DRAFT 

 

GAO-08-792R Royalty Relief 

United States Government Accountability Office

Washington, DC 20548 

June 5, 2008 

Congressional Requesters 

Subject: Oil and Gas Royalties: Litigation over Royalty Relief Could Cost the 

Federal Government Billions of Dollars 

Oil and gas production from federal lands and waters is critical to meeting the 

nation’s energy needs. This production provided about 31 percent of all oil and 29 

percent of all natural gas produced in the United States in fiscal year 2007. Every five 

years, the federal government decides the areas in the offshore waters of the United 

States it will offer for leasing and establishes a schedule for individual lease sales. 

The Department of the Interior’s Minerals Management Service (MMS) has conducted 

these sales at least once per year for at least the past 30 years. During the sales, oil 

and gas companies bid for the rights to explore and develop the oil and gas resources 

on these leases and also agree to pay the federal government royalties on the 

resources produced. 

In 1995, a time when oil and natural gas prices were significantly lower than they are 

today, Congress passed the Outer Continental Shelf Deep Water Royalty Relief Act 

(DWRRA), which authorized MMS to provide “royalty relief” on oil and gas produced 

in the deep waters of the Gulf of Mexico from certain leases issued from 1996 through 

2000.1

 This “royalty relief” waived or reduced the amount of royalties that companies 

would otherwise be obligated to pay on the initial volumes of production from leases, 

which are referred to as “royalty suspension volumes.” 2 The DWRRA also authorized 

the Secretary of the Interior to provide royalty relief to promote oil and gas 

development or to increase production from leases in the Gulf of Mexico. 

In implementing the DWRRA for leases sold in 1996, 1997, and 2000, MMS specified 

that royalty relief would be applicable only if oil and gas prices were below certain 

levels, known as “price thresholds,” with the intention of protecting the government’s 

royalty interests if oil and gas prices increased significantly. MMS did not include 

these same price thresholds for leases it issued in 1998 and 1999, and this action 

raised Congressional concerns that the federal government would lose billions of 

 1

These leases are covered under Section 304 of the act, which applies to leases issued between 

November 28, 1995 and November 28, 2000. However, since no leases were issued in 1995, we refer to 

these leases as DWRRA leases issued from 1996 through 2000. 

2

Royalty suspension volumes establish cumulative production volumes above which royalty relief no 

longer applies. Royalty suspension volumes vary according to depth, ranging from a minimum of 17.5 

million barrels of oil equivalent in water depths of 200 to 400 meters to a minimum of 87.5 million 

barrels of oil equivalent in water depths greater than 800 meters. 
Page 2 GAO-08-792R Royalty Relief 

 

dollars in forgone revenues.3 In addition, the Kerr-McGee Corporation—which was 

active in the Gulf of Mexico and is now owned by Anadarko Petroleum Corporation—

filed suit challenging the Department of the Interior’s authority to include price 

thresholds in DWRRA leases issued from 1996 through 2000. Recently, the U.S. 

District Court for the Western District of Louisiana granted summary judgment in 

favor of Kerr-McGee concerning the application of price thresholds to those leases.4

 

The court held that the DWRRA did not provide MMS with the authority to impose 

price thresholds on production below the royalty suspension volumes for leases 

issued under the DWRRA from 1996 through 2000. Interior officials disagree with the 

court’s decision, and in December 2007 the Department of Justice filed notice to 

appeal this decision. In response to the possible loss of future royalty revenues on 

these leases, Congress has been considering legislative action. 

We reported in April 2007 that MMS’s failure to include price thresholds on leases 

issued in 1998 and 1999 under the DWRRA would likely cost the federal government 

billions of dollars in forgone royalties, but precise costs were impossible to determine 

because of uncertain future prices and production levels.5

 However, we developed a 

number of scenarios to illustrate how different prices and production levels will 

influence these costs. We determined that, in addition to the $1 billion that had 

already been forgone, future costs could range between $4.3 billion and $10.5 billion 

over about 25 years, depending on the future prices of gas and oil and the volumes 

produced on these leases. MMS also estimated that the Department of the Interior 

faced losing an additional $60 billion in forgone royalties if it lost legal challenges to 

its application of price thresholds in all the DWRRA leases issued in 1996, 1997, and 

2000. We noted, however, that MMS made this estimate in October 2004 and that this 

estimate may have included overly optimistic assumptions about the amount of oil 

and gas production that could occur over the lifetime of the leases. In light of the 

recent rise of oil prices to more than $100 per barrel and natural gas to $8 per 

thousand cubic feet and the recent judgment against MMS-imposed price thresholds, 

you asked us to: (1) update our scenario that illustrates the potential loss of royalties 

because of the absence of price thresholds in leases issued in 1998 and 1999 and (2) 

provide an update of the possible consequences of Kerr-McGee’s legal challenge on 

royalties already collected and evaluate the potential for additional forgone royalties 

if price thresholds no longer apply to future production from the 1996, 1997, and 2000 

DWRRA leases. 

To update our scenario illustrating the potential loss of royalties from leases issued in 

1998 and 1999, we increased the upper bounds of oil and gas prices to $100 per barrel 

3

By forgone royalties, we mean royalties that would be payable if Congress had not authorized royalty 

relief under the DWRRA. 

4

Kerr-McGee Oil and Gas Corp. v. Allred, No. 2: 06-CV-0439, 2007 U.S. Dist., Lexis 83424 (W.D. La. 

Oct. 18, 2007). 

5

GAO, Oil and Gas Royalties: Royalty Relief Will Cost the Government Billions of Dollars but 

Uncertainty Over Future Energy Prices and Production Levels Make Precise Estimates Impossible 

at this Time, GAO-07-590R (Washington, D.C.: Apr. 12, 2007). 
Page 3 GAO-08-792R Royalty Relief 

and $8 per thousand cubic feet, respectively, well above the levels of our high-price 

scenario in the April 2007 report. We did not, however, revise our lower bounds for 

prices. To update the consequence of the Kerr-McGee challenge to royalties already 

collected, we interviewed MMS officials, reviewed legal documents, and reviewed 

MMS’s estimate on royalties paid to date. To evaluate the potential for forgone 

royalties on future production from the 1996, 1997, and 2000 leases, we reviewed 

estimates made by MMS in October 2004 and its more recent estimates released in 

February 2008. Specifically, we reviewed the methodology and assumptions MMS 

used to estimate the amount of future oil and natural gas production from DWRRA 

leases. To assess the likelihood of future oil and gas discoveries on DWRRA leases, 

we reviewed statistical data on field sizes, discovery success rates, and the 

availability of drilling rigs in the deep waters of the Gulf of Mexico. We determined 

that the data were sufficiently reliable for the purposes of this report. We also 

developed a series of scenarios to illustrate the uncertainty of prices and future 

production and their effect on the amount of future forgone royalties. A more 

detailed description of our scope and methodology is provided in enclosure 1. We 

conducted our review primarily from November 2007 through April 2008 in 

accordance with generally accepted government auditing standards. These standards 

require that we plan and perform the audit to obtain sufficient, appropriate evidence 

to provide a reasonable basis for our findings and conclusions based on our audit 

objectives. We believe the evidence we obtained provides a reasonable basis for our 

findings and conclusions based on our audit objectives. 

Summary 

Regarding the 1998 and 1999 leases, which included no price thresholds, the cost to 

the federal government could be significantly more than the upper bound we 

reported in April 2007 if higher oil and natural gas prices are sustained over the lives 

of these leases. In April 2007, we developed scenarios that illustrated the federal 

government could sustain losses of between $4.3 billion and $10.5 billion, depending 

on production levels and oil and gas prices over about the next 25 years. Assuming 

similar oil production levels but higher oil and natural gas prices of $100 per barrel 

and $8 per thousand cubic feet, respectively—prices that are closer to current prices 

than the maximum prices used in our 2007 scenarios—the upper bound of these 

scenarios could climb to as high as $14.7 billion, a 40 percent increase. There are no 

guarantees, however, about what future prices will be. For example, oil prices have 

topped $130 per barrel since we did the analysis for this report, but it is also possible 

that prices could fall below our lower price assumptions. Thus, these scenarios 

should not be viewed as probabilistic estimates of what actual forgone royalties will 

be, or even firm boundaries within which forgone royalties will fall. Rather, the 

scenarios reflect reasonable possibilities based on recent experience and possible 

future prices. 

With regard to the 1996, 1997, and 2000 leases, because the U.S. District Court for the 

Western District of Louisiana ruled in October 2007 that price thresholds do not apply 

to DWRRA leases, the federal government may have to refund over $1.13 billion in 

royalties that have already been collected from DWRRA leases issued in 1996, 1997, 
Page 4 GAO-08-792R Royalty Relief 

 

and 2000, if the government loses on appeal. The government also faces forgoing 

additional royalty revenues, which will likely be in the billions of dollars, on future 

production from these leases. We developed a number of scenarios that illustrate the 

magnitude of possible forgone royalties at different price levels. For example, our 

scenarios ranged from $15.1 billion of lost revenue for a low production scenario with 

$70 per barrel of oil and $6.50 per thousand cubic feet of gas to as high as $38.3 

billion for high production levels and prices of $100 per barrel of oil and $8 per 

thousand cubic feet of natural gas over about the next 25 years. The same caveats 

apply to interpreting these scenarios as those for the 1998 and 1999 leases. 

Overall, our work illustrates that the value of future forgone royalties is highly 

dependent upon oil and gas prices, production levels, and the ultimate outcome of 

litigation over price thresholds. Assuming that the District Court’s ruling in the KerrMcGee case is upheld, future forgone royalties from all the DWRRA leases issued 

from 1996 through 2000 could range widely--from a low of about $21 billion to a high 

of $53 billion. The $21 billion figure assumes low production levels and oil and gas 

prices that average $70 per barrel and $6.50 per thousand cubic feet over the lives of 

the leases. The $53 billion figure assumes high production levels and oil and gas 

prices that average $100 per barrel and $8 per thousand cubic feet over the lives of 

the leases. 

Not Including Price Thresholds in 1998 and 1999 Leases Could Cost the 

Government More in Forgone Royalty Payments Should Recent Increases in 

Oil and Natural Gas Prices Be Sustained 

In February 2007, MMS estimated that in addition to the $1 billion in revenues already 

forgone the range of future forgone revenues is between $6.4 billion and $9.8 billion 

from not including price thresholds in leases issued in 1998 and 1999. MMS 

calculated these estimates under a range of assumptions about oil and natural gas 

prices and future production levels. MMS used two price assumptions—one 

employing a constant price of $45 per barrel of oil equivalent and the other using the 

Office of Management and Budget’s (OMB) projected oil and gas prices, which 

escalate through time.6

 For future production volumes from the 1998 and 1999 leases, 

MMS made low and high estimates. The low estimate did not allow for expected 

growth in oil and natural gas reserves, while the high estimate included expected 

growth in reserves based on past experience with oil and natural gas leases in the 

Gulf of Mexico.7

 Reserves are the amount of oil and natural gas that is believed to be 

economically recoverable with current technology and prices. Reserve growth is the 

tendency of the initial reserve estimates to increase in the future as more becomes 

known about the oil and gas field. We reviewed MMS’s assumptions and 

methodology for estimating the potential forgone revenue from 1998 and 1999 leases 

and found them to be reasonable. 

6

One barrel of oil equivalent equals one barrel of oil or 5.62 thousand cubic feet of natural gas. 

7

As oil and gas reserves are developed and more knowledge of the field is obtained, proven reserves 

generally experience some growth. 
Page 5 GAO-08-792R Royalty Relief 

 

In order to provide further perspective on just how much these future costs may vary, 

we developed and analyzed different scenarios in April 2007 that illustrate how the 

cost to the federal government is sensitive to changes in both oil and natural gas 

prices and future production volumes.8

 Accordingly, our scenarios used a range of 

values for oil and natural gas prices and future production volumes to illustrate the 

uncertainty surrounding future forgone federal royalty revenues.9

 Because oil and 

natural gas prices have historically been volatile, at the time we made our initial 

estimates we selected a variety of prices, including $50 and $70 per barrel of oil and 

$6.50 per thousand cubic feet of natural gas. In our analyses, we assumed that price 

thresholds would rise 2.1 percent per year, based on their average annual increase 

over the past 12 years. Similarly, our scenarios included low and high volume 

estimates for future oil and natural gas production from these leases. In these 

scenarios, the estimated forgone royalty revenues vary significantly. For example, an 

oil price of $50 per barrel and a natural gas price of $6.50 per thousand cubic feet and 

low production volumes resulted in $4.3 billion in forgone royalties. 10 Alternatively, 

with $70 per barrel of oil and $6.50 per thousand cubic feet of natural gas, the high 

production volume assumption yielded $10.5 billion. 

In June 2007, MMS also provided an update on the loss of potential royalties from not 

including price thresholds on the leases issued in 1998 and 1999. MMS used oil and 

natural gas prices cited within OMB’s Economic Assumptions for the 2008 Budget. 

Based on an average oil price of $60.78 per barrel and an average natural gas price of 

$7.52 per thousand cubic feet, MMS estimated that between $5.3 billion and $7.8 

billion may be lost in future royalties. The low estimate assumes that reserves do not 

grow, and the high estimate assumes that reserves do grow over time. 

Because oil and natural gas prices increased substantially since the study we 

completed in 2007, we developed an additional scenario with higher oil and natural 

gas prices. We used the same methodology as that in our April 2007 study, updating 

only the oil and natural gas prices.11 At an oil price of $100 per barrel and a natural 

gas price of $8 per thousand cubic feet, a low production level yields potential losses 

of $8.7 billion. With the same prices and a high production level, potential losses 

climb to $14.7 billion. It is important to note, however, that there is no assurance 

8

These scenarios are not probabilistic estimates of what may actually happen with royalty revenue. 

Rather, they are illustrative examples using estimates of future oil and natural gas production that we 

believe are reasonable based on the history of leases in the Gulf of Mexico and using oil and gas prices 

that are within the range of prices that have existed in the past 3 years. As such, we believe the 

scenarios are reflective of plausible possibilities, but we do not assign any probabilities to any of the 

scenarios. 

9

The royalty rate for DWRRA leases in less than 400 meters of water is 16.67 percent, and the royalty 

rate for leases in waters greater than 400 meters is 12.5 percent. 

10It should be noted that if prices were to fall and remain at or below $36.40 per barrel for oil and $4.68 

per thousand cubic feet for natural gas in real 2007 dollars, no royalties would be due even if the price 

thresholds that were imposed on the 1996, 1997, and 2000 leases were applied to the 1998 and 1999 

leases. 

11See enclosure II in GAO-07-590R. 
Page 6 GAO-08-792R Royalty Relief 

these recent high oil and natural gas prices will be sustained over the lives of the 

leases, about 25 more years. For more information on this scenario, see enclosure II. 

Kerr-McGee’s Challenge of Interior’s Authority to Include Price Thresholds 

in DWRRA Leases Could Result in Refunding Royalty Payments 

As of September 30, 2007, leases issued under the DWRRA in 1996, 1997, and 2000 

have generated $1.13 billion in royalties for the U.S. government, according to MMS. 

If the Kerr-McGee decision is upheld on appeal and is applied to all 1996, 1997, and 

2000 DWRRA leases, the federal government may be required to refund these 

royalties. As of November 2007, 57 of the leases issued in 1996, 1997, and 2000 under 

the DWRRA have produced oil and natural gas upon which royalties have been paid. 

Only eight of the leases issued in 1996, 1997, and 2000 are expected to produce oil 

and gas in excess of their royalty suspension volumes. The amount of this excess 

production is expected to be about 14 percent of the total production from all the 

leases issued in 1996, 1997, and 2000 that are producing or expected to produce. 

In early 2006, Kerr-McGee filed the suit challenging the Department of the Interior’s 

authority to include price thresholds in its DWRRA leases. In effect, this suit sought 

to remove price thresholds from leases issued in 1996, 1997, and 2000 because 

Interior did not include price thresholds on leases issued in 1998 and 1999. In June 

2006, Kerr-McGee agreed to enter into mediation with Interior in an attempt to 

resolve the issue; however, the mediation was unsuccessful and litigation resumed. 

In October 2007, the U.S. District Court for the Western District of Louisiana ruled in 

favor of Kerr-McGee. 

The court held that price thresholds in leases issued under the DWRRA from 1996 

through 2000 to Kerr-McGee for oil and gas production below a threshold volume 

were unlawful. According to the court, “The Interior has no discretion to enact a 

price threshold requirement that applies to volumes below the minimum volume of 

royalty-free production.” The DWRRA specifies that royalties are not due on certain 

amounts of production, referred to in the ruling as “the minimum volume of royaltyfree production” and referred to by others as royalty suspension volumes. The court 

agreed with Kerr-McGee’s interpretation that the section of the DWRRA that requires 

mandatory royalty relief prevents Interior from enacting price thresholds for volumes 

below the royalty suspension volumes. 

Senior Interior officials and many congressional leaders disagree with the decision. 

They believe that Congress intended for royalty relief to apply only during times of 

low oil and natural gas prices and that the DWRRA grants Interior the authority to set 

price thresholds for new leases. In December 2007, the Department of Justice filed a 

notice to appeal the decision. 

Congressional leaders are seeking legislative remedies for the absence of price 

thresholds in DWRRA leases issued in 1998 and 1999. Sections 7502 and 7504 of H.R. 

3220, the New Direction for Energy Independence, National Security and Consumer 

Protection Act, would provide legislative avenues for addressing the absence of price 
Page 7 GAO-08-792R Royalty Relief 

thresholds. Section 7502 proposes that holders of leases issued in 1998 and 1999 

under the DWRRA can request the Secretary of the Interior to amend these leases to 

include price thresholds. This would formally allow Interior and the lessees to 

renegotiate these leases. Interior and some companies began negotiations in late 

2006 to apply price thresholds to future production from 1998 and 1999 leases. To 

date, 6 companies have formally agreed to terms, but 44 have not agreed to terms. 

Section 7504 would exclude parties that hold an interest in DWRRA leases issued 

from 1996 through 2000 from acquiring new oil and gas leases in the Gulf of Mexico 

unless the party renegotiates the leases to include price thresholds. This section 

would also impose a fee on oil and gas production from the Outer Continental Shelf 

lands in the Gulf of Mexico if these leases are not subject to price thresholds. Section 

223 of S. 701, the Strategic Energy Fund Act of 2007, contains an identical provision, 

as do H.R. 2809 and several other bills. 

Kerr-McGee’s Challenge Could Also Cost the Government Billions in Future 

Forgone Royalty Payments 

If the Kerr-McGee ruling is upheld on appeal and applied to all DWRRA leases issued 

in 1996, 1997, and 2000, the potential loss of royalties from future production is likely 

to be in the billions of dollars, but the exact amount will depend on future energy 

prices and production levels. MMS estimated in October 2004 that forgone royalties 

on the 1996, 1997, and 2000 leases could be as high as $60 billion. In 2006, we 

reviewed MMS’s assumptions and methodology for estimating the potential forgone 

revenue and found them to be reasonable. However, because much has been learned 

about the productivity of the leases since that initial estimate and because oil and 

natural gas price expectations have changed, we believe that this estimate needed to 

be updated. In particular, we found that estimates for reserve growth were overly 

optimistic in light of a more recent MMS study on reserve growth in the Gulf of 

Mexico. MMS’s 2004 estimates on the size and number of future discoveries also 

appeared overly optimistic, given historical statistics on field size, a 2006 assessment 

of the availability of drilling rigs in the Gulf of Mexico, and a smaller number of leases 

available to drill in 2008 than were available in 2004. MMS concurred with our 

observations. 

In February 2008, MMS released an update on its October 2004 estimate of potential 

losses from the 1996, 1997, and 2000 leases. MMS estimated a range of potential 

future forgone revenue between $15.7 billion and $21.2 billion, based on assumptions 

about oil and natural gas prices and future production levels. MMS used OMB’s 

prices of $80.92 per barrel of oil and $8.70 per thousand cubic feet of natural gas, as 

cited in OMB’s Economic Assumptions for the 2009 Budget. For future production 

levels, MMS made low and high estimates. The low estimate did not allow for 

expected growth in oil and natural gas reserves, while the high estimate included 

expected growth in reserves. We reviewed these assumptions and the methodology 

and found them to be reasonable. 

Nonetheless, in order to provide further perspective on just how much these future 

costs may vary, we developed and analyzed different scenarios that illustrate how the 
Page 8 GAO-08-792R Royalty Relief 

cost to the federal government is sensitive to changes in both oil and natural gas 

prices and future production volumes. These scenarios are similar to those we used 

to illustrate forgone royalty revenue from the 1998 and 1999 leases. To illustrate the 

uncertainty surrounding potential forgone federal royalty revenues, our scenarios use 

a range of values for oil and natural gas prices and future production volumes. 

Because oil and natural gas prices have been volatile and high during 2007 and 2008, 

we selected oil prices of $70 and $100 per barrel of oil and $6.50 and $8 per thousand 

cubic feet of natural gas. In our analyses, we assumed that price thresholds would 

rise 2.1 percent per year, based on their average annual increase over the past 12 

years. Similarly, our scenarios included low and high volume estimates for future oil 

and natural gas production from these leases. In these scenarios, as might be 

expected, the estimated forgone royalty revenues vary significantly. For example, an 

oil price of $70 per barrel and a natural gas price of $6.50 per thousand cubic feet and 

low production volumes result in $15.1 billion in forgone royalties. With the same 

prices but higher production volumes, this estimate increases to $27.2 billion. 

Alternatively, with $100 per barrel of oil and $8 per thousand cubic feet of natural gas, 

the low production volume assumption yields forgone royalties of $21.2 billion and 

the high production volume assumption yields $38.3 billion. For more detailed 

information on each of the scenarios and the estimated potential forgone royalty 

revenue, see enclosure III. 

Of the 84 leases issued in 1996, 1997, and 2000 that are currently producing or are 

capable of producing in the future, 76 do not appear capable of producing amounts of 

oil and gas that will exceed the royalty suspension volumes. The total amount of oil 

and gas for these 76 leases below the royalty suspension volumes represents about 86 

percent of the estimated amounts that the1996, 1997, and 2000 leases will collectively 

produce over their productive lives. Thus, only about 14 percent of the production 

from leases issued in 1996, 1997, and 2000 would be royalty bearing should Interior 

lose on appeal and the ruling in the Kerr-McGee suit is applied to DWRRA leases 

issued from 1996 through 2000. In addition to the impact on receiving fewer royalties 

in the future from the 1996, 1997, and 2000 leases, losing the appeal could also 

adversely affect the government’s negotiation of price thresholds for the 1998 and 

1999 leases. Some companies have suspended or delayed negotiations, pending 

outcome of the Kerr-McGee suit. 

Agency Comments 

We provided a draft of this report to the Department of the Interior and the Minerals 

Management Service (MMS) for review and oral comments. In commenting on the 

report, they generally agreed with GAO’s methodology and conclusions. In response 

to their comments, we added clarification as to why the potential for future forgone 

royalties from the 1996, 1997, and 2000 leases with grown reserves appeared higher 

than they anticipated. We also incorporated their technical comments as appropriate. 

- - - - - - - - - - 
Page 9 GAO-08-792R Royalty Relief 

We are sending copies of this report to appropriate congressional committees, the 

Secretary of the Interior, the Director of the Minerals Management Service, the 

Director of the Office of Management and Budget, and other interested parties. We 

will also make copies available to others upon request. In addition, the report will be 

available at no charge on GAO’s Web site at http://www.gao.gov. 

If you or your staffs have any questions about this report, please contact me at (202) 

512-3841 or ruscof@gao.gov. GAO staff who made contributions to this report 

include Ron Belak, Glenn C. Fischer, Mark Gaffigan, Dan Haas, and Barbara 

Timmerman. 

Frank Rusco 

Acting Director, Natural Resources and Environment 

Enclosures 
Page 10 GAO-08-792R Royalty Relief 

List of Requesters 

The Honorable Jeff Bingaman 

Chairman 

Committee on Energy and Natural Resources 

United States Senate 

The Honorable Carl Levin 

Chairman 

The Honorable Norm Coleman 

Ranking Member 

Permanent Subcommittee on Investigations 

Committee on Homeland Security and Governmental Affairs 

United States Senate 

The Honorable Ron Wyden 

Chairman 

Subcommittee on Public Lands and Forests 

Committee on Energy and Natural Resources 

United States Senate 

The Honorable Nick J. Rahall 

Chairman 

Committee on Natural Resources 

House of Representatives 

The Honorable Darrell E. Issa 

Ranking Member 

Subcommittee on Domestic Policy 

Committee on Oversight and Government Reform 

House of Representatives 

The Honorable Daniel K. Akaka 

United States Senate 

The Honorable Maria Cantwell 

United States Senate 

The Honorable Thomas R. Carper 

United States Senate 

The Honorable Byron L. Dorgan 

United States Senate 

The Honorable Richard J. Durbin 

United States Senate 
Page 11 GAO-08-792R Royalty Relief 

The Honorable Russell D. Feingold 

United States Senate 

The Honorable Dianne Feinstein 

United States Senate 

The Honorable Tim Johnson 

United States Senate 

The Honorable John F. Kerry 

United States Senate 

The Honorable Jon Kyl 

United States Senate 

The Honorable Frank R. Lautenberg 

United States Senate 

The Honorable Robert Menendez 

United States Senate 

The Honorable Barbara A. Mikulski 

United States Senate 

The Honorable Patty Murray 

United States Senate 

The Honorable Barack Obama 

United States Senate 

The Honorable Jack Reed 

United States Senate 

The Honorable Ken Salazar 

United States Senate 

The Honorable Charles E. Schumer 

United States Senate 

The Honorable Carolyn B. Maloney 

House of Representatives
Page 12 GAO-08-792R Royalty Relief 

 

Enclosure I: Scope and Methodology 

To update our scenario that illustrates the potential loss of royalties from leases 

issued in 1998 and 1999, we revised oil and gas prices upward to $100 per barrel and 

$8 per thousand cubic feet. The methodology is similar to that described below for 

leases issued in 1996, 1997, and 2000 under the Outer Continental Shelf Deep Water 

Royalty Relief Act of 1995 (DWRRA).12

To determine the fiscal impacts of price thresholds that may no longer apply to oil 

and gas leases issued in 1996, 1997, and 2000 under the DWRRA, we first met with 

Minerals Management Service (MMS) personnel in the Economics Division in 

Herndon, Virginia. We reviewed their October 2004 estimate of royalties that could 

be forgone if price thresholds did not apply to 1996, 1997, and 2000 DWRRA leases. 

We concluded that they followed standard engineering and financial practices and 

that they had generated the estimate in good faith. Since this estimate, however, 

additional information became available, and we believed their estimate needed to be 

updated. MMS concurred. Differences between our current estimates and MMS’s 

2004 estimate are due to changes in oil and gas prices, updated information on the 

size of deep water oil and gas fields that have been discovered but are not yet 

producing, the growth of oil and gas reserves over time, and the availability of drilling 

rigs in the Gulf of Mexico. MMS updated its 2004 estimate to address these issues 

and released this updated estimate in February 2008. We also reviewed this estimate 

and similarly found that it followed standard engineering and financial practices and 

was done in good faith. During the course of our work, we visited MMS’s Gulf of 

Mexico regional office in New Orleans and interviewed engineers and geologists 

about technical aspects of oil and gas production in the deep waters of the Gulf of 

Mexico. In addition, we contacted industry representatives for their opinions on oil 

and gas exploration and development in the deep waters of the Gulf of Mexico. 

Within MMS’s Technical Information Management System (TIMS), we identified all 

3,401 leases issued under the DWRRA, 2,369 of which were issued in 1996, 1997, and 

2000. From this database, we were able to identify the status of these leases, the 

extent to which they had been explored and developed, and the production that had 

occurred on some of them. As of April 2008, a total of 94 of the leases issued in 1996, 

1997, and 1999 have produced, are currently producing, or are expected to produce 

oil and gas in the future under DWRRA provisions. Ten of the 94 leases have either 

stopped producing or appear to be no longer capable of producing significant 

amounts, 47 are still producing, and 37 are expected to commence production at 

some future time. As of January 1, 2008, we estimate that about 135 of the additional 

1996, 1997, and 2000 leases were still active but had not yet been tested for oil and 

gas. We also collected pertinent information from TIMS, current through September 

2006, on the estimated reserves of leases that are currently producing and leases 

capable of producing but not yet connected to infrastructure (producible leases). We 

interviewed MMS personnel in New Orleans to better understand how these reserve 

estimates were made. For producing and producible leases, we corroborated lease 

12See GAO-07-590R, enclosure 1, page 8. 
Page 13 GAO-08-792R Royalty Relief 

information in TIMS with MMS’s final bid results. We also obtained recent 

information on reserve growth for each producing or producible lease and obtained 

monthly oil and gas production volumes through July 2006 from MMS’s Oil and Gas 

Operations Reports (OGOR). We updated these production data with additional 

production amounts through December 2007 when these data became available. We 

reviewed production data for characteristic decline patterns, questioned MMS 

personnel on how they verified these data and on reasons for periods of time with 

zero production (predominantly the result of hurricane activity), and compared each 

lease’s cumulative production with reserve estimates in TIMS. We found the data in 

TIMS and in OGOR to be sufficiently reliable for the purposes of our analysis. 

We considered the timing of future production to identify and exclude from our 

analysis the possible production volumes that will be royalty free when sales prices 

drop below anticipated price thresholds in the future. However, because only the 

sales price of $6.50 for natural gas is expected to fall below price thresholds during 

the time frame of our scenarios, this time is projected to be January 2024, and royalty 

revenue from gas production after January 2004 is anticipated to be less than 1 

percent of total gas royalty revenue, we did not adjust production volumes. 

To project production from future discoveries on 1996, 1997, and 2000 leases, we 

examined MMS projections for future drilling activity, historic discovery rates, 

average field sizes, and anticipated lease expiration dates for DWRRA leases in 

waters deeper than 800 meters, where MMS anticipates all the future DWRRA 

discoveries will occur. First, we assumed that the range for the number of possible 

untested leases drilled in all of the deep waters of the Gulf of Mexico would be 

between 30 and 60. This assumption was based on the availability of rigs to drill 

exploratory wells in waters deeper than 800 meters and MMS projections in the 2006 

deep water report. Second, we assumed the success rate of future deep water lease 

discoveries would be the same for such deep water leases drilled from 1974 through 

1995, which was 28 percent. Third, we scheduled the expiration dates of the 1996, 

1997, and 2000 leases for each year through 2010 and calculated for each of these 

years the percentage of all untested deep water leases below 800 meters that would 

be 1996, 1997, and 2000 leases. We assumed that there would be 3,700 total active 

deep water leases each year. Fourth, we assumed that each new field discovery 

would consist of two leases because 97 percent of the existing 198 fields in Gulf of 

Mexico waters deeper than 800 meters are composed of from one to four leases, with 

two leases being the average field size. Finally, for 2008 through 2010, we assumed 

the number of field discoveries on 1996, 1997, and 2000 leases would be between zero 

and five. This assumption was derived by multiplying the estimated range of untested 

leases that could be drilled in all Gulf of Mexico deep waters (30 to 60 per year) by an 

estimated percentage of all deep water leases that will be active untested 1996, 1997, 

and 2000 leases, and by also multiplying by the assumed historical success rate of 28 

percent. We doubled this number in order to account for the average field consisting 

of two leases and rounded the resulting high number to five. For these new 

discoveries, we converted these numbers into oil and gas production volumes by 

multiplying them by the average of the reserves for all producing and producible 

DWRRA leases. 
Page 14 GAO-08-792R Royalty Relief 

With these assumptions, we developed several scenarios that illustrate that the 

potential for forgone royalties is highly dependent upon prices and production 

volumes. We chose prices of $70 for oil and $6.50 for gas because these were in the 

range of common prices during late 2007. We also chose prices of $100 for oil and $8 

for gas because these prices are close to prices common in early 2008. We did not 

escalate oil and gas prices over the time period of our scenario. To illustrate the 

impact of changing production volumes on forgone royalties from producing and 

producible leases, we assumed low and high production levels. Our low production 

assumption is equal to MMS’s estimated reserves, which we corrected in several 

instances when cumulative production through December 2007 exceeded estimated 

reserves projected in July 2006. Our high production assumption is equal to the sum 

of the estimated reserves for each lease multiplied by its corresponding growth 

factor. To illustrate the impact of changing production volumes on forgone royalties 

from future discoveries, we also selected low and high assumptions. Our low 

production assumption is zero discoveries, and our high assumption is five 

discoveries. We did not multiply production assumptions from future discoveries by 

growth factors, but such growth is possible. 
Page 15 GAO-08-792R Royalty Relief 

Enclosure II: Scenario Illustrating the Sensitivity of Forgone Royalties to 

Changes in Future Production Volumes from 1998 and 1999 DWRRA Leases 

at High Oil and Natural Gas Prices 

Scenario 1 illustrates possible forgone federal royalty payments resulting from MMS’s 

omission of price thresholds in leases issued in 1998 and 1999 when oil and natural 

gas prices exceed price thresholds. This scenario updates the upper limit of prices 

chosen for our previous scenarios that we published in April 2007. In those 

scenarios, we used oil prices of $36, $50, and $70 per barrel and natural gas prices of 

$4.50 and $6.50 per thousand cubic feet. 

Scenario 1 uses an oil price of $100 per barrel and a natural gas price of $8 per 

thousand cubic feet and retains these prices over the lives of the leases (see table 1). 

We illustrate the forgone royalties with both low and high volume estimates of future 

oil and gas production. In this scenario, the productive time frame is from August 

2006 through the lives of the leases, which are about 25 years. In the low production 

volume estimate, we use MMS’s “ungrown reserve” estimates and assume five 

additional leases are discovered to be productive in the future. Our scenario results 

in $8.7 billion in forgone royalties. This estimate increases to $14.7 billion in the high 

production volume case, which uses MMS’s “grown reserves” and 10 future 

discoveries. 

Table 1: Scenario 1 Assumes That from 1998 and 1999 Leases, Oil Would Be 

Sold for $100 per Barrel and Natural Gas Would Be Sold for $8 per Thousand 

Cubic Feet. 

Ungrown reserves and five 

future discoveries 

Grown reserves and 10 

future discoveries

Forgone royalties on future production 

from producing and producible leases 

$7.3 billion $11.3 billion 

Additional forgone royalties on future 

production from leases with new 

discoveries 

$1.4 billion $3.4 billion 

Total forgone royalties $8.7 billion $14.7 billion

Source: GAO. 
Page 16 GAO-08-792R Royalty Relief 

Enclosure III: Scenarios Illustrating the Sensitivity of Forgone Royalties to 

Changes in Oil and Natural Gas Prices and Future Production Volumes from 

DWRRA Leases Issued in 1996, 1997, and 2000 

The following two scenarios illustrate the range of possible forgone royalties that 

could result if price thresholds are no longer applicable to leases issued in 1996, 1997, 

and 2000. 

Scenario 2 illustrates possible future forgone federal royalty payments if price 

thresholds are no longer applicable to these leases during times when oil and natural 

gas prices exceed the price thresholds (see table 2).13 Specifically, we selected an oil 

price of $70 per barrel and a natural gas price of $6.50 per thousand cubic feet to 

illustrate the forgone royalties with both low and high volume estimates of future oil 

and gas production. In this scenario, the production time frame is from January 2008 

through the lives of the leases, which is about 25 years. In the low production volume 

estimate, we use MMS’s “ungrown reserve” estimates and assume that no additional 

leases are discovered in the future. This scenario results in $15.1 billion in forgone 

royalties. The estimate increases to $27.2 billion in the high production volume case, 

which uses MMS’s “grown reserves” and five future discoveries. 

Table 2: Scenario 2 Assumes That from 1996, 1997, and 2000 Leases, Oil 

Would Be Sold for $70 per Barrel and Natural Gas Would Be Sold for $6.50 

per Thousand Cubic Feet. 

Ungrown reserves and no 

future discoveries

Grown reserves and five 

future discoveries

Forgone royalties on future production 

from producing and producible leases 

$15.1 billion $26.2 billion 

Additional forgone royalties on future 

production from leases with new 

discoveries 

$0 $1.0 billion 

Total forgone royalties $15.1 billion $27.2 billion

Source: GAO. 

Scenario 3 illustrates possible forgone royalties with higher oil and natural gas prices. 

Using similar assumptions on production volumes as in Scenario 2, $100 per barrel of 

oil and $8 per thousand cubic feet of natural gas yield $21.2 billion in forgone future 

royalties for the low production estimate and $38.3 billion in forgone future royalties 

for the high production estimate (see table 3). 

 

13In scenario 2, gas prices drop below price thresholds in the latter years of the producing lives of the 

leases, but this revenue is anticipated to be less than 1 percent of total gas royalty revenue. 
Page 17 GAO-08-792R Royalty Relief 

Table 3: Scenario 3 Assumes That from 1996, 1997, and 2000 Leases, Oil 

Would Be Sold for $100 per Barrel and Natural Gas Would Be Sold for $8 per 

Thousand Cubic Feet. 

Ungrown reserves and no 

future discoveries 

Grown reserves and five 

future discoveries 

Forgone royalties on future production 

from producing and producible leases 

$21.2 billion $36.9 billion 

Additional forgone royalties on future 

production from leases with new 

discoveries 

$0 $1.4 billion 

Total forgone royalties $21.2 billion $38.3 billion

Source: GAO. 

 

The $36.9 billion in forgone royalties on future production in table 3 is $15.7 billion 

greater than MMS’s highest estimate of $21.2 billion released in February 2008. About 

half of this difference is attributed to the higher oil and gas prices we used in table 3. 

The other half of the difference is because we anticipate greater reserve growth than 

MMS. 

(360963)