U.S. GOVERNMENT PRINTING OFFICE

45–026 CC WASHINGTON : 1997

OVERSIGHT HEARINGS ON ROYALTY-IN-KIND FOR

FEDERAL OIL AND GAS PRODUCTION

OVERSIGHT HEARINGS

BEFORE THE

SUBCOMMITTEE ON ENERGY

AND MINERAL RESOURCES

OF THE

COMMITTEE ON RESOURCES

HOUSE OF REPRESENTATIVES

ONE HUNDRED FIFTH CONGRESS

FIRST SESSION

JULY 31 AND SEPTEMBER 18, 1997, WASHINGTON, DC

Serial No. 105–41

Printed for the use of the Committee on Resources

(
(II)

COMMITTEE ON RESOURCES

DON YOUNG, Alaska, Chairman

W.J. (BILLY) TAUZIN, Louisiana

JAMES V. HANSEN, Utah

JIM SAXTON, New Jersey

ELTON GALLEGLY, California

JOHN J. DUNCAN, JR., Tennessee

JOEL HEFLEY, Colorado

JOHN T. DOOLITTLE, California

WAYNE T. GILCHREST, Maryland

KEN CALVERT, California

RICHARD W. POMBO, California

BARBARA CUBIN, Wyoming

HELEN CHENOWETH, Idaho

LINDA SMITH, Washington

GEORGE P. RADANOVICH, California

WALTER B. JONES, JR., North Carolina

WILLIAM M. (MAC) THORNBERRY, Texas

JOHN SHADEGG, Arizona

JOHN E. ENSIGN, Nevada

ROBERT F. SMITH, Oregon

CHRIS CANNON, Utah

KEVIN BRADY, Texas

JOHN PETERSON, Pennsylvania

RICK HILL, Montana

BOB SCHAFFER, Colorado

JIM GIBBONS, Nevada

MICHAEL D. CRAPO, Idaho

GEORGE MILLER, California

EDWARD J. MARKEY, Massachusetts

NICK J. RAHALL II, West Virginia

BRUCE F. VENTO, Minnesota

DALE E. KILDEE, Michigan

PETER A. DEFAZIO, Oregon

ENI F.H. FALEOMAVAEGA, American

Samoa

NEIL ABERCROMBIE, Hawaii

SOLOMON P. ORTIZ, Texas

OWEN B. PICKETT, Virginia

FRANK PALLONE, JR., New Jersey

CALVIN M. DOOLEY, California

CARLOS A. ROMERO-BARCELO ́ , Puerto

Rico

MAURICE D. HINCHEY, New York

ROBERT A. UNDERWOOD, Guam

SAM FARR, California

PATRICK J. KENNEDY, Rhode Island

ADAM SMITH, Washington

WILLIAM D. DELAHUNT, Massachusetts

CHRIS JOHN, Louisiana

DONNA CHRISTIAN-GREEN, Virgin Islands

RON KIND, Wisconsin

LLOYD DOGGETT, Texas

LLOYD A. JONES, Chief of Staff

ELIZABETH MEGGINSON, Chief Counsel

CHRISTINE KENNEDY, Chief Clerk/Administrator

JOHN LAWRENCE, Democratic Staff Director

SUBCOMMITTEE ON ENERGY AND MINERAL RESOURCES

BARBARA CUBIN, Wyoming, CHAIRMAN

W.J. (BILLY) TAUZIN, Louisiana

JOHN L. DUNCAN, JR., Tennessee

KEN CALVERT, California

WILLIAM M. (MAC) THORNBERRY, Texas

CHRIS CANNON, Utah

KEVIN BRADY, Texas

JIM GIBBONS, Nevada

CARLOS ROMERO-BARCELO ́ , Puerto Rica

NICK J. RAHALL II, West Virginia

SOLOMON P. ORTIZ, Texas

CALVIN M. DOOLEY, California

CHRIS JOHN, Louisiana

DONNA CHRISTIAN-GREEN, Virgin Islands

——— ———

BILL CONDIT, Professional Staff

SHARLA BICKLEY, Professional Staff

DEBORAH LANZONE, Legislative Staff
(III)

C O N T E N T S

Page

Hearings:

July 31, 1997 ..................................................................................................... 1

September 18, 1997 .......................................................................................... 55

Statements of Members:

Cubin, Hon. Barbara, a Representative in Congress from the State of

Wyoming ........................................................................................................ 1

Prepared statement of, September 18, 1997 ........................................... 55

Maloney, Hon. Carolyn, a Representative in Congress from the State

of New York ................................................................................................... 5

Prepared statement of ............................................................................... 8

Romero-Barcelo ́, Hon. Carlos, a Delegate in Congress from the Territory

of Puerto Rico, ............................................................................................... 3

Prepared statement of, July 31, 1997 ...................................................... 4

Romero-Barcelo ́, Hon. Carlos A., a Delegate in Congress from the Territory of Puerto Rico, July 31, 1997 ............................................................... 57

Prepared statement of, September 18, 1997 ........................................... 59

Thornberry, Hon. William M. ‘‘Mac,’’ a Representative in Congress from

the State of Texas, July 31, 1997 ................................................................ 55

Statements of witnesses:

Brian, Danielle, Executive Director, Project on Government Oversight ...... 62

Prepared statement of ............................................................................... 201

Brown, Robert E., Associate Director, Minerals Management Service, U.S.

Department of the Interior ........................................................................... 86

Prepared statement of ............................................................................... 264

Cohelan, Timothy, Esquire, Cohelan & Koury ............................................... 69

Prepared statement of ............................................................................... 249

Darouse, David, Mineral Revenue Regional Auditor Supervisor, Department of Natural Resources, Baton Rouge, Louisiana ................................ 23

Prepared statement of ............................................................................... 119

Hagemeyer, Fred, Coordinating Manager, Royalty Affairs, Marathon Oil

Company ........................................................................................................ 33

Prepared statement of ............................................................................... 141

Hamm, Sue Ann, Vice President, Oil Marketing/Sales, Continental Resources, Incorporated .................................................................................... 35

Prepared statement of ............................................................................... 154

Henderson, William, Market Development Representative, Gulf Canada

Resources ....................................................................................................... 60

Prepared statement of ............................................................................... 191

Magagna, Jim, Director, Office of State Lands and Investments, Office

of Federal Land Policy, State of Wyoming .................................................. 25

Prepared statement of ............................................................................... 121

Neufeld, Bob, Vice President, Environment & Government Relations, Wyoming Refining Company ............................................................................. 71

Prepared statement of ............................................................................... 257

Nichols, Larry, President, Devon Energy ....................................................... 31

Prepared statement of ............................................................................... 130

Quarterman, Cynthia, Director, Minerals Management Service ................. 45

Prepared statement of ............................................................................... 181

Reid, Spencer, Deputy Land Commissioner, Texas General Land Office .... 19

Prepared statement of ............................................................................... 21

Rorschach, Richard, National Chairman, National Association of Royalty

Owners ........................................................................................................... 63

Prepared statement of ............................................................................... 208

Rothschild, Edwin S., Public Affairs Director, Citizen Action ...................... 65
Page

IV

Statements of witnesses—Continued

Rothschild, Edwin S., Public Affairs Director, Citizen Action—Continued

Prepared statement of ............................................................................... 213

Segner, Edmund, III, Executive Vice President and Chief of Staff, Enron

Corporation .................................................................................................... 37

Prepared statement of ............................................................................... 172

Smith, Linden, Managing Director, Barents Group ...................................... 67

Prepared statement of ............................................................................... 224

Additional material supplied:

Briefing paper ................................................................................................... 96

Congressional Research Service, Library of Congress, Memorandum from

Marc Humphries and Lawrence Kumins .................................................... 270

Crude Oil Royalty Payment Analysis, Report to the State Land Offices

of Colorado, New Mexico, and Texas ........................................................... 138

DiBona, Charles, American Petroleum Institute ........................................... 94

Petroleum Marketing Act ................................................................................ 162

Questions from Mrs. Cubin and Mr. Romero-Barcelo ́ and answers from

witnesses ........................................................................................................ 291

State of Louisiana, prepared statement of, submitted by David Darouse ... 119
(1)

OVERSIGHT HEARING ON ROYALTY-IN-KIND

FOR FEDERAL OIL AND GAS PRODUCTION

THURSDAY, JULY 31, 1997

HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON ENERGY

AND MINERAL RESOURCES, COMMITTEE ON RESOURCES,

Washington, DC.

The Subcommittee met, pursuant to call, at 2:05 p.m., in room

1334, Longworth House Office Building, Hon. Barbara Cubin

[chairman of the Subcommittee] presiding.

STATEMENT OF HON. BARBARA CUBIN, A REPRESENTATIVE

IN CONGRESS FROM THE STATE OF WYOMING

Mrs. CUBIN. The Subcommittee on Energy and Mineral Resources will come to order. The Subcommittee is meeting today to

hear testimony on royalty-in-kind for Federal oil and gas production. Under Rule 4[g] of the Committee Rules, any oral opening

statements at hearings are limited to the Chairman and the Ranking Minority Member.

This will allow us to hear from our witnesses sooner and help

members keep to their busy schedules. Therefore, if other members

have statements, they can be included in the hearing record under

unanimous consent.

The Subcommittee meets today to review issues concerning the

collection of production royalties due to the United States from

Federal oil and gas leases on shore and on the outer continental

shelf. During the last Congress, Chairman Calvert held a hearing

to review the initial evaluation by the Minerals Management Service of the pilot program the agency had conducted in the Gulf of

Mexico for natural gas royalty-in-kind.

That effort led to inclusion of language in the Appropriations

Committee report for the 1997 Interior Department’s spending bill

urging consideration of further royalty-in-kind initiatives by MMS.

Many of us in Congress view the idea of a broad based royaltyin-kind program as a way to greatly diminish the enormous costs

associated with audit and enforcement functions of collecting royalty-in-value.

For fiscal year 1998, the House has funded the valuation and compliance subactivities within the MMS budget at $68.3 million,

but the true costs are still much higher because the Federal Government must expend substantial legal and administrative resources to answer protests, appeals, and litigation which ensue

from differing interpretation of the value of oil and gas for royalty

purposes.
2

Lest anyone forget, let me remind you that I represent the State

of Wyoming in this body. And my state bears by far the largest portion of any state’s cost burden under the so-called net receipts

sharing formula which was codified as permanent law in the Omnibus Budget Reconciliation Act of 1993.

And by my quick arithmetic, the State of Wyoming has had over $50 million taken from its half of the Federal mineral lease receipts since the inception of the net receipts sharing methodology

in fiscal year 1991.

The cumulative burden upon the states with onshore Federal leases for fiscal year 1997 alone is $22.1 million representing onefourth of the cost of administering onshore mineral leases by the

BLM, the U.S. Forest Service, and the MMS.

Without question, savings in these administrative costs, which

may be realized through efficiency gains such as collecting oil and

gas royalties-in-kind rather than in-dispute value, will reduce the

burden upon the states paying the Federal Government’s freight,

as well as enrich the U.S. Treasury to the benefit of taxpayers

throughout the nation.

To my way of thinking, there simply must be a better way to

more efficiently collect what is owed to the United States in return

for the right to explore, develop, and produce oil and gas from Federal lands; more efficient for the Feds and, therefore, by way of the

net value sharing formula, less burdensome on the states and, yes,

more efficient for industry which must put their money and capital

at risk in the first place so there would no income to the Federal

Government or the states.

Now, I realize that royalty-in-kind theoretically looks good, but

putting it into practice is not necessarily cut and dry. But should

we shy away from pursuing the idea because a particular segment

of the industry or perhaps a particular state or two has certain

problems with this method, I say absolutely not, nor should we in

Congress simply take at face value allegation by folks with a vested

interest in the status quo that R-I-K is a money loser.

But we must keep in mind the end goal. Increased efficiency

means greater net revenues to all parties involved. I take seriously

my job as Chairman of this Subcommittee, and I intend to see that

that remains our focus. My purpose then in calling today’s hearing

is to attempt to set in motion a consensus-seeking effort not unlike

that of two years ago, which ultimately resulted in the passage of

a bill which President Clinton was eager to sign, the Royalty Fairness Act.

I understand that there are naysayers within Congress, some of

whom may believe I have tried to stack the deck in this oversight

hearing. I disagree strongly with that assertion, but this will not

be the final hearing on royalty-in-kind. And we will hear from

other witnesses in September who may perhaps have fundamental

differences over whether or not R-I-K is an idea worthy of pursuit.

Furthermore, I have agreed to our Minority’s request to have

Representative Carolyn Maloney of New York as our first witness

today, given the fact that she seems to have an abiding interest in

royalty collection. And certainly I share that with you. I welcome

you here today, Mrs. Maloney, and now I recognize the Ranking

Member, Mr. Carlos Romero-Barcelo ́ for his opening statement.
3

[Briefing paper may be found at end of hearing.]

STATEMENT OF HON. CARLOS ROMERO-BARCELO ́ , A DELEGATE IN CONGRESS FROM THE TERRITORY OF PUERTO

RICO

Mr. ROMERO-BARCELO ́ Thank you very much, Madam Chair, and

we appreciate the opportunity to review the possibilities for a royalty-in-kind program in the Federal oil and gas leasing program.

And it is particularly agreeable to have our colleague, Carolyn

Maloney, Representative of New York, join us here today. Representative Maloney has indeed shown a great interest in the Federal royalty program for several years now. And her insight and

her comments will be very welcome on this Subcommittee.

The question of whether the Federal Government should take its

oil and gas royalties ‘‘in kind’’ presents a lot of interesting possibilities. Of course, we are interested in any option that purports to improve services at a reduced cost.

We share the Chair’s interest in developing more simple, certain,

and efficient methods of collecting oil and gas royalties. We are

pleased to learn that a group of the independent oil and gas producers, through their trade associations, is working together to develop a royalty-in-kind proposal; just as we are pleased that the

Minerals Management Service, under the able leadership of Ms.

Cynthia Quarterman, is aggressively examining the question. The

oil-producing states too have a valuable role to play in this discussion.

However, it is a bit unsettling to hear—after aggressive lobbying

by the states and oil and gas industry officials, and over the initial

objections of the Minerals Management Service—that the Royalty

Fairness and Simplification Act of 1996 that was signed by President Clinton just one year ago should be cast aside along with the

improvements made to the royalty management program and replaced with an in-kind marketing program. This is almost a 180

degree turn from what the oil industry and states were clamoring

for during the last Congress.

To a certain degree, I am being facetious. However, our experience with the Royalty Fairness Act illustrates an important factor

to bear in mind. We must all be very cautious and extremely deliberative in our consideration of the radical idea of replacing the traditional in value royalty payment with a royalty-in-kind program.

The Federal Government is the largest single owner of oil and

gas resources in the United States. What would be the consequences of changing the Federal role from royalty collector to oil

and gas marketer? What safeguards would be necessary to assure

that the taxpayers will receive their fair share from the development of our nation’s oil and gas resources?

Have we adequately considered the consequences of enabling the

Federal Government to dictate market price by virtue of its market

power? How would the various segments of the oil and gas industry

respond to having the Federal Government in the oil business?

We must know the answers to these and other critical questions

before we set about writing and considering legislation. Particularly one of the great concerns is we are going away from government being involved in many activities, and we are now asking the
4

government to get involved being an oil marketer. That is a very,

very step going away from where we are trying to go in many other

areas.

I think our experience in Puerto Rico has been that the government’s participation in businesses that are most appropriately private enterprise is a bad, bad experience. I think probably the worst

marketer in the world would be the government. Because, clearly,

if it is not handled correctly, a U.S. royalty-in-kind program could

seriously disrupt the domestic petroleum markets. So we must

move slowly and carefully to fully examine this idea.

We have a great deal of research and analysis to do before we

can say with any degree of certainty that royalty-in-kind is better

than in-value royalty. And there are others beyond these distinguished witnesses here today from whom we should hear, as our

Chair has already indicated.

For instance, none of the major oil and gas corporations are on

the witness list here today. I hope we will gain the benefit of their

views at the next hearing in September when we will also hear

from witnesses invited at the minority’s request.

Royalty-in-kind does offer interesting possibilities, but it is no

panacea to problems encountered with the current in-value royalty

program. Suggesting any specific, mandatory change to the Federal

royalty management program at this point in time is premature.

Only after additional study and experience, which MMS can gain

through its ongoing efforts and we in Congress can gain through

additional oversight hearings, can the subcommittee begin to consider what, if any, changes are necessary to the authorizing statutes. With that message of caution, I join the Chair in welcoming

our witnesses today.

[Prepared statement of Mr. Romero-Barcelo ́ follows:]

STATEMENT OF HON. CARLOS ROMERO-BARCELO ́, A DELEGATE IN CONGRESS FROM

THE TERRITORY OF PUERTO RICO

Madame Chair, we appreciate the opportunity to review the possibilities for a royalty-in-kind program in the Federal oil and gas leasing program.

It is particularly agreeable to have our colleague, Representative Carolyn Maloney

of New York, join us here today. Representative Maloney has shown an interest in

the Federal royalty program for several years now. Her insights and comments will

undoubtedly be of great value to the Subcommittee.

The question of whether the Federal Government should take its oil and gas royalties ‘‘in kind’’ presents many interesting possibilities. Of course, we are interested

in any option that purports to improve services at reduced cost.

We share the Chair’s interest in developing more simple, certain and efficient

methods of collecting oil and gas royalties. We are pleased to learn that a group of

the independent oil and gas producers, through their trade associations, is working

together to develop a royalty-in-kind proposal. Just as we are pleased that the Minerals Management Service, under the able leadership of Ms. Cynthia Quarterman,

is aggressively examining the question. The oil-producing States, too, have a valuable role to play in this discussion.

However, it is a bit unsettling to hear—after aggressive lobbying by the States

and oil and gas industry officials—and over the initial objections of the Minerals

Management Service—that the Royalty Fairness and Simplification Act of 1996 that

was signed by President Clinton just 1 year ago—should be cast aside along with

the improvements made to the royalty management program and replaced with an

‘‘in-kind’’ marketing program. This is almost a one-hundred and eighty degree turn

from what the oil industry and states were clamoring for during the last Congress.

To a certain degree, I am being facetious. However, our experience with the ‘‘Royalty Fairness’’ Act illustrates an important factor to bear in mind.
5

We must all be very cautious and extremely deliberative in our consideration of

the radical idea of replacing the traditional ‘‘in value’’ royalty payment with a ‘‘royalty-in-kind’’ program.

The Federal Government is the largest single owner of oil and gas resources in

the U.S. What would be the consequence of changing the Federal role from royalty

collector to oil and marketer?

What safeguards would be necessary to assure that the taxpayers would receive

their ‘‘fair share’’ from the development of our Nation’s oil and gas resources?

Have we adequately considered the consequences of enabling the Federal Government to dictate market price by virtue of its market power?

How would the various segments of the oil and gas industry respond to having

the Federal Government in the oil business?

We must know the answers to these and other critical questions before we set

about writing and considering legislation.

Because, clearly, if not handled correctly, a U.S. royalty-in-kind program could seriously disrupt the domestic petroleum market. So, we must move slowly and carefully to fully examine this idea.

We have a great deal of research and analysis to do before we can say with any

degree of certainty that ‘‘royalty in kind’’ is better than ‘‘in value royalty.’’ And,

there are others beyond those distinguished witnesses here today from whom we

should hear. For instance, none of the major oil and gas corporations are on the witness list today. I hope we will gain the benefit of their views at the next hearing

in September when we will also hear from witnesses invited at the Minority’s request.

‘‘Royalty in kind’’ does offer interesting possibilities, but, it is no panacea to problems encountered with the current ‘‘in-value’’ royalty program. Suggesting any specific, mandatory change to the Federal royalty management program is premature.

Only after much additional study and experience—which MMS can gain through its

ongoing efforts—and we in Congress can gain through additional oversight hearings—can the Subcommittee begin to consider what, if any, changes are necessary

to the authorizing statutes.

With that message of caution, I join the Chair in welcoming our witnesses today.

Mrs. CUBIN. Thank you. And now for our first witness, Mrs.

Maloney, the Representative from New York. Welcome.

STATEMENT OF HON. CAROLYN MALONEY, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK

Mrs. MALONEY. Thank you very much, Madam Chairwoman, and

other members of the Subcommittee. I appreciate very much the

opportunity to testify today. I would like to request that my entire

testimony be put in the record as whole, but I have a very, very

brief synopsis of it.

The American taxpayer has lost out on nearly $2 billion in unpaid oil royalties since 1980. I appreciate very much the efforts on

the part of the Department of the Interior and the Department of

Justice toward correcting this debt. However, I do not believe that

collecting royalties-in-kind will serve taxpayers well or the Federal

Government.

Let me bring you up to date very, very briefly on the oil royalty

situation. Last year, it came to the attention of the House Subcommittee on Government Management, Information, and Technology, on which I serve, that several oil companies had significantly underpaid their Federal oil royalties. The information came

through the Department of Interior’s Task Force on California

Valuation.

The task force revealed that the royalties paid were much, much

lower than they should have been because they were based on the

posted price of the oil rather than the real economic value of the

oil. The states who lost out in the undervaluation are pursuing

their losses. The State of California won a $345 million settlement
6

from major oil companies. Alaska, Texas, Alabama, New Mexico,

and Louisiana have also won settlements.

The Department of Interior and the Department of Justice are

both investigating the undervaluation reports. The Department of

Interior has issued bills for $440 million in unpaid royalties. And

the Department of Interior has proposed regulations on Federal oil

royalty valuation, which bases the price of oil royalties on the New

York Mercantile Exchange market price and the Alaskan North

Slope spot prices, which is a standard oil price that the oil companies use.

This came out in the task force report from the Department of

Interior, and this is the basis of price for the oil companies. If it

is the basis of price for the oil companies, it should be the basis

of price for the Federal Government. Here is the key. Those proposed new regulations would bring in an additional $100 million

annually. It is money that is owed to the American people and to

the Federal Government.

As you know, the industry is interested in a substitute system.

They would prefer to pay the royalties-in-kind. Such a deal would

force the Federal Government into the oil business, and it would

cost the citizens, the taxpayers money.

Here is what would happen under an in-kind system. Oil companies hand over oil as payment. The Minerals Management Service

then contracts out to marketers. The marketers then sell to refiners. The profits from the oil are partially eaten up in paying the

marketing costs, and American citizens and the Federal Government get jipped. It simply costs the government too much to get rid

of the oil.

Let me give you one example of how this might work. I see that

Devon Energy is here to testify today as an oil producer. But what

you all might not know is that Devon Energy is also a marketing

corporation. The royalty-in-kind proposal gives a company like

Devon the option of paying the government its royalties in oil, then

being paid by the government to market it.

I don’t mean to single out Devon Energy, which is an outstanding company. These practices are quite common in the industry, but they seem downright unfair when oil companies are making money at the expense of hardworking taxpayers.

You have heard and will hear today that the MMS, Minerals

Management Service, has changed. You will hear that it is making

sincere efforts to change its valuation rules to assure the collection

of real value. You will hear that it is working to correct the flaws

in its current royalty-in-kind program and to expand and improve

that system.

Despite the progress, I don’t believe the Federal Government has

any business playing J. R. Ewing from the old Dallas television series. The Interior Department does not have the culture, the incentives, or the equipment to become an effective competitor. There

are $4 billion in revenues at risk. I encourage other reforms of the

Royalty Management Program.

Earlier this year, I introduced the Royalty Collection Reform Act,

which would move the program from the Department of Interior to

the Department of Treasury to better ensure the collection of
7

money. I believe this is a better solution than shortchanging taxpayers to the advantage of the oil industry.

I would just like to add that last year an important bill was

passed out of Congressman Horn’s Subcommittee on Government

Management and Technology, and I worked very closely with him

on this reform. And I just mention it because it is similar in a

sense. We did a study that showed $55 billion was owed the Federal Government in loans, fines, fees—this is how we started looking at the royalties—and royalties.

And one of the things that we did to modernize collection is to

move collections to a centralized collector whose purpose and focus

is collecting money, the Department of the Treasury. For example,

the Education Department had many loans that they weren’t collecting, but their prime focus and purpose is to educate, not to collect money.

And so if you put it into a collector’s hands after a certain period

of time where the central agency tries to collect, then they will

focus on collecting it as their prime and main mission. So I just

mention it. And according to the Department of Treasury, our bill

has brought in roughly—they estimate will bring in $10 billion over

the next five years.

I would like to put three graphs into the record if I could that

point out simply the proposals. This is the royalty-in-kind proposal

and the new regulations that MMS has put into effect. The new

regulations that they are calling for would have the government

royalty based on the market price, which is the price that the oil

companies pay.

If it is good enough for private sector, why shouldn’t it be good

enough for government. The royalty-in-kind proposal will have the

government royalty—the market price could be diminished by the

marketing expenses and other expenses that may be involved.

This is a graph of how an oil company—many of our large oil

companies are integrated and formed. They have a production affiliate, a marketing affiliate, a transportation affiliate, and a refining

affiliate. And so there could be built-in costs before we would get

the real revenue. It is much simpler to just get the market price.

And, again, I give the current system, which is very simple. You

have the oil. You have the market price. You have MMS collecting

the market price for the government’s oil. Under the royalty-inkind, you would have MMS becoming hugely involved in marketing

to various contractors, to various oil refineries, and there will be

a lot of government cost and expense.

And it seems to me as we are working, as we speak on the floor

jointly in a bipartisan way to balance the budget and to invest in

values and really run government more efficiently that the more efficient way to collect oil royalties is with the market price, the market price that, in fact, serves the private sector. And I thank you,

and I tried to be brief, and I——

Mrs. CUBIN. And you did a good job.

Mrs. MALONEY. [continuing] would like to put this in the record.

Mrs. CUBIN. Without objection.

Mrs. MALONEY. And if there are any questions, I would love to

answer them. In any event, I look forward to working with you.

[Prepared statement of Mrs. Maloney follows:]
8

STATEMENT OF HON. CAROLYN B. MALONEY, A REPRESENTATIVE IN CONGRESS FROM

THE STATE OF NEW YORK

Thank you Madam Chairman and Members of the Subcommittee.

Background

Last year, in a hearing of the House Subcommittee on Government Management,

Information, and Technology, the Subcommittee discussed the findings of the Department of Interior’s Interagency Task Force on California oil valuation at great

length. According to the report, major oil companies underpaid Federal royalties by

posting the price of oil below the real economic value of the oil which the companies

determined to be the Alaskan North Slope (ANS) spot price.

On September 24, the Committee on Government Reform and Oversight released

a report entitled, ‘‘Crude Oil Undervaluation: The Ineffective Response of the Minerals Management Service.’’ This report contains three findings that pertain to this

hearing: 1) the Federal Government has received oil royalties below market value,

2) the oil undervaluation problem exists nationwide, and 3) the MMS royalty in kind

program may have left Federal financial interests unprotected.

Since the release of the Task Force and the Committee report, the Department

of Interior (DOI) has proposed new regulations on Federal oil royalty valuation

which bases the price of Federal oil royalties the New York Mercantile Exchange

(NYMEX) market price and the Alaskan North Slope (ANS) spot price.

Royalty In Kind

As you know, MMS’ proposed regulations have produced voluminous comments,

especially from industry. A surprising theme repeated throughout the industry comments on Interior’s proposal is that the Department should cease collecting royalties

in value and take its production in kind, meaning the Federal Government should

enter the oil business.

Compare this to the arguments we heard last year in support of the sale of the

Elk-Hills Naval Petroleum Reserve. In managing that Reserve, the Department of

Energy sold Federal oil. But last year, many of these same industry advocates were

arguing that the Department of Energy, as a government entity, simply had no

place in the oil business. But today, they urge us to force the Department of the

Interior to enter the market on a scale that would eclipse, by several fold, the DOE’s

Elk Hills program.

It was only last year that this Congress passed into law, the Federal Oil and Gas

Royalty Simplification and Fairness Act. This legislation imposed new requirements

on the Department of Interior to follow in the collection of royalties. As I understand

it, the Minerals Management Service has yet to fully implement these requirements

which has caused a flurry of rulemakings, task force groups and other re-direction

of resources. Now industry is advocating even more drastic changes—changes, which

if implemented in full would essentially scrap these recent reforms.

I believe the real impetus behind industry’s royalty in kind push is to avoid paying oil royalties based on market price as suggested in the new proposed oil valuation regulations.

Forcing the government to take the royalty in kind will trap the government in

the very posted price system that does not reflect value. Industry believes that bidding the production out at the lease will safeguard the public’s revenue interest

against posted prices. However, if the real independent producers cannot obtain

market value, how can the Federal Government? The fact is that those that could

purchase at the lease—the major integrated companies—have an interest in getting

access to cheap oil. And those others that more typically participate—brokers and

marketers—would not survive if they could not profit from the difference between

posted price and real value.

Industry also suggests that MMS use marketing middlemen to sell the government’s in kind production. This Subcommittee is fortunate to have oil marketers before it today, and I would urge you to question them closely about how use of marketing middlemen would protect the public’s revenue interest.

For example, Devon Energy, which is here to testify in support of a government

royalty in kind program, is not only a producer, but a marketer through its subsidiary, Devon Marketing Corporation. Devon’s SEC filings indicate that its marketing affiliate has purchased over 80 percent of its production from third parties

over the last few years. Logically, it is thus a potential purchaser of the government’s royalty in kind production. Those same documents indicate that Devon Marketing purchases third party oil production at the field postings and resells it at a

premium over posting.

I do not mean to single out Devon Energy. As I understand it, the practices of

its marketing affiliate are common.
9

But as potential purchasers of the government’s in kind production, I would urge

the Subcommittee to ask these industry marketers the following questions. Would

you follow your normal practice of purchasing product at the posted price for in kind

production? And, if not, what percentage of the premium received by your marketing

affiliate would you share with the Federal Government and what would you keep

as a ‘‘marketing fee’’?

My concern is simple. In the past, MMS operated its royalty in kind program as

a source of cheap oil for independent refiners. The current proposals suggest that

the economic advantage of cheap government oil will simply be transferred from

small refiners to marketers. Under either scenario, the public’s revenue interests

are left out of the equation.

I have also heard repeatedly from industry that MMS simply has no understanding of the crude oil market. If it is true that MMS’ knowledge lags the market,

how can we hope to assure that MMS will on a timely basis be able to evaluate

the performance of its marketing agents? And, if it does take five, 10 years for MMS

to catch up, as we have seen in the past, what protection will exist that the public

will not be short-changed?

In referring back to Interior’s task force report, our Committee found example

after example of how oil companies were very successful in losing MMS auditors in

a maze of oil transactions. Let me quote from the report:

On Page 18, the report states, ‘‘Most oil from Federal oil and gas leases is produced by integrated companies that transfer production from their production arm

to a trading or refining arm. After this initial non-arm’s-length transfer, oil produced from Federal leases loses its identity in companies’ accounting systems so

that its price in subsequent transfers cannot usually be determined.

And on Page 49-50, the report says, ‘‘After transferring Federal crude of a specific

type to a company’s trading division, the distinction between Federal and non-Federal crude oil was lost. Federal crude oil was not specifically invoiced in companies’

records after internal transfers, so it is unlikely that gross proceeds in excess of

posted prices can be traced to the production of specific Federal leases.’’

As much as I admire the efforts of the Secretary to make improvements to Interior’s Royalty Management Program, I believe the major oil companies have and can

continue to bury the Royalty Management Program audit teams in a maze of company trading transactions. Furthermore, the oil companies have made no secret of

their desire to use legal roadblocks and endless appeals to prevent the release of

their affiliate’s records. That’s why I believe that using spot prices like the ANS and

NYMEX is by far the most efficient, accurate and least bureaucratic method to

value royalty on.

Conclusion

You have heard and will hear today that MMS has changed. It is making efforts

to change its valuation rules to assure the collection of real value, and I applaud

those actions.

But, despite this progress, I simply not believe that the Federal Government

should enter the oil business. The Interior Department does not have the culture,

the incentives, or the equipment to become an effective competitor. Congress should

not risk $4 billion in revenues by forcing MMS to try and recreate itself into something that in reality it cannot effectively become.

Reform at MMS is possible. I too have called for further reforms of the Royalty

Management Program. I have introduced the Royalty Collection Reform Act, which

would move royalty collection to the Department of Treasury’s Financial Management Service (FMS) to better insure that funds owed the government are collected.

FMS can collect Federal royalties accurately without the need for a full blown oil

royalty in kind program.

Thank you.

[Graphs follow:]
10
11
12
13

Mrs. CUBIN. Thank you. I do have just a couple questions. First

of all, I know that you know this, but just for the record, when Federal minerals are produced in a state, then the state shares in the

royalties at 50 percent.

And so before I came up here today, I think want to say this because I want you to understand—not just you but everyone to understand—how not only do I think it is the right thing to do to collect the appropriate penny of the appropriate amount—every single

penny that is owed to the government in royalties, but it is also

for every constituent in my state.

Because I went back and looked up the data published by MMS

on all the royalties collected from Federal leases within each state

since the advent of the Mineral Leasing Act, and it may surprise

you to learn this that New York has had natural gas production

from Federal mineral estate totaling $54,327 in royalties from 1920

through 1995.

Now, let us compare that with the total of royalties paid into the

Treasury from the Federal leases in Wyoming over the same period

of time. According to MMS, over $6,680,000 of royalties were paid

from Wyoming, and so, obviously, our schools and our communities,

our highways—it is very important to me that we get every single

penny to which we are entitled. And we agree very strongly on

that.

There may be some disagreement. I think that is yet to be told.

But I want to ask you this question. Did your graphs show the

amount of money that the Federal Government spends on litigation, on enforcement, and audits, and all of those kind of things—

expenses that go into the current collection process?

Mrs. MALONEY. Well, we hope the regulations will fix some of

that. My graphs had no numbers on them at all. And as you know,

their new regulations greatly simplify their collections process, projecting to collect on the Alaskan North Slope prices and the New

York Mercantile Exchange, as opposed to the posted prices.

I would think that moving to that system would cut out a lot of

litigation just by common sense, that there is nothing to litigate.

I mean, it is very clear. Here is the price that the private sector

pays. Here is the price that the government pays. It is the same.

Mrs. CUBIN. Well, unfortunately, it really isn’t that simple. I live

right in the middle of an oil and gas field, and the problem that

I see at this point in time with the proposed rule is that what this

rule will do is move the point of valuation farther from the wellhead or from the border of the lease.

And so that the price then will include some beneficiation rather

than the actual price at the wellhead, and that is where the tax

ought to be assessed, in my opinion. You said that $51 billion or

$55 billion is owed in uncollected royalties. Is that correct?

Mrs. MALONEY. That was to illustrate centralizing collections in

the Treasury. This report that we did was one of 100 agencies

where they reported back what was owed to them, and this was not

just an oil report. This was all that was owed the Federal Government in uncollected——

Mrs. CUBIN. In minerals?

Mrs. MALONEY. No, no, no, in everything.

Mrs. CUBIN. Oh, OK.
14

Mrs. MALONEY. In everything—education, agricultural loans,

small business loans, loans, fines, fees, royalties, and other areas.

This was what was owed to the Federal Government that was not

collected. And Congressman Horn and I put in a bill to improve collections, not just for royalties but across the government, that modernized it, simplified it, and, very importantly, put collections in

one office whose mission it was and focus was to bring revenue into

the Federal Government.

Mrs. CUBIN. Thank you.

Mrs. MALONEY. And that has helped bring in—in fact, we are

working on our second report, and I will be glad to share it with

you with Mr. Horn of what has come in since our bill went into effect. But the Treasury projects that having done what we did, centralizing collections in Treasury, will improve collections across our

government by they said $10 billion in 5 years. That is a lot of

schoolteachers. That is a lot of police officers. That is a lot of investment in the interior and other things in our parks that we

need money for.

I just mentioned that as a way of possibly improving collections

instead of having the Department of Interior that has so many important responsibilities to possibly let the Treasury Department,

which is collecting now across government, likewise collect royalties. Maybe that is another issue maybe that is not just in-kind,

but I just brought it up since it had been successful in bringing in

revenue. And that is one of the focuses of the in-kind hearing that

you are having now, to bring in the revenue. In any event, I appreciate your time and of all the members here.

Mrs. CUBIN. Thank you. Did you have any questions, Mr.

Barcelo ́?

Mr. ROMERO-BARCELO ́. First of all, I would like to thank Mrs.

Maloney for her testimony and for being here with us——

Mrs. MALONEY. Thank you, Governor.

Mr. ROMERO-BARCELO ́. [continuing] and helping us and educating us. She knows more about this problem than I do. I am just

beginning to learn about it. But, Madam Chair, I would like to suggest that we ask for the Administration to give us an estimate on

the cost of litigation for the collection of the——

Mrs. CUBIN. Certainly.

Mr. ROMERO-BARCELO ́. OK. Thank you. Thank you, Madam

Chair. And I just have a couple of questions for Mrs. Maloney. Do

you know what has been the experience in those countries like

Venezuela and Mexico where the government is involved in the

business of marketing oil?

Mrs. MALONEY. I have not studied those countries. I could look

at it and get back to you.

Mr. ROMERO-BARCELO ́. Well, the experience is very, very, very

bad for those countries. I mention that because everywhere that

the government gets involved in something that is capitalistic as

marketing, they are never successful.

So if that is an option, this will be analyzed from all angles because it is very—as I said, the experience that we have had also

in Puerto Rico has been a very bad experience. What they had in

England and other countries has also been very bad when the government gets involved in selling goods or services.
15

The other thing I would like to ask you, Mrs. Maloney, is have

you been in touch with the Secretary of the Treasury or with anyone in the Federal Management Service about how they would go

about it and whether they would be interested in handling the

services of collecting the royalties?

Mrs. MALONEY. Absolutely. I have talked several times with Cynthia Quarterman and also with Secretary Babbitt, and I applaud

the Administration. They really appointed a task force that came

forward with the first government report that showed the undervaluation and took steps to correct it. And I think that they have

been innovative, and they have worked very hard on it, and that

they have done something constructively to correct a problem. And

I applaud them for their efforts.

Mr. ROMERO-BARCELO ́. I am talking about the suggestion that

you made that the collection of royalties be delegated to the Department of Treasury, not the Interior.

Mrs. MALONEY. I have talked to Treasury officials, but I have not

met with the Secretary, and I will try to meet with the Secretary

and discuss it with him and see what his viewpoints are on it. And

I put forward the proposal only with the deepest respect of the Department of Interior and the fine job that they are doing but in

probably helping with the management.

What we are doing across government is each agency will have

6 months to collect what is owed to them. Then it moves to the Department of Treasury where they then centralize it and try to bring

it in through a centralized method, which has been working very

well.

Mr. ROMERO-BARCELO ́. I just asked that question because the

idea to me seems very good because, obviously, the Treasury Department is much more trained to collect any kind of taxes or royalties than anybody else in the government. So——

Mrs. MALONEY. I think that a lot of times in government we are

very shortstaffed, and we don’t have enough time or energy or personnel to do all the many things that we need to do. And a lot of

times your main focus is that of your main purpose which in the

Department of Interior is our resources, our parks, our minerals,

our oils, and not necessarily the management.

And perhaps that would be a way, but I would, you know, of

course, want to work with Secretary Babbitt. I think he has done

an absolutely extraordinary job, and I might add that even though

there have been published reports about undervaluation of oil for

many, many years, this was the first time the Department of Interior appointed a task force, issued a report, then acted on the report’s recommendations constructively to correct it.

And I think they have done—I think that I am going to recommend them for one of Vice President Gore’s—what are they—the

Hammer Awards for government employees who do a good job because I think they have done a wonderful job with those.

Mr. ROMERO-BARCELO ́. Thank you, Mrs. Maloney.

Mrs. MALONEY. Thank you.

Mrs. CUBIN. Mr. Thornberry, did you have—Mr. Brady? Mr.

Dooley?

Mr. DOOLEY. Yes. Mrs. Maloney, before you leave, I just wanted

to ask one question. I appreciate all the work you have done.
16

Mrs. MALONEY. The last time I saw you you were on the floor.

Mr. DOOLEY. I know it.

Mrs. MALONEY. Now, you are back up here. I think when I left

my office you were on the floor giving a good speech.

Mr. DOOLEY. That is right. But, you know, a lot of it is appreciated—a lot of the work that you have done in terms of ensuring

that taxpayers are getting their fair share of the royalties. I guess

I come at this representing a lot of independent producers, and we

are a little bit concerned with some of the proposals in terms of

how are we going to ensure that the price is going to be reflective

of the real price if they are being paid for their product.

And as I was reading your testimony, I was somewhat struck because it seems like there is one sentence in your testimony that almost expresses a similar concern, and when you were talking about

how the in-kind will be difficult because you are concerned you will

not be able to safeguard the public’s revenue interest against posted prices, you go on to say, however, if the real independent producers cannot obtain market value, how can the Federal Government.

And my concern is is you are making a statement there that

independent producers are not necessarily receiving what will be

the fair market value, which MMS and I think which you are proposing will be reflected by an ANS price if you are from California,

as I am. And some of us are not convinced that that is actually

going to occur. In your statement, you state that they are not receiving that now.

Now, I hope that you are sensitive as we try to move forward,

you know, to make sure that that price of which the independents

are going to be paid on for their royalties are going to be a function

of is, in fact, the price that they are receiving for the oil. And do

you acknowledge—is this a problem? I mean, it seems to be as you

have stated in your testimony.

Mrs. MALONEY. I agree absolutely, completely, Congressman,

and, in fact, many independent producers have written my office

and actually have come by personally to see me in support of the

work of the Subcommittee on the valuation of oil.

Mr. DOOLEY. So would that mean that you would then be opposed to what MMS is proposing in terms of using a benchmark

at ANS for independent producers?

Mrs. MALONEY. No. I think that you need to—the independent

producers want the true value of the oil. Right? And that is the

value that we want, which is the——

Mr. DOOLEY. They want to pay royalties on the price of the oil—

on what they are being paid for the oil that they are selling?

Mrs. MALONEY. Right, exactly, exactly.

Mr. DOOLEY. Well, what you are saying in your testimony is that

sometimes they are not receiving what the fair market price is and

which we are assuming that what MMS is proposing is that the

fair market price will either be a New York Exchange price or an

ANS price?

Mrs. MALONEY. Yes.

Mr. DOOLEY. And so, you know, my concern is if you are acknowledging they are not getting paid that fair price now, we are
17

going to implement a system which is going to ensure that they are

paying higher royalties than what they should.

Mrs. MALONEY. Well, we should separate the independents from

the majors in the regulations.

Mr. DOOLEY. Thank you.

Mrs. MALONEY. But, you know, what we looked at in our committee which was getting the best price for the American taxpayer.

And the task force showed that the price that the oil companies

themselves were paying was Alaska North Slope in the case of

California, or the New York Mercantile Exchange for the others. I

am not an expert on the oil industry. We were not looking at it except for in a management role, which is the role of the committee.

I do know that several independent producers from California

and other states came to my office in support of having a system

that was not posted prices but, in fact, Alaska North Slope. So they

did, you know, support that work. And whatever their concerns

are, I would like to listen to them even more.

But in terms of the work of the committee and the reports coming out of MMS and the proposed system that MMS has suggested

in the regulations, the ones that came to my office were totally supportive of it. Now, if there are other independent producers who

have a different problem, I am not aware of it.

And as you pointed out, I don’t represent an oil state. I was not

coming at it from a state interest. I was coming at it from the purpose of the committee on which I serve, which is better management of government resources and reports that come forward that

oil is greatly undervalued and that California, Wyoming, and others—in fact, it was California that the whole issue really highlighted out of the collection system of the State of California.

Mr. DOOLEY. Well, I think most of the independents or representatives of their associations have come out in opposition and expressing some real concerns about the valuation process; at least

that is what the associations are communicating to me. The other

point I would make is——

Mrs. MALONEY. What is their problem with the valuation process?

Mr. DOOLEY. Well, precisely what you said in your testimony. I

mean, what you stated in your testimony was, however, if the real

independent producers cannot obtain market value, how can the

Federal Government. You have made a statement that independent

producers are not obtaining fair market value. What MMS is proposing is that fair market value can be determined by an ANS

benchmark. And you have already acknowledged that that is not

happening.

And so my concern is that you are stating in your testimony that

my guys, my independent producers are going to be paying a higher royalty than what they should based on what they are receiving

for the oil that they are producing, and that to me is an inequity

that we need to be concerned about.

Mrs. MALONEY. We agree some of the independents feel that the

majors give them an inequity, but, again, we were acting on the report of the task force that said the majors—and the task force report focused on majors, not the independents—said that the major

oil companies—10 to be exact—were basing their prices internally
18

on Alaskan North Slope and the New York Mercantile Exchange,

and that the posted prices were much lower than those two standards.

If independents—you know, maybe there should be separate regulations for the independents given the specific problems that the

independent oil companies have. And I would like to go back and

meet with some independent oil companies and become more aware

of their particular problems.

But, as I said, you know, I am not the Department of Interior.

We were looking at a report that oil was greatly undervalued, and

we acted on it. But you raised an important point, and I agree with

the great Congressman from the great State of California, which

actually brought this attention to the national level in the first

place.

Mr. THORNBERRY. [presiding] Mr. John, you have something?

Mr. JOHN. Yes. I don’t particularly have a question for the

gentlelady from New York, but with the pleasure and the OK of

the Chairman, I would like to make just a little observation, a little

statement about the importance of this issue.

Being from Louisiana, oil and gas industry is very, very impor- tant. As I served in the legislature, $1 billion in royalties is part

of the Louisiana budget for the State of Louisiana. So this issue is

very, very important.

And, moreover, than just the State of Louisiana, my district,

which sits on the Gulf of Mexico and bordered by the State of

Texas, is what I like to call the heartbeat of the offshore oil and

gas industry of the Upper Gulf of Mexico. So this issue is very important and very vital to my constituency, the oil and gas industry,

and the taxpayers of the State of Louisiana.

I think we must keep in mind as we go through these proceedings that I believe the bottom line, and to make it as simple

possible, is that we need to look at the cost associated with the proposed system and the systems already in place. What does it cost

MMS now to evaluate the problems that are caused, and what is

the value? Is it wellhead or is it whatever? Or what is it going to

cost to revamp a collections agency to go toward the in-kind.

So I think if we keep that in mind, that is the ultimate decision

that this Committee is going to have to do and decide upon. So I

just wanted to make a statement that it is very, very important to

my district in my State of Louisiana. And I thank the Chairman

of the Committee for holding these hearings. Thanks.

Mrs. MALONEY. Well, I thank you. And many of the attorney generals of the states that many of you represent that are oil-producing states have been in contact with our offices and the central

committee, most of whom are supportive of our efforts to revamp

the system.

Mr. JOHN. Well, this issue, like many others, has its proponents

and opponents, but I am anxious to hear the gentlemen from the—

or the testimony from the State of Texas that actually has an inkind program in the state on state waters and state lands to see

how it is working. I think I am interested in hearing that testimony. Thanks.

Mrs. MALONEY. Well, I look forward to reading about it too.

Thank you very much. I appreciate your time.
19

Mr. THORNBERRY. Mrs. Maloney, thank you for your testimony.

And certainly if your schedule permits, we would certainly invite

you to stay and sit up on the dais and listen to the testimony from

the State of Texas where they have had such a program since 1973.

I think it would be helpful for everyone.

We would call the next panel now; Jim Magagna, Director, Office

of State Lands and Investments, Office of Federal Land Policy,

State of Wyoming; Spencer Reid, Deputy Land Commissioner,

Texas General Land Office; and David Darouse, Mineral Revenue

Regional Auditor Supervisor, Department of Natural Resources,

from Baton Rouge, Louisiana.

Gentlemen, we appreciate each of you being here today and willing to share your perspectives with us on this issue. Mr. Reid, we

will let you start, and we will just go down the line from our right

to left.

STATEMENT OF SPENCER REID, DEPUTY LAND

COMMISSIONER, TEXAS GENERAL LAND OFFICE

Mr. REID. Mr. Chairman and members, Texas Land Commissioner Garry Mauro appreciates the invitation to appear before the

Subcommittee today and to discuss the Texas royalty-in-kind program and regrets that he is unable to personally attend, and he

has asked that I speak on his behalf.

One thing I would like to point out is we were asked to bring

comments about our experience with our program, and these comments are not intended to address any particular proposals that

are pending. We haven’t addressed anything in here like that.

We have been very pleased with the results of our in-kind programs and are glad to share this information. While royalty-in-kind

may not cure all of the disputes that arise between royalty owners

and producers, our experience in Texas has been that it does provide a means to substantially reduce royalty disputes, valuation

disputes particularly, reduce costs to both the states and the lessee,

and provide the royalty owner with an opportunity to obtain an enhanced return.

For those of you not familiar with the Texas General Land Office, it is headed by an elected state official. The principal duty he

has is to manage 20 million acres of state lands of which about 15

million have minerals under them, of that about 5 million is offshore of Texas either in the Gulf of Mexico or in the various bays

of the state.

And all of the land there is dedicated to the Permanent School

Fund or one of the Permanent University Funds. The Permanent

School Fund last year—the General Land Office deposited about

$155 million, which I know in Federal standards isn’t a lot of

money, but for Texas that has allowed us to build on a fund now

approaching $14 billion for support of public education in Texas.

There is also the Permanent University Fund in Texas that has

another—it has got over $5 billion that is operated by the University of Texas. It has a lot of land out on Permanent Basin. As to

the relative size of our production, we have about 33 billion cubic

feet of natural gas, which if Texas were a producer in its own right

would put us in probably the top 50 producers in the country.
20

The Texas program has been going on for about 14 years. It has

accelerated in the recent years. Over that time, we have enhanced

our income to the Permanent School Fund by $11 million in gas

and $5 million in oil. And another component of the state program

which is something that really is kind of the gist of our program,

we save state agencies in Texas over $90 million over that same

period of time in energy costs by selling them state gas from state

leases directly to state consumers.

Our in-kind program originated in the early 70’s. The legislature

passed the first statutory authorization for the program in 1973.

From then until the early 80’s, we took relatively small volumes of

gas and sold them in the marketplace just like a marketer.

In 1983, we began marketing gas directly to end-users, and by

the end of 1985, it was expanded to include state agencies. This expanded programs concentrated on sales to agencies, universities,

and public facilities. The goals of the program were twofold: first,

to generate more revenue to the Permanent School Fund and to

save money for the state agencies.

The Texas legislature has consistently supported the program

and in recent years has enacted laws that assured the smooth operation of the state program. Any state agency contract for over 100

Mcf of gas per day must be submitted to the General Land Office

to see if we can provide state gas and get them a better price. And

then we are able to transport gas and gas utility lines. They are

prohibited from—well, they are required to carry state gas if they

have capacity if it is destined for a state agency.

In addition to the natural gas in-kind program, the Land Office

takes approximately 2,400 barrels of oil per day and sells it inkind. That is 45 percent of our total production, our total royalty

share. The oil is sold under 6-month contracts at bid sales. Prices

are bid at premiums to posted prices, and at the last sale in April,

the premium was as high as $2.08 over the commonly used posting.

Last fiscal year, the gas program sold approximately 9.1 Bcf to

state agencies and 2.6 Bcf were sold on the spot market. Our total

gas sales represent about 35 percent of our total production—our

total royalty share, let us say. Our spot market sales assure that

adequate supplies have been retained to meet our state end-user

program. Gas is currently being taken in-kind from 105 leases, almost all of them offshore.

The contracts are in place with 103 state facilities, 28 state colleges and universities, and six other governmental bodies, including school districts, small cities. Transportation contracts are currently maintained with 35 different pipeline companies and local

gas distribution companies. And we maintain a contract for up to

one Bcf of gas storage in a facility near Houston.

Sales of gas on the spot market are sold through monthly solicitations of interest from prequalified gas marketers. We currently

have about seven marketers that bid on this. In order to qualify,

marketers must show financial stability. But in order to encourage

small business participation, the Land Office maintains a credit

risk insurance for those contracts.

Since 1973, all state oil and gas leases have provided for the

right of the state to take royalty-in-kind upon 60 days’ notice of our
21

intent to do so. On some leases, we have been able to negotiate inkind those that were issued prior to 1973.

Once we have exercised our right to take-in-kind for a particular

lease, we make every effort to continue to take gas from the lease

in order not to burden the lessee by alternately taking and not taking. We do have the authority to not take. We generally take possession at the point in which it has been made ready for sale or

commercial use through the removal of water, natural gas liquids,

and impurities.

Costs of transportation and other direct costs, together with the

markup or enhancement, which is what the additional royalty paid

the school funds is termed, and a set administrative fee that pays

for our operating costs of the program are charged to the gas purchasers—the end-user purchasers.

In all but a few cases, prices to the end-user agency are below

those available from private sources and are lower than local utility costs in almost every instance.

We make a decision at every sale and the local—the agency is

authorized to not buy from us if it is going to cost them money.

Gas and oil producers on state lands have almost been uniformly

supportive of both the gas and oil in-kind programs. We don’t have

specific figures on the administrative savings and other benefits,

but they are undoubtedly there. It is a lot easier to account for volumes of oil or gas physically delivered than to account for both volumes delivered and the market value of those volumes.

Delivering in-kind relieves the producer of the obligation to account for the market value of the gas and relieves the Land Office

from the burden of conducting the financial audits of producers.

Once accurate delivery is established, the producer no longer needs

to be concerned state auditors will dispute the value that they received.

Our programs are so successful we are looking at privatization

of our programs or bringing in a gas marketing firm. We put out

a RFP last summer. We have gone through the process and got

down to the company that we are negotiating final contract with.

The contract provisions provide that we are negotiating for an

expansion of our end-user program. They will take a three cents fee

for doing that activity. And then the balance of it, if we have overages, essentially works out to a gas sales contract indexed to a

pipeline.

I will close by just saying that Texas is very interested in a way

to obtain its share of Federal royalties that were paid in-kind. Volume is the name of the game in this business, and we would be

very anxious to work with Congress and Interior staff to see if a

way can be worked out to do that.

[Prepared statement of Mr. Reid follows:]

STATEMENT OF SPENCER REID, DEPUTY LAND COMMISSIONER, TEXAS GENERAL LAND

OFFICE

Ms. Chairman and Members:

Texas Land Commissioner Garry Mauro appreciates the invitation to appear before you to discuss the Texas royalty in-kind program, and regrets that he is unable

to be here. He has asked that I speak on his behalf.

The Land Office has been pleased with the results of our in-kind programs and

are glad to share information about them with you. While royalty in kind may not

cure all of the disputes that arise between royalty owners and producers, our experi-
22

ence in Texas is that it does provide a means to substantially reduce royalty disputes, reduce costs to both the State and the lessee, and provide the royalty owner

an opportunity to obtain an enhanced return.

For those of you not familiar with the General Land Office, please allow me to

briefly explain our role. The Land Commissioner, who heads our agency, is an elected official. One of his main duties is to manage the more than 20 million acres of

public lands and minerals owned by the various Texas government departments,

most prominently, the Permanent School Fund, a trust fund that supports public

education in Texas. In the fiscal year ending August 31, 1996, $155 million were

deposited in the Permanent School Fund, which, although not large by Federal

standards, has nonetheless allowed Texas to create a school endowment worth over

fourteen billion dollars. The State’s Permanent University Fund, which is similarly

structured, is valued at over five billion dollars. As to the relative size of State production, the approximately 33 billion cubic feet of natural gas that represents our

annual royalty share would rank the School Fund in the top 50 of the largest producers of natural gas in the United States.

Over the past fourteen years, the Texas in-kind program has enhanced royalty in- come for our Permanent School Fund by over $11 million in gas royalty and $5.1

million in oil royalty, saved State agencies over $90 million in gas utility bills, and

saved untold thousands of dollars for the General Land Office and oil and gas producers by eliminating the need for financial accounting for royalty volumes of oil

and gas taken in-kind. The program’s past success has led me to seek to expand

the program through a new public private alliance that I will describe for you in

a few minutes.

The Texas in-kind program originated in the early 1970’s. The Texas Legislature

passed the first statutory authorization for the in-kind program in 1973. From then

until the early 1980’s, relatively small volumes of gas were sold in the market to

obtain better prices than were being paid in cash royalties. In 1983, the General

Land Office began marketing gas directly to end-users and by the end of 1985, the

program was expanded to include State agencies.

This expanded program has concentrated on sales to State agencies, universities,

and other public facilities. The goals of the program are twofold—first, to enhance

income to the Permanent School Fund, the principal beneficiary of State royalty income. The second goal is to reduce gas costs to State facilities by providing State

gas at prices below those charged by gas utilities.

The Texas Legislature has consistently supported the program and, in recent

years, has enacted laws that assure the smooth operation of the State program. One

such statute requires all State agencies that consume at least an average of 100 Mcf

of gas per day to submit all gas acquisition contracts to the General Land Office

for review. If the Land Office is able to provide gas at the same or lower cost, it

may require the agency to purchase gas from it. Another supportive statute requires

all regulated gas utilities to provide transportation of State gas if capacity is available on their systems and it is destined for a state agency. These transportation

rates are competitive with those provided to private parties.

In addition to the natural gas in-kind program, the Land Office takes in-kind approximately 2400 barrels of oil per day. This oil is sold under six-month contracts

through a sealed bid auction. Prices are bid at premiums to posted prices. At the

last sale, held in April, these premiums were as high as $2.08 over one commonly

used posting.

Last fiscal year, the gas program sold approximately 9.1 Bcf of gas to State agencies and another 2.6 Bcf on the spot market which represented 35 percent of our

total royalty production. Spot market sales assure that adequate supplies have been

secured to meet State end-user demand. Gas is currently being taken in-kind from

105 leases, almost all of which are located along the coast. Sales contracts are in

place with 103 State facilities, twenty-eight State colleges and universities, and six

other government bodies, including school districts and small municipalities. Transportation contracts are currently maintained with thirty-five different pipelines and

local gas distributing companies. We also maintain a contract for up to one Bcf of

natural gas storage at a facility near Houston.

Sales of gas on the spot market are made through monthly solicitations of interest

from pre-qualified gas marketers, of whom there are currently seven. In order to

qualify, marketers must show financial stability. In addition, to encourage small

business participation, the Land Office maintains credit risk insurance.

Since 1973, all State oil and gas leases and statutes have provided for the right

of the State to take royalty in-kind upon sixty days notice of our intent to do so.

On some leases issued prior to 1973, in-kind takes have been provided for by agreement. Once we have exercised our right to take in-kind for a particular lease, we

make every effort to continue to take gas from that lease in order not to burden
23

the lessee by alternately taking and not taking. We generally take possession of the

gas at the point at which it has been made ready for sale or commercial use through

the removal of water, natural gas liquids, and impurities.

Costs of transportation and other direct costs, together with a markup or ‘‘enhancement’’ and a set administrative fee are charged to the gas purchasers. In all

but a few cases, prices to the end-user agency are below those available from private

sources, and are lower than local utility costs in almost every instance.

Gas and oil producers on State lands have been almost uniformly supportive of

both the gas and oil in-kind programs. Although I do not have specific figures, the

administrative savings and other benefits to both producers and the Land Office are

clear. It is far easier to account for volumes of oil or gas physically delivered than

it is to account for both the volumes delivered and the market value of those volumes. Delivery in-kind relieves the producer of the obligation to account for the

market value of the gas and relieves the Land Office from the burden of conducting

financial audits of producers. Once accurate delivery is established, the producer no

longer needs to be concerned that State auditors will dispute the prices that the producer received.

The in-kind programs have been so successful that we are now, as I mentioned,

starting the process of revising and more than doubling the gas program. The

changes in the natural gas marketplace in the past several years have made it possible, I believe, to form a public/private alliance with a gas marketing firm that will

bring the very specialized expertise of that kind of operation together with the gas

supply and markets that my office can provide, to the benefit of both the State and

the private company.

Last year, we invited over 60 gas marketing firms to submit initial proposals to

the General Land Office for just such a public-private alliance. In the invitation,

firms were asked to propose plans for their management of our end-user program,

the creation of a natural gas liquids sales program, and to purchase the balance of

our natural gas supply, approximately 15 Bcf per year at a price linked to the market price, and preferably at a premium. As a result of the responses to that invitation, a marketing firm was selected to begin finalizing a marketing contract by next

fall.

It is in this context that the State of Texas is interested in a way to obtain its

OSCLA share of production allocated to the States. The name of the game in gas

marketing is, of course, volume. These 8(g) volumes are approximately 11 to 15 million cubic feet per day. We would be anxious to work with Congressional and interior staff to accomplish this task.

We believe that in-kind royalty is worth the consideration of any royalty owner

that has the opportunity to take marketable volumes of oil or gas or has the opportunity to join with other royalty owners or producers in marketing significant volumes.

Mr. THORNBERRY. Thank you, Mr. Reid, and I failed to mention

that without objection each of our full statements will be made part

of the record. We will have a vote in just a moment, but for now

we would like to continue, Mr. Darouse. I think we have certainly

got time to have your statement in, and we will see how we get

from there. We have got 15 minutes before we have to be over

there.

STATEMENT OF DAVID DAROUSE, MINERAL REVENUE REGIONAL AUDITOR SUPERVISOR, DEPARTMENT OF NATURAL

RESOURCES, BATON ROUGE, LOUISIANA

Mr. DAROUSE. Thank you, Madam Chairman, and good afternoon. My name is David Darouse. I work for Secretary Jack

Caldwell at the Louisiana Department of Natural Resources. He is

unable to attend today so I am here at his behest. The purpose of

my testimony today is to explain and summarize our written testimony that we submitted earlier in the week and expound upon it

and answer questions as time permits.

It is obvious from our written testimony that we feel that in Louisiana, at least, there are certain legislative impediments that do

not allow the state to take oil and gas in-kind and receive the max-
24

imum price that it could, and those are laid out in our written testimony.

But let us assume for discussion purposes that these impediments were not in the way and look at how a program would operate. There are certain things that we need, to have a successful

take-in-kind program, and we also need to look at how success of

such a program would be measured.

One thing that we need are large volumes of oil and gas concentrated geographically in one area so that we can move these volumes to an aggregation point at low expense, to where we can extract the maximum price possible by selling to third parties.

In the 8[g] area, unfortunately, Louisiana participates in about

35 or 40 leases that are spread out from the Louisiana-Texas border—literally laying on the border—all the way to the LouisianaMississippi border over in Chandeleur Sound.

Out of those 35 to 40 leases, we have really only 20 or 25 that

are major-producing leases, and, again, they are spread out—not

randomly—some are aggregated in certain areas—but more or less

randomly across that strip of water. So we don’t really have the

concentrated geographic volumes that we can easily and inexpensively aggregate and move to a market and sell at a premium price.

But considering that we did have the concentrated volumes,

which may occur some day, how should we measure the success of

a potential take-in-kind program? One important criteria would be

to measure the net revenues from a take-in-kind program against

the existing royalty-in-value program that we have currently.

Net revenues would be defined as the gross revenues from a

take-in-kind sale less the additional costs that will occur in getting

that sale, and we have laid out a number of services: experts, forecasters, consultants, that we feel like we would have to have.

Maybe not all of these but certainly some would have to be added

to staff, either hired for the state to work for us or hired as contractors.

Let us look at the current oil—not regulations—we don’t have

regulations in Louisiana—but how we are currently enforcing our

oil leases in Louisiana. The program that we have in place is to

value oil that is sold nonarm’s length, not oil that independents or

anybody sells to a third party, but oil that is sold nonarm’s length

to an affiliate or marketing arm of the producer, for value of that

oil at what we call market price which we determine as either the

Empire Louisiana spot price or the St. James Louisiana spot price,

depending on whether we are looking at heavy oil or light oil.

Those prices are published by several major publications who

survey those markets on a daily basis. The publications are wellknown. Platt’s Oilgram is one. Bloomberg’s Oil Buyer’s Guide is another. So in situations where the oil is sold nonarm’s length, we are

currently getting royalty-in-value or trying to get royalty-in-value

by assessing those values against the values currently reported.

We are getting market value currently. We feel like on oil—like

we are getting on oil or we are trying to get market value on oil.

If we went to an in-kind program by taking oil in-kind, we feel like

in the best situation, a competent marketer striking a competent

deal on any given day can only get the price that we were getting
25

currently at Empire and St. James. That doesn’t even consider the

additional marketing cost.

So we feel like oil take-in-kind would basically be a no-go for the

state in the 8[g] zone or on state leases. On gas, we feel like an

opportunity does exist for the state or the MMS to make money by

marketing gas themselves. There are currently no spot prices

across the country and specifically across Louisiana other than one

location at the Henry Hub that gas value can be pegged to.

So in situations where we don’t know what the value of natural

gas is due to interaffiliate transfers, by taking gas in-kind and selling it and aggregating it on the open market, then that is a possible moneymaker for the state and we feel like also for the Federal

Government.

We commend the MMS for the past years of starting a pilot program back in 1994 which, although it was not revenue neutral, obtained many valuable lessons for the Minerals Management Service to apply in future take-in-kind programs.

We also applaud the MMS for having outreach programs over the

last year where they have held meetings across the country soliciting input from various constituents such as states and industry.

And we think they are heading in the right direction by realistically investigating potential R-I-K programs. And with that, I will

conclude my comments.

[Prepared statement of Mr. Darouse may be found at end of

hearing.]

Mr. THORNBERRY. Thank you, sir. I appreciate it. Mr. Magagna,

we will go ahead and let you. I believe we have time to get your

statement in if you would like to proceed in that way. When we

come back, we can start with questions.

STATEMENT OF JIM MAGAGNA, DIRECTOR, OFFICE OF STATE

LANDS AND INVESTMENTS, OFFICE OF FEDERAL LAND POLICY, STATE OF WYOMING

Mr. MAGAGNA. OK. Thank you, Mr. Chairman. I am Jim

Magagna, Director of the Office of State Lands and Investments for

the State of Wyoming. I want to take this opportunity to applaud

the initiative of Chairman Cubin in providing this important dialog

for the royalty-in-kind issue.

The State of Wyoming, under our Governor Jim Geringer, has assumed a leadership role, we believe, in seeking development and

implementation of a cost-effective and efficient royalty-in-kind program providing an opportunity for full participation by affected

states. We appreciate this opportunity to share our efforts and our

expectations with members of the Subcommittee.

As I have indicated in my written testimony, part of Wyoming’s

initial effort to look at the option of a royalty-in-kind program certainly and admittedly has been driven by our frustrations with the

current value based Federal royalty program. The Chairman earlier provided figures as to the tremendous amount of revenues and

level of dependence that the State of Wyoming has on this.

And since the initiation of net receipt sharing in 1991, we have

been frustrated in our efforts to truly define what are the costs of

administration that are being borne in part by the State of Wyoming through the deduct from our gross royalty revenues.
26

We were further frustrated when the Minerals Management

Service announced a devolution proposal nearly 2 years ago and

then quickly withdrew that proposal. We did work very closely with

the Administration and with Congress in the development and passage of the Federal Oil and Gas Royalty Simplification and Fairness Act.

While we think it represented in many areas an important step

forward, it was still very limiting from our perspective in the delegable functions which were recognized for the states. And it provided far greater secretarial discretion in delegation than we had

hoped for. However, we do continue to work with Minerals Management Service in developing standards and guidelines for the implementation of this Act.

To comment only briefly on the valuation issue, we recognize and

share concern that there are problems with the current system

with valuation as it applies to non-arm’s length transactions, and

we applaud the Minerals Management Service for their efforts to

address this. However, we feel that the attempt to impose a single

index type figure based on the NYMEX or some simpler guideline

does not apply to the situation that exists in Wyoming.

We have a unique situation here today with the completion of the

Express Pipeline which will suddenly bring an additional 140 to

170,000 barrels of oil a day from Canada into Wyoming, some of

which will stay in the Rocky Mountain region refineries.

What we have seen already in three short months of experience

with that indicates that the impact of an activity like that on the

market available to producers operating in Wyoming is very diverse from its impact on a national market as expressed by an

index such as the NYMEX. We have seen some significant price declines in Wyoming as a result of this increased foreign supply that

simply have not been reflected in the NYMEX or other standardized measurements to date.

But Wyoming is driven every bit as much by the opportunities

for revenue enhancement that we see in the royalty-in-kind program, and we recognize that with those opportunities comes risk.

We as a state are prepared to assume those risks that are associated with the private sector in the marketplace and that are necessary if you are to achieve the rewards that can be associated with

that.

As a first important step in this direction, the 1997 session of the

Wyoming Legislature passed legislation authorizing the Governor

to take the state’s share of Federal mineral royalties in-kind should

Federal law and policy so permit. This was a strong statement by

our legislature of their desire to have the state move in this direction.

In followup to this, as a part of the Minerals Management Service’s effort to look at possible pilot projects, Wyoming has offered

a pilot project to the Minerals Management Service. We are appreciative of their efforts in working with us.

However, I would offer one note of caution. While we believe that

there is value in a pilot process in order to test a methodology for

a royalty-in-kind program. Due to the inability to aggregate large

volumes and reduce administrative costs in a pilot program, we feel
27

it should not be looked upon as a test of the net ability to enhance

revenues as a result of royalty-in-kind.

I would like to move on and quickly focus on some of the key elements that the State of Wyoming believes are critical in a Federal

royalty-in-kind program in order to allow full participation by the

states. The first and most important of these would be that the

state would have an absolute right which it could exercise to receive at or near the lease its 50 percent gross share of Federal royalty oil and gas.

We would further encourage that the states be given an opportunity, or a preference I might say, to also acquire and market on

the Federal Government’s behalf the Federal 50 percent share provided that the net return to the Federal Government would not be

reduced thereby.

Because it has clearly been shown that there are advantages to

aggregation through the market strength that comes with larger

volumes, allowing the state to potentially handle 100 percent of the

royalty volume would be a step in the right direction.

We do think it is important in a royalty-in-kind program that the

state be entitled to the full 50 percent of its gross share of Federal

mineral royalties, and that the state then bear the marketing costs,

the state bear the risks associated therewith, but not be put in a

position of having to bear the Federal administrative costs, which

we would hope would be dramatically reduced as a result of a royalty-in-kind program. I am aware of several additional principles

that the industry has developed, and we would be supportive of

these.

Finally, let me say that a royalty-in-kind program is not a simple

step forward. I believe it does involve a major reengineering of the

current approach to royalty receipt. We have had the opportunity

to personally view the program in operation in Alberta, Canada.

While their situation is very different, we believe that their program as it currently operates would provide a good starting point

for the development of a Federal program in the states.

But I would emphasize in closing the importance that we see in

the development of a program that this be done as a joint effort involving the Minerals Management Service, the affected states, and

the industry on an equal footing basis. What comes out of this

would be something that there is a comfort level with that it will

work for all of the various interests. Again, I want to take this opportunity to thank you for being able to appear before the committee today.

[Prepared statement of Mr. Magagna may be found at end of

hearing.]

Mr. THORNBERRY. Well, thank you and I appreciate all of the testimony of each of you gentlemen. We are going to have to go vote.

We have a few minutes of debate and then the vote on the tax bill.

I just want to make one comment before we do that. As some of

you may know, I introduced a royalty-in-kind bill last Congress.

Anybody who suggests that that was an effort by the oil and gas

companies was not around because that was certainly not the case.

They were less than enthusiastic about that idea.

The motivation is what it can mean for the taxpayers, and those

are the ones that I think really have some to benefit, as well as
28

the states. And we have a lot to learn from what is going on in

your states, what is going on in Alberta, the input of the industry,

and the very valuable input that MMS is gaining in their meetings

across the country.

And I want to get that input because my plan in September is

to introduce another royalty-in-kind bill because I think it is important to push this idea forward, to have something to talk about,

and I want to see this move forward for the taxpayers and for everyone. And so that is the kind of input that we will look forward

to. We will recess temporarily as we go vote.

[Recess.]

Mrs. CUBIN. [presiding] Please pardon me for having to be gone.

I had a bill that I am the sponsor of being marked up in another

committee. And then, as you know, for the first time in 16 years

we just voted a tax cut for middle class Americans and all Americans. And we are really happy to have done that. I think I will let

Mr. Brady question the panel to begin.

Mr. BRADY. Thank you, Madam Chairman, very much. I appreciate the panel, first, your testimony and, second, the patience you

have for us to go vote today. I guess for Mr. Reid, because I am

from Texas and pleased with how the system works, as a member

of the legislature I have supported some of the changes to make

that program more efficient, more effective as you learn how to do

it well and better. And we are very pleased with the results.

Two thoughts: one, I am impressed with the efficiency of the

Texas R-I-K program versus the current Federal in-value system

on the basis of employees. And could you at some time provide to

the Subcommittee a table showing the staff-to-volume ratio in

Texas for both your oil and your gas programs?

Mr. REID. I would be happy to.

Mr. BRADY. And, second, do you have any suggestions on how the

Texas program could be expanded to a Federal program?

Mr. REID. If I understand your question, one of the issues with

the Texas program, of course, is so much of the benefits we receive

there come from the agency end-use program. Obviously, the Federal Government is a major consumer of gas, and there might be

a potential for a similar program at the Federal level.

As far as our experience on our in-kind, our spot sales say of gas

or oil sales, the issue in Texas—we do have a situation where we

have enough quantities—volumes in enough concentration for it to

work. I mean, there may be selected areas where MMS may have

the ability to do that.

Our spot sales do not generate the spread that our agency sales

do in terms of our enhancement. When you look at our total enhancement, they are probably less than 5 percent of it. But in

terms of how it works, I mean, we handle it in-house. We are looking at a private marketing firm to do it.

And in Texas it is really a cost benefit analysis. If we make more

money doing it the other way, we will do it. If we don’t make more

money for the school fund, we won’t. And we do a cost benefit analysis periodically on our gas program and on every oil sale to see

whether we are really generating more revenue for the school fund

than we would have received as a royalty payment.
29

Mr. BRADY. So it is in the State of Texas program. Rather than

using state resources passively to regulate and audit, you use it actively to get the most value for those in-kind products that you receive. Is that correct?

Mr. REID. Right.

Mr. BRADY. Thank you very much for your testimony. I appreciate it. And the representative from Louisiana, a question for you.

Do you have an assessment or have you done an assessment of the

cost savings of shifting your current audit staff and litigation expenses you have into a marketing type of program? Have you had

an opportunity to take a look at that type of change?

Mr. DAROUSE. No, sir, we have not.

Mr. BRADY. Is your program a bit—in your opinion, has it been

restrictive in its criteria as you have tried to enter the market and

look at the oil side of it or the gas side of it? Do you feel like there

are improvements in the Louisiana program that could allow you

to make it more effective?

Mr. DAROUSE. Our written comment addressed that. We think

that if there are certain changes made legislatively, and if conditions change, that it would be beneficial to market our gas in-kind.

Right now there just seems to be a consensus that there are some

prohibitions against doing this effectively. I know back in 1985 or

1986 we considered a program similar to where Texas ended up

and that would be taking state gas in-kind and sending it to institutions, and it never really got off of the ground.

Mr. BRADY. But that would be an implementation that could assist the cost benefit part of the program for the State of Louisiana

and could generate more——

Mr. DAROUSE. Yes, sir. To a certain extent, yes, sir.

Mr. BRADY. Great. Thank you. Thank you, Madam Chairman.

Mrs. CUBIN. I want to welcome you, Mr. Magagna. Everyone

knows you are from my great State of Wyoming, and thank you for

your testimony. As usual, you always do a yeoman’s job for the

state, for the Governor, and for me as well. And I want to thank

you for that.

While I wasn’t here to hear your testimony, I did read everyone’s

testimony before the hearing so I do have an idea of what all your

feelings are. But, Jim, your testimony about R-I-K was quite specific on what you believe will be necessary for a success.

And one of the things that you stated in your testimony was the

states must have the right to receive 50 percent of the gross share

in-kind. Does that mean that it would be entirely unacceptable to

Wyoming to adopt to a R-I-K program like they have in Alberta

where private marketers would sell all of the mineral?

Mr. MAGAGNA. Madam Chairman, no, not at all. In fact, we believe that the appropriate way for a program to operate would be

for the state to contract with private marketers to market the

state’s royalty share. All I mean to say by that is that we should

receive 50 percent of the gross without any obligation to any deduction therefrom back to the Federal Government.

Mrs. CUBIN. I am not sure and so I hope someone will correct me

if I am wrong about this, but I think that in Alberta they market

all of the mineral so that I think the way it would be is that a mar-
30

keter would sell the Federal share and the state share together and

then divide the money. Is that right?

Mr. MAGAGNA. All of it.

Mrs. CUBIN. Right, right. But, anyway, that would be the method, and is that an acceptable arrangement do you think for the

State of Wyoming?

Mr. MAGAGNA. That the marketer would share——

Mrs. CUBIN. Would sell the Federal share and state share and

then the money be divided after the sale.

Mr. MAGAGNA. That would be dependent on who negotiates that

marketing contract. It is our belief that the state should be given

the opportunity at least as to the state’s 50 percent gross of the

royalty mineral to arrange for that marketing; in other words, to

determine what the terms and conditions would be, to accept those

risks associated with the marketplace, even though we would market through a third party marketer.

We would not be comfortable with a situation that simply allowed the Federal Government to market 100 percent of the royalty

share as they saw fit with the state simply being the recipient of

a check for half of that amount.

Mrs. CUBIN. So then would it be acceptable for Wyoming to be

the marketer for all of the mineral and then divide the money and

then give the Federal Government their share?

Mr. MAGAGNA. We would certainly find that acceptable, and we

would anticipate if that were done and would be willing to accept

that there would have to be some criteria in order to assure that

the state, in fact, would not be getting less for the mineral than

what the Federal Government might be capable of getting. With

those parameters, certainly.

Mrs. CUBIN. I agree with you and your statement that de minimus-producing wells could really present a problem with R-I-K.

However, as the provisions of the Royalty Fairness Act became implemented which would allow once a year royalty payments or a

buyout of royalty obligations by lessors once a year with de minimus production, perhaps there would be room to consider how to

take R-I-K for stripper wells. Do you have any thoughts on the cutoff production level for de minimus?

Mr. MAGAGNA. I really would not be prepared today to recommend a particular cutoff level. But when you combine the provisions in the Royalty Fairness Act authorizing the annual payment

or the buyout with a royalty-in-kind program, we would be hopeful

as you put those together you would be able to thereby eliminate

the need for a continuation of a valuation based royalty system because that could be picked up through the specific provisions of the

Fairness Act.

Mrs. CUBIN. My time is up and because we have already been

interrupted with the vote and whatnot, with your permission, I

would like to submit some written questions to you, and then we

can move on to the next panel. Thank you very much for your testimony. And would the second panel please come forward? Thank

you very much.

I would like to introduce the second panel that is with us today;

Mr. Larry Nichols, who is the President of Devon Energy; Fred

Hagemeyer, the Coordinating Manager, Royalty Affairs for Mara-
31

thon Oil Company; Sue Ann Hamm, Vice President of Oil Marketing and Sales for Continental Resources; and Edmund Segner,

III, Executive Vice President and Chief of Staff for Enron.

I would like to remind the witnesses that under our Committee

rules that the testimony must be limited to 5 minutes, and certainly your entire testimony will appear in the record. So the Chair

now recognizes Mr. Nichols for his testimony.

STATEMENT OF LARRY NICHOLS, PRESIDENT, DEVON ENERGY

Mr. NICHOLS. Well, thank you, Madam Chairman. I am Larry

Nichols, President and CEO of Devon Energy Corporation, an independent producer who has Federal onshore production. I am here

today on behalf of Devon and 13 oil and gas associations who represent most of the payers of Federal oil and gas royalty payments.

For the purpose of the hearing today, I will summarize my comments but ask that the entire written statement be included in the

record, as well as this statement which reflects all of the trade associations who are endorsing my statement today.

Madam Chairman, we always appreciate the opportunity to work

with you in pursuit of a more simple, a more certain, and a more

efficient program for collecting royalties due to the Treasury and

the states from Federal oil and gas production.

As each year passes, the need to reengineer the royalty collection

system dramatically increases. With each new valuation rulemaking effort, more and more complexity and more uncertainly is

added to the royalty collection system. Instead of accepting a producer’s wellhead values, elaborate netback schemes are now being

developed that will only result in more and more disputes.

All of the agencies’ concerns and perceived problems over how to

value royalty can be addressed by a royalty-in-kind program. As a

consultant, who is regularly used by the MMS, stated in a report

to the states, ‘‘The only way to be absolutely certain that a fair

market value is received for royalty oil is to take the oil in-kind for

sale.’’ We agree that royalty-in-kind accurately measures value by

capturing all the value resulting from a transaction between a willing buyer and a willing seller at or near the lease.

There has been much theorizing about the benefits and drawbacks of royalty-in-kind. It is time to bring royalty-in-kind to the

drawing table, to build a successful royalty-in-kind program, and

once and for all to bring to an end years and years of disputes and

debate about royalty payments.

This hearing today brings royalty-in-kind into focus as an exciting reengineering opportunity for both the government and the industry. I would like to tell this committee what the industry is

doing to bring royalty-in-kind into reality. First, industry participated in a series of workshops that the MMS held this year in response to their fiscal year 1997 appropriations which asked them

to pursue additional royalty-in-kind pilot programs.

At these workshops, the MMS heard a consistent message from

the oil and gas industry—yes, we are without a doubt interested

in designing a royalty-in-kind program which would result in a

more simple and certain royalty collection system.

During these workshops, the industry agreed to outline for the

MMS and the states the goals, principles, and design elements of
32

a successful royalty-in-kind program. To initiate this progress, representatives from oil and gas associations from across the country

formed a royalty-in-kind workgroup. I am glad to report to the committee that this workgroup has developed an in-kind mission statement and a common set of principles for designing a successful royalty-in-kind program.

The mission statement and principles I am about to describe are

supported by the Independent Petroleum Association of America,

the Domestic Petroleum Council, the California Independent Petroleum Association, Colorado Oil and Gas Association, Independent

Petroleum Association of Mountain States, Independent Petroleum

Association of New Mexico, Louisiana Independent Association,

Mid-Continent Oil and Gas Association, National Oil Industries Association, New Mexico Oil and Gas Association, Oklahoma Independent Petroleum Association, Petroleum Association of Wyoming,

and the Rocky Mountain Oil and Gas Association.

This is a work in progress for all of us. Many critical implementing details need to be developed and discussed among these

groups before moving beyond support for these principles. The

agreed-to mission statement for a royalty-in-kind effort is to design

a royalty-in-kind program that will eliminate valuation uncertainty

and will be attractive to the Federal Government, the state governments, and the private sector stakeholders, while recognizing the

differences between oil and gas production.

The six agreed-to royalty-in-kind principles are as follows: one,

reduce the administrative and compliance burdens while providing

the opportunity for Federal and state governments to maximize

their revenues. This principle is intended to make sure that a royalty-in-kind program does not move forward unless it is a win-win

for the Federal Government, state governments, and the producers.

Two, require transactions to be at or near the lease as required

by the lease obligations. Three, provide that when the government

takes in-kind it must take all royalty production for a time certain.

Four, require use of private marketing expertise to streamline government operations.

We have heard some comments earlier today that expressed concern, with which we agree, that this plan might require the government to get into the business. That is not the case at all. Just as

the Federal Government can build buildings without becoming a

building contractor and just as the Federal Government can construct highways without becoming a highway constructor and getting into that business, so can the Federal Government market

their oil and gas business without getting into that business.

Five, provide the states with the opportunity to be involved in

designing and implementing the program. And, finally, six, to make

sure that royalty-in-kind programs are broadly available for public

purpose. As I just stated, there are a number of design issues that

need to be worked out to determine the success of the royalty-inkind program. We believe that issues such as transportation, aggregation processing, and other matters need to be resolved and

look forward to working on that in the future.

This is the time when we need to make certain that we can work

together as a cooperative effort. We are concerned with the manner

in which the MMS has qualified revenue losses in its gas in-kind
33

experiment. We think those mislead people into believing that a

successful in-kind program cannot be implemented.

And, second, and most importantly, we want to make sure—is

the concern that a royalty-in-kind program be revenue neutral. Let

us not forget that the real value of a royalty-in-kind program is to

save the tremendous administrative costs that are currently being

incurred by the Federal Government, the states, and the industries.

Before the MMS moves forward with a royalty-in-kind program,

we need to make sure that a royalty-in-kind program can adhere

to the six principles that I discussed above. Thank you very much,

Madam Chairman.

[Statement of Mr. Nichols may be found at end of hearing.]

[List may be found at end of hearing.]

Mrs. CUBIN. Thank you, Mr. Nichols. Mr. Hagemeyer, would you

please give——

STATEMENT OF FRED HAGEMEYER, COORDINATING

MANAGER, ROYALTY AFFAIRS, MARATHON OIL COMPANY

Mr. HAGEMEYER. Sure. I would be happy to. Thank you, Madam

Chairman, members of the committee. I am Fred Hagemeyer and

I am pleased to be here this afternoon representing Marathon Oil

Company. There are several oil and gas associations that have endorsed my written comments, and I would like to introduce those

into the record if I may.

Marathon is a fully integrated oil and gas company involved in

worldwide exploration, production, transportation, and marketing

of crude oil and natural gas. Marathon holds leases both onshore

and offshore. In 1996, Marathon paid royalties of over $84 million

for oil and natural gas produced from Federal and Indian lands. In

addition to the royalty paid in cash, the Minerals Management

Service took crude oil valued at over $9 million in-kind through the

small refiner royalty-in-kind program.

We are here today to discuss royalty-in-kind as an alternative

method for satisfying the royalty obligations of producers with Federal oil and gas leases. Public workshops were held this spring to

discuss and review possible options for a major royalty-in-kind program. Marathon actively participated in these sessions and welcomed the opportunity to candidly discuss critical features of a

workable R-I-K program.

At Marathon, we have learned that reengineering an entrenched

process is not easy. But if all stakeholders are engaged in the process and it is done properly, the results can be significant. Many

times the benefits are much greater than anticipated because it is

difficult to identify all the indirect benefits. As part of the MMS reengineering effort, Marathon believes that a R-I-K program can be

created which will fundamentally add value to the MMS royalty

process.

Royalty-in-kind is a concept whose time has come. The key is

turning this opportunity into reality. By taking its royalty oil or

gas in-kind, the MMS has the opportunity to aggregate volumes,

determine the most favorable sales locations, arrange transportation, and negotiate the terms and conditions of the sale of its royalty production.
34

Participation in these activities can result in optimized value if

the MMS manages the risks and costs associated with the marketing function. Expertise of a competitive private marketer would

allow the MMS to participate in these activities in the most efficient manner possible and thus achieve the greatest possible revenue benefits. The administrative burdens of both the MMS and

the Federal lessees, especially the audit and litigation costs, would

be reduced significantly or even eliminated.

As Larry Nichols mentioned, a multi-association task force has

been recently formed to develop a workable Federal royalty-in-kind

program. Marathon is an active participant in this task force. Marathon would welcome and does welcome the certainty of knowing

its royalty obligation was fulfilled once the royalty barrels were delivered to the MMS.

And Marathon recognizes that expertise in all segments of the oil

and gas business will be necessary to develop a Federal royalty-inkind program that is both viable and workable. It seems that the

Subcommittee can benefit tremendously from the efforts of this

task force. This process is not easy, but we feel it is vitally important in developing a successful program.

An important step in this process is to look at examples of existing R-I-K programs—the Texas GLO program, which you heard

about earlier, takes all of its royalty all in-kind from the Marathonoperated Yates field, one of the largest onshore oil fields in the

United States. Overall, Marathon’s experience with the Texas royalty-in-kind programs has been positive.

One of the lessons that we have learned from the Texas R-I-K

program is that any new comprehensive program is going to experience startup problems. During the first year of the Texas programs, there were problems concerning which party was responsible for gathering costs, the arrangement and verification of transportation, and the proper allocation of production.

However, over time, producers, the purchasers, and the state

have been able to work through these problems. And for this reason the MMS must be very careful if it chooses to implement and

evaluate any royalty-in-kind pilot program. In fact, Marathon believes it may be more prudent to expend this effort in developing

a permanent R-I-K program that could be phased in over time.

Marathon is concerned at the impact of a royalty-in-kind program on the Federal and state treasuries, that it be analyzed properly. API recently completed an assessment of the MMS review of

the 1995 Royalty Gas Marketing Pilot Program. Attached to my

testimony is the API report which raises a number of issues for the

underlying validity of the revenue assumptions and the cost analysis of the pilot. The concerns raised by API should be addressed.

In summary, I would like to say that Marathon believes the time

has come for the Federal Government and the oil and gas industry

to seriously consider royalty-in-kind as the best long-term solution

to satisfying the Federal lessees’ royalty obligation. A properly developed R-I-K program could streamline the royalty process for the

Federal and the state governments and the oil and gas industry.

Working together, we can minimize many of the startup problems which may occur and shorten the learning curve for both the

Federal Government and the lessees. A royalty-in-kind program
35

can be a win-win proposition for all the parties involved. Thank

you very much.

[Prepared statement of Mr. Hagemeyer may be found at end of

hearing.]

[List may be found at end of hearing.]

Mrs. CUBIN. Thank you very much. The vote that is being held

now is a vote to adjourn, and I think I will just let them decide

that without me so that we can get this hearing moving along. Ms.

Hamm, would you please give us your testimony now?

STATEMENT OF SUE ANN HAMM, VICE PRESIDENT, OIL MARKETING/SALES, CONTINENTAL RESOURCES, INCORPORATED

Ms. HAMM. Thank you, Madam Chairman. I am Sue Hamm, and

I am Vice President of Crude Oil Marketing for Continental Resources. And I am here on behalf of Continental, IPAA, OIPA, and

the RMOGA, Rocky Mountain Oil and Gas Association, and they

are all endorsing my written——

Mrs. CUBIN. Excuse me. Could I get you to pull the microphone

a little closer?

Ms. HAMM. Oh, I am sorry.

Mrs. CUBIN. Thank you.

Ms. HAMM. And I would like to submit that for the record. And

Continental Resources is a small, privately held independent producer who has Federal onshore production. And I am not going to

go into everything I have written to brag a little bit about Continental, but we are a growing company, and I am very proud of

them.

Two years ago, I began the crude oil marketing department for

Continental. And I did this after looking at our wellhead contracts.

Traditionally, we sold at the wellhead. And with change in transportation and unbundling and opportunities to transport on pipelines, I saw that there were opportunities.

And so I looked at—checked out all of the alternatives and opportunities, and I found that our company is able to realize a higher

average price per barrel by taking our oil to the end-user to make

all the transportation arrangements, exchanges, and final sales.

And we have even built our own gathering systems where that

proved economical for us to lower our transportation costs.

We tried to create as many alternatives as possible. The more

buyers there are, the higher the price is we find. And we have encountered a great deal more risk and costs than we had anticipated, but we have been able to work these out just by working

through them and with the advice. We looked to other industry experts. In fact, we even hired a consultant for a year and paid him

five cents a barrel to guide us through this.

And even at the five cents a barrel charge, we found a significant

increase over our net revenue from the wellhead price. And we continued to sell some at the wellhead so we did know what that wellhead price was, and we continued to negotiate very toughly for a

wellhead price. But even still we had a significant increase by taking on the responsibilities to market downstream.

And as we became more sophisticated in our marketing efforts,

we began to take our oil and gas from outside interests. And this

is a little bit like the MMS would be encountering because they are
36

not operating the wells in which they have their interests, and they

are not getting all the information as timely as an operator does.

But we have still found that in most instances we can improve

our price by taking an in-kind and taking it downstream. And to

determine whether it is economical, again, we look to a number of

factors—transportation costs, prices downstream, prices the purchasers will offer at the wellhead, and the price that the operator

is receiving because we can’t continue to sell through the operator.

But one factor we do not even consider is what price is the operator receiving through his contract. We just look at what he is paying us. We do not consider audits a value-enhancing measure or it

is not our job. And after we consider all the factors, we choose the

method which we will receive the highest price. As I said before,

this continues to be marketing downstream for the most part except for de minimus volumes.

And we have a fairly significant volume for a small company. In

fact, it is about 7 percent of MMS’s royalty volume. We have 15,000

barrels of oil a day, and we produce 75,000 Mcf of gas a day. And

this is 3 percent of MMS’s royalty gas. And this is a large amount

as far as the MMS’s volume, I believe, that we are able to handle

with two employees. And of our volumes, we have 200 equivalent

barrels which are Federal royalty barrels. And this is a negligible

amount for us.

But this is a small amount when you consider MMS’s royalty volume where I have heard that they say aggregating volume does not

enhance the value. Well, it sure did for us even with our small

amount. The more oil we produce and we include in our package,

the higher our prices become. The refiners are seeking us out. They

want to go directly to the producers to ensure their oil. Oil is still

a valuable product.

And the present situation between the MMS and the oil and gas

industry has become one of the most adversarial relationships of

any agency. And even though we have a negligible amount of Federal royalty barrels, it looks like we don’t have a dog in this fight,

I have heard you say.

But we are taking a broader view as you have recommended, and

we are going to stay involved in this issue because we are in the

oil and gas industry to stay. And anything that affects us—that affects the industry affects us. And we believe that the proposed

rules will negatively affect the industry, and, in fact, we oppose

them. And I really wanted to get into the Canadian effort, but

I——

Mrs. CUBIN. Go ahead.

Ms. HAMM. I went to Canada and met with Don Olineck, the Director of the Alberta Energy, and went through quite a few of his

programs, and he was very accommodating. He showed me all of

his flow charts. He showed me all of his forms. And I discussed this

thoroughly with him, and he believes that this could be transferred

to the MMS’s properties.

And he has offered all of his help in setting up the program, setting up the computer programs, advising. He will do anything he

can to help us transfer his program to our situation, and he believes it will help. Alberta Energy believes that they are increasing

their value by taking in-kind and selling it downstream.
37

And the goals for their R-I-K I believe meet MMS’s goals. They

are simple and certain; simple in the fact that a minimum number

of employees are required to run the program. Alberta Energy for

their 146,000 barrels of oil a day have 33 employees marketing the

oil. MMS has 204,000 barrels of oil a day—a little bit more than

Alberta—and they have 1,800 employees a day. Gas production is

roughly equivalent between the two companies. Alberta only has

232 total employees for all.

What is the reason? It is not the MMS employees that are not

competent. They are very competent people. They are high standards, high quality. It is the system they are having to work with.

That is why it takes so many. This audit—receive an audit is not

a workable situation.

And to follow the Alberta program, the MMS would have to take

its production at the wellhead, and the operator would deliver to

the MMS’s designated representative the royalty volume. And the

operator would continue to deliver to his own purchaser his volume.

The only difference from the operator’s current methods would be

to carve out the royalty share of volume, as opposed to the royalty

share of value. And by carving out just the royalty share of volume,

this would dramatically reduce the number of reporting requirements for the operator and for the MMS. Thus, the decrease in

number of employees.

And just to look at our situation, two employees for 15,000 barrels of oil a day; 1,800 employees for 204,000 barrels of oil a day.

Something is happening there. My husband and I own the company. I have a vital interest in increasing our revenue. I do not

have a stake in keeping a job in crude oil marketing. R-I-K works.

I recommend it for the MMS. I will help any way I can. There are

industry experts out here. We are all good at this.

The MMS can be good at this. They have to get in the program.

They have to get in the market. Just watching it doesn’t help. You

have to get in it and negotiate. And by hiring a representative and

with transparent contracts, the MMS will know and be assured

they are receiving market value. Thank you.

[Statement of Ms. Hamm may be found at end of hearing.]

[List may be found at end of hearing.]

[Petroleum Marketing Act may be found at end of hearing.]

Mrs. CUBIN. Thank you very much. Mr. Segner.

STATEMENT OF EDMUND SEGNER, III, EXECUTIVE VICE

PRESIDENT AND CHIEF OF STAFF, ENRON CORPORATION

Mr. SEGNER. I am Ed Segner, Executive Vice President of Enron,

a diversified energy company headquartered in Houston. As a

major participant in the upstream, midstream, and downstream domestic energy markets, Enron obviously has a direct interest in the

proposed R-I-K program, both as a marketer, in which we are one

of the very largest in the country, and as a producer.

Recent changes in the natural gas industry, including the deregulation of wellhead prices and the demise of pipelines as the primary purchasers of natural gas, directly affect the current debate

over royalty valuation. These changes have led to a number of controversies between industry and government. The Department of
38

Interior has been questioning the principle that royalties are to be

determined at or near the lease, as has been the historical practice

now for about 70 years.

Rather, the Department is apparently considering that royalty

values be determined far downstream of the lease after the value

has been enhanced by a variety of services performed in the midstream and downstream markets. This position, of course, fails to

recognize that participants in those markets make significant capital expenditures and undertake a variety of risks not associated

with the risks that are undertaken by oil and gas lessees.

Such a position, obviously, is fundamentally at odds with the way

in which natural gas is marketed today. Natural gas producers no

longer dedicate the production from specific properties to specific

sales contracts. Most production today is sold under contracts that

specify no source of supply but rather require that specified volumes be delivered to designated delivery points.

Producers can and do supply gas to such delivery points from

various sources of supply, including their own production, or in the

event of a shortfall in order to meet a firm delivery commitment,

by purchases from other producers or marketers. Even when a producer’s own production is used, it may come from a number of

properties upstream from the point of delivery.

Similarly, midstream producers do not supply their downstream

customers with gas obtained under specific purchases from identifiable producers. Rather, production is aggregated at pooling points

where it is bought and sold or transported to all other points all

in the marketer’s efforts to maximize its profits by seeking the best

market available.

Gas has become like grain or pork bellies, a fungible commodity.

Attempting to value gas on the basis of downstream transaction

would be like determining the value of a particular farmer’s corn

crop, by looking at the prices in the grocery store.

We believe that a properly designed royalty-in-kind program can

both resolve many of the current controversies arising out of these

changes, while providing many advantages to the government resulting in a win-win situation.

In a well-designed royalty-in-kind program, the Federal Government would use the expertise of sophisticated marketers to access

markets nationally and provide timely and accurate information.

Using the services of marketers, the government could realize increased revenues through, one, aggregation of its substantial volumes; two, the administrative savings of simplified auditing; and,

three, the absence of disputes.

Our Enron Oil Canada unit produces oil that is subject to Alberta’s royalty-in-kind program. Our experience under that program

has also been extremely positive. Valuation disputes under the program are virtually nonexistent.

Further, the program is simple to administer from both a

logistical and accounting standpoint. A single accountant in our

company spends less than 4 hours a month filing the required reports. In addition, the province bears its proportionate share of

downstream costs like any other interest owner, thus providing equitable treatment to the lessees.
39

In April 1995, after an exhaustive joint government and industry

study, the Minister of Energy advised that a cash based royalty

system such as that as used in the U.S. could not be implemented

because it would result in a financial loss to the province and create an administrative burden for both industry and government.

In addition, we have also recently begun to participate in the

Texas program. We also are very satisfied with that program. It

has been a positive experience. And, in fact, with respect to our operations, it operates so unobtrusively that I think that speaks volumes for the quality of the program.

It is for these reasons that a royalty-in-kind program is so important. Competitive bidding for the government’s share of production

would simply and fairly establish its value, while providing the

best means available to ensure that the government receives full

value for oil and gas production from Federal lands.

It offers the government the ability to realize the maximum

value for its share of production, while at the same time streamlining its own operations. We thank you very much for the opportunity to appear before this Subcommittee today, and at the same

time, we assure you that we offer our assistance in developing a

successful program any way we can.

[Prepared statement of Mr. Segner may be found at end of hearing.]

Mrs. CUBIN. Thank you very much. Mr. Thornberry, would you

like to begin questioning?

Mr. THORNBERRY. Thank you, Madam Chairman. I guess my

number 1 question that I would like to address to each of you, because some of you represent a number of companies and organizations, is do you think the industry is serious about getting this

done? Do you think a consensus can be built? And what is the primary obstacle to getting it done?

As I mentioned a few minutes ago, I have been down this road

before. And while some in industry said they thought it was a good

idea, it didn’t go very far. But I would like to get you alls’ view on

whether it can be done, whether we can reach a consensus. Mr.

Nichols, do you want to start?

Mr. NICHOLS. Yes. I definitely think we can reach a consensus,

and I would like to put this in some historical perspective. Earlier

in the hearing today, we heard that because last year we had

passed the Royalty Fairness Act, with the able leadership of this

Committee, that now was an inappropriate time to go back in and

reevaluate or do anything different.

The Royalty Fairness Act dealt with procedures. There is nothing

in the Royalty Fairness Act that dealt with valuation. Both this

Committee and the industry and the MMS recognize that those

valuation issues were out in front of us and were not touched at

all by the Royalty Fairness Act.

When we saw earlier this year the MMS proposal on oil valuation, which was based upon NYMEX, or despite some earlier

statements I heard today, NYMEX is not where the oil and gas industry trades amongst itself. We trade oil at the lease or near that,

not at NYMEX. That is totally false.

Our company sells a lot of oil, and it is not based on NYMEX

prices. That is not what we have any hope of realizing. Sometimes
40

it is up, sometimes it is down, but that is not where we trade. That

is where they trade in New York City. It is not where we trade in

Wyoming or the Texas panhandle or wherever.

When that was proposed with a complicated system to get it back

to where we really do trade, and the MMS recognized that NYMEX

was not where it was traded and was only using that as a starting

place, we had used a fairly complicated and somewhat arbitrary

within their own control system to get it back to the lease or attempt to get it back to the lease, many people in the industry

looked at that and said, ‘‘Good grief. There has got to be an easier

way.’’

Mr. THORNBERRY. So you think there is renewed focus on solving

the problem?

Mr. NICHOLS. The oil valuation program gave tremendous focus

and tremendous impetus within the industry to please find a simpler way, and R-I-K particularly became the simpler way.

Mr. THORNBERRY. What do you think is the biggest obstacle?

Mr. NICHOLS. The inertia, that change is always difficult, working out problems. In my testimony earlier, I listed the six principles that 14 trade associations have already in a relatively short

period of time gone together and agreed upon. We need to work on

the details of those, broaden the industry group to include everyone, but I believe that can be done.

Mr. THORNBERRY. Thank you, sir. Mr. Hagemeyer?

Mr. HAGEMEYER. Yes. I also would agree that the industry has

pulled together to focus on this particular issue for a variety of reasons, and we would be remiss in suggesting that it wasn’t because

valuation perhaps was a catalyst. In the past, you would have

maybe certain components in an integrated oil and gas company

who would look at valuation regulations. And what you have with

royalty-in-kind is probably a bigger picture.

So it encompasses all aspects of the oil company, and this takes

time for the oil companies to focus on this, and this is something

through this association task force that I think has just recently

started happening. If there was royalty-in-kind discussions in past

timeframes, it never had this kind of discussion, which is all encompassing, and a realization that you just don’t do it with little

bits and pieces and parts. And if you are going to put something

forward, it has got to be somewhat comprehensive.

And so it really has energized, in my opinion, a lot of companies

to really talk through the issues. And as Larry pointed out, there

were six principles developed in a matter of a few weeks by this

task force which kind of set a stage, and there was a lot of structural elements under that that have to be sorted out and talked

through. You know, there is a lot of very important issues that

have been mentioned before in terms of voluntary, mandatory, the

transportation issues, turning over title at what point, and how can

that be clean.

But the key is that it is kind of a reengineering focus. I mean,

the purpose of this group right now has really been trying to look

at it from a clean piece of paper, not being incumbered by other

things, and saying if you had a very, very good royalty-in-kind program that tried to satisfy all aspects, how would it work? And I
41

really feel confident that over the next few weeks or months that

that can come about.

Mr. THORNBERRY. OK. Thank you. Ms. Hamm and Mr. Segner,

I would like to get at least you alls’ opinion on what the biggest

obstacle is.

Mrs. CUBIN. And don’t worry about the light. You can have as

much time as you want, Mac.

Ms. HAMM. The transportation issue and the mandatory versus

voluntary appear to be the biggest obstacles that I have seen. And

I believe they are workable, especially—we need from MMS what

are their problems with transportation. What kind of comfort zone

do they need in order to work in the marketplace on transportation? If we knew what their fears were, then we could arrange

the principles and issues and help with the rule. And then the

mandatory versus voluntary we are going to, of course, have a consensus on that, and I believe in mandatory.

Mr. THORNBERRY. OK. Thank you. Mr. Segner?

Mr. SEGNER. I think the biggest issues are going to be in the

marketing side from the standpoint of dealing with the de minimus

volumes, finding mechanisms to make sure that a large enough

percentage of volumes is, in fact, being served under this program.

Obviously, 100 percent would be best in our view because we don’t

want to see a situation where you end up with a lot of administrative costs left over. So we want to be sure that we get the whole

thing.

I would say from the marketing standpoint I think clearly there

is huge competition now in marketing, as we all know, and I think

that having a producer—in essence, the Federal Government, be as

large as it is—that is a sizable volume, its portfolio well spread out.

I think it will be very well-received by the marketing community,

and I think it will be very competitively bid and structured.

Mr. THORNBERRY. Gives us lots of buying power when you have

that much oil to sell?

Mr. SEGNER. Yes.

Mr. THORNBERRY. Let me ask each of you, have any of you had

experience with the MMS pilot program on gas?

Mr. NICHOLS. We participated in a very minor way in the pilot

program offshore.

Mr. THORNBERRY. OK. Do you have comments about that program, ways that it can be improved, why we should or should not

learn particular lessons from it based on your experience? And if

you don’t have enough, that is fine. I just wondered.

Mr. NICHOLS. Yes. Our experience with it was extremely small

as an independent. I know there are a variety of design flaws in

the way it was implemented, that both we and the MMS learned

from that that could be corrected in a royalty-in-kind program. We

see nothing in the comments that I have read about that cannot

be easily corrected.

Mr. THORNBERRY. OK. Madam Chairman, one other thing. Mr.

Nichols, since your company was specific mentioned in some earlier

testimony, I thought you might want to have the opportunity to respond to the concern that some people have that someway a royalty-in-kind will prevent or you will lose arm’s length transactions,

and there will be some sort of sweetheart deal and this, and the
42

taxpayers are going to get the short end of the stick. If you would

like to respond, I certainly want to give you a chance to since your

company was specifically mentioned.

Mr. NICHOLS. Well, I must admit I was somewhat amused and

perhaps flattered to think that our company would be large enough

to successfully market Federal royalty oil. Earlier this year, we

were marketing a grand total of about 300 barrels a day, and that

feeble effort proved to be so small that we abandoned it on April

1. So I don’t think we have the capacity to be a marketer. That is

not what we are. We are a pure independent producer.

There is no doubt in our mind that a successful program could

be implemented. The reason the industry is in favor of a royaltyin-kind program is to reduce cost. The government is entitled to the

royalty oil that it gets. There is no one who argues that point—and

the royalty gas. You can take that and aggregate that together and

have a win-win situation where the government, because it can aggregate that oil and gas, can realize more revenue.

I know from my own company’s experience, we did an acquisition

at the end of last year that gave us more oil to market because we

own more oil in west Texas and southeastern Oklahoma. Just because of that small aggregation relative to us, we are able to realize a higher price for that oil.

The Federal Government could realize an even higher price because they have much, much larger volumes than we do. So you

have the ability to realize more revenue on one side, and the ability

to save costs, both for the industry and the MMS, on the other side.

It looks like a win-win.

Mr. THORNBERRY. Thank you. Madam Chairman, I appreciate

your indulgence. Because of the lateness of the hour, I won’t continue. I do have some questions I would like to submit for the

record, and hopefully these witnesses could provide us some additional insights if that is all right.

Mrs. CUBIN. And we also would ask unanimous consent for the

Minority to enter any questions in writing that they would like.

Mr. Dooley?

Mr. DOOLEY. Thank you, Madam Chairman, and I apologize for

having a conflict and not being able to hear the entire panel. I

guess my interest here is in terms if you did go to the royalty-inkind process, should it be structured in a way that perhaps we just

let the states administer it. I mean, we have Texas who already

has their program in place. You know, why should the Federal

Government be involved? Why don’t we just let the State of Texas

do it? Anyone that wanted—I guess, Mr. Hagemeyer, you——

Mr. HAGEMEYER. I will maybe just try to address that a little. I

guess you are asking a question that probably we haven’t ourselves

even had time to get into and discuss, and I think that is one of

the issues on the task force list to talk through; not that we have

necessarily the solution, but maybe we can talk through the pros

and cons.

You know, I think one thing that fundamentally we would see is

that, you know, the Federal Government would have the right of

the oil, the title to it when turning it over at the lease. And I guess

the key there would be what would be the most efficient way?
43

That is what we all would want to see. So if the states could do

it more efficiently than the Federal Government through a private

agency, then that is something to consider. I guess the options are

still open in reviewing that, and it is something that probably

when you talk it through, many of the states (Texas has quite a

bit of an experience, and Wyoming is now looking at it in various

stages), have a different scope of experience level.

So if you were to move into some program, you may only have

a few states who have enough experience to do very much. But I

guess the jury is still out.

Mr. DOOLEY. Well, that is kind of the way that I am looking at

this is that, you know, we have some states that are at different

levels of I guess competency just by experience by and large. But

I guess I question, you know, it might be something that it might

be best administered on state by state and basically be a state

choice, whether or not to go down that path of royalty-in-kind.

If you went down that track though, you know, I question whether or not we ought to have MMS in a position where they are required to put together the administrative infrastructure to administer a payment-in-kind program in one state that might have the

capability to do it themselves.

And maybe we would be better off letting them do that, and

those states that didn’t choose to go into royalty-in-kind that we

would maintain something, maybe even what is proposed hopefully

with some modifications.

Ms. HAMM. The industry workgroup has agreed that it would like

for the states to have the option to take their royalty-in-kind so I

think that answers your question to a degree. States which show

an interest we want to allow it to have the right to take their oil

in-kind.

Mr. DOOLEY. And that would just be the state’s share of the royalty-in-kind?

Ms. HAMM. That is as far as we have gotten. We haven’t addressed taking the Federal royalty. We would like for the states to

have the option to take the Federal royalty too, to have the right

to bid for it. And we haven’t written that down as a principle

agreed upon that has been discussed to let the states take the Federal royalty. But the only thing which has been agreed upon is the

states to take their own share.

Mr. DOOLEY. I had a chance to read some of your testimony, and

you visited Alberta and viewed theirs. How did they deal with—

and I think Mr. Segner made the comment, you know, the very,

very de minimus producer in some instances—you get to some level

that is not cost effective, you know, to put I guess in place an inkind type of program. Does Alberta have similar problems, and

how are they addressing that?

Ms. HAMM. My understanding is that they don’t take that which

they are not able to administratively costwise justify, and there are

some instances where they take the operator’s volume totally also

and market it for them because the operator believes that Alberta

Energy has more expertise than they do.

But I believe they have been at it so long that this was not all

thrown at them at one time. This has been as a well develops, as

wells are drilled, they have gotten to make the selection. And then
44

once they do have it in place, as wells decline, then it is easier to

keep the R-I-K in place. Where for us, we will have to make the

election with wells which are already declined whether to take it

in-kind of not, so it would be a little bit different deciding right off

to take everything.

Mr. DOOLEY. Does anyone else have a comment on any of those

questions? All right. Thank you.

Mrs. CUBIN. I want to ask you, Mr. Nichols and Mr. Hagemeyer,

anyone who wants to answer, a little bit more about the multi-association task force. That is the same industry working group that

you were referring to, Ms. Hamm? It is all the same group? OK.

And, Mr. Nichols, you are here representing those groups that are

in working on the task force. Is that correct?

Mr. NICHOLS. Yes.

Mrs. CUBIN. And that is mostly independents. Is that correct?

Mr. NICHOLS. Yes, of all sizes. There are very large independents

and very small independents, but they are all included in that

group.

Mrs. CUBIN. I am not going to ask a lot of questions now, but,

again, if you would indulge us and allow us to send some written

questions to you, I would appreciate that. But I do want to say one

thing. I know Mr. Thornberry is anxious to get this moving and

anxious to have a bill, and I support him in that.

And we would appreciate it, if you don’t mind my speaking on

your behalf, if the MMS and the states and your task force and the

majors could come together with some suggestions because I think

we will have better legislation if everyone can work on that than

if we just draft something just to get the issue moving. That is

what we would like and what we would appreciate is just some

movement on this.

So I don’t really have any other questions. I will just leave you

with that request, that you work together as much as you can in

a timely fashion so it makes it a little easier for Mac and for me.

Mr. Nichols?

Mr. NICHOLS. Yes. Madam Chairman, if I might add, included in

that group and included in those associations are major integrated

companies, that there really is no schism in the industry based on

size or character in facing this issue.

There are individual companies and individuals that are still

studying and are not yet committed to it. But I think that consensus is rapidly forming, and it will be one that is from the largest integrated down to the smallest mom and pop. You know, we

all share the common desire of a more simple and a more certain

royalty collection system.

Mrs. CUBIN. And I do encourage you to work with the states as

we go along that I know we can have a better bill by doing it that

way. Thank you all very much for your testimony today. Ms.

Quarterman, I certainly appreciate your sitting through all of these

hours of testimony and voting and whatnot. I know it has been a

long day for you, and we do appreciate your hanging in there with

us. So if you would kindly give us your wisdom, we would be happy

to hear it.
45

STATEMENT OF CYNTHIA QUARTERMAN, DIRECTOR,

MINERALS MANAGEMENT SERVICE

Ms. QUARTERMAN. My pleasure. Madam Chairman and members

of the Subcommittee, I appreciate the opportunity to appear today

to present testimony on behalf of the Minerals Management Service in our ongoing examination of the feasibility of taking oil and

gas royalties in-kind.

I would like to say that we are very excited about the notion of

taking R-I-K. We have been studying this issue and considering opportunities that in-kind royalties may offer the government, industry, and, most importantly, the American taxpayer.

Over the past several years, MMS has spent a considerable

amount of time studying the opportunity to take royalty-in-kind. It

has been a major learning process for us. We have, as you know,

conducted an analyzed R-I-K pilot that was implemented during

1995. We have convened six public workshops around the country

relating to R-I-K.

We have surveyed energy marketers that we would not ordinarily have an opportunity to work with. And we have interviewed

other government agencies who have experience in R-I-K, including

our international sister nations going over to Alberta, Canada, and

speaking with them as well.

In short, I believe that we have developed a significant body of

knowledge and expertise concerning the potential for applying inkind programs to Federal leases. I ask that my prepared testimony

be admitted to the record, and I will summarize for you here what

is in that testimony.

By way of background, the energy industry has changed dramatically over the past 10 years. As some of the folks who have been

here today have already testified, the once dominant wellhead sale

has been replaced by more frequent downstream sales by affiliated

energy marketers and is particularly true in the natural gas market.

A series of downstream activities frequently occur before a first

sale is ever made. For natural gas, first sales may not occur until

the burner tip in a residential consumer’s home. Increased downstream activity has complicated royalty valuation to a large extent

which has fostered disputes between the Minerals Management

Service and the producers.

Administrative appeals and litigation have proliferated as a result. And the energy industry and MMS have struggled over the

past several years to resolve these many issues. Along with clearer

valuation regulations, R-I-K programs may offer a solution to avoid

such disputes.

In what we see as a best case royalty-in-kind scenario, a number

of things we think would be possible. First, we think that valuation

disputes could be eliminated or at least reduced, that auditing

could be reduced to a simple volume reconciliation that would be

completed quite quickly, that there would be less need for royalty

reporting and verification, which would accrue to administrative

savings on behalf of both the government and industry.

We also believe that there is a potential to enhance Federal revenues by aggregating volumes and marketing. The extent of such
46

benefits requires examination and analysis, and that is what we

are currently in the process of doing.

As this Subcommittee will remember, back in 1995 we did implement a gas marketing pilot that was pursuant to Vice President

Gore’s Reinvention of Government Initiative. MMS sold at that

time by competitive bid at the lease approximately 45.6 billion

cubic feet of gas from 14 lessees covering 79 leases in the Gulf of

Mexico.

We saw a royalty loss of nine cents per MMBTU which overwhelmed a small administrative savings. I came before this Committee shortly thereafter about a year ago to present the results of

that pilot. Despite what some might think as disheartening results

of the pilot, we continued to pursue the notion of the Federal Government taking its royalty-in-kind.

And we have learned a substantial amount from that pilot. We

learned that the voluntary nature of the pilot reduced our ability

to aggregate and enhance volumes, that some of the downstream

value benefits that are possible were not seen because of the way

the gas was sold, and, finally, that the administrative relief was extremely limited because we continued to audit companies who had

taken the gas in-kind.

The R-I-K study that we are currently doing has two primary objectives, and the real objective is to ensure that any R-I-K program

is in the best interests of the United States and its taxpayers,

meaning that we are looking for a program that would offer potential revenue neutrality or enhancement for the Treasury, and that

would provide extensive administrative savings to both the Federal

Government and the oil and gas industry.

I will tell you now that we have some preliminary findings, but

they are only preliminary at this point. Our examination of R-I-K

is ongoing. A major finding is that under favorable circumstances

we believe that R-I-K programs could be workable, revenue neutral, or hopefully revenue positive, and administratively more efficient for both MMS and the industry.

The favorable circumstances that we see to be necessary would

include an opportunity for us to participate in downstream marketing in sales which could enhance revenues, that would allow us

to aggregate volumes, which we think could assure supply and

could increase our market leverage, and, finally, a program that

would provide administrative relief to both the Federal Government and to industry.

R-I-K programs would have reduced chance of success we think

under some unfavorable circumstances, and the unfavorable circumstances that we have in mind are continuation of our auditing,

producer’s share of production. It would include any statutory language which would give the government less leverage in creating

a workable R-I-K solution.

And another unfavorable circumstance would be if we were to try

to put in place a R-I-K program for production that is scattered in

many different basins with a decreasing potential for aggregation

and would require an increasing amount of learning on our part.

Our challenge in the future will be to see if we can identify appropriate R-I-K programs that meet the favorable conditions that

I have set forth, to develop a specific R-I-K program or programs
47

for these conditions, and to conduct those programs and economic

analyses associated with them.

In conclusion, as I mentioned before, we are enthused about the

prospects for developing a R-I-K program or programs that could

lead to success. And I agree with many of the witnesses before me

by saying that success is defined as a program that is a win-winwin for all the parties that are involved.

However, because there are some inherent risks in any R-I-K

program, we want to caution you not to move too quickly in trying

to reach a legislative solution. We need to be able to conduct more

detailed testing and analysis of any programs before there is broad

application. If there is anything that the Subcommittee heard

today, I think it would be the importance of flexibility in any sort

of R-I-K program.

We caution that we not prematurely provide any legislative assistance that would seek to make a one-size-fits-all solution for RI-K implementation in the future. We think success really relies on

the ability to be flexible because the market has changed rapidly

and quite a bit and will continue to change, we think, and we need

to be able to change with the market.

Legislative initiatives may lock us into a R-I-K program that

later turns out to be counter to the market and to the public interest. If we find that we need legislation after we have tested some

pilots, we will be back to you and ask you for the appropriate legislative changes.

Considering the magnitude of Federal royalties, this issue I believe is too important for us to rush to judgment and to do it

wrong. We are willing and excited about the prospects of working

with the states and with industry to develop and test R-I-K programs that are amenable to all parties.

Madam Chairman, that concludes my prepared remarks with respect to R-I-K. I did want to make one note unrelated to R-I-K before I offer myself up to questions, and that is having sat here this

afternoon, I noticed that there was one piece of information that

seems to not be accurately communicated to the Committee. And

I want to make sure that you were aware and that is with respect

to our oil valuation rule.

There were some questions earlier and statements about the

MMS attempting to move the point of valuation away from the

wellhead, and that independents would not necessarily receive fair

market price and would not be able to pay royalties according to

that. That has been a concern of mine as well.

And I think if you were to go and read the rule, and I offer you

up my staff, who is more expert than I am on this, to come and

sit with members of the Subcommittee to talk and walk you

through the rule, you will see that the discussion of NYMEX and

ANS prices is a second step in the rule.

The first benchmark in the rule would permit a producer to pay

on gross proceeds. If he has a contract for a sale at the lease, that

is the first benchmark—the first place that we go forward. We are

not interested in putting independents out of business here. So that

is the first step.

And, again, as to NYMEX prices or ANS prices, I remind everyone that it is a proposed rule. That means that we are open to any
48

other means of valuation that may be out there or other indexes

that may be more appropriate. With that, thank you.

[Prepared statement of Ms. Quarterman may be found at end of

hearing.]

Mrs. CUBIN. Thank you very much. I think one thing we can

agree on—everyone is that the current is sort of a disaster. It is

too expensive and it is too complicated, and, obviously, MMS having proposed a rulemakes a public pronouncement that we need

change. You stated, Ms. Quarterman, that you have a huge volume

of information from six workshops, and you have surveyed marketers, and you just have a vast amount of information on R-I-K. Do

you need to gather more information, or do you have the information and you just need to analyze it?

Ms. QUARTERMAN. We are in the process of analyzing the information. We had a team from our policy shop perform the workshops and gather the information. They are in the process of drafting a final report which they will present to me shortly with a

number of recommendations, I imagine.

Mrs. CUBIN. What would be an ideal situation for me is for MMS

and industry and the states to be working together and get moving

on this. It seems like it has been dragging to me. And I would really prefer a proposal to come from the work that all of you have

done rather than legislation as you requested. Sometimes it seems

though that we need legislation to get the ball rolling. So I would

ask all of you to go ahead and get working on that, and let us make

some progress and then the need won’t sit up here. Mr. Dooley?

Mr. DOOLEY. Yes. Thank you, Madam Chairman, and thank you,

Ms. Quarterman, for your really substantive testimony. It really

was helpful in trying to come to grips on how we should move forward.

I guess what I would like to spend, you know, some time with

though is on the rulemaking because maybe I have some misinformation. But from what I am hearing from a lot of my producers

in California is that they are at least under the impression, unless

there has been a modification to the rule that was proposed I guess

on January 24, that a lot of their production was going to be priced

based on an ANS benchmark or with a function of some adjustments based on sulphur content and a couple other issues. Now, is

that incorrect?

Ms. QUARTERMAN. Well, first, there has been a modification to

the rule since January when it was first published. We published

a supplemental rulemaking less than 30 days ago. I don’t know

what specific producers you are referring to, but the modification

would we think make the first provision of the rule, the gross proceeds provision, apply to many of the independents.

Mr. DOOLEY. And how would that differ now from the status

quo?

Ms. QUARTERMAN. That is the status quo.

Mr. DOOLEY. And what producers then would fall under that?

Ms. QUARTERMAN. Any producer who is selling through a true

arm’s length sale at the wellhead would fall under that.

Mr. DOOLEY. And so that would mean that as long as a company

wasn’t vertically integrated that they would not be—they would be

basically status quo in terms of their pricing?
49

Ms. QUARTERMAN. I would not go so far as to say if they are not

vertically integrated. We haven’t done the analysis to see exactly

how many, if any, independents would have to pay under an ANS

or a NYMEX scenario, but we don’t think that there would be that

many. The policy would be every single independent producer who

doesn’t have a refiner, but there would be quite a few who would

be covered. Yes.

Mr. DOOLEY. And I guess then the objective was basically to

some extent exempt the independents from this new methodology

in terms of valuation?

Ms. QUARTERMAN. I would say independent producers, yes. When

you say independents, there are a number. Yes.

Mr. DOOLEY. Right. Excuse me. OK. But that is, obviously, you

know, a significant concern. I guess, you know, the definition of

arm’s length status though is still—you know, what does that mean

I guess?

Ms. QUARTERMAN. It means you have a sale with a party who is

not affiliated with you at the well.

Mr. DOOLEY. And how long does that have to be?

Ms. QUARTERMAN. How often is that——

Mr. DOOLEY. How long for that—you know, is that separation I

guess from that party? Is that always—I mean, is there any—could

there be a past relationship or that could impact, you know, whether or not that is defined as arm’s length?

Ms. QUARTERMAN. I don’t want to mislead you. Let me ask that

I have my staff come in and give you a definition of an affiliate.

Mr. DOOLEY. Excuse me?

Ms. QUARTERMAN. I don’t want to mislead you not having read

the rule in about 3 months myself about what the definition of an

affiliate is in the rule.

Mr. DOOLEY. And it is obviously what my concerns are here in

terms—I just don’t want—you know, some people are producing

and primarily the smaller producers, you know, being placed with

a valuation that is not necessarily reflective of what they are getting paid for. And that is the gravest concern we have with going

to an ANS or a NYMEX benchmark.

You know, I don’t care whether you are a large producer or a

small producer. You know, sometimes, you know, we are concerned

that that will not be an accurate reflection. And I guess that is the

intriguing component of this payment-in-kind is that it reverses all

of the incentives—is that everyone at that point—the producer and

everyone else—has the incentive to maximize price opportunities

and that benefits the Federal Government and the taxpayers, as

well as the state government.

My question is if the Department and MMS is seriously considering going to a payment-in-kind as it appears that you are and

you are receptive to that, you know, should we be, you know, moving forward with in some ways a fairly significant change in the

royalty collection, you know, when we might be reinventing the

process once again in the relatively, you know, near future?

Ms. QUARTERMAN. I don’t want to mislead you by my testimony

in saying that we are very enthusiastic about R-I-K does not mean

that we think that we are at the point now or, in fact, we will ever
50

be at the point where it will be appropriate to take all oil and gas

in-kind.

I believe that the study that has been done shows that we should

consider expanding the gas R-I-K program that was done in the

past. There may be certain instances where it would be appropriate

to consider taking oil in-kind. We have been approached by the

State of Wyoming and have offered to work with them on the pilot

project that they have in mind. So, in other words, we would still

need a valuation system for that portion of the royalty that was not

taken in-kind.

Mrs. CUBIN. Mr. Thornberry?

Mr. THORNBERRY. Thank you, Ms. Quarterman. I appreciate your

testimony. If either of us sit back and look at what has happened

over the past two or three years, I think MMS and the states and

industry is all moving in the same direction. There is a little bit

of difference on how fast we are moving and maybe what all is included, but I think the trend is definitely going toward royalty-inkind.

And, obviously, I would hope that, as the Chairman said, as

much as possible we could all work together in getting the best possible royalty-in-kind plan because it is, obviously, not going to do

anybody any good if it increases administrative costs or if it increases lawsuits or if it doesn’t give the taxpayer a fair return on

the royalties that they are due. Then we haven’t accomplished very

much.

I am a little concerned about your last statement, and that is if

basically you to use the expression cherry-pick what kinds of leases

you want to put in a royalty-in-kind program, and some of them

don’t and so you have to still do the administrative evaluation for

that, you hadn’t really helped much of the administrative costs,

have you? I mean, you still have got to have the folks to do that.

Ms. QUARTERMAN. Well, I think it is a fallacy to think the administrative savings are going to be the savings that are important

here. I think the opportunity for revenue enhancement is the real

winner. Our royalty program, as was mentioned at the beginning,

is about $68 million a year, which is about a penny and a half for

every dollar that we collect.

About 18 percent of that is collections that we do on behalf of Indian tribes. That, of course, would have to remain. We would still

have to do collections for solid minerals and geothermal leases. We

would have to create a royalty-in-kind program. The administrative

savings are not going to be the real winner here I don’t think. If

there is a winner, it is that aggregating of volumes and enhancing

the value downstream.

Mr. THORNBERRY. Well, except we have heard some testimony

today about some remarkable differences in how many administrative folks it takes to keep up with certain programs. And so that

is something that we need to work through, but the other winner—

do you agree that another winner would be reduced litigation costs?

Ms. QUARTERMAN. Oh, absolutely. It would be. When you think

about administrative savings, don’t forget about the possible risks.

As it stands right now, we bring in close to $5 billion a year. We

collect that in royalties.
51

And basically we have 600 or so people in the royalty program who sit out in Denver, and we get $4 billion mailed into our office

no matter what we do every year. If we were to take all that oil

and gas in-kind, we put in jeopardy that $4 billion that we get

every year without doing anything. So we really need to be careful

in what we do, and that is all that I wanted to say to the Committee.

Mr. THORNBERRY. Yes, ma’am. I think you make a very good

point, and, as I mentioned, we all want a program that works better, not worse. And we don’t want to jeopardize the taxpayers. Let

me ask you, one of the issues that I know you all got comments

on in your meetings and is the subject of our discussion is whether

it is mandatory or voluntary. What is your view on that subject—

whether or not companies or even states can opt out?

Ms. QUARTERMAN. Well, I think if you want to be innovative that

you need to be open to different ideas. I think it is clear under the

existing Mineral Leasing Act and the OCS Lands Act that the Secretary can take oil or gas on demand is what the statute currently

reads. So any variation or change in that statute some might view

as a detriment to the taxpayer.

Having said that, I think that there are opportunities to work together with states and industry to work toward a solution that everybody can live with. But what we saw in the past was we didn’t

have enough volumes because it was voluntary.

Mr. THORNBERRY. Another point which in the notes from your

meetings I understand that participants were unanimous about is

that MMS take its royalty at the lease as far as delivery point goes.

Do you think that makes sense? That is where it has to be?

Ms. QUARTERMAN. Well, it makes it more difficult for the government. I think under, again, the existing law and the leases onshore, it seems pretty clear that the government would have to

take it at the lease offshore that we could ask a producer to bring

it onshore and pay reasonable costs. Again, if you want to have an

innovative program that everybody agrees to, you work those

issues out, and you don’t make any particular thing mandatory.

Mr. THORNBERRY. Let me ask you about one more. There was

concern expressed I know about MMS getting involved in downstream marketing, and yet as I understood your testimony, you

think that is an option that you want to keep in a royalty-in-kind

program. Is that right?

Ms. QUARTERMAN. When you say MMS, that does not necessarily

mean MMS employees. I do not think that the Federal Government

employees that I have now would be capable of that, and the recommendations that I see coming forward would not include Federal

Government employees doing that, but rather getting that skill

from somebody else. It is easier when you are an outside person to

stay up to speed on the market changes, and all those things would

be necessary in order to market oil and gas.

Mr. THORNBERRY. But in that scenario, MMS would hire somebody or some entity?

Ms. QUARTERMAN. Definitely.

Mr. THORNBERRY. But the Federal Government would continue

to own the product as it moved downstream to some point and

could market it and sell it there rather than at the lease?
52

Ms. QUARTERMAN. Right.

Mr. THORNBERRY. OK. And that is something you think is good?

Ms. QUARTERMAN. Well, I think it is something we should explore. Again, there are the risks there because if something happens to that oil or gas along the way, we have lost it for the government. We don’t own any pipelines, any storage space. You know,

there are risks.

Mr. THORNBERRY. Yes, and there are concerns, as you know,

from industry about getting the government involved in downstream marketing on particularly the amount of volume that the

government could potentially bring in, that it would pose some

danger to them as well.

Ms. QUARTERMAN. Yes. In the Gulf of Mexico, we have about 2.5

billion cubic feet of gas a day. I think that would make us the largest owner of gas in the Gulf.

Mr. THORNBERRY. Let me ask this final question. I understood

and you have expressed to me before your concern about moving

too quickly. If we do try to work with industry and the states to

develop a R-I-K program in legislation, would the MMS folks be

willing to work with us and offer their suggestions even if you were

not to believe that sort of thing would be needed at that particular

time?

In other words, I think it is important for us to have your input

whether or not you think the timing is right. And would you be

willing to work with us even if you thought the timing was not

right?

Ms. QUARTERMAN. Well, certainly, we would work with you.

Whether we would support you in the end is a different issue.

Mr. THORNBERRY. Fair enough. Thank you.

Mrs. CUBIN. Mr. Thornberry’s questions raise some questions in

my mind. I don’t exactly understand why the $4 billion that just

automatically comes in would be in jeopardy if we adopted a royalty-in-kind policy or a royalties-in-kind policy.

Ms. QUARTERMAN. Well, essentially, right now what happens is

that oil and gas companies are required to pay us their royalty

share, and that amounts to about $4 to $5 billion a year. And they

mail in that amount and really what we argue about are things

along the margin—potential increases to that amount, audit findings, verification of volumes, et cetera, which amount to another

$100 or so million every year. That happens.

If we take our oil and gas in-kind, it means that we are now responsible for taking that oil or gas from the lease into the marketplace. We have to transport it. We have to sell it. We have to make

sure that if it blows up, we have liability to cover any damage that

is associated with it. It is a risk.

Mrs. CUBIN. But I really can’t see why that is—of course, it is

a risk. It is a risk to get up in the morning, but I don’t see why

it is a significant risk when you consider the fact that the government does have storage, for one thing. It is the strategic petroleum

reserves. So, you know, there is storage available.

And if the companies or the producers don’t have a market and

can’t sell it, then you are not going to be getting a royalty. I mean,

I just think that is a real exaggerated view that all of that money
53

is at risk. I think that the benefits certainly far outweigh that risk

it would appear to me.

Then you said one other thing, and I just want to be sure I have

this right. You weren’t making or offering the opinion that you

wouldn’t want to take the mineral at the lease because it is more

difficult for the government. That would not be the reason or any

reason that you would not want to take the mineral at the lease.

Is that right?

I think the statement you said when Mr. Thornberry asked

about, ‘‘Then would you be willing to take the mineral at the

lease?’’ and you said, ‘‘Well, it would certainly be a lot more difficult for the government to do that.’’

Ms. QUARTERMAN. No, no. I wasn’t saying that we would not take

it at the lease. I was saying that probably we would take it at the

lease, and, in fact, onshore I think that is a requirement.

Mrs. CUBIN. OK. I just wanted to get that clear. Thank you. Mr.

Brady?

Mr. BRADY. Thank you, Madam Chairman. As a Member of Congress, I would agree that it is a risk getting up in the morning

around here. I had stepped out for a minute, and I only have two

quick questions. So if I wander into an area that has already been

covered, let me know please.

Thanks for the testimony. Thanks for hanging on through all

this. You mentioned your reluctance to include all the oil and gas

in the R-I-K program. And I know that in Texas over the years we

have learned from the process in trying to improve all the time,

and it has become clear that I think many of us would like to see

legislation that provides for a staged process where we would stage

in different regions so that we could accumulate and gather as

much of that volume as possible. Are you supportive of a staged approach as we go forward?

Ms. QUARTERMAN. Without seeing what the stages are, it is hard

for me to comment on that.

Mr. BRADY. Obviously, putting in place for both the agency and

for the industry enough time and thought in different areas so that

we are, in fact, gathering as many of those different wells and producers and all in order to gather all the oil and gas in the system.

Ms. QUARTERMAN. I suppose it is possible.

Mr. BRADY. And it would make sense sort of if——

Ms. QUARTERMAN. The stage approach could make sense, but it

is hard to talk to without seeing it.

Mr. BRADY. Considering and thinking through some of the benefits of this system, including providing contracts for other government agencies using and bidding for these contracts, but thinking

about the litigation, the time of that, the cost of that, especially the

delay of that, I see the benefit of R-I-K providing, once we are up

and moving, money to your pocket and taxpayers’ pockets sooner

and us gaining that increase of time value, of having the money inpocket. Do you agree with that?

Ms. QUARTERMAN. There would be an increase in revenues for

the time value of money for, again, the incremental amount that

we would get from audit, not for the bulk of the money. And was

there a first half to that question?

Mr. BRADY. No, it was just regarding the litigation costs——
54

Ms. QUARTERMAN. Oh, the litigation.

Mr. BRADY. [continuing] expenses, time, delay.

Ms. QUARTERMAN. Well, unfortunately, I am not as well staffed

with attorneys as some of my adversaries. I think we have about

four lawyers who work on royalty matters of the Interior Department. They also work with staff at the Justice Department on any

Federal litigation. So the costs there are not as high as you might

think.

Mr. BRADY. OK. Although I would say the Federal Government

does pretty well with the lawyer pool. I think you all are pretty

well covered in that area overall.

Ms. QUARTERMAN. Top notch.

Mr. BRADY. Just a thought. Thank you, Madam Chairman.

Mrs. CUBIN. Maybe if you told the Secretary that you needed

those lawyers, he could free them up on that mineral bonding. Ms.

Quarterman, the Ranking Member requested earlier, and so I will

make the formal request to you if you would please do this—he

asked that you would send to us a record of the estimated litigation

costs so we would appreciate if you did.

Ms. QUARTERMAN. We will do that.

Mrs. CUBIN. Thank you very much and thank all of you for attending the hearing today and will look forward to working with

you in the future. This Subcommittee stands adjourned.

[Whereupon, at 5:38 p.m., the Subcommittee was adjourned.]
(55)

HEARING ON: ROYALTY-IN-KIND FOR FEDERAL OIL AND GAS PRODUCTION (PART II)

THURSDAY, SEPTEMBER 18, 1997

HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON ENERGY

AND MINERAL RESOURCES, COMMITTEE ON RESOURCES, Washington, DC.

The Subcommittee met, pursuant to notice, at 2:15 p.m. in room

1334, Longworth House Office Building, Hon. Barbara Cubin

(chairman of the subcommittee) presiding.

STATEMENT OF THE HON. WILLIAM M. ‘‘MAC’’ THORNBERRY, A

REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS

Mr. THORNBERRY. [presiding] The hearing will come to order. Ms.

Cubin has been detained in another markup, and she will join us

later. And at this time, I would like to submit her opening statement into the record without objection.

[The prepared statement of Ms. Cubin follows:]

STATEMENT OF HON. BARBARA CUBIN, A REPRESENTATIVE IN CONGRESS FROM THE

STATE OF WYOMING

The Subcommittee on Energy and Mineral Resources will come to order. The Subcommittee is meeting today to hear testimony on the Feasibility of Taking Federal

Oil and Gas Royalties In Kind. Under Rule 4(g) of the Committee Rules, any oral

opening statements at hearings are limited to the Chairman and the Ranking Minority Member. This will allow us to hear from our witnesses sooner and help Members keep to their schedules. Therefore, if other Members have statements, they can

be included in the hearing record under unanimous consent.

The Subcommittee meets today to continue its review of issues concerning the collection of production royalties due the United States from Federal oil and gas leases

onshore, and on the Outer Continental Shelf (OCS). This oversight follows upon our

hearing of July 31st for which were unable to hear all witnesses identified by both

the Minority and Majority as having meaningful views on R-I-K feasibility.

After today I am hopeful that the Subcommittee will have gained sufficient insight to begin a legislative initiative resulting in a workable R-I-K program at the

Minerals Management Service (MMS).

As I said at the last hearing, my intent is to greatly diminish the enormous resources spent in the audit and enforcement functions of collecting royalty-in-value,

because these costs are a loss to both the Federal and state treasuries. Yes, I understand the administrative costs of the Departments of the Interior necessary to conduct audits, bill lessees and then attempt to collect those bills is conducted with appropriated dollars, not direct spending.

Likewise, Justice Department costs associated with litigation over valuation disputes are subject to appropriation, and therefore the obvious savings that an R-IK program ought to bring the government may not appear in a CBO analysis. But,

my constituents in Wyoming, and I suspect Americans everywhere, don’t care about

arcane budget enforcement scoring rules. They, like me, simply want these royalties

collected in the most efficient manner possible because that will result in a net gain

for all.

I need not reiterate my opening statement from July. Suffice it to say there must

be a better way to collect what is owed for the right to produce oil and gas from
56

the public lands and the OCS. I trust the testimony from today’s witnesses will help

us in that endeavor.

Before I turn to our Ranking Member, Mr. Romero-Barcelo ́, for any statement he

may have, let me collectively welcome all our witnesses. I wish to especially thank

Mr. Henderson who has traveled all the way from Calgary, Canada, to be with us

today and shed light upon the private marketing of the Crown’s oil produced in Alberta Province. I’m sure there are lessons we can learn from this system in designing a workable program for the U.S. As with the last hearing, I have asked the

MMS to testify after other witnesses so that I can be sure the feds have listened

intently to the preceding testimony, and perhaps gained some insights from it.

To wit, I am concerned about MMS’ response to written questions which I posed

in early August (and for which we have only yesterday received a response). It

seems to me the general tone of the response to be ‘‘Remember, the Gulf of Mexico

gas pilot lost money, so lets be exceedingly slow and cautious about doing more RI-K.’’

I believe that analysis deserves further scrutiny before we take as gospel the

MMS’ extrapolation of an $82 million loss if all natural gas in the Gulf had been

included. Besides, its time we climbed the learning curve and made another attempt

to avoid the mistakes in the design of the 1995 pilot. Programs in Alberta and Texas

both are apparently successful at adding value for those governments. Its time to

get on with making it work for the benefit of all our citizens.

The Chair now recognizes the Ranking Minority Member for any statement he

may have.

Mr. THORNBERRY. The Subcommittee is meeting today to hear

testimony on the feasibility on taking Federal oil and gas royaltiesin-kind. Under Rule 4(g) of the committee rules, any opening statements at hearings are limited to the chairman and ranking minority member. This will allow us to hear from our witnesses sooner

and help members keep to their schedules. Therefore, if any other

members also have statements, they can be included in the hearing

record under unanimous consent.

I would like to thank Chairman Cubin for holding this hearing

today. Royalty-in-kind is an issue that I have worked on for 2

years, and it is an issue that I believe deserves a lot of consideration by all the parties involved.

The subcommittee meets today to continue its review of issues

concerning royalty-in-kind. This oversight hearing follows our hearing on July 31st for which we were unable to hear all the witnesses

identified by the minority and majority as having meaningful views

on RIK feasibility.

Today I am hopeful the subcommittee will have gained sufficient

insight to begin a legislative initiative resulting in a workable RIK

program at MMS.

Suffice it to say there must be a better way to collect what is

owed for the right to produce oil and gas from public lands in OCS.

I trust the testimony from today’s witnesses will help us in that endeavor.

Let me collectively welcome all our witnesses. I want to especially thank Mr. Henderson, who has traveled all the way from

Calgary, Canada to be with us and hopefully had, help shed light

on the private marketing of the Crown’s Oil produced in Alberta.

I am sure that there are lessons we can learn from this system in

designing a workable program for the U.S., and as with the last

hearing, Ms. Cubin asked that MMS testify after other witnesses

so that we can be sure that they have listened to the testimony and

hear their comments on it.

Like Mrs. Cubin, I, too, am concerned about MMS’ response to

written questions that were posed in early August and for which
57

the subcommittee only yesterday received a response. It seems to

me that the general tone of the response is remember, the Gulf of

Mexico gas pilot lost money, so let us be slow and careful about

doing anything more. Personally, I believe the results of the Gulf

of Mexico pilot project are invalid and have, call into serious question the, the worthiness of, of considering that pilot program. The

lessons learned with the pilot—there were some lessons to be

learned with the pilot project, but I believe those lessons could be

entitled how not to administer a pilot project.

As many of you know, RIK is an important issue to me. For the

record, I think that most of my colleagues at least know that 2

years ago, I was approached by the Texas General Land Office with

a request to pursue RIK. I admit that at the time, it was something

I was not familiar with, but after looking into it, I believe that it

is something important for the country. In my view, a well-structured and developed RIK program would reduce the size of the

Federal Government, eliminate burdensome paperwork for oil and

gas industry, MMS and state governments, and provide additional

revenue for the Federal Government.

When I first discussed this issue with the oil and gas industry

and with MMS, there was a significant level of opposition from

both sides. I am continuing to press forward, because I believe that

RIK is in the best interest of the Federal Government and the industry and the taxpayers. Two years ago, RIK was going nowhere.

This year again I reopened the file and tried to give it, tried to give

it another try. I have been meeting with both MMS and representatives of the oil and gas industry and have requested their help

and assistance in crafting legislation. I have indicated to both parties that I intend to introduce legislation at some point this fall,

and it is my request that all interested parties assist us in making

this program work as, as well as it possibly can. Frankly, we have

had resistance from the industry. We have had resistance from

MMS. But I believe it is worth pursuing and, and I need, we all

need the assistance in making it work as, as well as possible.

Today I am again asking for assistance, because I believe it is

in everyone, including MMS’ best interest, to participate while the

oil and gas industry is now talking with us about how to make RIK

work. At times, they have been reluctant participants. But I believe

it is the right thing to do and intend to pursue. And I certainly

want to work with all those who are interested in completing this

legislation.

Before we begin our testimony, I would turn it over to the ranking member for any comments he would like to make.

STATEMENT OF THE HON. CARLOS A. ROMERO-BARCELO ́ , A

DELEGATE IN CONGRESS FROM THE TERRITORY OF PUERTO RICO

Mr. ROMERO-BARCELO ́. Thank you, Mr. Chairman, and we appreciate the additional opportunity to review the potential for a royalty-in-kind program in the Federal oil and gas leasing program.

We believe that a great deal more analysis and assessment is required before we can responsibly determine whether or not legislation is required to impose the royalty-in-kind program on the Federal Government and the petroleum industry.
58

To focus our dialog on this issue, the minority has requested that

the Congressional Research Service analyze the various issues attendant to the royalty-in-kind concept. With the agreement of the

Chair, I would like to submit for the record a September 17 memorandum from the CRS, Congressional Research Service, addressing

our questions.

And the CRS report discusses the major issues that would be involved in the establishment of a large-scale royalty-in-kind program in the United States. In summary, the CRS found, and I

quote, that ‘‘RIK proponents contend that the system would reduce

administrative costs and disagreements over the valuation of oil

and gas production for royalty collections. However, such a system

also would require an effective system for marketing the Federal

Government’s oil and gas and could lead to significant government

involvement in oil and gas markets.’’ As noted previously at our

last hearing, our experience in Puerto Rico with involvement—involving the government in areas of market, marketing areas and

private business has not been positive. It has been very, very poor

experience, and we are privatizing again all of those services which

were made into government services.

Also, at the Minority’s request, we will hear today from three

highly respected and exceptional individuals who do not work in

the petroleum industry but who are also very knowledgeable on the

structure, economics and trends in this dynamic sector. Mr. Tim

Cohelan, Mr. Ed Rothschild and Ms. Danielle Brian each approach

this issue from different perspectives and will provide the subcommittee with an objective and well-informed assessment of the

royalty-in-kind concept.

And we commend the Minerals Management Service for taking

such a positive yet a cautious approach to the royalty-in-kind concept in the September 2nd report which we will learn more about

this afternoon.

The MMS proposal to conduct a good-sized pilot for natural gas

in the Gulf of Mexico, built on the lessons learned in the 1995 effort, should provide quantitative and reliable information. Likewise, the proposals for ventures with Wyoming and Texas should

produce valuable and necessary information.

And before moving forward with legislation, we need to determine that a royalty-in-kind program would be administratively feasible and fiscally sound. The detailed revenue impact analysis to be

conducted by the MMS will assess the market risks and costs they

would face in this new arena. We should allow them the time necessary to analyze the advantages and risks before we conclude that

royalty-in-kind is a better way to more effectively—efficiently collect oil and gas royalties.

Meanwhile, we can and should continue our investigation into

this area, and it is important that we have a clear understanding

of the domestic oil and gas industry as it exists today, if we are

to seriously consider privatizing the Federal program.

Thank you.

[The prepared statement of Mr. Romero-Barcelo ́ follows:]
59

STATEMENT OF HON. CARLOS ROMERO-BARCELO ́, A DELEGATE IN CONGRESS FROM

THE TERRITORY OF PUERTO RICO

Madame Chair, we appreciate the additional opportunity to review the potential

for a royalty-in-kind program in the Federal oil and gas leasing program.

We believe that a great deal more analysis and assessment is required before we

can responsibly determine whether or not legislation is required to impose a ‘‘royalty-in-kind’’ program on the Federal Government and the petroleum industry.

To focus our dialog on this issue, the Minority has requested that the Congressional Research Service analyze the various issues attendant to the ‘‘royalty-in-kind’’

concept. With the agreement of the Chair, I would like to submit for the Record a

September 17 Memorandum from the CRS addressing our questions.

The CRS report discusses the major issues that would be involved in the establishment of a large-scale royalty-in-kind program in the United States. In summary,

the CRS found, and I quote, that ‘‘RIK proponents contend that the system would

reduce administrative costs and disagreements over the valuation of oil and gas production for royalty collections. However, such a system also would require an effective system for marketing the Federal Government’s oil and gas and could lead to

significant government involvement in oil and gas markets.’’ As noted previously at

our last hearing, our experience in Puerto Rico with involving the government in

private business has not been positive.

Also, at the Minority’s request, we will hear today from three highly respected

and exceptional individuals who do not work in the petroleum industry, but, who

are also very knowledgeable on the structure, economics and trends in this dynamic

sector. Mr. Tim Cohelan, Mr. Ed Rothschild and Ms. Danielle Bryan each approach

this issue from different perspectives and will provide the Subcommittee with an objective and well informed assessment of the royalty-in-kind concept.

We commend the Minerals Management Service for taking such a positive yet

cautious approach to the ‘‘royalty-in-kind’’ concept in its September 2 report which

we will learn more about this afternoon.

The MMS proposal to conduct a good-sized pilot for natural gas in the Gulf of

Mexico, built on the lessons learned in the 1995 effort, should provide quantitative

and reliable information. Likewise the proposals for joint ventures with Wyoming

and Texas should produce valuable and necessary information.

Before moving forward with legislation, we need to determine that a royalty-in

kind program would be administratively feasible and fiscally sound. The detailed

revenue impact analysis to be conducted by the MMS will assess the market risks

and costs they would face in this new arena. We should allow them the time necessary to analyze the advantages and risks before we conclude that R-I-K is the

‘‘better way to more efficiently collect’’ oil and gas royalties.

Meanwhile, we can and should continue our investigation into this area. It is important that we have a clear understanding of the domestic oil and gas industry as

it exists today, if we are to seriously consider privatizing the Federal program.

Thank you.

Mr. THORNBERRY. I thank the gentleman. Now I am going to introduce our first panel of witnesses. Mr. William Henderson, Market Development Representative, Gulf Canada Resources; Danielle

Brian, Executive Director, Project on Government Oversight; Richard Rorschach, National Chairman, National Association of Royalty

Owners; Ed Rothschild, Public Affairs Director, Citizen Action; Linden Smith, Managing Director, Barents Group; Timothy Cohelan,

Cohelan & Koury; and Bob Neufeld, Vice President, Environmental

& Government Relations, Wyoming Refining Company.

I believe all the, the witnesses are at the table. Let me remind

our witnesses that under the committee rules, they must limit

their oral statements to 5 minutes but that their entire statement

will appear in the record. And we also want to allow the entire

panel to testify, and then we will, we will have our questions.

Mr. Henderson, if you would like to lead off, sir.
60

STATEMENT OF WILLIAM HENDERSON, MARKET DEVELOPMENT REPRESENTATIVE, GULF CANADA RESOURCES

Mr. HENDERSON. Good afternoon. On behalf of Gulf Canada Resources Limited, it is my pleasure to be here this afternoon and

give you Gulf’s thoughts with respect to Alberta’s current royaltyin-kind process for crude oil. I understand the Minerals Management Service is now debating whether to move to an in-kind type

of system, and I hope my comments will be of some benefit to both

the service and yourselves.

Alberta’s royalty-in-kind process started in 1974 as a result of

the energy price shocks in the early seventies together with jurisdictional issues involving the Federal provincial government over

Canada’s mineral resources. The in-kind process has undergone a

number of changes throughout the years, the most recent being the

move toward privatization. Previous to June 1996, the Alberta government used the services of 100 percent government agency, the

Alberta Petroleum Marketing Commission, or APMC for short, to

market the royalty share of crude oil.

As a result of government funding cutbacks and the general desire to get out of the business of being in business, the government

turned the marketing responsibilities over to three agents, Gulf

Canada being one of them. The decision to move to privatization

using agency relationships took over 2 years and involved a number of studies and a great deal of industry consultation, much the

same as you are going through now.

A number of different alternatives were exampled—or sorry,

were examined including two variations of a cash royalty system.

First, royalties would be based on the royalty payer’s actual cash

proceeds of sale. Second, they looked at royalties based on a series

of reference prices ultimately netted back to the field location using

the extensive quality and location data base maintained by the government. These reference prices were to be further adjusted by a

market differential obtained through pricing surveys of producers.

These two options were rejected by the government, as we believe

that either one would, would result in less royalty revenue as compared to the in-kind system.

I should note that it was the first of these two options favored

by larger industry producers, as these companies were very concerned about volume control. Smaller producers preferred an inkind system and were generally—sorry, were generally in favor of

the status quo. Privatization options including bid block sales were

also examined but rejected by the government due to net back concerns and whether, in fact, the government was actually getting

out of the sales business.

Finally, at the end of the review, the government opted on retaining the in-kind process using private sector agents to market

the royalty oil instead of the APMC. Using revenue pooling principles, the government would be assured that it was receiving the

same net backs as its agents while at the same time achieving its

No. 1 objective of getting out of the sales business. With benchmark formulas built into the contracts, the government would also

be assured the agents were receiving market prices for all sales.

Also with ownership of the royalty volumes staying with the government until point of sale, the government could call upon its
61

agents to undertake policy initiatives to protect the value of Alberta’s resources or in making the production and marketing processes

more efficient.

In the decision as to which agents to select, bids were solicited

and reviewed based on a number of published criteria. Although

not formally published, I believe one of the fundamental criteria

was for the government to align itself with companies who had the

same basic objective as the government, to maximize revenue. This

is why Canadian producers such as Gulf Canada were chosen and

large integrateds with refining operations, where pipeline companies with marketing arms were not.

The incorporation of the government volumes in the Gulf’s marketing processes and systems was relatively painless. There was a

large up-front data load required to get the appropriate data into

our systems, but this was a one-time process.

As Crown volumes awarded to Gulf were of similar qualities to

Gulf’s existing volumes, the buyers were the same. The sales contracts were easily adjusted or signed. Day-to-day operational difficulties have been minimal with the only real troublesome spot

being royalty volume forecasting. We have seen large volume

swings between forecast and actual have, have resulted in some

last minute scrambling, and we are currently working with the

government to address this problem.

Gulf believes that both industry and the government have benefited from the recent privatization move. Government has achieved

it is getting out of business objective while keeping its revenue

streams intact if not enhanced. At the same time, it has been able

to keep a relatively simple and straightforward in-kind process

while not increasing administrative costs. Industry has benefited

as it has not had to go through the pain of a major change in royalty systems. In fact, other than having to change the name of the

organization to which reports are directed, there has been absolutely no change in industry administration.

In moving to agency relationships, the government was concerned that it would lose its window on market events and issues

as it had with the APMC. This concern was unfounded, as Gulf has

been very active in government liaison and maintaining the communication channels. For example, we were recently partnered

with the government in a lengthy regulatory hearing regarding the

reversal of the strategic Eastern Canadian pipeline.

In terms of benefits to Gulf, the most obvious and direct benefit

we obtain is the marketing fee attached to the Crown barrels. The

major indirect benefit is that with larger volume control, we are

able to provide both the governments and our customers with increased service and more flexibility.

On a final and more subtle note, we are observing a large change

in the structure of the oil and gas industry throughout North

America. We see the Shell Texaco, Ashland Marathon and other

mergers taking place. We see our producing competition from the

south, Venezuela and Mexico, as huge nationalized producers. In

order for Alberta to compete, it appears we too will have to become

bigger. I think the province of Alberta realized this when choosing

the agents it did.

Thank you.
62

[The prepared statement of Mr. Henderson may be found at end

of hearing.]

Mr. THORNBERRY. Thank you. Ms. Brian.

STATEMENT OF DANIELLE BRIAN, EXECUTIVE DIRECTOR,

PROJECT ON GOVERNMENT OVERSIGHT

Ms. BRIAN. Thank you very much. I ask that my written comments are submitted into the record.

I think it is important for us to sort of step back and remember

why we are here. The reason we are considering any change in the

royalty management program is that the government has finally

recognized, along with other landowners, private landowners and

states, that we have not been getting enough money for the crude

that is produced on our land. As a result, the MMS finally recognized they needed to make a change, and they proposed a new rule

in which they would actually be collecting more money. Suddenly,

as a reaction to that suggestion, RIK came up as an idea that industry really wanted to pursue, but it absolutely fails to address

the reasons why landowners have not been able to collect the

money that was owed to them. It is really simply a diversion tactic

from focusing on the real problem.

The reason that we landowners, we American citizen landowners,

have not been getting enough money for crude produced on our

land is that there is really no competition at the wellhead. As a result, we get the undervalued crude. RIK will not change this problem. We start talking about entirely different issues leaving the

heart of the problem and the reason we are all involved in this exercise totally untouched. States and private royalty owners, when

balancing the differences between RIK and being paid in value

have chosen to go to the NYMEX system.

Mr. Thornberry, in his opening comments, referred to the fact

that Texas was interested in RIK a couple of years ago. But now

that they have really started evaluating the success of that system,

Texas in their comments to the committee concluded the bottom

line is that their state in-kind program would not exist if royalty

payments were based on the market value of oil.

Another example from the states in deciding whether RIK was

of value to them is when you look at California’s success. I have

four charts showing, actually it is Federal crude in California, and

when you look at the differences in, in here we have at Midway

Sunset, the differences between postings and RIK, they are getting

the same prices. There was no success, no added value to going to

RIK from postings.

There are four myths that I want to address in my oral statements. The first is the myth that RIK would mean more revenue

to the government. This was initially industry’s proposal, this

would really be a better thing to do than the proposed rule. I have

noticed in the last set of comments suddenly industry has moved,

and now they are saying it is revenue neutral. They are no longer

trying to claim it is going to be a revenue enhancer anymore.

MMS, in their feasibility study, pointed that out also, that when

they asked marketers how is government really going to come out

ahead? How are we going to be making more money? The marketers themselves could not give any convincing evidence the govern-
63

ment was going to get anymore money by moving to RIK. These

are the people who would be doing it, and they said they could not,

could not explain it.

I am not opposed to RIK as a concept at all. I am simply suggesting that we go in with the pilot programs that MMS is already

suggesting that we move in. There is really no reason to have legislation that would require a nationwide program and eliminate the

opportunity to actually get paid for the market value of our oil.

The argument also that is being made as to why RIK would be

better for the government is that we would be reducing the size of

the MMS. But when you look at the numbers, the entire budget of

the MMS is $60 million a year, and through their current auditing

process, which I am the last person to defend, they are still making

$125 million, and the proposed rule would actually, is estimated to

increase that revenue by at least another $100 million. So if you

eliminated MMS entirely through going to RIK, we have no government auditors for gas, oil, any of the other mineral royalties that

they work on, you are still going to have to justify $225 million

that is coming in through a value-based program, and RIK simply

cannot do that by itself.

The other myth that I wanted to dispel is the fear that has been

spread that independents would be forced to pay the market price

or the NYMEX price even if they did not receive it. The revision

to MMS’ rule absolutely makes that concern baseless. If you see in

the rule, they are given the option if an independent sells in an

arm’s-length transaction, they are given the option either of paying

by, by NYMEX or gross proceeds. I was concerned about the independents’ plight too, actually, and I thought that was really a terribly important distinction to make.

I wanted to just finally say that the argument also that the

NYMEX does not reflect real prices is really extraordinary coming

from an industry that uses NYMEX in all of their annual statements as a reflection of crude oil prices.

I am sure it is not lost on you that industry is in favor of RIK

and opposes the new rule. Of course they are. They are interested

in their bottom line and not ours. You cannot blame them for trying, but we certainly should not let them get away with it.

Thank you.

[The prepared statement of Ms. Brian may be found at end of

hearing.]

Mr. THORNBERRY. Thank you. Mr. Rorschach.

STATEMENT OF RICHARD RORSCHACH, NATIONAL CHAIRMAN,

NATIONAL ASSOCIATION OF ROYALTY OWNERS

Mr. RORSCHACH. Good afternoon, Chairman Thornberry and

members of the committee. I am Richard Rorschach. I am an oil

and gas lawyer from Kilgore, Texas. I am the national chairman

of National Association of Royalty Owners. I am also the managing

partner of Pentagon Oil Company which is a minerals management

company. We own the minerals, and we manage them.

We are here today to talk about the royalty owners’ comments

concerning the changes to the current cash-based collection system

and, and maybe to give the committee at least insight from, from
64

the royalty owners’ standpoint, at least the, the owners, private

royalty owners’ standpoint.

My organization, NARO, the National Association of Royalty

Owners, has approximately 5,000 members. We also represent the

interests of five major indian tribes, the Apache, the Navajo, the

Sac and Fox, the Osage and the Chickashay—Chickasaw. We are

dedicated to the needs of the nation’s more than 4.5 million private

royalty owners. There is 4.5 million of us kicking around this country. A large number of our members are over 70 years of age. They

rely on their royalty income to supplement their Social Security

checks. Most of us or many of us live in rural areas still. I live on

a farm. We have a number of farmers and ranchers in our organization. They rely on their royalty check during periods of drought

in the summer and, and bad weather in the wintertime to carry

them through. The towns around which they live benefit from, from

the royalty checks that come in, because these royalty owners

spend their checks, and in fact, an oil country banker has said that

royalty income is the financial heartbeat of the heartland. So you

can see that royalty income is very important to the members of

my organization and to 4.5 million people in this country.

We have wrestled with the problem of posted prices which is, is

part of the problem for many years, and in recent years, the industry has become in disarray about pricing policies. Recently has, has

been alluded to, there have been a number of lawsuits filed, probably the most publicized is the General Land Office suit in the

state of Texas. However, there have been some other class action

lawsuits filed throughout the country. Now it is apparent to me

that as a result of these lawsuits that the last few nails are being

nailed into the coffin of posted prices. We are going to have a new

method to determine the value on which royalty is calculated. The

question is what is the best method.

Well, we think that the best method is one that most easily determines the fair market value of the production and which generates the least amount of paperwork. Now let us look at a couple

of things. The Minerals Management Service has about 61,000

wells on Federal land. Forty six thousand of those wells are low

volume or marginally producing wells. That accounts for about

140,000 barrels of production a day. Now if we overburden the producers of these low margin, low margin wells, these low volume

wells with onerous paperwork, you know what they are going to

do? They are going to shut those wells in. We are going to lose

140,000 barrels of oil a day, and we cannot afford to do that.

I know most of you are familiar with the Commerce Department

report that stated earlier in the year that imports, imported crude

oil is, is a threat to our national security. If we lose that 140,000

barrels because of onerous paperwork, we are going to have to import 140,000 other barrels which, according to Commerce Department, is a threat to our national security.

But then, not only that, if all this paperwork is generated out in

the field, it has got to come to Washington. People in Washington

have got to look at it. That is going to—I do not know how many

people. That is—you can remember the old Federal Power Commission days if, if some of you remember that, and the volumes, the
65

truckloads of paperwork that came into Washington, some of which

was never even looked at. I do not want to get into that situation.

Now how do we avoid this mass of paperwork and still receive

a fair market value? Well, the royalty-in-kind may just be the answer to this. If we could—and, and I am not talking about the Federal Government taking and FISHKA physically taking possession

of it, because they will think they have to. The MMS could set up

auctions throughout the various parts of the country in which the

MMS operates and auction off the crude once a month, once every

3 months, whatever, to qualified bidders who would—and what

would you realize from that? One, you would realize the maximum

price. At an auction, you are going to get the maximum price. The

crude oil buyers are going to come in there and pay what they need

to pay to get what they need. Two, you are going to reduce the paperwork. And three, you are not going to be required to hire on

anymore personnel at the MMS.

Now you have heard the Canadian brother, and Canada processes 146,000 barrels of crude oil every day with 33 people. We

have got 950 people in the MMS processing 204,000 barrels. We

ought to be able to do as well as our Canadian brothers.

Our goal in my organization is we want to see the establishment

of fair, accurate and workable pricing in royalty practice—reporting

practices to the end that a true value for basing royalty calculations can be determined. We in NARO think that an RIK program,

where feasible, it is not going to be feasible in all areas, but in the

areas where it is feasible, is the way to go.

That concludes my comments. Thank you for your attention.

[The prepared statement of Mr. Rorschach may be found at end

of hearing.]

Mr. THORNBERRY. Thank you, sir. Mr. Rothschild.

STATEMENT OF EDWIN S. ROTHSCHILD, PUBLIC AFFAIRS

DIRECTOR, CITIZEN ACTION

Mr. ROTHSCHILD. Thank you, Mr. Chairman, and we do appreciate the opportunity to testify today on RIK.

Just some observations first, and the most intriguing of which is

I have been doing energy work, energy policy work on the consumer side about 25 years. There are some people in the audience

that know that quite well. And in all that time, there, all the time

that MMS has been operating, all that time we have had Federal

leases, there has been no charge or interest in moving to an RIK

system. I think that only after the states particularly started suing

oil companies for underpayment, and as a result settling as they

have in Texas to pay on the basis of market prices based upon

NYMEX prices, and that the MMS has suggested similar types of

pricing, that all of a sudden, RIK—importance.

Now if the industry is so interested in RIK, then I have to say

well, is this going to be good for the government? And the bottom

line I think as a government official, as people working to protect

the fiduciary responsibility of protecting the public’s interest, the

bottom line is simply which system or group of systems or combination of systems will generate fair market value for the public, for

the U.S. Treasury. Not for royalty owners or private royalty owners, not for oil companies or gas producers or oil producers. They,
66

they will pursue their own interests. The job is to protect U.S.

Treasury and the public’s interest.

So what does that mean? Does that mean we should absolutely

go mandatory RIK? Absolutely not. I do not think, from the evidence that I have seen, that an RIK program would fit everywhere.

This is not a one-size-fits-all policy, and we should not go in that

direction.

Now does that mean that RIK will not work in some areas? It

may very well. I think there was, as Mr. Chairman you mentioned,

a test. Was not a very good one. You are absolutely right. They had

a lot of learning to do, and I think they have learned some lessons

from that test. But we need a few more tests. This may very well

work with respect to offshore natural gas, and if it does, if it is the

best program to use for offshore natural gas, we should use it.

I also suspect, however, that it will not be that good for oil, particularly offshore oil. And there, I turn your attention to some of

the tables in the testimony I have submitted. You can see the fact

that there has been a severe decline in the number of oil producers,

that the largest producers have remained stable over time, that the

eight largest companies, you know, have been the eight largest

companies for a long time, that the amount of U.S. production has

remained fairly stable at or near 70 percent, and that they are the

largest royalty payers on Federal land, the top 10 companies accounting in 1996 for 61 percent of oil royalties, which is not true

on the natural gas side, where they only account for 42 percent of

the royalties paid.

Secondly, in many cases, your transactions that occur with respect to oil, we see that there are not arms-length transactions,

that there is no real competition for those sales. And that would

put a very great burden on whether the government or some marketing outfit that the government hires tries to sell that oil. It is

not likely to work. And so I do not think an RIK program in that

situation makes a great deal of sense if you are not going to be able

to assure that it is going to be a competitive price. And I think that

has got to be the bottom line, and we heard the idea about an auction. An auction would be very nice, but if there is a single pipeline, if that pipeline is owned by the production company on the,

on the lease, you have all sorts of structural problems, and if you

do not really resolve those and account for those and deal with

those, this kind of program is not going to work.

So the—I would point out also that the industry has made a

great issue about the costs of marketing oil or gas. And I suspect

those are, in most cases, fictitious. The—in their comments and response to questions from the committee, I point out that Texas, I

think, said very clearly that in general, our leases require the lessee to deliver the product without deduction for the cost of producing, gathering, storing, separating, treating, dehydrating, compressing, processing, transporting and otherwise making the product ready for sale or use. That is what they do. That is what they

have done clearly in all of these leases, and it seems to me that

that ought to continue, that that is the job of the companies taking

the oil from the lease.

Mr. Chairman, I will be happy to stop there and be willing to answer any questions.
67

[The prepared statement of Mr. Rothschild may be found at end

of hearing.]

Mr. THORNBERRY. Thank you. A vote has just started, but I believe, Mr. Smith, if you would like to proceed, we will have time

to do your testimony, and then we will probably have to go vote on

an amendment on the floor.

STATEMENT OF LINDEN SMITH, MANAGING DIRECTOR,

BARENTS GROUP

Mr. SMITH. OK, thank you. My name is Lin Smith, and I am a

managing director of Barents Group LLC, a KPMG Company. I

lead the firm’s legislative and regulatory policy economics practice,

and I am appearing today on behalf of 21 industry trade associations listed in my written statement. These associations represent

producers of essentially all the oil and gas produced in the U.S.

I am here today to discuss how a permanent royalty-in-kind program can provide a net benefit to the Federal Government, the

states and lessees, and specifically, to focus on some of the Federal

policy and budgetary implications of an RIK program. Clearly, any

serious legislative alternative will need to be scored CBO as being

at least revenue neutral.

Several broad principles are important to keep in mind when

considering a well-designed Federal royalty system. Some are basic

to good government policy while others are specific to the Federal

royalty area. I will raise just a few of these now, but I encourage

you to read my written testimony.

First, it needs to be market driven. Paying royalties on fair market value is the principle that all parties in the debate accept. The

issue is how to measure it. The most accurate measure of market

value will be based on arm’s-length prices actually received.

Second, it recognizes that value is added after oil and gas is produced. Various steps and processes are required to deliver crude oil

and natural gas to its final destination that add value to the product. Adding value requires investment, results in cost and necessitates a market rate of return. It is no more appropriate to impose

royalties on costs downstream of the lease, including downstream

marketing costs, than it is to impose royalties on the cost of operating a gasoline station. Both add value to the product. Neither requires investment by the lessor. Neither is related to the lessor’s

mineral rights.

Third, it is perceived by all parties as providing fairness and equity to the Federal Government, state governments, producers, operators, marketers and refiners. If some parties do not believe they

are being treated fairly, the credibility of the system will suffer,

compliance will be reduced, investment and production will fall and

the approach will have failed.

Fourth, it avoids economic distortion. Any government mandated

approach that produces an inappropriate royalty value will distort

investment and production decisions. This could occur if the effective royalty rate exceeds the contractual royalty rate with the use

of a methodology that overstates market value.

Because it is market based, an RIK program at or near the lease

meets each of these policy objectives. That is, by being responsive

to market-driven changes and prices, it will capture the full value
68

for Federal royalty purposes without a government induced distortion in investment choices.

Because the committee is not yet considering specific legislation,

it is impossible to draw any firm conclusions about Federal budget

effects other than to observe that the ultimate design matters

greatly in achieving revenue neutrality. I would now like to mention a few of the more important design issues that matter for

scorekeeping purposes.

First, does the proposal change current law? If legislation simply

provides additional options to MMS, it is unlikely to be scored by

CBO.

Second, will the RIK program be mandatory or voluntary? Scorekeepers are unlikely to score a voluntary program where MMS can

choose which production to take in kind, because it can largely do

that without legislation. They would likely score legislation allowing lessees to choose the RIK leases as causing a revenue loss. A

well-designed, mandatory system avoids both results and would be

scored.

Third, does the program create value for the Federal Government? Additional value can be created in a variety of ways, including allowing greater volumes to be aggregated, capturing a share

of the value added by moving production downstream and capturing the benefits from increased competition. If these can be

quantified by the scorekeepers, they will be scored.

Fourth, how will pipeline transportation costs be determine? Oil

pipeline tariff rules are in a state of flux, and that makes it difficult for the scorekeepers to develop a current law budget baseline.

All I can say today is that the revenue impact of this issue is far

from clear, and CBO must develop an official position on current

law. Until we reach that point, the committee should carefully consider its policy objectives and work with CBO to see how they will

score the issue. It is premature to simply conclude that pipeline

transportation charges will result in a revenue loss.

I would like to make two other quick observations. The committee should focus on the net revenue impact of the comprehensive program. Any legislation will likely include revenue raising

and losing provisions. Simply observing that one feature causes a

revenue loss is not by itself a problem. A budget problem occurs

only if aggregate losses exceed aggregate gains.

The other point is administrative cost savings will benefit both

the U.S. and the states. Half the onshore oil and gas program cost

savings under an RIK program will be shared with the states.

Costs are minimized by a program that applies uniformly to all

production. The states would get no cost reduction benefit from an

RIK program just in the OCS.

In conclusion, a well-designed, mandatory RIK program has significant potential to increase economic efficiency, maintain Federal

and state revenues, reduce controversy and be regarded as a fair

approach for the Federal and state governments, lessees and the

nation’s taxpayers. It is possible for the committee to design an

RIK program that applies to all production on Federal lands, onshore and offshore, for oil and for gas, it is in the aggregate at least

revenue neutral.

Thank you.
69

[The prepared statement of Mr. Smith may be found at end of

hearing.]

Mr. THORNBERRY. Thank you, sir. And if—the Subcommittee will

stand in recess while we go vote right quick. This is a vote on Murtha-Tauzin amendment, and we should be back shortly.

[Recess.]

Mrs. CUBIN. This Subcommittee will come to order. I apologize

for not being here. We always have conflicts while we are trying

to do work the last few weeks of the session, so I do appreciate all

of you being here. Thank you for your testimony for those of you

who have already given your testimony, and I would like to call on

Timothy Cohelan to give us his testimony at this time.

STATEMENT OF TIMOTHY COHELAN, ESQUIRE, COHELAN &

KOURY

Mr. COHELAN. Thank you very much, Madam Chairman. Today

I would like to focus in a general sense by way of background on

the concerns that, that I have identified based upon my observations of the upstream and downstream markets. It appears that

the, the deliberations and the discussion concerning the propriety

of this RIK system is appearing in a series of market shifts that

make it more difficult to, to analyze. It appears that again looking

at California there has been a substantial consolidation of the

downstream, that is from the refinery level to the street. Those

trends basically include the consolidation of refinery ownership,

the, the use of supply and exchange agreements and term sales in

a way that has the effect of balancing off crude oil capacity as

against market share.

And finally, there is a relationship with branding and branded

marketing that as we sit here today has resulted in California in

95 percent of the motor gasoline being sold through seven or eight

entities. There is a merger pending between the Shell and Texaco

downstream operations that would mean seven. So we have a substantial consolidation of the entities that would be in the marketplace to purchase crude oil.

California’s experience, I understand, is, is one that, that is, is

similar in overall trends to that nationally. There is a national

trend apparent to move toward refinery rationalization. Refinery

rationalization as a process is one in which surplus refining capacity is generally aligned in a closer manner with the downstream

markets. To the extent that this particular condition continues in

the United States as a whole, it has implications for the marketing

of crude oil.

In California, again returning to California, there has been an

additional concentration of upstream. Upstream again are the, are

the producing, producing properties both offshore and domestic.

The ownership, as I think I mentioned in my, in my statements,

the ownership mergers of upstream producing properties are going

to result very soon in about 60 percent of the crude oil produced

in California being marketed by just three companies.

Our unique situation in California may also apply in the sense

that our crude oil reaches the markets. Again, the markets are primarily these refineries and are fewer of them. Basically, what happens is that the refineries will buy domestic and Alaska North
70

Slope crude oil for use in refining and manufacturing gasoline for

sale. The decisions that are going to be made in California then are

going to be made by those refineries. They are going to be—to the

extent there is going to be fewer of them in the Northern and

Southern California marketplaces, and to the extent that there is

common ownership, it is going to be less of a competitive market.

Well, that has a lot of implications for, for anyone that is talking

about attempting to use a market mechanism, because when you

look at a market mechanism as a substitute for something that

seems to be working now, you got to ask yourself how many sellers

there are and how many buyers there are, how they interact and

what you are going to use to assign a value to that.

Basically, in California again on the downstream basis, we have

what the economists call an oligopoly. That is a small number of

sellers in a market. We have had, in my opinion, there have been

anticompetitive characteristics that will be discussed in a civil action in, in the California court system. But the implication is that

the decisionmaking for crude oil domestically in these markets will

be made in a different way than it has been in the past. There are

simply fewer refiners to participate in this market. All of our small

refiners in California have been unable to make the conversions to

manufacture motor gasoline, and so they are either providing feed

stocks in some limited situations for other refiners, or they are entirely out of business, such as the Power Refinery which could not

start.

So the larger companies, the larger manufacturers with the, with

the larger refineries are in a position now where they make all

those decisions, and their purchasing agents for crude oil are the

ones, the traders that will be making these very important decisions with regard to what prices are paid. On natural gas, I would

suggest that what I have read and, and learned from the regulatory authorities in California is that that is a different marketplace. There may be things about the commingling nature of, of

natural gas royalties that make it a fairer measure. There is apparently other interactions in market centers that have been established that may make that a better candidate for some kind of an

RIK approach.

But I would like to, if nothing else, point out how dangerous I

think it might be to adopt a national, a national policy without

looking at the implications in local markets. The second major

point I would like to make is you are talking about a moving target. Every day there are new mergers downstream and upstream,

and the marketplaces in which you are going to place the government under such a program is changing drastically. And finally,

your review, in my humble opinion, should be done with your fiduciary duty hat on, and you ought to have very substantial and compelling reasons that the taxpayers and the, and the people who are

ultimately receiving this benefit are going to be better off as a policy, and we ought to go a little farther than just identifying administrative burden.

Thank you very much for inviting me here today, and I will be

available for questioning.

[The prepared statement of Mr. Cohelan may be found at end of

hearing.]
71

Mrs. CUBIN. Thank you for your testimony. I would like to welcome Mr. Neufeld from my home state of Wyoming and ask if you

would please present us your testimony now.

STATEMENT OF BOB NEUFELD, VICE PRESIDENT, ENVIRONMENT & GOVERNMENT RELATIONS, WYOMING REFINING

COMPANY

Mr. NEUFELD. Thank you, Madam Chairman, members of the

Committee. My name is Bob Neufeld. I am the Vice President of

Environment & Governmental Relations for Wyoming Refining

Company. I am here today because I want to tell the committee

about how the Minerals Management Service is driving my company toward bankruptcy, is inflicting serious damage on other

small refiners in the country and is destroying a Congressionally

authorized program that has been operating successfully since

1946.

I think the committee would like to hear what I have to say, because our experience with the Minerals Management Service and

the currently authorized small refiner royalty-in-kind program will

shed some new perspective on why 20/20 hindsight, armchair quarterbacking, second-guessing and post-hoc valuations have no place

in the determination of the value of Federal crude oil and will lead

you to the common sense conclusion that the only fair and equitable way to really know that you are getting market value for

your oil is to market the oil.

Wyoming Refining Company is a small 12,500 barrel a day refinery in Newcastle, Wyoming. We are, nevertheless, the largest private employer in Weston County, Wyoming. We provide about 50

percent of the motor fuel supply for the Black Hills region of Wyoming and South Dakota, and over the last, I would say, 10 years

or longer, we have provided about 90 percent of the jet fuel supply

for Ellsworth Air Force Base in Rapid City, South Dakota. Our demise would have serious implications for that region of the country

in terms of availability of refined motor fuel products and possibly

national defense implications as well.

The royalty-in-kind program in which we participate was authorized by Congress in 1946, and it operates this way. When the Secretary of Interior determines that adequate supplies of crude oil

are not available to small refiners, the royalty is taken in-kind

from select leases and sold to small refiners. And historically, that

has been at prices reported by the producer. The purpose of this

is to be sure that large, vertically integrated oil companies do not

have exclusive access to Federal crude oil and that small refiners

are around to provide a stable supply of national defense fuel supplies.

We have been in the program since about 1980, and historically

over the last 10 years, it has provided about 40 percent of our

crude oil supply. And everything was fine until 1995, when we got

a demand letter from the Minerals Management Service that said

we have audited the producer, we think the producer has undervalued the oil that we sold you between 1987 and 1992, (that is as

much as 8 years prior to the letter) and because the producer, we

think, undervalued the oil, you owe us another $2.5 million.
72

We could not understand how we could owe $2.5 million for

somebody else’s alleged mistake, and we filed an appeal bond to appeal the matter to the Minerals Management Service director.

The—we have subsequently learned that other leases from which

we purchase royalty oil are under review and that at the present

count, we may owe another $4.5 million. Our banks have told us

that if that letter, demand letter issues, we will be taken involuntarily into bankruptcy.

The lessons to be learned from this are threefold. No. 1, we think

the damage that is being done is that the Minerals Management

Service has denied us our opportunity to cancel the contract. When

we receive a delivery of oil, and then the invoice comes 45 days

later, we have to pay for that oil, but if we do not like the price,

we can cancel future deliveries. But if we do not find out what the

real price of the oil is going to be until 8 years after the delivery,

we have no chance to cancel those deliveries. They forced us to purchase oil. Their position is they can force us to purchase oil we

would not otherwise purchase, and in fact, we would have refused

delivery on.

Secondly, and it is what is most egregious about this, is that we

have evidence, and it is clear from the case against the producer,

that MMS suspected the prices that it was billing us for on this oil

were incorrect as early as 2—1 year into our audit period, as early

as early 1988 or 1990—1989, excuse me. Nevertheless, even though

they suspected that the prices that the producer were reporting

might be incorrect, they continued to repeat those prices in our invoice and continued to sell us oil. In other words, they stood back

and watched us continue to buy this oil when they should have

known that it was increasing our contingent liability and our exposure under a future audit of the producer.

And third, and this one is almost as egregious as the second, is that we spent somewhere in the neighborhood of $250,000, which

is a big amount for a company of 95 employees, trying to defend

the producer’s valuations in this matter. MMS has said: It does not

matter what your evidence is. We had a case over here with the

producer where we did the audit, and that is where we determined

what the value is, and we are going to bind you to it. So apparently, MMS has determined that there is, in fact, an exemption to

the due process clause of the Constitution for small refiners who

are allowed to unknowingly purchase oil that they could not afford

and would not have otherwise purchased.

My conclusion is that we think that MMS is confused as to

whether or not it is selling oil or collecting royalty, and it cannot

do both. If it is going to sell oil, it has to do it in an arm’s-length

transaction. That is not what is happening here. Every purchase

that we make under this program is a contingent liability. There

must be some finality in the price of oil when it is sold. You cannot

go on for ever and ever knowing that, not knowing what the price

is going to be. The consequences go beyond the producers. It goes

to our consumers and to our employees. And again, I would remind

you that the only way—we feel that the only way to know what the

market value of the oil is is to take the oil and market it.

Madam Chairman, one final comment. I would like to say that

Gary–Williams Refining, Age Refining of Texas, Placid Refining of,
73

of Texas and Louisiana and Giant Industries have authorized me

to say they concur in my remarks and have added, given me some

additional testimony statement that they would like to have submitted to the record.

[The prepared statement of Mr. Neufeld may be found at end of

hearing.]

Mrs. CUBIN. Without objection, it will be so ordered.

I thank the panel for their testimony, and now we will go to the

questioning portion of the hearing. I want to remind the members

that according to the Committee Rule 3(c), we have a 5-minute

limit on our questioning and ask that they will hold to that as

much as they can, and then if their questions are not all asked and

answered, and members want a second round of questioning, then

we will grant that as well.

So to begin questioning, I will call on the Ranking Member, Mr.

Romero-Barcelo ́. Mr. ROMERO-BARCELO ́. Thank you, Madam Chair. I thank the

panel for their testimony and for helping us try to figure out something, what is the best that we can do as far as the—and the states

are concerned. And I believe that each one of you would agree that

even though there, while there are many benefits associated with

going to a royalty-in-kind program, that there are also risks that

must be recognized and which should be resolved before implementing such a radical change. And which one would each, each of

you believe it to be the greatest risk associated with a national inkind program? And can we go from left to right and start over

here?

Mr. HENDERSON. I am sorry, your question was?

Mr. ROMERO-BARCELO ́. Which do you believe that the greatest

risk that would be associated with, in a national in-kind, a royaltyin-kind program? Or, or maybe you do not accept that there are

any risks at all. If you do, which one you think is the greatest risk?

Mr. HENDERSON. I, I cannot speak from, from the U.S. perspective, and I can just give you an indication of what I saw happen

in Canada over the last 3 years. One of the biggest concerns that

the, the government had in, in maintaining the in-kind system was

in fact that it was not achieving market value for its crude. I think

from that perspective, that is why it went to an agency basis and

the pooling of revenue concept so that would, in fact, ensure that

it was receiving market value. Together with our contracts, they

have benchmarks built in to, to test against market, general market prices.

Mr. ROMERO-BARCELO ́. Thank you. Ms. Brian.

Ms. BRIAN. I think that is similar to my comment. I think that

by far the biggest risk is that we would then think we fixed the

problem and moved on, and we in fact would not have done anything toward fixing the problem in the government getting market

value for its crude.

Mr. ROMERO-BARCELO ́. Thank you, Ms. Brian. Mr. Rorschach.

Mr. RORSCHACH. I, I do not, I do not see any very big risks. The

only, only problem I see is in some areas, and I am not familiar

with, with Federal leases, in small Federal leases, if there are such

thing, that it might, a royalty-in-kind program might be a problem,

because it would be very difficult to, to aggregate crude so it could
74

be taken in-kind. In large leases, no problem there at all. So the

only, only problem or a risk, if you want to call it that, would be

in, in small leases, small in area.

Mr. ROMERO-BARCELO ́. Thank you, Mr. Rorschach. Mr. Rothschild.

Mr. ROTHSCHILD. I think it is the problem of having one shoe fitting all sizes, and I think the, as my testimony made clear, while

an royalty-in-kind program may be appropriate, may work well in

some areas, it may be horrible in others. And therefore, I think the

idea of having a mandatory program is inappropriate, and I think

a structured program that applies it in the right places and not in

the wrong places probably makes more sense.

And second, I think the irony here is all of a sudden we are, you

know, we are trying to get the government out of the oil business,

as we are in selling off Naval petroleum reserves, and all of a sudden here, a national program, if it is mandatory, would put the

government in a, in a huge way into the oil business, and I think

you got to consider that as well.

Mr. ROMERO-BARCELO ́. Thank you, Mr. Rothschild. Mr. Smith.

Mr. SMITH. Thank you. My, my reaction would be that I would

be concerned if we moved too quickly without giving consideration

to the operational design of the program. There are an awful lot

of details that must be addressed in looking at this kind of program

that need to be worked through very carefully, and I would view

this as something where the MMS and industry and the committee

have to work together to get these details right. I think that if that

cooperation exists and that willingness to work together exists that

we can come up with a workable program, but the risk is one of,

of moving too fast or not working on, together with good faith to

try to resolve these many issues that, in fact, do have to be considered carefully.

Mr. ROMERO-BARCELO ́. Thank you, Mr. Smith. Mr. Cohelan.

Mr. COHELAN. Yes, very briefly, I think the, the major risk is

that there would be a substantial revenue loss. The revenue loss

would then require continued public discussion. Continued public

discussion would revisit. There would be new hearings. There

would be a re-examination. Following up on what Mr. Smith said,

if the appropriate time and consideration is given, given, including

but not limited to the differences in geographic markets and the

hardship cases that you are hearing about here today, then I think

you can minimize that. But a revenue loss by a precipitous enactment of a national mandatory RIK is something that would just occasion a continued debate by the representatives of the public and

so on.

The fact that there is a dispute today is a function of their disagreement over valuation. We all like to see disputes minimized.

We have a civilized society and a good governmental structure

where we resolve disputes in a focused and intelligent way, and our

system of government is better at it than any other. We should not

run away from this just because there is disputes. There should

be—hard cases generally make bad law. Somebody ought to be

looking at, at the administrative processes and problems that

somebody like Mr. Neufeld is having and then make a determination whether you have a sufficient degree of administrative relief
75

in the system. But when you look at 140,000 barrels a day as an

example of national production, and then you look at a small refinery as a, as a focal point for a description of a very large problem,

what you really want to do is, is help those people in, in their individual circumstances and assist them in a systematic way that

does not require you to re-engineer the whole system.

Mr. ROMERO-BARCELO ́. Thank you, Mr.—Mr. Neufeld.

Mr. NEUFELD. From the other side of the fence as a purchaser

of the crude oil, we cannot see any risks in an RIK program that

match the risks involved in the current policy of deliver and reprice. We would like to be sure, however, that small refiners continue to have an equal opportunity to compete for the oil and perhaps a right of first refusal in which the best price, if it is put up

for bid, the small refiner has an opportunity to match that price

and purchase it at the same price as the winner.

Mr. ROMERO-BARCELO ́. Thank you very much.

Mrs. CUBIN. You want to go last? Mr. Duncan, are you prepared

at this time to ask questions?

Mr. DUNCAN. Well, I will tell you, I know the least about this of

anybody here, but what I want to ask is this. I am—and I did not

get to hear all of the testimony. But I see that Mr. Rorschach said

in his testimony today the average Mom and Pop business in the

oil field is the operation of marginally producing or low-volume

wells. These operators are now totally over their heads with regulations and Federal environmental requirements. And I guess my

question is are we, are we heading in a direction toward more regulations and more paperwork? Is that what you are concerned

about?

Mr. RORSCHACH. Yes, sir. If, if you go to, if you go to a system

that is going to require more and more reporting to—and my, my

thing is if you go to an, an RIK program, you are going to get rid

of just practically all the reporting that you would have that would

be required by another system.

Mr. DUNCAN. If, if we go to a royalty-in-kind program, you, you

think that we could do away with a lot of the paperwork? Is that

what you are saying?

Mr. RORSCHACH. I do not think there is any question about it.

Mr. DUNCAN. And, and——

Mr. RORSCHACH. As opposed to some, some of the, as opposed to

some of the methods that are currently proposed in the proposed

rules.

Mr. DUNCAN. And that would, and that would help the small

businesses in this——

Mr. RORSCHACH. I—as I said in my testimony, I think if you, if

you put anymore burden on, on the, on the marginal well operators, they are just going to shut them in, turn them to the right

and walk away.

Mr. DUNCAN. When I see your testimony that you are over your

head with the environmental requirements, it seems to me that

these environmental extremists have become the greatest ally to

extremely big business. And, and they are doing terrible harm to

small businesses. And, and I would like to see us provide more assistance to the small businesses, and so I, I like your testimony.

Mr. RORSCHACH. Thank you.
76

Mr. DUNCAN. Thank you.

Ms. BRIAN. Mr. Duncan, could I, could I——

Mr. DUNCAN. Thank you, Madam Chair.

Ms. BRIAN. [continuing] could I make one comment on, on Mr.

Duncan’s question please?

Mrs. CUBIN. Certainly.

Ms. BRIAN. Thank you. I just wanted to clarify one point. The—

what we are talking about is RIK on Federal leases. It is really not

going to have anything to do with the landowners that we are talking about who are suffering. What we are talking about here is

RIK on, on Federal crude.

And the second point is that, that what we are talking about is

an alternative to the current system that everyone hates, going to

a NYMEX system which is publicly disclosed every day where we

would have less dispute over value, because we would have the

market telling all of us when we open the paper exactly what we

are talking about, so it would actually be resulting in less paperwork.

Mr. RORSCHACH. If I might respond just briefly, you are talking

about—we—I understand you are talking about Federal leases. It

has been my experience, and I have been around this oil patch for

35 years, that anytime a Federal program gets initiated before very

long, that camel’s nose is into the private owner’s tent. And we

want to prevent that if we can.

Mr. DUNCAN. Well, all I have noticed is that the more you regulate an industry, and the more paperwork you require, the more it

ends up in the hands of a few big giants. And I do not care what

the industry is. It, it happens in everything and, and if we go in

the direction of more and more regulation and more and more paperwork and more and more red tape, and we have gone way overboard on some of these environmental regulations, as you point out

in your testimony, and if we keep going in that direction, we are

going to drive all the small guys out of any of these major industries. And I will tell you, we are going to be really sorry if we do

that.

Mr. NEUFELD. Madam Chairman——

Mr. RORSCHACH. I think you and I are looking through the same

knothole.

Mr. DUNCAN. Thank you. That is all.

Mr. NEUFELD. Madam Chairman, I, I might have an additional

perspective to add to that if I might—over here on the end. As a

person who buys Federal crude oil, we found that the process of

purchasing Federal crude oil under the current system is much

more complicated than our ordinary purchases. And anything that

makes it as simple to buy Federal royalty oil as ordinary purchases

will be worthwhile and an improvement. I am beginning to think,

after our current experience with the Minerals Management Service, that EPA is like a walk in the park, frankly.

Mr. ROTHSCHILD. Madam Chairman, could I just add one thing?

Mrs. CUBIN. As long as that light is green, you——

Mr. ROTHSCHILD. OK.

Mrs. CUBIN. [continuing] you all can have this day. I am going

to ask you, Mr. Smith, as well, as long as that light is green, we

are still on Mr. Duncan’s time.
77

Mr. ROTHSCHILD. In Mr. Rorschach’s comments, he pointed out

that the posted price was too low. That is one of the problems that

has been occurring in the industry, and the question I would have

is why that happened. And our view of it is that if you do not have

very much competition in the industry, he may want to explain

that. Second, it was the state of Texas, for example, instead of California, instead of Alaska, that intervened on behalf of, and particularly in Texas, on behalf of all the royalty owners, the state and

the private royalty owners, to collect underpayments. So you know,

I am very intrigued, and I am also intrigued by Wyoming Refining,

you know. Here we have a program that is a government effect, a

government subsidy for small refiners, not one that I would dispute. But that is what it is, because it keeps them in business.

So on the one hand, you do have the government playing a positive role. On the other one, I can understand why he is upset about

what has happened. But we ought to keep in mind that the reason

that the government program is there is to be able to get crude to

his company which he says is as much as 40 percent of his usage.

Unidentified Speaker. I will dispute the—comment.

Mrs. CUBIN. However, he could have, he could have not purchased that oil and would have not purchased that oil——

Mr. ROTHSCHILD. I understand that.

Mrs. CUBIN. [continuing] had MMS given them any, any indication that this might be the end result. I just have to add that in

trying to be impartial here.

Mr. John.

Mr. JOHN. Thank you, Madam Chairman. I, I want to, I want to

thank the, the committee and the subcommittee for undertaking

this debate, because I think it is very important. I think everybody

in this room today, as I look across the audience, believe that, that

the system that we have in place is, is somewhat burdensome,

cumbersome and full of paperwork. And I think that the bottom

line, as we were discussing here, is to balance the risk versus the

benefits of changing the system.

Ms. Brian was pretty definitive in her remarks about and her opposition to an RIK program. And Mr.—the gentleman from Puerto

Rico asked her, asked Ms. Brian what do you feel this is obviously

the, the biggest risk, and you said getting the fair market value of

it, of our crude and making sure that the Federal and the state

governments are getting the best price that they possibly can. Do

you feel that the system intact today does that?

Ms. BRIAN. Oh, no, no. First I would like to say I, I specifically

was not definitive in my opening statements. I hope I did not make

that point or appear to be definitively opposed to RIK. I am definitively opposed to a nationwide RIK program. I think, for example,

in Wyoming, it sounds before this hearing, I have understood that

there really are a lot of reasons why maybe Wyoming would be a

great pilot program. So I am not in any way opposed on principle

to RIK at all. My concern is this, this absolute, nationwide, mandatory program.

But what I certainly would never do, and I have spent the last

3 or 4 years actually attacking, is defend the current system. I

have four reports that we have written showing how the current

system has failed and how the Federal Government alone has been
78

owed as much as $3 billion that has not been collected because of

the fact that Federal crude has been undervalued.

So what we really do believe, however, is that the appropriate response is what MMS is proposing. And I frankly find it remarkable

that I am here saying that, but I think that by moving to a marketbased valuation system, where we do not have an arbitrary posting, which is what we exist with now, that is made up. It is not

in fact the value of the crude that we are getting paid on. If you

have a NYMEX or something based on the NYMEX, and you take

into account the transportation costs, which is absolutely reasonable. This calculation has been used before and would go on under

an RIK program too. That would simplify things. We would have

an open price that everyone would know what it was. It would not

be under dispute. And then we would be getting towards collecting

the money that is owed to us.

Mr. JOHN. Would you agree that the best possible price is the actual price at which you could get for that crude?

Ms. BRIAN. Not the price the Federal Government has been getting. It certainly is not the best possible price, no.

Mr. JOHN. Well, I think—well, I just believe that we need to proceed carefully and slowly, and I think that was reiterated through

the panel today, about looking at this. My state of Louisiana has

lots of interest in what is happening here. My district is oil and gas

and dependent on that industry. So I am, I am taking a look at this

and, and making sure that we do just the right thing. And, and I

along with Mr. Duncan just believe that we can make it more simple, more—less litigious. In a lot of the, the situations that we run

into, we are in court battling over the, the prices and, and the well

and the wellhead and arm’s-length and, and all of the other litigation that happens with it. I think that the, the RIK program has

some merit, and I think we need to move forward on it.

Mrs. CUBIN. Thank you, Mr. John. Mr. Thornberry.

Mr. THORNBERRY. Mr. Smith, let me start with you. You did not

really get into this much in your testimony, but you have had considerable experience in the government in estimating the revenue

effects of, of different things that the Federal Government has done

and, and your testimony, I think, as a matter of fact, you are as

qualified as anybody outside of government to, to look at these

things. Your testimony said that it all depends on how the program

is written on, on the revenue coming back into the government.

But I wanted to ask you, if it is done, is there anything that you

have seen in what you have looked at that says that there is no

way to develop an RIK program that will not be at least revenue

neutral. I mean is there any impediment that is just going to prevent that from happening? That you have seen.

Mr. SMITH. I think—oh, I am sorry. Well, first of all, before—one

thing I would like to add, I am here representing now 22 associations. The Louisiana Independent Oil and Gas Association has

signed on to this as well, and I just wanted to get that in the

record.

In terms of impediments, no, I do not believe there is any impediments to a revenue neutral program being designed as long as

it is carefully considered, and the budget scorekeeping effects of

specific decisions are taken into account. Can you design an RIK
79

program that loses money? Absolutely you can design one that

loses money. Can you avoid having one that loses money by, loses

money by carefully designing it? Yes, you can, as you can come up

with a program that does accomplish your objectives of being at

least revenue neutral through careful design and consideration of

its features.

Mr. THORNBERRY. Thank you. Now you have heard a great deal

of discussion from just about every member of the panel today

about how difficult it is to figure out what the market price of, of

oil or gas is. And you have heard everything from the government

coming back 8 years later, or whatever it was, to say that is really

not what the price was. You have heard the difficulties of some

people allege that we have not gotten nearly as much as we should

have in the past. All of these disputes about the market price. Can

you tell me what would be better to figure out the market price of

it than actually the market itself?

Mr. SMITH. I do not think there is anything that is better than

the market itself. That is if we look at an RIK program where a

significant share of production, in this case one-eighth of onshore

production, one-sixth of offshore production, is taken in-kind, we

are going to have a large new supply thrown out to the marketplace up for bid. And that bidding process is going to result in a

determination of, in fact, a fair market value price. And so I think

this is exactly the kind of direction we want to go in to come up

with the correct measurement of price.

Mr. THORNBERRY. Well, why can you not use a one national price

all across the board that is posted so everybody knows what it is?

Why does that not work?

Mr. SMITH. Well, I assume you are referring to something like

NYMEX. And the problem with NYMEX is NYMEX is what is

called a derivative price. It derives its value from the underlying

cash markets. It is trying—and it is trying to use that to anticipate

what prices will be in the future. NYMEX, NYMEX is basically for

trading on a futures contract for a paper barrel of crude oil. And

so you are using something that comes from a cash market to forecast what a paper barrel would be worth in the future, and you are

trying to turn that around and apply that back to cash markets

again. You get into this circularity issue which is just sort of a

crazy approach to trying to establish a price. The real price is what

a willing buyer will pay a willing seller for a quantity of any product. And I would again say that if you put a large volume of production out for bid, you will get a market price. That will be the

best measure there is of the, of the true market value of the, the

product.

Mr. THORNBERRY. Thank you. Mr. Cohelan, I notice that, that

you are with a law firm in San Diego specializing in class action

suits and have, have done a lot of plaintiffs’ work in litigation over

the last few years. From, from your background as, as being a trial

lawyer, do you not think that if we could have an RIK program we

could at least reduce the amount of litigation that is, is just eating

us up from the government and private sector fighting about what

the price of oil is and was?

Mr. COHELAN. Well, I think the short answer is yes if you, if you

define it right. You, you mentioned why do we not use the market
80

to define the prices. Of course, that is, that is saying a whole

bunch, because the problem is what is the market. The, the

NYMEX, use of the NYMEX is an effort, imperfect though it is, to

establish objective benchmarks. People in good faith, you know,

using old Adam Smith’s invisible hand are seeking their own interests, and that is great. That is what made our country what it is.

The problem is when you rub up against public policy, you got to

look more closely at those markets and ask yourself if you are getting a fair market value. If you had an objective benchmark, and

you perhaps add some kind of arbitration procedure, you could take

this stuff out of the courts pretty easily. The reason it is in the

courts right now is that people of good will on both sides have real

strong disagreements over what fair market value is, and you get

around that by getting something out of their hands that defines

fair market value like a NYMEX or ANS crude price.

Mr. THORNBERRY. Well, thank you. It seems, going back to what

we were just talking about, I do not see how you can improve on

the actual market.

Mr. Henderson, let me ask you, before my time runs out, in Canada, you all have lots of lawsuits?

Mr. HENDERSON. No, we do not.

Mr. THORNBERRY. And out of the, let us see, you have 36 people

administering this program as I understood. Was that about what

it was, your, your testimony? You had about thirty some odd people

and, and you do not have a bunch of other lawyer—see, the problem we have got in, in MMS is we have got a lot of other lawyers

throughout the Department of Interior that are involved in these

lawsuits, and it is hard to figure out exactly how many people are

involved in all of the litigation that arises. Do you all have that

problem?

Mr. HENDERSON. I, I do not see that problem arising in Canada

where we have got, and you say 30 people. I, I am not quite sure

what the government has over there now. I know when they made

the transition to, to the private, private sector, there was about 10

people that moved over into the private sector with that.

In terms of lawsuits, the government is administering three contracts up there with three agents, and when you have that few of

contracts, and when you have good relationships, you are not going

to have the problems you see, particularly on the marketing side.

Mrs. CUBIN. Thank you. We have a vote on the Tauzin amendment to the ethics legislation that is before the Congress, so we

will go vote, and we will be right back. Two more people on this

round of questioning, and then we will see if we need another

round.

[Recess.]

Mrs. CUBIN. I ask the panel to take their seats please. Mr.

Dooley, would you care to begin your questioning?

Mr. DOOLEY. Yes, thank you. I thank all the panelists for coming

today.

Mr. Henderson, I was interested in your testimony where you

talked about in the case of Alberta they considered a number of different options, and they made a decision really stay with the royalty-in-kind but went to a privatization in terms of the marketing

or handling of it I guess I could say. And you also made the state-
81

ment that this was done in, in some ways because this was going

to maximize returns to the government? Is that—did I—is that correct or——

Mr. HENDERSON. When the government went through the, the

process of reviewing all the options, and it is much the same as you

are doing now, one of the studies they did and, was a comprehensive price survey amongst all producers in the province. And to appreciate the Alberta, it is very concentrated in one location, and

they were able to undertake this study. The study was subsequently verified by an independent consulting firm. What they

found is that in applying the models on the cash models to the realizations that the Alberta petroleum marketing was, was getting is

that the, the proceeds, the market values the APMC was getting

were slightly higher than under the, the models applied under the

cash system, and I think that is one of the, the aspects that they

looked at thinking well, we are pretty close to be revenue neutral.

Why change a fairly efficient system and go through the, the two

to three or four or 5 year pain that would probably come in the

change of such a massive system when we are revenue or slightly

better than revenue neutral now?

Mr. DOOLEY. Um-hum. Ms. Brian, in your testimony, you contend that if we were to go to an RIK type of approach that just the

opposite would be what you would expect to happen. And why

would that be the case? Why would it be different——

Ms. BRIAN. No, I am not sure I said the opposite would happen.

One thing I said is—actually, I did not say that I would like to say

now is that while it sounds that in Canada it really has been a

very appropriate system, the, the feasibility study that just was released by MMS shows there are some significant differences between what happens in Canada and what happens in the United

States. For example, in Canada, the marketers cannot have any

ownership interest in refineries which clearly is not true in the

United States. Another point is the Canadian marketers are

banned from financial hedging. They only receive a flat fee in Alberta. They only have 5 cents a barrel, so that is—these are elements to their system that are really very different from anything

we could imagine happening in the United States.

But I am not, as I said earlier, I am not in principle opposed to

RIK. All I am saying is the reason we are looking at changing the

system is because there has not been a competition at the wellhead. As, as my colleague from NARO was saying, his, his members were receiving postings which were unacceptable which is

what we, as Federal landowners, have also been receiving. And by

going to an RIK system, we are not addressing that fact at all. We

are simply going to change the subject and continue to be relying

on this posted——

Mr. DOOLEY. Now were they not—when they discarded accepting

the proposal that used basically a benchmark and brought it back

with some of the, putting in some reductions for different factors,

were they not in effect evaluating what you are suggesting, and

they made the determination that this was not going to be as effective in terms of maximizing government returns and also giving

the most accurate reflection of what actual prices are?
82

Ms. BRIAN. I, I do not, I do not quite understand. Who

rejected——

Mr. DOOLEY. I thought in Canada you I think basically made the

statement that you looked at posted prices and reference prices

that would be adjusted, and I would—what I would—my extrapolation is that an—or a NYMEX or an ANS is a reference price that

we are talking about adjusting back, and it appears that that is

one of the programs that was basically considered and then decided

that the RIK program was going to be better in, in Canada. And

Mr. Henderson, is that——

Mr. HENDERSON. Yes, that is correct. The, the benchmark reference prices they were looking at were Canadian posting and, and

a NYMEX-type price. The adjustment I was referring to would

have been an adjustment done by a survey of producer prices and

adjusted for not arm’s-length transactions, those type of transaction, exchange transactions, etc. The, the survey prices would

then come up with an average. The benchmarks would have then

have been adjusted by that, that adjustment.

Mr. DOOLEY. I guess the other issue is, and, Ms. Brian, you made

a statement that if we, we went to the, the royalty-in-kind is that

you would see the marketer capturing the what you would, what

you would expect to be the difference between the posted price and,

and the market price which you would——

Ms. BRIAN. Or some part of that. I mean you expect them to——

Mr. DOOLEY. You would contend they would be different. But if

you had a situation which would, I would expect if we put in place

any type of RIK system that allowed for, you know, the competition

or even the bidding on the oil that the government would, would

be receiving as royalty, why should we not expect the competitive

pressures of the marketplace to diminish any excessive returns to

the marketer?

Ms. BRIAN. Because the, the implementation of an RIK system

would not in any way increase the competition at the wellhead. It

is, it is just not addressing that issue. We are not getting more people suddenly with pipelines arriving at the Federal land saying we

all want to buy the Federal crude, and we are going to increase the

posting in order to, because we really want your crude. That—it

just is not addressing that issue.

Mr. DOOLEY. And that is where I guess we go back to, you know,

the concern that I had that I think that the MMS proposal, the

new proposal is addressed is that you are in effect, if you make

that argument, you are then acknowledging that in some respects

the posted price is different than the market price or the NYMEX

price——

Ms. BRIAN. Right.

Mr. DOOLEY. [continuing] and that is where the, the fundamental

issue here is how do we ensure that there is equity in terms of the

royalty that is being paid, and that royalty should be a function of

what people are receiving. And I guess I am not sure you can have

the argument both ways. You know, there is a problem there, if we

have an imperfect market, you know, maybe there are some reasons for that. But I mean the whole oil industry is, is somewhat

of an imperfect market. NYMEX, what happens, you know, when

OPEC meets and they, they make a, you know, a decision which
83

is basically a function of an imperfect market there. NYMEX jumps

or goes down. That is a function of an imperfect market too, and

I guess my concern is is what we are trying to ensure is that for

the oil that is, that we have a royalty that is due that it is fair

compensation to the government based on the price that is actually

received. And that is where I, you know, I am struggling with, you

know, if it is not a royalty-in-kind which would be a direct function

of what we would hope that that oil, the value of that oil would

have where it is at, you know, how could we get any better than

that, I guess? How could we get anything that is any, any more responsive to what the real valuation in this particular location?

Ms. BRIAN. If you will indulge me for a second, I have, for example, a chart that shows Exxon’s interfield postings where you see

East Texas, Hawkins, and their prices are down here. These are

fields where Exxon does not own the land. They have to pay royalties on it. The postings are pretty low when you compare them here

to West Texas Sour and, and Yates which is primarily—and the

irony here is that, in fact, East Texas is closer to the refinery. So

if you look at what the market should have, what should have happened if this were a competitive market is that these prices should

have actually been higher, because they are worth more with lower

transportation costs. But this is an example of what we are not addressing if we go to RIK. This is going to continue to be happening.

Mr. DOOLEY. Um-hum. And I would be interested in getting some

more of the details of that. I am not familiar with that, that situation.

Ms. BRIAN. Sure. I am happy to submit this for the record.

Mr. DOOLEY. Thank you.

[The information referred to may be found at end of hearing.]

Mr. SMITH. Could I just ask one question on that? I—my recollection—I have not looked at this in a long time. But I thought Hawkins was a much lower gravity field, and so you would expect a different kind of price relation——

Ms. BRIAN. It is actually not much lower. There is only about a

.2 difference. And so you can see, actually, if you really want to

know what is—what is really interesting is is you can see when the

Texas suits were filed when suddenly the postings started going up

almost to the day in, in 1995. Suddenly, the postings started rising

and, and started to mirror the spot prices. And what I understand

is that differential, which is relatively small, really is what reflects

the quality differential. But these enormous differences could not

possibly be answered by that.

Mrs. CUBIN. Thank you. And I do apologize again for having

missed the first part of the hearing when the most of you testified.

I did read your testimony, and so I have an idea where we are coming from. I want to say there was, there was some testimony that

was somewhat inflammatory to me. It, it got my ire up, and particularly some from you, Ms. Brian. I was raised in oil patch. I represent all of those people that work in the oil and gas industry, and

all of those people that receive services from the state government

and all of those people that provide services by the state government and all of those people that work in the state. I do not represent oil companies or gas companies, and so any, any implication

at all or any insinuation that my main goal is not maximizing the
84

amount of money that goes into the state treasury and the Federal

treasury is just simply unfair, and it is wrong. Wyoming, as you

know, receives more Federal mineral royalties than the next three

or four states put together. And I am committed to a system that

collects every single penny that is due to the Federal Government

and the state government but not one penny more. And——

Ms. BRIAN. I want to apologize if you misunderstood my point,

and I think that we are really on the same side. I had no, in no

way meant to suggest that you did not want to get everything for

the, the landowners and the people who work in Wyoming.

Mrs. CUBIN. That is good, and certainly that is the intention of

the entire subcommittee. We want a program, whether it is

NYMEX or the program that MMS is proposing or whether it is

royalty-in-kind, we want the best program that there is. And I

look—I think about the fact that Americans put a man on the

moon. Americans have better health care than anybody in the

world. I do not think this could possibly be—I realize it is complicated. But I do not think putting an RIK program in place could

possibly be so complicated that we cannot figure out how to do it

and how to do it fairly to all the parties involved.

And certainly, there are problems, and it is so complicated that

we want to do it right and, and possibly a pilot program in a certain area is the thing to do. But, but I think minds that are more

knowledgeable in this area than mine need to, need to make those

recommendations.

I want to start off by talking to—asking Mr. Smith, could you expand for me how an RIK program might score?

Mr. SMITH. It, I guess, first of all depends on whether MMS implements an RIK program along their recommendation, the line of

their recommendations or whether the committee takes action to

implement an RIK program. If MMS goes along with its existing

recommendations and implements a program, it does not score.

That is, it is not the result of Congressional action. Instead, it is

the result of powers that the agency has to use today. And so it

does not create a scorekeeping issue.

On the other hand, if, if the committee enacts legislation that requires MMS to undertake certain actions that it would not take absent legislation, then it will score. Whether it scores positive or

negative is, is again a function of the design of the legislation. And

so at that point, I think you get into the case where the details

matter greatly. So again, I think that the committee can come up

with something that is scorable and can be revenue neutral, but it

does require legislation in order for scorekeeping to become an

issue.

Mrs. CUBIN. Could you give me some, some more background on

the implications of mandatory versus a voluntary program? Do you

have any thoughts on that?

Mr. SMITH. Sure. I mean if, if we have a—well, let us split voluntary into two pieces, and let us assume this is in the context of

legislation, so it does become a scorekeeping exercise. We have a

voluntary program where MMS can determine which properties it

chooses to take and which properties it does not choose to take. I

believe that would be consistent with their authority under current
85

law, and so it then would have no score. CBO would, would not

score it.

Now one of the implications of that is if you should do that in

the context of something like a budget reconciliation bill, the provision could be knocked out under the Byrd rule over in the Senate,

and the House gets very concerned about that, but nevertheless,

the Byrd rule is very effective in killing legislation where the committee is doing something again that the Agency can do already.

So I think there is a problem there.

On the other hand, if we have a program that is voluntary from

the lessee side, then the lessees can in effect cherry pick which

kinds of properties they want as part of the program, and that will

trigger a revenue loss. So the only way of getting around this, I

think, is to have a mandatory program where MMS is required to

implement the, the program and to design it in such a way that,

in fact, it will be revenue neutral. At that point, you have got a

workable program. I think a voluntary program just will not accomplish anything that you can, can honestly work with.

Mrs. CUBIN. Thank you. Mr. Rorschach, I know that you have to

leave at 4:20 and it is 4:20. I have one more question, because I

have the yellow light, and I will be going on into the red. I am

going to talk to Mr. Neufeld here, but I will be submitting questions in writing if you would not mind responding—if all of you

would not mind responding to those. So if you need to excuse yourself, that is fine.

Mr. RORSCHACH. I, I would like to make one comment. I do not

know whether this is particularly germane to the subject, but I

heard many questions asked about why, why we cannot just use

the market to determine the market, and I have heard comments

saying well, there is only one pipeline into the lease, and therefore

that—well, these people are looking at different leases than I have

looked at, because most of the leases I have seen, there is no pipeline in there at all. The truck comes in and picks up the oil. And

I am telling you, there are lots of trucks around. There are lots of

people who own trucks who are, who are willing to come pick up

that oil and, and how it happens is the pumper calls the, the trucker and says look, come on out. We got a tank full of oil. And the

trucker comes out, and the pumper straps out the tank and, and

off it goes and he leaves him a run ticket. Now there is no pipeline

involved there, and the market can certainly handle that.

Mrs. CUBIN. Thank you.

Mr. RORSCHACH. Thank you.

Mrs. CUBIN. Mr. Neufeld, I will be asking this same question of

Mr. Brown with the MMS, but I want you to, since you are up,

seems to me that the producers are the ones that are liable for paying the royalty. Why in this case is the refiner being charged with

the royalty retroactively? Do you——

Mr. NEUFELD. I, I believe——

Mrs. CUBIN. [continuing] what reasons have you been given, or

do you understand it? It is beyond me.

Mr. NEUFELD. Yes. The Minerals Management Service points to

a provision in our contract that says that the price of the oil that

we are charged will be determined under 30 C.F.R. which is a large

section of the Code of Federal Regulations. Our understanding and,
86

and we believe based on, on memos that were written to us by

MMS, and this is getting into the legal aspects, and I do not want

to try the case here. But our understanding of that provision is

that MMS would take the benchmarks in the rules, apply them to

their oil and reflect that in our invoice. Their interpretation is: no,

that was not the case. When we said that we agreed to have the

oil priced under 30 C.F.R., we agreed that when they went back

and audited the producers, after the fact, that we would be bound

by those proceedings and agreed to have our prices adjusted accordingly. And so it is a difference in interpretation over that section of the contract.

Mrs. CUBIN. Well, thank you very much all of you for being here

today. I know it has been a long time, but we do appreciate your

coming. It is very important to the process, and so if you would like

to take your leave, that is fine.

Now I would like to call Mr. Brown from the MMS to please

come forward to testify. Thank you very much, Mr. Brown, for

being here. We have a vote coming up maybe in about 20 minutes,

and so I think if we all stick to the 5-minutes that we are allotted,

we will have just about the right amount of time, and then we can

adjourn this hearing, and everyone can be off on their way. So if

you would like to present your testimony.

STATEMENT OF ROBERT E. BROWN, ASSOCIATE DIRECTOR,

MINERALS MANAGEMENT SERVICE, U.S. DEPARTMENT OF

THE INTERIOR

Mr. BROWN. Thank you, Madam Chairman, members of the subcommittee. I appreciate the opportunity to appear today to present

testimony on the Mineral Management Service’s examination and

implementation of programs to take oil and gas royalties-in-kind.

We at MMS are excited to be discussing these issues. It appears

to us from our recently completed royalty-in-kind feasibility study

that the exercise of Federal lease rights to take Federal oil and gas

production share in-kind may offer opportunities to both dramatically streamline the royalty management process and at the same

time enhance mineral receipts, if we deliberately and intelligently

design and implement RIK programs where appropriate.

Today I will describe our future plans in this area, but first I

would like to briefly discuss the major results of our feasibility

study. I ask that my prepared testimony be entered into the record.

Our final report on the royalty feasibility study was issued just

about a month ago, and the feasibility study was taken as one of

a series of MMS initiatives to examine how we can improve our

royalty management processes through innovation. Additionally,

we had reported language from the Congress in the last session

recommending that we undertake studies of the feasibility of royalty-in-kind programs. The final report is available on our home

page at www.mms.gov.

The primary objective was to determine if RIK programs are in

the best interest of the United States, meaning if they, one, offer

potential revenue enhancement or neutrality for the Federal treasury, and two, provide extensive administrative relief for MMS and

for industry.
87

We concluded that RIK programs, if implemented under favorable conditions, could be workable, revenue neutral or positive and

administratively more efficient for MMS and for industry. What

are favorable circumstances? Well, we would participate, particularly in, in gas and downstream marketing and sales, and particularly again for gas that aggregation would provide supply assurance which would provide market opportunities for the Federal production, and administrative relief both for us and for the producers.

Less reporting, less auditing for all parties.

Now unfavorable conditions which could lead to the program not

being successful we think should be avoided are if we continue to

audit the producers’ shares of production. Second, if we required

MMS to take in-kind everywhere or at the lessee’s discretion.

Third, if we had to pay above-market transportation rates where

we encounter nonjurisdictional lines. Fourth, if we had to accept

RIK volumes that were at less than marketable condition, and

fifth, RIK on scattered, onshore basins with minimis volumes.

The report recommends three in-kind pilots. The first is a royalty

marketing program for the Gulf of Mexico involving natural gas

which we believe would have a high chance of success if it involved

substantial volumes and ran for at least 3, if not 5 years and was

contractually performed by an energy marketer and provided for

MMS to share in downstream proceeds realized. Although actual

revenue returns will depend on specific proposals from energy marketers, we believe that royalty revenues will increase due to increased aggregation of downstream market.

Thus, the report recommends pursuing a long-term RIK program

in the Gulf of Mexico in which substantial volumes of natural gas

would be marketed and sold by an energy marketer under contract

with MMS. We stress that before decisions are made to implement

this program, we need to do detailed economic studies and make

certain that that leading proposal would, in fact, be revenue neutral. Implementation would occur if all indications are positive.

The second recommendation of the report concerns crude oil inkind programs. We had workshops and meetings with energy marketers which did not produce any clear evidence of revenue enhancements or, for that matter, in some cases revenue neutrality

from crude oil RIK. But based on our research, we believe that the

revenue implications continue to be uncertain for oil RIK. Consequently, we do not endorse widespread implementation. However,

considering the significant interest on the part of producers, marketers, and the State of Wyoming, the report concluded that a

small-scale program for crude oil RIK could be jointly pursued by

MMS in that state. Similarly, the report notes that the State of

Texas has interest in RIK, and as a result, the third recommendation calls for a joint exploration of options with the state for both

8(g) leases and Federal offshore leases for oil or gas.

Regarding future activities, our senior management team at

MMS has accepted the report and its recommendations. Within the

next month, we will begin our implementation of the report’s recommendations. Our first course is to consult with Congress, which

we have done with staff and we are doing here today, and consult

with the states. We sent a formal invitation to Governor Geringer

of Wyoming and to Commissioner Mauro of Texas to form teams
88

to begin implementation. Governor Geringer has responded positively and will begin meeting with members of his staff in the near

future to begin implementation of the pilot.

We will meet with industry. We have meetings set for next week,

both the 22nd in Washington and the 24th in Denver, to followup

on the report and discuss the implementation. And then finally, inreach within our own program explaining to the royalty program

employees and to the offshore program how these programs will

work.

We will soon form an implementation team to pursue the report’s

recommendations. The team will identify the scope and overall

framework of the offshore gas in-kind program and will work with

Texas and Wyoming to do the same for the other pilot. We would

like to work with industry in developing program details.

I would like to reiterate that before actual implementation of any

program, we will conduct detailed economic analysis necessary to

determine chances for a program’s success. As stewards of a public

asset, our responsibilities are first and foremost to ensure that the

public’s assets are wisely managed.

In closing, I would like to express our cautious optimism that inkind programs may provide us with a great opportunity to resolve

a difficult area of public lands management in the manner that

could provide substantial benefits for the regulated industry, MMS,

and most importantly, the American taxpayer.

Madam Chairman, this concludes my prepared remarks, and I

would be pleased to answer any questions your or members of the

subcommittee may have.

[The prepared statement of Mr. Brown may be found at end of

hearing.]

Mrs. CUBIN. Thank you for your testimony. Mr. Thornberry,

would you like to begin the questioning?

Mr. THORNBERRY. Yes, ma’am. Thank you.

Mr. Brown, were you here through all the prior testimony?

Mr. BROWN. Yes, sir.

Mr. THORNBERRY. OK. A couple of points seemed to me that we

had pretty much universal agreement on. No. 1 is that, that the

current system is a mess. The second one is that pretty much everybody agreed, in principle at least, that royalty-in-kind makes

some sense. Would you concur that that is kind of a summary of

where we are generally among people who are interested in this

issue?

Mr. BROWN. I think that is fair representation of what the people

in the panel had to say. Some are more cautious about RIK than

others.

Mr. THORNBERRY. Sure. But I have not heard, and this is the second hearing we have had within a couple months, I have not had

any, heard anybody stand up and defend the current system, and

I have not heard anybody say that under no circumstances would

royalty-in-kind make sense. And so what, what that leads me to

think is now it is a question of working out the details of how it

is going to work. And I understand that that is, that is an important challenge, and we got to get it right.

I guess what I am really curious about is what is the commitment of MMS to sit down with industry folks, others that are inter-
89

ested, to work on these details regardless of whether you all think

it needs to be mandatory or whether Congress ought to impose it

nationally or how. But, but what is your commitment to sit down

and work on transportation issues and these, these other things?

Mr. BROWN. Well, I think in regard to the pilots, our commitment is to sit down and, do that immediately. As Director

Quarterman testified in July, we will be happy to sit down and

look at legislative proposals. We are not going to mandate that we

or commit to agreeing to them, but we would be happy to discuss

them.

Mr. THORNBERRY. Are you all going to have a legislative proposal

that you are going to send up here for us to look at?

Mr. BROWN. Well, sir, we do not believe that we need legislation

to carry forward on these programs, and we believe that carrying

out these cautious pilots should be able to give us indications that

would lead later to legislative relief if necessary.

Mr. THORNBERRY. I understand that, and I understand that, that

you do not want to commit to supporting something, but you are

willing to sit down in the meetings next week and, and otherwise

to work through some of these details with industry and talk about

how it could work if we were to do something like that.

Mr. BROWN. Certainly.

Mr. THORNBERRY. OK. Do you have any idea how many disputes

MMS is currently involved in now relating to the amount of Federal royalty owed, whether they are lawsuits or administrative

claims of some sort?

Mr. BROWN. Well, one of my areas of responsibility is processing

the administrative appeals, and we have a docket of some 600, 700

active appeals. As you remember in the last session, the Congress

passed legislation, the Royalty Simplification and Fairness Act,

which requires us to complete the docketing of those cases in 36

months. We had substantial backlogs in the previous period. We

are effectively moving to eliminate those. But that would not capture all of the disputes. There are other disputes that are farther

along with the bureau. The Interior Board of Land Appeals, and

additionally there is litigation, so I could not give you a specific

number.

Mr. THORNBERRY. OK. Let me ask this. One, one of the issues

that has been discussed is transportation issues, particularly for

offshore where you have pipelines. As I understand the way it

works now, royalties are based on a price, and then there is a deduction for transportation costs through the pipeline to get it onshore.

Mr. BROWN. Correct.

Mr. THORNBERRY. And it is also my understanding that MMS

pretty much sets the amount of that deduction.

Mr. BROWN. Well, what occurs on offshore, the pipelines are not

covered by FERC tariffs, so the actual calculation is done on a calculation of the amortized cost of the production of the pipeline. So

there is an audited price.

Mr. THORNBERRY. OK. Do you have any idea what the relationship is between that calculated price and the market price for some

other company that comes and tries to use that pipeline to bring

their crude say onto shore?
90

Mr. BROWN. Well, in this case it is a nonjurisdictional pipeline

that is privately owned, and well, we would let them deduct their

actual costs for those firms. In other words, if another firm uses

that——

Mr. THORNBERRY. So——

Mr. BROWN. If another firm uses that pipeline, that firm would

deduct its actual cost, because it had engaged in an arm’s-length

agreement to transportation. It is only in the case of someone who

owns the pipeline and would essentially be setting the price for

themselves that we do that calculating.

Mr. THORNBERRY. And do you know what, if one oil company say

wants to use a owned pipeline, you set the cost for the government

to be reduced from the government’s share. Do you know what the

relationship is between the market price and that generally and

what the price that you all set——

Mr. BROWN. I would, I would.

Mr. THORNBERRY. My understanding is it is lower, and I, I wonder if you, if you——

Mr. BROWN. If the market price is lower than what we

calculate——

Mr. THORNBERRY. That you are, that you are lower.

Mr. BROWN. We may very well be. But that is where we are talking about amortizing their costs, and then they have to make a

profit when they are selling that transportation to someone else. So

in the first case, it is derived simply from their cost, and in the second case, they are deriving a profit over and above their costs.

Mrs. CUBIN. Everyone agrees that if we have, in order to measure the success of an RIK program, we have to know the costs that

MMS currently incurs in enforcing what we have right now. When

Director Quarterman was in front of the committee in July, I asked

her for a summary of the Federal Government’s cumulative cost on,

associated with audit and enforcement of royalty obligations including, but not limited to, other Department of the Interior costs such

as workload at the Office of Hearings and Appeals and the Justice

Department resources spent in litigation. We have not received

that information yet. Would you have any idea when we will?

Mr. BROWN. I will make certain you get it as soon as possible,

Madam Chairman. I regret that we have not provided that yet.

[The information referred to follows:] ——————

Questions from Chairman Cubin

1. In questions posed to MMS following the July 31, 1997 R-I-K hearing,

I asked for a summary of the Federal Government’s cumulative costs associated with audit and enforcement of royalty obligations, including other

Department of the Interior costs, such as the workload at the Office of

Hearings and Appeals, and Justice Department resources spent in litigation on these issues. MMS did not provide this estimate, that I can see, in

any of the follow-up answers received September 17, 1997. The Subcommittee would like to have this information in order to get a better handle on the real costs government-wide associated with the current valuation system.

The Department’s costs for audit and enforcement of royalty obligations total approximately $28 million for fiscal year 1997. This includes Royalty Management

Program audit and enforcement costs of about $26 million, Interior Board of Land

Appeals costs of $150 thousand, Office of the Solicitor costs of $400 thousand, and

MMS Appeals Division costs of $1.3 million. As you may know, litigation on behalf

of the Department of the Interior is handled by the Department of Justice. We are

not in a position to provide the Department of Justice costs associated with litigat-
91

ing the issues. It is our understanding, however, that the Department of Justice

does not routinely calculate the costs of individual cases, and therefore does not

keep records in the form you request.

We caution that even under the best-designed R-I-K program not all litigation

costs would disappear. Litigation cost savings would depend on the type and scope

of oil or gas R-I-K programs implemented, and litigation costs would continue for

Indian, solid, and geothermal minerals that are not taken in kind. Further, expected

reductions in auditing costs would be deferred for at least 6 years as auditors complete reviews of prior periods.

Mrs. CUBIN. Because certainly that is very important for us to,

to know before we proceed.

Mr. BROWN. It is, in some cases, difficult for us to derive what

the Justice Department spends. But we, we should be able to give

you a calculated cost.

Mrs. CUBIN. An educated estimate at any rate. CRS did a report

on the Alberta RIK program in relation to potentially one in the

United States, and it said that there were two factors that seemed

to contribute to the Alberta RIK programs that, that have caused

it to be successful, that is large oil volumes and low-cost transportation. And one thing I wanted to know is do you think that the

pilot project in Wyoming will be a true indicator of whether or not

an RIK program nationally will be successful?

Mr. BROWN. Well, that is a two-stage question, Madam Chairman, if I could first address the Alberta situation. As we understand the province of Alberta, the—we have large concentrations of,

of volume, of production with limited refining capability. That is,

that there is less refining capability in the province than there is

production. And so that crude has to seek a market somewhere

else, and it seeks the market in the, in Chicago and in Ontario and

others—much of what the marketer does—the uplift that the marketers are achieving they are achieving through moving that crude

to those markets.

In Wyoming, there is a certain similarity in that there is limited

refining capability for the production in Wyoming, and there is only

certain places that one can take that, and perhaps by marketing

that crude beyond those refineries and by aggregating the volumes,

we can achieve the same kind of results as have been achieved in

Alberta. The state of Wyoming is very sanguine about the possibility of that result, and we are a little skeptical, but we are willing

to attempt to make certain that we do everything to make it work.

Mrs. CUBIN. Well, the reason I asked that question is because if

we really wanted to try to draw some sort of similarity to the Alberta experience, the Alberta province is approximately 255,000

square miles with a pipeline infrastructure that reaches to all of

the corners of the province. This is just less than the total square

miles in Wyoming, Utah and Idaho combined and less than the

Gulf of Mexico. So why not expand the, the pilot program if——

Mr. BROWN. Well, because of the interest of the state we have

chosen Wyoming. As you pointed out earlier to the earlier panel,

the onshore states derive significant incomes from production on

oil, of oil and gas on, on Federal lands. The State of Wyoming is

interested in RIK and has expressed an interest, so many of the

other states have expressed no interest or have, have said that

they are not, they are opposed to such a program. We did not think

that we could go forward with an RIK program that, that poten-
92

tially had some risk without the concurrence of the state who is deriving revenue from that production. So the Wyoming’s interest is

primarily the reason why we are moving forward in the Wyoming

area.

Mrs. CUBIN. But you——

Mr. BROWN. In addressing the second question, in the Gulf of

Mexico, there is substantially more refining capability in Louisiana

and Texas than there is production in the, from the Gulf of Mexico.

There is gas, oil being brought—excuse me, oil being brought in

from overseas through—and through Houston and Corpus Christi

to be refined there so that we do not have the same—it is the reverse of the circumstance in Alberta where you have large volumes

of crude production with limited refining capability, and the, in the

Gulf of Mexico, you have, you have more refining capability than

you have production.

Mrs. CUBIN. In the followup question that was submitted by Representative Romero-Barcelo ́ after the July 31st hearing, you outlined plans for the MMS to proceed on RIK, and specifically, you

mentioned preparing detailed requirements, program strategies

and, and analysis of impacts. We have not seen that yet either. Do

you have any idea when that will be complete?

Mr. BROWN. We have not completed it yet. Now that is the next

stage right now. What we have done is complete the feasibility report, and the next thing we have to do is develop implementation

plans. And, and part of our, the recommendation in the report is

that, that we would be using a different approach than we did at

our previous pilot which we specified very clearly the how, how the

marketer, where, where they were to take the production, which

was at the lease, and, and what they were to do with it. Very specified classic government kind of contract.

What we are proposing to do here is take a different approach

and say that we would make available to qualified energy marketers the specifics of what production we intend to take and ask them

to give us a business case solution for how they would market that

gas and, and how we would share in the profits that were derived

from that marketing. And the one that gives us the best business

case and the largest result would be the marketer that got the contract. So that would require—our analysis will have to go forward

until we actually get to the point of receiving bids from these folks

to really know what the results would be.

Mrs. CUBIN. One last question. While I, I am pleased that Wyoming will be used as a pilot or a test on this issue, I still cannot

help but be concerned that, that the results of the pilot program

really may not be a good reflection of what might happen nationally. If in fact the program in Wyoming turned out not to be profitable for the government because we do not—I am not aware of the

major lawsuits, at any rate, like have gone on in California, and

certainly those costs would not be in the Wyoming model, and the,

the volume of oil that Alberta is dealing with would not be in the

model, and we all agree that larger volumes give a better profit.

So are—do you think that absent legislation that MMS would use

a not real successful program in Wyoming to decline any action

moving forward on RIK?
93

Mr. BROWN. Well, I would have to assume that it would depend

on the reasons why it was not successful. Clearly, if it was unsuccessful because of peculiarities of the market that we did not anticipate, that should not be a reason why we would not go forward

with RIK. It might not be unlike the circumstances of our 1995

pilot where clearly, we did not understand the way in which the

market operated. We created a pilot that as one of, I believe Mr.

Thornberry said was really an absolute wrong way to conduct a

pilot. We would not do it again. And if we—if that was the reason

why we were unsuccessful, then certainly that should not be a bar

for us moving forward. If the reason we were unsuccessful was peculiarities of the Wyoming market, then again, I do not think that

would necessarily be a bar to moving forward with the in-kind programs.

Mrs. CUBIN. Well, thank you very much. I do appreciate the testimony. It has been very valuable. We will keep the record open for

10 days if there are additional comments. And if there is no further

business, then this Subcommittee is adjourned.

[Memorandum from Mr. Condit may be found at end of hearing.]

[Memoranda from Mr. Humphries may be found at end of hearing.]

[Statement of Mr. DiBona may be found at end of hearing.]

[Whereupon, at 4:47 p.m., the Subcommittee was adjourned.]

[Additional material submitted for the record follows.]
94

PREPARED STATEMENT OF THE AMERICAN PETROLEUM INSTITUTE, SUBMITTED BY

CHARLES DIBONA

The American Petroleum Institute (API) is a trade association with over 350

members engaged in all aspects of the petroleum industry. API respectfully submits

this statement of its views for the record on the Royalty-in-Kind issue for oil and

gas valuation.

The American Petroleum Institute supports the development of a Royalty-in-Kind

(RIK) program as an alternative to the present royalty valuation rules for crude oil

and natural gas production from Federal leases, and to the Minerals Management

Service (MMS) proposed rule for the valuation of crude oil production. Properly

crafted, an RIK program would reduce valuation uncertainty and would also reduce

administrative costs to both government and oil and gas producers. Also, an RIK

program can be revenue neutral, while reducing government administrative costs,

thereby yielding a net increase in revenues to the government.

In 1988, the MMS adopted its current regulations governing royalty payments for

oil and gas produced on Federal leases. Under this rule, oil and gas royalties are

based on the value of production which is measured by either the gross proceeds

accrued to the lessee, or benchmarks such as posted prices. The MMS audits the

valuation estimates submitted by the companies and challenges estimates when the

agency believes errors have been made. This process has been characterized by numerous and costly disputes, both for the MMS and for the companies that must document and defend their valuation estimates. This is why both the companies and

MMS have concluded that the current royalty system has many problems, and

should be changed.

An alternative to the present royalty valuation system is an RIK program in

which the government takes its royalties ‘‘in kind’’ (in physical units) and sells its

royalties in the open market. In 1995, MMS conducted a pilot RIK program for natural gas production in the Gulf of Mexico. The aim of the program was to test an

RIK program operationally and to determine its impact on Federal revenues. MMS

concluded initially that the program appeared to reduce revenue, but API and others have indicated that MMS’ analysis was incomplete and inconclusive.

In January 1997, MMS proposed a new valuation rule for crude oil. Among other

things, this proposed rule would scrap the existing rule’s reliance on benchmarks,

such as posted prices, for valuing production in non-arm’s length transactions. In

its place, lessees would be required to use an index valuation scheme involving New

York Mercantile Exchange (‘‘NYMEX’’) or Alaska North Slope (‘‘ANS’’) prices adjusted for locations and product quality. API responded to this proposed rulemaking

in detail, identifying several serious flaws. API also stated that the MMS should

fully explore royalty-in-kind as an alternative to the proposed index-based scheme.

Since both the existing royalty valuation rules and the MMS-proposed alternative

are problematic, many lessees have come to view RIK as an alternative. Accordingly, in Spring 1997, API joined with several industry trade associations to form

an RIK Workgroup to determine if the industry could develop a workable RIK program. Joining API in this effort were several other industry associations, including

the Independent Petroleum Association of America (IPAA), the Domestic Petroleum

Council (DPC), the Mid-Continent Oil and Gas Association (MCOGA), the National

Ocean Industries Association (NOIA), and a number of state and regional organizations. The Workgroup developed six basic principles that all members, including

API, agreed should govern any RIK program. API supports these principles, as key

components of any RIK program.

The first principle calls for the reduction of administrative and compliance burdens while providing the opportunity for Federal and state governments to maximize their respective revenues. The MMS should have the ability to optimize value

by aggregating volumes, determining the most favorable sales location, arranging

transportation, and negotiating the terms and conditions of the sale. The potential

for increased revenues would require the MMS to manage the risks and incur the

costs associated with marketing royalty oil and gas. Federal lessees should not see

any increase in administrative costs or experience operational burden. Federal lessees should have certainty through elimination of disputes associated with royalty

valuation. Similar benefits will accrue to the government. Also, lessees should not

have any costs or obligations beyond the lessee’s obligation to deliver at, or near the

lease. Reporting should be related to volumes produced and delivered, not sales

prices or other related valuation information. Finally, marketers should be provided

a business opportunity which has an acceptable risk/revenue ratio, thereby enticing

participation by the most professional and successful marketers in the business.

The second principle requires transactions at, or near, the lease to fulfill the lease

obligations. Once the production is delivered at an RIK delivery point at, or near,
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the lease, the lessee’s royalty obligation must be completely satisfied. A lessee must

have no duty to market or transport the government’s oil or gas past this point. All

risks and costs incurred downstream of the RIK delivery point should be borne by

the lessor or its purchaser, in the hope of realizing maximum revenue from reselling

the production downstream. An effective RIK program should not hold the purchaser liable for the lessee’s failure to perform under the lease contract.

The third principle provides that when the government elects to take ‘‘in kind,’’

it must take all royalty production for a time certain. Further, if the government

takes its royalties ‘‘in kind,’’ it must give sufficient notice and, for a time certain,

take the full royalty fraction tendered by the lessee(s) from a given property. The

government must have no right under the lease to defer its take obligation, or leave

its production in the ground. Moreover, the government must have no right under

the lease to defer any production from either new or existing leases. Otherwise, lessees will be unduly burdened by additional marketing and operational problems.

The fourth principle requires the use of private marketing expertise to streamline

government operations. The government’s oil or gas should be marketed through a

competitive, privatized system in order to maximize benefits, and streamline government operations.

The fifth principle provides that the states should have the opportunity to be involved with designing and implementing the program. At least one state, Wyoming,

has been actively promoting royalty-in-kind concepts this year. In addition to being

actively involved in the design of a government RIK program, the states need to be

given the opportunity to participate in the marketing of the Federal royalty stream

taken ‘‘in kind.’’

The sixth and final principle makes royalties taken ‘‘in kind’’ broadly available for

public purchase. Any production subject to this royalty-in-kind program should be

made available on an open, competitive basis to a broad-based public market. This

would include providing the opportunity to market to a broad group of interested

and qualified marketers.

If an RIK program for oil and gas were to be implemented based on the above

principles, MMS would benefit in several ways. First, MMS would have the opportunity to maximize the value of its oil and gas. Second, an RIK program would

eliminate many of the complexities and uncertainties surrounding valuation of product at the lease. When royalty is taken ‘‘in kind’’ rather than in value, the market

value is basically the price the MMS receives in the marketplace from a willing

buyer. Finally, the administrative burdens for both MMS and the Federal lessees,

particularly audit, record keeping and litigation costs, would be sharply reduced.

Finally, API supports the MMS’s efforts to move forward with an examination of

potential RIK programs, as described in its Royalty in Kind Feasibility Study (August 1997), released September 2, 1997. API urges MMS to look closely at the workability of an RIK program for crude oil as well as for natural gas production. Such

a program could accomplish the goals stated by MMS Director Cynthia Quarterman

last week when she noted the potential for RIK programs to ‘‘both streamline the

royalty reporting and auditing process and to enhance revenues to the U.S. Treasury.’’ API also fully supports the decision by MMS to seek additional input on alternatives to crude oil valuation before proceeding further with the oil valuation rulemaking.
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