS could not provide accurate royalty collection data from its CAM Program activities. MMS provided us with a summary of CAM Program collections for October 1999 to March 2006 distributed by audits, compliance reviews, and other activities.  MMS reported collections from compliance activities totaling $699 million of which approximately $293 million were attributed to compliance reviews.  MMS stated that although it was confident about the collection totals for each year, it could not vouch for the accuracy of the distribution to CAM Program activities.  We found the following:

> CIM contained 12,800 lines of unmatched findings and collections that have not been reconciled to a specific audit or compliance review.  Until these lines have been reconciled, collection data are not complete.

> The data include duplicated collection amounts.  We scanned the database and selected eight instances of collections for the same amount that appeared to be duplicate entries.  After further tests and confirmation by MMS, we determined that six of the eight were actual duplicate entries.  These six entries totaled $2.2 million.

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Qui tam refers to a case filed under the Federal Civil False Claims Act by a private citizen in the name of the U.S. Government, charging that a government  contractor or other entity has defrauded the government.  The person shares in any money recovered.

MMS collection data also included approximately $134 million resulting from qui tam royalty settlements, representing 19 percent of the total reported collections.  Qui tam settlements do not directly result from an MMS-initiated audit or compliance review and, accordingly, their inclusion overstates program accomplishments.

MMS computed a cost benefit analysis in 2006 which showed that compliance reviews were more cost effective than audits.  However, we found that the data used in the analysis did not always agree with the supporting documentation and that the methodology was flawed.  For example, MMS analysis considered only its labor costs instead of total costs for compliance reviews, which would better reflect the true costs of conducting compliance activities.  Consequently, an uninformed reader of MMS analysis could easily be misled about the true benefits of compliance reviews. 

We also found that the cost to conduct an individual audit or compliance review is unknown because MMS activity based costing system does not provide detail at the individual audit or compliance review level.  In addition, MMS cannot provide an accurate count of completed audits and reviews.

MMS needs to ensure that it has the necessary data to determine the effectiveness of both audits and compliance reviews.  MMS would benefit from activity based costing information with line item detail at the individual audit and compliance review level.


CONSEQUENCES OF UNRELIABLE DATA

As a result of the issues identified above, MMS cannot:

> effectively use existing systems for day-to-day management and reporting purposes;

> develop an effective strategy for deploying personnel and other resources between audits and compliance reviews;

> provide reliable information on CAM Program operations and results to stakeholders, including the Congress and state and tribal audit organizations; and

> determine the true cost and benefits of compliance reviews and audits.

Additionally, we noted that MMS must query multiple information systems to compile CAM Program data and much of the data are redundant.  This is not an efficient business practice; MMS would benefit from consolidating its information into a single system.


COMPLIANCE REVIEW PROCESS DOES NOT MAXIMIZE OUTCOJME

We found that MMS developed extensive policies and procedures for conducting compliance reviews and that MMS generally followed the guidance.  Our audit disclosed some areas where the compliance review process should be improved to maximize the benefits.  The following paragraphs describe these areas and present our proposals for improving the effectiveness of the process. 


INSUFFICIENT VOLUME ANALYSIS	

To test the reasonableness of reported volumes, MMS compares company royalty reports to company production reports to identify discrepancies.  This procedure does not provide an independent verification of volume.  Without additional analytical steps, MMS has no assurance that the reported production amounts are reasonable.3  We identified several additional procedures that could be performed to verify the reasonableness of oil and gas volumes.  These include:
 
> Request companies to provide actual source documents (for example, run tickets, tank gauging reports, and oil and gas sales summary statements) for at least one test month.  This would allow a more precise expected volume amount to be established for the property.

> Coordinate with the Bureau of Land Managements (BLM) Energy and Minerals Program, which maintains inspection and enforcement data that can be used to help validate the reasonableness of reported volumes for onshore properties.  The Program is responsible for overseeing the mineral industrys exploration, development, and production operations on federal and Indian lands.  This includes regular inspections of production facilities and enforcement of laws, regulations, and lease terms.  BLMs Automated Fluid Minerals Support System (AFMSS) tracks property and well data for each federal onshore and Indian lease.  The Compliance  Review Manual states that MMS has access to AFMSS, but we saw no evidence that MMS used the system in conducting compliance reviews.

> Use the Liquid Verification System (LVS) and Gas Verification System (GVS) to validate the reasonableness of production volumes for offshore leases.  These systems, which are maintained by MMS Offshore Minerals Management Program, provide actual oil and gas volume data that are based on company-provided source documents.  Before implementing this procedure, MMS will need to address known data reliability issues with the LVS and GVS.  MMS has allocated resources during FY2006 to help address this matter.



INADEQUATE ANALYSIS OF ALLOWANCES	

MMS performs an important test to determine whether reported transportation and processing allowance deductions exceed statutory limits.  However, source documents are not obtained to enable a precise determination of what the allowances actually should be for oil and gas leases.  Consequently, other than checking that the maximum permissible limits were not exceeded, compliance reviews have not assessed whether companies improperly claimed allowances.  Requesting companies to provide actual source documents for at least one test month would allow a more precise expected amount to be established.

The Compliance Review Manual states that transportation allowances can be checked for reasonableness by using online sources such as TariffMaster, the Federal Energy Regulatory Commission (FERC), and the Petroleum Information Grid (PI Grid), but we saw no evidence that MMS was using them.  We did note that one CAM component instituted revised steps in April 2006 requiring staff to access these information resources.  All CAMs should make this research mandatory as part of the allowance analysis.

In addition, MMS could test the reasonableness of allowances by compiling historical trends from audit-verified data and comparing this to the reported amounts.


RATIONALE FOR VARIANCE THRESHOLDS NOT DOCUMENTED  	

Variance thresholds are a critical element of the compliance review process because they are the determining factor for whether MMS accepts the reported royalties.  We found, however, that MMS could not explain the rationale or methodology used to establish thresholds for the CAM components.  Each CAM has set its own threshold which differs significantly in the dollar amounts and methodology.  For example, one CAM applies both a monthly and annual limit, one has just an annual limit, and another simply uses professional judgment.  We concluded that the [Ex. 2 (high)] threshold at one CAM is set so high that significant underpaid royalties may not be collected.
 
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A variance threshold is the pre-determined percentage or value set by each CAM for the acceptable difference between the reported and expected values for each element of the royalty equation.  If the threshold is exceeded, the company is first notified to obtain comments about the findings.  If this does not resolve the matter, MMS follows up with formal communications, such as an order to pay or an order to provide records.

MMS needs to fully define the compliance review process, including variance thresholds.  For onshore leases, MMS should work with state and tribal governments in establishing thresholds because all parties have an interest in the distribution of royalties.  When setting the thresholds, MMS should also weigh the estimated costs of pursuing the variance issue versus the expected return.


GUIDANCE FOR AUDIT REFERRALS NOT DEVELOPED

We found that the Compliance Review Manual does not provide analysts with specific guidance or trigger points for determining when compliance review issues should be referred to full scale audits as this decision is left to individual judgment.  In addition, MMS could not provide complete data on the number of compliance reviews that have been referred because one of the CAMs has not maintained this information.  MMS should develop detailed guidance, such as addressing systemic issues found in compliance reviews that more appropriately warrant audits and should track all referral actions.


COMPANIES NOT NOTIFIED WHEN COMPLIANCE REVIEWS PERFORMED	

For oil and gas properties, MMS does not typically notify the company when a compliance review is conducted unless a discrepancy is detected that exceeds an established variance threshold.  Accordingly, if no discrepancy results, the company will generally be unaware that its royalty reporting had been subjected to regulatory oversight.

MMS should notify companies when compliance reviews begin to increase the visibility of the CAM Program and promote a deterrence effect that may motivate companies to more accurately report and pay royalties.


COLLECTION FOLLOW UP PROCEDURES NOT ENFORCED  

MMS Compliance Review Manual does not have procedures to verify that underpayments identified by compliance reviews are actually billed and collected.  For example, our sample of 20 compliance reviews disclosed one instance where a $12,400 underpayment issue had not been collected 8 months after the review was completed.  This was caused by a lack of coordination and communication between the compliance review team and the accounting team responsible for collecting the underpayment.


ADHERENCE TO QUALITY CONTROL PROCEDURES	NOT ENFORCED

Our review of a sample of 20 compliance reviews disclosed instances in which MMS did not follow required procedures in its Compliance Review Manual.  Specifically:

> File summaries did not always provide sufficient detail of the work conducted.

> Supervisory reviews often were not done or not timely performed.

> Independent math verifications were not always documented. 


MMS needs to address the above issues to ensure the quality of its work. 


ADDITIONAL RISK FACTORS NOT USED IN COMPLIANCE STRATEGY

MMS employs a risk-based strategy in selecting the properties and companies subjected to compliance work.  This strategy is driven by MMS performance measures and focuses on the properties with the highest royalty dollars.  MMS should consider additional risk factors for selecting companies and properties for compliance work, such as chronic erroneous reporting and the possibility of fraudulent reporting.  In selecting companies for review, MMS should identify companies that have:

> historically underreported royalties to MMS or

> falsely reported information to other federal agencies such as the Environmental Protection Agency and IRS. 

MMS should also incorporate fraud indicators into its compliance review procedures to help identify intentional false reporting.  It could develop the fraud indicators from the results of prior audits and compliance reviews.  MMS should also publicize that it has a comprehensive compliance program that includes randomly selected company audits.  This would help enhance the deterrence effect by making companies aware that they could be chosen for audit.


STRAC NOT PROVIDED ACCESS TO ALL COMPLIANCE REVIEW TOOLS	

MMS has requested that the state and tribal audit organizations include compliance reviews as part of their compliance activities.  STRAC has expressed reluctance to perform any work other than audits.  STRAC has questioned the benefit of compliance reviews and some STRAC members question MMS legal authority to direct state and tribal audit organizations to perform compliance review work.  However, the Federal Oil and Gas Royalty Management Act provides legal authorization for MMS to contract with state and tribal audit organizations to perform a wide variety of compliance work including both audits and compliance reviews.   

Despite MMS request for STRAC members to perform compliance reviews, MMS has been slow to provide the tools necessary to effectively perform them.  While MMS has been implementing Compliance Program Tools (CPT) to help conduct compliance reviews, it has not yet shared these tools with the states and tribes.  MMS has been working to resolve information security concerns to provide STRAC members access to the data.  STRAC members cannot effectively perform compliance reviews until MMS resolves this access issue.


PERFORMANCE MEASURES NEED REVISION

Performance measures are management tools that provide agencies with the information they need to assess program accomplishments.  MMS has two performance measures related to the CAM Program that we found to be flawed.  In addition, MMS needs to establish measures to evaluate the efficiency of its Program operations. 


COMPLIANCE INDEX NOT RELIABLE

The compliance index is intended to indicate overall industry compliance with MMS regulations and reporting guidelines and the effectiveness of MMS compliance efforts.  The measure calculates the percentage of the predicted revenues from a production year that is collected within 3 years.  For example, the FY2005 performance goal was that by the end of the fiscal year, MMS would have collected 98 percent of calendar year 2002 predicted revenues.

This measure suggests a high rate of compliance by reporting that MMS collected 98 percent of royalties that should have been paid.  Unfortunately, MMS cannot know the total dollar amount of royalties that should have been paid.  Therefore, MMS uses a prediction of those royalties to calculate the compliance index.  MMS methodology for predicting revenues does not provide a valid figure for calculating the compliance index.  MMS methodology is based solely on information from offshore and some Indian oil and gas leases.  The formula excludes onshore federal oil and gas, solid minerals, and geothermal leases.  MMS officials recognize the limitations of this measure and they have not used the measure to manage program operations.  MMS should stop using this measure to present program results.     


COMPLIANCE COVERAGE MEASURE IS MISLEADING

MMS measures the percentage of reported royalty dollars that it addresses with its compliance activities.  The compliance coverage measure calculates the percentage of reported royalties from a production year for which MMS will have conducted compliance work within a 3-year period.  For example, the FY2005 performance goal was to complete compliance work on 71 percent of calendar year 2002 reported royalties.

The compliance coverage measure is misleading because it weighs audits, compliance reviews, and RIK analyses equally, when they provide very different levels of assurance.  We agree that there is a need to measure compliance coverage; however, we believe that MMS needs to modify its measure to report these activities separately. 

Further, the use of the compliance coverage measure has negatively affected the number of companies and properties subjected to compliance work.  The measure focuses solely on royalty dollars, and as a result, many of the same companies and high dollar properties have been reviewed year after year.  For example, in the past 3 years, MMS has reviewed only 9 percent of its properties and 20 percent of companies as illustrated in Figure 1 below.  For the Onshore CAM alone, 92 percent of the properties selected for review in FY2006 had been reviewed in the previous 2 years.  As such, most companies and properties are not likely to be selected for compliance work.  MMS should consider modifying its CAM Program strategy to ensure appropriate coverage of properties and companies within a reasonable timeframe even if this results in a reduction in the overall percentage of dollars covered.

Figure 1.  Compliance Coverage of Leased Properties and Companies (See table in PDF version).


The measure also is not fully representative of all CAM Program activities because compliance reviews that do not cover the entire royalty equation (known as limited scope compliance reviews) are excluded.  For example, the Indian CAM performs extensive limited scope reviews to assess the reasonableness of reported prices.  Accordingly, MMS should have a performance measure for these types of activities. 


EFFICIENCY OF COMPLIANCE ACTIVITIES NOT MEASURED

MMS should consider adding additional performance measures and goals to assess efficiency of its operations.  The IRS has multiple measures related to processing tax returns and resolving compliance issues, which help evaluate performance.  For example, in FY2005 one IRS efficiency measure was calculated by dividing the total number of examined tax returns by the number of employees.  MMS could compute similar efficiency rates for its own audits and compliance reviews.

In discussions with MMS management, MMS does recognize that the GPRA goals for these particular issues need improvement, and MMS is reconsidering all of its current goals and measures.  To develop performance measures that are more useful and meaningful, MMS needs to link work activities to CAM Program goals and establish better output and outcome measures to serve as indicators of CAM Program performance.


RECOMMENDATIONS

We recommend that the Director, Minerals Management Service:

1. Develop and implement a plan to provide reliable data for managing and reporting on CAM Program operations.  This plan should include:

> addressing the data reliability issues in CIM, GPRA databases, LVS, and GVS; and

> consolidating systems where appropriate.  

MMS Response:

MMS concurred with our recommendations to address the data reliability issues and to consider consolidating its various systems.  MMS did not concur with the recommendation in the draft report to develop activity-based costing information at the individual audit and compliance review level.  MMS explained that it manages a very large number of these activities and providing this information would not be cost effective.  MMS also stated that it is appropriate to record qui tam settlement collections in the compliance tracking system.

OIG Analysis of MMS Response:  
   
Based on MMS response, we deleted the draft reports recommendation that activity-based costing information should be provided at the individual audit and compliance review level.  While we believe that management would benefit from this information, we recognize that maintaining such detail could be burdensome.

Although we agree that MMS should track qui tam settlements, the amounts should not be included in the cost and benefit analyses for audits and compliance reviews.  As stated in the report, MMS should not take credit for qui tam settlements because these findings did not result from MMS-initiated work.

2. Strengthen the compliance review process by:  

> including additional procedures to provide greater assurance concerning the reasonableness of:

* volumes by requesting actual source documents for at least one test month, or using inspection and enforcement data, or using production data from LVS and GVS; and

* allowances by requesting actual source documents for at least one test month, or using online sources (such as TariffMaster, FERC, and PI Grid), or compiling historical trends;

> documenting the rationale for determining thresholds for pursuing potential underpayments;

> developing additional guidance for audit referrals and by tracking referral actions;  

> notifying companies undergoing compliance reviews to give greater visibility to the CAM Program and to deter them from inaccurately reporting royalties;

> improving adherence to quality control procedures; 

> using risk-based criteria for selecting companies for CAM Program coverage; and

> ensuring that state and tribal auditors have access to all necessary compliance review tools, including the CPT.

MMS Response:

MMS concurred with most of our proposals to strengthen the compliance review process.  However, MMS did not agree that it should request source documents for one test month for the volume and allowance analyses, stating that alternative procedures of accessing other information was, or would soon be, available.  MMS also did not agree that it needs to document the procedures related to the billing and collections process, because adequate procedures were already in place.

MMS concurred with our recommendation to use a risk-based strategy for selecting companies for CAM Program coverage, but the response did not specifically mention that procedures would include inquiring whether companies have falsely reported information to other federal agencies.

OIG Analysis of MMS Response: 

We revised our recommendation to reflect that obtaining source documentation is only one of several means to improve the review of volume and allowances.  We agree that the other sources identified should be sufficient to meet MMS need; however this information may not always be available.  In cases where MMS cannot obtain the necessary information on volume and allowances from other existing sources, it should request actual source documentation. 

Because we found an instance where an underpayment had not been collected, we originally recommended that CAM Program analysts establish procedures to follow up on collections.  MMS response correctly points out that the Financial Management Program has responsibility for collecting identified underpayments and has written procedures for billing and collecting.  We therefore deleted this element of the recommendation to the CAM Program. 
Concerning MMS risk-based strategy, a companys historical reporting record with other federal agencies could be a valuable resource in identifying habitual noncompliance with regulations and requirements.  Accordingly, we ask that MMS affirm that it will incorporate this step into its risk-based strategy.

3. Revise performance measures to better reflect CAM Program operations.  Specifically, MMS should:

> eliminate the compliance index performance measure;

> separate the compliance coverage measure for audits, compliance reviews, and royalty-in-kind compliance activity;

> develop separate performance measures for companies and properties subjected to compliance coverage; and 

> develop performance measures to monitor the efficiency of audits and compliance reviews.

MMS Response:

MMS agreed to implement all recommendations regarding the performance measures except our recommendation to separate the compliance coverage measure by the type of compliance activity.  MMS stated it would track the information internally along with some of its limited scope compliance reviews, but would not report the measures separately to the Department.

OIG Analysis of MMS Response: 

The various compliance activities provide different levels of assurance.  The compliance coverage measure does not fully disclose the different levels of coverage and is therefore misleading and easily manipulated by changing the ratio of the different compliance activities.  We continue to recommend that MMS separate the measure for audits, compliance reviews, and royalty-in-kind. 


Appendix 1
SCOPE AND METHODOLOGY
Our audit scope addressed compliance review activities from FY2000 to June 2006.  It included a review of MMS design and implementation of compliance reviews, as well as its overall management of the CAM Program.  Our scope included MMS CAM Program and its four component offices.  Our scope did not include the Royalty In-Kind program activities. 

To accomplish our objectives, we: 

> Reviewed MMS policies and procedures for the compliance review program and performed walkthroughs of the compliance review process for each CAM.

> Held meetings with senior management and the four CAM managers to discuss how they implement their compliance review program and assess and monitor results.

> Gained an understanding of each CAMs audit and compliance review strategy. 

> Selected a haphazard sample of 20 compliance reviews to determine if MMS followed its policies and procedures.

> Gained an understanding of MMS information systems used to manage the CAM Program. We analyzed the data provided by the Compliance Information Management (CIM) system and the four GPRA databases and performed limited data verification steps that we considered necessary.  Specifically we looked at data regarding:
 collections resulting from audits and compliance reviews,
 audit and compliance review completion data,
 GPRA property and company information, and 
 obligations and disbursements for STRAC cooperative agreements.

> Reviewed information in MMS cooperative agreements with the states and Indian tribes for fiscal years 2001 through 2006 to determine the amount of funding provided to conduct audits. 

> Reviewed other federal and private entities, including the Internal Revenue Service, that have comparable activities to MMS compliance reviews for the purpose of identifying best practices. 

> Reviewed the Department of the Interiors Annual Report on Performance and Accountability for fiscal years 2003 to 2005.  The reports contained no reported weaknesses within the objectives and scope of our audit.

> Reviewed the Department of the Interiors Strategic Plan for fiscal years 2003-2008 to determine the goals and measures related to the CAM Program.

We performed our audit from April through June 2006 at MMS Minerals Revenue Management offices in Lakewood, Colorado, and Washington, DC.  We conducted our audit in accordance with Government Auditing Standards issued by the Comptroller General of the United States. 

Concurrent with conducting this audit we also compiled information to answer additional questions posed by the U.S. Senate Committee on Energy and Natural Resources.  These questions related to MMS auditor positions, the number of royalty audits initiated by MMS, the adequacy of MMS resources, and the funding for state and tribal audit organizations.  Our answers are presented in Appendices 4 and 5.


Appendix 2
MMS RESPONSE  TO DRAFT REPORT
(13 pages scanned into report)


Appendix 3
STATUS OF RECOMMENDATIONS

Recommendation:  1
Status:  Management   partially concurs - additional information needed.  
Action Required:  Consider the revisions made to the recommendation and provide an action plan with target dates and title of official responsible for implementation. 


Recommendation:  2
Status:  Management partially concurs - additional information needed
Action Required:  Consider the revisions made to the recommendation and provide an action plan with target dates and title of official responsible for implementation.  Also, clarify whether the risk-based strategy will consider how companies have complied with other federal agencies.


Recommendation:  3
Status:  Management partially concurs - additional information needed.
Action Required:  Provide an action plan with target dates and title of official responsible for implementation.  Also, reconsider the response related to the separate reporting of audit, compliance review, and RIK compliance activities.

Appendix 4
OIG RESPONSE TO QUESTIONS POSED BY THE U.S. SENATE COMMITTEE ON ENERGY AND NATURAL RESOURCES

Question 1.  Has MMS reduced the number of auditor positions?  If so, how many positions have been cut?  Why?

      MMS has reduced the number of auditor positions since 2000 as illustrated in Figure 1 below.  MMS reduced the number of its auditors located in the Compliance and Asset Management (CAM) Program by 35 or 20.7 percent (from 169 to 134).  During the same period, the approximate number of state and tribal auditors funded by MMS decreased by 10 or 8.5 percent (from 118 to 108)4.  The total number of auditors decreased by 45 or 15.7 percent (from 287 to 242).
      
            Figure 1.  Number of auditors for MMS and STRAC (See table in PDF version).


      MMS provided the following three reasons for the decline in audit staff: 

> A steady growth of royalties being taken in-kind instead of in-value has resulted in personnel being transferred to the Royalty-In-Kind Program.

> MMS reengineered its compliance processes and developed more efficient methods to augment the traditional audit approach.  In particular, the recently developed compliance review process has enabled MMS to provide broader coverage with fewer resources.

> MMS has not been fully funded for growth in pay and benefits, which has reduced overall staffing levels by nearly 9 percent since 2001.


Question 2.  Has MMS reduced the number of audits that it undertakes?  How many audits were initiated in 2005 as compared to each of the five preceding years?

      Because of errors in MMS data, we were unable to compare audit initiation data on an annual basis.  Specifically, some audits started in FY2004 were inappropriately identified as FY2005 audits.  This occurred because MMS was implementing a new tracking system.  We were unable to reasonably adjust for this error.  Therefore, for purposes of answering this question, we combined the audits initiated figures into biennial periods.  

      The overall number of audits initiated by MMS (including state and tribal audit organizations) decreased during this period as shown in Figure 2.   MMS initiated 595 audits in FYs 2000/2001 and 461 audits in FYs 2004/2005, a decrease of 22 percent.  We did not evaluate the substance of the audits or audit work conducted.  


           Figure 2.  Number of audits initiated. (See table in PDF version).


Question 3.  Does MMS have adequate resources to ensure that the royalties are properly collected on Federal and Indian leases?

      We were unable to determine whether MMS has adequate resources to ensure that royalties are properly collected because MMS lacked reliable management information to allow us to conduct such an analysis.  Our audit report disclosed the lack of reliable information on compliance activities and the costs and benefits associated with those activities.  
      
      FY2006 funding for the CAM Program was $42.7 million supporting 380 staff.  MMS stated that it has sufficient resources to conduct an effective audit and compliance program and added that its annual percentage goal for confirming "reasonable compliance" of mineral royalties (e.g. 71 percent for FY2005) "constitutes a significant level of compliance coverage.  The use of compliance reviews together with audits helps MMS achieve this level of coverage.  MMS further indicated that it would not be practical to request full funding to enable 100 percent audit coverage of the royalty dollars due to the extreme expense.  MMS estimated that it would cost about $430 million and require over 4,000 staff to audit 100 percent of the royalties.  MMS stated that it is significantly covering royalties, but could increase coverage if more funding was provided.  


Question 4.  Have funding levels for state and tribal cooperative agreements for auditing been reduced? If so, please provide information regarding the amount of the reductions.  How has this affected the amount of production that can be audited by states and tribes on an annual basis?

      Since FY2001 there have been small fluctuations in the overall planned budgets for state and tribal cooperative agreements.  The budgets increased from $9.1 million in FY2001 to $9.5 million in FY2003 and then decreased to $9.0 million in FY2006.  The actual obligations were significantly lower than the budgets for some of those years because the states and tribes did not always use all the funds allocated to them.  For example, in FY2001, $9.1 million was funded but only $7.7 million was actually obligated.  MMS stated that this occurred because, in the past, MMS obligated only about 85 percent of the funds based on the amount the states and tribes historically used.  However, MMS stated that it now obligates 100 percent of the budget.  Figure 3 below provides the budget and obligations for FY2001 to FY2006.  FY2006 obligations are as of June 2006. 
      

          Figure 3.  Combined state and tribal budget and obligations. (See table in PDF version).


      Although the combined funding level for all state and tribal activities has remained relatively stable over the past 5 years, there have been significant fluctuations in funding provided to individual states and tribes.  For example, in FY2006 when MMS reallocated funding amongst states and tribes, budgets for California and Colorado decreased 21 percent and 25 percent, respectively.  In contrast, budgets for Wyoming and Louisiana increased 23 percent and 43 percent, respectively.  MMS attributed this reallocation to the need to cover higher risk properties.  Appendix 5 illustrates the budgets and obligations for each state and tribe for FY2001 to FY2006.  
 
      We did not analyze the impact the reallocation of funding had on individual states and tribes.  Collectively, audits initiated by the states and tribes have increased since FY2000 as shown in Figure 4. 
      

         Figure 4.  Number of STRAC audits initiated. (See table in PDF version).
      
Generally, budgets exceeded obligations for most organizations.  However, in some cases, obligations exceeded budget amounts because unspent funds in one year carried forward to future years or adjustments were made for the payment of prior year administrative costs.  Additionally, for several states, the budget amounts were based on the federal fiscal year while obligations were made based on the states fiscal year.  


Appendix 5
State and Tribal Audit Organization Funding Total Original Budget (Planned Funding) and Obligations FYs 2001-2006[0]

States
(See table format, in PDF version)

Tribes
(See table format, in PDF version)

Alaska
(See table format, in PDF version)
*Alaska did not enter into a cooperative agreement with MMS until 2004.


California
(See table format, in PDF version)

Colorado
(See table format, in PDF version)
Louisiana
(See table format, in PDF version)

Montana
(See table format, in PDF version)

New Mexico
(See table format, in PDF version)

North Dakota
(See table format, in PDF version)

Oklahoma
(See table format, in PDF version)

Texas
(See table format, in PDF version)

Utah
(See table format, in PDF version)

Wyoming
(See table format, in PDF version)

Blackfeet
(See table format, in PDF version)

Crow
(See table format, in PDF version)
  *The cooperative agreement with Crow was terminated in 2005.

Jicarilla
(See table format, in PDF version)

Navajo
(See table format, in PDF version)

Northern Ute
(See table format, in PDF version)

Southern Ute 
(See table format, in PDF version)

Shoshone Arapaho
(See table format, in PDF version)

Ute Mountain Ute
(See table format, in PDF version)


Appendix 6
RELATED REVIEWS 
Reports Issued by the Office of Inspector General 

During the last 5 years, we issued three reports that relate to our audit objectives and scope.   

> Audit of Oversight Performed by Minerals Management Service of Non-Federal Auditors, Report No. 2003-I-0061, August 2003.

We concluded that MMS' oversight of non-federal auditors was reasonably effective to ensure states and tribes complied with the Government Auditing Standards.  However, we found that (1) some cooperative agreements contained outdated provisions, (2) audits of Jicarilla tribal leases were not covered by internal quality control reviews, and (3) neither the MMS internal quality control reviews nor the state peer reviews had a formal follow-up process.

The MMS Director agreed with three of the four recommendations and with all five of the suggested improvements.

> Audit of the Minerals Management Service Audit Offices, Report No. 2003-I-0023, March 2003.

During our audit, MMS was designing and implementing a re-engineered compliance process.  The new process shifted the focus from auditing on a company basis (auditing all of a company's leases at the same time) to a property basis (auditing leases grouped in one producing geographic location).  Overall, we concluded that MMS internal quality control system was not sufficient and that MMS audits did not always comply with the Government Auditing Standards.  Specifically, we found that:

* MMS' internal audit process was ineffective because it lacked accountability, did not cover all audit work, and was incomplete.

* MMS auditors recreated a set of workpapers that had been lost.

* Not all MMS auditors met their continuing education requirements.

MMS generally agreed with the report's findings and concurred with all recommendations.  


> Evaluation of Vulnerabilities to Underreporting:  Royalty-in-Value Versus Royalty-in-Kind, Report No. 2002-I-0044, August 2002.

At the request of the Deputy Secretary, we performed this evaluation to determine whether MMS' royalty-in-value (RIV) program or its royalty-in-kind (RIK) program was more vulnerable to underreporting.  We concluded that the RIV program was more vulnerable because the lessor established the basis for product valuation as well as the transportation and processing costs.  The RIK program was less vulnerable because MMS received actual proceeds from product sales and paid actual transportation and processing costs.  Nevertheless, RIV was preferable in certain instances.  In addition to these findings, we concluded that MMS could improve its controls over the RIK program in the areas of gas imbalances, credit lines of approval, manual data entry, and sales contract limitations.

MMS officials generally concurred with our conclusions and had initiated actions to address the control issues noted in our report.

Reports Issued by the Government Accountability Office (GAO)

During the last 5 years, GAO issued three reports that relate to MMS CAM Program. 

> Royalty Revenues: Total Revenues Have Not Increased at the Same Pace as Rising Oil and Natural Gas Prices due to Decreasing Production Sold,  Report No. GAO-06-786R, June 2006

GAO found that federal and Native American royalty revenues did not increase at the same pace as oil and natural gas prices between 2001 and 2005 principally because the volumes upon which royalties are based declined substantially during this time. 

> Mineral Revenues, Cost and Revenue Information Needed to Compare Different Approaches for Collecting Federal Oil and Gas Royalties, Report No. GAO-04-448, April 2004.

GAO reported that although data was limited, RIK realized substantial administrative cost savings over RIV.  Further, MMS used these cost savings to audit additional RIV leases but could not quantify the benefit.  Also, MMS had not yet implemented the recommendations contained in GAOs 2003 report.  GAO suggested that Congress consider directing MMS to establish a systematic evaluation of the revenue impacts of all future RIK sales and quantify overall changes in the administration of royalty collections.  MMS agreed with the reports conclusions and recommendations.
 

Mineral Revenues, A More Systematic Evaluation of the Royalty-in-Kind Pilots is Needed, Report No. GAO-03-296, January 2003.

GAO reported that MMS had made substantial progress in establishing an RIK program, but that more work was needed before the program could be adequately assessed and expanded.  In particular, MMS needed to establish clear strategic objectives linked to statutory requirements and to collect the necessary information to enable effective monitoring and evaluation of the RIK program.  MMS generally agreed with the reports conclusions and recommendations.
> 


Appendix 7
ACRONYMS AND ABBREVIATIONS

AFMSS
Automated Fluid Minerals Support System

BLM
Bureau of Land Management

CAM
Compliance and Asset Management

CIM
Compliance Information Management

CPT
Compliance Program Tools

FERC
Federal Energy Regulatory Commission

FY
Fiscal Year

GAO
Government Accountability Office

GVS
Gas Verification System

GPRA
Government Performance and Results Act

IRS
Internal Revenue Service

LVS
Liquid Verification System
MMS
Minerals Management Service

OIG
Office of Inspector General

PI Grid
Petroleum Information Grid

RIK
Royalty-in-kind

RIV
Royalty-in-value

STRAC
State and Tribal Royalty Audit Committee




_______________________________________
Footnotes:
1 A company refers to an organization that pays royalties to MMS.  This includes a corporation, partnership, sole proprietorship, or individual.  (page 1)
2 A company refers to an organization that pays royalties to MMS.  This includes a corporation, partnership, sole proprietorship, or individual.  (page 7)
3 MMS did not have data on the actual number of state and tribal auditors; however, it provided a calculated estimate based on the number of hours provided by the state and tribal audit organizations.  (page 32)