U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

1

27–369 CC 1996

Union Calendar No. 465

104th Congress, 2nd Session – – – – – – – – – – House Report 104–858

CRUDE OIL UNDERVALUATION: THE INEFFECTIVE RESPONSE OF THE MINERALS

MANAGEMENT SERVICE

SEVENTEENTH REPORT

BY THE

COMMITTEE ON GOVERNMENT

REFORM AND OVERSIGHT

SEPTEMBER 27, 1996.—Committed to the Committee of the Whole House

on the State of the Union and ordered to be printed
ii

COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT

WILLIAM F. CLINGER, JR., Pennsylvania, Chairman

BENJAMIN A. GILMAN, New York

DAN BURTON, Indiana

J. DENNIS HASTERT, Illinois

CONSTANCE A. MORELLA, Maryland

CHRISTOPHER SHAYS, Connecticut

STEVEN SCHIFF, New Mexico

ILEANA ROS-LEHTINEN, Florida

WILLIAM H. ZELIFF, JR., New Hampshire

JOHN M. MCHUGH, New York

STEPHEN HORN, California

JOHN L. MICA, Florida

PETER BLUTE, Massachusetts

THOMAS M. DAVIS, Virginia

DAVID M. MCINTOSH, Indiana

RANDY TATE, Washington

DICK CHRYSLER, Michigan

GIL GUTKNECHT, Minnesota

MARK E. SOUDER, Indiana

WILLIAM J. MARTINI, New Jersey

JOE SCARBOROUGH, Florida

JOHN B. SHADEGG, Arizona

MICHAEL PATRICK FLANAGAN, Illinois

CHARLES F. BASS, New Hampshire

STEVEN C. LATOURETTE, Ohio

MARSHALL ‘‘MARK’’ SANFORD, South

Carolina

ROBERT L. EHRLICH, JR., Maryland

SCOTT L. KLUG, Wisconsin

CARDISS COLLINS, Illinois

HENRY A. WAXMAN, California

TOM LANTOS, California

ROBERT E. WISE, JR., West Virginia

MAJOR R. OWENS, New York

EDOLPHUS TOWNS, New York

JOHN M. SPRATT, JR., South Carolina

LOUISE MCINTOSH SLAUGHTER, New

York

PAUL E. KANJORSKI, Pennsylvania

GARY A. CONDIT, California

COLLIN C. PETERSON, Minnesota

KAREN L. THURMAN, Florida

CAROLYN B. MALONEY, New York

THOMAS M. BARRETT, Wisconsin

BARBARA-ROSE COLLINS, Michigan

ELEANOR HOLMES NORTON, District of

Columbia

JAMES P. MORAN, Virginia

GENE GREEN, Texas

CARRIE P. MEEK, Florida

CHAKA FATTAH, Pennsylvania

BILL BREWSTER, Oklahoma

TIM HOLDEN, Pennsylvania

ELIJAH CUMMINGS, Maryland

———

BERNARD SANDERS, Vermont

(Independent)

JAMES L. CLARKE, Staff Director

KEVIN M. SABO, General Counsel

JUDITH MCCOY, Chief Clerk

BUD MYERS, Minority Staff Director

SUBCOMMITTEE ON GOVERNMENT MANAGEMENT, INFORMATION, AND TECHNOLOGY

STEPHEN HORN, California, Chairman

MICHAEL PATRICK FLANAGAN, Illinois

PETER BLUTE, Massachusetts

THOMAS M. DAVIS, Virginia

RANDY TATE, Washington

JOE SCARBOROUGH, Florida

CHARLES F. BASS, New Hampshire

SCOTT KLUG, Wisconsin

CAROLYN B. MALONEY, New York

MAJOR R. OWENS, New York

JOHN M. SPRATT, JR., South Carolina

PAUL E. KANJORSKI, Pennsylvania

COLLIN PETERSON, Minnesota

TIM HOLDEN, Pennsylvania

EX OFFICIO

WILLIAM F. CLINGER, JR., Pennsylvania CARDISS COLLINS, Illinois

J. RUSSELL GEORGE, Staff Director/Counsel

MARK BRASHER, Professional Staff

MARK STEVENSON, Minority Professional Staff
(iii)

LETTER OF TRANSMITTAL

HOUSE OF REPRESENTATIVES,

Washington, DC, September 27, 1996.

Hon. NEWT GINGRICH,

Speaker of the House of Representatives,

Washington, DC.

DEAR MR. SPEAKER: By direction of the Committee on Government Reform and Oversight, I submit herewith the committee’s

seventeenth report to the 104th Congress.

WILLIAM F. CLINGER, Jr., Chairman.

v

C O N T E N T S

Page

I. Summary of oversight findings and recommendations ................................. 1

A. Introduction .......................................................................................... 1

B. Summary of findings and recommendations ...................................... 2

C. Background ........................................................................................... 3

D. Proceedings of the Subcommittee on Government Management,

Information, and Technology ............................................................. 5

E. Findings ................................................................................................. 11

F. Recommendations ................................................................................. 13

G. Conclusion ............................................................................................. 15
1 Rules of the House of Representatives, 104th Congress, X, 1(g)(6) and (12) and X, 2(b)(2).

Union Calendar No. 465

104TH CONGRESS REPORT " ! HOUSE OF REPRESENTATIVES 2nd Session 104–858

CRUDE OIL UNDERVALUATION: THE INEFFECTIVE

RESPONSE OF THE MINERALS MANAGEMENT SERVICE

SEPTEMBER 27, 1996.—Committed to the Committee of the Whole House on the

State of the Union and ordered to be printed

Mr. CLINGER, from the Committee on Government Reform and

Oversight, submitted the following

SEVENTEENTH REPORT

On September 24, 1996, the Committee on Government Reform

and Oversight approved and adopted a report entitled ‘‘Crude Oil

Undervaluation: The Ineffective Response of the Minerals Management Service.’’ The chairman was directed to transmit a copy to the

Speaker of the House.

I. SUMMARY OF OVERSIGHT FINDINGS AND RECOMMENDATIONS

A. INTRODUCTION

The Committee on Government Reform and Oversight (‘‘the committee’’) has primary legislative and oversight jurisdiction with respect to the ‘‘overall economy, efficiency and management of Government operations and activities, including Federal procurement.’’

It also has primary oversight responsibility to ‘‘review and study,

on a continuing basis, the operation of Government activities at all

levels with a view to determining their economy and efficiency.’’ 1

In addition to its other oversight responsibilities:

[T]he Committee on Government Reform and Oversight

may at any time conduct investigations of any matter

without regard to the provisions . . . conferring jurisdiction over such matter upon another standing committee.

The committee’s findings and recommendations in any

such investigation shall be made available to the other
2

2 Rules of the House of Representatives, 104th Congress, X, 4(c)(2).

standing committee or committees having jurisdiction over

the matter involved....2

Pursuant to this authority, Subcommittee on Government Management, Information, and Technology of the Committee on Government Reform and Oversight convened an oversight hearing on

June 17, 1996 to examine whether companies under agreements to

extract oil from Federal lands in California undervalued the oil and

as a result, underpaid royalties to the Federal Government. The

subcommittee also reviewed the management of this program by

the Minerals Management Service of the Department of the Interior.

B. SUMMARY OF FINDINGS AND RECOMMENDATIONS

Between 1978 and 1993, oil companies did not pay sufficient royalty on crude oil drilled on Federal lands in California and elsewhere. These amounts may reach as high as $2 billion nationwide.

This is a serious problem that the Department of the Interior’s

Minerals Management Service has failed to seriously address.

FINDINGS IN BRIEF

1. There is an undervaluation problem, where crude oil royalties

received by the Federal Government have been below fair market

value.

2. The Minerals Management Service has delayed collecting

crude oil royalty revenues due to these undervaluations.

3. Global settlements between the Federal Government and

major oil companies have not protected the financial interests of

the U.S. Government and its taxpayers.

4. The crude oil undervaluation problem is not limited to California; it exists in other oil-producing States.

5. Royalty-in-kind transactions may have left Federal financial

interests unprotected.

6. Pipelines which cross Federal lands harm Federal interests by

depressing oil royalty revenues and preventing an efficient oil market through the monopolistic distortion caused by proprietary pipelines.

RECOMMENDATIONS IN BRIEF

1. The Minerals Management Service must prepare a timetable

for collecting royalty underpayments.

2. The Minerals Management Service needs to consider outside

audit assistance to supplement its existing audit staff.

3. The Minerals Management Service, together with the Department of Justice, should review existing global settlements to determine whether Federal financial interests can be salvaged and prevent future problems with global settlements which reduce the potential for royalty collections by the Federal Government.

4. The Department of the Interior should immediately proceed to

examine whether other underpayments have occurred in States

other than California.
3

3 California Department of Conservation homepage, Internet address http://www.consrv.ca.gov/

dog/facts.html. 4 Ibid.

5 U.S. Department of the Interior, History of the California Pricing Issue, undated document

released with the Final Interagency Report on the Valuation of Oil Produced from Federal Leases

in California, May 16, 1996. The oil companies involved in the suit included ARCO, Shell, Chevron, Mobil, Texaco, Unocal, and Exxon. 6 Ibid. Posted prices are the announced prices at which crude oil purchasers, generally major

refiners, will purchase crude oil from producers at the wellhead. 7 Ibid. 8 Ibid. The State of California and the city of Long Beach had attempted to show collusion

between the oil companies to keep posted prices low. The State and city’s demonstration of

underpricing of crude oil have been more convincing than the charge of collusion, as the collusion/antitrust claim is more difficult to prove. 9 Ibid. In the mid-1980’s, MMS, the General Accounting Office and the Internal Revenue Service independently analyzed the issue, but the information available to them at the time was inconclusive in proving that Federal oil was undervalued at posted prices. For example, see U.S.

General Accounting Office, California Crude Oil: An Analysis of Posted Prices and Fair Market

Value, GAO/GGD 88–114, September 8, 1988. 10 U.S. Department of the Interior, Final Interagency Report on the Valuation of Oil Produced

from Federal Leases in California, May 16, 1996, page 1 of the Executive Summary.

5. The Department of the Interior should examine royalty-in-kind

payments to determine whether these amounts also suffered from

undervaluation, and whether the royalties can be recovered.

6. The Department of the Interior should enforce the administration’s stated policy on oil pipelines, and discuss the issue with officials in the State of California to ensure that all pipelines in California promote an efficient oil market and protect Federal financial

interests.

C. BACKGROUND

California is the fourth largest oil-producing State in the United

States.3 During 1994, California’s crude-oil production totaled

about 345 million barrels of oil, or just under 1 million barrels a

day.4 This includes a large amount of oil produced on Federal lands

in California. In 1975, the State of California and the city of Long

Beach initiated litigation against seven major oil companies operating in California alleging that the companies conspired to keep

posted oil prices low.5 The city and State claimed they had been

damaged because their oil revenues depended on posted prices and

the royalty thereon.6 If the posted price is below fair market value,

the Federal Government loses royalty revenue.

In 1986, the Minerals Management Service (MMS) of the Department of the Interior contacted State officials in California to assess

the appropriateness of posted prices as the royalty value basis.7

MMS concluded that the system of posted prices existing at the

time fairly represented market value. Weighing heavily in the

MMS decision was the fact that the State of California and the city

of Long Beach had been unsuccessful with their antitrust claims in

court.8 The Department of Justice looked into the issue and chose

not to pursue an investigation.9

In 1991, six of the companies involved (ARCO, Shell, Chevron,

Mobil, Texaco, and Unocal) reached settlements totaling $345 million to end the court actions by the State and city alleging undervaluation.10 A seventh defendant, Exxon, went to trial and was exonerated on the antitrust charges relating to State oil leases. That

decision was appealed, and Exxon won the appeal in January
4

11 Ibid. 12 Ibid, page 15. 13 Ibid, page 15. 14 Ibid, page 2. The Department of Justice subsequently resigned from the team, citing the

move away from the interagency team from investigating antitrust violations and more focus

on undervaluation of royalty payments. 15 Ibid, page 44. 16 Ibid, page 50. 17Summit Resource Management, Inc., Crude Oil Royalty Payment Analysis, February 21,

1995, page 5. The Summit report compares lease pricing methods with trade pricing methods

and concludes that the ‘‘sales price at the lease has absolutely no bearing on the actual price

received for the sale of the oil.’’

1995.11 A separate appeal covering a different time period is still

pending.

In light of the 1991 settlement relating to undervaluation of

State crude oil leases, MMS performed a scoping exercise to estimate the size of any potential royalty underpayments relating to

Federal lands.12 However, since the MMS scoping exercise lacked

crucial information relating to the Long Beach cases such as internal oil company records, the State of California urged the Department of the Interior to begin a more formal investigation.13 MMS

responded by creating an interagency task force in 1994.14 The

task force consisted of representatives from MMS, the Office of the

Solicitor in the Department of the Interior, the Department of

Commerce, the Department of Energy and the Department of Justice.

The State of California assisted the Federal team in obtaining

court records from the earlier litigation. These documents were instrumental in demonstrating the undervaluation of crude oil to the

Federal interagency team. In May of 1996, the Federal interagency

team released its report, which concluded that companies often received gross proceeds higher than their posted prices.15 The bulk

of crude oil in California was not sold in competitive markets with

competing economic interests. Rather, it was moved through

intracompany transfers; straight exchanges (where one oil company

trades oil at one location with another company which has oil at

another location; this allows both to avoid or reduce transportation

costs); and buy/sell contracts (which include other costs in addition

to the value of the crude oil, including transportation costs or other

considerations).16 In the absence of vigorous competition amongst

competing economic interests, it is difficult to determine a proxy for

the market value of oil. Correspondingly, it is easy for oil companies to hide the true value of the crude oil in complicated contracts

with separate charges for transportation.17

The interagency report estimates that Federal revenues from oil royalties on California leases alone are between zero and $856 million for the period between 1978 and 1993. The report recommended: • that MMS focus collection efforts on those companies (about

10) that produce 90 percent of Federal crude oil in California; • that for the period beginning March 1, 1988, Federal royalties

be computed by the premium paid on competitive arm’s-length contracts for oil produced from the same field or area; • that the Assistant Secretary of the Interior issue a royalty

payor letter ordering targeted oil companies to submit all arm’slength contract records for the periods in question so as to minimize audit expenses;
5

18 U.S. Department of the Interior, Final Interagency Report on the Valuation of Oil Produced

from Federal Leases in California, May 16, 1996, pages 54–87. 19Press Release, U.S. Department of the Interior, MMS Pursues California Undervaluation

Royalties, July 18, 1996. 20 Ibid. 21Wall Street Journal, U.S. May Have Lost Out on Vast Oil Royalties, August 15, 1996, section A, page 3. 22 U.S. Department of the Interior, Office of Inspector General, Draft Audit Report, Negotiated

Royalty Settlements, November 1995, pages 5–6.

• that the Federal Government submit a bill for 1989 and 1993

to Texaco, since MMS audited those records; • that MMS’s oil royalty valuation regulations be revised to consider alternatives to reliance on posted prices and improve clarity;

and• that a method be chosen to determine royalties owed. The

team was split on which approach to take for the period before

March 1, 1988. The team was split as follows:

(1) the Commerce and Energy Departments recommended using Alaska North Slope oil market prices as

the basis for valuing Federal crude oil in California for

purposes of determining royalties (this is less audit intensive, but potentially open to legal challenges) and that

MMS pursue underpayments from 1980 forward; while

(2) the MMS/Solicitor’s office recommended using the

same procedures before 1988 as after 1988 (these procedures require labor-intensive audits, but closely conform to

established precedent), and that MMS and the Solicitor’s

office determine how far back to pursue royalty underpayments.18

Subsequently, MMS announced that it would accept part of the

task force’s recommendations and attempt to collect approximately

$440 million.19 The $856 million figure was reduced due to global

settlements between the oil companies and the Department of the

Interior, payments-in-kind of the royalty, and other factors. However, this does not include potential underpayments from States

other than California. It is limited solely to Federal crude oil coming from lands in California.20

In August of 1996, a draft report of the inspector general of the

Department of the Interior was obtained by various press

sources.21 The draft report criticized the Department for improper

procedures during negotiations with oil companies. During these

negotiations, the Department reduced the estimated value of items

to be negotiated by more than $350 million—without documentation.22 The draft report is dated November 1995; it has not yet

been released, having been delayed for nearly 1 year.

D. PROCEEDINGS OF THE SUBCOMMITTEE ON GOVERNMENT

MANAGEMENT, INFORMATION, AND TECHNOLOGY

On June 17, 1996, the subcommittee convened a hearing examining whether the Federal Government was receiving the oil royalties

that are due it. Subcommittee Chairman Horn opened the hearing

noting that the recently enacted Debt Collection Improvement Act

provided to agencies the tools they need to collect delinquent debts

owed to the Federal Government, and the great interest of Congress in general, and the Committee on Government Reform and
6

23Opening statement of Subcommittee Chairman Stephen Horn before a hearing of the Subcommittee on Government Management, Information, and Technology, House Committee on

Government Reform and Oversight, Valuation of Federal Oil—Is the U.S. Getting the Royalties

it is Owed? June 17, 1996. 24Opening statement of Representative Carolyn Maloney before a hearing of the Subcommittee on Government Management, Information, and Technology, House Committee on Government Reform and Oversight, Valuation of Federal Oil—Is the U.S. Getting the Royalties it is

Owed? June 17, 1996. 25Statement of Representative Ken Calvert before a hearing of the Subcommittee on Government Management, Information, and Technology, House Committee on Government Reform and

Oversight, Valuation of Federal Oil—Is the U.S. Getting the Royalties it is Owed? June 17, 1996. 26 H.R. 1975 passed the House of Representatives on July 16, 1996 under suspension of the

rules and passed the Senate on August 2, 1996. President Clinton subsequently signed the Federal Oil and Gas Royalty Simplification and Fairness Act on August 13, 1996. It became Public

Law No. 104–185. 27Statement of Representative Ken Calvert, during debate on H.R. 1975, the Federal Oil and

Gas Royalty Simplification and Fairness Act, Congressional Record, page H7606. 28Oral testimony of Director Cynthia Quarterman, Director, Minerals Management Service,

U.S. Department of the Interior before a hearing of the Subcommittee on Government Management, Information, and Technology, House Committee on Government Reform and Oversight,

Valuation of Federal Oil—Is the U.S. Getting the Royalties it is Owed? June 17, 1996. 29 U.S. Department of the Interior, Final Interagency Report on the Valuation of Oil Produced

from Federal Leases in California, page 29. The contract was with Innovation and Information

Consultants, Inc., which had assisted the State of California in analyzing oil sales contracts for

the Long Beach litigation.

Oversight in particular, in collecting these amounts.23 Ranking

member Representative Carolyn Maloney noted her interest in seeing that oil royalties are collected. Mrs. Maloney advocated using

the market price of Alaska North Slope crude as a proxy for fair

market value of California crude oil rather than auditing each Federal mineral lease contract.24

Representative Ken Calvert, chairman of the Subcommittee on

Energy and Mineral Resources of the Committee on Resources, reviewed his committee’s activities regarding the royalty management program: ‘‘The Federal Government runs an inefficient, complicated, and burdensome system for royalty collection and accounting which has resulted in enormous amounts of litigation over the

years.’’ 25 Mr. Calvert advocated the passage of H.R. 1975, the Federal Oil and Gas Royalty Simplification and Fairness Act, to help

solve the problem.26 The cornerstone of the bill is expanded authority for State governments to manage the royalties from Federal

lands located in the State. Mr. Calvert noted that half of the revenues from onshore crude oil production go to the State from which

they are derived. The legislation will assist in solving the royalty

underpayment problem in the future, but will not give any directions on how the Minerals Management Service should pursue past

underpayments.27

Director of the Minerals Management Service Cynthia

Quarterman testified that in 1993, the Office of Policy Analysis at

the Department of the Interior asked MMS to review the undervaluation issue in light of the 1991 settlement in the Long Beach

litigation.28 Director Quarterman described the timing of events

surrounding the crude oil undervaluation issue. A scoping exercise

in 1993 and 1994 confirmed that the underpayment issue should

be pursued using an interagency task force employing representatives from MMS and the Solicitor’s office in the Department of the

Interior, and the Departments of Commerce, Energy and Justice.

The Federal employees were supplemented by consultants.29 Abraham E. Haspel, Chief Economist at the Department of Energy, described the role of the Department of Energy in the interagency
7

30 U.S. Department of the Interior, memorandum from Bob Berman to Brooks Yeager, California Common Carrier and Crude Valuation, August 6, 1993. 31 U.S. Department of the Interior, electronic mail message from David Hubbard, MMS Denver, CO, to James W. Shaw, MMS Denver, CO. 32Testimony of Director Quarterman, June 17, 1996. 33 Ibid. 34Oral testimony of Robert Berman, Office of Policy Analysis, U.S. Department of the Interior

before a hearing of the Subcommittee on Government Management, Information, and Technology, House Committee on Government Reform and Oversight, Valuation of Federal Oil—Is

the U.S. Getting the Royalties it is Owed? June 17, 1996. 35Testimony of Director Quarterman, June 17, 1996.

task force and summarized some of the conclusions which the task

force generated.

In the question period, Subcommittee Chairman Horn quoted a

1993 memorandum in which Robert Berman, an economist in Interior’s Office of Policy Analysis, suggested that the Department

should ‘‘[p]roceed immediately to ascertain the amount of additional royalties due and initiate collection procedures.’’ 30 Adding

that this was the same conclusion reached by the interagency team

after a 3-year delay, Subcommittee Chairman Horn placed in the

record a 1994 electronic mail message from the interagency team

leader David Hubbard, expressing his concern about the timetable

for completing the interagency report and his feeling that he has

‘‘stalled on this issue long enough.’’ 31 In the hearing, Director

Quarterman responded that the agency was not engaging in a pattern of delay and stressed that auditing oil company records was

a time-consuming process.32

Mrs. Maloney noted her belief that MMS should attempt to collect underpayments which occurred during the period 1980–85,

since nearly three-fourths of all underpayments occurred in that

time period. Director Quarterman declined to commit to that request, noting that there were other factors at work, including competing demands for time and staff which might involve greater dollar figures. Mrs. Maloney repeated her wish that the prices for

crude oil from the Alaska North Slope (ANS) be used as a proxy

for market value in California. Again, Director Quarterman would

not commit MMS to this course of action, despite the use of ANS

prices as market value in California by the task force and by major

oil companies.33

Subcommittee Chairman Horn asked what would be an appropriate gauge of market value of crude oil. Mr. Berman indicated

that a market price, such as the price of crude oil on the New York

Mercantile Exchange, or, on the west coast, ANS prices, provide

the best benchmark for economic value. Subcommittee Chairman

Horn inquired whether adjustments needed to be made for transportation costs. Mr. Berman believed that could be easily done by

using the spot market for a given commodity in a given location.

He added that it is easy for the owner of a pipeline to disguise a

premium on crude oil.34

Director Quarterman described the changing resource levels devoted to the royalty management program, and the recent addition

of $4 million above the President’s request by the House Committee on Appropriations for the audit division.35

Mrs. Maloney reviewed the chronology of MMS’s actions with respect to crude oil undervaluation. She pointed out that MMS entered into a global settlement with Exxon and Chevron after an in-
8

36Statement of Representative Carolyn Maloney, June 17, 1996. 37Testimony of Director Quarterman, June 17, 1996. 38 Ibid. 39 Ibid. 40Testimony of Mr. Berman, June 17, 1996. 41Oral testimony of Assistant Secretary for Land and Minerals Management, U.S. Department of the Interior, Robert Armstrong, before a hearing of the Subcommittee on Government

Management, Information, and Technology, House Committee on Government Reform and Oversight, Valuation of Federal Oil—Is the U.S. Getting the Royalties it is Owed? June 17, 1996. Mr.

Armstrong’s testimony contradicted that of Director Quarterman, who indicated that bills for

these audits would not be sent out in a ‘‘piecemeal fashion.’’ A bill has not yet been sent.

ternal memorandum noted that perhaps $422 million was owed in

underpayments.36 Director Quarterman replied that the Exxon

agreement included a provision that would allow MMS to collect in

the case of fraud, malfeasance, concealment or misrepresentation of

fact. Director Quarterman agreed not to proceed with additional

global settlements without an exclusion relating to crude oil valuation.37

Mrs. Maloney quoted the task force conclusion that pipelines

owned by a vertically integrated oil company—through which oil

may be required to go—contribute to the undervaluation problem.

Director Quarterman asserted that the Department of the Interior

did not have jurisdiction over the pipelines in California since they

do not traverse Federal land or raise interstate commerce issues by

going through another State.38

Subcommittee Chairman Horn noted the task force recommendation that bills be sent immediately to oil companies which were

subjected to audits by the task force. Director Quarterman testified

that she did not anticipate sending bills, to avoid a piecemeal approach to collecting underpayments.39

Mrs. Maloney asked whether Mr. Berman had sent a memorandum warning MMS of the potential loss of Federal revenue if the

undervaluation issue was included as a part of the global settlements being negotiated with certain oil companies. Mr. Berman

said that he had sent this memorandum to Brooks Yeager, the Director of the Office of Policy Analysis, and discussed the matter

with Yeager and Ted Heintz, Berman’s immediate supervisor.

Mr. Berman testified that he had initiated an investigation to determine whether posted prices reflect market value outside of California. According to Mr. Berman, the initial investigations indicate

that posted prices are below market value outside of California.

Subcommittee Chairman Horn asked the amount by which posted

prices understated value. Mr. Berman replied that posted prices

might have been between 3 and 10 percent below the market value

of the crude oil.40

Assistant Secretary of the Interior for Land and Minerals Management Robert Armstrong was asked by Subcommittee Chairman

Horn for a timetable of when bills would be sent to Texaco, which

was the subject of an audit during the task force deliberation. Mr.

Armstrong responded that in 4 to 6 weeks, a bill would be sent.41

Subcommittee Chairman Horn asked Mr. Berman whether the

appropriate market gauge for fair market value for crude oil is the

ANS price. Mr. Berman noted that a common benchmark should be

used. In California, this benchmark is the ANS price, while outside

of California there are other, more useful market benchmarks such

as the price on the New York Mercantile Exchange, Cushing, and
9

42Mr. Speir indicates that he and the Department of Commerce representative prefer a market-based valuation for fair market value, while the Department of Interior personnel from

MMS and the Solicitor’s office appear to be more interested in consistency and performing the

task of valuation as it has always been done. 43Oral testimony of Robert Speir, U.S. Department of Energy before a hearing of the Subcommittee on Government Management, Information, and Technology, House Committee on

Government Reform and Oversight, Valuation of Federal Oil—Is the U.S. Getting the Royalties

it is Owed? June 17, 1996. 44Oral testimony of Brian McMahon, Hoecker and McMahon, before a hearing of the Subcommittee on Government Management, Information, and Technology, House Committee on

Government Reform and Oversight, Valuation of Federal Oil—Is the U.S. Getting the Royalties

it is Owed? June 17, 1996. Mr. McMahon refers to a letter from William Weitzel of Texaco, Inc.

to the Federal Trade Commission referring to Texaco’s acquisition of Getty Oil. The letter refers

to a Consent Order requiring Texaco to sell oil at posted price and characterizes this action as

‘‘inappropriate and unfair’’ since ‘‘posted prices are currently lower than market.’’ Page 9. 45 Ibid. The premia is present where the price obtained through a market sale was higher

than a price obtained through the use of a posted price, with the premium being the difference

between the two prices, and premia being the plural of premium. 46Testimony of Mr. Speir, June 17, 1996.

St. James. Mr. Horn urged that a market price be used in determining fair market value.

Mrs. Maloney asked Robert Speir, an economist at the Department of Energy and a member of the interagency task force, why

the task force opinion diverged on whether to use ANS crude oil

prices as a proxy for market value. Mr. Speir indicated that the divergence resulted from different opinions on how to value crude oil

accurately.42 Mr. Speir explained that since ANS represents fair

market value, that was the determinant in his belief in the appropriateness of using an ANS benchmark. Mr. Speir also noted that

oil companies used an ANS benchmark to determine value and that

he had reviewed oil company documents that indicated that posted

prices did not represent fair market value.43

Mrs. Maloney asked Mr. Armstrong, Mr. Haspel, Mr. Berman

and Mr. Speir the number of heated oil pipelines which crossed

Federal lands in California. There was agreement that there was

only one pipeline, Mobil’s M–70, that crossed Federal land. Mr.

Haspel noted that it is the policy of the Department of Energy that

pipelines operate as common carriers.44

Brian McMahon, an attorney with Hoecker and McMahon, represented the city of Long Beach and the State of California in litigation regarding crude oil undervaluation. Mr. McMahon testified

that periodic oil selloffs by the Federal Government at Elk Hills in

California, or by the State of California or the city of Long Beach

would typically yield premia over posted prices.45 McMahon also

noted Texaco’s assertion, in an official document to the Federal

Trade Commission, that posted prices were lower than market

value.46 Mr. McMahon noted that there was a problem with the

pipelines in California and their continuing usage of posted prices:

To my knowledge, there is only one heated pipeline coming out of the San Joaquin Valley to Los Angeles, and that

is the pipeline identified as the M–70 of Mobil. That goes

through the Angeles National Forest, and we know that

the Mobil Co. received an MLA permit, it is called, a Mineral Leasing Act permit, in order to pass through Federal

lands. That permit required Mobil to dedicate its pipeline

as a common carrier. In fact Mobil does not dedicate its

pipeline as a common carrier, and crude oil producers in

the San Joaquin Valley must sell their crude at the price
10

47Testimony of Mr. McMahon, June 17, 1996. 48Often, oil companies are vertically integrated, with the same firm owning or controlling the

drilling, transportation, refining and marketing of petroleum products. These various units are

sometimes made into a subsidiary corporation for favorable legal purposes. 49 Ibid. 50 Ibid. 51Oral testimony of Robert Shannon, assistant city attorney, city of Long Beach, CA, before

a hearing of the Subcommittee on Government Management, Information, and Technology,

House Committee on Government Reform and Oversight, Valuation of Federal Oil—Is the U.S.

Getting the Royalties it is Owed? June 17, 1996. 52Testimony of Mr. McMahon, June 17, 1996. 53 Ibid. The bottleneck theory of antitrust holds that monopolies can flow from dominating either production, distribution or transportation hubs through which a particular product must

pass. In the 19th century, railroads were a necessity to get many products to market. The differential prices which railroads charged different customers allowed trusts, such as the Standard Oil Trust, to dominate the market.

Mobil sets for its crude oil, and that price is the posted

price.47

Mr. McMahon described an instance where the production unit

of Union Oil Co. was faced with a situation where the posted price

was lower than the price of production.48 The company affirmed

that the posted price did not represent market value.49 In response

to this situation, the production arm suggested that it should share

in the value of the refined value of the crude oil, much like what

the State of California has suggested that the oil companies should

do in correcting undervaluation of crude oil.

In response to questioning by Mrs. Maloney, Mr. McMahon indicated that the documents relating to the Long Beach undervaluation cases contain very sensitive information evidencing underpricing.50 Robert Shannon, assistant city attorney for the city of

Long Beach, testified that the competitors of the oil companies had

seen the documents, and that this mooted the question of commercial sensitivity.51

Mr. McMahon also described the difficulty of determining what

is an arm’s-length transaction. For example, Mr. McMahon characterized shadow transactions which had the effect of disguising market value:

Suppose that I am tired of [California] earthquakes and

my friend in Hartford, CT, is tired of snow, so we decide

I am going to move to Hartford and he is going to move

to California. And we both have a Ford Taurus, and he has

a car that is 1 year younger than mine, and it is worth

$2,000 more. We say why should we drive both cars cross

country. Let’s just sell it to each other. Then I say that I

will price yours at $22,000 and you price mine at $20,000,

and we will write checks for that amount. So he says,

‘‘Wait a minute! If we do that, we are going to have to pay

a lot of tax on this. Let’s price my car at $3,000 and your

car at $1,000.’’ This preserves the $2,000 real difference in

price, but we paid much less in taxes. And that is what the

oil companies are doing with the posted prices.52

Mr. McMahon further elaborated on the issue, comparing the pipeline distribution system to other transportation bottlenecks, such

as the railroads in the 19th century.53
11

54 U.S. Department of the Interior, Final Interagency Report on the Valuation of Oil Produced

from Federal Leases in California, pages 63–64. 55 U.S. Department of the Interior, Office of Inspector General, Draft Audit Report, Negotiated

Royalty Settlements, November 1995, page 1.

E. FINDINGS

The committee finds the following:

The Minerals Management Service has delayed collecting royalty

undervaluations

In the hearing held by the committee on June 17, 1996, members

expressed concern over delays in collecting underpayments. MMS

has engaged in tactics to delay the release of the interagency report, as evidenced by an electronic message to his supervisor in

1994, David Hubbard, the interagency task force leader, in requesting additional audit resources, stated that he has ‘‘stalled long

enough.’’

Once MMS disclosed that it would attempt to collect $440 million, it did not include a timetable for the completion of this task.

MMS will not simply send the oil companies a bill using Alaska

North Slope crude prices as a proxy for the market price of oil. Instead, MMS will audit each and every contract. Given that MMS

will have to use scarce audit resources, it will likely take many

years to complete this task. This is especially true because the

MMS audit division is not committed to collecting these revenues.

Unpublished Department of the Interior notes quote the head of

the MMS audit division dismissing the interagency task force report in November 1995 as ‘‘a piece of [expletive deleted].’’ Giving

control of the audit process to staff who vehemently disagree with

the results provides MMS management with further opportunities

to delay implementation of sensible policies.

The MMS announcement does not outline any interim steps the

agency will take. The interagency task force audited Shell’s contracts in California for 1984 and Texaco for 1989 and 1993.54 As

recommended in the report, bills should immediately be sent to

those companies for those years. During the June 17 hearing on

this issue, Assistant Secretary of the Interior for Land and Minerals Management Robert Armstrong stated that bills would be

sent out within 4 to 6 weeks. As of the date of this report, 9 weeks

have passed since the date of the hearing, and no action has occurred.

Global settlements may not have protected U.S. financial interests

MMS engaged in global settlements (i.e., a settlement agreement

between the Federal Government and an oil company which covers

a number of issues and claims in one fell swoop) which allowed two

oil companies with large underpayments to avoid payment with the

full knowledge that there were substantial problems with underpayments in California in this program. These agreements may

have extinguished the claim of the Federal Government to collect

the amounts owed. Apparently, the inspector general also recognized that these agreements did not demonstrate that the best interests of the United States were protected.55 In a draft report, the

inspector general noted that the royalty settlements were not con-
12

56 Ibid, page 4. 57 Ibid, pages 5–6. 58Testimony of Mr. Berman, June 17, 1996. 59Testimony of Mr. Berman, June 17, 1996 and press release by the Project on Government

Oversight, August 5, 1996. Berman testified that the undervaluation of crude oil was probably

between 3 and 10 percent. Using this information, the Project on Government Oversight estimated that applying this percentage to crude oil royalties outside of California would yield $1.3

billion. 60 U.S. Department of the Interior, Final Interagency Report on the Valuation of Oil Produced

from Federal Leases in California, page 40, footnote 16.

ducted in accordance with ‘‘Minerals Management Service Settlement Negotiation Procedures.’’ The report faults MMS for including

‘‘no documentation for the estimated values of the issues concerning the underpayment of royalties to be negotiated. . . .’’ 56 In addition, the report faults MMS for writing down amounts owed for

no apparent reason:

Prior to negotiations, one of the Service’s Royalty Management Program divisions estimated the value of a particular issue to be negotiated in a global settlement to be

about $439 million. However, the list of issues and values

prepared by the negotiation team prior to negotiations estimated that the same issue was valued at $78 million.

Documentation in the settlement file was insufficient to

explain the $360.4 million difference in the estimated values of this issue.57

These are serious charges. It would be helpful for MMS to realize

that the problem that we have with the Federal budget deficit

means that we must protect the taxpayers of this country through

better financial management. MMS’s poor management and slow

response reflect poorly on the administration’s record. During testimony in a hearing on this topic on June 17, Robert Berman, an

economist in the Office of Policy Analysis of the Department of the

Interior testified that he issued a memorandum expressing his concern that MMS was entering into global settlements with no consideration given to the underpayment issue.58 This memorandum

was issued prior to the global settlements, but apparently went

unheeded.

The California undervaluation problem exists in other States

During the June 17 committee hearing, Robert Berman also testified that the amount of the undervaluation of oil extracted from

Federal lands may amount to between 3 and 10 percent for States

other than California. This may amount to more than $1.3 billion

if the higher range is used.59

Royalty-in-kind transactions may have left U.S. financial interests

unprotected

The May 1996 interagency task force report acknowledged that

the team had not ‘‘investigated recoupment of additional revenues

on royalty-in-kind crude oil that might have been undervalued.’’

The report recommends that the ‘‘Department [of the Interior]

should consider the effects of RIK [royalty-in-kind] volumes in its

decisionmaking, including potential collections where these volumes were undervalued.’’ 60
13

61See note 17. 62 U.S. Department of the Interior, Final Interagency Report on the Valuation of Oil Produced

from Federal Leases in California, page 47. 63Letter from Deputy Secretary of Energy Bill White to Secretary of the Interior Bruce Babbitt, dated March 29, 1994.

In concept, royalty-in-kind oil is taken by the Department of the

Interior and sold directly to a refiner. In practice, the Department

relied on the Federal leaseholder and the refiner-purchaser to arrange the terms of sale and transfer to the refiner’s facility. The

Federal Government then received payment from the refiner. Typically, this was the posted price, which has been determined to be

undervalued. It is possible that royalty-in-kind purchasers were effectively forced to pay, through excessive transportation charges,

more for their Federal crude oil than the Federal Government received (i.e., the Federal Government may not have received all of

the fair market value of the crude oil which it was due since some

of the value may have been retained by the leaseholder through excessive transportation charges).61

To the extent that royalty-in-kind purchasers were forced to exchange their royalty-in-kind crude oil with the Federal leaseholder

because the purchaser could not gain access to proprietary pipelines, the purchasers may have had to pay a premium due to lack

of access to transportation assets.

Pipelines which cross Federal lands harm Federal interests by depressing royalty revenues and preventing an efficient oil market

The problem of proprietary pipelines was well understood by the

task force. As the task force notes:

The market restrictions imposed by proprietary pipelines

operated by the major oil refiners had two critical effects.

First, it greatly restricted open-market trading in California crude oil; second, it segregated the crude oil markets

of the San Joaquin Valley and Ventura Basin from the refining centers in San Francisco and Los Angeles. The reports [of two consultants employed by the task force] concluded that the pipeline situation contributed to postings

substantially understating California crude oil values.62

The Department of Energy also recognizes this problem. The Department of Energy has indicated that the administration’s Domestic Natural Gas and Oil Initiative included a pipeline reform

plank.63 The Department of Energy requested that the Department

of the Interior require pipelines that cross Federal lands operate as

common carriers. The Department of the Interior has not taken

any action on the issue, allowing a continued distortion of the California oil market.

F. RECOMMENDATIONS

The committee urges that the Secretary of the Interior: (1) begin

collecting amounts relating to royalty underpayments in California

which are well established; (2) begin assessing and collecting

amounts relating to royalty underpayments in other States; and (3)

ensure that any global settlement sensibly values the possibility of

these collections. There is an unwillingness to address issues relat-
14

64Staff conversation with Brian McMahon. 65Title 31, United States Code, Section 3711(a)(2).

ing to the undervaluation of crude oil at the Minerals Management

Service. Leadership is required to address these problems.

With these goals in mind, the committee urges action in the following areas:

Timetable for collections

The MMS and the Department of the Interior should develop a

timetable to collect these amounts, including specific dates by

which to achieve specific goals. This would assist Congress in providing oversight of this essential task, and commit the administration to a realistic schedule of collecting these debts.

Audit resources

There is some question as to whether MMS’s audit staff can perform the task of implementing the interagency task force report

without prejudice. If the audit staff is unwilling to support program

goals determined by the Administration, then MMS should contract

with a professional firm of certified public accountants. In depending on a private law firm, the State of California took a similar approach, which resulted in a $345 million settlement. California now

contracts with a professional firm of certified public accountants to

manage its oil sales.64 If MMS is experiencing internal resistance

in key functions to collecting these underpayments, then MMS

should seek outside assistance to expedite collections.

Review global settlements

The question of whether the global settlements will prevent recoveries of underpayments needs to be addressed. The Department

of the Interior should request that the Department of Justice prepare an opinion certifying that these amounts have been negotiated

away by MMS.

Also, the Department of the Interior needs to review its compromise procedures, which are more sweeping than almost any

other Federal agency. Agencies which compromise debts are limited

in their authority to do so. Under existing Federal law, Federal

agencies may:

Compromise a claim of the Government of not more than

$100,000 (excluding interest) or such higher amount as the

Attorney General may from time to time prescribe that has

not been referred to another executive or legislative agency

for further collection action.65

The Department of the Interior, in connection with the Office of

Management and Budget and the Department of Justice, should

examine whether the persistent mismanagement at MMS requires

a threshold for global settlements which would trigger the involvement of the Department of Justice.

Collecting underpayments in States other than California

The Department of the Interior should develop a strategy to address this issue and advise the committee of its plan. If there is an
15

underpayment problem in California, it is highly likely that the

same problem exists elsewhere.

Royalty-in-kind transactions

The May 1996 interagency task force report recommends that the

Department of the Interior should consider potential collections

where crude oil royalties which were taken in-kind were undervalued. This should be done.

Common carrier pipelines

The Department of the Interior should alter its policy to comport

with the administration’s recommendations regarding the Domestic

Natural Gas and Oil Initiative. In addition, the Department should

contact officials from the State of California and demonstrate the

problem of proprietary pipelines, and the harm which unregulated

pipelines can bring to consumers, crude producers and royalty owners such as the State of California and the Federal Government.

G. CONCLUSION

The Minerals Management Service needs to review its operations

to ensure that the amounts which are owed to the Federal Government are collected in a timely fashion. For years, oil companies

were able to use complex transactions to disguise premia on crude

oil from Federal regulators. Now that the Federal Government has

determined that there are hundreds of millions of dollars of additional payments owed, MMS must aggressively pursue this problem to protect Federal financial interests. MMS has failed to do so.

There is still time to accomplish this task. Until that happens, the

crude oil undervaluation issue is a serious hole in the Federal

budget deficit that amounts to perhaps $2 billion nationwide for

crude oil leasing. This is a problem that is preventable, and requires the attention of senior management in the administration. Æ