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[Senate Hearing 110-7]
[From the U.S. Government Publishing Office]

                                                          S. Hrg. 110-7
 
                 OIL AND GAS ROYALTY MANAGEMENT AT DOI

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                                   on

ISSUES RELATING TO OIL AND GAS ROYALTY MANAGEMENT AT THE DEPARTMENT OF 
                              THE INTERIOR

                               __________

                            JANUARY 18, 2007

                       Printed for the use of the
               Committee on Energy and Natural Resources

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33-870 PDF                  WASHINGTON : 2007
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Washington, DC 20402-0001

               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii              PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota        LARRY E. CRAIG, Idaho
RON WYDEN, Oregon                    CRAIG THOMAS, Wyoming
TIM JOHNSON, South Dakota            LISA MURKOWSKI, Alaska
MARY L. LANDRIEU, Louisiana          RICHARD BURR, North Carolina
MARIA CANTWELL, Washington           JIM DeMINT, South Carolina
KEN SALAZAR, Colorado                BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey          JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas         GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont             JIM BUNNING, Kentucky
JON TESTER, Montana                  MEL MARTINEZ, Florida
                    Robert M. Simon, Staff Director
                      Sam E. Fowler, Chief Counsel
            Frank J. Macchiarola, Republican Staff Director
             Judith K. Pensabene, Republican Chief Counsel
                      Patty Beneke, Senior Counsel

                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Allred, C. Stephen, Assistant Secretary, Land and Minerals 
  Management, Department of the Interior.........................    18
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................     1
Devaney, Earl E., Inspector General, Department of the Interior..     6
Domenici, Hon. Pete V., U.S. Senator from New Mexico.............     4
Gaffigan, Mark E., Acting Director, Natural Resources and 
  Environment, Government Accountability Office..................     9
Sanders, Hon. Bernard, U.S. Senator from Vermont.................     3
Wyden, Hon. Ron, U.S. Senator from Oregon........................     3

                                APPENDIX

Responses to additional questions................................    57

                 OIL AND GAS ROYALTY MANAGEMENT AT DOI

                              ----------                              

                       THURSDAY, JANUARY 18, 2007

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9:32 a.m., in 
room SD-G50, Dirksen Senate Office Building, Hon. Jeff 
Bingaman, chairman, presiding.

OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW 
                             MEXICO

    The Chairman. Why don't we call the hearing to order? I 
thank everybody for coming today. We thank our witnesses for 
being here. Today the committee will hear from witnesses on the 
topic of oil and gas royalty management in the Department of 
the Interior. Problems in this program have been the subject of 
work both by the Department, the Department's Inspector 
General, Mr. Devaney, who is here today and also by the 
Government Accountability Office. Mr. Gaffigan is here today 
representing that office.
    I've had a chance to briefly review the IG's report that is 
being released today and it's obvious there is a lot of blame 
to spread around on this issue. Almost a year ago, we became 
aware that Outer Continental Shelf oil and gas leases issued in 
1998 and 1999 in the Gulf of Mexico did not contain so-called 
price thresholds, therefore allowing a certain volume of 
royalty-free production under the Deep Water Royalty Relief Act 
of 1995.
    At that time, I was joined on a bipartisan basis by 21 
members of the Senate and some members from the House in 
requesting the General Accountability Office to look into the 
matter. The problem may result, I'm informed, in losses to the 
Treasury of $10 billion over 25 years.
    While this error initially occurred in the Clinton 
administration, I think it is clear that it was an error that 
was accomplished by civil servants working in the Department. 
Lease terms were changed without the Solicitor's Office being 
asked to review the modifications. Communications were confused 
when the error was discovered. Mid-level managers did not raise 
the issue with departmental officials higher up in the 
Department.
    Subsequently, when the problem became known in the Bush 
administration to some of their officials, there was not much 
done initially, but efforts in the last year have resulted in 
settlement agreements with, I believe, six different companies. 
There are still many companies that have leases that have not 
agreed to settle.
    From my vantage point, the entire matter raises serious 
questions about management and organization at the Department, 
and the adequacy of resources committed to this activity, 
particularly in the Solicitor's Office. I hope the testimony 
today can lead to some concrete, constructive steps, such as 
increasing resources that are needed, any changes in 
management, management reforms, and legislative solutions, if 
those are required.
    I'm also deeply concerned about pending litigation that has 
been brought by the Kerr McGee Corporation. They have recently 
been acquired by Anadarko Petroleum. That litigation relates to 
the same Deep Water Royalty Relief Program. The lawsuit 
challenges the authority of the Secretary of the Interior to 
impose price thresholds for any leases issued from 1996 through 
2000. I believe Congress intended that price thresholds apply 
but if the industry were to prevail in that litigation, the 
exposure to the Treasury and the windfall to the industry could 
be very large. I'm told it could be in the range of $60 billion 
over 25 years.
    Unfortunately, the royalty management problems don't end 
with those items that I've mentioned. Last month, the IG issued 
a report related to the audit and compliance review process for 
both onshore and offshore royalties. That report indicates MMS 
has reduced the number of auditor positions by over 20 percent 
since 2000. The number of audits has been reduced by 22 percent 
over the period from 2000 to 2004. Ensuring the MMS collects 
the proper amount of royalties has implications not only for 
the Federal Treasury, it also has implications for the States 
that share in the royalty proceeds and for Indian tribes, with 
Indian oil and gas resources involved and they are in some of 
what we're talking about.
    I've been concerned also that for-government auditors who 
have monitored leases for oil and gas on Federal lands have now 
alleged that the Interior Department suppressed their efforts 
to recover millions of dollars from leasees. These individuals 
have filed qui tam cases under the Federal Government Civil 
False Claims Act, seeking to recover these amounts on behalf of 
the Government. I believe the IG is looking into this matter. I 
don't know if he will be able to testify on any aspect of it 
today.
    Finally, last June, Chairman Rahall and I requested GAO to 
review whether the royalty rates for oil and gas leases are 
commensurate with royalties received by States and by private 
interests on their lands. I note with interest that this last 
week, the administration announced an increase in royalty rates 
for OCS leases in the deep waters of the Gulf of Mexico. I hope 
the GAO will be able to give us some initial findings in that 
regard.
    The final point I would mention is that Mr. Devaney, in 
your testimony last fall, I believe on the House side, you made 
a statement that I thought was fairly striking. You said short 
of a crime, anything goes at the highest levels of the 
Department of the Interior. Congress needs to take its 
oversight responsibilities seriously. Obviously that's the kind 
of statement that needs to get our attention. We're anxious to 
hear any comments you have on that issue today.
    Let me defer to Senator Domenici for any statement he has 
and then we'll go to the witnesses.
    [The prepared statements of Senators Sanders and Wyden 
follow:]
 Prepared Statement of Hon. Bernard Sanders, U.S. Senator From Vermont
    Mr. Chairman, Mr. Ranking Member, thank you for holding this 
hearing today. The mismanagement of the royalty program at the 
Department of the Interior is something that this Committee rightly 
must thoroughly oversee. And, it isn't only the mismanagement that 
needs oversight--although clearly, with a billion dollars already lost 
and billions more at risk, we must get a grip on what is happening. We 
need to thoughtfully assess the underlying idea of royalty relief, 
which is nothing more than an embarrassing giveaway of taxpayer 
dollars. At this point in time, when we should be encouraging movement 
away from fossil fuels that cause global warming and moving toward 
clean, renewable sources of energy, why would the federal government 
give oil and gas companies--while they are making record profits and 
consumers feel the pain--free money for the resources they take from 
public lands? If I didn't know better, I would laugh if someone tried 
to tell me about the situation.
    Unfortunately, it is no joke.
    Along with many of my colleagues, I am glad that the New York Times 
exposed the mismanagement issues last year and I look forward to 
helping ensure that the Department of the Interior changes its tune. I 
appreciate the work done by the Interior Department's Inspector General 
and the GAO, and I thank them for appearing here this morning. I also 
appreciate the Assistant Secretary for Lands and Minerals Management 
spending time with the Committee today.
                                 ______
                                 
     Prepared Statement of Hon. Ron Wyden, U.S. Senator From Oregon
    Thank you, Chairman Bingaman and Senator Domenici, for scheduling a 
hearing on this important subject--how American taxpayers are getting 
fleeced for billions of dollars by oil and gas companies drilling on 
public land and on the Outer Continental Shelf. Drilling in these 
places isn't a right, it's a privilege, and I am deeply concerned about 
the on-going taxpayer ripoffs in this program uncovered over the last 
year.
    In December, the Inspector General issued a report documenting 
numerous problems in how the Mineral Management Service is failing to 
make sure that companies pay what they owe. Not surprisingly, the 
amount of money collected through MMS enforcement actions in 2005 was 
about one-fourth what it had been a few years earlier.
    Things are apparently so bad in the audit program that four MMS 
auditors have filed their own lawsuits under the Federal False Claims 
Act on behalf of the government to collect tens of millions of dollars 
in unpaid royalties. The auditors--agency veterans--say their superiors 
at MMS ordered them not to pursue these cases on the job, so they are 
doing it on their own. And how did the Interior Department respond? One 
of the auditors claims he was forced out of his job and the other three 
have been reassigned to other jobs and are the subject of internal 
Department investigations.
    Today, the IG has released another report, this one on why hundreds 
of leases in the Gulf of Mexico were signed without price thresholds, a 
failure that will cost the taxpayers billions of dollars in lost 
royalties while oil companies report record profits. Despite the IG's 
best efforts, it's still not clear exactly how this happened--we hear 
that nobody read the leases, that it was bureaucratic bumbling at its 
worst, that current MMS officials have known about the problem for 
years but did nothing--and this is all a damning indictment of the way 
the Department handles billions of dollars worth of oil and natural gas 
leases.
    Mr. Chairman, the problems with the mineral leasing programs don't 
end here. The program is also the subject of multiple criminal 
investigations, at least one involving the Royalty-In-Kind program--a 
program that started with serious problems, as documented by the GAO in 
2003 and 2004, and which appears to have gotten worse. States and 
Indian tribes that carry out royalty audits under agreement with MMS 
say they are being reined in so they can't properly do their job or 
challenge the agency's decisions. I could go on.
    The bottom line, Mr. Chairman, is that today's hearing is a good 
first step, but there is much more to do. And I want to work with you 
and our colleagues on the Committee on both sides of the aisle, and 
especially on the Public Lands Subcommittee, to understand this mess 
and fix it. The way things are being handled at the Interior Department 
and MMS is simply unacceptable.

       STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR 
                        FROM NEW MEXICO

    Senator Domenici. Senator Bingaman, first, thank you for 
your statement. Thank you for calling the hearing and thank you 
for your demeanor. As usual, you have, in my opinion, laid this 
issue properly before the Congress. Thank you.
    First, let me make sure we understand that thresholds are 
missing from 1998 and 1999 leases and that equals 1,032 leases 
in that time period that we did not have thresholds. It's not 
leases before that and it's not leases after that. It's leases 
during that period of time. Now, just so we straighten out who 
was in office and running the show, not by way of laying blame 
because right now, I don't think we lay blame on anybody. But 
those were Clinton years, followed by Bush years. Somehow or 
another, for those 2 years, leases that were issued--they were 
issued under this new act, which was supposed to sensitize that 
part of the gulf to more activity. Senator Craig, the act was 
supposed to be something that would excite the leasees to go 
out and bid and in spite of us being here today, worrying about 
what happened, the truth of the matter is, the act did work. A 
lot more people bid to get a leasehold going because of the act 
that we're speaking of that invited more activity.
    So, we are able to determine how much occurred during those 
2 years and already, the action has cost the Treasury and I 
think all of you sitting in front of me will confirm this--if 
not all of you, at least some of you, will confirm that $900 
million was lost during that time period because of the price 
of oil and we are assuming, a lack of a threshold. A threshold 
wasn't there. We should have been gaining money and the 
estimate is $900 million. We hear another term, $10 billion. 
Well, that is projected further out by GAO to cost $10 billion 
and that's a GAO estimate. If you go all the way out, that's 
what it would cost for the leases that are missing thresholds 
during the 2 years that I've talked about.
    Now, obviously, we all know enough now, Senator Salazar. 
Nobody contemplates putting these leases on without thresholds, 
at least I hope so. With these hearings, it ought to make 
anybody thinking about doing that rather uncomfortable, it 
would seem to me.
    Now having said that, again, I want to thank the chairman 
and I want to thank the witnesses. I have not had a chance to 
talk to all of you but I did get a chance to talk to you, Mr. 
Secretary, yesterday for just a few moments. You have a 
difficult job and I thank you for coming here and being very 
forthright and I urge that you continue to do so. There are 
some unanswered questions that still, as of this morning, if 
you read the GAO and your report, you still don't get the 
answers to all the questions. There are some unanswered 
questions about what happened to whom, who was there to take 
telephone calls, who died and who has dementia among those 
people that are part of this overall activity.
    What I want you to know is that the issue is of enormous 
significance to the American people and to our Nation's fiscal 
well being. According to the Interior Department, I've already 
told you that the MMS collected $9.9 billion in royalties from 
approximately 27,800 producing leases. So the stakes of getting 
this right are terrifically important. In 1998 and 1999, the 
Department of the Interior failed to include so-called price 
thresholds in deep-water oil and gas leases. From all accounts, 
from this time, it appears that the omissions of these 
thresholds were the result of negligence and not a nefarious 
action.
    Nevertheless, according to an initial estimate from the 
GAO, this failure during the Clinton administration Interior 
Department, it could have cost the taxpayers $10 billion over 
25 years.
    Last summer, I sponsored an amendment that passed the 
Interior Committee that among other things, encouraged, Mr. 
Chairman, the negotiation of 1998 and 1999 leases and provided 
the Secretary of the Interior with the clear authority to 
negotiate these leases to include price thresholds. Though the 
Interior Appropriations bill was never brought up on the Senate 
floor, I suspect that the committee vote sent the proper signal 
to the companies and the Department.
    In December, six companies negotiated, as I understand it, 
with you, Mr. Secretary. You're the one doing that work. Six 
companies negotiated the terms of the agreements to include 
price thresholds. The Department of the Interior believes that 
this will bring an estimated 20 percent of the outstanding lost 
royalties as a result of the error in the 1998 and 1999 leases.
    I continue to encourage all companies to come forward and 
re-negotiate with the Department of the Interior. It is 
important for our Nation's fiscal stability. It's important 
that we know what these leaseholds will yield. That's a very 
important fact for us to know. It is significant. It is 
important to get this issue resolved so that the Department and 
these companies, these holders can get back to doing what they 
do best--that is, produce American oil and gas supplies to help 
reduce our energy dependence.
    As we heard at last week's global oil hearing, this is an 
economic security issue. It is a foreign policy issue and a 
national security issue and we should keep our focus on that 
fact. Additionally, I want to make it clear that the Deep Water 
Royalty Relief Act of 1995 was a good thing. We should not 
confuse the failure of the Clinton administration's 
implementation for 2 years with its substantive policy advance 
and achievement made as a result of this act. Since President 
Clinton signed the act into law, our domestic oil and gas in 
deep water has increased dramatically. In 2005, oil production 
was over 400 percent greater than 1995 and natural gas was 340 
percent greater than 1995 and as we begin to make our judgments 
on how to resolve this issue of the 1998 and 1999 leases, I 
trust that we will examine the important and difficult legal 
issues, contractual and property and constitutional issues, 
that this situation presents for all of us.
    I hope this Congress will resist the temptation of the 
headlines and will act in a thoughtful, practical way. We 
should know that the eyes of the world and Mr. Chavez and Mr. 
Putin are watching how we treat shareholders of property and 
contract rights on our Federal lands.
    I thank the chairman for holding this important hearing and 
look forward to hearing my colleagues ask questions. Thank you, 
Mr. Chairman.
    The Chairman. Thank you very much. Why don't we just go 
through each of the witnesses, if they would each take 10 
minutes or so and give us the substance of their testimony. 
Obviously, your written testimony will be included in the 
record but if you have significant points you want us to focus 
on, we'd be anxious to have you explain what those are. Why 
don't we start with you, Mr. Devaney and we'll just go right 
across the row that way.

STATEMENT OF EARL E. DEVANEY, INSPECTOR GENERAL, DEPARTMENT OF 
                          THE INTERIOR

    Mr. Devaney. Thank you Mr. Chairman and members of the 
committee. I want to thank you for the opportunity to address 
the committee this morning about the various oversight 
activities being conducted by my office regarding the Minerals 
Management Services Royalty Program.
    Specifically, I'm here today to discuss the results of our 
audit of MMS's compliance review process, which was released 
publicly in December 2006 and the results of our investigation 
into the circumstances surrounding MMS's failure to include 
price thresholds in deep water leases entered into during 1998 
and 1999, which is being released this morning.
    Our audit of the compliance review process was initiated in 
response to requests from this committee and other members of 
Congress. This is not our first audit of MMS's Compliance and 
Asset Management Program. For instance, in 2003, we conducted 
an audit of MMS's audit function in which we concluded that 
MMS's internal quality control system could not ensure that the 
audits were being conducted in accordance with government 
auditing standards. We also found incredibly, that MMS auditors 
had recreated and backdated working papers prior to that audit.
    Since that time, however, MMS audit offices have undergone 
and passed two external peer reviews, an indication that MMS 
has corrected the problems we identified in 2003.
    From our most recent audit of the compliance review 
process, we found that compliance reviews can provide a broader 
coverage of royalties using fewer resources than traditional 
audits. They do not, however, provide the same level of detail 
or assurance that a traditional audit provides. As a result, we 
concluded that compliance reviews should only be used in 
conjunction with audits and in the context of a well-defined 
risk based compliance strategy. We discovered two principle 
weaknesses that are preventing MMS from maximizing the benefits 
of compliance reviews.
    First, we discovered that very few full audits were ever 
triggered by anomalies discovered during those compliance 
reviews. We also learned that because the program's performance 
measures were tied to dollar figures, only the big companies 
and leases were being reviewed, leaving hundreds of smaller 
companies that MMS never looks at. With few exceptions, MMS 
agreed with our recommendations and as promised, they have 
provided us with an action plan for implementing these changes.
    We've just finished our investigation into the failure of 
MMS to include price thresholds in the terms of deep-water 
leases issued in 1998 and 1999. We conducted our investigation 
with two primary purposes in mind: how and why price thresholds 
were omitted from the leases and what happened once the 
omissions were discovered. During the course of our 
investigation, we conducted 44 interviews and reviewed 
approximately 19,000 e-mails and 20,000 pages of documents. We 
determined that MMS intended to include price thresholds in 
leases issued pursuant to the Deep Water Royalty Relief Act, as 
evidenced in the first leases issued in 1996 and 1997, as well 
as in 2000. But while MMS was developing new regulations 
relating to the Deep Water Royalty Relief Act, there was 
significant confusion among the MMS's operational components 
and the Office of the Solicitor as to whether or not the 
regulations would address price thresholds. In the end, the 
regulations did not and the price thresholds were left out of 
the leases.
    The person responsible for directing the preparation of the 
leases said he was told by persons in MMS's Economic and 
Leasing Divisions to take the price threshold out of the 
leases. He successfully passed a polygraph exam. The people in 
the Economics and Leasing Divisions denied telling him to take 
the language out and the one person involved in both the 
regulation development and the notice of sale review process, a 
solicitor's attorney, conceded that he should have spotted the 
omission but did not. The official who signed the leases on 
behalf of MMS told us he relied on that same solicitor attorney 
and his own staff before signing.
    When the omission was discovered by MMS staff in 2000, it 
was unexplainably not conveyed up the chain of command to the 
MMS Director. Unfortunately, the official who made this 
particular decision is now deceased. We interviewed the former 
MMS Directors who were in place at the time of the omission and 
the time of its discovery as well as the present Director. Each 
told us that they only became aware of the omission when the 
first New York Times article came out last fall.
    Near the end of the investigation, however, we found a 
series of e-mails, which suggested that the present Director 
had been advised of the price threshold omission as early as 
2004. We went back to her with this information and when she 
read the e-mails, she appeared genuinely surprised but conceded 
that the e-mails indicated that she probably had been told of 
the omission in 2004. She still had no independent recollection 
but speculated that she was probably told of the mistake in 
conjunction with being informed that the Solicitor's Office had 
opined that nothing could be legally done to remedy the 
situation.
    Mr. Chairman, this, at a minimum, is a shockingly cavalier 
management approach to an issue with profound financial 
ramifications, a jaw-dropping example of bureaucratic bungling 
and a total reliance on surname process, which diluted 
responsibility and accountability. Although we found massive 
finger pointing and blame enough to go around, we do not have a 
smoking gun or any evidence that this omission was deliberate. 
We do, however, have a very costly bureaucratic mistake.
    I'd like to tell you that this concludes the summary of 
oversight activities my office is conducting relative to MMS's 
royalty program. Unfortunately, it does not. We have several 
other investigations ongoing, some of which are criminal in 
nature. As a result, I'm not at liberty to discuss them with 
you here today. However, we have coordinated closely with the 
Department in order to provide Assistant Secretary Allred with 
enough general information so that he could take some interim 
preventative measures. In fact, I'd like to publicly thank both 
Secretary Kempthorne and Assistant Secretary Allred for being 
very receptive to our findings and recommendations of these 
matters. I'm encouraged that they both share my belief that 
beyond any actual impropriety, appearances do matter.
    This concludes my formal testimony. Thank you for the 
opportunity to appear before the committee today. I'll be glad 
to answer any questions any of you might have.
    [The prepared statement of Mr. Devaney follows:]
       Prepared Statement of Earl E. Devaney, Inspector General, 
                       Department of the Interior
    Mr. Chairman and members of the Committee, I want to thank you for 
the opportunity to address the Committee this morning about various 
oversight activities being conducted by the Office of Inspector General 
(OIG) for the Department of the Interior (DOI) concerning multiple 
issues involving the Minerals Management Service (MMS). Specifically, I 
am here today to discuss the results of our audit of MMS' Compliance 
Review Process, which was released publicly in December 2006, and the 
results of our investigation into the circumstances surrounding MMS' 
failure to include price thresholds in deepwater leases entered into 
during 1998 and 1999, which is being released publicly this morning.
    Our audit of the compliance review process--one of several tools 
utilized by MMS' Compliance Asset Management (CAM) Program--was 
initiated in response to a request from this Committee and other 
members of Congress to assess the effectiveness of these compliance 
reviews. This audit was timely--not only because it followed the first 
of several New York Times articles on MMS and its royalty program, but 
also because the compliance review process, which was launched in 2000, 
was ripe for an audit in 2006.
    This is not our first audit of MMS' Compliance Asset Management 
Program. In 2003, we conducted an audit of MMS' audit function in which 
we concluded that MMS' internal quality control system could not ensure 
that its audits were being conducted in accordance with policies, 
procedures and Government Auditing Standards. We also found an instance 
of MMS auditors recreating and back-dating working papers. Since that 
time, however, the MMS audit offices have undergone and ``passed'' two 
external peer reviews, an indication that MMS has corrected the 
problems we identified in 2003.
    From our audit of the compliance review process, we found that 
compliance reviews play a useful role in MMS' greater Compliance and 
Asset Management Program. Compliance reviews can provide a broader 
coverage of royalties, using fewer resources than traditional audits. 
They do not, however, provide the same level of detail or assurance 
that a traditional audit provides. As a result, we concluded that 
compliance reviews should only be used in conjunction with audits, in 
the context of a well-designed, risk-based compliance strategy. We also 
discovered two principal weaknesses that are preventing MMS from 
maximizing the benefits of compliance reviews. First, we discovered 
that very few full audits were ever triggered by anomalies discovered 
in the compliance review process. We also learned that because the 
program's performance measures were tied to dollar figures, only the 
big companies and leases were being reviewed, leaving hundreds of 
smaller companies that MMS never looked at.
    In addition, we made several recommendations to improve CAM's 
management data, and to strengthen the compliance review process 
overall. With few exceptions, MMS agreed with our recommendations; most 
notably, MMS agreed to revise its performance measures and to develop 
and pilot a risk-based compliance strategy for its compliance review 
process; and, as promised, MMS has now provided us with an Action Plan 
for implementing these changes.
    Contemporaneous with our audit of the compliance review process, we 
conducted an investigation into the failure of MMS to include price 
thresholds in the terms of deepwater leases issued in 1998 and 1999. We 
conducted our investigation with two primary questions in mind: How and 
why were price thresholds omitted from the leases; and what happened 
once the omission was discovered. During the course of our 
investigation, we conducted 44 interviews and reviewed approximately 
19,000 e-mails and 20,000 pages of documents. We have determined that 
MMS intended to include price thresholds in leases issued pursuant to 
the Deepwater Royalty Relief Act, as evidenced in the first leases 
issued in 1996 and 1997, as well as in 2000; but while MMS was 
developing new regulations relating to the Deepwater Royalty Relief 
Act, there was significant confusion among MMS operational components 
and the Office of Solicitor (SOL) as to whether or not the regulations 
would address price thresholds. In the end, the regulations did not, 
and the price thresholds were left out of the leases.
    The person responsible for directing the preparation of the leases 
said he was told by persons in MMS' Economics and Leasing Divisions to 
take the price threshold language out of the leases. The people in the 
Economics and Leasing Divisions denied doing so. The one person 
involved in both the regulation development and lease review process, a 
SOL attorney, conceded that he should have spotted the omission, but 
did not. The official who signed the leases on behalf of MMS told us he 
relied on the SOL attorney and his own staff.
    When the omission was discovered by MMS staff in 2000, it was not 
conveyed up the chain of command to the MMS Directorate. Unfortunately, 
the official who made this particular decision is deceased. We 
interviewed the former MMS Directors who were in place at the time of 
the omission and the time of its discovery, as well as the present 
Director. Each told us that they only became aware of the omission when 
the first New York Times article came out last fall.
    Near the end of our investigation, however, we found a series of e-
mails that suggested that the present Director had been advised of the 
price threshold omission as early as 2004. We went back to her with 
this information and conducted a follow-up interview. When she read the 
e-mails, she appeared genuinely surprised, but conceded that the e-
mails indicated that she had probably been told of the omission in 
2004. She still had no independent recollection, but speculated that 
she was probably told of the mistake in conjunction with being informed 
that the Solicitor's Office had opined that nothing could be legally 
done to remedy the issue.
    Mr. Chairman, this, at a minimum was a shockingly cavalier 
management approach to an issue with such profound financial 
ramifications, a jaw-dropping example of bureaucratic bungling, and a 
reliance on a surname-process which dilutes responsibility and 
accountability. Although we found massive finger-pointing and blame 
enough to go around, we do not have a ``smoking gun'' or any evidence 
that this omission was deliberate; we do, however, have a very costly 
mistake which might never have been aired publicly absent the New York 
Times, the interest of this Committee, the House Subcommittee on Energy 
and Resources and that of several other interested members of Congress.
    I would like to say that this concludes the summary of the 
oversight activities my office is conducting relative to MMS; 
unfortunately, it does not. We have several other investigations 
ongoing, some of which are criminal in nature. As a result, I am not 
presently at liberty to discuss them. With regard to these matters, 
however, we have coordinated closely with the Department in order to 
provide Assistant Secretary Allred with enough general information so 
he could take some interim preventive measures. In fact, I would like 
to publicly thank both Secretary Kempthorne and Assistant Secretary 
Allred for being receptive to our findings and recommendations. I am 
encouraged that they both share my belief that beyond actual 
improprieties, appearances do matter.
    This concludes my formal testimony. Thank you for the opportunity 
to appear here before the Committee today. I will be happy to answer 
any questions you may have.

    The Chairman. Thank you very much for your testimony, Mr. 
Devaney. Next is Mark Gaffigan, who is the Acting Director of 
the Natural Resources and Environment section in the Government 
Accountability Office. I appreciate you being here.

    STATEMENT OF MARK E. GAFFIGAN, ACTING DIRECTOR, NATURAL 
  RESOURCES AND ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Gaffigan. Thank you, Mr. Chairman, ranking member 
Domenici, members of the committee. Good morning. I'm pleased 
to be here to assist you in your oversight of royalties 
obtained from the sale of oil and natural gas produced from 
Federal lands and waters.
    MMS recently reported collecting about $10 billion in 
annual oil and gas royalty revenue from Federal production that 
supplies about one-third of all the oil and one-quarter of all 
the natural gas produced in the United States. Obviously, such 
a large and financially significant resource must be carefully 
managed and developed to strike a balance between meeting our 
Nation's significant energy needs while also ensuring a fair 
return to the American people, especially in light of the 
current and long range fiscal challenges facing the Nation.
    As part of this balance, the Federal Government has 
provided royalty relief, which is the waiver or reduction of 
royalties in order to encourage the development of oil and gas. 
However, to maintain balance and ensure a fair return, royalty 
relief also typically includes volume limitations or price 
thresholds that limit relief and restore royalties once a 
certain amount of oil or gas has been produced or once market 
prices reach certain levels.
    In 1995, in a period of lower prices and declining 
production, a significant royalty relief act, the Deep Water 
Royalty Relief Act of 1995, mandated relief for oil and gas 
leases issued in the deep waters of the Gulf of Mexico. Sadly, 
the establishment of limitations on the royalty relief provided 
by this act has been fraught with problems, likely costing 
billions of dollars in foregone royalty revenues and placing 
into question whether a fair return has been achieved.
    Based on our ongoing work reviewing the fiscal impact of 
royalty relief, I would like to emphasize three points. First, 
a series of mistakes and legal challenges in implementing 
relief under the 1995 Act will likely add billions in 
unanticipated costs. For example, Interior lost a 2004 court 
case on MMS's establishment of volume units for royalty relief, 
resulting in higher volume limits being applied and thus, more 
relief. MMS has estimated that this decision could cost up to 
$10 billion in foregone revenue.
    Another problem that has been widely reported has been the 
price thresholds left off the 1998 and 1999 leases. MMS has 
estimated that this could cost another $10 billion, a billion 
of which has already been foregone.
    Finally, Kerr McGee, in a current lawsuit, is questioning 
whether MMS even has the authority to establish price 
thresholds for any of the leases issued under the 1995 Act, 
thus bringing into question another 2,300 leases issued in 
1996, 1997 and 2000. If this case is lost, again MMS has 
preliminarily estimated that this could add up to another $60 
billion.
    My second point--while we are reviewing these cost 
estimates, even without the uncertainty stemming from this 
litany of problems that has resulted in these potential, 
unanticipated costs, determining the fiscal impact of royalty 
relief is inherently difficult. It is difficult because of 
uncertainty about the amount and timing of future oil and gas 
production and future prices. In addition, potential benefits 
that may offset costs should also be considered. For example, 
benefits might include increased production or higher amounts 
companies are willing to pay for leases.
    My third point--although leases are no longer issued under 
the 1995 Act, royalty relief can still be granted today under 
two basic existing authorities. First, MMS currently offers 
several royalty relief programs under the discretionary 
authority granted to the Secretary of the Interior. In 
addition, the Energy Policy Act of 2005 also contains several 
royalty relief provisions. Relief under these discretionary 
programs and legislation may further impact future royalty 
revenues.
    Royalty policy can be an important tool in striking a 
balance between encouraging production and ensuring a fair 
return. However, this balance must be struck in careful 
consideration of both the costs and benefits of all royalty 
relief provisions. Unfortunately, the Federal Government has 
not consistently given this careful attention, resulting in 
unforeseen costs and many questions about the ultimate impact 
of royalty relief.
    As we continue our work, GAO looks forward to assisting the 
Congress and MMS in the future, through its reviews of these 
issues. This concludes my opening remarks. I have submitted a 
written statement for the record and I welcome any questions 
you might have. Thank you.
    [The prepared statement of Mr. Gaffigan follows:]
   Prepared Statement of Mark E. Gaffigan, Acting Director, Natural 
      Resources and Environment, Government Accountability Office
                         why gao did this study
    Oil and gas production from federal lands and waters is vital to 
meeting the nation's energy needs. As such, oil and gas companies lease 
federal lands and waters and pay royalties to the federal government 
based on a percentage of the oil and gas that they produce. The 
Minerals Management Service (MMS), an agency in the Department of the 
Interior, is responsible for collecting royalties from these leases. In 
order to promote oil and gas production, the federal government at 
times and in specific cases has provided ``royalty relief,'' waiving or 
reducing the royalties that companies must pay. However, as production 
from these leases grows and oil and gas prices have risen since a major 
1995 royalty relief act, questions have emerged about the financial 
impacts of royalty relief.
    Based on our work to date, GAO's statement addresses (1) the likely 
fiscal impacts of royalty relief on leases issued under the Outer 
Continental Shelf Deep Water Royalty Relief Act of 1995 and (2) other 
authority for granting royalty relief that could further impact future 
royalty revenue.
    To address these issues our ongoing work has included, among other 
things, analyses of key production data maintained by MMS; and reviews 
of appropriate portions of the Outer Continental Shelf Deep Water 
Royalty Relief Act of 1995, the Energy Policy Act of 2005, and 
Interior's regulations on royalty relief.
                         OIL AND GAS ROYALTIES
Royalty Relief Will Likely Cost the Government Billions, but the Final 
                    Costs Have Yet to Be Determined
                             what gao found
    While precise estimates remain elusive at this time, our work to 
date shows that royalty relief under the Outer Continental Shelf Deep 
Water Royalty . Relief Act of 1995 will likely cost billions of dollars 
in forgone royalty revenue--at least $1 billion of which has already-
been lost. In October 2004, MMS estimated that forgone royalties on 
deep water leases issued under the act from 1996 through 2000 could be 
as high as $80 billion. However, there is much uncertainty in these 
estimates. This uncertainty stems from ongoing legal challenges and 
other factors that make it unclear how many leases will ultimately 
receive royalty relief and the inherent complexity in forecasting 
future royalties. We are currently assessing MMS's estimate in light of 
changing oil and gas prices, revised estimates of future oil and gas 
production, and other factors.
    Additional royalty relief that can further impact future royalty 
revenues is currently provided under the Secretary of the Interior's 
discretionary authority and the Energy Policy Act of 2005. 
Discretionary programs include royalty relief for certain deep water 
leases issued after 2000, certain deep gas wells drilled in shallow 
waters, and wells nearing the end of their productive lives. The Energy 
Policy Act of 2005 mandates relief for leases issued in the Gulf of 
Mexico during the five years following the act's passage, provides 
relief for some gas wells that would not have previously qualified for 
royalty relief, and addresses relief in certain areas of Alaska.

    Mr. Chairman and Members of the Committee:
    We appreciate the opportunity to participate in the Committee's 
hearing on federal royalties obtained from the sale of oil and natural 
gas produced from federal lands and waters. Oil and gas production from 
federal lands and waters is vital to meeting the nation's energy needs, 
supplying about 35 percent of all the oil and about 25 percent of all 
the natural gas produced in the United States in fiscal year 2005. Oil 
and gas companies that lease federal lands and waters agree to pay the 
federal government royalties on the resources extracted and produced 
from the lease. In fiscal year 2006, oil and gas companies received 
over $77 billion from the sale of oil and gas produced from federal 
lands and waters, and the Minerals Management Service (MMS), the 
Department of the Interior's (Interior) agency responsible for 
collecting royalties, reported that these companies paid the federal 
government about $10 billion in oil and gas royalties. Clearly, such 
large and financially significant resources must be carefully developed 
and managed so that our nation's rising energy needs are met while at 
the same time the American people are ensured of receiving a fair rate 
of return on publicly owned resources, especially in light of the 
nation's current and long-range fiscal challenges.
    In order to promote oil and gas production, the federal government 
has at times and in specific cases provided ``royalty relief''--the 
waiver or reduction of royalties that companies would otherwise be 
obligated to pay. When the government grants royalty relief, it 
typically specifies the amounts of oil and gas production that will be 
exempt from royalties and may also specify that royalty relief is 
applicable only if oil and gas prices remain below certain levels, 
known as ``price thresholds.'' For example, the Outer Continental Shelf 
Deep Water Royalty Relief Act of 1995, also known as the Deep Water 
Royalty Relief Act (DWRRA), mandated royalty relief for oil and gas 
leases issued in the deep waters of the Gulf of Mexico from 1996 to 
2000. These deep water regions are particularly costly to explore and 
develop. However, as production from these leases has grown, and as oil 
and gas prices have risen far above 1995 levels, serious questions have 
been raised about the extent to which taxpayer interests have been 
protected. These concerns were brought into stark relief when it was 
learned that MMS issued leases in 1998 and 1999 that failed to include 
in the lease contracts the price thresholds above which royalty relief 
would no longer be applicable, making large volumes of oil and natural 
gas exempt from royalties and significantly affecting the amount of 
royalty revenues collected by the federal government. Although leases 
are no longer issued under DWRRA, further royalty relief is currently 
available under other legislation and programs, raising the prospect 
that the federal government may be forgoing additional royalty 
revenues.
    Recently, congressional committees, the Department of the 
Interior's Office of the Inspector General,\1\ public interest groups, 
and the press have questioned whether our nation's oil and gas 
royalties are being properly managed. Many of these entities have also 
amplified questions about whether the oil and gas industry is paying 
its fair share of royalties, especially in light of rapidly rising oil 
and gas prices, record industry profits, and a highly constrained 
federal budgetary environment. GAO has expressed similar concerns, and 
the U.S. Comptroller General has highlighted royalty relief as an area 
needing additional oversight by the 110th Congress.\2\
---------------------------------------------------------------------------
    \1\ Minerals Management Service's Compliance Review Process, 
Department of the Interior Office of the Inspector General, Report No. 
C-IN-MMS-0006-2006 (Washington, D.C.: December, 2006).
    \2\ Suggested Areas for Oversight for the 110th Congress, GAO-07-
235R (Washington, D.C.: November 17, 2006).
---------------------------------------------------------------------------
    You asked us today to address royalty relief issues based on our 
ongoing work for this Committee. Specifically, my testimony (1) 
discusses the likely fiscal impacts of royalty relief for leases issued 
under the Deep Water Royalty Relief Act of 1995 and (2) describes other 
authorities for granting royalty relief that could further impact 
future royalty collections. To address these issues, our ongoing work 
has included interviews of MMS personnel in the Economics Division in 
Herndon, Virginia and the Gulf of Mexico OCS Region in New Orleans, 
Louisiana. We have collected and are analyzing key production data 
maintained by MMS and are examining numerous documents and studies. We 
are also reviewing appropriate portions of the Deep Water Royalty 
Relief Act of 1995, the Energy Policy Act of 2005, and Interior's 
royalty relief regulations. Our work follows the issuance of our report 
last year explaining why oil and gas royalties have not risen at the 
same pace as rising oil and gas prices.\3\ In addition, we are 
conducting other work for your Committee on federal oil and gas royalty 
rates and the diligent development of federal oil and gas resources. 
Our work is being done in accordance with generally accepted government 
auditing standards.
---------------------------------------------------------------------------
    \3\ Royalty Revenues: Total Revenues Have Not Increased at the Same 
Pace as Rising Natural Gas Prices due to Decreasing Production Sold, 
GAO-06-786BR (Washington, D.C.: June 21, 2006).
---------------------------------------------------------------------------
    In summary, we have found the following:

   Our work to date shows that the likely fiscal impact of 
        leases issued under the Deep Water Royalty Relief Act of 1995 
        is in the billions of dollars in lost royalty revenues, but 
        precise estimates of the costs are not possible at this time 
        for several reasons. First, MMS's failure to include price 
        thresholds for leases issued in 1998 and 1999 along with 
        current attempts to renegotiate these leases have created 
        uncertainty about which leases will ultimately receive relief. 
        MMS estimates that the failure to include these price 
        thresholds during a period of higher oil and gas prices could 
        cost up to $10 billion in forgone royalty revenue. To date, 
        about $1 billion has already been lost. In addition, a recent 
        lawsuit questions whether MMS has the authority to set price 
        thresholds for the leases issued from 1996 through 2000. 
        Depending on the outcome of this litigation, MMS preliminary 
        estimates indicate that this could result in up to $60 billion 
        in additional forgone royalty revenue. Beyond the problematic 
        implementation of the royalty relief provisions, assessing the 
        ultimate fiscal impact of royalty relief is a complex task, 
        involving inherent uncertainty about future production and 
        prices. We are currently assessing MMS's estimates of royalty 
        relief costs in light of two years worth of additional 
        production data and several other variables, including changing 
        oil and gas prices, revised estimates of the amount of oil and 
        gas that these leases are expected to produce, the availability 
        of deep water rigs to drill untested leases, and the present 
        value of these royalty payments. In addition, any loss in 
        royalty revenues may be partially mitigated by the potential 
        benefits of royalty relief, such as increased production or 
        increased fees that companies are willing to pay the federal 
        government to acquire these leases.
   Additional royalty relief, potentially affecting future 
        federal royalty collection, is offered under other programs and 
        legislation. More specifically, royalty relief can be provided 
        under two existing authorities: (1) the Secretary of the 
        Interior's discretionary authority and (2) the Energy Policy 
        Act of 2005. MMS currently administers several royalty relief 
        programs in the Gulf of Mexico under discretionary authority 
        provided by the 1978 amendments to the Outer Continental Shelf 
        Lands Act of 1953. These programs largely address royalty 
        relief for certain leases issued in deep waters after 2000, 
        certain deep gas wells drilled in shallow waters, and wells 
        nearing the end of their productive lives. In addition, the 
        Congress authorized additional royalty relief under provisions 
        of the Energy Policy Act of 2005. Certain provisions in the 
        Energy Policy Act of 2005 are similar to those in DWRRA in that 
        they mandate royalty relief for leases issued in the Gulf of 
        Mexico during the five years following the act's passage. The 
        Energy Policy Act of 2005 also extends royalty relief to gas 
        produced in the Gulf of Mexico from certain new wells that 
        previously would not have qualified for royalty relief. Other 
        provisions in the act address royalty relief in areas of Alaska 
        where there currently is little or no production.
                               background
    The Department of the Interior (Interior), created by the Congress 
in 1849, oversees and manages the nation's publicly owned natural 
resources, including parks, wildlife habitat, and crude oil and natural 
gas resources on over 500 million acres onshore and in the waters of 
the Outer Continental Shelf. In this capacity, Interior is authorized 
to lease federal oil and gas resources and to collect the royalties 
associated with their production. Onshore, Interior's Bureau of Land 
Management is responsible for leasing federal oil and natural gas 
resources, whereas offshore, MMS has leasing authority. To lease lands 
or waters for oil and gas exploration, companies generally must first 
pay the federal government a sum of money that is determined through a 
competitive auction. This money is called a bonus bid. After the lease 
is awarded and production begins, the companies must also pay royalties 
to MMS based on a percentage of the cash value of the oil and natural 
gas produced and sold.\4\ Royalty rates for onshore leases are 
generally 12 and a half percent whereas offshore, they range from 12 
and a half percent for water depths greater than 400 meters to 16 and 
two-thirds percent for water depths less than 400 meters. However, the 
Secretary of the Interior recently announced plans to raise the royalty 
rate to 16 and two-thirds percent for most future leases issued in 
waters deeper than 400 meters. MMS also has the option of taking a 
percentage of the actual oil and natural gas produced, referred to as 
``taking royalties in kind,'' and selling it themselves or using it for 
other purposes, such as filling the nation's Strategic Petroleum 
Reserve.
---------------------------------------------------------------------------
    \4\Specifically, royalties are computed as a percentage of the 
monies received from the sale of oil and gas, with the total federal 
royalty revenue equal to the volume sold multiplied by the sales price 
multiplied by the royalty rate.
---------------------------------------------------------------------------
    the deep water royalty relief act will likely cost the federal 
government billions of dollars in forgone royalty revenues, but precise 
                        estimates remain elusive
    Based on our work to date, the Deep Water Royalty Relief Act 
(DWRRA) will likely cost the federal government billions of dollars in 
forgone royalties, but precise estimates of the costs are not possible 
at this time for several reasons. First, the failure of MMS to include 
price thresholds in the 1998 and 1999 leases and current attempts to 
renegotiate these leases has created uncertainty about which leases 
will ultimately receive relief. Second, a recent lawsuit is questioning 
whether MMS has the authority to set price thresholds for the leases 
issue from 1996 through 2000. The outcome of this litigation could 
dramatically affect the amount of forgone revenues. Finally, assessing 
the ultimate fiscal impact of royalty relief is an inherently complex 
task, involving uncertainty about future production and prices. In 
October 2004, MMS preliminarily estimated that the total costs of 
royalty relief for deep water leases issued under the act could be as 
high as $80 billion, depending on which leases ultimately received 
relief. MMS made assumptions about several conditions when generating 
this estimate and these assumptions need to be updated in 2007 to more 
accurately portray potential losses. In addition, the costs of forgone 
royalties need to be measured against any potential benefits of royalty 
relief, including accelerated drilling and production of oil and gas 
resources, increased oil and gas production, and increased fees that 
companies are willing to pay through bonus bids for these leases.
Implementing Royalty Relief Has Been Problematic and Resulted in 
        Unanticipated Costs
    The Congress passed DWRRA in 1995, when oil and gas prices were low 
and production was declining both onshore and in the shallow waters of 
the Gulf of Mexico. The act contains provisions to encourage the 
exploration and development of oil and gas resources in waters deeper 
than 200 meters lying largely in the western and central planning areas 
of the Gulf of Mexico. The act mandates that royalty relief apply to 
leases issued in these waters during the five years following the act's 
passage--from November 28, 1995 through November 28, 2000.
    As a safeguard against giving away all royalties, two mechanisms 
are commonly used to ensure that royalty relief is limited and 
available only under certain conditions. The first mechanism limits 
royalty relief to specified volumes of oil and gas production called 
``royalty suspension volumes,'' which are dependent upon water depth. 
Royalty suspension volumes establish production thresholds above which 
royalty relief no longer applies. That is, once total production for a 
lease reaches the suspension volume, the lessee must begin paying 
royalties. Royalty suspension volumes are expressed in barrels of oil 
equivalent, which is a term that allows oil and gas companies to 
combine oil and gas volumes into a single measure, based on the 
relative amounts of energy they contain.\5\ The royalty suspension 
volumes applicable under DWRRA are as follows: (1) not less than 17.5 
million barrels of oil equivalent for leases in waters of 200 to 400 
meters, (2) not less than 52.5 million barrels of oil equivalent for 
leases in waters of 400 to 800 meters, and (3) not less than 87.5 
million barrels of oil equivalent for leases in waters greater than 800 
meters. Hence, there are incentives to drill in increasingly deeper 
waters. Before 1994, companies drilled few wells in waters deeper than 
500 meters. MMS attributes additional leasing and drilling in deep 
waters to the passage of these incentives but also cites other factors 
for increased activity, including improved three-dimensional seismic 
surveys, some key deep water discoveries, high deep water production 
rates, and the evolution of deep water development technology.
---------------------------------------------------------------------------
    \5\ One barrel of oil equals one barrel of oil equivalent. One 
thousand cubic feet of gas (mcf) is converted to barrels of oil 
equivalent by dividing it by 5.62.
---------------------------------------------------------------------------
    After the passage of DWRRA, uncertainty existed as to how royalty 
suspension volumes would apply. Interior officials employed with the 
department when DWRRA was passed said that they recommended to the 
Congress that the act should state that royalty suspension volumes 
apply to the production volume from an entire field. However, oil and 
gas companies paying royalties under the act interpreted the royalty 
suspension volumes as applying to individual leases within a field. 
This is important because an oil and gas field commonly consists of 
more than one lease, meaning that if royalty suspension volumes are set 
for each lease within a field rather than for the entire field, 
companies are likely to owe fewer royalties. For example, if a royalty 
suspension volume is based on an entire field composed of three leases, 
a company producing oil and gas from a 210 million barrel-oil field 
where the royalty suspension volume is set at 100 million would be 
obligated to pay royalties on 110 million barrels (210 minus 100). 
However, if the same 210-million barrel field had the same suspension 
volume of 100 million barrels applied to each of the three leases, and 
70 million barrels were produced from each of the three leases, no 
royalties would be due because no lease would have exceeded its royalty 
suspension volume. After passage of the act, MMS implemented royalty 
relief on a field-basis and was sued by the industry. Interior lost the 
case in the Fifth Circuit Court of Appeals.\6\ In October 2004, MMS 
estimated that this decision will cost the federal government up to $10 
billion in forgone future royalty revenues.
---------------------------------------------------------------------------
    \6\ Santa Fe Snyder Corp. v. Norton, 385 F.3d 884 (5th Cir. 2004).
---------------------------------------------------------------------------
    A second mechanism that can be used to limit royalty relief and 
safeguard against giving away all royalties is the price threshold. A 
price threshold is the price of oil or gas above which royalty relief 
no longer applies. Hence, royalty relief is allowed only so long as oil 
and gas prices remain below a certain specified price. At the time of 
the passage of DWRRA, oil and gas prices were low--West Texas 
Intermediate, a key benchmark for domestic oil, was about $18 per 
barrel, and the average U.S. wellhead price for natural gas was about 
$1.60 per million British thermal units. In an attempt to balance the 
desire to encourage production and ensure a fair return to the American 
people, MMS relied on a provision in the act which states that 
royalties may be suspended based on the price of production from the 
lease. MMS then established price thresholds of $28 per barrel for oil 
and $3.50 per million British thermal units for gas, with adjustments 
each year since 1994 for inflation, that were to be applied to leases 
issued under DWRRA.
    As with the application of royalty suspension volumes, problems 
arose with the application of these price thresholds. From 1996 through 
2000--the five years after passage of DWRRA--MMS issued 3,401 leases 
under authority of the act. MMS included price thresholds in 2,370 
leases issued in 1996, 1997, and 2000 but did not include price 
thresholds in 1,031 leases issued in 1998 and 1999. This failure to 
include price thresholds has been the subject of congressional hearings 
and investigations by Interior's Office of the Inspector General. In 
October 2004, MMS estimated that the cost of not including price 
thresholds on the 1998 and 1999 leases could be as high as $10 billion. 
MMS also estimated that through 2006, about $1 billion had already been 
lost. To stem further losses, MMS is currently attempting to 
renegotiate the leases issued in 1998 and 1999 with the oil and gas 
companies that hold them. To date, MMS has announced successful 
negotiations with five of the companies holding these leases and has 
either not negotiated or not successfully negotiated with 50 other 
companies.
    In addition to forgone royalty revenues from leases issued in 1998 
and 1999, leases issued under DWRRA in the other three years--1996, 
1997, and 2000--are subject to losing royalty revenues due to legal 
challenges regarding price thresholds. In 2006, Kerr McGee Corporation 
sued MMS over the application of price thresholds to leases issued 
between November 28, 1995 and November 28, 2000, claiming that the act 
did not authorize Interior to apply price thresholds to those 
leases.\7\ MMS estimated in October 2004 that if price thresholds are 
disallowed for the leases it issued in 1996, 1997, and 2000, an 
additional $60 billion in royalty revenue could be lost.
---------------------------------------------------------------------------
    \7\ Kerr-McGee (Andarko) suit 3/17/06, W.Dist. LA, CV06-0439LC.
---------------------------------------------------------------------------
Assessing the Fiscal Impact of Royalty Relief Is Inherently Complex
    Trying to predict the fiscal impacts of royalty relief is a complex 
and time-consuming task involving considerable uncertainty. We reviewed 
MMS's 2004 estimates and concluded that they had followed standard 
engineering and financial practices and had generated the estimates in 
good faith. However, any analysis of forgone royalties involves 
estimating how much oil and gas will be produced in the future, when it 
will be produced, and at what prices. While there are standard 
engineering techniques for predicting oil and gas volumes that will 
eventually be recovered from a lease that is already producing, there 
is always some level of uncertainty involved. Predicting how much oil 
and gas will be recovered from leases that are capable of producing but 
not yet connected to production infrastructure is more challenging but 
certainly possible. Predicting production from leases not yet drilled 
is the most challenging aspect of such an analysis, but there are 
standard geological, engineering, and statistical methods that can shed 
light on what reasonably could be expected from the inventory of 1996 
through 2000 leases. Overall, the volume of oil and gas that will 
ultimately be produced is highly dependent upon price and technology, 
with higher prices and better technology inducing greater exploration, 
and ultimately production, from the remaining leases. Future oil 
prices, however, are highly uncertain, as witnessed by the rapidly 
increasing oil and gas prices over the past several years. It is 
therefore prudent to assess anticipated royalty losses using a range of 
oil and gas prices rather than a single assumed price, as was used in 
the MMS estimate.
    Given the degree of uncertainty in predicting future royalty 
revenues from deepwater oil and gas leases, we are using current data 
to carefully examine MMS's 2004 estimate that up to $80 billion in 
future royalty revenues could be lost. There are now two additional 
years of production data for these leases, which will greatly improve 
the accuracy of estimating future production and its timing. We are 
also examining the impact of several variables, including changing oil 
and gas prices, revised estimates of the amount of oil and gas that 
these leases were originally expected to produce, the availability of 
deep water rigs to drill untested leases, and the present value of 
royalty payments.
    To fully evaluate the impacts of royalty relief, one must consider 
the potential benefits in addition to the costs of lost royalty 
revenue. For example, a potential benefit of royalty relief is that it 
may encourage oil and gas exploration that might not otherwise occur. 
Successful exploration could result in the production of additional oil 
and gas, which would benefit the country by increasing domestic 
supplies and creating employment. While GAO has not assessed the 
potential benefits of royalty relief, others have, including the 
Congressional Budget Office (CBO) in 1994, and consultants under 
contract with MMS in 2004.\8\ The CBO analysis was theoretical and 
forward-looking and concluded that the likely impact of royalty relief 
on new production would be very small and that the overall impact on 
federal royalty revenues was also likely to be small. However, CBO 
cautioned that the government could experience significant net losses 
if royalty relief was granted on leases that would have produced 
without the relief. The consultant's 2004 study stated that potential 
benefits could include increases in the number of leases sold, 
increases in the number of wells drilled and fields discovered, and 
increases in bonus bids the amount of money that companies are willing 
to pay the federal government for acquiring leases. However, questions 
remain about the extent to which such benefits would offset the cost of 
lost royalty revenues.
---------------------------------------------------------------------------
    \8\ Waiving Royalties for Producers of Oil and Gas from Deep 
Waters, Congressional Budget Office, May 1994. Effects of Royalty 
Incentives for Gulf of Mexico Oil and Gas Leases, P.K. Ashton, L.O. 
Upton III, and M.H. Rothkopf, under Contract No. 0103CT71722, U.S. 
Department of the Interior, Minerals Management Service, Economics 
Division, Herndon, VA, OCS Study 2004-077.
---------------------------------------------------------------------------
     additional programs and legislation authorize royalty relief, 
        potentially affecting future federal royalty collection
    Although leases are no longer issued under the Deep Water Royalty 
Relief Act of 1995, royalty relief can be provided under two existing 
authorities: (1) the Secretary of the Interior's discretionary 
authority and (2) the Energy Policy Act of 2005. The Outer Continental 
Shelf Lands Act of 1953, as amended, granted the Secretary of the 
Interior the discretionary authority to reduce or eliminate royalties 
for leases issued in the Gulf of Mexico in order to promote increased 
production. The Secretary's exercising of this authority can 
effectively relieve the oil and gas producer from paying royalties. MMS 
administers several royalty relief programs in the Gulf of Mexico under 
this discretionary authority. MMS intends for these discretionary 
programs to provide royalty relief for leases in deep waters that were 
issued after 2000, deep gas wells located in shallow waters, wells 
nearing the end of their productive lives, and special cases not 
covered by other programs. The Congress also authorized additional 
royalty relief under the Energy Policy Act of 2005, which mandates 
relief for leases issued in the Gulf of Mexico during the five years 
following the act's passage, provides relief for some wells that would 
not have previously qualified for royalty relief, and addresses relief 
in certain areas of Alaska.
MMS Currently Administers Royalty Relief Using Discretionary Authority
    Under discretionary authority, MMS administers a deep-water royalty 
relief program for leases that it issued after 2000. This program is 
similar to the program that DWRRA mandated for leases issued during the 
five years following its passage (1996 through 2000) in that royalty 
relief is dependent upon water depth and applicable royalty suspension 
volumes. However, this current program is implemented solely under the 
discretion of MMS on a sale-by-sale basis. Unlike under DWRRA, the 
price thresholds and the water depths to which royalty relief applies 
vary somewhat by lease sale. For example, price thresholds for leases 
issued in 2001 were $28 per barrel for oil and $3.50 per million 
British thermal units for natural gas, with adjustments for inflation 
since 2000. As of March 2006, MMS reported that it issued 1,897 leases 
with royalty relief under this discretionary authority, but only 9 of 
these leases were producing.
    To encourage the drilling of deep gas wells in the shallow waters 
of the Gulf of Mexico, MMS implements another program, the ``deep gas 
in shallow water'' program, under final regulations it promulgated in 
January 2004. MMS initiated this program to encourage additional 
production after noting that gas production had been steadily declining 
since 1997. To qualify for royalty relief, wells must be drilled in 
less than 200 meters of water and must produce gas from intervals below 
15,000 feet. The program exempts from royalties from 15 to 25 billion 
cubic feet of gas per well. According to MMS's analysis, these gas 
volumes approximate the smallest reservoirs that could be economically 
developed without the benefit of an existing platform and under full 
royalty rates. In 2001, MMS reported that the average size of 95 
percent of the gas reservoirs below 15,000 feet was 15.7 billion cubic 
feet, effectively making nearly all of this production exempt from 
royalties had it been eligible for royalty relief at that time.\9\ This 
program also specifies a price threshold for natural gas of $9.91 per 
million British thermal units in 2006, substantially exceeding the 
average NYMEX futures price of $6.98 for 2006, and ensuring that all 
gas production is exempt from royalties in 2006.
---------------------------------------------------------------------------
    \9\ The average of the other 5 percent was 105 billion cubic feet, 
and these reservoirs are within the highly productive Norphlet Trend.
---------------------------------------------------------------------------
    Finally, MMS administers two additional royalty relief programs in 
the Gulf of Mexico under its discretionary authority. One program 
applies to leases nearing the end of their productive lives. MMS 
intends that its provisions will encourage the production of low 
volumes of oil and gas that would not be economical without royalty 
relief. Lessees must apply for this program under existing regulations. 
MMS administers another program for special situations not covered by 
the other programs. Lessees who believe that other more formal programs 
do not provide adequate encouragement to increase production or 
development can request royalty relief by making their case and 
submitting the appropriate data. As of March 2006, no leases were 
receiving royalty relief under the ``end of productive life,'' and only 
three leases were receiving royalty relief under the ``special 
situations'' programs.
The Energy Policy Act of 2005 Authorizes Additional Royalty Relief
    The Congress authorized additional royalty relief under the Energy 
Policy Act of 2005. Royalty relief provisions are contained in three 
specific sections of the act, which in effect: (1) mandate royalty 
relief for deep water leases sold in the Gulf of Mexico during the five 
years following passage of the act, (2) extend royalty relief in the 
Gulf of Mexico to deep gas produced in waters of more than 200 meters 
and less than 400 meters, and (3) specify that royalty relief also 
applies to certain areas off the shore of Alaska. In the first two 
situations, the act specifies the amount of oil and/or gas production 
that would qualify for royalty relief and provides that the Secretary 
may make royalty relief dependent upon market prices.
    Section 345 of the Energy Policy Act of 2005 mandates royalty 
relief for leases located in deep waters in the central and western 
Gulf of Mexico sold during the five years after the act's passage. 
Similar to provisions in DWRRA, specific amounts of oil and gas are 
exempt from royalties due to royalty suspension volumes corresponding 
to the depth of water in which the leases are located. However, 
production volumes are smaller than those authorized under DWRRA, and 
this specific section of the Energy Policy Act clearly states that the 
Secretary may place limitations on royalty relief based on market 
prices. For the three sales that MMS conducted since the passage of the 
act, MMS included prices thresholds establishing the prices above which 
royalty relief would no longer apply. These price thresholds were $39 
per barrel for oil and $6.50 per million British thermal units for gas, 
adjusted upward for inflation that has occurred since 2004. The 
royalty-free amounts, referred to as royalty suspension volumes, are as 
follows: 5 million barrels of oil equivalent per lease between 400 and 
800 meters; 9 million barrels of oil equivalent per lease between 800 
and 1,600 meters; 12 million barrels of oil equivalent per lease 
between 1,600 and 2,000 meters; and 16 million barrels of oil 
equivalent per lease in water greater than 2,000 meters. MMS has 
already issued 1,105 leases under this section of the act.
    Section 344 of the Energy Policy Act of 2005 contains provisions 
that authorize royalty relief for deep gas wells in additional waters 
of the Gulf of Mexico that effectively expands the existing royalty-
relief program for ``deep gas in shallow water'' that MMS administers 
under pre-existing regulations. The existing program has now expanded 
from waters less than 200 meters to waters less than 400 meters. A 
provision within the act exempts from royalties gas that is produced 
from intervals in a well below 15,000 feet so long as the well is 
located in waters of the specified depth. Although the act does not 
specifically cite the amount of gas to be exempt from royalties, it 
provides that this amount should not be less than the existing program, 
which currently ranges from 15 to 25 billion cubic feet. The act also 
contains an additional incentive that could encourage deeper drilling--
royalty relief is authorized on not less than 35 billion cubic feet of 
gas produced from intervals in wells greater than 20,000 feet deep. The 
act also states that the Secretary may place limitations on royalty 
relief based on market prices.
    Finally, the Energy Policy Act of 2005 contains provisions 
addressing royalty relief in Alaska that MMS is already providing. 
Section 346 of the act amends the Outer Continental Shelf Lands Act of 
1953 by authorizing royalty relief for oil and gas produced off the 
shore of Alaska. MMS has previously included royalty relief provisions 
within notices for sales in the Beaufort Sea of Alaska in 2003 and 
2005. All of these sales offered royalty relief for anywhere from 10 
million to 45 million barrels of oil, depending on the size of the 
lease and the depth of water. Whether leases will be eligible for 
royalty relief and the amount of this royalty relief is also dependent 
on the price of oil. There currently is no production in the Beaufort 
Sea. Although there have been no sales to date under this provision of 
the act, MMS is proposing royalty relief for a sale in the Beaufort Sea 
in 2007. Section 347 of the Energy Policy Act also states that the 
Secretary may reduce the royalty on leases within the Naval Petroleum 
Reserve of Alaska in order to encourage the greatest ultimate recovery 
of oil or gas or in the interest of conservation. Although this 
authority already exists under the Naval Petroleum Reserves Production 
Act of 1976, as amended, the Secretary must now consult with the State 
of Alaska, the North Slope Borough, and any Regional Corporation whose 
lands may be affected.
                              conclusions
    In order to meet U.S. energy demands, environmentally responsible 
development of our nation's oil and gas resources should be part of any 
national energy plan. Development, however, should not mean that the 
American people forgo a reasonable rate of return for the extraction 
and sale of these resources, especially in light of the current and 
long-range fiscal challenges facing our nation, high oil and gas 
prices, and record industry profits. Striking a balance between 
encouraging domestic production in order to meet the nation's 
increasing energy needs and ensuring a fair rate of return for the 
American people will be challenging. Given the record of legal 
challenges and mistakes made in implementing royalty relief to date, we 
believe this balance must be struck in careful consideration of both 
the costs and benefits of all royalty relief. As the Congress continues 
its oversight of these important issues, GAO looks forward to 
supporting its efforts with additional information and analysis on 
royalty relief and related issues.
    Mr. Chairman, this concludes my prepared statement. I would be 
pleased to respond to any questions that you or other Members of the 
Committee may have at this time.

    The Chairman. Thank you very much. Our third and final 
witness today is the Honorable C. Stephen Allred, who is the 
Assistant Secretary for Land and Minerals Management at the 
Department of the Interior. We appreciate you being here very 
much.

 STATEMENT OF C. STEPHEN ALLRED, ASSISTANT SECRETARY, LAND AND 
        MINERALS MANAGEMENT, DEPARTMENT OF THE INTERIOR

    Mr. Allred. Thank you very much, Mr. Chairman, Senator 
Domenici and members of the committee. I appreciate the 
opportunity to visit with you today about these issues. I 
believe that our government institution employees must always 
act to protect the public interest of the United States and as 
well, must be perceived that we are doing so. The controversies 
that we are discussing here today, whether in fact or 
perception, damage that image to the detriment of all of us.
    You have the report of the Inspector General in front of 
you and that information will be interpreted by different 
individuals in different ways. However, what I want to do in 
the next couple of minutes, to allow you the maximum time for 
questions, is to tell you what the Secretary and I are doing to 
deal with these issues that are the subject of this hearing.
    After the Senate confirmed me as Assistant Secretary some 
3\1/2\ months ago, which sometimes seems like a lifetime, 
Secretary Kempthorne asked me to review the issues involving 
the Minerals Management Service. As you know, he places great 
importance on the Department, its agencies and its employees 
acting in a highly ethical manner, again both in fact and 
perception.
    With regard to the first issue that Mr. Devaney discussed, 
as to whether or not MMS is collecting the full amount of oil 
and gas revenues, which are due the United States, the States 
and the Tribes, I have reviewed the Inspector General's report. 
I have traveled to the Minerals Management Service's Denver 
Operation Center where these activities take place and have 
been thoroughly briefed on their royalty collection processes.
    We are forming a high-level review panel to look at those 
processes and procedures. We hope to announce that very 
quickly. Based on my review, however, I believe that we are 
collecting the revenues that are due to the United States, the 
States and the Tribes. As with any large organization with 
complex operations, there are many opportunities to improve 
those operations. The Inspector General's recommendations and 
those of the review panel will give us the opportunity to 
continue to do so.
    Regarding the price threshold issue in the 1998 and 1999 
leases, we have just started to review the voluminous report 
that the Inspector General has provided to us. As we begin to 
understand and review the information contained in the report, 
we will take further steps regarding this issue. It is 
important, as many of you have said, to understand that this 
issue occurred in 1998 and 1999. Since 2001, this 
administration has made sure that price thresholds have been 
included as part of any royalty relief granted under the Deep 
Water Royalty Relief Act that you have passed.
    I have discussed this issue with the companies who hold 
these leases and in those discussions, I have three guiding 
principles. The first, there is a valid contract between the 
United States and the companies. Second, my goal has been to 
focus on the greatest amount of royalties available, those 
which will be derived from future production and third, I have 
sought to minimize to the extent possible, the opportunities 
for legal challenges to the processes that we will follow.
    As you are aware, we have been successful in negotiating 
for future royalties with six companies. We are continuing 
discussions with the companies but I believe that we will not 
make further progress until Congress has defined the role that 
it chooses to play in this issue.
    The Inspector General has discussed ongoing investigations 
regarding employees in the Denver office. I want to very 
briefly address this issue. The Director of the Minerals 
Management Service asked the Inspector General to investigate 
this matter. The Director, with my concurrence, removed those 
subject employees from positions that they held and placed them 
in less sensitive positions for the duration of the 
investigation. I have looked at this issue and subject to 
forthcoming information from the Inspector General, I do not 
believe that these issues involve the royalty program itself.
    The Director of MMS has also recently taken action in a 
separate incident at another location, to terminate an employee 
who failed to follow the agency's ethics rules.
    I assure you that the Secretary and I take these issues 
very seriously. We will demand that our employees conduct 
themselves according to the highest ethical standards and we 
will hold individuals accountable when they fail to do so. I 
also believe, based on my experience in the Interior so far, 
that our agencies and employees are serving the public well. I 
intend to make sure that we continue to do so and improve upon 
that.
    Mr. Chairman, we've submitted testimony for the record and 
I'd be most happy to answer questions from the panel.
    [The prepared statement of Mr. Allred follows:]
Prepared Statement of C. Stephen Allred, Assistant Secretary, Land and 
            Minerals Management, Department of the Interior
    Mr. Chairman, thank you for the opportunity to appear here today to 
discuss with you the Department of the Interior's role in managing 
energy production on the Outer Continental Shelf and revenue from all 
Federal and Indian mineral leases. I know this Committee has been 
instrumental in shaping our domestic energy program, particularly with 
regard to encouraging environmentally sound development of our domestic 
oil and gas resources on the Outer Continental Shelf.
    The Department and its agencies, including the Minerals Management 
Service (MMS), serve the public through careful stewardship of our 
nation's natural resources. The Department also plays an important role 
in domestic energy development. One third of all energy produced in the 
United States comes from resources managed by the Interior Department.
    As energy demand continues to increase, these resources are all the 
more important to our national security and to our economy. The Energy 
Information Administration estimates that, despite increased 
efficiencies and conservation, over the next 20 years energy 
consumption is expected to grow more than 25 percent. Even with more 
renewable energy production expected, oil and natural gas will continue 
to account for a majority of energy use through 2030. Interior's 
domestic energy programs, particularly offshore oil and gas production, 
will remain vital to our national energy portfolio for some time to 
come, as evidenced in Figure A attached at the end of my statement.*
---------------------------------------------------------------------------
    * Figures A-D have been retained in committee files.
---------------------------------------------------------------------------
    Since assuming the duties of Assistant Secretary of Land and 
Minerals Management three months ago, I have developed a deeper 
appreciation for the complexities involved in managing federal energy 
production. I also am committed to ensuring we provide an accurate and 
transparent accounting of the revenue this production generates for the 
American people.
    At the direction of Secretary Kempthorne, two important topics have 
been my major focus over the past three months--the deep water leases 
issued without price thresholds for royalty relief in 1998 and 1999, 
and the management of royalty revenues.
    I would like to begin by providing some background on MMS's role in 
Federal energy production and revenue collection. I then will discuss 
in greater detail the two primary issues I am focusing on with MMS.
                             mms background
    The MMS has two significant missions: managing access to offshore 
federal energy resources and managing revenues generated by federal and 
Indian mineral leases, on and offshore. Both of these functions are 
important to the nation's economic health and are key to meeting the 
nation's energy needs.
    The Federal Outer Continental Shelf (OCS) covers 1.76 billion acres 
and is a major source of crude oil and natural gas for the domestic 
market. In fact, according to the Energy Information Administration, if 
the Federal OCS were treated as a separate country, it would rank among 
the top five nations in the world in terms of the amount of crude oil 
and second in natural gas it supplies for annual U.S. consumption.\1\
---------------------------------------------------------------------------
    \1\ EIA U.S. Imports by Country of Origin, 12-21-2006.
---------------------------------------------------------------------------
    Since 1982, MMS has overseen OCS production of 9.6 billion barrels 
of oil and more than 109 trillion cubic feet of natural gas.
    During that time, OCS leasing increased by 200 percent and since 
1994, OCS oil production has increased by 63 percent. According to 
MMS's calculations, within the next 5 years, offshore production will 
likely account for more than 40 percent of oil and 20 percent of U.S. 
natural gas production, primarily due to deep water discoveries in the 
Gulf of Mexico.
    Attached Figure B shows the Energy Information Administration's 
2007 forecast for total domestic oil and gas production and illustrates 
what the significance of the OCS contribution is to the Nation's energy 
security.
    To support increased production offshore, MMS's Proposed 5-Year OCS 
Oil and Gas Leasing Program for 2007-2012 calls for a total of 21 lease 
sales.
    We are closer to achieving the goals of this proposed program since 
the President last week modified a Presidential withdrawal in order to 
allow leasing in two areas previously closed--the North Aleutian Basin 
in Alaska and an area in the central Gulf of Mexico. The President 
modified the leasing status of these two areas in response to 
congressional action and the request of Alaska State leaders. In 
addition, this Administration has increased the royalty rate from 12.5 
percent to 16.7 percent for any new deep water leases offered in the 
Gulf of Mexico.
    In implementing the mandates of the Gulf of Mexico Energy Security 
Act, MMS will offer deep-water acreage in the ``181 South'' area and in 
a portion of the Sale 181 area remaining in the Eastern Gulf of Mexico.
    Our analysis indicates that implementing the new program would 
result in a mean estimate of an additional 10 billion barrels of oil, 
45 trillion cubic feet of gas, and $170 billion in net benefits for the 
nation over a 40-year time span.
    In addition to providing and managing access to the OCS, MMS 
administers and enforces the financial terms for all Federal mineral 
leases, both onshore and offshore and on Indian lands.
    These activities have generated an average of more than $8 billion 
in revenue per year over the past five years, representing one of the 
largest sources of non-tax revenue to the Federal Government. (In FY 
2006, $12.6 billion was collected, and 60 percent of that was from 
offshore activities).
    Since 1982, the MMS has distributed approximately $164.9 billion to 
Federal, State, and Indian accounts and special funds, including 
approximately:

   $101.1 billion to the General Fund of the U.S. Treasury;
   $20.4 billion to 38 states;
   $5.2 billion to the Department's Office of Trust Funds 
        Management on behalf of 41 Indian tribes and 30,000 individual 
        Indian mineral owners; and
   $38.2 billion to the Land and Water Conservation Fund, the 
        National Historic Preservation Fund, and the Reclamation Fund.

    MMS carries out these responsibilities under statutory mandates and 
ongoing oversight by Congress, the Government Accountability Office 
(GAO) and the Department's Office of Inspector General.
    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 and its delegated 
independent auditing firm.
    1998-1999 ocs leases without price thresholds for royalty relief
    Earlier today, the Department's Office of Inspector General 
presented its findings on the 1998-1999 deep water leases issued 
without price thresholds. The MMS requested this independent review 
last year. We appreciate the Inspector General's work and look forward 
to further reviewing the report.
    The Department of the Interior shares Congress's frustration that 
during the previous Administration price thresholds were not included 
in the 1998-1999 deep water leases. This Administration has included 
price thresholds in all deep water leases it has issued with royalty 
relief. The American people own these resources and are entitled to 
receive a fair return.
    The Deep Water Royalty Relief Act of 1995 required deep water 
leases issued from 1996-2000 to include a royalty incentive to allow 
companies to produce a set volume of oil and gas before they began 
paying royalties. Since enactment, the deep waters of the Gulf of 
Mexico have become one of the Nation's most important sources of oil 
and natural gas. Price thresholds limit royalty relief when oil and gas 
prices are high. Price thresholds were included in leases before 1998 
and after 1999. They were not included in the 1998-1999 leases.
    This matter has been a focus of mine since I assumed this position 
last fall. In an attempt to address the missing price thresholds, we 
are now negotiating with companies to obtain agreements to apply price 
thresholds to the deep water leases issued in 1998-1999. We are 
focusing our negotiations on obtaining the much larger royalty amounts 
to be realized from future production, estimated to exceed $9 billion.
    To date our progress has included agreements reached in December 
2006 with six companies. This is a significant but first step; there is 
still much more work to do in reaching agreements with additional 
companies.
    I have adopted three basic principles to guide my actions in 
seeking to resolve this matter. First, our focus will be to negotiate 
price thresholds in leases prospectively; second, we will not give 
economic advantage to one company over another; and finally, we will 
strive to amend these agreements in a way that will minimize litigation 
risk.
    To achieve these principles, the Administration and the Congress 
must work together. We cannot do this alone.
    We know that Congress will consider addressing this issue 
legislatively. We appreciate Congress's efforts to encourage companies 
to come to the negotiating table. However, we must be mindful of 
potential unintended consequences. For example, potential new 
legislation could conceivably result in litigation. If legislation 
addressed future lease sales, and if a judge were to enjoin future 
lease issuance for a period of time, the resulting impacts would be 
significant. Litigation could take years to resolve. The MMS has 
attempted to project what the potential loss of production, revenue and 
royalties if lease sales were delayed for a three-year period could 
look like.
    Attached Figure C shows for example, for a 3-year delay, production 
over 10 years would be reduced 1.6 billion barrels of oil equivalent 
(boe).
    Attached Figure D shows for example, the expected cumulative 
revenue decline over a 10 year period of $13 billion for a 3-year 
delay.
    We all can agree this would not be in the Nation's best interest. 
The OCS is a significant supplier of oil and gas. We cannot afford 
major delays in offshore energy production due to unintended 
consequences.
    We look forward to working with Congress on resolving this issue of 
national interest.
                     management of royalty revenue
    My second focus is the management of royalty revenue collected from 
Federal and Indian mineral leases. In FY 2006, about 2,600 companies 
reported and paid royalties totaling $12.6 billion from approximately 
27,800 producing Federal and Indian leases.
    MMS's mineral revenue processes and procedures are complex and 
involve implementing myriad statutory authorities and regulations, as 
well as a complex set of case law from over 50 years of administrative 
and judicial decisions on Federal royalty matters.
    The process begins when companies calculate their payments for 
royalties owed the Federal government. Royalties are calculated based 
upon four components: the volume of oil and gas produced from the 
lease, which is verified by BLM or MMS officials during regular on-site 
inspections; the royalty rate, which is specified in the lease 
document; the value of the oil and gas as determined by regulations; 
and any deductions for the the costs of transporting and/or processing 
the oil and gas production, which are also determined by regulations. 
Companies are required to report this information and submit their 
royalty payments to MMS on a monthly basis.
    MMS receives reports and payments from payors and accepts them into 
the accounting system, similar to filings with the Internal Revenue 
Service. Fundamental accounting processes identify revenue sources, and 
funds are distributed to recipients as prescribed by law. Interest is 
assessed on late and/or under payments.
    MMS's audit and compliance program assesses whether royalty 
payments are correct. The types of questions that arise during 
compliance activities include whether the company reported and paid its 
royalty on the right volume, royalty rate, and value and whether the 
company correctly calculated allowable transportation and processing 
costs. Findings of underpayments are followed by collection of the 
payment plus interest. Enforcement proceedings range from alternative 
dispute resolution to orders to pay and penalty actions.
    The current compliance strategy uses 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 2006, this 
strategy resulted in compliance reviews on $5.8 billion in Federal and 
Indian mineral lease revenues, 72.5 percent of total mineral revenues 
paid for calendar year 2003.
    In recent years, MMS has completed an increased number of audits, 
doubling the number of audits in the most recent three-year period over 
the previous three years. From 1998-2001, MMS, State, and Tribal 
auditors completed 784 audits compared to the 1,572 audits completed 
from 2002-2005. This increase is partially the result of the effort in 
2005 on the part of MMS to close a significant number of old audits as 
a result of a recommendation from an external peer review of our audit 
activities. Collections based on audit work fluctuate from year to 
year. The apparent reductions in collections resulting from compliance 
efforts from 2001 through 2004 stand in contrast with very large 
collections in the 1998-2001 period. This anomaly is due to resolution 
of numerous lawsuits on undervaluation of crude oil and natural gas 
during the 1998-2001 period. The result of the resolution of these 
issues was large payments of additional royalties. Because these issues 
were resolved, no additional large payments were owed in 2002-2005.
    The MMS compliance and enforcement program has generated an annual 
average of more than $125 million for each of the last 24 years. In 
other words, MMS has collected a total of more than $3 billion dollars 
in additional mineral revenues since program inception in 1982.
    From FY 2003 through FY 2005, for every dollar spent on compliance 
reviews, MMS has collected $3.27. For every dollar spent on audits, MMS 
has collected $2.06.
    MMS aggressively pursues interest owed on late payments as required 
by law. In Fiscal Year 2006, MMS issued over 3,800 late payment 
interest bills and collected a net amount of $7 million.
    MMS has authority to use civil penalties in situations where 
routine compliance efforts have been unsuccessful. During the last 5 
years MMS has collected over $23 million in civil penalties resulting 
from MRM enforcement actions. So far in FY 2007 MMS has issued over $2 
million in civil penalty notices that are now in the administrative 
process. When combined with other MMS enforcement actions during the 
same time frame, MMS collected a total of 52.4 million.
    Last year, the MMS while performing reconciliation of volume 
imbalances, promptly identified that the Kerr McGee Oil and Gas 
Corporation had underdelivered royalty gas volumes to MMS's Royalty-In-
Kind (RIK) program--at a time of very high gas prices. MMS pursued the 
issue and collected $8.1 million--based on these high price periods--to 
resolve the issue.
    In December, MMS announced that a bill for over $32 million had 
been issued to BP America Production Company for additional royalties 
and interest due identified through audit work of BP's coalbed methane 
production that occurred in the state of New Mexico.
    These day-to-day efforts are just part of MMS's normal course of 
business. These efforts are not only effective at ensuring compliance, 
but also beneficial in bringing the appropriate revenues to the states, 
Indians, and the American public.
    I would like to emphasize, however, that although this work is 
important, our focus is not on numbers of audits or amounts obtained in 
collections. The real goal is to increase upfront compliance. We 
measure success in having higher levels of upfront compliance so that 
companies are making correct payments the first time. Audits act as a 
deterrent, but we hope that audits will reveal fewer problems as 
companies increase voluntary compliance.
    MMS has taken steps to improve compliance rates in order to achieve 
this goal. They include the following:

   Clearer regulations--MMS has made significant progress in 
        developing and implementing clearer regulations, eliminating 
        much uncertainty and ambiguity that previously resulted in 
        major findings.
   RIK--MMS is receiving an increasing percentage of revenues 
        through its RIK program and has eliminated many valuation 
        issues for the RIK volumes. During FY2005, for example, MMS 
        received about one-third of its revenues through RIK.
   More effective compliance strategies--Compliance reviews 
        have allowed MMS to cover more properties than were possible 
        using audits alone, thereby increasing the deterrent effect. 
        This increased presence encourages companies to be more 
        vigilant about proper reporting and payment.

    We appreciate the recent report of the Office of Inspector General 
concerning the audit and compliance program. The results are similar in 
substance to audits I have reviewed in State government or in the 
private sector. My experience is that in any organization with such 
large and complex operations, I would expect any performance audit to 
find opportunities for improvement. MMS has embraced virtually all of 
the findings, and has an action plan to address them.
    We note the Inspector General's major conclusion that compliance 
reviews are a useful tool in our program, and we look forward to 
implementing recommendations to further improve our application of 
compliance reviews. We submit for the Committee's attention our 
``Action Plan to Strengthen Minerals Management Service's Compliance 
Program Operations'' which documents improvement actions taken and 
planned in this area.
    MMS does not work alone in its efforts to ensure the proper 
collection of royalties; MMS collaborates with the States and tribes on 
our compliance and audit activities. In addition, every three years, 
the federal audit function of MMS is peer-reviewed by an outside 
independent certified public accounting firm. Most recently, in 2005, 
the MMS audit program was found to meet all applicable government 
auditing standards. I am also happy to point out that for the past five 
years, as part of its annual Chief Financial Officer audit, MMS 
consistently has received clean audit opinions from the Office of the 
Inspector General and its delegated independent auditing firm.
    Having said that, it is also true that MMS continues to look for 
ways to improve its programs, practices and performance. We welcome 
input from this Committee, the full Congress, the Office of the 
Inspector General, GAO and the public.
    In response to the recent interest regarding the accuracy and 
effectiveness of the MMS's royalty management program, Secretary 
Kempthorne and I determined that an independent panel should be 
convened to review the procedures and processes surrounding MMS's 
management of mineral revenue. We are committed to ensuring our 
processes are effective and transparent, and we welcome advice and 
counsel.
    The new panel will operate as a Subcommittee under the auspices of 
the Royalty Policy Committee, an independent advisory board appointed 
by the Interior Secretary to advise on royalty management issues and 
other mineral-related policies.
    The Subcommittee on Royalty Management has been asked to review 
prospectively:

   The extent to which existing procedures and processes for 
        reporting and accounting for federal and Indian mineral 
        revenues are sufficient to ensure that the MMS receives the 
        correct amount.
   The audit, compliance and enforcement procedures and 
        processes of the MMS to determine if they are adequate to 
        ensure that mineral companies are complying with existing 
        statutes, lease terms, and regulations as they pertain to 
        payment of royalties.
   The operations of the Royalty-in-Kind program to ensure that 
        adequate policies, procedures and controls are in place to 
        ensure that decisions to take federal oil and gas royalties in 
        kind result in net benefits to the American people.

    The Subcommittee will conduct its review over a six-month period 
and then provide its final findings and recommendations to the full 
Royalty Policy Committee and the Secretary of the Interior. We will be 
happy to share the recommendations with you when they are available.
    Members of the Subcommittee will be announced in the near future.
                               conclusion
    In the three months since I was confirmed to this position, I have 
been working closely with the MMS to understand the complex processes 
associated with accounting for the revenues generated from oil and gas 
development on Federal lands, including the Outer Continental Shelf. In 
an effort to gain a greater understanding of this work, earlier this 
month I traveled to MMS's Denver office where I reviewed the procedures 
and controls used to ensure that minerals revenues are properly 
reported and accounted for. I also visited offices and reviewed 
operations in the Gulf of Mexico Regional Office.
    This work is very important and must be undertaken carefully. 
Equally important, and very important to Secretary Kempthorne and me, 
is that we conduct business with the highest standards of ethics 
possible. Making sure we can live up to that standard has been a high 
priority of mine. I have stressed, and will continue to stress, our 
obligation to conduct ourselves in accordance with the highest ethical 
standards and to be accountable for our actions. Moreover, our conduct 
must be ethical both in fact as well as in perception.
    To summarize my remarks today, I want to reiterate I will continue 
to focus on several key areas as I provide oversight to the Minerals 
Management Service.
    We will issue our 5-year proposed OCS leasing program on time. This 
is an important plan that addresses national energy security and 
facilitates the development of critical energy resources now and in the 
future.
    I will continue to seek prospective royalty agreements with the 
companies that entered into leases issued in 1998 and 1999 that lack 
price thresholds in order to capture the majority of the revenues the 
government would have received.
    I am pleased at the results of our efforts thus far, but recognize 
that there is much more work to be done. I look forward to continuing 
to work with you, the members of Congress, to address this important 
issue.
    In addition, I will continue to work with MMS to review and improve 
our royalty management programs. I have every confidence that MMS will 
successfully implement appropriate Inspector General's recommendations 
and that the review by the soon-to-be finalized royalty policy 
subcommittee will provide a fresh perspective on royalty management 
issues and challenges.
    I welcome your input on all of these initiatives, and I look 
forward to working with you.
    Mr. Chairman, this concludes my remarks. I would be happy to answer 
any questions you have.

    The Chairman. Thank you very much. Let me ask a few 
questions and then we'll do 7-minute rounds here.
    Mr. Devaney, let me first just ask by clarification, you 
make reference to a--I think it's a surname process. I think 
your testimony says a surname process, which dilutes 
responsibility and accountability. This is in connection with 
the way that these leases were entered into or managed or 
drafted. Could you explain that somewhat? I'm not clear what 
you mean by a surname process there.
    Mr. Devaney. Mr. Chairman, that's the process by which MMS 
sends the documents forward and gets signed off from various 
officials within the Department. It tends to be very stove 
piped and comes up different stovepipes of MMS and Assistant 
Secretary Allred and I have briefly discussed this issue. We're 
both concerned, I think, that too many people are involved. 
Nobody is being--I'll let Assistant Secretary Allred speak for 
himself but my concern is that nobody is actually held 
responsible and accountable for the final product that comes 
out of Interior, that people are just getting these voluminous 
documents, putting their initials on top and passing it on to 
the next person and in the case of when it went over, at least 
in one case, when it went over to the Solicitor's Office, it 
wasn't reviewed as thoroughly as we all might have hoped. So 
it's a process that needs fixing. It's some lessons learned 
here and I think it can be fixed but it's broken right now.
    The Chairman. Does this management plan that you referred 
to that is the action plan for correcting the problems, does it 
do the job in your view, the MMS Action Plan?
    Mr. Devaney. I was pleased with two things. First, I was 
pleased with the reception that our recommendations actually 
got from Secretary Kempthorne and Assistant Secretary Allred 
and I was also pleased that I got so quickly an action plan to 
implement those changes. So I am, at this point, very pleased.
    The Chairman. To try to just understand, obviously the 
mistakes in the drafting of these leases were made in 1998 and 
1999. My impression is that in addition to that mistake, it was 
a mistake not to go ahead and confront the issue and try to 
correct the problem more quickly once it did come to light. Am 
I understanding that right? It would seem to me that trying to 
get these leases re-negotiated or trying to deal with this 
issue has become more and more difficult as time has gone on. 
Is that your view of things, Mr. Devaney?
    Mr. Devaney. Well, it's extraordinarily difficult to 
predict what would have happened had it been confronted head 
on. Suffice to say, in hindsight, with the benefit of 
hindsight, I would have hoped that the issue would have been 
thought about in a much more robust way than it was. I mean, 
when it was first identified in 2000 by an analyst down in the 
gulf and for some unexplained reason, it never reached the 
higher levels of MMS for full discussion. Then in 2004, 
similarly, there appeared to be just a casual conversation that 
was held that suggested that well, the Solicitor's Office has 
already made a decision on this so there is no use talking 
about it.
    I think, in hindsight, a more--a fuller discussion should 
have occurred. I would hope that that would happen today if it 
happened again but I have no way of knowing whether that would 
have actually resulted in any additional revenues being 
collected.
    Senator Domenici. Mr. Chairman, could I ask a question?
    The Chairman. Sure.
    Senator Domenici. You just asked Mr. Devaney when ``it''--
what is the ``it?'' What we are talking about?
    Mr. Devaney. I'm sorry, Senator?
    Senator Domenici. It--I T. You said--you referred to the 
``it''--what is the ``it?'' What is it that is being 
considered?
    The Chairman. I think it was a mistake----
    Mr. Devaney. Oh, that the--excuse me, Senator. I think what 
I meant to say was, if that kind of an issue was brought to 
management's attention today, I would hope that they would call 
the Solicitor himself in, perhaps DOJ in and have a discussion. 
Now, the answer might be, we can't do anything about it. But 
that is the going back, retrospectively and asking the oil 
companies to pay back royalties.
    Senator Domenici. Thank you very much.
    Mr. Devaney. Sure.
    The Chairman. Mr. Gaffigan, you cited the various problems 
that you've identified looking forward as far as ability to 
collect appropriate royalties and I think I heard you say that 
one of the problems is, is that there is no requirement in the 
law now for the Secretary to charge a royalty or to impose a 
royalty above any threshold--that that's purely discretionary. 
Is that what I heard you say?
    Mr. Gaffigan. Well, the discretionary authority I was 
referring to is that the Secretary does have the discretionary 
authority to offer royalty relief, under different programs and 
he or she has done so over time, through the MMS and MMS has 
administered several different discretionary programs. I think 
the major one that they've looked at has sort of extended the 
relief in the deep water of the gulf and I think there were 
about 1,800 leases potentially, to date, that have had that 
kind of relief put on there. And of course, they have put in 
thresholds and volume limits using their discretion.
    The Chairman. But am I correct in understanding, for 
example, in last year's bill, we put a provision in saying that 
the Secretary may place limits on royalty relief, not that the 
Secretary has to. The Secretary may.
    Mr. Gaffigan. Right.
    The Chairman. Do you see that as problematic?
    Mr. Gaffigan. It just depends in terms of the 
implementation. Given our track record of the legal challenges 
and such that have come up, I would look closely at how we're 
implementing that act. Again, we have not done that. We're not 
aware that there are any problems and we do know that in the 
implementation of the EPAct, the MMS has put in both price 
thresholds and volume limits.
    The Chairman. OK. Mr. Allred, let me ask you. What is your 
opinion as to the best way forward to try to obtain for the 
U.S. taxpayer, a reasonable royalty on the resources that have 
been and are continuing to be produced in this outer 
continental shelf?
    Mr. Allred. Mr. Chairman, members of the committee, I still 
think that negotiations between the Government and the 
companies is what has to happen. I'm afraid that if there are 
other measures taken which would abrogate those contracts, we 
will end up with substantial problems going forward in leasing 
and developing new oil resources and in the full testimony, 
there are some numbers in there in what I call the ``unintended 
consequences'' that could involve both drastic reductions in 
production and significant loss of revenues to both the U.S. 
Government and the States. Now, how do you obtain agreement to 
modify those contracts that we currently have? First of all, I 
want to point out that six have and these are six--the majority 
of them are large companies that we know on an everyday basis. 
I believe that we could bring more in and perhaps also solve a 
problem by offering some additional incentives that do not 
result in monetary losses to the U.S. Government and I would be 
glad to work with this committee on some of those ideas.
    But I believe that given the right set of circumstances and 
the right actions designed to accomplish that by Congress, we 
can re-negotiate those agreements and obtain what we need to 
do.
    The Chairman. My time is up.
    Senator Domenici.
    Senator Domenici. Sir, the last statement that you made 
goes to the heart of the issue. If I heard you right, you said 
to the committee here that you thought the best way we could 
handle this would be to permit you to negotiate this matter out 
and to negotiate the best deal you could with the companies 
that have leases during that span and have no threshold on 
them, thus they are not paying any royalties. That's what we've 
been struggling with all along. What leads you to believe that 
they will do that? I tend to have a feeling much like you but 
it's just my opinion. Do you have something more than just your 
opinion, which would lead you to think that's the way to do it, 
that we could just start negotiating? What would we have to do? 
Have a resolution saying we urge it? We already adopted a 
resolution in a Subcommittee of Interior Appropriations, which 
encouraged the negotiations, is that not correct? What else are 
you talking about us doing that would give you the latitude to 
go negotiate?
    Mr. Allred. Mr. Chairman, what I'm suggesting is that 
Congress give us additional tools that we do not now have.
    Senator Domenici. Like?
    Mr. Allred. One, for example, would be to offer for those 
who would sign and those who would have had diligence on their 
leases, to offer them an extension on the deep water leases 
that they have. I think that would be of advantage to them and 
of advantage to the United States because as you well 
understand, these are very expensive, very difficult 
developments to undertake and the 5-year period * that we 
currently provide on the leases may not be sufficient to 
maximize the results of those leases.
---------------------------------------------------------------------------
    * In the Gulf of Mexico, deep water leases have 5 year lease terms 
in water depths between 200 and 400 meters, 8 year terms in water 
depths between 400 and 800 meters, and 10 year lease terms for leases 
in water depths greater than 800 meters.
---------------------------------------------------------------------------
    Senator Domenici. First let me back up and commend you on 
the work you've done. You have not been there a long time. I 
have not heard anyone from the outside looking at your work 
that has been anything other than rather laudatory of the way 
you do it. I hear Mr. Devaney talking here. He's doing that. 
He's nodding affirmatively.
    But I'm of the opinion that for those who say why don't we 
just go out and cancel the leases--that's kind of acting the 
way Hugo would act, the way the Russians would act and it would 
not be considering the sanctity of contracts--we'll just decide 
that we're going to go pick and choose and cancel these certain 
kinds. I believe that would be detrimental over the long run to 
the United States. What is your feeling and if you know the 
Department's feelings on that, could you tell us?
    Mr. Allred. Senator Domenici, with your permission, if I 
could show you a couple of graphs that I have, I think perhaps 
it will illustrate it as to what we believe the impact would 
be, the unintended consequences of any law which could be 
challenged in the courts. The first one I'd like to show you is 
with regard to the loss of production.
    This particular graph shows that with regard to--if we were 
to proceed with the next sales which will be this fall and if 
we were to be enjoined by a court from issuing leases, this 
graph demonstrates our estimate of what might be the foregone 
production in a 10-year period from a 3-year delay due to court 
action and as you can see here, with regard to production, it 
would equal about 1.6 billion barrels of oil equivalent from 
that 3-year delay. That is a significant amount of delay in the 
production of oil with regard to our energy security.
    The second graph I would like to show you is the estimate 
of the decline in revenue, again during a 10-year period from a 
3-year period of delay in issuing new leases and you will see 
there that that is a $13 billion decline during that 10-year 
period from what would be an unintended consequence.
    I'll only point this out from the standpoint that I think 
it is--I think there is an important role here for Congress to 
play in solving this. I cannot solve it or the Department 
cannot solve it by ourselves. But how we do it is extremely 
important, such that we do not get into a situation where the 
United States cannot issue new leases. So that's why I'm very 
concerned about--we need to do it but we need to be very 
concerned about how we do do it.
    Senator Domenici. Thank you very much. Thank you, Mr. 
Chairman.
    The Chairman. Senator Wyden.
    Senator Wyden. Thank you. Thank you very much, Mr. 
Chairman. Gentlemen, in my view, this oil royalty relief 
program has the stench of conflict of interest and incompetence 
all over it and every time you think you're at the bottom of 
the slump, you seem to come up with more muck.
    Let me start with you, if I might, Mr. Allred. I'm looking 
at the press release you issued on November 14 of last year. 
This was many months after I went to the floor of the Senate 
and spent almost 5 hours in one spot, talking about problems 
with the program and you announced this new panel that you're 
talking about to review this particular program where so much 
has gone wrong. And the person named to head the program is a 
gentleman named David Deal. I went to his website to look at 
his background and let me just read to you from his own website 
with respect to his background. He said on his website that he 
was centrally involved in all Federal royalty management 
rulemaking since 1980. He was the principle author of all 
American Petroleum Institute written comments on Federal 
royalty rulemaking from 1986 to 2004. He was the principle 
author of all inner association oil industry comments from 1996 
to 2004 and he was the regular industry spokesman at agency 
hearings and workshops. How does it send a message of 
independence to put at the head of your new watchdog group, 
somebody with that background?
    Mr. Allred. Senator Wyden, first of all, I might clarify 
that he was not--we did not pick him. He was picked by the 
chairman of the Royalty Policy Group, which is a FACA outside 
group that advises the agency. He is the person off the Royalty 
Policy Group who will have a role in supporting another group, 
which is being created under that FACA Committee. I guess I 
would urge you to wait and see who the appointees are. I would 
hope that when you see those, you will feel very comfortable 
with the people who are the co-chairs on that group.
    Senator Wyden. I'm just looking at your press release and I 
will say, given the fact that this was so touted in November. 
Now this was long after we'd been in it that that would have 
been an opportunity to show it was a fresh day and it looked 
like once again, the foxes were going to be in charge of the 
henhouse.
    Let me ask one other question of you, Mr. Allred, again 
dealing with today's circumstances. It has come to light 
recently that Ms. Burton was warned about the leases as early 
as 2004. She told a congressional committee she didn't know 
about that. Now you all are moving in areas that were 
interested in working with you on with respect to re-
negotiating leases but why wasn't any action taken to this date 
to hold people accountable for what is now on the record? 
Wouldn't you have moved Ms. Burton to another position? 
Wouldn't something be done to show that when the people who are 
responsible for these mistakes face some consequences?
    Mr. Allred. Senator Wyden, first, we have just received 
this information, as you have and while I have reviewed the 
summary, I have not had an opportunity to go through this in 
detail. I have talked with Mr. Devaney about what's in it. 
These mistakes that occurred did not occur under her 
management. My experience at this point in time with Director 
Burton is that I have found her to have the highest integrity 
and be a very competent person. I have not seen a reason yet to 
make a change in her status.
    Senator Wyden. But she knew about the problems as early as 
2004 and she told a congressional committee she didn't know 
anything about it until 2006. I'm going to see if I can get one 
other question, if I might and one for you, Dr. Devaney. As I 
understand it, with respect to this audit process, essentially 
as of right now, the Government pretty much takes the oil 
companies' word for what's really going on. There are these 
compliance reviews and that's pretty much where we are as of 
today. After all that has come out on this program, we pretty 
much take the oil companies' word for what goes on. Is that 
correct?
    Mr. Devaney. It's more or less of an honor system. There 
are checks and balances that take place during the compliance 
review process to ensure that the numbers being put forward 
are, relatively speaking, industry standards. There also are 
some audits being done. So there are audits although as the 
chairman pointed out earlier, there are fewer audits today than 
there used to be.
    Senator Wyden. My time has expired, I think, but my 
understanding is with respect to recoveries, the royalties are 
really coming in from all of you--the $568 million--you are the 
ones bringing in the royalties, isn't that correct?
    Mr. Devaney. Well, it is true that in the context of qui 
tam investigations that we've done, we've raised that--we've 
brought in that kind of----
    Senator Wyden. That is the amount that the Department did 
not catch that you did. Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Senator Thomas is next.
    Senator Thomas. Thank you, Mr. Chairman. I'm glad we're 
having this hearing. It certainly is an issue that is very 
important to us. I think we ought to get right into the real 
issue and that is, why were these thresholds omitted and how 
were they omitted and more importantly, now what do we do about 
it? Now we seem to be pretty busy from time to time, blaming 
some of the current people that are there about it, which 
distresses me a little bit but in any event, we need to know 
why this took place, we need to know what we can do about it. 
We need to know how it can be done. We certainly don't want to 
be in the process of breaking contracts. I don't think we want 
to be in the process of the Government going back and doing 
Venezuelan kinds of things in terms of changing the contracts. 
I don't know why we're quite so involved in the personnel 
aspect of it, quite frankly but I think Mr. Devaney, it's your 
reports that have kind of caused that. You described Johnnie 
Burton's management as shockingly cavalier and her reaction to 
hearing the Clinton administration as a jaw-dropping example of 
bungling. But you refrain from similar language about the 
Clinton administration officials who did it in the first place. 
Now, the fact is, Johnnie in the meantime, has done something 
about it, has gotten six of them going and so how do you 
respond to that assessment of management style in this way?
    Mr. Devaney. Senator, I was not attributing those remarks 
to Johnnie Burton herself. My remarks were not directed towards 
Johnnie Burton. My remarks were directed towards--after the 
mistake was made in 1998 and 1999. In 2000, the mistake was 
discovered by our low level employee down in the gulf and for 
some unexplained reason, that mistake was never brought to the 
attention of the two former Directors or anybody in Washington. 
In 2004, it appears through the e-mails we discovered and from 
talking to Johnnie Burton, there was a very brief discussion 
about the fact that the omissions had been raised again and the 
discussion was very brief and centered around the fact that the 
Solicitor's Office had opined that there was nothing that could 
be done about it and that was the end of the discussion. Our 
remarks were, quite frankly, to be fair in hindsight, I think, 
a much more robust discussion should have occurred in which the 
Solicitor himself as opposed to a line solicitor, perhaps the 
Department of Justice and others came together and discussed 
what, if anything, could be done. Now I have no reason to 
believe that anything would have changed but I am disappointed 
that that conversation did not occur.
    Senator Thomas. I guess I was a little interested too, why 
the New York Times' writing detailed accounts of your report 
before this committee and the American people were given a 
chance to review it.
    Mr. Devaney. I have no idea how that happened. I was not 
happy myself. Quite frankly, the purported remarks did not 
reflect my true feelings or my testimony today.
    Senator Thomas. I see. In your testimony, you mentioned an 
attorney from the Solicitor's Office during the Clinton 
administration who admitted that he should have spotted the 
mistake but did not. Who was that?
    Mr. Devaney. His name is Milo Mason.
    Senator Thomas. Do you believe it would have been 
productive for Mr. Mason to provide the committee with 
testimony?
    Mr. Devaney. Mr. Mason did testify on the House side about 
this issue in the fall of last year and he probably is somebody 
that you might want to hear from.
    Senator Thomas. The leases from 1998 and 1999 did not 
contain the price threshold but leases issued in 2000 did. 
Apparently somebody discovered it and remedied the problem.
    Mr. Devaney. Yes. They did. They took care of that.
    Senator Thomas. So why are we complaining about 2004 then, 
if we took care of the problem--we need to get down to the core 
of the problem but all the discussion seems to be about who was 
here, who heard what when and frankly, I think I've kind of 
observed and I have a little more involvement than most with 
Johnnie Burton but I think she's done a great job and she seems 
to be getting all the complaints about it when there is no 
evidence that that should be the case. At any rate, I hope we 
can move on to find some answers to the thing and I appreciate 
your interest.
    The Chairman. Senator Dorgan.
    Senator Dorgan. Mr. Chairman, thank you very much. I regret 
I had to go chair another hearing for a brief period and missed 
part of the presentation. I've had a chance to read through 
your presentations. Let me ask a question--maybe it's already 
been asked. What percent of the production that exists on these 
disputed leases, disputed contracts--what percent of the 
production comes from companies with whom you've now made an 
agreement on the price thresholds? Mr. Allred, could you answer 
that?
    Mr. Allred. Senator Dorgan, it's about 20 percent of what 
we believe might be future production. These are estimates.
    Senator Dorgan. So about 80 percent, at this point, is 
still outside the area that has been settled and would be 
producing under circumstances in which there is not a price 
threshold?
    Mr. Allred. That is correct. There is about--there is 20 
percent within these companies. There is another 20 percent 
held by one other company and then there is about another 20 
percent that are held by what I'll call offshore foreign 
companies and then a smattering of others.
    Senator Dorgan. Does that 20 percent mean that we are, with 
the estimate of $10 to $11 billion that 20 percent of that now 
will be recovered and there is a shortfall of perhaps about $8-
plus billion to the American taxpayer? Is that a proper way to 
calculate that?
    Mr. Allred. Senator, our numbers--about $1.5 billion would 
be produced by these new agreements with those six companies.
    Senator Dorgan. You know, I don't understand this issue as 
well as I should. Some others perhaps do. But I come from a 
town of 300 people and if there are businesses on main street 
of my home town doing contracts with each other and one 
contract is done and there is a major omission by mistake and 
the person that is the beneficiary of that omission says, you 
know what? That's tough. You've signed it. Tough luck. You're 
out of luck. I'm not re-negotiating anything. You know what the 
first business would say? That's just fine. Don't come around 
here anymore then. Don't show up here if that's the way you're 
going to be. You understand it's a mistake. We understand it's 
a mistake. This is a windfall for you. If we both understand 
it's a mistake and we do and you're not willing to negotiate 
and you're not willing to correct this mistake, don't show up 
here anymore because you're not going to do business with me 
anymore. Why would you not take that position, Mr. Allred? Why 
would the Government, why would the Department not at this 
point, take that position? Say, you know what? Either you re-
negotiate with us or sorry, Charlie. You're out of luck. We're 
not going to do business with you.
    Mr. Allred. Senator Dorgan, obviously we have to enforce 
the laws that you pass and those laws don't allow us to do 
that. Before you were able to get here, we did talk a little 
bit about unintended consequences and I can go over that a 
little bit or I can brief you separately if you'd like.
    Senator Dorgan. I'm sorry--you did, I believe, indicate 
that you would like some additional incentives or tools with 
which to go to these companies to say, you know what? We need 
to redo this because there was a mistake and you want some 
tools or incentives. I'm just saying that the best incentive is 
to say, you know what? Either you come clean on this. This was 
a mistake. We both understand that or don't show up the next 
time there is a bid. The next time there is a lease you want to 
bid on, don't show up around here. Now, if you don't have the 
capability to do that and you need some legal authority to do 
that, I'm perfectly happy and I know there will be great 
dispute about that, perhaps but I'm perfectly happy to give you 
that. But my sense is that the Department has not been as 
aggressive as I would prefer to have it. I mean, there is a 
legal doctrine called mutual mistake. I don't know whether you 
pursue that. Maybe it's a long shot, maybe not. It seems to me 
you would be very aggressive and pursue every opportunity you 
have to get what we should get here and what was omitted by 
mistake in those contracts. The fact is, this is not a perfect 
government. Mistakes are made. This one is--I'm sure everybody 
up here feels the same frustration. It's unbelievable that 
somebody would be involved in contracts like this and make a 
mistake that has the consequence of $10 or $11 billion over the 
long term but if that's where we find ourselves, then let's try 
to figure out how we deal with it and I say, deal with it 
aggressively. We've got about 80 percent of the potential 
ramification for the Government and therefore the taxpayer is 
still laying out there that may never be collected unless we 
become more aggressive. How can you become more aggressive? 
What tools do you need from us?
    Mr. Allred. I have, in a previous discussion, identified 
one that I think would be very helpful and it has to do with 
creating a reason for companies to sign without giving them a 
benefit which would decrease royalties to the United States. 
There are probably some other things that we could do as well 
and as I have volunteered to the committee, I would very much 
like to work with your staffs to develop that suite of tools 
that I think could bring the companies to the table. I will say 
that I have been aggressive and I'm sure you've heard, 
probably, some complaints about how aggressive I've been. I 
clearly believe these are contracts that we cannot abrogate but 
I think there is a responsibility to re-negotiate them. We have 
looked at the mistakes theory and information that while we 
still have to look at in detail, based upon the information 
that Mr. Devaney has provided to us, it appears that these were 
conscious decisions to remove these in 1998 and 1999. I don't 
believe they were malicious but they were conscious. That would 
make it, as I understand it from our solicitor, very difficult 
to argue a mistakes theory.
    Senator Dorgan. Mr. Allred, I understand about contracts 
sanctity and I understand the concerns others have expressed 
about abrogating a contract. On the other hand, this is a 
different situation than just abrogating a contract. It is a 
contract that was produced by error. Those who are the 
beneficiaries of that, I'm sure are smiling all the way to the 
bank and will for 10, 20 years. But I think it is our 
responsibility to decide that we're going to try to make this 
right on behalf of the American taxpayer. The American 
taxpayers, at this point, have a significant interest here and 
I'm not--boy, I don't think we need a lot of sugar here to lay 
out as sweeteners. You need the tools from us. I think we 
should give you the tools to say to these companies, you want 
to keep bidding? Then own up on this issue to a mutual mistake. 
We made it, perhaps, in the agency but everyone understands 
it's an omission and a mistake. Own up to it and you're going 
to be a partner here and keep bidding. If not, go somewhere 
else because we don't need you if that's the way you're going 
deal with us. So I hope you will tell us what you need. I think 
you have plenty to proceed ahead but if you need more, I'm 
perfectly willing to work to get it there because I don't think 
we need sweeteners. You just need to say that we're open for 
business only for those folks who in good faith understand 
they're willing to join us in correcting a very serious mistake 
that disadvantages the American people to the tune of $10 or 
$11 billion.
    Finally, my time is up but I do want to say, Mr. Devaney, 
I've read your work extensively and when I chaired the Interior 
Appropriations Subcommittee, I read the statements you made 
about the Interior Department. I am very concerned about that 
as the chairman indicated he was in his statement. All of us 
want good government and you keep being aggressive and keep 
pushing and keep giving us information we need with which to do 
our job as well. I want to thank all three witnesses for coming 
today, Mr. Chairman.
    The Chairman. Thanks very much.
    Senator Craig.
    Senator Craig. Well, Mr. Chairman, thank you. I apologize 
like my colleague did, a few moments ago for not being here for 
your testimony. I was involved elsewhere but I have read a fair 
amount of it and I have focused on this issue quite a bit and 
Mr. Chairman, thank you for doing the oversight that is clearly 
important here, as we deal with, I think, this issue.
    I find it interesting that in reading Mr. Devaney's report 
and listening to the Secretary that this was not an omission 
but a bad decision. Is that something that is a reasonable 
conclusion to draw? Either of you?
    Mr. Devaney. Sir, I would say it was not a deliberate 
omission. It was a mistake.
    Senator Craig. Mr. Secretary?
    Mr. Allred. Well, I'm depending upon Mr. Devaney's 
information but it would appear there was a decision to remove 
them, whether that was good or bad. I don't believe it was done 
at the--it was not designed to be to the detriment of the 
United States but I think it was a decision that either was not 
fully understood or was not carried through as it should have 
been.
    Senator Craig. Therein lies, I think, for any prosecutable 
effort a very real frustration if that is the reality of what 
we're dealing with here and there is a reality of contracts, 
our contracts and they have some degree of sanctity and they 
must have in our Nation of laws. At the same time, I am 
extremely frustrated that we don't get it corrected and do so 
in an appropriate way with the companies involved.
    I find it interesting that you had a number of companies--
Marathon, Conoco, Phillips, BP and Shell in December become 
very proactive in solving the problem. Then all of the sudden, 
it appears to have stopped. Mr. Secretary, is there any reason 
for that, from your knowledge and experience now in the 
position that might have caused that?
    Mr. Allred. Senator Craig, I have an opinion. I don't know 
for sure but my opinion is that those companies that have not 
signed are waiting to see the role that Congress will play in 
this issue.
    Senator Craig. That's an interesting opinion because there 
is a bit of street talk out there that suggests that that is 
exactly what's happening--that companies, more of them, would 
be forthcoming to solve this problem but with a new Congress, 
in some instances, they are being told, step back. We are going 
to legislate this so that we can score it for the budget or in 
fact, we will gain political points by muscling this issue 
around a bit. If that is happening out there, if that is what 
some of us are saying to these companies, shame on us. We ought 
to get this problem solved, first of all, voluntarily if we can 
and it appears that that was happening at a fairly rapid rate 
and a substantial amount of money has been saved as a result of 
that in royalties to come and some retrieved. And I would hope, 
more to come so I think I join with my ranking member in saying 
to the companies involved here, don't wait for the vicissitudes 
of Congress or the politics of this issue. Move forward now. I 
don't blame the Senator from North Dakota for saying what he 
says but there is goodwill and if contracts were negotiated in 
good faith--South Dakota, I'm sorry. It's so cold in those two 
States right now, I can't tell one from the other. But I don't 
blame him for that frustration.
    But the major finds of oil in the next decade for our 
supply are going to come out of the gulf and there are a 
limited number of companies who have the capability to drill in 
deep water and bring that production to this country and into 
our system. We ought to be working to solve the problem, 
enhance the situation and move on. Let me conclude with these 
questions, then.
    Mr. Secretary, do you believe the audits and compliance 
reviews relating to royalty payments should be undertaken by 
MMS or another entity?
    Mr. Allred. Senator Craig, I think that operation is so 
integral into MMS's operations; it would be very difficult to 
do it. For example, we monitor the meters--there are MMS 
supervised meters on every offshore well on every offshore 
gas--both oil and gas that determines the amount of product 
that is being produced. We do the analysis of the material 
being produced. We collect information with regard to 
transportation costs and processing costs. My own personal 
viewpoint is that it would be very difficult to separate that 
sort of information from the operation of the audit program or 
the compliance program. Audit is only part of it. The 
compliance, I believe, as Mr. Devaney agrees, is an important 
tool that we need.
    Senator Craig. Well, do you believe the IG should have a 
permanent role in overseeing MMS audit and compliance 
activities?
    Mr. Allred. Senator Craig, that's not something I've really 
thought much about, but my own opinion would be that the reason 
to have an Inspector General is to have someone who is in an 
oversight role and who does not have a conflict of interest in 
reviewing the operations of the agency. My concern would be 
that--not specific to the Inspector General but to put any 
oversight role into an actual operating process would certainly 
lesson the independence of that review.
    Senator Craig. OK. My last question, Mr. Chairman. Mr. 
Devaney, do you believe that the current budget for the 
compliance and assessment management program is adequate?
    Mr. Devaney. Senator, we really didn't address that issue. 
My sense is they could always use more resources to do that 
job. As we've identified in our audit, we believe that it is 
the combination of audits and compliance reviews done in a 
strategic risk based compliance system that would ensure the 
greatest possibility of total oversight and they need the 
resources to do that.
    Senator Craig. You've answered the question then, I guess 
and we will certainly take a look at that as we deal with your 
budgets in the coming months to make sure that these tools are 
right and that hopefully, mistakes and/or decisions of this 
kind are not made in the future. Obviously, it is important 
that this be a resource for our government; therefore for our 
citizens. At the same time, we want to maintain a solid working 
relationship with these companies that do have the capability 
to reach out into that deep water and supply us with these 
resources and that's only going to happen when those 
relationships are legal, stable, transparent, understandable, 
and predictable as it relates to production and certainly that 
will fit with the costs at hand in dealing with these kinds of 
production units. So we thank you very much, Mr. Chairman. 
Thank you for our role and responsibility and let me close by 
saying, I would hope that the companies who are still out there 
waiting, would come forward. If they are waiting for the 
politics of this issue to settle and for legislation to come 
about, they may wait a while longer. I hope we do act 
responsibly here and we don't cause companies to say, this is 
no place to do business. More importantly, our government is no 
partner in a business relationship. Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Senator Tester, you're next.
    Senator Tester. Thank you, Mr. Chairman, a couple of 
questions. Mr. Devaney, the audit was publicly released in 2006 
and I will follow the other ones--excuse me if this has been 
covered and I haven't been here to hear it. But in 1998 and 
1999, the offense was committed. When did you start your audit?
    Mr. Devaney. We started our audit about a year ago.
    Senator Tester. And was that at the direction of this 
committee? Or why did you start that audit? Why was it 
initiated?
    Mr. Devaney. It was a request not only by this committee 
but also of a dozen or so individual members of the committee--
members of the Senate and House.
    Senator Tester. Is there a normal audit that would catch 
this situation? I mean, you talk about the compliance audit. Is 
that the only way?
    Mr. Devaney. We did an audit in 2003 and looked at the 
program. We had some findings that I spoke about in my opening 
remarks that have been corrected now and they have gone through 
two peer reviews. We periodically drop in on this program. What 
I mean by that is, every 3 or 4 years.
    Senator Tester. Every 3 or 4 years?
    Mr. Devaney. Right.
    Senator Tester. Okay, so that would have been 2003?
    Mr. Devaney. That was 2003.
    Senator Tester. As some of my comrades on this committee 
have already stated, hopefully the situation from a business 
standpoint will be cleaned up. I can't help to think that if I 
was in the business of oil production that I would have known 
exactly what the rules were when I went into the contract and 
known exactly if I was going to get a good deal that actually 
subverted somewhat the rules. So I too, hope it's cleared up. 
In your testimony here, you said you don't have any evidence of 
a smoking gun or evidence that this omission was deliberate and 
then in the next paragraph, it talks about investigations are 
going on. Can you tell me how many people are being 
investigated?
    Mr. Devaney. We're looking at the behavior of perhaps a 
dozen.
    Senator Tester. A dozen people? Can you tell me if that 
investigation includes personal financial benefits?
    Mr. Devaney. I'm not prepared to say that today, Senator.
    Senator Tester. OK. As many steps as this went through the 
bureaucracy, this type of mistake is hard for me to think that 
it was a mistake. Now I know you said that it wasn't 
deliberate. It may be a question to revolve around. What makes 
you think it wasn't deliberate? I mean, I saw at least three 
steps here.
    Mr. Devaney. We have taken a very close look at the people 
involved in this and heard them out and tried to understand the 
context in which they were making those decisions. The 
organizational components of MMS were in different parts of the 
country. There was clearly a communications breakdown. They 
were trying to understand themselves, the ramifications of the 
Royalty Relief Act. It appears to us at the end of the day that 
this was a mistake, a bureaucratic mistake and a very costly 
one.
    Senator Tester. Point well taken. Was there a reduction in 
audit staff force on this or has this been kind of the way 
business has been done for the last 10, 15 years as far as the 
frequency of the audit?
    Mr. Devaney. We're talking about MMS's audit program, not 
our audit program in my office but MMS's audit program has had 
a slight reduction in auditors and a definite shift in thinking 
that they wanted to do more compliance reviews in the belief 
that that would allow them to cover a broader range of 
companies and leases. Those compliance reviews are not 
traditional audits and do not provide as good of coverage as a 
traditional audit would provide so they have had a shift in 
philosophy by trying to cover a broader range of companies and 
leases, to more or less go to this compliance review, which is 
sort of a checklist process. It is done from a desk in an 
office as opposed to knocking on the door and saying, let us 
see your books.
    Senator Tester. In your personal opinion, do you think that 
there would be a cost benefit ratio if we were able to bump up 
not the compliance audit but more of the regular audits like 
you are doing?
    Mr. Devaney. As I tried to answer the earlier question, 
this is a place where investments might be wise because of the 
financial ramifications of what we're talking about.
    Senator Tester. Thank you very much. Thank you, Mr. 
Chairman.
    The Chairman. Thank you very much.
    Senator Sessions is next.
    Senator Sessions. Thank you, Mr. Chairman. It's a very 
valuable hearing and important hearing. Mr. Devaney, you have 
suggested--said flatly that there was no one to take 
responsibility. I assume you mean that was a mindset that 
papers just got moved along. But Mr. Allred, somebody had 
responsibility when a lease is signed, any lease, particularly 
one that involves billions of dollars, who is it? Is it the 
Assistant Secretary? Is it the Secretary? Or who?
    Mr. Allred. Senator, my belief is that the top management 
of the Department is always responsible for----
    Senator Sessions. Well, top management. Is that you?
    Mr. Allred. That is I and the Secretary.
    Senator Sessions. Well, which one of you is ultimately 
responsible for signing the lease?
    Mr. Allred. We are responsible for the activities of the 
agency. Neither I nor the Secretary were here when this 
happened.
    Senator Sessions. I'm well aware of that. But today, if a 
lease is signed, who in this Department is the person 
responsible for final approval and authorization of the lease?
    Mr. Allred. I and the Secretary.
    Senator Sessions. Both of you?
    Mr. Allred. Well, I first and then the Secretary.
    Senator Sessions. You make a recommendation to the 
Secretary?
    Mr. Allred. That's correct.
    Senator Sessions. And he ultimately signs the lease?
    Mr. Allred. The actual signature does not take place at 
that level but we are responsible for assuring that that is 
done in the manner in which we instruct people to do it.
    Senator Sessions. Well, there we go. Now, does the 
Secretary himself or herself sign some document to say I 
approved the lease?
    Mr. Allred. No.
    Senator Sessions. Well, then I would say that the Secretary 
is not actually deeply involved if they don't make any 
signature. Whose signature is required on such a document?
    Mr. Allred. The signature on the document itself is 
delegated to the Mineral Management Service. The agency--I and 
the Secretary--specify what they are to consider and how they 
are to do that.
    Senator Sessions. Well, first let me just suggest to you, 
Mr. Allred, that the legal department doesn't seem to have 
functioned well in this. Is that department that reviews these 
leases--do they report to you? Are you responsible for their 
ultimate effectiveness?
    Mr. Allred. The Solicitor's Office does not report to me 
but we utilize the services of the Solicitor's Office. There is 
a solicitor within the Department of the Interior. It is our 
responsibility to make sure that we ask the right questions and 
get adequate advice.
    Senator Sessions. Mr. Gaffigan, I believe your comments 
troubled me. Along that very same line, you said there were a 
series of mistakes, vague language that may be as to what the 
threshold may be and maybe litigation over that. Of course, the 
issue we're confronting here, the thresholds that were not in 
that and even Kerr McGee's threat of a lawsuit. Would you say 
that in any major Federal agency, you need the best legal 
department you can get and when you're dealing with millions, 
even tens of billions of dollars, that these are--every word in 
these leases and documents must be given the most careful 
scrutiny and you need the best legal team available?
    Mr. Gaffigan. Given the track record of the legal 
challenges in this area and this whole area of royalties has a 
whole history of litigation going back to litigation over the 
value of royalties and what the sales value is there. So I 
would say yes, it's very important that we look at both the 
regs and the laws.
    Senator Sessions. And Mr. Allred, you say the Congress 
needs to help you. Senator Domenici asked exactly what, exactly 
how. Are you an attorney and an expert in the legal matters of 
leasing and so forth, yourself?
    Mr. Allred. Senator, I am not. I am just an engineer.
    Senator Sessions. Well, with regard to that then, I think 
it is incumbent upon you to get the Solicitor General and the 
Secretary of the Interior and when you ask us to do something, 
it needs to have been thought through from every possible 
angle. That's all I'm saying. We've got to have a higher degree 
of responsibility here to make this system work. We don't want 
to end up continuing to have lawsuits and vague language that 
leads to disagreements.
    Mr. Devaney, I have to follow up on this a little bit. 
According to your report, the person responsible in 1998, I 
guess, for directing the preparation of leases, said he was 
told by persons in MMS's economic and leasing divisions, to 
take the price threshold language out of the leases. Now you 
keep saying that was a mistake. Somebody made a decision to 
take that out. Who did it? Was it negotiated with the oil 
companies? Did the legal staff review that? Who came up with 
this idea to take the language out?
    Mr. Devaney. Well, we spent a considerable amount of time 
trying to identify the person that told him. He suggested to us 
that it was one of three people. We talked to all of those 
three people. All three denied that they had told him to take 
that out. I will say that my reference to the mistake was that 
it's--at the end of our investigation, we believe that the 
mistake was that there was an assumption that the Royalty 
Relief Act regulations would actually include the price 
threshold language when in fact it did not. When the Royalty 
Relief Act regulations finally came out, it did not have any 
threshold language in it. And up until that time----
    Senator Sessions. I'm not arguing with you but your report 
here would indicate that this was as to whether this language 
was actually going to be incorporated by reference and to do it 
in a certain way?
    Mr. Devaney. That's right.
    Senator Sessions. Not to actually change the policy of 
previous leases and to eliminate the threshold.
    Mr. Devaney. That's right.
    Senator Sessions. And you never discovered any discussions 
about actually changing the threshold limit by any policy 
makers or lawyers?
    Mr. Devaney. No.
    Senator Sessions. And Mr. Allred, then therefore, I think 
you have a potential--the main thing, mutual mistake. It was 
never explicitly discussed, an intention to change it. I'm not 
sure that cause of action is gone.
    Mr. Allred. Senator, we have not discarded that 
opportunity. Congress has asked the Attorney General to provide 
an opinion and we look forward to that opinion.
    Senator Sessions. I would be curious and will issue some 
written questions, Mr. Allred, about the impact that this could 
have, for example, on the legislation we passed, the Security 
Act of 2005 and the way we have on my home State of Alabama and 
other States. I hope you would review that and give us some 
information. But I think you need to tell us what you need to 
fix this thing and we need to evaluate it and see if we can do 
it, consistent with principles of contract law and the 
constitution. Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. I was eager to 
join with you in asking for the IG's report and I am 
appreciative of this hearing today. You know, as I listen to 
some of the statements, I'm reminded of the story of lawyers; 
when you have the law on your side, you argue the law. When you 
have the facts on your side, you argue the facts. And when you 
have neither the law nor the facts, you pound on the desk and 
you create a diversion. It seems to me that either under the 
guise of political intrigue or dire consequences based upon 
some calculation of the action of Congress, that we are moving 
to a diversion of the real issue here, which is the rip off of 
billions of dollars in taxpayers' money.
    Now, Mr. Secretary, you were quoted by the New York Times 
last month as saying with regards to the royalty program, 
``while I think there is a lot of room for improvement, I have 
not been able to find anything that's drastically wrong.'' Do 
you stand by that assessment today?
    Mr. Allred. Senator Menendez, that's correct.
    Senator Menendez. Well, I don't understand that. Now here 
is a process that has effectively cheated the American 
taxpayers, at this point, out of billions of dollars. It 
resulted in several criminal investigations, and has auditors 
filing their own suits under the Civil False Claims Act because 
they claim the Department won't pursue action against oil and 
gas companies. Sounds like we're ready for another ``heck of a 
job'' comment.
    Mr. Allred. Senator, I've looked at all of those and I'd be 
glad to respond individually but I do not believe the conduct 
of the agency at this point in time is such that it puts the 
United States at risk. It can be improved. There is no question 
about it.
    Senator Menendez. Mr. Devaney, there is nothing drastically 
wrong here?
    Mr. Devaney. Oh, I think that there is plenty of room for 
improvement here.
    Senator Menendez. I think that is very charitable. Now I 
want to join Senator Wyden in saying to you, Mr. Secretary, 
that I have a real concern that the panel to review complaints 
and problems with the royalty program is headed by the former 
General Counsel for API. There are a great deal of people in 
this country who expect the Department of the Interior to act 
as the American peoples' watchdogs on this issue and I am 
hopeful that you and the Secretary will be making the changes 
necessary to restore our trust in your mission. But I'm not 
sure that having an API lawyer head an independent royalty 
review panel is a step in the right direction in restoring that 
trust. So I want to echo Senator Wyden's concerns.
    But the most pressing question, of course, is how are we 
going to fix the problem that the IG reported on today. The 
House has been debating several options and we will have some 
of our own ideas but what I want to know is, Director Burton 
testified before the House that MMS had met with about ten 
companies and I heard you say today, you've actually re-
negotiated with about six of them. So there are four or so that 
you are still working with, is that correct?
    Mr. Allred. Senator, there is more than that. I've talked 
to not all of the leaseholders but probably a majority of the 
leaseholders, including the offshore companies.
    Senator Menendez. I think she was talking about some of the 
major companies. Are there still four major companies that are 
outstanding?
    Mr. Allred. Probably more than four if you count the 
offshore.
    Senator Menendez. Is ExxonMobile one of those?
    Mr. Allred. Pardon?
    Senator Menendez. Is ExxonMobile one that is outstanding?
    Mr. Allred. Yes, it is.
    Senator Menendez. Well, in the third quarter of 2006, 
ExxonMobile reported over $10 billion in profit--in one 
quarter. That's the second highest profit of all time, second 
to their own record from a year ago. And right now, they and 
many others have wildly profitable companies and are taking 
advantage of a mistake--a mistake made against the clear intent 
of Congress and the Department of the Interior and it seems to 
me that we're already contributing billions of dollars to 
ExxonMobile at the gas pump as American consumers. It is 
outrageous that they are unwilling to re-negotiate. And that is 
what jumps at me about this whole issue, the huge disparity 
about how we treat the American taxpayer and the multi-national 
oil conglomerates.
    Mr. Devaney, I believe you recently found that MMS doesn't 
have a good way to determine interest payments for companies 
that underpay royalties, is that true?
    Mr. Devaney. That's an ongoing inquiry we're conducting. It 
appears to us that they are collecting interest but not in a 
way that we would all hope. It is very slow.
    Senator Menendez. Meaning they are not collecting as 
comprehensively as they should, as much as they should? What do 
you mean?
    Mr. Devaney. Well, the collection of interest in the modern 
world is done by computer and their computer program is not up 
to speed and it's a very slow process to collect this interest.
    Senator Menendez. Well, it's interesting. If the average 
taxpayer has an amount due, the IRS has no problem in sending 
them a notice with penalty, the exact amount that they are 
owed, including interest to the very penny. Yet we can't do 
that with the oil industry. Ask the American taxpayer if they 
think that that's fair.
    Now let me ask you with reference to the audits. I 
understand, Mr. Secretary, that MMS has cut the number of 
auditor positions by over 20 percent since the year 2000 and 
reduced the number of audits by roughly 22 percent, and I 
believe that the amount of money that the Department has 
collected through auditing and compliance has gone from an 
average of $115 million per year before 2002 to about $48 
million since. Do those numbers sound right to you?
    Mr. Allred. Mr. Chairman, I don't have those in front of me 
but I know that our opinion with regard to compliance is that 
we are seeing more people comply than we did previously. I 
think it is because of two reasons. First, the regulations and 
our activities are much clearer to people. They understand 
better. Second, there were a large number of settlements that 
had to do with when we were first implementing the act that 
came in the previous time period. We are covering a wider 
number both in our audits and in our compliance reviews.
    Senator Menendez. Something is going wrong because we have 
gone to nearly a third of collections of what we had before 
when we had a greater number of auditors.
    Mr. Allred. Senator, I would hope that what we're seeing is 
people are doing a better job of paying their royalties up 
front.
    Senator Menendez. Well, I hope that's the case but to be 
very honest with you, audits are not the only ways to keep the 
companies honest, they are a revenue raiser to the people of 
this country, and with the economic situation we find ourselves 
in, with the struggle of middle class families in this country, 
I think they would find it totally intolerable that they can be 
told to a penny what they owe the government and we cannot get 
the oil companies to do what is right. Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Senator Murkowski.
    Senator Murkowski. Thank you, Mr. Chairman. Very important 
hearing this morning and gentlemen, I had really hoped that I 
was going to be able to come in here this morning and gain 
truly a better sense about how we got to where we are today and 
we've heard the discussion around the dais here about it is a 
mistake, it is a decision--extremely costly decision for this 
country and I have to admit that after listening, I'm not quite 
sure whether it was a mistake, or an omission, it sounds like 
there was a decision that was made. And it was a very wrong 
decision. I come from a State where we negotiate with the oil 
companies on a relatively frequent basis and let me tell you, 
they have the best and the brightest going over every single 
word of every single contract and if we as a State aren't 
similarly matched, we know that we get into this ongoing, 
endless litigation over royalty and other terms related in that 
contract. So the fact that you could have, perhaps vague 
language in the Deep Water Royalty Relief Act that might have 
suggested that you didn't have to include the language is one 
thing but then to know that in the year 2000, just 2 years 
afterwards, we went ahead and we did include the provisions 
within the leases, if I understand the testimony correctly, 
leads me to believe that we caught our mistake in relatively 
short order then. We have just failed to do anything about it 
for quite some time, which I think is greatly distressing.
    Mr. Gaffigan, I guess I'd pose a question to you. We had 
this vagueness, if you will, within the Deep Water Royalty 
Relief Act and hopefully, we're beyond that now. We know what 
it says and what it means and how we can interpret that. But we 
also have royalty relief provisions within the OCS Lands Act, 
within the Energy Policy Act of 2005. Is there any possibility 
that in these two acts, we might have similar problems that 
we've either discovered or may discover a few years down the 
road? Give me some assurance.
    Mr. Gaffigan. I wish I could. The reason we raised the 
issue is that there is this relief out there under those two 
provisions. Again, we are not aware of any problems but who is 
to say, given the track record and how we have consistently 
lost cases in this matter that there might be other challenges 
out there that we are not aware of. So I would be taking a 
good, hard look at all these provisions and not only looking at 
the cost benefits of them but also making sure we're sound 
because as you say, everyone does take a good, hard look at 
these things from a litigation standpoint.
    Senator Murkowski. So we in the Congress need to be making 
sure that the laws that we are drafting are very, very clear 
but from the administration perspective and within the 
Department and within the agencies, they too, need to be making 
sure that there is no uncertainties.
    Mr. Gaffigan. I think everyone shares in that 
responsibility.
    Senator Murkowski. Let me ask then, I've said that 
extremely costly mistake or decision that we are in today, 
facing potentially a $10 billion loss and we recognize, if I am 
to believe your charts, Secretary Allred here, that the 
decisions that we make going forward as a Congress could add 
even more loss revenue to this Nation if we do not figure out 
how to do it right. So it is not just pointing the finger at 
how we got here but we have got an obligation to move very 
carefully and make sure that we are acting responsibly as we 
figure out what we do next. You have mentioned one possible 
tool and that was in terms of additional incentives. You 
indicated that perhaps an extension on deep-water leases might 
be one way that we can get some of these companies to re-
negotiate. Has this been put in front of them? Have they been 
receptive? Do you think that this is going to be a useful tool 
for you as you try to re-negotiate some of these?
    Mr. Allred. Senator Murkowski, in trying to figure out what 
tools we might use, I have had some very preliminary 
discussions, being careful not to commit to anything, with some 
of the companies and I believe that there are significant 
companies who would find that very attractive.
    Senator Murkowski. Can I ask you--and I'm going to ask you 
to speculate a little, Mr. Allred, on the likelihood of success 
on the Kerr McGee suit. I believe that I heard somebody mention 
that the potential liability to us on that was $60 billion. Am 
I correct in that? Mr. Allred?
    Mr. Allred. Senator, I'm not sure about the total liability 
but I believe it's in that range. The argument in that case, as 
you probably know, is whether or not the law gave us the 
authority to impose price thresholds. Our solicitor tells me 
that they are confident in our position. I've been around long 
enough to know that you can never predict what a court will do 
but the arguments that the Solicitor has he believes are very 
sound.
    Senator Murkowski. So the potential for us could be $10 
billion that we are seeing as a loss now and if Kerr McGee were 
to be successful in its litigation, an additional $60 billion 
on top of that. Is that correct?
    Mr. Allred. Senator, I believe that those are inclusive, 
that if we are not able to impose price thresholds totally, the 
lost opportunity for income could be up to $60 billion. The $10 
billion would be a portion of--if we are unable to recover the 
1998 and 1999.
    Senator Murkowski. OK. And then one final question for you, 
Mr. Allred and this is how the Department sets the royalty 
rates and there has been some discussion about the discretion 
of the Secretary. Traditionally we've seen these royalty rates 
set at 12.5 percent with some of the more prospective leases at 
16\2/3\ percent. It was, I guess, just a few weeks ago that the 
Administration recently raised the royalty to 16\2/3\ percent 
in most places with the exception of Alaska, where it remains 
at 12.5. I just wanted to ask kind of what the rationale was 
behind that decision.
    Mr. Allred. Senator, when we were asked to evaluate whether 
or not that should be done or not, we looked at a number of 
items but specifically, in our consideration, as to whether or 
not the 12.5 was needed offshore, continentally offshore. Our 
conclusion was that as we looked at the competition that was 
available and the interest in the oil companies and the state 
of the technology and that's very important--the state of the 
technology with regard to deep water offshore development that 
we did not think that the reduction in royalty rate was no 
longer necessary. It certainly probably was when we started but 
the technology has been developed sufficiently and there is 
sufficient interest and competition that we felt that it was 
appropriate to bring it up to 16\2/3\ as it is in shallow water 
on the OCS.
    Senator Murkowski. Thank you. Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Senator Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman. Mr. Devaney, as 
you started your investigation, did you advise the agency on 
not deleting e-mails?
    Mr. Devaney. Actually I didn't have to, Senator. Under the 
Cobell lawsuit, the agency retains their e-mails. It is a 
wonderful thing for IGs.
    Senator Cantwell. And in that process, did you review e-
mails between--the personnel and any of these companies that 
are involved in this?
    Mr. Devaney. We looked at some 19,000 e-mails so while I 
can't definitively say, my assumption is, we have done that, 
yes.
    Senator Cantwell. So it wasn't just internal communication, 
it was communication between those employees and these 
companies as well?
    Mr. Devaney. I believe so.
    Senator Cantwell. Is that in the report that we're 
receiving today? Are those e-mails in that report?
    Mr. Devaney. No. But it is much more common that the e-
mails reflected conversations within the Department. It would 
be few and far between e-mails with the oil companies 
themselves.
    Senator Cantwell. So we do not know whether those were 
asked for?
    Mr. Devaney. I don't know as I sit here right now. I'm 
assuming that because we looked at such a large volume that it 
included--if there were any e-mails, it would have included 
them.
    Senator Cantwell. But that is something that we could go 
back and look at as well, is that correct?
    Mr. Devaney. We could go back and look at them but our 
investigators have looked at them to see if there was 
conversation in those e-mails that might relate to these 
issues.
    Senator Cantwell. Mr. Chairman, I'm assuming we're getting 
a copy of this report today, with these e-mails, that members 
can review, is that correct?
    Mr. Devaney. My belief is you are not getting the 19,000 e-
mails, no.
    Senator Cantwell. In this report?
    Mr. Devaney. No. You're getting today the e-mails that are 
relevant to the discussions, which go to the issue of whether 
or not anyone at MMS knew about these issues in 2004. There are 
four or five e-mails. It's a brief string of e-mails.
    Senator Cantwell. OK. But we are getting those e-mails, is 
that correct?
    Mr. Devaney. Yes.
    Senator Cantwell. The committee will have access to those?
    Mr. Devaney. Yes.
    Senator Cantwell. And we can get a clarification about this 
issue of external e-mails between employees?
    Mr. Devaney. I would be glad to work with you on that.
    Senator Cantwell. Thank you. Secretary Allred, do you know, 
since this is an ongoing investigation, do you know of any 
discussions, meetings, or verbal reports that aren't included 
in the information today that might be cover-up discussions 
within the organization about this issue and ways in which to 
take this information and package it differently for Congress?
    Mr. Allred. Senator, I'm not aware of any discussion that 
would present this information any differently than what Mr. 
Devaney has supplied it to you with.
    Senator Cantwell. I know you haven't been on the job very 
long, along with the Secretary--but didn't you come onto the 
job and hear discussions between employees about well, this is 
the way we ought to present this or change what's happened or 
anything of that nature? You're not aware of any such e-mail? 
We're not going to show you an e-mail later and you're going to 
say, oh, I don't remember receiving that?
    Mr. Allred. Senator, one of my problems is I can't type so 
you probably won't see any e-mails but no, in fact, I found 
just the opposite. When I came on board, I found a very high 
level of concern about how to fix the problem and of course, 
Director Burton and others were actively involved in trying to 
figure out how to solve this issue with the oil companies and 
we have discussed a lot of strategy with regard to that.
    Senator Cantwell. Help me then understand your comments 
that you just made here this morning about this decision in the 
change of these 1998, 1999 contracts being a conscious 
decision. Help me in understanding that.
    Mr. Allred. Senator, in the information that Mr. Devaney 
has supplied to you and to us, there is indication there that 
there was direction to an individual who was drafting the 
leases that they were to remove the price threshold. So that 
was a definitive decision.
    Senator Cantwell. By whom?
    Mr. Allred. That is a problem and that's probably where you 
need to follow up with Mr. Devaney. But my understanding is 
that it was one of three people. He has interviewed all three 
of those. I understand one of them is not capable of 
responding. So how that happened and for what reason, the 
report is not indicative of that.
    Senator Cantwell. I think that's not a $10 billion 
question, it's the $80 billion question this morning. So you're 
saying it was a conscious decision and you're saying some 
individual made this decision and communicated that.
    Mr. Allred. That's my understanding.
    Senator Cantwell. And Mr. Devaney, I'm just reading your 
report, which Deputy Director Cruickshank is simply saying, 
well it was a screw up and internal miscommunication. So we're 
hearing from the Secretary that it was a conscious decision by 
an individual and we're also having a report that kind of 
contradicts that. To me, that's a very interesting development 
this morning, that your report says it was just an internal 
screw-up and we're having the Secretary testify here that it 
was a conscious decision.
    Mr. Devaney. Let's see here if I can not add to the 
confusion but perhaps make something clear--clearer. When 
Assistant Secretary Allred states that someone deliberately 
told somebody to do something, that's true. But it was done in 
the belief that--see, the price threshold language was always 
contained in the previous leases in an addendum that was 
attached to the leases.
    Senator Cantwell. I'm very well aware that the final rule 
mysteriously does not refer to this and that the agency then 
tried to say that they were covering their bases by referring 
to that rule that is then absent of the price threshold 
language. What I want to know is who gave that direction and 
why did the agency continue to pretend like this wasn't costing 
the taxpayers $10 billion. Now, this is a very important issue 
for the U.S. Senate and I hope, Mr. Chairman, that we will 
exercise our oversight responsibilities in getting to the 
bottom of this. I applaud the IG and the GAO for their 
diligence thus far but we don't have the whole story. I 
appreciate Mr. Allred being honest this morning and saying that 
he thinks it was a conscious decision. We need to get the 
bottom of this and I know I'm going to run out of time, Mr. 
Chairman, but as somebody who has spent the last 5 years on 
contract sanctity as it related to Enron, I appreciate the 
committee's really good work and due diligence on this issue. 
When it came to the bottom line, we saw some regulatory capture 
within the Federal Energy Regulatory Commission and them 
interpreting the statute the way they wanted to interpret it at 
the benefit of those industries that they were supposed to be 
regulating. So I hope that's not the case here. I hope that's 
not the case here. But I hope that we will not be buffeted by 
the notion of contract sanctity and then somehow forget our 
responsibilities to the taxpayers of this country. We have to 
get to the bottom line here and we have to make sure that there 
is reform within this agency that it does its proper job in 
oversight responsibilities to the taxpayers.
    Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Senator Landrieu.
    Senator Landrieu. Thank you, Mr. Chairman. I'd like to 
follow up by saying, as someone who's been very focused on this 
issue for any number of reasons for quite a long time, that 
obviously there is a need for reform, for revamping, for 
transparency to give taxpayers both in Louisiana and throughout 
the gulf coast that now benefit rather directly or will benefit 
rather directly by this royalty sharing provision as well as 
taxpayers everywhere that this agency can operate, it can 
collect the revenues that are due and support an industry that 
creates hundreds of thousands of jobs for this country.
    And in my view, Mr. Chairman, there really is hardly an 
issue other than the global issue of energy and dependence and 
balance that is more central than this one for that purpose 
because when we talk about more production, it's important that 
we get that production done correctly, which is where to drill, 
how to drill and how the revenues will be divided between 
either the State where the drilling is or the taxpayers 
generally and to move forward without this being corrected and 
addressed is going to be very difficult.
    So I, for one, am willing to spend as much time as it takes 
to get to the bottom of exactly what happened. Senator Cantwell 
is very correct and as usual, has done a very good job. It is 
extremely important, Mr. Chairman, for this committee, whether 
through an oversight function or otherwise, to get to the 
bottom of whether this was a decision or a mistake because that 
will govern which direction we can move forward.
    No. 2, I understand that the three people most responsible 
for this--whatever it was--a mistake or a decision, was Bruce 
Babbitt, who was the Secretary of the Interior during this 
time, Bob Armstrong, who was the Assistant Secretary for Land 
and Minerals Management, who was responsible for overseeing 
that, who is now in a health condition that he is unable to 
testify, correct? Mr. Devaney?
    Mr. Devaney. No, that's not a name I'm familiar with.
    Senator Landrieu. That is not correct so he can testify?
    Mr. Devaney. I believe he could. I don't know the man.
    Senator Landrieu. Well, I'd like--does anybody know at this 
table if he can or can't testify?
    [Answer inaudible.]
    Senator Landrieu. OK. Carolita Kallaur? K A L L A U R, who 
was Associate Director from 1998. She is deceased.
    Mr. Devaney. Yes.
    Senator Landrieu. OK, so she is obviously unable to 
testify. Those are the three people most responsible for 
whatever this was, an error or a decision. Is there anyone else 
that is a principal that we should know about?
    Mr. Devaney. Those are--leaving aside the individuals that 
are deceased. We focused our attention on three employees of 
the Minerals Management Service.
    Senator Landrieu. Could you, for the record, state their 
names?
    Mr. Devaney. The names are Mr. Rodi, who was the person who 
actually changed the language. When we asked him why he did it, 
he said he was told to do it by one of three people.
    Senator Landrieu. Who were those three people?
    Mr. Devaney. We asked him to take a polygraph exam and he 
passed that polygraph exam.
    Senator Landrieu. Who were the three people though?
    Mr. Devaney. One person by the name of Rose. If you just 
give a second, I'll----
    Senator Landrieu. You can take a minute. While you're 
looking at that, I think it is important for the record to 
reflect that, Mr. Chairman. But let me step back for a minute 
and take a second for this committee to recognize that the 
revenue increases from offshore oil and gas revenues have grown 
in a tremendous way over time and we don't want to do anything 
on this committee to reverse that positive trend. It's positive 
for the Treasury. It's positive for domestic job creation and 
now because of the good work of this committee, it's a very 
positive development to protecting and supporting America's 
energy coast and just for the record, Mr. Chairman, I'm going 
to submit what the actual numbers are projected to be between 
2006 and 2016 but I'm also going to go back to the 1950's when 
this program started, in 1954, when the first offshore lease 
sale was done, I believe, in the mid-fifties and show to the 
country that this is a substantial increase.
       Estimated Yearly Receipts From the Outer Continental Shelf
    2006: $7.575 billion
    2007: $8.875 billion
    2008: $10.125 billion
    2009: $9.775 billion
    2010: $9.975 billion
    2011: $10.075 billion
    2012: $9.425 billion
    2013: $10.975 billion
    2014: $10.825 billion
    2015: $10.850 billion
    2016: $11.175 billion
  

Source: Congressional Budget Office 1/30/06.

    Senator Landrieu. No. 2, the 1995 Act that Senator Bennett 
Johnson, Chairman of this committee and our predecessor 
passed--one of its purposes--the Senator from Oregon should 
know and the Senator from Washington wasn't to diminish 
revenues to the Treasury but to increase revenues to the 
Treasury. That 1995 Deep Water Relief Act was drafted 
specifically to increase economic production and to generate 
more royalties, not less.
    So I know for a fact that the principle author of this 
legislation had it as his intention and I'm sure if he would 
have been asked to testify, would tell you the same thing I'm 
testifying to you. It wasn't to get less revenues for the 
Treasury but more. And if it operates correctly, Mr. Chairman, 
that's exactly what will happen, which is going to be a great 
benefit for everyone.
    Oil companies and gas companies drill more, the public gets 
more money so we can lower taxes if we wish or invest in 
education or highways and now because of the act that this 
committee took, the gulf coast, the energy coast that produces 
100 percent of these revenues--they are not produced off the 
western coast, Mr. Chairman, and they are not produced off the 
eastern coast, Mr. Chairman and they're not produced in the 
Interior. They are produced in the Gulf of Mexico. So the gulf 
coast States have as much interest in getting this straight as 
anyone and I think this committee should hold as many hearings 
as possible until we determine, was it a mistake or was it a 
decision because then we can move forward so we don't get 
caught up in court for the next 10 years, recover the money 
that is owed, reform an agency, produce transparency, and allow 
an industry that can do good work and does good work, continue 
to do good work for America.
    I hope--my final point is--as people are so anxious to 
wield these huge clubs, that we don't wield the club so huge 
that we hit our own self in the head by doing it and this is 
not that complicated, frankly, with the right information. So 
Mr. Chairman, I thank you for that and I will finally say one 
thing, if the committee will indulge me. I don't mind holding 
the people responsible accountable and I'd like to read again 
that it was the Secretary, former Secretary Bruce Babbitt, 
where this error occurred and his staff and whoever was in the 
Department. But for current people to be held liable for what 
happened in 1998--now they are, for not correcting it and we'll 
see, then fine. But please, let's direct our anger on the 
people responsible for when this occurred. Thank you.
    The Chairman. Let me just clarify. I think there is a lot 
of confusion about the testimony we've had here. When a 
contract is entered into, it involves, presumably a meeting of 
the minds, an agreement between the two parties as to what is 
contained in the contract. From the Government's perspective, 
as I understand your testimony, Mr. Devaney, you say this was a 
bureaucratic mistake. You're saying that these lease thresholds 
or price thresholds were left out, consciously left out, based 
on a mistaken belief that the price thresholds were otherwise 
provided for in statute or regulation. Am I right?
    Mr. Devaney. Yes.
    The Chairman. So there was no decision by the Government to 
enter into a lease that did not contain price thresholds. They 
believed that the legal effect of the lease was to continue to 
have price thresholds?
    Mr. Devaney. That is the conclusion we draw from our 
investigations.
    The Chairman. So there was no conscious decision to enter 
into a lease that was very different from the previous leases 
or than was very different from the subsequent leases on the 
part of the Government?
    Mr. Devaney. We found no evidence of that.
    The Chairman. On the part of the companies, do we have any 
reason to believe that they understood that they were getting 
away with not having to pay any royalty ever, to the Government 
on the production from these leases? I assume that they were 
ignorant as well at the time these leases were signed. Do you 
have any reason to believe otherwise, Mr. Devaney?
    Mr. Devaney. I think actually it was the companies 
themselves that brought the mistake to the attention of MMS in 
both 2000 and 2004. There were still companies that were 
involved in these leases that were expressing to MMS, could you 
clarify it for us? Did you really mean this? And those 
questions were being directed to folks in sort of the lower 
levels of MMS and the issue bubbled up, both in 2000 and 2004 
because of those inquiries.
    The Chairman. So the companies were coming forward and 
saying, you know, this has come to our attention here. It 
hadn't come to our attention before but it now has, that these 
leases are different than the ones that we previously entered 
into and maybe could you clarify what the deal is here. Is that 
basically what happened?
    Mr. Devaney. Well, it's difficult to understand what their 
motivation for asking the question was, but it is true that 
during the course of our investigation, we found evidence that 
they were asking that question.
    The Chairman. And in the bidding on these leases, as I 
understand the way this process works, when leases are let, 
companies come in and bid and give a bonus bid to get the 
lease. Is there any evidence that people were willing to bid 
more for these leases because these leases were written in such 
a way that companies were never going to have to pay any 
royalty and that was a great boom to them?
    Mr. Devaney. That certainly was not uncovered during our 
investigation, no.
    The Chairman. All right. Well, I guess at least from what I 
take from your statement, this was a mistake. It was a 
bureaucratic mistake. It was a mistake in what wound up in the 
language that was operative on the leases, and it seems to me 
that in light of that, we need to try to get it corrected. I 
mean, the companies didn't understand that they were getting 
away without having to pay royalties. The Government didn't 
understand that they were entering into leases that didn't 
require payment of royalty, regardless of the price of oil or 
gas and it seems to me, we ought to get it corrected and 
companies ought to be willing to come in and agree to re-
negotiate these leases to get a reasonable royalty to the 
taxpayers of this country. I think that's the best result.
    Now if that result isn't possible, then obviously we need 
to look at alternatives, legislative alternatives to get the 
problem fixed. But I would hope that we would have more 
companies willing to step up and be willing to recognize and 
acknowledge that a mistake was made here and that they should 
not take unfair advantage of that, as they have been taking for 
some period of time here.
    Let me also just clarify, Mr. Devaney, I think you said 
that your investigation indicated that the decisions about this 
were made by the individuals involved and that there was no 
communication to higher officials in the Department about the 
issue, since there was no decision made not to include these 
price thresholds. Obviously, that wasn't communicated. But the 
fact of the mistake was not communicated either, to higher 
officials until 2000, is that what I'm informed?
    Mr. Devaney. Even in 2000, the mistake, when it was 
uncovered by a lower level MMS employee, it was communicated to 
the individual mentioned earlier who is now deceased and we, of 
course, would have liked to have asked her why she decided, 
apparently, not to communicate that to the Assistant Secretary 
level.
    The Chairman. She did not communicate that to Mr. Armstrong 
or to Mr. Babbitt or anybody else in the Department?
    Mr. Devaney. No.
    The Chairman. Let me just ask about this chart. Mr. Allred, 
I understand your good faith and your concern about potential 
downside risks to the Government of sort of forcing this issue 
or enacting something that would wind us up in court. But there 
is a very substantial financial incentive for these companies 
to want to see leasing continue in the gulf coast. I mean, we 
just had quite a debate last fall and there are a lot of people 
walking the halls up here, lobbying in favor of additional 
leasing in the gulf coast.
    So as I understand it--I'll give you a chance to respond 
here, but I hope you're not saying that we should not insist on 
fairness for the taxpayer because to do so or to be too heavy-
handed in it would run the risk that industry would go to court 
to prohibit additional leasing from occurring. It doesn't sound 
credible to me that it is in the interest of industry to 
prohibit additional leasing from occurring.
    Mr. Allred. Mr. Chairman, my concern is not what we do. I 
believe we have to take action and I think Congress has a real 
role in that action. The only thing I'm urging is to think that 
through very carefully so that we minimize the possibility of 
being enjoined from doing leasing. I could--if you would like 
me to, I can lay out for you the scenario that has me concerned 
and that is, where a company would be prohibited from bidding 
and then because they were prohibited from bidding, it might be 
in their interest to delay the bidding process until they could 
have that resolved. And that is the action that I'm concerned 
about that could result in a significant delay in the 
development of the oil resources, an actual reduction in 
production and the delay of income to the U.S. Government.
    I think there are many ways to do this and my concern in 
bringing this forward is just to illustrate that we have to 
make sure that we think through unintended consequences of an 
action and as I said before, I pledge to this committee to work 
with you and your staff to make sure that we consider what we 
do so that we avoid unintended consequences. I believe there is 
a real role for this committee to play.
    The Chairman. Thank you very much.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman. And Mr. Chairman, 
let me just say, as the incoming chair of the Subcommittee on 
Public Lands, it's my intent to work very closely with you to 
follow up on this and to work with all of our colleagues on a 
bipartisan basis because obviously we've got a number of 
outstanding issues.
    I want to follow up on something also, to state in the 
clarification of business. We've had a lot of discussion back 
and forth about whether the central problem stemmed from a 
decision or a mistake. That is sort of how it was framed. I 
want to be very clear, Mr. Devaney. I want you to confirm 
something. This was not a one-time occurrence involving one 
lease. As far as I can tell, this involved hundreds of leases. 
Is that correct?
    Mr. Devaney. I think there were over a thousand leases 
involved in this.
    Senator Wyden. All right, because we've now framed this as 
if we've got to get out and find one person who said--one 
instance that there was a mistake or a conscious decision but 
what we have, in my view, is an incredible pattern here, a 
pattern of incompetence and I believe, conflict of interest.
    Let me, if I might, with you, Mr. Allred, go through 
something else that I find disquieting about what is happening 
right now. As you know, there have been a number of auditors 
with the agency, MMS, that have filed False Claim Act cases--at 
least two different courts of appeals, including the 10th 
Circuit where these auditors live and are pursing their cases, 
have held that the auditors--that the Federal employees have 
legal standing to file these claims under the False Claims Act. 
And other whistle-blower protection statutes may also come into 
play but let me tell you what I'm very troubled about this.
    I've got a copy of an e-mail that was sent on January 9 of 
this year--this is an MMS e-mail asking for the sign-up sheets 
for any and all mandatory training courses taken by these three 
auditors in 2004, 2005 and 2006. Mr. Chairman, I ask your 
consent that this e-mail be made part of the record.
    The Chairman. We'll include it in the record.
    [The e-mail referred to follows:]

From: Sawicki, Michelle
Sent: Tuesday, January 09, 2007 2:06 PM
To: Ohadi, Pauline
Cc: Gilmore, Holly-Jean; Fields, Gary; Johnson, Ralph; Tyler, 
Paul
Subject: Documentation request
Importance: High

    Debbie Gibbs Tschudy has asked for sign-in sheets for any 
and all mandatory courses (i.e. Ethics, FOIA, Privacy Act, 
Fraud, IT Security Awareness, Illegal Acts, etc.) taken by 
Randy Little, Joel Arnold and Lannis Morris during 2004, 2005 
and 2006.
    I am having Jeryl pull any sign-in sheets we may have for 
courses entered into the MRM Training Database. I will let you 
know if there are any we cannot find.
    During the 03/04 CPE cycle each office had differing 
opinions on entering courses that did not carry CPE into the 
MRM Training DB. So, our dilemma is that many of the mandatory 
courses were not entered into the MRM Training DB. Therefore, 
we do not have record of those employees attending the 
mandatory training. We need for you to provide any sign-in 
sheets for those courses to Gary Fields no later than noon on 
Thursday January 11th.
    Holly-Jean told me that the 05/06 training files are in 
Houston. If there are any sign-in sheets that we need during 
that time frame, we will have to have Holly-Jean get those for 
us.
    Thanks for your cooperation on this in such a quick turn 
around time.
    Paul, if you are not Pauline's supervisor, please forward 
to the appropriate person.
    If you have any questions or need anything from me, please 
let me know.

Michelle

    Senator Wyden. My question, Mr. Allred, because I'm 
concerned about the climate of making sure that these whistle-
blowers, who've told us an awful lot about what is actually 
going on there, that this climate does not degenerate further 
and that whistle-blowers will come forward. So my question is, 
why are the managers at the Mineral Management Service checking 
the training records for just these three employees? It sure 
looks to me like this is not a kind of coincidence. If it's a 
program, you look at a lot of people, but what the e-mail shows 
is that it's just these three people. Do you find that 
troubling? Do you have any explanation? What message would you 
like to send today with respect to whistle blowing at the 
Department?
    Mr. Allred. Senator, I'm not familiar with that e-mail but 
I can tell you, I will not allow any retribution against these 
people. I do not approve of what these people have done. It 
appears to me it's to their own benefit. But they still have 
that right and I will just not stand for reprisals against 
them. The responsible agency for investing what's going on is 
the Inspector General and that is where these sorts of 
questions and investigations should take place.
    I can assure that--and now that I am aware of that, I will 
find out what's going on and I will not allow any retribution 
against these or any other people.
    Senator Wyden. Pretty hard, Mr. Allred, to see it as a 
coincidence, that nobody else's records get tracked except 
these three courageous public servants who watched, year after 
year, as the taxpayer got fleeced. These were the only three 
who have their records tracked. Wouldn't you say that's a 
little unusual?
    Mr. Allred. Senator, again I don't know the circumstances. 
The first time I've heard about this is when you asked it. I 
would hope that you will reserve judgment on the claims that 
those people have made until the Inspector General has 
investigated it and reported it. I am aware, there are a number 
of circumstances that would raise questions about some of the 
statements they have made. But I will not allow any retribution 
against anybody like that.
    Senator Wyden. I understand the controversy that surrounds 
some of their claims, but we do know that a number of non-
partisan officials, people who have no partisan bias on this, 
have been willing to step forward at considerable risk to their 
careers. Now they're the ones who are having their sign-up 
sheets pulled and apparently nobody else and that again, 
strikes me as hard to accept as coincidence.
    Let me wrap up with you, Mr. Devaney and again, just 
commend you as my colleagues have, for your comments. It really 
strikes me that even today, at the heart of this, the 
Government is taking the oil companies' word with a program 
like this. Where it is clear we are going to be out several 
billions of dollars and it may even be $80 billion and I would 
tell my very good friend from Louisiana who I admire greatly, 
we all understand this program began when the price of oil was 
$19 a barrel.
    When I was on the floor, trying to get a vote to make some 
changes, the price of oil was $72 a barrel. So we very much 
want the people of Louisiana to be productive and contributing 
to our energy security, but we have a program where it is now 
on the record that the taxpayers have been fleeced and it has 
not happened once. There hasn't been just one ``mistake'' or 
one ``decision.'' It involved hundreds of leases and as we wrap 
up this morning, after Chairman Bingaman's thorough and 
commendable hearing, we are left with the fact that today, by 
Mr. Devaney's words, we've got an honor system.
    I asked you about the oil companies, essentially being able 
to have the Government sign off on their figures. Your words 
were, we have an honor system. I just don't think that's good 
enough and Mr. Chairman, I want to say again that as chair of 
the Subcommittee on Public Lands, I'm going to work very 
closely with you and with Senator Domenici and all our 
colleagues as we follow up today.
    The Chairman. Thank you very much.
    Senator Cantwell, did you have additional questions?
    Senator Cantwell. I did, Mr. Chairman but I will be brief. 
I just wanted to ask of the Secretary about a report that they 
commissioned in 2003 that over a 40 year period, the current 
incentive program would lead to the discovery of only 1.1 
percent more oil reserves than if there was no system of 
royalty relief at all. Are you familiar with that report?
    Mr. Allred. I'm aware of the report but I have not had the 
opportunity to study it. Understand that again, I have not seen 
the thing, other than I am aware of some news reports of 
another study that was done like that.
    Senator Cantwell. But this, I think, was your own agency 
saying that it is--basically giving us a 1.1 percent return.
    Mr. Allred. I just--I could not intelligently comment on 
that report. I would be glad to visit with you after I've had a 
chance to look at it.
    Senator Cantwell. And second, if we had not seen or if the 
New York Times had not run this article, would--and your 
testimony today is that it was a conscious decision--would 
anything have changed if we hadn't seen anything in the 
newspaper?
    Mr. Allred. Senator, it's hard to speculate on what would 
have happened in the agency. When I came into the agency, 
management did know about it and so I don't know what might 
have happened in the previous times. I can tell you that the 
current management, the Secretary and I take this very 
seriously.
    Senator Cantwell. But in the context of you saying earlier 
there was a conscious decision and then they knew about it. If 
it hadn't been in the newspaper then maybe the policy would 
have continued beyond 1998.
    Mr. Allred. Senator, obviously somebody discovered the 
discrepancy in 2000 because the leases after 2000 all contained 
the price thresholds.
    Senator Cantwell. But as Senator Wyden was talking about, 
within this time period, there were still thousands of leases 
that haven't been acted on. So I think we're getting maybe like 
20 percent of the revenue that you might end up getting from 
these. I mean, we've only fixed 20 percent of the problem, is 
my point, as it relates to these thousand-plus leases. We still 
need to come back and fix that.
    My last question--the President opposes the House 
legislation that is moving through as a proposed solution to 
this problem. Could you be specific about why the 
administration opposes that legislation?
    Mr. Allred. I'm aware that there is a statement that the 
administration has drafted. I don't know that it has gone 
forward, and I would not be capable of intelligently briefing 
you on that.
    Senator Cantwell. Well, it too, is in the press, along with 
these other things so if we could get the Secretary to respond 
to whether the proposals being put forth by the House--my guess 
is, will probably pass overwhelmingly, what specific provisions 
of those changes the administration doesn't support. That would 
be very helpful. Thank you.
    The Chairman. Senator Landrieu, did you have additional 
questions?
    Senator Landrieu. Just to clarify a few things because I 
want to talk for a second and clarify this pattern issue and 
the quantity of the leases in question, because again, I think 
it is very important that we focus to find this solution and 
not run down rabbit holes.
    Can somebody on the panel--maybe Mr. Allred, you would be 
the best one, explain how many leases are usually entered into 
in these 5-year trenches. Now this has been going on almost 
every 5 years since the 1950's and there is a big difference, 
Mr. Chairman, whether this is a pattern over time, from the 
1950's to the present or whether it is an aberration or a 
terrible mistake or whatever, a change in that pattern starting 
in the lease sale that we're speaking about. Mr. Allred, could 
you add? How many leases are, on average, leased in a 5-year 
period?
    Mr. Allred. Well, Senator in a typical----
    Senator Landrieu. Or in a lease sale?
    Mr. Allred. In a lease sale, there could be as many as 600 
leases.
    Senator Landrieu. Lease sales occur twice a year?
    Mr. Allred. Yes. In the new 5-year program, for example, 
there would be 21 lease sales in that 5-year period. Perhaps 
just for some comparison purposes, we currently have some 20--
almost 28,000 leases that we deal with--over 8,000 on the OCS--
and of course, those rotate as they come back in and we put 
them out in new lease sales.
    Senator Landrieu. But what you're saying is in the next 5 
year lease sale, there are going to be 21 lease sales in 5 
years so that's about 4 lease sales per year. And in each one 
of those lease sales, there are approximately how many?
    Mr. Allred. Well, we haven't defined that yet. We do it at 
the time of the sale but typically you might look at 600 leases 
in a sale.
    Senator Landrieu. Okay but out of those 600, like in this 
instance, how many were actually active in terms of actually 
producing out of those 600? In these leases in question, in 
this particular lot?
    Mr. Allred. If we look at the 1998 and 1999, which is where 
I have some information, there originally were 1,032 leases. 
Five hundred and seventy of them are still in force, being 
actively developed by 45 companies. Of those, 19 are producing.
    Senator Landrieu. So Mr. Chairman, it's important for the 
record that we understand that it's been 19 producing leases 
that we have to focus on in terms of contracts entered into 
where royalties are not being collected and what that revenue 
stream might be and then focus on the other several hundred 
that are ``active,'' which I don't have time now but I'm going 
to get into some specifics about what that term actually means 
because prospectively, Mr. Chairman, if a lease is not being 
drilled and it is not active, it is released.
    So in other words, we can correct prospectively this quite 
easily. It's the issue of the leases that are now producing 
under this faulty or bad decision contracts that if we could 
focus on, we could resolve this in a way that continues to 
produce money for the Treasury, relief to the gulf coast, and 
jobs for the taxpayers and that is what I'm hoping the bottom 
line here will be, instead of us either trying to whatever--
beat up on oil companies or beat up on the Government or beat 
up--I mean, that can be done. I hope it's not done in a way 
that prevents us from actually solving the taxpayer problem 
right now. Thank you.
    The Chairman. Thank you very much. Thank you to the 
witnesses for all of your time and good testimony. I think this 
has been helpful. In case there are members who came or who 
were not able to come who have questions, we'd ask that they 
provide those in writing by the end of business tomorrow and 
then we would ask sometime in the next couple of weeks, if you 
could respond to those in case there are written questions.
    Thank you again and that will end the hearing.
    [Whereupon, at 12:02 p.m., the hearing was adjourned.]
                                APPENDIX

                   Responses to Additional Questions

                              ----------                              

                        Department of the Interior,
                               Office of Inspector General,
                                  Washington, DC, February 6, 2007.
Hon. Jeff Bingaman,
Chairman, U.S. Senate, Committee on Energy and Natural Resources, 
        Washington, DC.
    Dear Senator Bingaman: With this letter, I am transmitting my 
written responses to questions submitted by you and members of the 
Committee following my testimony on January 18, 2007 on issues relating 
to oil and gas royalty management at the Department of the Interior.
    I respectfully request that my written responses be included in the 
record. If you have any additional questions or concerns, please do not 
hesitate to contact me at (202) 208-5745, or your staff may contact 
Associate Inspector General for External Affairs, Kris Kolesnik, at 
(202) 513-0326.
            Sincerely,
                                           Earl E. Devaney,
                                                 Inspector General.
[Enclosure.]
              Responses to Questions From Senator Bingaman
    Question 1. Pending Work--Turning to the royalty management issues, 
could you please describe the additional work and related 
investigations that you have pending? When do you expect this work to 
be completed?
    Answer. The additional investigations related to royalty management 
issues presently underway involve the outstanding Qui Tam cases, and 
several criminal investigations. My investigative staff is working hard 
to conclude each of these matters as expeditiously as possible. Given 
the recent verdict in the Qui Tam case against Kerr-McGee, however, we 
must evaluate the impact that the verdict might have on our Qui Tam 
investigation which will undoubtedly extend the time it takes for us to 
conclude the matter. As for the criminal investigations, I am hesitant 
to estimate when our work will be completed, as additional 
investigation is often requested by the Department of Justice in 
criminal matters.
    Question 2. Management Issues--Your testimony makes reference to a 
``surname-process which dilutes responsibility and accountability.'' 
Could you please elaborate and explain how this may have played into 
the royalty price threshold problem?
    Answer. The surname process that I referred to in my testimony is a 
review process that requires the reviewers to sign their surname on a 
form, indicating their approval or assent to forwarding the document in 
question to the next reviewer. We have found that in many instances, an 
excessive number of people are expected to review and surname a 
document. This, in my view, spreads responsibility for the accuracy and 
appropriateness of a document among too many people, leaving no one 
ultimately responsible. In the royalty price threshold matter, 
signatories to the surname process told us they signed off without 
thorough review, in reliance upon staff that reviewed and surnamed 
before them. This dilutes responsibility further, and undermines the 
very purpose of the surname process.
    Question 3. Ongoing Price Threshold Issues--Your report on the OCS 
lease price threshold problem identifies e-mail from last year that 
indicates some ongoing confusion in the MMS with respect to 
implementation of price thresholds for royalty relief provisions 
enacted as part of the Energy Policy Act of 2005. Is this correct? What 
should be done to address this?
    Answer. An e-mail from a lower level MMS employee was found seeking 
guidance regarding application of price thresholds in lease sales that 
were pending at the time. We feel that this e-mail is a symptom of a 
much bigger organizational issue regarding communication and policy 
documentation. To address this one issue, immediate policy must be 
developed and disseminated to all MMS and SOL individuals involved with 
the lease process. Once developed and disseminated, the policy must be 
memorialized for future reference.
    Question 4. Audit and Compliance Action Plan--With respect to your 
report last month on the audit anti compliance review process (December 
2006, ``Minerals Management Service's Compliance Review Process,'' 
Report No. C-IN-MMS-0006-2006), I understand that MMS has committed to 
preparing an action plan to address your recommendations. How will you 
track MMS's implementation of this plan?
    Answer. We will track the recommendations in accordance with Office 
of Management and Budget Circular No. A-50, Audit Followup, and the 
Department of the Interior's implementing regulations. In its response 
to the final audit report, MMS provided an action plan for implementing 
all of our recommendations. We have forwarded that action plan to the 
Department's Assistant Secretary for Policy, Management and Budget 
(PMB) for tracking of implementation. PMB maintains the inventory of 
open recommendations and is responsible for ensuring that 
recommendations are implemented before they are closed. After PMB 
notifies us that all of the recommendations from this audit report have 
been closed, we will conduct a verification review to ensure that the 
recommendations have actually been implemented.
    Question 4a. In your view, what are the key reforms on which this 
Committee should focus to ensure substantial improvements are made in 
the agency's existing compliance review system?
    Answer. Our report provides three recommendations for 1) improving 
data reliability, 2) improving the compliance review process, and 3) 
revising performance measures to better reflect program operations. We 
believe that these are the three key reforms on which the Committee 
should focus.

   Improving Data Reliability: MMS needs to develop and 
        implement a plan to provide reliable data for managing and 
        reporting on its compliance activities. Until this is 
        accomplished, 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 program operations and results to 
            stakeholders, including the Congress and state and tribal 
            audit organizations; and
    --determine the true costs and benefits of compliance reviews and 
            audits.

   Improving the Compliance Review Process: Our report 
        identifies numerous improvements that MMS can make to its 
        compliance review process. Most importantly, MMS needs to 
        develop risk-based criteria for selecting companies for audits 
        and compliance reviews. MMS also needs to strengthen its 
        procedures for verifying volumes and allowances reported by 
        companies.
   Revising Performance Measures: We found that the performance 
        measures used by MMS to manage and report on its operations 
        were either unreliable or misleading. MMS needs to revise its 
        performance measures to better reflect the program operations 
        and allow stakeholders, including the Congress, to assess MMS' 
        performance.

    Question 5. Audits and Impacts on States and Tribes--Are the 
shortcomings that you have identified in the audit and compliance 
review process impacting revenues owing to states and tribes? If so, do 
you have estimates of the magnitude of the impacts? What 
recommendations do you make to avoid this?
    Answer. The issues that we identified could be impacting royalty 
revenue to states and tribes because the issues prevent MMS from 
maximizing the outcome of its compliance program; however, we cannot 
estimate the magnitude of any potential impact. Because MMS lacks 
quality data, it cannot develop an effective strategy for deploying 
resources and cannot determine the true costs and benefits of 
compliance reviews and audits. Our report identifies improvements that, 
if implemented, could ultimately result in MMS identifying and 
collecting additional royalties. States and tribes would share in any 
additional collections resulting from improved compliance reviews. 
Additionally, the ability of states and tribes to conduct compliance 
reviews is hindered because they do not have full access to MMS' 
automated tools.
    Unfortunately, there is no way to estimate additional royalties 
that might be collected as a result of more effective strategies and 
improved compliance reviews. MMS lacks the quality data needed to make 
such estimates. Ultimately, collection of any additional royalties 
would depend on 1) the amount of royalties underreported by companies 
and 2) MMS' ability to identify those additional royalties through its 
audit and compliance reviews.
    Question 6. Incomplete Data--Regarding your finding that MMS' 
compliance review process relies on four separate databases, which in 
turn contain unreliable, incomplete and inconsistent information: what 
do you believe would be a reasonable timeline, enabling the MMS to 
correct its system's biggest flaws?
    Answer. MMS' action plan indicates that it will complete 
implementation of our recommendation concerning data reliability by 
September 2007. This is an aggressive schedule, but reasonable if MMS 
focuses its attention and resources on the implementation of this 
recommendation.
    Question 7. Compliance Review Actions Plan Implementation--flow 
will you track implementation of the MMS action plan for compliance 
with the recommendations of your December 2006 audit of the compliance 
review and audit process? In your view, what are the key reforms that 
this Committee should focus on, to ensure substantial improvements are 
made in the agency's existing compliance review system?
    Answer. We will track the recommendations in accordance with Office 
of Management and Budget Circular No. A-50, Audit Followup, and the 
Department of the Interior's implementing regulations.
    Our report provides three recommendations for 1) improving data 
reliability, 2) improving the compliance review process, and 3) 
revising performance measures to better reflect program operations. We 
believe that these are the three key reforms on which the Committee 
should focus. Once MMS addresses these issues, it will be able to 
better develop and implement effective strategies for ensuring company 
compliance with royalty regulations. MMS should periodically evaluate 
and monitor the effectiveness of its strategies and recalibrate them to 
improve its overall performance goals under the Government Performance 
and Results Act.
    Question 8. Variance Thresholds--I was troubled by your conclusion 
in the December 2006 report that MMS cannot adequately explain its 
rationale or methodology for establishing acceptable ``variance 
thresholds'' between the revenues MMS expects to receive, and the 
royalty obligations a company reports to the agency.
    What are your suggestions for how the agency might best revisit its 
methodology for establishing these thresholds, in a way that would 
provide more clarity and consistency?
    Answer. We support MMS' use of thresholds in the compliance review 
process. Compliance review procedures calculate the expected royalties 
from a company based on available data and then compare the expected 
royalties to the royalties actually reported. These procedures are less 
precise than audit procedures; therefore, MMS needs to establish 
thresholds for when variances between the expected royalties and 
reported royalties are unreasonable and should be pursued in more 
depth. Where to set that threshold is a matter of professional judgment 
which should primarily be based on an analysis of costs and benefits of 
the additional procedures MMS would undertake to pursue the issue. If a 
threshold is too high, MMS risks loss of significant additional 
royalties. If a threshold is too low, MMS risks spending more resources 
pursuing the matter than it will ultimately collect in additional 
royalties.
    While we agree with the use of thresholds, we were concerned that 
MMS had not documented its rationale or methodology for the thresholds 
that it had established. We found that the thresholds separately set by 
each of the program components differed significantly. For example, one 
component applied both a monthly and an annual limit, one component 
applied only an annual limit, and one component simply used 
``professional judgment'' on an individual case basis. While we 
understand that thresholds may differ among the components, MMS should 
document how each was derived and why it is reasonable for them to 
differ. We also concluded that the threshold at one component was set 
so high that significant underpaid royalties may not be collected. No 
matter how the thresholds are derived, MMS should have the methodology 
clearly documented in writing to provide uniform guidance to all of the 
components.
    In addition to costs and benefits, MMS should incorporate elements 
of risk into its establishment of thresholds. For example, if MMS has 
evidence that a company has underreported royalties in the past or has 
misreported information to other federal agencies, then MMS might lower 
the threshold for that company. A lower threshold might be warranted in 
this high risk situation because there is a greater likelihood of 
underreported royalties, a greater likelihood of additional 
collections, and the additional procedures could provide a deterrent 
for the company to underreport in the future.
    MMS agreed with our conclusion and has indicated that it will 
revise its thresholds for pursuing underpayments. As part of this 
process, it will incorporate an analysis of costs and benefits to 
determine at what level it makes sense to pursue an underpayment. MMS' 
action plan indicated that this will be accomplished by December 2007. 
As MMS addresses its data reliability issues, it will have better data 
on the costs and benefits of audits and compliance reviews. This data 
should allow MMS to periodically reassess its thresholds and make 
changes in the future as necessary. Additionally, since states and 
tribes participate in compliance activities and are affected by their 
outcome, MMS should consult with them in establishing future 
thresholds.
    Question 9. Qui Tam Cases--You noted in your audit that while MMS 
reported $699 million in collections from compliance activities from 
October 1999 to March 2006, about $134 million--or 19 percent of the 
total--actually resulted from qui tam royalty settlements, which were 
initiated when individual citizens file claims with the Department of 
Justice under the federal False Claims Act.
    Please elaborate on your rational for recommending that collections 
resulting from qui tam cases be excluded from MMS' calculation of 
revenues claimed by its compliance review program.
    Answer. Because collections resulting from Qui Tam cases do not 
originate from activity initiated by MMS' Compliance and Asset 
Management (CAM) Program, we believe that the inclusion of collections 
resulting from Qui Tams distorts the results of CAM's efforts.
    Qui Tam collections are a result of lawsuits filed by individuals 
on behalf of the government to collect underpayments. These are 
generally cases where an underpayment has been identified and pursued 
by someone outside of MMS. Collections from these Qui Tam lawsuits do 
not result directly from MMS' audits and compliance reviews and should 
therefore not be considered as part of the benefits of the program.
    MMS points out that, in some cases, it provides support for the Qui 
Tam lawsuits. While we agree and can support tracking of Qui Tam 
collections, we don't believe those collections should be included in 
the analysis of costs and benefits of the compliance program. 
Collections from Qui Tam lawsuits depend primarily on the number of Qui 
Tams that are filed and the time it takes for those lawsuits to be 
settled. Including those collections in the cost/benefit analysis skews 
the benefits of the program and makes it difficult to compare benefits 
of the program from one year to another. It also does not aid in 
developing strategies for conducting MMS' audits and compliance 
reviews.
    I understand you are continuing to investigate allegations 
surrounding the most recent batch of qui tam cases, filed by a group of 
current or former MMS auditors, Please give the Committee an idea about 
the scope and timeline of this ongoing investigation.
    Answer. The primary scope of our on-going investigation regarding 
the Qui Tams includes:

   Allegations raised by Relators,
   MMS response to allegations,
   Whether Relators followed DOI/MMS policy on disclosing 
        allegations,
   Did MMS retaliate in any manner against Relators.

    We have also received additional allegations from the Relators some 
of which will be incorporated into the current investigation; others 
may result in additional, separate investigations. The investigation is 
targeted to be complete by early spring.
              Responses to Questions From Senator Domenici
    Question 1. Attachment 56 of the Price Threshold Report of 
Investigation (the ``Report'') has a time line relating to 3/15/04, but 
the page 18 and 19 account of this event discussed within is far from 
definitive. Please provide the material that demonstrates the assertion 
made in the timeline.
    Answer. The timeline contains a typographical error. The entry 
referring to 3/15/04 states the following: ``Director of MMS makes 
formal decision that price thresholds will not apply to leases issued 
in 1998 & 1999.'' The entry should have stated, ``Directorate of MMS 
makes formal decision that price thresholds will not apply to leases 
issued in 1998 & 1999.'' (emphasis added)
    Question 2. Please clarify specifically who you are referring to in 
your testimony when you refer to a, ``cavalier attitude'' at MMS? Is 
this a reference to the current Director of MMS?
    Answer. When I referred to the ``cavalier attitude'' associated 
with the price threshold omission, I did not intend to disparage 
Johnnie Burton herself by my comments. In my testimony, both written 
and spoken, I was referring to virtually everyone involved in this 
debacle, to include Ms. Burton, but particularly those who in 2000 knew 
of the price threshold omission and failed to bring it to the 
Director's attention, as well as those who raised the issue in 2004 
through a series of e-mails and, apparently, through oral discourse 
which was referenced in the e-mails.
    While Johnnie Burton has told us that she has no independent 
recollection of being told about the issue in 2004, she readily 
conceded that the e-mails we presented to her suggested otherwise. She 
went on to speculate what her thinking may have been nearly 3 years 
ago. Neither I nor my investigators found reason to question Ms. 
Burton's veracity about this issue.
    I have known Johnnie Burton for nearly 5 years, and have found her 
to be forthright and responsible. She is one of the very few bureau 
directors in this Department who has made an effort to meet with me on 
a regular basis. She has also been, perhaps, the most responsive of the 
bureau directors to Office of Inspector General (OIG) findings and 
recommendations. I have never had a reason to question her integrity.
    Question 3. Please provide any conclusive evidence that the current 
Director of the Minerals Management Service (MMS) knew of the price 
threshold omissions of 1998/1999 in 2004? Do you feel that you should 
clarify the record to reflect that e-mails between and among MMS 
employees regarding this issue in 2004 did not include messages sent 
directly to the current Director?
    Answer. The only evidence we have to suggest that the current 
Director of MMS knew of the price threshold omissions in 2004 is the 
series of e-mails and personal recollections we identified in the 
report. None of these e-mails was sent directly to the current 
Director.
    Question 4. Upon all evidence available as to when the current MMS 
Director knew of the missing price thresholds, what specific legal 
steps could the Director have taken to include price thresholds in the 
1998 and 1999 leases?
    Answer. Recognizing that I am armed with the benefit of hindsight, 
I believe that Ms. Burton should have conducted a much more thorough 
vetting, including a formal documented decision, for an issue of such 
enormous financial magnitude, although the end result may have been the 
same in 2004 as today. The informal and cavalier manner in which this 
matter was communicated by career staff from MMS and the Solicitor's 
office, however, did not serve Ms. Burton--or the previous MMS 
Directors--well.
    Question 5. Please explain why the Report refers to certain 
individual Department of the Interior officials by name and position, 
while identifying other individuals by position only. Similarly, please 
explain why the Report does not identify by name political appointees 
serving at the Department of the Interior during the time of the issued 
leases which are the subject of the Report while identifying current 
political appointees by name.
    Answer. Two versions of the Report of Investigation were provided 
to the Committee--an unredacted version which contained the names of 
all individuals interviewed, as well as all attachments, and a redacted 
version which was prepared for public dissemination which did not 
include attachments or the names of certain individuals, including the 
former Directors of MMS. The practice of my office is to issue a public 
version of high-profile reports which protects the personal privacy 
interests of those individuals whose identity warrants protection 
pursuant to the balancing of personal privacy interest against public 
disclosure, as required by the Freedom of Information and Privacy Acts. 
In this case, we concluded that the identities of the former Directors 
who have since left public service and who were not advised of the 
omission during their tenure, should be protected. They are, however, 
identified by name in the unredacted version of the report that was 
provided only to the Department and the Committee.
    Question 6. In your testimony before the Committee, you stated 
that, ``there is blame enough to go around.'' However, would you 
acknowledge that the Report fails to determine who is ultimately 
responsible for omitting price thresholds on the leases issued in 1998 
and 1999 and who is responsible for the failure to address this issue 
when first discovered (as shown by the Report's evidence in 2000)?
    Answer. While I continue to believe that there is blame enough to 
go around, I agree that our investigation and the resulting report 
fails to identify precisely who was ultimately responsible for omitting 
price thresholds on the leases issued in 1998 and 1999. I believe our 
report does, however, identify the individual responsible for the 
decision not to address the discovery in 2000. Unfortunately, that 
person is deceased.
    Question 7. In your judgment, who told Mr. Rodi to omit price 
thresholds from the 1998 and 1999 leases in question? Why was Mr. Rodi 
given this directive?
    Answer. While I have no reason to believe that Mr. Rodi changed the 
language in the lease documents unilaterally, our investigation was 
unable to definitively discern who gave Mr. Rodi this direction. 
Because we could not identify precisely who gave this direction, 
however, and we could not find a paper trail to support this decision, 
we are left to speculate as to why.
    Question 8. In the Report, there are references to several 
interviews. Are these interviews transcribed? And, if so, is the record 
of these interviews made available? Are these interviews performed 
under oath?
    Answer. The interviews we conducted were neither transcribed nor 
performed under oath. Investigative Activity Reports documenting the 
interviews were included in the unredacted Report of Investigation as 
Attachments. In the case of four witnesses, we asked that they prepare 
written statements that they then signed under oath. These are also 
included as Attachments to the unredacted Report.
    Question 9. In as complete a manner as possible, please identify 
all employees of the Department of the Interior employed at any period 
of time between January 1993 and January 2007 who participated in any 
manner, (and specify the individual's title, office, role and level of 
participation) in the following:

   The drilling of the Deepwater Royalty Relief Act of 1995 
        (DWRRA).
   The consideration of the Statement of Administration 
        Position of the DWRRA.
   The consideration and/or drafting of any rules and/or 
        regulations implementing the DWRRA.
   The consideration, preparation and approval process of any 
        oil and gas leases issued between the years 1995 and 2001. 
        Please specify the leases and employees.
   The preparation for and participation in public meeting held 
        in Louisiana on March 12 and March 13, 1996 referenced on page 
        5 of the Report.
   The phone conversation and subsequent discussions relating 
        to the phone conversation involving Mr. John Rodi referenced on 
        page 7 and page 8 of your report.
   The 1998 APPL Committee meeting referenced on page 14 in 
        your report.
   The consideration and approval of all Proposed Notice of 
        Sales Final Notice of Sales from January 1, 1997 to January 1, 
        2001, including those individuals participating in the surname 
        process.
   The decision to exclude addenda incorporating royalty relief 
        restrictions in the first instance on 1998 leases referenced on 
        page 8 of the Report.
   The decision in the first instance to include an addendum on 
        leases issued in 2000.

    Answer. Much of the information requested here goes beyond the 
scope of our investigation. To the extent our investigation addressed 
these issues, they are contained in our report and the attachments. 
Most of this information could be best provided by MMS.
    Question 10. To the best of your knowledge, please identify all 
communications between the Office of Inspector General and the New York 
Times between January 1, 2007 and January 7, 2007.
    Answer. The Office of Inspector General had no communications with 
the New York Times between January 1, 2007 and January 7, 2007.
    Question 11. Under the byline dated January 16, 2007 Edmund Andrews 
of the New York Times wrote the following, in reference to MMS Director 
Johnnie Burton, ``A top official was told nearly three years ago about 
a legal blunder that allowed drilling companies to avoid billions of 
dollars in payments for oil and gas pumped from publicly owned waters, 
a report by the department's chief independent investigator has 
found.'' Is this statement accurate in its entirety? Is this statement 
an accurate reflection of your thoughts or the Report findings? If this 
statement is not accurate, please elaborate specifically on how it 
conflicts with the findings of the Report.
    Answer. The statement in the January 16, 2007 New York Times 
article was more conclusory than our report was. In this regard, I 
reiterate a portion of my response to question #2, above: While Johnnie 
Burton has told us that she has no independent recollection of being 
told about the issue in 2004, she readily conceded that the e-mails we 
presented to her suggested otherwise. She went on to speculate what her 
thinking may have been nearly 3 years ago. Neither I nor my 
investigators found reason to question Ms. Burton's veracity about this 
issue.
    Question 12. Please list the date that the Report was made 
available to the public?
    Answer. The redacted version of our report was made available to 
the public via the Office of Inspector General website 
contemporaneously with my testimony on January 18, 2007.
    Question 13. Please list all applicable federal statutes pertaining 
to the public availability of information in a Report of Investigation 
from the ice of Inspector General of the Department of the Interior.
    Answer. The Freedom of Information and Privacy Acts are the primary 
federal statutes guiding public availability of a Report of 
Investigation issued by the Office of Inspector General for the 
Department of the Interior. Additional statutes governing grand jury 
secrecy, confidential business information, and other privileges may 
also apply to our determination of the content of reports made 
available to the public.
    Question 14. Are you investigating how the New York Times reported 
on aspects of the content and substance of the Report prior to its 
receipt by the U.S. Senate Committee on Energy and Natural Resources 
and prior to its public release?
    Answer. The New York Times has reported on several issues being 
investigated by my office. Various articles have contained information 
that had not been publicly released at the time of publication. In one 
instance, we had provided limited information to the Department about 
the investigation, but had also conducted a considerable number of 
interviews. In regard to the Report of Investigation which we released 
publicly on the date of my testimony, we had provided copies of the 
report to the Department and the Committee 2 days prior. I do not know 
how the New York Times obtained the information that was published in 
the articles, in either instance, but the article referred to 
``sources'' that appear to have been disgruntled MMS employees. The OIG 
is not, however, conducting an investigation into these incidents.
    Question 15. Are you concerned that with the approximately 40 
stories published by the New York Times in just the past year on the 
issue of royalty relief, the release of privileged and confidential 
information prior to its public availability could prejudice the 
integrity of your investigations and the fairness of any potential 
civil or criminal litigation? What steps are you taking to avoid this? 
Could improvements be made with regard to this issue? If so, please 
specify.
    Answer. While I am concerned about information being reported 
prematurely in a national publication, I do not believe that any 
potential civil or criminal litigation has been compromised by the 
articles. Because I am obligated by the Inspector General Act of 1978, 
as amended, to inform the Secretary and Congress of problems and 
deficiencies related to the programs and operations of the Department, 
I cannot necessarily control the further dissemination of such 
information. To the extent that information I provide to the Secretary 
or Congress is privileged or confidential, I will always identify it as 
such and request that it be treated accordingly.
    Question 16. In Feb. 2001, the Associate Director of Offshore 
Minerals wrote, ``For Notices of Sales held in 1998 and 1999 the price 
trigger language was left out of the Notices and lease document. This 
was within the discretion of MMS and the Secretary.'' The Associate 
Director does not note that this was a ``mistake.'' Since your report 
does not determine who directed Mr. Rodi to modify these terms, in 
1998, or why they were modified, please provide specific evidence that 
allows you to conclude that this change was a ``mistake.''
    Answer. Several of the interviews included in the report identify 
statements of MMS employees indicating their belief that the omissions 
were the result of a mistake. Additionally, the e-mails included in the 
report indicate that the authors of the e-mails in 2000 (after 
discovery of the omissions) considered the omissions to be a mistake. 
Moreover, the action taken by MMS in 2000 after discovery of the 
omissions, to include the price thresholds in the leases for Sale 175, 
indicate that MMS was attempting to correct a mistake, rather than 
changing a conscious decision to not include them in 1998 and 1999.
    Ultimately, a distinction must be made between the intentional act 
by Mr. Rodi to include reference to regulations in the leases and the 
mistaken result, which was the omission of price thresholds.
    Question 17. Please reconcile seemingly conflicting findings on 
page 5 and 6 of the Report, which suggest that both thresholds on all 
deepwater leases issued between 1996 and 2000 was a Department of the 
Interior policy and that threshold language was affirmatively excluded 
from 30 CFR 260 because according to the Report, Mr. Cruickshank 
asserted that, ``MMS wishes to remain flexible in deciding whether the 
thresholds would apply on a sale-by-sale basis.''
    Answer. According to MMS Deputy Director Cruickshank, it was the 
policy of MMS to include the price thresholds in all of the leases 
issued between 1996 and 2000. Cruickshank also stated that MMS decided 
not to include price thresholds in 30 CFR 260 because MMS wished to 
retain flexibility in deciding ``whether the thresholds would apply on 
a sale-by-sale basis.'' These findings are not conflicting. MMS did in 
fact retain its flexibility in applying the thresholds because it 
theoretically could change its policy at any time not to include the 
price thresholds if they desired to do so, whereas, if the thresholds 
were placed in the regulation, MMS' flexibility in applying the 
thresholds would be greatly diminished since MMS could not readily 
change the regulation.
    Question 18. Please provide all evidence to support the contention 
that the inclusion of price thresholds on deepwater leases issued from 
1996 through 2000 was an Official policy of the Department of the 
Interior. Please specify in the evidence that you proffer, how one 
typically shows that a particular practice of the Department of the 
Interior is classified as Department policy.
    Answer. All evidence was included in our report. MMS record keeping 
on policy development and retention was found to be deficient and a 
major obstruction to our investigation. We relied upon interviews and 
e-mail reviews to corroborate statements that asserted it was MMS 
policy to include thresholds.
    Question 19. On page 5 of the Report, Mr. Cruickshank is reported 
to state that based upon Section 303 of the DWRRA, MMS made the policy 
decision in 1995 to apply price thresholds to all new leases issue 
under the Act. However, in February 1996, the MMS in its Advanced 
Notice of Proposed Rulemaking (as detailed on page 3-4 of the Report) 
asked for comments on whether price thresholds should apply to 
suspension volumes for new leases. How do you reconcile these 
inconsistencies?
    Answer. The PowerPoint presentation that occurred on March 12-13, 
1996, which is the only documentation we identified indicating MMS' 
intention to apply price thresholds to upcoming sales, occurred prior 
to MMS receiving responses to the ANPR. We can not explain the rational 
behind the ANPR question. This would be better answered by MMS.
    Question 20. On page 6 of the Report, Mr. Mason is quoted as 
testifying on June 21, 2006 to the House Subcommittee that, ``most of 
my legal advise is oral.'' Please provide evidence beyond this 
testimony that shows that it was the practice of the Office of the 
Solicitor during the time of the issuance of leases in question to 
render advice on matters of such significance as the applicability of 
price thresholds on oil and gas leases in oral rather than in written 
form, through memos or opinions.
    Answer. The OIG has, through various audits and investigations, 
identified multiple instances in which the Office of the Solicitor 
renders legal advice in oral or summary check-list form, rather than in 
formal written form through memoranda or opinions. We have shared our 
concern about this practice with the Solicitor who has said he is 
taking corrective action.
    Question 21. In your investigation, did you find any written advice 
or opinion from the Office of the Solicitor during the time of the 
issuance of the leases in question bearing on the question of whether 
to include price thresholds in either leases or by regulation? If so, 
please provide that information to the fullest extent possible and 
available.
    Answer. We did not find any such written advice or opinion.
    Question 22. Please comment specifically on the kind of flexibility 
pursuant to the DWRRA that the Secretary of the Interior is given in 
choosing to omit price thresholds from regulation and instead apply 
such thresholds on a lease-by-lease basis.
    Answer. We did not analyze the authority of the Secretary under 
DWRRA as a part of our investigation. We relied on the information 
provided by witnesses as to MMS' interpretation of this authority.
    Question 23. How many leases did the Department of the Interior 
issue in 1998 and 1999 pursuant to the DWRRA? Now many of the leases 
contained thresholds? How many of these leases are still active at 
present? Please explain with specificity the status of all of the 
leases that are not active.
    Answer. According to information supplied to us by MMS, 1032 leases 
were issued in 1998 and 1999 and 570 remain active, and none of the 
leases contain thresholds. MMS would be better situated to explain the 
status of all of the leases that are not active.
    Question 24. With respect to royalty collections, are their (sic) 
compliance review practices employed by the private sector and other 
federal agencies that you believe should be adopted by the MMS? If so, 
which?
    Answer. We determined that MMS could benefit from adopting 
practices similar to the Internal Revenue Service (IRS). IRS has a 
similar mission to collect monies that are due to the federal 
government. In addition to audits, IRS extensively uses automated 
procedures to analyze tax returns and identify potential errors or 
irregularities. These procedures can identify discrepancies within the 
tax returns that are potential errors to be corrected. Additionally, 
the procedures can match information submitted by the taxpayer with 
related information submitted by other parties, such as the taxpayer's 
employer.
    MMS would benefit by implementing similar automated procedures. 
These automated procedures could identify discrepancies in the 
information provided by companies reporting both production and royalty 
information. MMS could also match data provided by companies to other 
independent sources, such as the Bureau of Land Management's inspection 
data.
    We also believe that MMS would benefit by adopting some of the 
performance measurement practices of the IRS. MMS should consider 
additional performance measures and goals to assess the efficiency of 
its operations. The IRS has multiple measures related to processing tax 
returns and resolving compliance issues, which help evaluate the 
efficiency of its operations. 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.
    We did not identify any private sector practices that we recommend 
MMS adopt.
    Question 25. Do you believe that the MMS should continue to 
undertake audits and compliance reviews? If not, which entity should be 
responsible for these activities?
    Answer. Having the royalty audit function in MMS creates the 
potential for a conflict of interest, either in fact, or at minimum, in 
appearance. Audit organizations have a responsibility to maintain 
independence so that their opinions, conclusions, judgments and 
recommendations will be impartial and will be viewed as impartial by 
knowledgeable third parties. Royalty audits require auditors to 
independently assess the accuracy of royalty information reported by 
companies to MMS. Reasonable questions can arise about independence 
when the auditors are within MMS, the organization whose primary 
mission includes collecting, accounting for and distributing royalty 
revenues.
    In addition to its fiduciary role over royalties, MMS also 
establishes and enforces applicable regulations and negotiates leases 
with the companies extracting minerals. It can be difficult for third 
parties to consider MMS auditors as independent when MMS is party to 
the leases under review. Whether or not the perception of 
``friendliness to industry'' is accurate, the current positioning of 
the audit organization within MMS lends credence to the ability of MMS 
to use the audit function to push an agenda.
    The Office of Inspector General (OIG) may be better suited to 
manage the royalty audit function because of its status as an 
independent audit and investigative organization. The Inspector General 
Act of 1978 establishes the independence of the Inspector General by 
removing the inherent conflict of interest that exists when audit and 
investigative functions are under the authority of the program being 
reviewed. This independence is brought about by the fact that the 
Inspector General, by law, reports to both the Secretary of the 
Department and the Congress. Moving the function from MMS to OIG would 
sever the relationship between audits and the programmatic functions of 
managing leases and collecting, accounting for, and distributing 
royalty revenues. The Department would be less prone to criticism 
concerning its compliance program, because audits would be conducted by 
the organization responsible for auditing the Department.
    Question 26. Do you believe you should have a permanent role in 
overseeing MMS' audit and compliance activities?
    Answer. I believe that the GIG already has a permanent role in 
overseeing MMS' audit and compliance review activities, as long as MMS 
is a part of the Department of the Interior.
    Question 27. Do you believe that additional funding is required in 
order for MMS to adopt the recommendations contained in the Compliance 
Review Report? If yes, what do you believe would he an adequate amount?
    Answer. This question would be better addressed by MMS, which could 
better assess the amount of resources it needs to implement its action 
plan. In our opinion, it is possible that MMS may need some additional 
resources on a temporary basis for initial implementation of our 
recommendations. Once the recommendations are implemented, however, we 
do not believe that there would be an ongoing need for additional 
resources to maintain the new processes. For example, addressing data 
reliability will require a significant one-time effort to evaluate and 
correct existing data in MMS' systems and to develop new procedures to 
ensure the reliability of future data entered into the systems. This 
one-time project may require significant resources or the redirecting 
of current resources from other activities such as current audits and 
compliance reviews. Once MMS implements new procedures for ensuring 
reliable data, the need for additional resources would diminish. MMS 
should make a determination of whether additional resources are 
necessary.
    Question 28. If additional funding for MMS is required for proper 
royalty collection, for what purposes should it be appropriated? To 
hire additional employees? To improve information technology?
    Answer. In our opinion any additional funding in the near future 
should be limited to those resources needed to implement the 
recommendations in our report. For example, implementing the 
recommendation designed to address data reliability issues may require 
additional IT resources and expertise. Or MMS may need additional 
resources to research and resolve the backlog of data needed to update 
the system. Additional resources may also be required to implement the 
recommendations aimed at strengthening the compliance review process by 
increasing data testing. MMS should determine whether it needs 
additional near term resources to meet the milestones set in its action 
plan to implement the recommendations.
    Currently, MMS does not have the data that would be needed to 
develop a cost/benefit analysis to support a general increase in 
funding for compliance operations. In our opinion, MMS should first 
address the data reliability issues, improve its compliance review 
procedures, and develop performance measures that better reflect its 
operations, before expanding its program. Once those tasks are 
accomplished, then an evaluation could be performed to determine the 
optimal amount of funding that would ensure MMS effectively completes 
its mission.
    Any additional funding that is provided should be specifically 
directed to the Compliance and Asset Management Program to ensure that 
the funds are solely used to improve the royalty compliance process. 
Additional funding could be used by MMS in the future to increase the 
number of companies subjected to compliance reviews and/or audits, 
perhaps increasing the identification of underreported royalties.
    Question 29. It is my understanding that you are preparing a report 
on pending Qui Tam suits in which four government auditors allege that 
lessee companies failed to pay adequate royalties. When do you 
anticipate that this report will be completed?
    Answer. My investigative staff is working diligently to conclude 
the investigation related to the Qui Tam suits as expeditiously as 
possible. Given the recent verdict in the Qui Tam case against Kerr-
McGee, however, we must evaluate the impact that the verdict might have 
on our pending investigation which will undoubtedly extend the time it 
takes for us to conclude the matter. In addition, we have received 
additional allegations from the Relators, some of which will be 
incorporated into the current investigation; others may result in 
additional, separate investigations. The pending investigation is 
targeted to be complete by early spring.
    Question 30. Can you assure this Committee that the privileged and 
confidential nature of the information of this investigation regarding 
the Qui Tam suits will be protected vigorously by the Office of 
Inspector General and that information related to this investigation 
will be provided to the public in a manner consistent with all 
applicable Federal laws?
    Answer. Yes. The OIG takes seriously its obligation to protect any 
privileged and confidential information that becomes the subject of an 
investigation or audit. We also take seriously our obligation to inform 
the Secretary, the Congress and the public of the results of our audits 
and investigations, in keeping with applicable laws and regulations. In 
this regard, the general practice of the OIG is to provide a limited 
number of unredacted reports to the Secretary, and to the Congress, 
when we receive a written request from the Chair of a Committee or 
Subcommittee. The OIG must rely on the Secretary and Congress to assist 
in protecting such information when it is disclosed in such a limited 
way.
    The OIG also goes to great lengths to issue a reader-friendly, 
public version of high-profile reports which protect privileged and 
confidential information as well as the personal privacy interests of 
those individuals whose identity warrants protection pursuant to the 
balancing of personal privacy interest against public disclosure, 
required by the Freedom of Information and Privacy Acts.
    Question 31. Between 1998 and 2001, the Justice Department settled 
16 Qui Tam lawsuits for nearly $440 million. The suits alleged that 
between 1980 and 1998, lessee companies underpaid on royalty 
obligations. What new regulations, if any, were promulgated by the 
Department of the Interior as a result of these lawsuits?
    Answer. This was beyond the scope of our investigation. We believe 
that this question would be best answered by MMS.
    Question 32. Please comment on the duties and responsibilities of 
the MMS as well as the duties and responsibilities of lessees to oil 
and gas leases on federal lands as it currently exists pursuant to the 
Federal Oil and Gas Royalty Management Act or 1982 and amendments to 
that Act, as well as all other relevant Federal law. And, do you think 
these duties and responsibilities ensure fairness and accuracy in the 
process of royalty valuation and collection?
    Answer. The MMS is responsible for Outer Continental Shelf leasing 
and monitoring activities as well as for collecting, accounting for, 
and distributing royalties paid by companies that extract oil, gas, and 
other minerals from leased federal and Indian properties. Lessees are 
responsible for accurately reporting and paying royalties from leased 
federal and Indian properties. The applicable royalty and leasing laws 
include the Allotted Indian Land Leasing Act of 1909, as amended; the 
Mineral Leasing Act of 1920, as amended; the Indian Mineral Leasing Act 
of 1938; the Minerals Leasing Act for Acquired Lands of 1947, as 
amended; the Outer Continental Shelf Lands Act of 1953, as amended; the 
Geothermal Steam Act of 1970; the Combined Hydrocarbon Leasing Act of 
1981; the Indian Mineral Development Act of 1982; the Federal Oil and 
Gas Royalty Management Act of 1982; the Federal Oil and Gas Leasing 
Reform Act of 1987; the Federal Oil and Gas Royalty Simplification and 
Fairness Act of 1996; and the Deep Water Royalty Relief Act.
    The royalty monitoring process is complicated due to the large 
number of leases, differences in lease terms, and various valuation 
issues. Royalty valuation has been a contentious issue since at least 
the early 1980s. MMS has made efforts to improve valuation guidance and 
has issued revised guidance on both Federal Oil and Gas regulations as 
well as Indian Gas regulations. MMS has worked to keep those 
regulations up-to-date by amending them as appropriate.
    Our December 2006 audit report concluded that compliance reviews 
can serve a useful role as part of MMS' Compliance and Asset Management 
Program. 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. We believe that 
implementation of the report's recommendations should improve the 
accuracy of royalty collections.
               Responses to Questions From Senator Thomas
    Question 1. Can you provide me with the following lists of Interior 
Department Officials? Please indicate their tenure at the Department of 
the Interior and whether or not they are still working for the federal 
government in any capacity? I would like to know:
    Who at the Department of the Interior was involved in the issuance 
of offshore oil and gas leases in the 1998 to 1999 time frame.
    Who at the Department of the Interior was involved in the drafting 
of the Deep Water Royalty Relief Act of 1995.
    Who at the Department of the Interior was responsible for including 
price thresholds in leases issued during 1998 and 1999.
    Answer. Our investigation focused on how and why price thresholds 
were not included in the 1998 and 1999 leases, and what the 
Department's response was once the omission was discovered. In our 
Report of Investigation, we have identified everyone that we were able 
to determine may have been involved in either of these two aspects. We 
did not endeavor to discern who, if anyone, at the Department was 
involved in the drafting of the Deep Water Royalty Relief Act of 1995.
    Question 2. You have shared in testimony before the House and 
Senate your assessment of the way in which Johnnie Burton initially 
handled finding out about the omission of price thresholds in the 1998 
and 1999 leases. Assuming the Solicitor's opinion that there was no 
legal option at Director Burton's disposal to recover lost revenues is 
accurate and would have remained so regardless of how public those 
deliberations were, do you care to elaborate on the way in which 
Director Burton has subsequently handled the effort to fix this 
problem?
    Answer. I commend the efforts of Director Burton, Assistant 
Secretary Allred and the Office of the Solicitor to seek voluntary re-
negotiation of the leases by the lessee oil companies. I believe that 
they are now exploring all possible avenues to ameliorate this problem.
                                 ______
                                 
                  Government Accountability Office,
                         Natural Resources and Environment,
                                  Washington, DC, February 6, 2007.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate.
Hon. Pete Domenici,
Ranking Minority Member, Committee on Energy and Natural Resources, 
        U.S. Senate.
Hon. Jeff Sessions,
U.S. Senate.
    This letter acknowledges the questions you submitted concerning our 
testimony on oil and gas royalty management before the Senate Committee 
on Energy and Natural Resources on January 18, 2007. Please see the 
enclosure for our responses.

                                          Mark E. Gaffigan,
                                                   Acting Director.
[Enclosure.]
              Responses to Questions From Senator Bingaman
    Question 1. Royalty Rates--Chairman Rahall and I asked you to look 
at whether the royalty rates being charged for the production of oil 
and gas by the Department are commensurate with rates charged by states 
on state land and by private landowners on their lands. Can you share 
your findings to date with us?
    Answer. We are currently in the process of evaluating and comparing 
the federal government's royalty rates to those of Alaska, Colorado, 
Louisiana, Montana, New Mexico, Texas, Utah, and Wyoming as well as 
private landowners, where possible. As part of this study for you and 
Representative Rahall, we are also considering other contract terms 
that may impact the royalty rates charged, including factors such as 
bonus bids and rental fees. We plan to share our preliminary findings 
with your offices in February 2007.
    Question 2. Price Assumptions--Your testimony indicates that 
precise estimates of the revenues forgone to the Treasury remain 
elusive. However, MMS has indicated that the price threshold issue may 
result in up to $10 billion in forgone revenues over 25 years and that 
the Kerr McGee (Anadarko) litigation puts $60 billion at risk. What are 
the price assumptions underlying these estimates?
    Answer. It is our understanding that MMS estimates assumed prices 
from January 2005 onwards of $45 per barrel of oil and $5.63 per 
million cubic feet of gas adjusted by an annual inflation rate of 2.1 
percent.
    Question 3. Ongoing Work--Can you please describe GAO's ongoing 
work with respect to oil and gas royalties and provide us with a 
timeline for completion of the work?
    Answer. We currently have three engagements underway in response to 
congressional requests about oil and gas royalties. The first 
engagement is reviewing the laws and regulations for the offshore 
royalty relief program and estimating the fiscal impact of royalty 
relief on leases issued under the Outer Continental Shelf Deep Water 
Royalty Relief Act and other authorities. The second engagement 
currently focuses on two major blocks of work (1) comparing federal oil 
and natural gas royalty rates, as well as other contract terms, with 
state and private royalty rates and terms; and (2) describing statutory 
and regulatory ``diligent development'' requirements for federal lands. 
We plan to discuss the timeline for the completion of both of these 
assignments with your staff in February in order to attempt to best 
meet the needs of the Committee. The third engagement, which will be 
staffed in February, will analyze the accuracy of royalties collected 
on oil, condensate, and natural gas produced under leases of federal 
and Indian lands. A timeframe for this work has not yet been agreed 
upon with the requesting members' offices.
              Responses to Questions From Senator Domenici
    Question 1. In your testimony, you state that the failure to 
include thresholds in the 1998 and 1999 leases could cost up to $10 
billion in forgone royalty revenue. How did you arrive at this 
estimate? How does this estimate change by the fact that six of the 
company lessees have come forward and renegotiated these leases?
    Answer. The estimate of $10 billion in foregone royalty revenues, 
resulting from the failure to include price thresholds in the 1998 and 
1999 leases, was developed by the Minerals Management Service (MMS). 
GAO has not yet completed an independent assessment of these foregone 
royalties. Further, the scope of our ongoing work does not include an 
assessment of how the ongoing negotiations between MMS and the six 
companies will affect estimates of foregone royalty revenues.
    Question 2. How did you arrive at your estimate to the potential 
cost to the Federal Treasury with respect to the possibility of an 
unfavorable outcome for the United States in the Kerr McGee lawsuit, 
referenced in page 7 of your testimony as Kerr-McGee (Anadarko) suit 3/
17/06, W Dist. LA, CV06-0439LC? Was this MMS estimate of $60 billion 
referenced on page 7 of your testimony ever published by MMS? Please 
state what the GAO estimate is at present?
    Answer. MMS developed the $60 billion estimate in foregone royalty 
revenues should the Kerr-McGee (Anadarko) lawsuit result in an 
unfavorable outcome for the United States--whereby MMS could not 
enforce price thresholds on any of the leases issued under the Deep 
Water Royalty Relief Act of 1995 for the period 1996-2000. As noted 
above, GAO's assessment of MMS' estimates is ongoing. To our knowledge, 
this MMS estimate was not published.
    Question 3. In the introductory page of your written testimony 
dated January 18, 2007, you state that, ``at least (emphasis added) $1 
billion [of which] has already been lost'' because of the failure to 
include price thresholds on the 1998 and 1999 leases. On page 3 of your 
statement you state that, ``about (emphasis added) $1 billion has 
already been lost. Can you provide a precise amount of royalty revenue 
that has been lost? Please comment on the accuracy of your estimate, 
describe how you arrived at this estimate and comment on whether this 
is consistent with the Department of the Interior's estimate of 
revenues lost thus far.
    Answer. Because GAO's work is still ongoing, we do not have a 
precise estimate of the foregone royalty revenue resulting from the 
lack of price thresholds in 1998 and 1999 leases. Our reference of $1 
billion refers to an analysis performed by MMS, which showed forgone 
royalty revenue of slightly greater than $1 billion.
    Question 4. In the introductory page of your written testimony, you 
state that, ``In October 2004, MMS estimated that foregone royalties on 
deep water leases issued under act from 1996 through 2000 could be as 
high as $80 billion.'' Please specify who at MMS made this estimate and 
whether this estimate was ever published in any form. Please also 
comment on whether the Director of MMS made or was aware of this 
estimate.
    Answer. The Economics Division of MMS, located in Herndon, 
Virginia, prepared this estimate. The $80 billion estimate is the 
combination of potential foregone royalties from: (1) litigation that 
overturned MMS's application of royalty suspension volumes on a field 
basis ($10 billion); (2) MMS's failure to include price thresholds in 
the 1998 and 1999 leases ($10 billion); and (3) MMS potentially losing 
Kerr McGee's (Anadarko's) legal challenge to the application of price 
thresholds for 1996, 1997, and 2000 leases ($60 billion). We are not 
aware of whether this estimate was published, nor do we know whether 
the Director of MMS was made aware of this estimate.
    Question 5. You state on page 2 of your testimony that the GAO is 
reviewing appropriate portions of the Energy Policy Act of 2005 
(EPAct). Can you please specifically identify the sections that contain 
oil and gas royalty relief provisions and of those sections, please 
identify those that do not allow for the application of price 
thresholds. Additionally, please identify those sections in which 
leases issued pursuant contain price thresholds and those which do not.
    Answer. As stated in our testimony, the sections of the Energy 
Policy Act of 2005 that contain oil and gas royalty relief provisions 
include Sections 344, 345, 346, and 347. For these sections, the Act 
provides the authority to the Secretary of Interior to place 
limitations on royalty relief based on market prices.
    Question 6. On page 6 of your testimony, you state that the Santa 
Fe Snyder decision cost the federal government up to $10 billion in 
foregone future royalty revenue. Would it be more accurate, in fact, to 
state that the Fifth Circuit Court of Appeals affirmed Federal District 
Court's holding that the Department of the Interior was in fact 
implementing royalty relief in a manner contrary to the intent of the 
Deepwater Royalty Relief Act? Would it be more accurate to state that 
the Department of the Interior's decision in the 1990's to apply this 
royalty relief on a field basis was contrary to the law?
    Answer. GAO's work examines the fiscal impacts of royalty relief on 
leases issued under the Outer Continental Shelf Deep Water Royalty 
Relief Act of 1995. Specifically, GAO is reviewing the revenue that the 
government would have collected but for the Act, which in our 
testimony, we referred to as ``forgone'' or ``lost'' revenue. The 
Court's interpretation of the Act in the Santa Fe Snyder decision, that 
the royalty relief in question must be implemented on a lease basis, 
resulted in an increase in the dollar amount of forgone revenue under 
the Act, as compared to the dollar amount based on MMS's field basis 
interpretation. As we noted in our testimony, MMS estimates that the 
decision increased future forgone royalty revenues under the Act by up 
to $10 billion. Whether MMS's initial determination to apply the relief 
on a field basis was contrary to law, was not relevant to our estimate 
of revenue forgone under the Act.
    Question 7. How many leases did the Department of the Interior 
issue in 1998 and 1999 pursuant to the Deepwater Relief Act? How many 
of the leases contained thresholds? How many of these leases are still 
active at present? Please explain with specificity the status of all of 
the leases that are not active.
    Answer. According to data provided by MMS, 1,032 leases were issued 
in the Gulf of Mexico in 1998 and 1999, none of which included price 
thresholds. As of December 31, 2006, 574 of the 1998 and 1999 leases 
were still active. GAO does not have detailed information on the 
remaining 458 leases.
    Question 8. On page 8 of your written testimony, you state that, 
``to fully evaluate the impacts of royalty relief one must consider the 
potential benefits in addition to the costs of lost royalty revenue.'' 
Why was such an evaluation and assessment not made?
    Answer. A number of Congressional members asked GAO to examine the 
costs of royalty relief--in light of rapidly rising oil and gas prices 
and press reports and questions by other interested parties as to 
whether the oil and gas industry was paying its fair share of 
royalties--not the benefits. However, as GAO indicated in its 
testimony, benefits are an important part of an overall assessment of 
royalty relief. These benefits may include increased bonus bids, 
greater production, and increased oil and gas exploration, among other 
things. We are in the process of identifying studies that attempt to 
analyze the benefits of royalty relief.
    Question 9. Please elaborate more fully on your statement on page 9 
of your written testimony, ``However questions remain about the extent 
to which such benefits would offset the cost of lost royalty 
revenues.'' Should such ``benefits'' factor into estimates of lost 
revenue?
    Answer. The potential benefits of royalty relief should be netted 
out of the foregone revenue associated with royalty relief to get a 
full accounting of the costs and benefits of the relief. These benefits 
include potentially higher bonus bids on leases as well as any 
associated benefits that accrue as a result of an increase in oil 
production that would otherwise not have occurred.
    Question 10. The estimates from GAO fail to take into account 
potential increased production (and thus increased royalties) as a 
result of providing royalty relief. Does the GAO similarly fail to 
estimate the economic impact that increased domestic production has on 
a reduction in our nation's trade deficit in providing economic 
analysis of the impacts of royalty relief?
    Answer. To our knowledge, no full cost-benefit study of the Outer 
Continental Shelf Deep Water Royalty Relief Act of 1995 has been 
conducted. Such a complete study would be very difficult to achieve 
with any assurance of accuracy because (1) the final costs depend on 
future oil production and future oil prices and these are difficult to 
predict, and (2) estimating the benefits depend on determining how much 
of the oil production that will occur is the result of, rather than 
simply coincident with, royalty relief. Because oil prices are much 
higher now than in 1995, when the royalty relief act was passed, the 
expected costs of the relief have gone up considerably. In addition, 
such higher oil prices would likely have led to greater oil exploration 
and development in the deep water regions of the Gulf of Mexico, even 
in the absence of royalty relief. These changing conditions are 
indicative of the difficulty in estimating the full costs and benefits 
of royalty relief.
              Responses to Questions From Senator Sessions
    Question 4. Based on your understanding of the Energy Security Act 
of 2005 (``Act'') (Public Law No. 109432), and assuming that no further 
negotiations are successful in including price thresholds in existing 
leases, what is the actual impact, in dollar terms, of the exclusion of 
price thresholds in the leases in question on the amount of royalty 
revenue that is shared with producing states under the revenue-sharing 
provisions of the Act during the next ten years? What is your estimate 
of the impact on the revenue shared with the state of Alabama, 
specifically?
    Answer. The scope of GAO's work to date has not included the 
estimated fiscal impacts of the revenue-sharing portions of Gulf of 
Mexico Energy Security Act of 2006 on producing states. We are unaware 
of any estimate having been completed on this issue.
    Question 5. Based on your understanding of the Energy Security Act 
of 2005 (``Act'') (Public Law No. 109-432), and assuming that no 
further negotiations are successful in including price thresholds in 
existing leases, what is the actual impact, in dollar terms, of the 
exclusion of price thresholds in the leases in question on the amount 
of royalty revenue that is shared with producing states under the 
revenue-sharing provision of the Act in the years between 2017 and the 
expiration of any then existing leases? What is your estimate of the 
impact on the revenue. shared with the state of Alabama, specifically?
    Answer. The scope of GAO's work to date has not included the 
estimated fiscal impacts of the revenue-sharing portions of Gulf of 
Mexico Energy Security Act of 2006 on producing states. We are unaware 
of any estimate having been completed on this issue.

                                    

      
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