U.S. Department of Energy 

Office of Inspector General 

Office of Audit Services 

Audit Report 

Department of Energy's Receipt of 

Royalty Oil

DOE/IG-0786 January 2008 
Department of Energy 

Washington, DC 20585 

January 4, 2008 

MEMORANDUM FOR THE SECRETARY 

FROM: reg y . rledman 

Inspector General 

SUBJECT: INFORMATION: Audit Report on the "Department of Energy's 

Receipt of Royalty Oil" 

BACKGROUND 

The Department of Energy's Strategic Petroleum Reserve is a critical component of this 

Nation's energy security strategy. Established in 1975 in the aftermath of the oil 

embargo, the Reserve is one of the primary means of assuring U.S. energy stability and 

security in the event of a petroleum production or import disruption. 

The Department of Interior operates a Royalty-in-Kind program designed to handle oil 

collected from private production platform operators in the Gulf of Mexico as royalties to 

the Federal Government. Through a Memorandum of Understanding between the 

Department of Energy and the Department of Interior, a portion of the royalty oil has 

been used to fill the Reserve. The Department of Interior's Mineral Management Service 

(MMS) transfers oil to the Department of Energy at specific oil terminal locations 

referred to as "market centers." MMS and the Department use contractors to both deliver 

and receive oil at the market centers. 

Since 2002, MMS has transferred over 11 2 million barrels of royalty oil to the 

Department, with an approximate value of $4.4 billion. The Department plans to use the 

royalty oil to increase the size of the Reserve from 727 million barrels of oil to 1 billion 

barrels as authorized by the Energy Policy Act of 2005. 

Because of the significant value of royalty oil and the importance of the Reserve to U.S. 

energy security, we initiated an audit to evaluate the effectiveness of the Department of 

Energy's control system over the receipt of royalty oil. 

PSSULTS OF AUDIT 

We concluded that the Department had not implemented an effective internal control 

system over the receipt of royalty oil at the market centers. Specifically, the Department 

had not: 

Resolved discrepancies between scheduled oil deliveries and contractor claimed 

receipts at the market centers; 

Ensured that documentation adequately supported royalty oil receipts; and, 

49 Printed with sny ink on recycled paper 
Addressed the vulnerabilities associated with contractors acting as both the 

shipping agent for MMS and receiving contractor for the Department. 

To illustrate our findings regarding discrepancies, during a four-month period in Fiscal 

Year 2005, two Department contractors reported receiving 308,000 barrels of royalty oil 

less than the amount that MMS had scheduled for delivery to the market center. Yet, 

despite this significant shortfall, the Department took no action to resolve the discrepancy 

and to ensure that it had received all of the oil shipped by MMS. Although the 

Department was unable to explain the differences, we were eventually able to obtain 

documentation from NIMS that identified the causes for 276,000 of the 308,000 barrels 

variance. This included a decision by MMS to sell royalty oil rather than ship it to the 

Department. However, the remainder of the variance was unresolved. 

The supporting documentation for oil transfers covered by these contracts was also 

inadequate to support the receipts claimed by the Department of Energy's contractors. 

Department contractors maintained spreadsheets without supporting documentation and 

made unsupported handwritten changes to the amounts recorded as received from MMS. 

In analyzing the receipt oTroyalty oil, we concluded that the Department relied too 

heavily on unverified contractor assertions concerning the amount of oil received. For 

example, Department officials informed us that they believed that contractor reports of 

royalty oil receipts, contained in e-mails, were more accurate than MMS' scheduled 

delivery information, which was subject to frequent changes. 

While responsible Department representatives agreed that discrepancies between the 

schedules and reported oil receipts were an indicator of differences that should be 

explained based on their materiality, Department officials stated that a more meaningful 

comparison would be of actual delivery reports to actual receiving reports. We found this 

argument compelling, however, because the Department had not obtained actual 

shipment and receipt documentation, neither we nor the Department could perform such a 

comparison. Department officials acknowledged that the available documentation was 

not adequate. 

Finally, the Department's control system did not recognize the risk posed by the fact that 

the same contractor often acted as both the shipping agent for MMS and the receiving 

agent Tor the Department. The lack of an arms-length relationship and the absence of 

compensating controls increased the risk that errors or unauthorized transactions could go 

undetected. Department officials asserted that they were unaware of the extent of intracompany relationships between Department and MMS contractors. 

To its credit, the Department acknowledged that improvements were needed in its 

controls over royalty oil receipts and has initiated corrective actions. Specifically, as a 

resi~lt of the audit, the Department included in its most recent contract solicitation a 

provision ror contractors to submit documentation supporting royalty oil receipts. The 

Department also proposed an amendment to the Memorandum of Understanding 

requiring it and MMS to provide and reconcile any market center discrepancies. 
It is important that the Department have adequate assurance that it has and is receiving all 

of the oil shipped by MMS. This is especially true as the Department implements its plan 

to use royalty oil to increase oil volume in the Reserve. As a consequence, we made 

several recommendations to address weaknesses in the process. The results of our 

evaluation were referred to the Department of the Interior's Office of Inspector General 

and to WIMS program management. The Deparlment of the Interior's Office of Inspector 

General told us that they, as will we, intend to follow-up on agency efforts to work 

cooperatively in resolving this matter. 

MANAGEMENT REACTION 

Management concurred with the recommendations and stated that they reflect control 

weaknesses that when corrected will strengthen the Department's management of royalty 

oil receipts from MMS. Management stated that variances identified in our report did not 

result from the Deparlment receiving less oil than shipped by MMS. Rather, 

Management asserted that variances could be attributed to differences between MMS 

shipping schedules and actual quantities delivered to the Department. 

Actions taken or planned by Management to improve controls over royalty oil receipts 

are responsive to our recommendations. These actions when fully implemented will help 

to ensure that future variances are fully explained, and will reduce the risk of errors in the 

receipt and recording of oil deliveries by the Department and its contractors. Although 

Management asserted that variances discussed in this report were due to differences 

between MMS schedules and actual deliveries, without a formal reconciliation process, 

the Department has no assurance that it is receiving the quantities of oil it is entitled to 

under the Royalty-in-Kind program. 

Attachment 

cc: Deputy Secretary 

Under Secretary of Energy 

Acting Principal Deputy Assistant Secretary for Fossil Energy, FE-30 

Acting Deputy Assistant Secretary for Petroleum Reserves, FE-40 

Chief of Staff 

Pro-ject Manager, Strategic Petroleum Reserve Project Management Office, FE-44 

Team Leader, Audit Liaison, CF-1.2 

Audit Liaison, Strategic Petroleun~ Reserve Project Management Office, FE-445 
REPORT ON THE DEPARTMENT OF ENERGY'S RECEIPT OF 

ROYALTY OIL 

TABLE OF 

CONTENTS 

Royalty Oil Receipts 

Details of Finding ...................................................................................................................... 1 

Recommendations and Comments ............................................................................................. 5 

Appendices 

I. Objective, Scope, and Methodology .................................................................................... 8 

2. Other Matters ..................................................................................................................... 10 

3. Summary Table of Discrepancies ...................................................................................... 1 1 

4. Related Audit Reports ........................................................................................................ 12 

5. Management Comments .................................................................................................... 13 
ROYALTY OIL RECEIPTS 

Controls over Royalty 

Oil Receipts 

The Department of Energy (Department) had not 

implemented an effective internal control system over 

the receipt of royalty oil at the market centers. 

Specifically, the Department had not resolved 

discrepancies between scheduled oil deliveries and 

contractor claimed receipts. The Department also had 

not ensured that contractor documentation adequately 

supported the amount of royalty oil received. Finally, 

high-risk contractor relationships existed that were 

not identified and effectively managed by the 

Department. 

The Department's system of controls for royalty oil 

receipts was not consistent with Government-wide 

standards for internal controls designed to safeguard 

assets and to prevent and detect errors and fraud. The 

Stalzdurds for Internul Control in the Federal 

Government require Federal managers to, among 

other things: reconcile transaction information 

concerning resource transfers and receipts; maintain 

appropriate transaction documentation; and, identify 

and manage risks posed by a single entity controlling 

two or more phases of a transaction. 

Resolution of Discrepancies 

Significant differences existed between the amount of 

oil that the Minerals Management Service (MMS) 

scheduled to be shipped to the market center and the 

amount of oil the Department's contractors reported 

as receiving. The Department entered into contracts 

with companies to receive royalty oil based on 

deliveries scheduled by MMS. We judgmentally 

selected and reviewed 9 of 18 contracts, covering 

calendar years 2002 through 2005, to determine 

whether the Department received the amount of oil 

scheduled by MMS for delivery at the market center. 

We used scheduled deliveries for comparison 

purposes with reported receipts because the 

Department had not obtained actual delivery data 

from MMS. These 9 contracts represented 21 4 oil 

transfer groupings from MMS. 

Page 1 Details of Finding 
Our analysis of the nine contracts showed that the 

Department's receiving reports did not equal MMS' 

shipping schedules in 28 percent (60) of the transfer 

groupings analyzed. For example, in the most recent 

contract, we determined that the contractor reported 

receiving approximately 2 10,000 barrels of oil or 3 

percent less than MMS reported as shipped over a 4- 

month period. During this same period, we found that 

a second Department contractor reported receiving 

98,000 barrels of oil, or 3 percent less than the 

scheduled shipments by MMS. Prior to our audit, the 

Department had not reconciled the receiving 

contractors' reported receipts to MMS' scheduled 

shipments to explain reasons for the differences. 

Subsequent to the issuance of the draft report, the 

auditors were able to work with MMS to resolve the 

majority of this variance. Specifically, we were able 

to obtain docunlentation from MMS explaining 

reasons for 276,000 of the 308,000 barrels variance 

between scheduled deliveries and reported receipts, 

including a decision by MMS to sell royalty oil rather 

than ship it to the Department. Nonetheless, a 

variance of approximately 32,000 barrels, valued at 

over $1 million, remained unresolved. Appendix 3 

summarizes the discrepancies between MMS' 

delivery schedules and recorded receipts for the 9 

contracts. 

Oil Receipt Documentation 

Also, the Department's contractors' documentation 

was not always sufficient to ensure that royalty oil 

receipts were accurately recorded and reported. The 

Department required its contractors to obtain 

supporting documentation for royalty oil receipts such 

as pipeline operators' meter records. We reviewed the 

supporting documentation for oil transfers covered by 

the two previously discussed contracts, where 

scheduled deliveries did not equal receipts, and found 

that the documentation was inadequate to support the 

contractors' claimed amounts. Contractor 

documentation included: 

Spreadsheets without source documentation; 

Page 2 Details of Finding 
Control Environment 

Unsupported handwritten changes to pipeline 

operator reports that recorded the amount of 

oil transferred at the market center; and, 

Pipeline statements that contained caveats 

against their use for accounting purposes. 

High-Risk Transactions 

Further, the Department's control system did not 

address high-risk transactions resulting from 

potential impairments to contractor independence 

and implement corresponding increases in controls. 

Specifically, the Department did not require 

contractors to disclose corporate relationships at the 

market center. We determined that contractors acted 

as both the shipping agent for MMS and receiving 

contractor for the Department in about 20 percent, 

(1 8 of 93) of the oil transfer contractor relationships 

reviewed. For example, in one of the most recent 

contracts, the same contractor was the MMS 

shipping agent and the Department's receiving 

contractor in three of the eight transfer relationships. 

We also identified two instances where the oil 

platform operator who owed royalty oil to the 

Government, the MMS shipping agent, and the 

Department receiving contractor were subsidiaries of 

the same organization. In these cases, the 

Department did not increase monitoring and 

implement compensatory controls over contractors' 

royalty oil receipts to ensure that potential contractor 

impairments were controlled. 

The Department's control system was not effective 

because it relied too heavily on unverified contractor 

assertions concerning the amount of oil received. 

For example, the Department's position was that 

contractor reports of royalty oil receipts, contained in 

e-mails, were more accurate than MMS' scheduled 

delivery information. However, a senior MMS 

official stated that, although scheduled deliveries 

fluctuate, the scheduled deliveries were reliable and 

that they could be used as a benchmark. The MMS 

official also stated that differences between the 

schedule and receipts should be reviewed and 

resolved. Further, the Department did not require 

contractors to submit doc~~mentation for royalty oil 

Page 3 Details of Finding 
Programmatic Risks 

receipts nor did they verify that the documentation 

retained by the contractors was sufficient to support 

the contractors' assertions. 

Finally, Department officials were not fully aware of 

the extent of the relationships among MMS and 

Department contractors. In our view, these 

relationships increased the risk that errors would not 

be detected. Also, these relationships could increase 

the contractors' ability to influence the transaction 

for their benefit. Department officials stated that, as 

a result of our audit, they recognize the increased 

risk and plan to focus more attention on contractor 

relationships. 

During the audit, the Department acknowledged that 

improvements were needed in its controls over 

royalty oil receipts. Specifically, as a result of the 

audit, the Department included in its most recent 

contract solicitation a provision for contractors to 

submit documentation supporting royalty oil 

receipts. The Department also proposed an 

amendment to the Memorandum of Understanding 

requiring it and MMS to provide and reconcile any 

market center discrepancies. 

The Department exposed itself to unnecessary risks 

by not instituting a more robust control environment 

for this program. In the absence of effective 

controls, the Department did not have assurance that 

it received all of the oil shipped by MMS. For 

example, a discrepancy between scheduled 

shipments and reported receipts of 32,000 barrels of 

oil, valued at about one million dollars, remain 

unresolved. 

Additionally, improved controls are important given 

ongoing and planned increases to the volume of oil 

in the Reserve. Currently, the Department has a new 

fill initiative that will add approximately 27 million 

barrels of crude oil to the Reserve. 

Page 4 Details of Finding 
RECOMMENDATIONS We recommend the Project Manager, Strategic 

Petroleum Reserve enhance controls over royalty oil 

receipts by: 

1. Requiring Department contractors to submit 

supporting documentation for royalty oil 

receipts in future contracts; 

2. Providing MMS with Department royalty oil 

receipts and working collaborative1 y with 

MMS to reconcile actual delivery and 

receiving reports at the market centers so that 

each agency knows the actual amounts of oil 

shipped and delivered; 

3. Developing a surveillance program 

commensurate with the level of risk posed by 

contractor relationships; and, 

4. Verifying, to the extent practicable, past 

royalty receipts through supporting 

documentation and/or reconciliation with 

MMS. 

MANAGEMENT 

REACTION 

Management concurred with the recommendations 

and stated that they reflect control weaknesses that 

when corrected will strengthen the Department's 

management of royalty oil receipts from MMS. In 

response to our report, management stated that they 

are now obtaining supporting documentation, for 

royalty oil receipts, from their contractors. 

Additionally, management stated that they have 

improved collaborations with MMS on all aspects of 

the Royalty-in-Kind program, are providing NlMS 

with the supporting documentation obtained from 

Department contractors and are actively engaging 

MMS to assure mutual agreement on the quantities 

of royalty oil transferred to the Department at the 

market center. Moreover, management will expand 

the scope of its annual crude oil accountability audit 

to include the market center royalty oil transfers, 

with particular focus on related-party transactions. 

Finally, management agreed to provide MMS with a 

record of actual royalty oil receipts received at the 

market center and request that MMS indicate its 

agreement or disagreement with the reported 

amounts. 

Page 5 Recommendations and Comments 
AUDITOR 

COMMENTS 

With respect to the Department's role and 

responsibilities and royalty oil variances, 

management wanted to clarify some specific areas. 

Management stated that the report recommendations 

adequately captured the respective responsibilities of 

each organization; however, they felt that this 

distinction was not as clear in other areas of the 

report. Management stated that the Royalty-in-Kind 

program is an MMS program over which the 

Department has no management control or 

responsibility. Management contended the report 

erroneously indicated that the Department is 

responsible for upstream activities such as 

reconciling nomination estimates and market center 

receipts. 

Department management also emphasized that there 

was no indication that the variances between 

shipping schedules and contractor receipts were a 

result of the Department receiving less oil than 

shipped by MMS. Instead, the Department stated 

that variances between shipping schedules and 

contractor reported receipts could be attributed to 

differences between MMS' shipping schedules and 

the actual quantities delivered to the market centers. 

The Department opined that the variances could 

usually be explained by time lags in updating 

shipping schedules and occasional changes by MMS 

in the distribution of royalty oil. In its response to 

our draft report, the Department further stated that 

based on records shared with MMS, accounting 

adjustments made by MMS, and assertions made by 

MMS during the course of this audit; there are strong 

indications that the 308,000 barrel variance 

discussed in this report will be reconciled by MMS 

in favor of the Department reported market center 

receipts. The Department committed to work with 

MMS to bring closure to this issue. Therefore, 

management did not believe that variances discussed 

in this report should be characterized as a 

programmatic impact. 

Management comments are responsive to our 

recommendations and if all recommendations are 

implemented successfully the Department's control 

environment over the Royalty-in-Kind program will 

be enhanced. 

Page 6 comments 
In response to management's comments on roles and 

responsibilities, the Department and MMS jointly 

developed and operate the Royalty-in-Kind program 

with specific requirements on each side of the 

transaction. We agree that the Department was not 

responsible for control over upstream activities, 

however, as stated in the report the Department has a 

responsibility to verify the market center receipts 

reported by its contractor. Additionally, the 

Stundards for Internal Control in the Federul 

Government require Federal managers to reconcile 

transaction information concerning resource 

transfers and receipts. 

Regarding management's assertion that there were no 

indications that the Department received less oil than 

shipped by MMS, we concluded that unexplained 

variances between scheduled shipment and reported 

royalty oil receipts represented a programmatic risk 

of errors in the receipt and recording of oil by the 

Department and its contractors. Regarding 

management's belief that the 308,000 barrel variance 

would be resolved in the Department's favor, neither 

the Department nor MMS were able to provide 

documentation to reconcile 32,000 barrels of this 

variance. The existence of unexplained variances 

represents a programmatic risk in the receipt and 

recording of oil to the Department until fully 

explained. Further, we identified variances relating 

to earlier shipments that management had not 

reconciled. 

Page 7 comments 
Appendix 1 

OBJECTIVE 

SCOPE 

METHODOLOGY 

The objective of this audit was to evaluate the 

effectiveness of the Department of Energy 

(Department's) control system over the receipt of 

royalty oil. 

This audit was performed between March and 

October 2007 at the Strategic Petroleum Reserve 

Project Management Office in New Orleans, 

Louisiana, and St. James Terminall Capline Market 

Center in St. James Parish, Louisiana. The scope of 

the audit was limited to Royalty-in-Kind receipts 

from 2002 to 2005. 

To accomplish the audit objective, we: 

Reviewed essential Royalty-in-Kind 

program documentation including 

Memorandums of Understanding, 

solicitations, and contracts; 

Analyzed Mineral Management Service 

(MMS) transmissions containing scheduled 

royalty deliveries between contractors; 

Selected a judgmental sample of contracts 

for further review; 

Performed a reconciliation of scheduled 

deliveries to contractor reported royalty 

receipts; 

Assessed the adequacy of supporting 

documentation for royalty receipts from two 

contractors; 

Analyzed relationships between contractors 

that delivered royalty oil at the market 

center and contractors that received royalty 

oil at the market center; 

Evaluated accounting entries associated with 

Royalty-in-Kind exchanges; 

Obtained and reviewed laws, regulations, 

policies, and procedures relevant to 

Department of Energy asset management; 

Page 8 Objective, Scope, and Methodology 
Appendix 1 (continued) 

Assessed the Department's adherence to 

Standards for Internal Control in the 

Feder~tl Government related to risk 

management; 

Reviewed the results of prior audits and 

reviews; 

Held discussions with Office of Fossil 

Energy personnel, Strategic Petroleum 

Reserve personnel, MMS personnel, and 

industry traders; and, 

Coordinated with the U.S. Government 

Accountability Office and the Department of 

Interior Office of Inspector General. 

We conducted this performance audit in accordance 

with generally accepted Government auditing 

standards. Those standards require that we plan and 

perform the audit to obtain sufficient, appropriate 

evidence to provide a reasonable basis for our 

findings and conclusions based on our audit 

objectives. We believe that the evidence obtained 

provides a reasonable basis for our findings and 

conclusions based on our audit objectives. The audit 

included tests of controls and compliance with laws 

and regulations related to the Department's Royaltyin-Kind program. Because our review was limited, it 

would not necessarily have disclosed all internal 

control deficiencies that may have existed at the time 

of our audit. Also, we examined the establishment 

of performance measures in accordance with the 

Government Performance and Results Act of 1993, 

as they related to the audit objective. We found that 

performance measures related to the Strategic 

Petroleum Reserve fill program had been 

established. Finally, we did not conduct tests to 

establish the reliability of computer-processed data 

because we did not rely on the data to accomplish 

our audit objective. 

Management waived an exit conference. 

Page 9 Objective, Scope, and Methodology 
Appendix 2 

OTHER MATTERS 

While the Department assumed ownership of royalty oil at the market center, it did not 

make an accounting entry to recognize royalty oil as an asset upon transfer of custody 

from the Minerals Management Service. Rather, the Department recognized the royalty 

oil as an asset only after it had been exchanged for other oil appropriate for storage in the 

Strategic Petroleum Reserve. Therefore, the transfer of royalty oil from Minerals 

Management Service to the Department was not appropriately documented and did not 

adhere to Department guidance, which directs that assets be recorded from the time of 

acquisition. We informed Department management at the Strategic Petroleum Reserve 

Project Management Office of this weakness. 

Page 10 Other Matters 
Appendix 3 

SUMMARY TABLE OF DISCREPANCIES 

The table below shows the differences between the amount of royalty oil that the Minerals 

Management Service (MMS) scheduled to be shipped to the market center and the amount of 

oil the Department's contractors reported as receiving. The table is for the nine contracts for 

the period April 2002 through July 2005. For two of the contracts (Phases IIIa and IIIe), the 

Department's contractors reported receiving more oil than scheduled to be shipped by MMS. 

For four contracts (Phases Illb, IIId, and IIIg) the Department's contractors reported receiving 

less than the scheduled amounts, while the aggregate amount reported as received for the 

remaining three contracts was equal to the MMS benchmark. 

The reported total barrels* are net discrepancy amounts for each contractor. Thus, they 

reflect the sum of "overages" and "underages" of multiple shipments. The table includes the 

discrepancies discussed in this report, specifically, Contractor H and Contractor I 

representing 209,904 barrels and 98,090 barrels of oil, respectively. The Department did not 

require contractors to provide supporting documentation for claimed royalty oil receipts or 

reconcile the contractors' reported receipts to NIMS' scheduled shipments to explain reasons 

for the differences. 

Summary of Discrepancies 

Page 11 Surr~mary Table of Discrepancies 

Phase 

I I Ia 

IIIb 

IIlc 

1 l Id 

Ille 

lIIf 

IIIg 

Contractor 

Contractor A 

Contractor B 

Contractor C 

Contractor D 

Contractor E 

Contractor F 

Contractor G 

Contractor H 

Contractor I 

TotaI Barrels * 

395,826.91 

-66,344.61 

0 

-14,618.49 

0 

43,25 1.86 

0 

-209,904.1 5 

-98,090.00 
Appendix 4 

RELATED AUDIT REPORTS 

Strutegic Petroleum Reserve: Available Oil Can Provide SignzJicunt BeneJits, but 

Many Factors Should Injluence Future Decisions about Fill, Use, and Expansion, 

(GAO-06-872, August 2006). Industry experts recommended that a number of 

factors be considered when filling and using the Strategic Petroleum Reserve. 

They generally agreed that filling the Reserve by acquiring a steady dollar value 

of oil over time, rather than a steady volume of oil over time, as has occurred in 

recent years, would ensure that more oil will be acquired when prices are low and 

less when prices are high. Experts also suggested allowing oil producers to defer 

delivery of oil to the Reserve at a time when supply and demand are in tight 

balance, with oil producers providing additional oil to the Reserve to pay for the 

delay. Regarding use of the Reserve, experts described several factors to consider 

when making future use decisions, including using the Reserve without delay 

when it is needed to minimize economic damage. 

A udit of Strutegic Petroleum Resenle Royalty-in-Kind Oil Program, (ER-L-00-0 1 , 

November 1999). The audit reported that the Strategic Petroleum Reserve 

(Reserve) Project Management Office had implemented the Royalty-in-Kind 

program to restock the Reserve. However, written agreements or understandings 

between the Departments of Energy (Department) and Interior had not been 

finalized. In response to the report, the Departments of Energy and Interior 

created a Memorandum of Understanding to outline the responsibilities of each 

Department. 

Page 12 Related Audit Reports 
Department of Energy 

Strategic Petroleum Reserve Project Management Office 

900 Commerce East 

New Orleans, Louisiana 70123 

M EMORANDtlM 'TO: (.icorgc W. Collard 

Assistant Inspector (iciicral fix I'erfi1rnlancc Audits 

Ol'licc ol'li~spcctor (iciicral 

W illialn C'. (iibso~~. .Is.. I'roject Manager, ', !,;'I 

Strategic I'etrolcum Kcscr\.c , , \\\" ', i 

I Ilc Str;~lcgic I'ctrolculn Rcscrvc (SI'K) appreciates the opport~l~lit)o review atid 

comment OII this dralt report. 'l'he SI'I< concurs with the k,ur rcco~i~rncr~tlatioris prcsciltcd 

ill the drnli report. I'hc Oflicc of Inspcctor General has been \.cry liclptiil in idcntilyiiig 

conlrol \\caki~csscs that \\hen corrected will strcngthcn the I1cpartlncnt's ~nallagclncnt of 

rqxlty oil i.cccipLs Iroin the 11cpartmcnl of Interior (1101). I'hc corrccti\~c actions 

plannctl or t:lkcn arc summarizctl bclo\v: 

~p 

l<ccommcntli~tio~i - I : In addition to the prcviulrsly required monthly suinmarics. the - --- ...... . . . p~ 

SI'IZ is no\\ obt;~ining supporting documentation (c.g.. pipeline statements. inctcr 

tickets. ctc.) I'ronl its contractors. 

I<ccoir~mcndatioi~ 3: l'hc SI'IZ has improvctl its collaboratio~l \vitli 1)01 on all 

i~spccts ol'thc IZoyaltg -111-Kind prograin. An amendment to tlic Mc~norl~ntlum of

I lntlcrstanding hct\vccn the Department ol'lncrgy (1101:) and 1101 addressing thc 

cxch;u~gc ol'inli,r~nation has been sigrlcd by I)OL; and sent to L)OI. .l'lic SI'IZ is 

provitling 1101 with the supporting tlocu~ncntation obtainctl troin its contractors and 

is actively cilpiigiilg 1101 to assure mutual agrccmcnt on the il~~an~itics ol'royalty oil 

tnulsli.rrcd tt) 1)OE at lhc illarkcl ccnlcrs. 

Kccommendation 3: The impro\.cd docuincntation and collaboration addressed in 

coll~lcctio~l wit11 the first t\vo rccolnmcndations \\ill also scrvc to reduce the 

incrcasctl risk associatctl u.ilh rclatctl-pill-ty transactions. .I-he SPR also plans. b\ 

March 3 1. 3008. to expand the scope of its annual crude oil accountnhility autlit to 

i~icludc the rnarkct center royally oil tralls1i.r~. \sith particular focus oil related-part!; 

transactions. 

Page 13 Management Comments 
Appendix 5 (continued) 

(ieorgc W. Collard. Office of Inspector (icncral 2 

Recc)mn~endation 4: I3y March 3 I, 7-008, thc SPR will provide DO[ with a listing of 

actual royalty receipts. DO1 will be requested to indicate its agreement or 

disagreement, by June 30,2008. with the quantities reportcd by thc SI'K. I he SPK 

will work with DO1 to resolve any areas of disagreement by September 30, 2008. 

Please iir~d attached additional commentary for your consideration in finalizing the 

subjecl rcport. 

Should you have any questions about this response, plcase contact Michacl McWilliams, 

Assistant I'rojcct Manager I'or Management and Administration. Sf'K. 

cc (wlattachment): 

Acting l'rincipal Deputy Assistant Secretary for Fossil Energy, I:E-30 

Acting Ileputy Assistant Secretary fix Petroleum Rcserves, FF,-40 

I'earn 1,cadcr. Audit 1,iaison. C1:- 1.2 

Audit Idlaison. Strategic Petroleum Reserve, I:E-445 

Page 14 Management Comments 
Appendix 5 (continued) 

S'I'RATECIC' PETROL.EUM RESERVE FINAL. COMMENTS 

DRAFT REPORT ON DEPARTMENT OF ENERGY'S 

RECEIPT OF ROYALTY OIL 

'l'hcrc arc two arcas ol'thc rcport that we \voultl like to address. I'hc lirst deals with the 

respective roles and rcsponsihilitics ol'thc 11epartnicnt of Interior (1101) and the 

I)cpartr~lc~lt ol' Encrg! (1)OE). I'hc second Socuscs 011 the signilicancc ol'varianccs 

hct\vccrl 1101 rlon~ination csti~natcs and market center receipts. 

'l'hc lioyalty-In-Kintl prograln is a 1101 program over which I1Oli has no management 

control or rcspo~lsibility. Ilpstrcam activities such as production estimates, royaltj. 

csti~ilatcs. no~nination csti~nates. ant1 transportation ot' royaltv oil to the market ccrltcrs 

arc within the esclusivc pilrvicw 01' DOI. I lo\vcvcr. I)Ol: and 1101 have joint 

rcslx~~sihilit~ lor tl~c 1rans1i.r of royalty oil ar the ~narket centers. Specificall>. rhc) 

shoultl i~grcc 011 the custo(l!. transli.~. point mcasurcmcnts. 'l'hc drali report's 

rcco~nmcndatio~~s have as their proper focus this area in which DOI: and 1)Ol have,ioint 

rcsponsihility since I)Oti can only improve processes over \vhich it has comc control. On 

the other hantl. the tindings ant1 conclusions arc less clear on this division ol' 

rcspo~~sihilily. inclicatiug that DOE is responsible Sor upstrcaln acti\,iLics such as 

reconciling ~lomi~lation estinlates and market centcr receipts. 

Royalty Oil Variances 

I'hc tlrali report suggests that variances hcr\+ce~l DO1 nominations and ~narhcr center 

translkrs to 1)OI: arc negative indicators tha~ quantities shipped to 1)01< were not 

received hy 1)OI:. Such variances arc not uncspcctcd. .l'hc time lag irl uptlating 

no~ninatio~l csti~natcs ilntl occ;~>ional changes hy l)Ol in the distribution ot' royalty oil arc 

typical reasons li)r \arianccs. 

'l'hc rcport ;~dil~-csscs ;I 308.000-barrel variance occurring tlurirlg the April 2005 to .lulj 

2005 ti~nc period. I'hcrc is no indication that 1101: received less oil than bvns irltc~ltlcd. 

In l'act. Ihasctl on records shared with 1101 by 1)Ol: in the past. accounting ad.justments 

~nadc hy 1)Ol ti^ rllc pcriotl in cl~~cstiorl. and assertions 111adc hy 1)Ol during thc cotlrsc ol' 

this audit. thcrc arc srrong indications that this variance will be rcconcilctl by 1101 in 

Iivor oSthc 1)Ol:-reported 1narkc1 center receipts. 1101: will continue to work \\it11 001 

to hring closure to this issue. tlrldcr the circu~nstanccs. the 308.000-barrel variance 

sllould not hc charactcri/cd as a program~n;~ticmpact. ahscnt a stronger showing ot'what 

the impact was. 

Page 15 Management Comments 
1G Report No. DOEIIG-0786 

CUSTOMER RESPONSE FORM 

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