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73-043 PS 2002

COLLECTION AND DISPOSITION

OF FEDERAL OIL AND GAS

ROYALTIES TAKEN IN-KIND

OVERSIGHT HEARING

BEFORE THE

SUBCOMMITTEE ON ENERGY AND

MINERAL RESOURCES

OF THE

COMMITTEE ON RESOURCES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

June 12, 2001

Serial No. 107-36

Printed for the use of the Committee on Resources

(

Available via the World Wide Web: http://www.access.gpo.gov/congress/house

or

Committee address: http://resourcescommittee.house.gov

(II)

COMMITTEE ON RESOURCES

JAMES V. HANSEN, Utah, Chairman

NICK J. RAHALL II, West Virginia, Ranking Democrat Member

Don Young, Alaska,

Vice Chairman

W.J. ‘‘Billy’’ Tauzin, Louisiana

Jim Saxton, New Jersey

Elton Gallegly, California

John J. Duncan, Jr., Tennessee

Joel Hefley, Colorado

Wayne T. Gilchrest, Maryland

Ken Calvert, California

Scott McInnis, Colorado

Richard W. Pombo, California

Barbara Cubin, Wyoming

George Radanovich, California

Walter B. Jones, Jr., North Carolina

Mac Thornberry, Texas

Chris Cannon, Utah

John E. Peterson, Pennsylvania

Bob Schaffer, Colorado

Jim Gibbons, Nevada

Mark E. Souder, Indiana

Greg Walden, Oregon

Michael K. Simpson, Idaho

Thomas G. Tancredo, Colorado

J.D. Hayworth, Arizona

C.L. ‘‘Butch’’ Otter, Idaho

Tom Osborne, Nebraska

Jeff Flake, Arizona

Dennis R. Rehberg, Montana

George Miller, California

Edward J. Markey, Massachusetts

Dale E. Kildee, Michigan

Peter A. DeFazio, Oregon

Eni F.H. Faleomavaega, American Samoa

Neil Abercrombie, Hawaii

Solomon P. Ortiz, Texas

Frank Pallone, Jr., New Jersey

Calvin M. Dooley, California

Robert A. Underwood, Guam

Adam Smith, Washington

Donna M. Christensen, Virgin Islands

Ron Kind, Wisconsin

Jay Inslee, Washington

Grace F. Napolitano, California

Tom Udall, New Mexico

Mark Udall, Colorado

Rush D. Holt, New Jersey

James P. McGovern, Massachusetts

Anibal Acevedo-Vila, Puerto Rico

Hilda L. Solis, California

Brad Carson, Oklahoma

Betty McCollum, Minnesota

Allen D. Freemyer, Chief of Staff

Lisa Pittman, Chief Counsel

Michael S. Twinchek, Chief Clerk

James H. Zoia, Democrat Staff Director

Jeff Petrich, Democrat Chief Counsel

SUBCOMMITTEE ON ENERGY AND MINERAL RESOURCES

BARBARA CUBIN, Wyoming, Chairman

RON KIND, Wisconsin, Ranking Democrat Member

W.J. ‘‘Billy’’ Tauzin, Louisiana

Mac Thornberry, Texas

Chris Cannon, Utah

Jim Gibbons, Nevada,

Vice Chairman

Thomas G. Tancredo, Colorado

C.L. ‘‘Butch’’ Otter, Idaho

Jeff Flake, Arizona

Dennis R. Rehberg, Montana

Nick J. Rahall II, West Virginia

Edward J. Markey, Massachusetts

Solomon P. Ortiz, Texas

Calvin M. Dooley, California

Jay Inslee, Washington

Grace F. Napolitano, California

Brad Carson, Oklahoma

(III)

CONTENTS

Page

Hearing held on June 12, 2001 ............................................................................... 1

Statement of Members:

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

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

Prepared statement of ............................................................................... 3

Kind, Hon. Ron, a Representative in Congress from the State of

Wisconsin, Prepared statement of ............................................................... 64

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

of New York, Press release and statement submitted for the record ....... 51

Tancredo, Hon. Thomas G., a Representative in Congress from the State

of Colorado, Prepared statement of ............................................................. 63

Statement of Witnesses:

Cruickshank, Walter, Associate Director, Policy and Management

Improvement, Minerals Management Service ............................................ 29

Prepared statement of ............................................................................... 31

Harpole, John A., President, Mercator Energy LLC ..................................... 34

Prepared statement of ............................................................................... 36

Jacob, James M., Manager of Consumer Advocacy, KeySpan Corporation . 45

Prepared statement of ............................................................................... 47

Leggette, L. Poe, Fulbright & Jaworski LLP, on behalf of the American

Petroleum Institute, Independent Petroleum Association of America,

Independent Petroleum Association of Mountain States, Domestic

Petroleum Council, and U.S. Oil and Gas Association .............................. 18

Prepared statement of ............................................................................... 19

McMahon, M. Brian, McMahon & Spiegel, .................................................... 4

Prepared statement of ............................................................................... 6

(1)

COLLECTION AND DISPOSITION OF FEDERAL

OIL AND GAS ROYALTIES TAKEN IN-KIND

Tuesday, June 12, 2001

U.S. House of Representatives

Subcommittee on Energy and Mineral Resources

Committee on Resources

Washington, DC

The Subcommittee met, pursuant to notice, at 10:05 a.m., in

Room 1324, Longworth House Office Building, Hon. Barbara Cubin

[Chairman of the Subcommittee] presiding.

STATEMENT OF THE HONORABLE BARBARA CUBIN, A

REPRESENTATIVE IN CONGRESS FROM THE STATE OF

MYOMING

Mrs. CUBIN. The oversight hearing by the Subcommittee on

Energy and Mineral Resources will come to order.

The Subcommittee is meeting today to hear testimony on collection and disposition of Federal oil and gas royalties taken in-kind.

Under Rule 4(G), the Chairman and the Ranking Member are the

only ones that can make opening statements, and so I wonder if

Ron would mind if I made his. In this hearing, I think it would

probably be okay, but he will be here later. He is on a flight back

to Washington and I am sure he will be able to make it for part

of the hearing.

This hearing will continue to focus on the Subcommittee’s inquiry on issues relevant to our energy supply for the nation from

public lands and the outer continental shelf. But we are not today

here to decry the lack of access to potential reservoirs of oil and

gas, or seams of coal, or geothermal resources on our public land.

Nor are we here today to ponder ways to get those energy reserves

into production and thence to consumers more quickly than the

current regulatory regime has allowed. Rather, the topic for today’s

discussion is about whether the Federal Government ought to consider greater use of in-kind collections for oil and gas royalties

owed on producing leases.

The Subcommittee has a history over the past several Congresses

of debating the problem of valuing oil and gas for royalty purposes

in those instances where no arm’s length transaction exists at the

wellhead. Royalty in-kind, or RIK, is simply the exercise by the

Secretary of Interior of her existing authority to demand that a

Federal lessee surrender to the government his or her royalty obliVerDate 11-MAY-2000 11:51 Mar 18, 2002 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 73043.TXT HRESOUR1 PsN: HRESOUR1
2

gation, not in a cash payment but rather as a fraction of the oil

and gas volume that is produced.

In this manner, the morass of calculating the wellhead value of

the commodity from a downstream price with a net-back formula

for processing, transportation, and marketing deductions is eliminated. Auditing of the volume of oil and gas produced must still

occur, but this has to happen with in-value royalty payments, as

well, so what it amounts to is checking the flow meters and seals

against tampering, which would be a far easier job than calculating

value.

But what happens then? The Secretary must dispose of these volumes in some manner. In the Wyoming crude oil pilot MMS

project, royalty oil was aggregated (and oil from State leases, as

well) and they were bid out at semi-annual auctions. This appears

to have been a success in terms of demonstrating an ability to receive an uplift for the Federal Government and the State of Wyoming compared to those leases which did not participate in the RIK

project.

On the outer continental shelf of the Gulf of Mexico, natural gas

royalties have been targeted for in-kind pilot programs. As I have

noted in previous hearings, MMS has transferred gas to the General Services Administration, which has used it to heat Federal facilities, including the Longworth House Office Building, which we

are now in—In fact, I wish they would use a little bit more of it,

John, to get the air conditioning a little cooler in here, please.

This is as far as the General Services Administration has used

RIK so far, but in what other ways is it possible that RIK might

provide flexibility to fill another governmental need?

Well, President Bush’s National Energy Policy report recommends that the Secretary of Interior work with the Secretary of

Health and Human Services to draft legislation to bolster the LowIncome Home Energy Assistance Program, or LIHEAP, through the

dedication of oil and gas royalties. While this could be done with

royalty dollars rather than royalty gas molecules, is there a reason

to explore the latter approach? I think there is.

Could a pilot program be established to test the benefits of directing Federal royalty natural gas volumes to a utility with experience in delivering energy to low-income households? If so, would

OCS leases be the better choice for a pilot, or would onshore public

land leases?

These are several of the questions that we shall pose to our witnesses today to begin to flesh out, or put some flesh on the bones

of the President’s recommendation.

And lastly, I would like to thank all of our witnesses for coming

to educate us on this issue. The RIK idea has engendered passionate debate in the past about whether the oil and gas industry

is trying to escape its proper obligation to pay royalty based on a

fair market value of the production. I think at this time it is

demagoging to portray the industry as ‘‘cheats.’’ Yes, we all acknowledge that large sums have been proffered by companies in

settlements of lawsuits, and a recent judgment in an Alabama

court levied a huge award against one major oil company. But a

jury in California a few years ago rebuffed claims that this same

energy company had cheated on its State lease obligations.

3

One point should be obvious, that had the Federal lessees paid

these disputed royalties, in-kind, the U.S. taxpayer would have

been the immediate beneficiary because there would have been no

delay in collecting the proper value. My position continues to be

that each and every lessee is obligated and must pay every single

penny that it owes in royalties, whether it is in cash or in-kind, no

more and no less. But they have to be held responsible for that.

Within the context of all of this, now let us turn to the issue of

whether RIK can provide a benefit to our less fortunate citizens on

a cold winter’s night or a hot summer’s day, like today.

[The prepared statement of Mrs. Cubin follows:]

Statement of The Honorable Barbara Cubin, Chairman,

Subcommittee on Energy and Mineral Resources

This hearing will continue the Subcommittee’s inquiry on issues relevant to energy supply for our Nation from public lands and the outer continental shelf. But

we aren’t today to decry the lack of access to potential reservoirs of oil and gas, or

seams of coal, or geothermal resources.

Nor are we here today to ponder ways to get those energy reserves into production

and thence to consumers more quickly than the current regulatory regime has allowed.

Rather, the topic for today’s discussion is about whether the Federal Government

ought to consider greater use of in-kind collections for oil and gas royalties owed

on producing leases.

The Subcommittee has a history over the last several Congresses of debating the

knotty problem of valuing oil and gas, for royalty purposes, in those instances when

there is no arm’s-length transaction at the wellhead. Royalty-in-kind, or R–I–K, is

simply the exercise by the Secretary of the Interior of her existing authority to demand that a Federal lessee surrender to the government his or her royalty obligation not in a cash payment but rather as a fraction of the oil and gas volume produced.

In this manner, the morass of calculating the wellhead value of the commodity

from a downstream price with a net-back formula for processing, transportation,

and marketing deductions is eliminated. Auditing of the volume of oil and gas produced must still occur, of course, but this must happen with in-value royalty payments, too, and it amounts to checking the flow meters and seals against tampering

- a far easier job than calculating value.

But, what happens then? The Secretary must dispose of these volumes in some

manner. In the Wyoming crude oil pilot MMS has aggregated its royalty volumes

(and those of State leases as well) and bid them out at semi-annual auctions. And

this appears to have been a success in terms of demonstrating an ability to receive

an ‘‘uplift’’ for the feds and the State of Wyoming compared to those leases which

did not participate in the R–I–K pilot.

On the outer continental shelf (OCS) of the Gulf of Mexico, natural gas royalties

have been targeted for in-kind pilot programs. As I have noted in previous hearings,

MMS has transferred gas to the General Services Administration which has used

it to heat Federal facilities - including the Longworth House Office Building in

which we sit.

This is fine as far as it goes, but in what other ways might R–I–K provide flexibility to fill a governmental need?

Well, President Bush’s National Energy Policy report recommends that the Secretary of the Interior work with the Secretary of Health & Human Services to draft

legislation to bolster the low income home energy assistance program, or LIHEAP,

through the dedication of oil and gas royalties. While this could be done with royalty

dollars rather than royalty gas molecules, is there a reason to explore the latter approach?

Could a pilot program be established to test the benefits of directing Federal royalty natural gas volumes to a utility with experience in delivering energy to lowincome households? If so, would OCS leases be the better choice to pilot or would

onshore public lands leases? These are several questions we shall pose to our witnesses today to begin to put flesh onto the bones of the President’s recommendation.

Lastly, I’d like to thank all of our witnesses for coming to educate us on this issue.

The R–I–K idea has engendered passionate debate in the past about whether the

oil & gas industry is trying to escape its proper obligation to pay a royalty based

4

upon a fair market value of the production. I believe that demagoging the industry

as ‘‘cheats’’ is unproductive. Yes, large sums have been proffered by companies in

settlements of lawsuits and a recent judgment in an Alabama court levied a huge

award against one major oil company. But a jury in California a few years ago

rebuffed claims that this same company had cheated on its state lease obligations.

One point should be obvious - had the Federal lessees paid these disputed royalties in-kind, the U.S. taxpayer would have been the immediate beneficiary because

there would have been no delay in collecting the proper value. My position continues

to be that each and every lessee is obliged to pay every penny of royalty owed incash or in-kind. No more and no less.

Within this context let us now turn to the issue of whether R–I–K can provide

a benefit to our less fortunate citizens on a cold winter’s night, or a hot summer’s

day.

Mrs. CUBIN. Since the Ranking Member is not here, I would be

happy to recognize Mr. Inslee, if he would like to make an opening

statement.

Mr. INSLEE. I will defer, Madam Chair. Thank you very much.

Mrs. CUBIN. I would like to introduce the first panel of witnesses

and welcome them and thank them very much for being here with

us today. Mr. M. Brian McMahon, McMahon and Spiegel; Mr. L.

Poe Leggette, Fulbright and Jaworski, on behalf of API, IPAA,

IPAMS, EPC, and USOGA.

The Chair now recognizes Mr. McMahon. I would like to remind

you that your verbal testimony is limited to 5 minutes, but your

entire testimony will be put in the record, and point the timing

lights out to you.

STATEMENT OF M. BRIAN McMAHON, McMAHON AND SPIEGEL

Mr. MCMAHON. Thank you, Madam Chairman. I would like to

thank you for inviting me to appear today to this hearing, and I

would like to thank specifically Carolyn Maloney, Representative

from New York, who personally invited me to talk at this hearing

Friday afternoon.

In May 1998, I appeared before—

Mrs. CUBIN. Well, that was quick work and good work to get

here.

Mr. MCMAHON. I got little sleep. In May 1998, I appeared before

this Subcommittee to support MMS’s efforts to adopt new valuation

regulations for Federal royalty oil. At that time, we discussed the

use of RIK sales. These are important issues for California. We

have a large amount of Federal oil production in California and

California’s share of royalties goes directly to support its educational system.

California is concerned that the recent Wyoming RIK experience

not be misinterpreted and used to justify unwise or costly RIK policies. As we pointed out in 1998, California has decades of experience in conducting RIK sales. We made the following points then

in 1998 and we make them today.

First, Long Beach and California have been conducting royalty

in-kind sales since the early 1970’s.

Second, RIK sales achieve prices consistently higher than posted

prices for California crudes.

Third, major oil companies, with rare exceptions, will not bid on

RIK sales. The reason is that if they bid higher than their posted

prices, they would undermine their posted prices. They use posted

5

prices as the basis of their royalty obligations for non-Federal oil

and for many of their purchases of crude oil from producers and

non-working interest owners.

Fourth, although RIK sales prices are consistently above posted

prices, they are consistently below fair market value. We noted

then and note now that the price of Alaska North Slope crude oil,

ANS crude oil, sold in Long Beach is consistently above the royalty

in-kind’s prices that we receive in California. Attached to my written testimony, you will see a bar chart which compares posted

prices, RIK sales in California, and ANS prices as quoted in Long

Beach.

For these reasons, we supported MMS’s efforts to base Federal

royalties on readily available and competitive market prices, such

as the spot price of ANS on the West Coast and the reported spot

market prices for West Texas sour crude and West Texas intermediate crude.

The observations we made before the Committee 3 years ago

about Long Beach’s and California’s RIK sales are still true today.

Major oil companies, with rare exception, still do not bid on RIK

sales, but when we do get RIK sales, non-majors bid on RIK sales

and their prices are higher than postings.

One preliminary observation: MMS published their new regulations on April 15 of last year and they were to go into effect June

1 of the year 2000. MMS, as far as I know, has no reliable data

on the prices they have received under the new regulations. I am

not faulting MMS for doing this, but when they did their study of

the Wyoming RIK sales, they did not compare the prices received

under those sales with the prices they are to receive under the new

regulations. There is no reason to ignore the impact of the new regulations, even though we still do not have any results yet. Much

less is there any reason to abandon the new regulations in favor

of an all-out RIK program on the basis of this pilot study.

Let me look now to the Wyoming study itself. As shown in the

report that I have prepared and attached to my testimony, its

striking feature is that it is consistent with California and Long

Beach’s experience. First, only 15 companies ever bothered to submit comments. Only one of those, Exxon, was a major oil company.

Only seven companies were winning bidders and none of them was

a major oil company. Most of them were marketers or brokers, not

refiners, which suggests that these firms would be reselling the oil

to refiners at even higher prices.

Second, as in the California experience, the accepted bids were

higher than the prices posted by the major oil companies.

And third, as discussed below, the RIK sales prices were lower

than market prices. We are going to use Canadian crude oil prices

to measure the effectiveness of the RIK sales in Wyoming.

Fourth, the sales constituted 1.6 million barrels over an 18-

month period, and that represents less than 1 percent of the total

crude production of the Rocky Mountain area.

I guess I am out of time already?

Mrs. CUBIN. You are out of time, if you could just sum it up.

Mr. MCMAHON. Okay. What we did, in brief, Madam Chairman,

was we compared Canadian crude prices, we adjusted for transportation to Wyoming, and as three charts show that are attached in

6

a study we commissioned on the RIK sales in Wyoming, they show

that in all cases, the prices that—we will call this market prices

for Canadian crude—are higher than the RIK sales prices.

That does not mean that we believe that MMS did not conduct

the sales correctly. We approve of the way MMS conducted the RIK

sales. But what this shows is that unless major oil companies are

willing to participate in RIK sales, that is, bid on oil and bid prices

higher than their postings, you are going to continuously find, even

in the future, that the prices received in RIK sales are less than

true market prices. That is why we recommend that the MMS new

regulations, which do depend on market prices, are continually

used in the future.

I think at some appropriate time, when MMS gets more data on

the new regulations and how the costs of the new regulations compare with the RIK sales and the prices received under the new regulations, then I think we are in a more appropriate position to be

determining the effectiveness of the RIK program. Thank you very

much.

Mrs. CUBIN. Thank you, Mr. McMahon.

[The prepared statement of Mr. McMahon follows:]

Statement of M. Brian McMahon, for the City of Long Beach as

Trustee for the State of California

Madam Chairman and members of the Subcommittee:

Thank you for your invitation to appear today to testify in this hearing on the

collection and disposition of Federal oil and gas royalties taken in kind.

Introduction

In May 1998, I appeared before this Subcommittee to support MMS’s effort to

adopt new valuation regulations for Federal royalty oil. At that time, we discussed

the use of royalty-in-kind (RIK) sales. These are important issues for California. We

have a large amount of Federal oil production in California, and California’s share

of royalties goes directly to support its educational system. California is concerned

that the recent Wyoming RIK experience not be misinterpreted and used to justify

unwise and costly RIK policies.

As we pointed out in 1998, California has decades of experience in conducting RIK

sales. The points we made then are still valid today:

• Long Beach and California have been conducting royalty-in-kind sales since the

early 1970’s.

• RIK sales achieve prices consistently higher than posted prices.

• Major oil companies, with rare exceptions, will not bid on RIK sales. The reason

is that if they bid prices higher than posted prices, they would undermine their

posted prices. They use posted prices as the basis for their royalty (non-Federal)

obligations, and for many of their purchases of crude oil from producers and

non-working interest owners.

• Although RIK sales prices are consistently above posted prices, they are consistently below fair market values. We noted that Alaska North Slope (ANS) crude

prices in Long Beach are consistently above the RIK prices in sales by Long

Beach and California, as shown by the attached bar chart.

For these reasons, we supported MMS’s efforts to base Federal royalties on readily available and competitive market prices, such as the spot price of ANS on the

West Coast and the reported spot market prices for West Texas sour crude and

West Texas Intermediate crude.

The observations we made before this subcommittee three years ago about Long

Beach and California’s RIK sales are still true today: major oil companies still do

not bid and RIK sales prices continue to be higher than posted prices, but lower

than market values.

One final preliminary observation must be made: MMS published the new pricing

regulations on March 15, 2000 to go into effect on June 1, 2000. Thus, MMS does

not yet have any reliable data concerning the amount of royalties collected under

the new regulations. MMS has not been able to compare the prices received in RIK

sales of Wyoming crude oil with the prices they receive under the new regulations.

7

Nonetheless, that is no reason to ignore the impact of these regulations in evaluating a pilot RIK program. Much less is there any reason to abandon the new regulations in favor of an all out RIK program on the basis of a very small pilot study.

The MMS Wyoming Study

This brings us to the Wyoming study itself. As shown by the attached report, its

most striking feature is that it is consistent with Long Beach’s and California’s ex- periences in RIK sales. First, as to participants, only 15 companies ever bothered

to submit comments on the proposed program and only one, Exxon, was a major oil

company. Only seven companies were winning bidders. None of the winning bidders

was a major oil company. Most winning bidders were marketers or brokers, not refiners, which suggests that these firms could resell the oil to refiners at even higher

prices.

Second, as in the California experience, the accepted bids were higher than the

prices posted by the major companies.

Third, as discussed below, the RIK sales prices were lower than market prices.

Fourth, these sales of 1.6 million barrels over an 18 month period represent less

than 1% of the total crude oil production in the Rocky Mountain area.

Canadian Crude Oils are a proper Benchmark to Evaluate the RIK Prices

Contrary to MMS claims, Canadian crude prices are the appropriate standards for

evaluating the Wyoming RIK program. The Rocky Mountain area is a crude deficit

area, i.e., it produces less crude oil than it refines. Canadian crude oils are the marginal supply for refineries in the Rocky Mountain area. Canadian crude oils are refined in Colorado, Wyoming, Montana and Utah and constitute about one third of

the crude oil refined in the Rocky Mountain states. Canadian crude oil is an appropriate pricing benchmark for the Rocky Mountain area.

The RIK Prices are below Market Value

We compared spot prices for both sweet and sour Canadian crude oils that are

shipped into the United States with the three Wyoming RIK crude types. The RIK

prices for Wyoming sweet crude were compared with the spot price of Edmonton Par

crude (a sweet crude) after adjustment for transportation into Wyoming. See

Figure 1 of the study by our consultant, which shows that the spot prices of Edmonton Par crude were significantly higher than the RIK prices for the relevant time

period. The difference was $2 to $3 per barrel. Put another way, the RIK prices

were $2 to $3 per barrel below market value.

The RIK prices for Wyoming General Sour crude were compared with the spot

prices for Canadian Bow River Crude oil (a sour crude oil). (See Figure 2). In the

early months of the pilot program, the Canadian Bow River spot price exceeded the

RIK price for Wyoming General sour crude by as much as $4.50 a barrel, although

in the last five months of the program, the prices fell much closer in line.

We also compared the RIK prices for Wyoming Asphaltic crude with the spot

prices for Canadian Bow River crude (see Figure 3). The RIK price was considerably

below the Canadian crude price during the first pilot sale and then was not as much

below the Canadian crude price in the other two pilot sales. RIK prices for Asphaltic

crude reached near parity with the spot prices of Canadian Bow River crude oil in

the second half of the third sale.

The fact that Canadian crude oils were generally priced above the RIK pilot prices

is evidence that the RIK sales prices usually did not equate to market value.

MMS was wrong to reject Canadian Crude Oils as Benchmarks

MMS alluded to three reasons why Canadian crude oils should not be used as a

benchmark for the RIK sales prices. First, not all Wyoming crude oils compete with

Canadian crude oil at Billings (Montana). Second, Canadian crude production is less

mature than Wyoming crude production. Third, Canadian crude is transported to

both Midwest refineries and Rocky Mountain refineries. None of these is a valid reason to reject Canadian crude oils as benchmarks for RIK sales of Wyoming crude

oils. None of these considerations is sufficient to reject Canadian crude as a benchmark with which to compare the Wyoming RIK prices.

First, whether Canadian crude oils compete with Wyoming crude oils at Billings

is irrelevant. They do compete with Wyoming crude oils generally in the Rocky

Mountain area. Second the fact that Canadian crude oil production is less ‘‘mature’’

than Wyoming crude oil production is similarly irrelevant. Presumably, MMS means

that crude oil is cheaper to produce in less mature areas than in mature areas. Although that fact may be important to the profits of crude oil producers in both

areas, that is no reason why it should have anything to do with how much refiners

should be willing to pay for crude oils. Therefore, the maturity of crude oil producing areas does not affect the market values of crude oils.

8

Finally, both Canadian crude oils and Rocky Mountain crude oils are refined in

both the Rocky Mountain area and the Midwest. These crudes compete with one another in both areas.

Other alleged Benefits of RIK Sales

MMS admits that, because it is still developing its processes for managing RIK,

it is unable to document cost savings at this time. Just as the costs of the RIK program are uncertain so are the costs of using the new MMS valuation regulations.

In analyzing the possible benefits of the RIK program, MMS has compared the RIK

prices with posted prices and not with the prices established by the new valuation

regulations. The proper comparison is with the prices established by the new valuation regulations. So, too, in documenting any cost savings achieved by RIK sales,

the cost of the RIK program should be compared to the cost of implementing the

new valuation regulations. Those regulations, like the RIK program, are designed

to reduce the costs of auditing.

In short, because the costs of auditing under the new MMS valuation regulations

are uncertain at this time, no legitimate estimate of any cost savings using RIK

sales can be made at this time.

Congress should not take money from the states

The probable losses from the Wyoming pilot underscore that Interior needs to experiment and evaluate the pros and cons of an RIK program further before Congress

begins legislating. The need for legislation is, indeed, doubtful. The right to take in

kind exists under current law. The respective obligations of the lessee and lessor

are set out in the lease and in long held interpretations of leases. Neither the government nor industry has demonstrated a need for an additional authority to operate an RIK program. Moreover, other than speculation, no evidence has been offered

that the additional authority requested will result in enhancing, rather than decreasing, royalty revenues to the public beneficiaries. It is noteworthy that the

former Chairman of this Committee exempted his own State of Alaska from the RIK

legislation then under consideration.

Under current law, states receive a percentage of the United States’ ‘‘royalty interest.’’ A royalty interest is a cost free interest. It is unlike, for example, a working

interest, under which the owner of that interest shares in the costs of exploring, developing and operating the lease. The cost of those obligations that a lessee is required to perform are not deductible from a royalty interest.

The oil industry, however, seeks to allow Interior to use royalty revenues to pay

for performing certain services—services that are not deductible from the United

States’ interest when royalties are paid in value.

Clearly, industry is supporting this added authority as an adjunct to its claims

that Federal lessees are not required to pay for these types of costs. Their assertion

of a need for Interior to have funds to pay ‘‘downstream’’ costs is but a euphemism

for post-production and marketing costs. Their claims for deducting those costs from

royalties, however, were rejected repeatedly during the lengthy rulemaking leading

to the 1988 regulations, and during the more recent rulemaking on the new oil

rules. Interestingly, industry prohibits deducting those same type of costs when it

is the royalty owner.

The oil industry advocates allowing Interior to use royalty revenues to pay for

such matters as the hiring of independent brokers or marketers to sell production

taken in kind. Let’s be honest: if the government feels that it is inadequate to the

task of marketing—that privatization will be of assistance—it should continue to

take royalty in value. Taking royalty in value is the essence of ‘‘privatization’’. Moreover, such ‘‘privatization’’ can only reduce the ‘‘royalty interests’’ of states like Wyoming and California by forcing them to assume costs that currently do not reduce

their royalty revenues.

Last year, Congress finally passed legislation to end the Net Receipts Sharing program, under which the costs of Interior’s administration of the mineral leasing laws

were deducted from the states’ share of royalties. As the Chair will surely recall,

the Net Receipts Sharing program resulted in substantial disputes between the

states and Interior because the Federal Government could not justify and account

for its costs. Indeed, Wyoming was at the forefront of the Net Receipts sharing

battle. The authority that industry seeks for Interior is simply Net Receipts Sharing

in a different form.

If Congress wants the government to be in the oil business, it should appropriate

the money to do so through the annual appropriations process, where its performance can be evaluated and budgeted on a yearly basis. What it should not do, however, is transform the very nature of the public’s royalty interest into a working interest through the guise of making the in-kind program ‘‘permanent.’’ If Congress

9

wants Interior to stand in the shoes of a lessee, without the express consent of the

royalty beneficiaries, the Federal Government should assume those costs that lessees assume today, leaving the states’ and the public’s cost free royalty interest

intact.

I will be happy to answer any questions the Committee may have.

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Mrs. CUBIN. The Chair now recognizes Mr. Leggette.

STATEMENT OF L. POE LEGGETTE, FULBRIGHT AND JAWORSKI, ON BEHALF OF AMERICAN PETROLEUM INSTITUTE

(API), INDEPENDENT PETROLEUM ASSOCIATION OF AMERICA (IPAA), INDEPENDENT PETROLEUM ASSOCIATION OF

MOUNTAIN STATES (IPAMS), DOMESTIC PETROLEUM COUNCIL (DPC), AND U.S. OIL AND GAS ASSOCIATION (USOGA)

Mr. LEGGETTE. Madam Chairman, Mr. McMahon went over by a

minute and 20 seconds, so I will make up for it by going under by

a minute and 20 seconds.

Mrs. CUBIN. And we will appreciate that very much.

Mr. LEGGETTE. Madam Chairman, the associations on whose behalf I appear today want to thank you for the leadership that you

have shown in prodding the Federal Government into taking more

of its royalties in-kind. As the record of this hearing will show,

your efforts are beginning to pay off. MMS is beginning to find that

it can, at least in many cases, make more money with less administrative expense than it can when taking royalty in-value. It is beginning to find that it can manage RIK with fewer personnel than

is needed to manage royalty in-value.

Madam Chairman, you are right to continue to press MMS to

pursue RIK. The reason is simple. Members of this Subcommittee

know that all claims that RIK is bad financial business for the government boil down to a debate over one of two things, either the

so-called duty to market production at no cost to the Federal Government, or a debate over whether comparison of the oil that is

being sold, such as Wyoming oil or oil from the San Joaquin Valley

in California, can fairly be compared with other oil, such as Alaskan North slope crude oil or Canadian crude oil, with multiple adjustments to try to make it equivalent.

Now, on the duty to market point in particular, if members believe that lessees have such a duty, then they are likely to think

that the government will be worse off if it takes royalties in-kind.

Let me explain why that position hurts the Treasury.

Even the prior administration agreed that no lessee is required

to sell production downstream. It said so repeatedly in legal briefs.

If the duty to market does exist, MMS cannot be sure that it will

capture the benefit of value added downstream if it relies on royalty in-value. The lessee always has the option of selling at the

lease. The only way the government can be sure to gain value

added downstream is to take the royalty in-kind and sell it itself.

Furthermore, we have litigated with the government over this socalled duty. So far, we have won. If we continue to win in IPAA

v. Armstrong, the government will never get more than the value

at the lease if it takes royalty in-value, even when the lessee markets downstream. Again, the only way the government can be sure

to gain value added downstream is to take royalty in-kind and sell

it itself.

The most important issue today, however, is not the value of gas

at the wellhead, it is the high cost of gas at the burner tip, in the

homes of low-income families. Using RIK gas to benefit LIHEAP,

the Low-Income Housing Program, is a brilliantly creative idea.

Some have introduced legislation to take Federal royalty revenues

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from royalty in-value and help fund LIHEAP, a good idea, perhaps,

but let me suggest a better one. Use RIK. Why? For the reasons

that you gave yourself at the start of this hearing.

A unit of gas is a unit of gas. When I produce six units of gas

in the Gulf of Mexico, I owe the government one of those units. All

reasonable people can agree on that. But people will disagree over

whether the unit that I owe the government is worth $3, $3.25, or

$4. In short, if Congress funds LIHEAP through royalty in-value,

it will import into that program years of controversy over what the

value of production really is. If it supports LIHEAP through RIK,

it dramatically reduces the controversy. Better yet, as the next

panel will explain, it can reduce the administrative costs of running the LIHEAP program itself.

If Congress decides to pursue RIK for LIHEAP, our associations

stand ready to help the Committee prepare legislation to make the

concept work. The LIHEAP concept is an exciting new use of the

RIK program, a program that recent MMS experience shows can

equal or exceed the value obtained from royalty in-value, take

fewer personnel to administer, and increase the certainty for all

stakeholders.

Again, we thank you, Madam Chairman, and all members of this

Subcommittee who continue to support a program where everyone

wins. Thank you.

Mrs. CUBIN. Thank you, Mr. Leggette.

[The prepared statement of Mr. Leggette follows:]

Statement of L. Poe Leggette, Partner, Fulbright & Jaworski

Introduction

Good afternoon, Madame Chairman and members of the subcommittee. My name

is Poe Leggette. I am a partner at the law firm of Fulbright & Jaworski, LLP. I

am grateful for the opportunity to appear here before you today on behalf of the

American Petroleum Institute (API), the Independent Petroleum Association of

America (IPAA), the Independent Petroleum Association of Mountain States

(IPAMS), the Domestic Petroleum Council (DPC) and the U.S. Oil and Gas Association (USOGA).

My testimony will discuss the advantages of royalty–In-kind (RIK), for both the

industry and the government. We applaud the committee for holding a hearing to

explore the potential efficiencies available to the Federal Government and to industry if the use of in-kind royalty collections is broaden beyond current practice, and

to compare and contrast this with the more typical practice of in-value collections.

The entire oil and gas industry believe RIK provides the government numerous opportunities to creatively provide energy to in-need end-users while at the same time

efficiently ensuring that the Country is receiving each royalty molecule of gas or oil

due to the government. In fact Madame Chairwoman, it is this very committee that

has led the way for encouraging RIK since the 104th Congress. We appreciate your

efforts, including the RIK appropriations language contained in fiscal year 2001 Interior Appropriations, which gave MMS limited flexibility to do more with RIK.

For several years, there has been and remains today widespread support for RIK

in the oil and gas industry. So much so, in fact, that in 1997 the trade associations

mentioned above, which represent substantially all of the U.S. oil and natural gas

industry, united to organize a multi-association committee to work in conjunction

with the Minerals Management Service (MMS) and other stakeholders to formulate

and promote a workable system through which Federal royalties might be taken inkind.

I am pleased to be able to report to you today that MMS has made great strides

in this arena through the establishment and continuing operation of its RIK pilot

projects. The industry applauds the MMS RIK management team for the creativity

and flexibility it has demonstrated in putting together these RIK pilots. While problems have inevitably arisen, industry views none of these as being intractable so

long as the agency maintains its demonstrated commitment to cooperatively searching for the best and most efficient solutions.

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Despite the successes of these RIK pilots, industry believes much work remains

to be done. The pilots can only go so far, given certain legislative barriers. We encourage Congress to provide MMS the legislative RIK tools needed to fully expand

the volumes of oil and gas royalties it takes in kind, it Congress and the Administration deem appropriate, to provide energy to in need consumers.

Complexity of the Royalty In–Value Process

RIK offers the most logical and efficient means of avoiding the kinds of disputes

over oil and gas valuation that have arisen in recent years. The markets for oil and

gas are extremely volatile, and their rapidly changing nature renders the determination of product value at various points of sale a very complex, labor-intensive

exercise which all too often results in protracted, costly disputes. Any set of regulations designed to capture value in such an uncertain atmosphere must of necessity

be vague and open to interpretation by the various players in the process. Interpretations lead to disagreements, disagreements to disputes, disputes to litigation.

Capturing volume is a very simple process by comparison. A barrel of oil is a barrel of oil. A cubic foot of gas is a cubic foot of gas. So long as the measuring devices

used are accurately calibrated, there is no room for interpretation, and no need to

estimate the value of the production. For example, if a lessee in the Gulf of Mexico

produces six barrels of oil, he satisfies his royalty obligation by delivering one barrel

to the government. Simple as that.

With RIK, the accounting is simplified. There is no need to estimate the value

of production. The auditing is simplified; all that needs to be verified is the volume

of production and the volume delivered as royalty. Disputes are fewer.

This simplicity of process is the main reason for the industry’s support of the RIK

process. Lessees have a business need for certainty in the royalty payment process,

but simplicity should be appealing to every stakeholder; the lessee, who produces

the oil and gas and pays the royalties; the Federal Government, who collects the

royalties; and the beneficiaries who share in the royalty revenues, states like Wyoming, New Mexico, Colorado and California.

We urge the Federal Government to take full advantage of RIK and make it the

standard method for collecting royalties, with royalty in-value becoming the exception rather than the rule. A permanent RIK program would greatly enhance government flexibility by offering several options for disposing of its royalty share: selling

the royalty production on the open market or to small refiners; making available

the royalty production for use in government/public facilities; filling the strategic petroleum reserve; or providing cheaper energy to pre-approved low-income families.

For example, satisfying low-income heating needs via RIK versus sending royalty

payments, ensures that every molecule is delivered in a timely fashion and provides

the government and utilities an opportunity to provide further advantage to low income families by participating in the market place.

We were pleased that RIK was referenced in the Administration’s National Energy Policy as a way to accommodate the strategic petroleum reserves. Additionally,

the National Energy Policy proposes the use of royalty payments for LIHEAP. As

you will hear today, by taking this payments in-kind, many benefits will occur to

both the government and the recipients under the LIHEAP program.

Need for Legislative Action

The governing mineral leasing statutes already allow the Secretary to take royalties in-kind. The pilot projects thus far conducted by MMS demonstrate that RIK

works. However, some enhancements to the current statutory language would make

RIK work even better.

It is important to note that the RIK concept had its germination and grew rapidly

during the last years of the Clinton Administration. Clinton Administration officials

were resistant to the idea at first, but commendably were willing to explore the idea

through the conduct of a series of pilot projects. Over time, these pilots evolved and

became better tests of RIK as experience was gained. The pilot projects now demonstrate that RIK can increase revenues to the Treasury and reduce administrative

costs. The pilot projects also show that the Secretary is handcuffed in some instances by existing statutory language and by budgetary constraints that prevent

the department from fully exploiting the concept. MMS and industry joined together

last year to endorse language that would have corrected some of these roadblocks,

but much of that language was unfortunately struck on the floor of the House.

We urge Congress to work together with the Administration to craft solutions to

eliminate or avoid unnecessary obstacles to optimization of an already proven RIK

program. . Industry does believe the current statutes provide MMS much flexibility

to enter into creative RIK programs, but to eliminate any uncertainty legislative

language should:

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• Clearly delineate producer and government obligations

• Provide the government use of in-value proceeds to cover any expenses downstream of the lease

• Provide for reports to congress

• Allow disposition to Federal agencies or entities designated by the Federal Government

In closing, let me again thank you for this opportunity to appear before you today

on behalf of the industry trade associations

The industry also wishes to commend you, Madame Chairman, and this Committee for all the hard work you and your staff members have put in over the years,

encouraging the creation and growth of the Federal RIK program. Working together,

this Committee, the Congress, MMS and industry have demonstrated that RIK is

a very useful tool to optimize MMS’s royalty collection efforts. Working together, we

can ensure that RIK ultimately achieves its maximum effectiveness.

I would be happy to answer any questions the committee may have.

Mrs. CUBIN. I will begin the questioning. I would remind the

members and have them remind me if I go over that our questioning is limited to 5 minutes.

I wanted to ask you, Mr. McMahon, your testimony seemed to be

more about RIK in general than its application to LIHEAP, which

is really what the subject of this hearing is. So I would just like

to know what your opinion about royalty in-kind being used for

LIHEAP, what is your opinion for that?

Mr. MCMAHON. To tell the truth, I have not had a lot of time to

think about that, but I will share with you some experiences we

have had in California recently.

Mrs. CUBIN. Well—

Mr. MCMAHON. And I am going to tie it in to LIHEAP.

Mrs. CUBIN. Okay, because your testimony focused just really

pretty much on RIK in general—realizing you had such a short

time to prepare.

Mr. MCMAHON. Right.

Mrs. CUBIN. So please do not think in any way I am being critical about that. But I would really sort of like a broader picture,

because the question that I would like to have answered is, is RIK

for LIHEAP a reasonable option, especially in times when we are

in a situation where we have energy problems? Would gas from the

outer continental shelf or from the public lands be better used if

we channeled that to a utility to distribute it?

It seems to me common sense that when you eliminate the audits, you eliminate the lawsuits from royalty, or for the value, and

you eliminate the middleman, that you could deliver more energy

to the houses of poor people if you did that. So if you would just

respond to that, that is what I am trying to get at.

Mr. MCMAHON. Sure. But our California experience is this.

Where we get gas is from the Gulf Coast area and New Mexico. Let

us suppose that the government does have production of gas in

that area and we use some of that gas. It has to go through a pipeline which is owned by a company called El Paso. El Paso, as far

as I know, does not own the production. So some arrangement

would have to be made to go through El Paso pipeline—

Mrs. CUBIN. Sure. There would be transportation costs, right.

Mr. MCMAHON. And more than that. Because there is a constriction in the pipeline now, it is not clear now much of the extra gas

can go through. The next step is the utilities in California, like

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Southern California Gas Company, PG&E. Again, what obligation

do they have to ship Federal gas over their lines?

Mrs. CUBIN. I would think that it would be ludicrous to assume

that gas would be coming out of California to take care of this proposal, or at least this idea that we are entertaining. No, California

needs everything it has got, so that would not be it.

I would like to ask Mr. Leggette, you have been working, as you

said in your statement, on royalty in-kind issues and talking about

this issue for a long time. Could you please describe to me the

problems that there are with the administration of a royalty inkind program? And what I am specifically talking about are the accurate volumes being recorded and those kind of things and what

you would do to go about making sure that the correct volumes

were reported and that the government got its correct share?

Mr. LEGGETTE. For Federal production, production from Federal

leases, lessees are required to submit plans to the government for

approval in advance of installing their production equipment. The

government is entitled to veto those plans or require alterations if

it feels it necessary to make sure that oil or gas will be accurately

measured. MMS then conducts, or onshore, the Bureau of Land

Management, periodic site inspections to check the meters, and

companies are required routinely to check the meters and provide

the results of those checks to the Federal Government.

Now, this regulatory hand is in addition to the incentive in the

private sector between producer and purchaser to make sure that

these instruments are working correctly. But it is, compared with

determining what royalty value is, it is a relatively simple process.

Mrs. CUBIN. And certainly, it seems that there is room for mischief there, measuring volumes.

Mr. LEGGETTE. Oh, absolutely.

Mrs. CUBIN. But that same mischief is available when you measure the volumes when they are going to be charged in-value, the

royalties in-value, because it has to come out of the well and the

volume has to be measured correctly and that is when the arguments start. So RIK is not any more vulnerable to this sort of tampering, or mischief, if you will, than royalty in-value, would you

agree with that?

Mr. LEGGETTE. That is exactly right.

Mrs. CUBIN. And could you explain to me how you think the duty

to market issue would play out under RIK?

Mr. LEGGETTE. Well, it would be addressed because the government would be fulfilling its obligation to market its production and

to get the best return it can for the taxpayers, or alternatively, to

serve alternate purposes that reduce the cost of government or

other government programs, such as heating this building or perhaps benefitting a program like LIHEAP.

Mrs. CUBIN. Or preferably cooling it today.

Mr. LEGGETTE. Point well taken.

[Laughter.]

Mrs. CUBIN. The Chair now recognizes Mr. Inslee.

Mr. INSLEE. Thank you. I may ask some fairly low-level questions here, but I hope you will appreciate this is a relatively new

issue, at least to me.

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I would ask both gentlemen to comment. As I understand the

proposals for universal RIK, its intent is to reduce litigation, reduce uncertainty, and the like. But it would seem to me if we go

that route, it is going to set up a whole new level of responsibility

for the Federal Government, both as to merchandising, marketing,

transporting, storing, insuring, a whole new system of the Federal

Government for handling this product as a marketing agent. Is

that a fair assessment, and if so, what are the challenges and how

would that be done? I just ask both gentlemen to comment on that.

Mr. LEGGETTE. Mr. McMahon yields.

Mr. MCMAHON. For the time being.

Mr. LEGGETTE. For the moment. Yes, he reserves the right to

rebut.

There is no reason why the Federal Government would have to

create a large new marketing department to make royalties in-kind

work. Experience in Alberta, Canada, indicates just the opposite,

and I believe, if you were to ask that question of the MMS witnesses coming after me, they would say that the early indication

is that they can manage a large volume of Federal production with

far fewer people when promoting it in-kind rather than claiming it

in-value, and the reason is that the Federal Government, even

without the aid of help from outside marketers, enjoys a very important position in the marketplace. It has access to substantial

volumes in every field in which there is a Federal lease.

And so companies can come to MMS with creative proposals, unusual transportation arrangements that can beat the market and

give the government better value than other producers can get.

More importantly, one change that we would hope the Congress

would consider would be to allow MMS to contract with the expertise of private marketers to further enhance its position in the market.

Mr. MCMAHON. Let me respond. Right now, as far as we can tell,

MMS does not have the qualifications to market crude oil. The option would be, if all the oil is sold in-kind, if you do not want MMS

marketing Federal production, then MMS is subject to being passive and let oil companies come in and tell MMS what price they

are willing to pay.

Obviously, in my mind, you are going to have to set up a bureaucracy to deal with marketing. Marketing is complicated; not a

simple matter, and you simply cannot let oil companies dictate the

processes that will be used to market the crude oil. You have to go

out and market it aggressively. So I think there is a large cost involved in RIK which is not involved in an intelligent, comprehensive evaluation procedure.

I emphasize again, I think the major issue here is unless you

have competition, true competition among major oil companies for

RIK sales, you are not going to get competitive prices. We have yet

to see that happen, either in Long Beach or California or even in

the Wyoming experience. You do not have majors coming in to bid,

and if they do not come in and bid, then you are only going to have

a small segment of the market that is bidding on the crude oil. So

far, we have not had the experience of the major oil companies bidding on RIK sales.

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Mr. INSLEE. When you say bid, do you mean bid for purchase

from the government?

Mr. MCMAHON. Correct. We have not seen that. In 30 years in

California, only one major oil company has ever won a bid, and

that is Texaco, and Texaco is about to disappear because it is being

purchased by Chevron. Chevron, Mobil, and Exxon, even though

they have large presence on the West Coast, have never bid on royalty crude oil, and we do not see any majors in Wyoming bidding

on Federal royalty crude oil. What you see are the marketers, the

middlemen, and the only sense that that makes is that they are

going to resell it at a higher price. I mean, why else would you be

a middleman if you did not think you could get a higher price from

a refiner?

Now, why do the refiners not go out and bid for royalty crude oil?

Because then they would have to turn to their royalty owners and

say, well, we did bid this price which is higher than what you are

getting for your crude. So you see the conflict they would be in. So

they would rather have the middlemen come in, do the bidding, do

the dirty work, and then purchase from then, so then they can turn

to their royalty owners and say, we did not buy the crude at the

lease and so, therefore, we do not have to pay you the higher price.

So they are in a conflict situation regarding the royalty in-kind and

that is why, as far as we can tell, they will never bid on the royalty

in-kind oil.

Mr. INSLEE. Mr. Leggette, do you want to respond to that concern?

Mr. LEGGETTE. Well, in the time remaining, probably the most

effective thing I can do is to defer to the answer that the Minerals

Management Service people will give you. They have the experience not only with the Wyoming project, but with a gas pilot

project in the Gulf of Mexico. My impression is that some very

heavy-duty players in the gas market are bidding on those programs, but they have the details.

Mr. INSLEE. Thank you.

Mrs. CUBIN. The Chair now recognizes Mr. Otter.

Mr. OTTER. Thank you very much, Madam Chairman, and gentlemen, I apologize for being late. If I cover some ground that has

already been plowed, I sincerely apologize for it.

One of the things that is always of interest to me in a marketplace is what is the next generation going to look like. Perhaps,

and I do not know if you are willing to speak for the industry or

your segment of that industry, but what I would really like to know

is where do we go from where we are today? My question centers

to how much of the industry profit today is actually being spent on

alternate forms of energy, research and development, alternate

forms of drilling and recovery, proving up an oil field, blocking new

oil bodies or ore bodies? How much of the industry profit or cash

flow is going into the next generation of energy needs?

Mr. LEGGETTE. I will only be able to give you a most general answer. It, of course, varies from company to company, but my impression is that for most companies, it is quite a lot. Many— Mr. OTTER. What is quite a lot?

Mr. LEGGETTE. Money is going back into looking for new reserves, but also exploring alternative forms of energy. Some of the

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majors have established whole new business units that focus on alternative forms of energy. Shell and British Petroleum come prominently to mind, but they are hardly alone. And the independents

that IPAA and IPAMS represent are very active in plowing the

money that is currently being made in the prevailing price regime

back into new exploration, to enhancement of declining fields, to

new drilling in existing fields to further enhance the ability to deliver through the existing pipeline infrastructure.

Mr. OTTER. Mr. McMahon?

Mr. MCMAHON. I am really not qualified. I will make two observations, though. One is that the major oil companies are pulling

out of California. For example, Chevron turned back some leases

they had offshore which were already being developed. They appear

to be sending their money overseas because they make higher overseas profits.

The second point is, the L.A. Times reported just this past week,

the opposition of the oil companies against the use of ethanol in

California as a way of cleaning up the gasoline. So at least on that

issue, they appear to be opposed to that kind of alternative energy

source. But generally speaking, I am not in a position to answer

the question.

Mr. OTTER. Well, gentlemen, what I am concerned about, as we

see the consolidation of energy resources and energy production, I

know 20 years ago when I was drilling oil wells in the Knox zone

of Kentucky, Tennessee, and Ohio, there was an awful lot of folks

that were interested in the development side of it, and today, we

were at five and now it looks like we are going to be at four with

the Texaco and Chevron merger. I am as concerned about that consolidation and what that consolidation can do to our dependence on

those consolidated efforts, and I am well aware that not all the consolidation is purely marketplace driven. But I am concerned that

where our next generation of energy is going to come from along

the line I just asked on energy production and the research and development for the future.

How about on the conservation side, and if you could give me a

percentage. Now, if you were telling me, for instance, Mr. Leggette,

that 15 or 20 percent of the cash flow or 35 or 40 percent of the

profits that the industry is generating is going in to develop the

next generation, is that too high? Is 35 to 40 percent of the profit

going into the next generation, is that too high? Let me ask you

that question first.

Mr. LEGGETTE. I would be guessing wildly, although I would be

happy to try to get that information for you.

[The information referred to follows:]

Members of the Independent Petroleum Association of America are largely nonintegrated oil and gas exploration and production companies whose focus is the development of oil and gas reserves. It is estimated that these companies put nearly

all of their profits back into exploration and production activities. These companies

typically do not allocate funds to the pursuit of alternative or renewable energy

sources.

Mr. OTTER. How about you, Mr. McMahon?

Mr. MCMAHON. I would have no idea.

Mr. OTTER. Along that same line, how much research and development is going into conservation? When are we going to see 70

miles a gallon for an internal combustion engine? When are we

26

going to see more kilowatts produced per 250 megawatt hydropower plant now on X-number of cubic feet per second? And I am

not exactly sure what that figure is, but it seems to me that if the

lowest-hanging fruit here in this whole thing is conservation, or

getting a larger bounce for our buck, that is where we ought to be

spending our profits for the future. If you could just review that— I am out of time, but if you could just quickly embrace that for me

for a minute, I would appreciate it.

Mr. MCMAHON. All I could tell you, Congressman, is that in California, the electricity-generating facilities are not owned by major

oil companies. They are owned by much smaller companies. It appears that the major oil companies have figured they cannot make

money generating electricity, so they are not devoting their resources to more efficient electrical generating facilities.

Mr. LEGGETTE. Questions about car fuel efficiency really will

have to be addressed to Detroit, not to Houston, and about kilowatt

hours to the Edison Electric Institute and not the American Petroleum Institute or the IPAA.

But plainly, as I think the President’s plan recognizes, we have

to attack both sides of the equation. The NRDC issued a report earlier this year indicating that if two steps were taken, increasing the

CAFE standards for cars and imposing requirements on replacement tires, the nation could save 50 billion barrels of oil over the

next 50 years. That is about a billion barrels a year.

The Department of Energy, however, projects that increase in demand domestically for crude oil between now and 2020 will be two

billion barrels of oil a year, meaning even if we did everything that

the NRDC was proposing, that would only reduce the increase in

our demand for petroleum. Plainly, both sides of the equation need

to be addressed, production and conservation.

Mrs. CUBIN. The Chair now recognizes Mrs. Napolitano.

Mrs. NAPOLITANO. Thank you, Madam Chairman. I am very

much interested in the statements, and I, too, also was a little bit

late in getting here, so I am assuming some of the information

might have been covered.

Part of what really troubles me, and I have been in government

long enough to know that private industry normally says, government, stay out of business. You are not in the business to do business. You are in the business to do government policy, et cetera.

So to buy into an idea that the government can begin to have in

their hands, and as Mr. McMahon was indicating, to set up another

infrastructure, another bureaucracy to deal with the sale and the

proceeds and everything that goes with it just does not quite make

sense. To me, I would think industry would be saying, government,

stay out of it. We will take care of it.

One of the questions that I have is the industry itself is asking

that the government take in-kind?

Mr. LEGGETTE. Yes, ma’am.

Mrs. NAPOLITANO. And the reason is?

Mr. LEGGETTE. Unlike proposals in the 1970’s, where the Federal

Government was considering forming its own oil and gas company

to drill offshore and install its own production platforms, this is a

much more limited role for Federal Government in the marketplace. The government is not taking on the geologic risks of drilling

27

and the safety risks and operational risks of installing and operating platforms.

Mrs. NAPOLITANO. But it is taking other risks, sir.

Mr. LEGGETTE. Certainly, it is taking some market risks, like

other entities in the marketplace. The reason that the industry

supports that move is that, in the long run, it is more efficient both

for the government and for industry to let the government make

its money on its own, because the alternative is to have companies

exposed to endless rounds of lawsuits under the False Claims Act

and investigations and criticisms by Members of Congress.

Mrs. NAPOLITANO. How would those be avoided, sir, because

right now, from what I am reading in some of the information

given to us, is there are already several—a few suits against some

of the major oil companies, as well as some of the minor companies,

in regard to the False Claims Act. It seems to be there is a serious

issue in underreporting.

Now, if we were able to bring that into compliance somehow, and

I do not understand why the oil companies would be not happy to

do what is naturally requested of almost any business, is adequately report, and they are trying to overturn that law, it just

does not make sense for us to say, on one hand, it is okay to go

ahead and start having the government set up its own, we will

take care of it, when they are not even providing fully adequately

reported sales, if you will.

Mr. LEGGETTE. There is only one lawsuit of which I am aware

where someone is claiming that companies have underreported the

volume of natural gas. That is a case where the government took

its royalties in-value, not in-kind, the Chairman’s point earlier.

That case was investigated by the Department of Justice, which

has declined to intervene. But under law, the relator is entitled to

go forward, and that matter is in litigation and we will see what

comes of it. But that is a problem that is a possibility that can

occur whether you take royalty in-value or in-kind. If you take it

in-value, you have two potential sources of dispute. If you take it

in-kind, you only have one.

Mrs. NAPOLITANO. But it would be very expensive for the government for me. How could an RIK program be designed that would

minimize the pitfalls?

Mr. LEGGETTE. To minimize the pitfalls?

Mrs. NAPOLITANO. Right. In other words, be able to do away with

that second pitfall you were just talking about, the thicken problem.

Mr. LEGGETTE. The value pitfall?

Mrs. NAPOLITANO. Right.

Mr. LEGGETTE. Well, by taking royalty in-kind, the government

is then putting the production out for bidding and we think the

best way to make sure that the government does the best job it can

is to allow the government to hire outside marketing expertise to

advise it. Let me assure you that it is a whole lot cheaper for the

government to hire a marketing consultant than it is to pay millions of dollars in royalties to False Claims Act private relators in

these cases. There would be a big savings for the government there

alone.

28

Mrs. NAPOLITANO. Well, I am afraid that government does not do

things expediently, so I would be prone to challenge that a little

bit.

Mr. McMahon, your comment?

Mr. MCMAHON. Yes, a couple of comments. One is that you are

absolutely correct that in order to market properly, you have to

have a bureaucracy to do it. You do not want people that are not

sophisticated trying to market the crude and getting a good price

for the Federal Government. Some of the oil is in out-of-the-way

places, for example, offshore, California for one place, and in order

to bring it to a market center where there are competitive prices,

you need someone that is sophisticated to be able to do that.

The second point I will make is that we have heard a lot here

today about litigation, and why was there litigation? There was litigation because, in the past, what the oil companies did was they

reported the value of crude oil in terms of their own prices. That

is, oil companies like Chevron, Mobil, Exxon would say, this is

what the crude is worth and this is, therefore, what we are going

to pay you. There was no check on them.

What we found, and throughout the country this was happening,

was that the oil companies were setting up affiliated oil companies

in which they were selling the production at posted price to an affiliate and the affiliate would then turn around and sell at a higher

price. That was clearly an unfair situation.

Now, what MMS has done, it took them 4 years because of oil

industry objections, they went to market-based criteria for value.

When you are hearing in the news every day the price of West

Texas crude is X-amount of dollars, it is because that is a market

that is recognized throughout the oil industry. The price is not dependent on a single oil company. It is like the stock market. The

reported price of West Texas crude oil is the result of lots of buyers

and sellers coming together. That is a great indication of what the

value of the crude is, and there cannot be a dispute about what the

value of West Texas crude oil is. So we will expect fewer disputes

under the new regulations, and that is what we would like to see

actually put in place and look at it maybe in a year or two as to

whether it is working or not.

Mrs. NAPOLITANO. Thank you very much, Madam Chairman.

Mrs. CUBIN. I would like to thank the witnesses for their testimony and answers to the questions. Thank you, Mr. McMahon, for

coming on short notice. We appreciate your being here.

Mr. MCMAHON. Thank you, Madam Chairman.

Mrs. CUBIN. Likewise, Mr. Leggette.

Mrs. CUBIN. The Chair now would like to recognize the second

panel, Mr. Walter Cruickshank, the Associate Director of Policy

and Management Improvement of the Minerals Management Service, who has been a regular visitor with this Committee. He is accompanied by Mr. Milt Dial, the Assistant Program Director for

Royalty In-Kind; Mr. John Harpole, the President of Mercator Energy; and Mr. James Jacob, Manager of Consumer Advocacy,

KeySpan Corporation.

I would like to also welcome all of you gentlemen and thank you

very much for being here. We always appreciate hearing from Mr.

Cruickshank, who has been, as I said, a regular person here in

29

front of this Committee, and so now I will recognize him for 5 minutes. I point out again that the timing lights will be there on the

table.

STATEMENT OF WALTER CRUICKSHANK, ASSOCIATE

DIRECTOR OF POLICY AND MANAGEMENT IMPROVEMENT,

MINERALS MANAGEMENT SERVICE, ACCOMPANIED BY MILT

DIAL, ASSISTANT PROGRAM DIRECTOR, ROYALTY IN-KIND,

MINERALS MANAGEMENT SERVICE

Mr. CRUICKSHANK. Thank you, Madam Chairman. Good morning

to you and members of the Subcommittee. Thank you for the opportunity to testify this morning about the MMS’s royalty in-kind program. I have submitted written testimony for the record, and given

your background on this issue, I will just briefly provide an overview of the current status of our RIK projects and a summary of

our findings of our initial evaluation of the Wyoming oil RIK pilot.

Turning first to Wyoming, MMS and the State have been cooperatively developing an oil RIK program since 1998. MMS has been

taking up to 6,000 barrels per day of RIK crude oil and competitively selling that production in the open market. The State of Wyoming has also included RIK oil from the State lands in this program. Currently, we are selling approximately 2,000 barrels per

day of Federal RIK oil in Wyoming.

In March of this year, MMS issued its initial evaluation of the

Wyoming pilot for the first 18 months of operations. The report

concludes that the Wyoming pilot demonstrates that in some, but

not all, circumstances, taking oil royalties in-kind and selling it

through a competitive bidding process is a viable alternative to the

historical method of collecting royalties in-value. We used the following criteria as the basis for evaluating success: Revenue neutrality for the government; reduced administrative burdens for both

lessees and the government; and simplicity, accuracy, and certainty

for all parties.

To summarize, the main findings of the report, first, selective use

of RIK can be revenue neutral. We received an average premium

of about 45 cents per barrel over the value reported to the State

for royalty and severance tax purposes. And I would note that the

State’s regulations for royalty and severance tax, in essence, are

the same as the requirements for value under the new oil valuation

rule. However, at the time of the evaluation, the payments to the

State had been largely unaudited.

Second, lessees benefit from a reduced administrative burden,

from both the dramatic reduction in reporting to MMS as well as

the avoided costs of audits and valuation disputes.

Third, there is greater certainty for both lessees and the government. Not only are the valuation disputes avoided, but the potential exists for completing the volume reconciliation process in 90 to

120 days, allowing us to close the books on royalty obligations in

months rather than years.

However, RIK does not work across the board. One of the things

we found in Wyoming is that a number of properties served only

by trucks were not drawing competitive bids or purchaser interest,

and, therefore, we stopped offering those properties in the State.

30

Currently, we are working with the State in planning the next

phase of competitive sales of Wyoming RIK oil, with deliveries commencing this fall.

In 1998, MMS also started working with the State of Texas

General Land Office on a second RIK pilot involving natural gas

production from Federal leases in the 8(g) zone, offshore Texas. The

primary activity under this pilot was to mutually explore ways to

market Federal RIK from 8(g) leases, building on GLO’s experience

with their own successful RIK program. Competitive sales began in

June 1999 and initially focused on monthly spot market sales of

natural gas. Total sales volumes reached 75,000 MMBTUs per day,

with deliveries to both Federal facilities and private purchasers.

For reasons of administrative simplicity, this pilot was merged

this fiscal year with our broader OCS gas pilot. We have started

work on our evaluation of the Texas gas pilot and expect to complete that by the fall.

In November 1999, MMS began our third RIK pilot involving

natural gas from OCS leases across the Gulf of Mexico. Much of

this initial gas was sold to the General Services Administration for

use in managing its program of supplying natural gas to Federal

facilities. As previously mentioned, we did combine the two gas pilots together and today we are selling approximately 380,000 million BTUs per day of natural gas at offshore and onshore delivery

points.

An important feature of this pilot is that with the authority provided in the fiscal year 2001 appropriations bill, we have begun entering into agreements for transportation of the RIK gas to pooling

points and market centers away from the lease. Because of our

strong presence across the Gulf, we have found this authority to be

a cost effective means for shipping the government’s share of production. In some cases, we have been able to negotiate better rates

than other shippers along the pipeline. We have also used the new

authority to pay processing costs, and that has proven beneficial in

situations where pipeline companies have issued operational flow

orders requiring gas to be processed. We feel the continuation of

this authority beyond fiscal year 2001 is critical for testing alternative approaches to selling production at market centers removed

from the lease.

In August of 2000, we commenced our fourth pilot for RIK crude

oil in the Gulf of Mexico. We are currently selling about 7,600 barrels per day and planning the next sale with deliveries in October.

Finally, I would note that we are continuing to operate our small

refiner RIK program, currently providing five small refiners with

a total of 70,000 barrels of RIK oil per day from the Gulf of Mexico

and the Pacific.

In closing, I would like to say that we are continuing to study

RIK as a possible business approach for managing oil and gas royalties. Pilots are founded on the premise that oil and gas royalties

are a revenue-generating asset for the public and the decision

whether to take royalties in-kind or in-value would be based on the

best way to manage that asset.

Your Subcommittee is now considering whether to broaden RIK

beyond this current practice. MMS is prepared to provide technical

assistance to you as you proceed. We also expect to work with all

31

stakeholders as the administration implements the recommendation from the President’s National Energy Policy to bolster

LIHEAP funding using a portion of oil and gas royalty payments.

I thank you, Madam Chairman, and I would be happy to answer

any questions.

Mrs. CUBIN. Thank you, Mr. Cruickshank.

[The prepared statement of Mr. Cruickshank follows:]

Statement of Walter Cruickshank, Associate Director, Policy and

Management Improvement, Minerals Management Service

Madam Chairman, I wish to thank you and the members of your Subcommittee

for the invitation for the Minerals Management Service (MMS) to be here today to

present testimony regarding its royalty in kind (RIK) activities.

Introduction

As you are aware, MMS’s mission consists of two major programs: Offshore

Minerals Management and Minerals Revenue Management (MRM). The leasing and

oversight of mineral operations on the OCS and all mineral revenue management

functions for Federal (onshore and offshore) and American Indian lands are centralized within the bureau. In 2000, OCS oil and natural gas production accounted for

roughly 25 and 26 percent, respectively, of our Nation’s domestic energy

production—oil production was over 500 million barrels and natural gas production

was over 5 trillion cubic feet. The amount of oil and natural gas production in 2000

was the most ever produced on the OCS. In addition, in fiscal year 2000, MMS collected and distributed about $7.8 billion in mineral leasing revenues from Federal

and American Indian lands.

By provisions of law and lease terms, Federal oil and gas royalties can be paid

by the lessee either as a share of cash proceeds realized by the lessee (in value) or

with a share of production (in kind). The decision as to whether royalties will be

paid in value or in kind is solely the lessor’s (the Government). Historically, the

MMS collected royalty payments in value, except for its Small Refiner Program

whereby the Government receives oil royalty payments in kind on selected leases

and in turn sells the production to qualified small refiners at fair market value.

RIK Feasibility Study

In 1997, the MMS formed an RIK Study Team to investigate the feasibility of the

U.S. Government taking its oil and gas royalties from Federal leases in kind rather

than in value. The Study Team concluded that under the right circumstances, RIK

could be workable, revenue neutral or positive, and administratively more efficient

for MMS and industry. The Study Team also recommended the following:

• Development of a long-term OCS RIK pilot program with input from the States

of Texas and Louisiana for the marketing of substantial volumes of U.S. royalty

gas.

• Establishment of a joint MMS/Wyoming team to examine the viability of an oil

RIK program in Wyoming.

• Establishment of a joint MMS/Texas team to identify and assess a range of possible RIK programs involving OCS 8(g) leases offshore Texas.

• Evaluate the potential for additional RIK pilot programs upon the successful implementation of any pilot project.

In response to the recommendations of the Study Team, MMS aggressively initiated a series of pilot projects with the following goals:

• To determine the circumstances (market conditions) in which RIK makes sense

and identify those key success factors.

• To determine if the government (and industry) can save money by reducing the

administrative cost and burden of collecting and verifying royalties.

• To determine if RIK can provide accurate, simple and certain royalty collection.

• To determine if RIK can create value (revenue enhancement or neutrality) for

the taxpayer.

• To conduct evaluations, which will include the criteria listed above, of each of

the pilots and share with all interested parties.

RIK Pilot Program

The RIK pilot program commenced in 1998 with the initiation of its first pilot

with the State of Wyoming involving crude oil. Since then, the pilot program has

continued to expand in Wyoming and on the OCS in the Gulf of Mexico for both

oil and gas. Each of the pilot projects is designed to test a variety of approaches

32

to utilization of the RIK option for managing the Federal royalty asset. Pilot evaluations are being conducted to ascertain pilot successes and lessons learned that are

incorporated into succeeding pilot activities. I would like to briefly address each of

MMS’s RIK pilots and the evaluation work that has been completed to date.

The Wyoming Oil RIK Pilot

Under the Wyoming pilot, the MMS and the State of Wyoming’s Office of State

Lands and Investments have been cooperatively developing an oil royalty in kind

program. Since 1998, MMS has been taking up to 6,000 barrels per day of RIK

crude oil produced from Federal leases in the Powder River Basin and Big Horn

Basin of Wyoming and competitively selling the production in the open market

under 6-month term contracts. The State of Wyoming has also included State lands

RIK oil in the pilot sales. Currently approximately 2,000 barrels per day of Federal

RIK oil are being sold under the Wyoming Pilot.

In March 2001, MMS issued its evaluation of the Wyoming Pilot for the period

October 1998 through March 2000. The report concludes that the Wyoming Oil RIK

pilot successfully demonstrates that in some but not all circumstances, taking oil

production in kind and selling it through a competitive bid process is a viable alternative to the historical method of taking royalties in value. The following criteria

were established as the basis for evaluating its success: • Simplicity, accuracy, certainty for lessees and government.

• Revenue neutral (or better) for government;

• Reduced administrative burdens for lessees and government.

To summarize the main findings of the report, the Wyoming oil RIK pilot demonstrated: • Selective use of RIK can be revenue neutral—MMS received an average premium of 45 cents per bbl over the values reported to the State for royalty and

severance tax purposes.

• Lessees benefit from a reduced burden—an 80% decline in the number of lines

reported and the avoided costs of valuation disputes.

• Greater certainty for both lessees and the government—valuation disputes are

avoided and the potential exists for completing the volume reconciliation process

in 90–120 days. • RIK does not work across the board—MMS stopped offering trucked properties

because of the lack of competitive bids and purchaser interest.

The Wyoming pilot also provided the MMS and the State with valuable experience

in operating an ongoing RIK program. In several areas, experience from the three

sales allowed the MMS and State to review previous results and improve processes

for the next cycle. Reviewing the bidding mechanisms and the properties which were

receiving bids led to the expansion of the possible bidding and pricing mechanisms

and to the elimination of trucked properties from subsequent sales. Feedback from

sale participants provided impetus to eliminating burdensome and unnecessary

qualification requirements. On the pricing side, MMS gained valuable insights into

the complexities of the Wyoming oil market and discovered the need for MMS and

the State to further investigate alternative pricing mechanisms and different sales

terms. Although the overall value received in kind was at or above the comparable

in-value number, this was not the case for every month for every property.

MMS and the State of Wyoming are currently in the planning phase for the next

competitive sale of Wyoming RIK oil for deliveries commencing in the Fall 2001.

The Texas 8(g) Gas Pilot

In 1998, MMS in partnership with the State of Texas General Land Office initiated the second RIK pilot project involving OCS natural gas production from Federal leases in the Texas 8(g) zone of the Gulf of Mexico. The 8(g) zone refers to

leases within 3 miles of State waters and from which Texas receives 27 percent of

the revenues. The primary activity under this pilot was to mutually explore ways

to cost-effectively market both Federal RIK gas from the 8(g) zone and State leases.

Sales began in June 1999, and initially focused on monthly spot market sales of

about 25,000 mmbtu/day of natural gas. Total sales volumes reached 75,000 mmbtu/

day with deliveries to both Federal facilities and private purchasers. For reasons of

administrative simplicity, the pilot was merged in fiscal year 2001 with the OCS

pilot for non–8(g) gas. Sales of 8(g) gas to Federal facilities and other purchasers

continues under the overall Gulf of Mexico gas pilot.

The MMS has commenced its evaluation of the Texas 8(g) gas pilot and expects

to complete its analysis in the Fall 2001.

The Gulf of Mexico Gas Pilot

In November 1999, MMS began a third RIK pilot, involving non–8(g) Federal offshore leases in the Gulf of Mexico. Initial activities centered around competitivelyVerDate 11-MAY-2000 11:51 Mar 18, 2002 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6621 73043.TXT HRESOUR1 PsN: HRESOUR1
33

offered contracts with successful bidders taking approximately 200,000 mmbtu/day

of royalty natural gas from specified offshore locations and delivering natural gas

volumes and qualities of equivalent value to a specified onshore location. Much of

this gas was sold to the General Services Administration for use in managing its

program of supplying natural gas to Federal agencies. As previously mentioned, for

reasons of administrative simplicity, the MMS merged the OCS Texas 8(g) and the

non–8(g) gas into one pilot in fiscal year 2001. Under the merged gas pilot, the

MMS is today selling approximately 380,000 mmbtu/day of natural gas at offshore

and onshore delivery points.

An important feature of this pilot is that, with the authority provided in the fiscal

year 2001 appropriations bill, MMS began entering into agreements for the transportation of RIK natural gas to pooling points and market centers away from the

lease. Because of the strong presence of MMS royalty production throughout the

Gulf, the MMS has found this authority to be a cost-effective means for shipping

the Government’s share of production. In some instances, MMS has been able to negotiate better rates than other shippers along the pipeline. Authority for the payment of processing costs has also proved beneficial for operating this pilot, particularly in situations where MMS was forced to process its royalty share due to operational flow orders. Continuation of this authority beyond fiscal year 2001 is critical

to the RIK pilots for testing alternative approaches to selling production at market

centers removed from the lease.

The Gulf of Mexico Oil Pilot

In August 2000, the MMS commenced a fourth pilot for the competitive sale of

RIK crude oil from Federal offshore leases in the Gulf of Mexico. Under this pilot,

MMS is currently selling about 7,600 barrels of crude oil per day through September

2001. We are now in the planning phase for the next sale with deliveries beginning

October 2001.

Small Refiner RIK Program

Beyond the RIK pilot program, the MMS continues to operate its existing Small

Refiner RIK Program. The objective of the Small Refiner Program is to help assure

adequate supplies of crude oil at equitable prices are available to eligible small refiners. The business processes followed in operating the program have historically

been complicated and labor intensive. The MMS has worked with parties affected

by the Small Refiner Program in the last several years to bring about a number

of improvements including:

• introduction of a competitive bidding process that increases price certainty for

the small refiner and MMS.

• establishment of a volume nomination process for MMS to manage operators’

deliveries of oil to small refiners thereby reducing monthly imbalance problems

• changes in MMS payment requirements to have small refiners pay on actual oil

deliveries rather than estimated volumes, thereby reducing problems with small

refiners having to pay for oil they did not receive, and

• streamlined information collection by no longer requiring operators to report

RIK sales on the MMS royalty report.

Today, MMS is providing three small refiners in the Gulf of Mexico and two small

refiners in the Pacific with a total of about 70,000 barrels of RIK oil per day.

Managing MMS’s RIK Activities

To provide the needed management focus and visibility to RIK activities for the

future, the MMS established through its October 2000 reorganization of the Royalty

in Kind Office within the MRM. The RIK Office is the focal point and accountable

for the management and coordination of all MMS activities related to the operation

of the RIK pilots, the Small Refiner Program, and other RIK activities. The RIK Office is staffed with employees experienced in the pilot program and the Small Refiner Program. The Assistant Program Director for RIK reports directly to the Associate Director for the MRM.

Evolving MMS’s RIK Activities

In January 2001, MMS published its RIK Road Map to the Future. The Road Map

outlines a 3-year business plan for further development and operation of MMS’s RIK

pilots and Small Refiner Program, and integration of the RIK option into the overall

asset management strategies of the MMS.

Closing Remarks

We at the MMS are striving to adopt a balanced approach in developing the RIK

option as a viable tool for the management of the Nation’s royalty assets. We have

been deliberate in exploring new opportunities for optimizing value and gaining

34

market insight, yet have remained cautious to proceed slowly and build upon the

lessons learned through experience.

This MMS is continuing to study RIK as a possible business approach for managing oil and gas royalties. MMS is evaluating experiences to date and will continue

to explore the potential of RIK through pilot projects and long-term projects.

Madam Chairman, this concludes my prepared remarks. However, I will be

pleased to answer any questions Members of the Subcommittee may have.

Mrs. CUBIN. The Chair now recognizes Mr. John Harpole to testify.

STATEMENT OF JOHN HARPOLE, PRESIDENT,

MERCATOR ENERGY, LLC

Mr. HARPOLE. Thank you, Madam Chairman and members of the

Committee. I am John Harpole, President of Mercator Energy. I

would just like to thank you all for having me here today. I come

from a big family. I am the eighth child of nine and I am really

not used to people wanting to hear what I have to say, so thank

you for this opportunity.

Mercator Energy is a natural gas services consulting company

based in Denver that provides marketing services to natural gas

end users and producers. During my 20-year career in the gas industry, I have purchased gas for most of General Electric’s industrial facilities and also marketed gas for producers such as

McMurry Oil Company located in Casper, Wyoming. Those varied

experiences have provided me with an extensive view of the natural gas industry, from the wellhead to the burner tip.

Today, I am here representing myself. My goal is to help author

an efficient solution for low- and fixed-income individuals who have

been and continue to be hurt by rising natural gas prices. I would

like to describe the efficiencies of a novel concept to expand existing low-income energy assistance programs by taking Federal royalty gas in-kind and allocating that gas directly to prequalified lowincome energy assistance needs.

This Committee is certainly aware of the dramatic increase in

natural gas prices during the last 12 months. I have prepared an

illustration that shows the average gas prices from 1991 to 2001.

You can see that just in the 2001 time period as compared to the

10-year average, we have got a 126 percent increase.

All three sectors of the natural gas customer base have been dramatically impacted by the price increase. Residential customers,

the largest consumer sector, have naturally screamed the loudest.

Most residential customers are what natural gas derivative traders

refer to as ‘‘naked the forward price’’ for natural gas. While commercial and industrial customers have the option to lock down forward prices to ease the impact of volatile pricing, residential customers remain exposed. The financially naked residential natural

gas customer is too often the one turning off the thermostat and

throwing on the extra blankets.

The irony of all this is apparent in this illustration. In sheer

numbers, the 58 million residential customers are those that vote,

and as a result, they can drive public policy on an issue that they

rarely have control over. Of those 58 million residential customers,

24 percent, nearly 13.8 million people, qualify for LIHEAP assistance. LIHEAP assistance is available to households whose income

35

is 150 percent of the Federal poverty level, or 60 percent of the

State median income. Administrative expenses for LIHEAP

organizations are required to stay at or below 10 percent of total

monies funded.

Now, how can royalty gas help? It is simple. As an owner of royalty interests in all Federal lands, the Federal Government is the

largest natural gas producer in the U.S. In 1999, the Federal Government received $2.1 billion in revenue for natural gas. In 2001,

based on the price increase, the Federal Government should receive

nearly $6 billion, a $4 billion increase as compared to 1999.

Why not incorporate those dollars in a solution for the needy? I

would like to walk you through one possible solution. KeySpan Corporation, the largest gas utility in the Northeast, serves about 2.4

million customers in three States. KeySpan consumes about one

million MMBTU of gas per day in their New York service territory.

One of their many long-term supply contracts calls for the purchase

of gas from an offshore Gulf of Mexico producer in the amount of

60,000 MMBTU per day, so 60,000 a day as compared to the million a day that they consume in New York City. That volume is

then transported a distance of 1,400 miles on Transco pipeline to

KeySpan service territory in New York City. In January of 2000,

KeySpan’s 54,000 low-income customers burned about 8,200

MMBTU per day. That is, the low-income used about 8,200

MMBTU per day.

Under the proposed solution, the offshore producer could change

the price for that 8,200 a day—that is the portion of that 60,000

MMBTU sale to KeySpan—to $2 or whatever the Secretary of Interior deems an appropriate price for the price transfer to the

LIHEAP folks. This one transaction, one transaction, could lower

the natural gas price for 54,000 low-income customers in New York

City. Under this solution, the utility simply transfers the price benefit directly to the low-income recipient via their monthly utility

bill. LIHEAP incurs no additional administrative burden because it

has already qualified the recipient for assistance.

Additionally, a number of other flexible royalty in-kind to

LIHEAP approaches can be pursued that help address issues

raised by various industry participants. This concept is not meant

to be a long-term social welfare entitlement program. Rather, when

natural gas spot market prices return to levels near the 10-year average, the program could be reviewed on a seasonal basis. We need

enabling legislation to see this thing happen.

The benefits are three-fold, at least beyond helping the low-income. The proposed program could provide an additional benefit to

the low-income in addition to increasing LIHEAP funding. The

LIHEAP program, and this is a quote from the Chair of the National Fuel Funds Network, ‘‘The LIHEAP program may be nearing

its administrative capacity in terms of delivering significantly more

dollars. Additional delivery mechanisms,’’ and I quote, ‘‘such as

utilities, would expedite delivering dollars to people in need.’’

Producers, pipelines, and utilities could work in collaboration in

pursuit of the solution, and the diversity of this approach would

allow residential customers perhaps to better understand how the

molecule of gas gets to the burnertip.

36

In conclusion, we are requesting this Subcommittee’s assistance

in putting together the required enabling legislation. That is my

reason for appearing here today. The efficiencies of this proposal

and the benefits to all parties involved should motivate us to move

forward. Thank you for your time.

Mrs. CUBIN. Thank you, Mr. Harpole.

[The prepared statement of Mr. Harpole follows:]

Statement of John A. Harpole, President, Mercator Energy LLC

Introduction

Madam Chairwoman and members of the Committee: I am John Harpole, President of Mercator Energy. Mercator Energy is a natural gas services consulting company based in Denver, Colorado that provides marketing services to both natural

gas end-user and natural gas producing customers. In the mid–1980’s, the Federal

Energy Regulatory Commission (FERC) created open-access transportation on interstate natural gas pipelines via FERC Order 436. At that time, I was employed by

an oil and gas production company owned by General Electric. As a result of FERC

Order 436, I was put in charge of supplying natural gas to 55 General Electric industrial plants behind 34 utilities and 18 interstate pipelines. It may also be of interest to you, Madam Chairwoman, to note that my company marketed all of the

natural gas production out of the Jonah Field in Sublette County, Wyoming, for

McMurry Oil Co. from 1992 to 2000. Those varied experiences have provided me

with an extensive view of the natural gas industry—from the wellhead to the

burnertip.

Additionally, I have served as Vice–Chairman of the Natural Gas Committee of

the Independent Petroleum Association of America and on the governing boards of

two regional producer trade associations, the Colorado Oil and Gas Association and

the Independent Petroleum Association of Mountain States. Over the last twelve

years, I have authored articles about a number of timely issues affecting the natural

gas industry for such publications as American Oil & Gas Reporter, Oil and Gas

World, Hart’s Energy Markets, and Natural Gas Focus. Although I have testified

before FERC, this is my first opportunity to testify before Congress.

I am here representing myself and my company, an independent, regional natural

gas consulting firm, not an industry organization or political entity. My participation is the result of my interest in seeing the idea that I will describe further herein,

reach fruition. While the resulting program should provide opportunities for positive

public relations and increased public awareness of how the natural gas industry

‘‘works’’, my true goal is to help author an efficient solution for low- and fixed-income individuals who have been and continue to be hurt by rising natural gas

prices.

Last month, President Bush’s National Energy Policy Development Group specifically recommended that the President ‘‘take steps to mitigate impacts of high energy

cost on low-income consumers’’, including ‘‘directing the Secretaries of the Interior

and Health and Human Services to propose legislation to bolster LIHEAP [Low Income Home Energy Assistance Program] funding by using a portion of oil and gas

royalty payments’’ and ‘‘redirecting royalties above a set trigger price to LIHEAP,

whenever crude oil and natural gas prices exceed that trigger price, as determined

by the responsible agencies.’’ (Chapter 2, page 2–12)

Today, I appear before you to describe and explain the efficiencies of a novel concept to expand existing low-income energy assistance programs by taking Federal

royalty gas in-kind and allocating that gas directly to pre-qualified low-income energy assistance needs. On February 7, 2001, Colorado Governor Bill Owens sent a

letter to Vice President Cheney’s office outlining the general terms of the concept.

That letter resulted in press coverage from a number of natural gas industry trade

publications. I have attached copies of the letter from Governor Owens and the response from Vice President Cheney’s office as exhibits to this testimony.

After the effort that a number of parties contributed to this concept, it was gratifying to see the National Energy Policy Development Group select it for inclusion

in the policy document that was released last month. As evidence of the bi-partisan

support this concept has received, a variation of this idea was introduced in the

House of Representatives on March 8, 2001 by Carol Maloney, (D–NY) as HR962,

and a similar bill in the Senate by Charles Schumer (D–NY) and Hillary Rodham

Clinton (D–NY).

37

The Need

This Committee is certainly aware of the dramatic increase in natural gas prices

during the last 12 months. Most experts agree that the two major driving forces behind the price increase were the following:

1. A wholesale shift from coal to natural gas as the fuel of choice by electric utilities. This change is a result of stricter Federal air quality standards for coalfired power plants; and

2. The exploration and production communities’ inability to keep pace with increases in demand which has been exacerbated by more restrictive Federal

land access and right-of-way regulations.

We, as a country, cannot simultaneously restrict coal-fired electric generation

emissions, access to Federal lands, waters, and right-of-ways, and not expect a resultant increase in natural gas prices. Recent Federal policy and regulations have

contributed significantly to the recent surge in gas prices. If the Federal Government decides to pursue the concept I am proposing, the irony of a Federal solution

that would address the needs of those individuals most severely impacted,—that is,

those with low or fixed incomes—might not be lost on the American public.

In an effort to convey the dramatic price increase, I have prepared an illustration

that shows the average gas prices from 1991 to 2001.

All three sectors of the natural gas customer base have been dramatically impacted by the price increase. Unlike their industrial and commercial counterparts

who can lock down gas prices either physically or financially, residential

customers—the largest consumer sector—who rely on utilities to supply their natural gas, do not have access to individually-negotiated fixed-price contracts or any

other type of long-term, fixed-price hedging tools. In fact, as a result of various state

public utility commission rulings, regulated utilities generally are allowed to pass

through the actual cost of natural gas to residential customers, regardless of what

the price may be. However, the utilities are not allowed to earn a rate of return

on the commodity portion of those pass-through gas charges. If they were allowed

to do so, simple logic would dictate that the more they paid and charged for gas,

the higher the utility’s rate of return would be.

Furthermore, most utilities have no incentive to try to predict or ‘‘outguess’’ the

forward price for natural gas by locking down long-term, fixed-price contracts for

their residential customer base. Utilities face the 20–20 regulatory hindsight of

state public utility commissions whenever commodity prices increase. Many of those

utilities, instead, buy gas for their residential customer base under contracts that

are tied to a monthly spot-price index. Utilities have found themselves in a no-win

situation. There is no incentive to pursue the absolute lowest prices available, and

their purchasing strategy is constantly second-guessed when higher prices occur.

This situation results in a purchasing methodology relegated to a laissez-faire

monthly spot-market price. Many public utility commissions are now rethinking

purchasing policies as a result of the recent dramatic natural gas price increase.

38

Because of the trend toward spot-market purchasing, most residential customers

are what natural gas derivative traders refer to as ‘‘naked the forward price’’ for

natural gas. The spot market purchasing strategy provides tools for commercial and

industrial customers to mitigate the impact of volatile pricing, but residential customers remain vulnerable. The financially ‘‘naked’’ residential natural gas customer

is too often the one turning off the thermostat and throwing on the extra blankets.

The irony of all this is apparent in the illustration below. Residential gas consumers in this country total about 58 million, more than ten times the number of

commercial customers and 250 times the number of industrial customers. Yet residential customers are those most severely impacted by gas prices. In sheer numbers,

the 58 million residential customers are the voting public, and consequently, they

can drive public policy on an issue that they rarely have control over. Of those 58

million residential customers, 13.8 million qualify for LIHEAP assistance.

LIHEAP

‘‘The Low Income Home Energy Assistance Program (LIHEAP) was created under

the Omnibus Budget Reconciliation Act of 1981 (OBRA) to help low and fixed income households pay their fuel and utility bills. LIHEAP funding is allocated by the

Department of Health and Human Services (HHS) and administered by the states,

with the states having maximum flexibility in directing program funds.

‘‘LIHEAP is one of the original seven block grants authorized by OBRA. Over the

last decade, the LIHEAP program has evolved from providing only financial assistance to low-income households to today’s efforts that include residential weatherization and home-energy repair. ‘‘[under the program] states are given the flexibility

to direct program funds as needed, allowing individual states to tailor programs

according to the needs of its low and fixed income residents. In addition, states are

required to maintain administrative expenses at or below ten percent [of the total

allocated dollars], ensuring that most of the monies go directly to needy households.—Finally, LIHEAP serves as discretionary, in many cases one-time, assistance

providing a bridge that helps the working poor and avoiding dependence on welfare

programs.’’ (LIHEAP Issue Brief 1998–04)

According to the qualification criteria set forth by the Federal LIHEAP program,

approximately 24% of the country’s 58 million residential customers qualify for energy assistance. LIHEAP assistance is available to households whose annual income

is 150% of the Federal poverty level or 60% of the state median income. As you can

well expect, the number of applicants increased dramatically in conjunction with the

natural gas price increase over the last heating season. Nearly 70% of the households receiving LIHEAP assistance in 1995 survived on an annual income of less

than $8,000. Nearly 34% of those households had at least one member 60 years of

age or older. In addition to low-income households, senior citizens and individuals

on fixed-incomes have been especially impacted by high natural gas costs.

39

The Source

The Federal Government is the largest natural gas producer in the United States.

When royalty volumes from every onshore and offshore well are aggregated, the volume of daily production owned by the Federal Government exceeds that of the country’s largest commercial natural gas producer. In 1999, the Federal Government re- ceived $2.1 billion in total revenues from onshore and offshore natural gas royalty

payments paid individually each month by each natural gas ‘‘wellhead operator’’. Based upon actual NYMEX natural gas settlement prices for the first six months

of 2001 and the projected NYMEX futures prices for the remainder of this year, the

Federal Government should receive nearly $6 billion in royalty payments in 2001.

The Federal Government, through the Minerals Management Service (MMS), currently takes in-kind approximately 400,000 MMBtu per day of its total 2.5 million

MMBtu per day of offshore royalty gas. That is, the Federal Government sells the

gas itself rather than relying on a sale by the wellhead operator. The administration

of this program and its associated costs and benefits represent a true success story

within the Department of Interior. Fewer than 14 employees at the MMS sell the

400,000 MMBtu per day of gas in the open market on a monthly basis. The Federal

Government also manages a successful onshore oil royalty-in-kind program in the

state of Wyoming.

By any standard, the royalty revenues received in 2001 by the government can

be considered a windfall for the Federal treasury and for the onshore states that

receive a 50% share of these onshore royalty revenues. Rather than see that windfall ‘‘disappear’’ into Federal and state treasuries, why not incorporate those dollars

in a solution for the needy?

One Approach

Most, if not all, utilities in the eastern United States have arranged for long-term

natural gas supplies from producers in the Gulf of Mexico. As you are aware, the

Federal Government, under the terms of Federal leases granted to exploration and

production companies, has the option to receive a one-sixth royalty payment on production located in offshore waters or take the equivalent volume of gas in-kind.

Nearly every utility in the western half of the country acquires a portion of its

natural gas supplies from production located on Federal lands in the Rocky Mountains. On those lands, the Federal Government receives a one-eighth royalty payment and also retains, under its lease agreements, the option to receive its royalty

in-kind.

In the majority of cases, whenever a utility purchases gas from producers with

production on Federal lands, the utility utilizes its own transportation contracts on

interstate pipelines in order to effectuate the transportation of gas ‘‘from the water’’ (Gulf of Mexico) or from ‘‘The Rockies’’ to their utility’s front door, the ‘‘citygate.

As an example, KeySpan Corporation, the country’s fifth largest gas utility and

the largest gas utility in the Northeast, serves 2.4 million customers in three states.

On an average January ‘‘peak’’ usage day, KeySpan consumes 1,100,000 MMBtu in

its New York City service territory alone.

In January of 2000, in KeySpan’s New York City service territory, 54,000 prequalified residential low-income customers accounted for a ‘‘low-income average

daily demand’’ of 8200 MMBtu per day. Obviously the 8200 MMBtu per day of

usage related to low-income demand is just a fraction (seven-tenths of one percent)

of the total volume of gas consumed in New York City by KeySpan customers. The

‘‘low-income volume’’ was calculated by identifying the LIHEAP recipients by account number and totaling the daily usage for each account. That aggregate demand

volume obviously changes each month. Note that the ‘‘low-income volume’’ for

KeySpan’s New York City service territory of the largest gas utility in the northeast

amounts to less than three-tenths of one percent (0.3%) of the Federal Government’s

total offshore royalty gas volume.

One of KeySpan’s many purchase contracts calls for delivery of gas from an offshore Gulf producer in the amount of approximately 60,000 MMBtu per day. That

volume is then transported by KeySpan under a firm transportation agreement with

Transcontinental Gas Pipe Line Corp. a distance of 1400 miles to KeySpan’s service

territory in New York City. As a result of this transaction, the offshore producer/

wellhead operator, pays the Federal Government a monthly royalty equal to onesixth of the Gulf Coast sales price arrived at with KeySpan. The producer remits

payment to MMS with MMS Form 2014.

Under this proposed program, KeySpan, in conjunction with the offshore producer,

could change the price for the 8,200 MMBtu per day of the total 60,000 MMBtu per

day to $2.00 per MMBtu (or whatever ‘‘set trigger price’’ might be determined by

the Secretary of Interior). This one transaction could lower the natural gas price for

54,000 LIHEAP and other prequalified low-income customers in New York.

40

This solution adds no net administrative burden or cost to either the offshore producer, the utility or the state LIHEAP administrator. The producer could simply indicate on the required Federal royalty paperwork (a simple redesign of Form 2014

would be required) that a specified portion of the royalty gas was sold in-kind at

the predetermined LIHEAP set trigger price to the producer’s utility customer, who

verifies the sale volume and price for audit purposes. The utility then transfers the

price benefit directly to the pre-qualified low-income recipients via their monthly

utility bills. LIHEAP incurs no additional administrative burden because it has already qualified the recipient for assistance.

Under this approach, the producer handles the sales transaction of in-kind royalty

gas. The only additional administrative burden is MMS’s audit of the transaction.

By not having to add special purchase contracts, the utility can simply transport

the gas under existing long-term arrangements.

The above approach is not the only solution to moving royalty in-kind gas to lowincome recipients. A number of flexible options can be pursued that help address

the concerns of various industry participants. For example, some utilities may not

have the information systems infrastructure necessary to allow them to identify specific recipients and pass through the lower-priced royalty-in-kind gas. Additionally,

it may make more economic sense to have the government purchase firm transportation directly from the pipelines or pipeline shippers in those few instances where

short-term ‘‘released-capacity’’ transportation may be cheaper than the utility’s underlying firm transportation agreements.

Enabling Legislation and Pilot Projects

This novel concept is not meant to become a long-term social welfare entitlement

program. Rather, when spot market prices return to levels near the ten-year average (which could be calculated on either a NYMEX, regional, or citygate basis), the

need for the program could be reviewed on a seasonal basis.

Enabling legislation is, however, needed to address the Mineral Leasing Act and

the Outer Continental Shelf Lands Act to allow the Secretary of Interior to accept

a price that benefits the low-income.

We must move quickly in order to implement a pilot program that will address

the high natural gas prices that are anticipated for this coming winter’s heating season. Utilities could be selected for pilot programs in which each utility could tailor

the concept to its own needs and requirements.

More than enough Federal royalty gas exists to satisfy all of the low-income demand nationwide. The nation’s top 25 natural gas utilities serve 52.5% of all residential consumers in the United States. Under the above-described ‘‘KeySpan’’ approach, one ‘‘deal’’ alone can ‘‘cover’’ the low-income needs behind one of the largest

gas utilities in the country utilizing only 3/10ths of one percent of the available offshore Federal royalty gas volumes. Imagine what 25 ‘‘deals’’ a month could do for

other low- and fixed-income consumers! Auditing 25 transactions a month would be

a nominal task for the MMS given the measure of benefit it would provide to recipients. MMS’s cost to audit would be minuscule compared to the ‘‘up-to-ten-percent’’

cost of LIHEAP administration.

The Benefits

Important collateral benefits to this program are apparent beyond lowering the

price of natural gas for low- and fixed-income households.

1. The proposed program could provide an additional benefit to the low-income in

addition to increasing existing LIHEAP funds. This is best described by Karen

Brown, current Chairman of the National Fuel Funds Network, who says in a

letter (copy attached) that, ‘‘Additionally, in times of such crisis as last year,

simply increasing dollars to be delivered through a finite and, in some cases,

much outdated delivery structure such as LIHEAP is not fully effective. The

LIHEAP program may be nearing its administrative capacity in terms of delivering significantly more dollars—especially without investing more dollars to

improve such an infrastructure. Additional delivery mechanisms such as utilities would expedite delivering dollars to people in need.

2. By working in collaboration, producers, pipelines and utilities can direct more

dollars to the needy by avoiding the ‘‘up-to-ten percent’’ administrative cost inherent in the LIHEAP program. As an example, if this Federal royalty-in-kind

(RIK) solution results in $1 billion in benefits to LIHEAP customers, eliminating the 10% administrative charge adds another $100 million to the bottom

line for low- and fixed-income customers.

3. LIHEAP and similar programs could redirect a larger pro-rata share of their

funds to conservation efforts as a result of the base cost of natural gas being

addressed by this program.

41

4. The diversity of this approach allows for a greater level of understanding about

how a ‘‘molecule of gas’’ travels from the wellhead to the burnertip. For example, utilities could provide informative leaflets with their bill that describe the

program in simple, everyday terms, thereby helping to educate and raise the

level of awareness among those customers who know the least amount about

our industry and yet are impacted the most by price volatility.

Conclusions

If, as many industry experts indicate, natural gas prices continue to remain 30%

higher than just one year ago, more and more individuals on low or fixed incomes

will continue to seek energy assistance from state and Federal programs. Under this

proposed program, the Secretary of Interior has the option to decide if and when

natural gas prices become high enough to warrant allocation of royalty in-kind gas

to LIHEAP programs. If the Secretary so designates, producers, utilities and state

LIHEAP organizations will not need to scramble to introduce new programs overnight, but will have the flexibility to reduce the price of gas supplies designated for

LIHEAP recipients.

While LIHEAP offers other energy assistance programs that can benefit from any

additional dollars the Federal Government may allocate to them in times of high

energy prices, 100% of the benefit of low-priced, in-kind royalty gas is passed on to

LIHEAP recipients free of any additional administrative fees.

Requesting this Subcommittee’s assistance in putting together the requisite enabling legislation is my reason for appearing here today. The efficiencies of this proposal and the benefits to all parties involved should motivate us to move forward.

[A map and letters attached to Mr. Harpole’s statement follow:]

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43

44

45

Mrs. CUBIN. The Chair now recognizes Mr. James Jacob to testify.

STATEMENT OF JAMES JACOB, MANAGER OF CONSUMER

ADVOCACY, KEYSPAN CORPORATION

Mr. JACOB. Good morning, Madam Chairman and members of

the Committee. KeySpan is the largest gas company in the Northeast and the fifth largest in the country. We serve 2.4 million gas

customers in three States. We are also the largest privately-owned

power producer in New York State, with 6,200 megawatts of generation.

Since 1998, KeySpan, formerly known as the Brooklyn Union

Gas Company, has grown from one of the most respected local gas

distribution companies in the country to a diversified energy company with a footprint in the Northeast. KeySpan also provides

management services for the electric transmission and distribution

services owned by the Long Island Power Authority. In addition to

our natural gas customers, KeySpan serves 1.1 million electric customers on Long Island.

KeySpan is committed to providing assistance to low-income and

special needs households. We have over many years established

partnerships with State and local government social service agencies and community-based organizations to maximize the use of the

limited resources available to serve this at-risk population.

KeySpan is an active participant in the New York State HEAP

Block Grant Advisory Council. We take an active role in promoting,

advertising, and enrolling eligible customers in this vital program.

Recognizing our corporate obligation to the communities we

serve, KeySpan has supported urban renewal initiatives through

our Cinderella program, now in its 31st year. In 1983, we created

a fuel fund in New York City that we call the Neighborhood Heating Fund. This fuel fund has been a critical part of KeySpan’s response to the need for public and private partnerships to supplement LIHEAP funding. We have created or support similar fuel

funds in all of our service territories.

This winter was extraordinary in the Northeast because of two

main factors, the cold weather lasting for longer than average and

the high price of gas used in heating homes. Understanding the incredible burden faced by low-income customers, KeySpan responded by adding additional funds to their heating fund. To date,

KeySpan has contributed more than $7.4 million to these energy

assistance programs. As there was an increased demand for energy

assistance, this money quickly made its way to the households desperately in need of assistance.

In the early 1990’s, KeySpan created two targeted low-income assistance programs. The first is On Track, a comprehensive behavioral modification program focused on energy and financial management that serves 1,700 customers per year in New York State.

The second is the Residential Reduced Rate. This program helps

make energy more affordable for our low-income customers in New

York City by providing a discount on their basic service charge.

I would like to focus on our New York City operation today as

I ask for your support in piloting a natural gas royalties in-kind

program for low-income customers. KeySpan Energy Delivery of

46

New York serves 1.1 million customers in three counties within

New York City. We currently have identified over 120,000 special

needs households in this area. Studies we have conducted tell us

that over 43 percent of our payment trouble customers have incomes at or below 150 percent of the Federal poverty level. Census

data and other income studies conducted for our service territory

support the findings of our research.

Every year, KeySpan works with thousands of low-income households struggling to meet their energy expenses. These are good people and they are facing hard times. Many are having difficulty with

their bills for the first time. We see families that have had their

income reduced by catastrophic illness, senior citizens adjusting to

the loss of a spouse and the associated change in their financial

status, and single-parent households struggling to keep their families together, and many of our neighbors who, because of loss of

employment, are facing a crisis.

Recognizing that a large number of households are facing difficult choices, KeySpan implemented a discount rate for low-income

customers in 1993. We currently have 54,000 households enrolled

in this program. The special needs customers enrolled in this program receive a 30 percent reduction in their basic service charge.

As we develop the proposals I am supporting today, we approached our regulatory agency, the New York State Public Service

Commission, and we are pleased to report that they are supportive

of this undertaking. While this project was underway, the price of

natural gas has increased substantially. We believe that the timing

for a new public-private partnership to assist low-income households is critical.

In our residential reduced rate, we have a self-identified group

of low-income and special needs customers who have asked us for

the lowest possible residential rate. Our proposal would not mandate participation, but offers the lower-priced commodity based on

program eligibility criteria. We believe that the voluntary enrollment provision is critical since we support the right of customers

to choose and to make informed decisions in the emerging competitive marketplace. As these customers are already aggregated for

our discount rate, they are the group that would benefit the most

from the commodity discounts associated with royalties in-kind.

This group has a better bill payment history than our normal residential customers and this has been a multi-year experience, and

we are concerned that with the growing energy crisis, that these

customers will face additional terminations for non-payment in the

near future unless we come up with a mechanism to reduce energy

burden.

With your support, the Department of the Interior can arrange

for the delivery of natural gas as royalties in-kind. In the program

that we are proposing, KeySpan would need an average of 8,200

decatherms of natural gas per day for these customers during January. When this has been accomplished, KeySpan could supplement the already discounted transportation rate with a much lower

commodity cost. We would continue to provide all the customer

care functions for these customers and we would use our existing

capacity to transport the natural gas. We would also seek to reduce

47

or eliminate any associated demand charges related to this new

supply.

This partnership would reduce the energy burden for low-income

households, helping them to reach the elusive goal of energy affordability. We ask that you support the proposal for natural gas royalties in-kind as a direct and meaningful method of addressing the

energy burden of low-income households. LIHEAP and royalties inkind are essential to the well-being of a major segment of our population. Thank you very much.

Mrs. CUBIN. Thank you very much, Mr. Jacob.

[The prepared statement of Mr. Jacob follows:]

Statement of James M. Jacob, Manager of Consumer Advocacy,

KeySpan Corporation

Introduction

Madame Chairman and members of the committee: I am James Jacob, Manger

of Consumer Advocacy for the KeySpan Corporation. KeySpan is the largest Gas

Company in the Northeast and the 5th largest in the country. We serve 2.4 million

gas customers in three states. We are also the largest privately owned power producer in New York State with 6,200 Megawatts of generation. Since 1998, KeySpan

formerly known as The Brooklyn Union Gas Company has grown from one of the

most respected local gas distribution companies in the country to a diversified energy company with a footprint that spans the Northeast. KeySpan also provides

management services for the electric transmission and distribution services owned

by the Long Island Power Authority. In addition to our natural gas customers,

KeySpan serves 1.1 Million electric customers on Long Island.

KeySpan is committed to providing assistance to low income and special needs

households. We have, over many years, established partnerships with State and

Local Government social service agencies and community based organizations to

maximize the use of the limited resources available to serve this ‘‘at risk’’ population. KeySpan is an active participant on the New York State HEAP Block Grant

Advisory Council. We take an active role in promoting, advertising and enrolling eligible customers in this vital program. Recognizing our corporate obligation to the

communities we serve, KeySpan has supported urban renewal initiatives through

our ‘‘Cinderella’’ program now in its 31st year. In 1983, we created a fuel fund in

New York City that we call the Neighborhood Heating Fund. This fuel fund has

been a critical part of KeySpan’s response to the need for public/private partnerships to supplement LIHEAP funding. We have created or support similar fuel

funds in all of our service territories. This winter was extraordinary in the northeast

because of two main factors, the cold weather lasting for longer than average and

the high price of gas used in heating homes. Understanding the incredible burden

faced by low-income customers, KeySpan responded by adding additional funds to

their heating funds. To date, KeySpan has contributed more than $7.4 Million to

these energy assistance programs. As there was an increased demand for energy assistance, this money quickly made it’s way to the households desperately in need

of assistance.

In the early 1990’s, KeySpan created two targeted low-income assistance programs. The first is ‘‘On Track’’ a comprehensive behavioral modification program focused on energy and financial management that serves 1,700 customers per year in

New York State. The second program is the Residential Reduced Rate. This program

helps make energy more affordable for our low-income customers in New York City

by providing a discount on their basic service charge for qualified customers.

I would like to focus on our New York City operation today as I ask for your support for piloting a Natural Gas Royalties in Kind program for low-income customers.

KeySpan Energy Delivery of New York serves 1.1 Million customers in three counties within New York City. We currently have identified over 120,000 special needs

households in this area. Studies we have conducted tells us that over 43% of our

payment troubled customers have incomes at or below 150% of the Federal poverty

level. Census data and other income studies conducted for our service territory support the findings of our research. Every year KeySpan works with thousands of lowincome households struggling to meet their energy expenses. These good people are

facing hard times. Many are having difficulty with their bills for the first time. We

see families that have had their income reduced by catastrophic illness, senior citizens adjusting to the loss of a spouse and the associated change in their financial

48

status, single parent households struggling to keep their families together and many

of our neighbors who because of the loss of employment are facing a crisis.

Recognizing that a large number of households were facing very difficult energy

choices, KeySpan, implemented a discount rate for low-income customers in 1993.

We currently have 54,000 households enrolled in this program. KeySpan’s Residential Reduced Rate offers a discounted transportation rate or basic service charge

that includes the first 6 therms of natural gas. The special needs customers enrolled

in this program receive a 30% reduction on their basic service charge.

In order to qualify for the Residential Reduced Rate, a customers must be currently receiving Medicaid, SSI, Public Assistance, LIHEAP, Food Stamps, Child

Health Plus (New York State health insurance for uninsured children), Veteran’s

Disability Pension or Veteran’s Surviving Spouse Pension.

Four years ago, as part of our ongoing advocacy program, we initiated research

into a mechanism to deliver lower priced natural gas to this identified special needs

population. Traditional utility rate setting mechanisms do not have a provision for

directing the lowest priced commodity to a sub-set of customers. As we developed

our proposal, the Company approached our regulatory Agency, the New York State

Public Service Commission, and we are pleased to report that they are supportive

of this undertaking. While this project was underway, the price of natural gas has

increased substantially. We believe that the timing for a new public/private partnership to assist low-income households is critical.

In our Residential Reduced Rate, we have a self-identified group of low-income

and special needs customers who have asked us for the lowest possible residential

rate available. Our proposal would not mandate participation but offers the lower

priced commodity based on program eligibility criteria. We believe that the voluntary enrollment provision is critical since we support the right of customers to

choose and to make informed decisions in the emerging competitive marketplace. As

these customers are already aggregated for our discount rate, they are the group

that would benefit from commodity discounts associated with the Royalties–In–Kind

proposal. Our Residential Reduced Rate customers as a group have demonstrated

a better bill paying history when compared to the general residential customer population. This multi-year collection experience shows the direct results of affordable

energy for low-income consumers. However, current collection forecasts project a

somewhat darker future as low-income consumers react to higher energy prices. We

have already seen growth in the amount of our past due accounts. We expect that

delinquency and subsequent terminations of service for non-payment will grow if a

mechanism for reducing energy burden is not found.

Many of the customers in our program were recipients of Public Assistance. We

believe that additional targeted energy education materials including the use of bill

inserts, coupled with affordable energy, will assist these households in the transition to self-sufficiency.

With your support, the Department of the Interior can arrange for the delivery

of natural gas as royalties in kind. In the program that we are proposing, KeySpan

would need an average of 8,200 dth of natural gas per day for these customers during the month of January. When this has been accomplished, KeySpan could supplement its already discounted transportation rate with a much lower commodity cost.

KeySpan would continue to provide all of the customer care functions for these customers and would use its existing transportation capacity for this program. We

would seek to reduce and or eliminate any associated demand charges related to

this new supply with our existing natural gas suppliers.

This new public/private partnership would reduce the energy burden for these

low-income households helping them to reach the elusive goal of affordable energy.

Conclusion

We ask that you support the proposal for using Natural Gas Royalties in kind as

a direct and meaningful method of addressing the energy burden of low-income

households. In today’s uncertain economic climate with energy costs rising, there

are more people in need of help than ever before. In the face of daily announcements

of layoffs, industry restructuring, and downsizing, programs such as LIHEAP and

Royalties in Kind are essential to the well being of a major segment of our

population.

Mrs. CUBIN. I will begin the questioning. I would like to start

with Mr. Cruickshank. Rumor has it that Joe Skeen’s Subcommittee markup of the fiscal year 2002 appropriation for Interior

49

has the same RIK language that it had last year. Is that sufficient

or do you think Secretary Norton needs more authority?

Mr. CRUICKSHANK. I think that that language will be sufficient

for us continuing what we are doing now. If the Secretary wanted

to consider taking the program in a different direction, then we

would have to see if the authority was sufficient for those decisions.

Mrs. CUBIN. So to use RIK gas for LIHEAP, you would think

that it would be necessary for Congress to take action or not?

Mr. CRUICKSHANK. It might. I think we would have to work

through the specific proposal and see how it fit with our existing

authorities. Some things we would be able to do, some we might

not, and we would need to really work through specific proposals

on that.

Mrs. CUBIN. Okay.

Mr. CRUICKSHANK. But as you have noted, the President’s energy

plan does call for us to propose legislation to use royalties to bolster LIHEAP, so I am sure we will be considering those authorities

in that context.

Mrs. CUBIN. How would an RIK LIHEAP program actually work?

Mr. CRUICKSHANK. Do you want to handle this one, Milt?

Mrs. CUBIN. I mean, I have been working with royalty in-kind

ever since I have been here, and so has Mr. Thornberry, but the

other members of the Committee have not, and so I think what I

would like you to describe is the collection, the distribution, the offset of the value or just how a program works, how an RIK program

works and how we would get it out to the people that we are trying

to take care of.

Mr. DIAL. In answering that question and making reference to

Mr. Jacob’s proposal, basically, from an RIK perspective, if we were

dealing with outer continental shelf leases in the Gulf of Mexico

and we were dealing with natural gas, typically, what would occur

would be an identification of properties where a royalty obligation

exists, or a royalty collection is occurring. That collection, if it were

currently in-value, would be converted at the discretion of the Secretary to an in-kind collection, basically, a one, for most leases, a

one-sixth of total production coming off a lease be converted to an

in-kind take of royalty, and that in-kind take of royalty, that physical production, would be delivered to a central aggregation point.

What I heard Mr. Jacob describe would be that KeySpan would

either itself or through intermediaries arrange for the physical

movement of that gas to New York. That is the physical aspects of

how, I guess, we would envision, just in the short discussion that

we have had, of this particular proposal.

Mrs. CUBIN. So in other words, the gas itself would go to the utility. The utility would deliver the gas to the homes and that would

replace an additional appropriation that the Congress would make.

Would that be a shortcut to it? Mr. Harpole?

Mr. HARPOLE. Can I try to answer your first question, and then

I will try to clarify the second? Deanna, can you put up the map,

please? The concept that I have discussed with KeySpan is that

they hold firm transportation on Transco right now that actually

picks up gas in the Gulf Coast. And so one of their purchases—they

may have 40 different packages of gas that they buy on a daily

basis, but one of their purchases is directly with the producer on

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the Gulf Coast. That accounts for about 60,000 MMBTU per day,

60,000 of the million that they use behind their New York City

service territory.

And so if you imagine there is a one-sixth royalty on all that gas,

10,000 of that, if the producer did not do it in-kind, 10,000 of that

MMBTU would be paid to the Federal Government on a 2014

Form. What I am saying is, instead of doing that, let us have

KeySpan identify the volume that they need under the existing

contract. KeySpan says, I need 8,200 of that 60,000 at the Secretary of Interior’s price, but I will transport it. I will transport it

even though my transportation value is probably—the value of that

transportation that they hold in the winter is four to five times less

than what the market could charge for that similar transportation

quantity.

So it is kind of a seamless transaction. You do not have to buy

new gas to cover those people, and I would love to kind of address

the California question that was asked earlier, but it is a pretty

seamless transaction that would cover 54,000 people with one deal.

One thing I would like to point out is that only three-tenths of

1 percent of the available royalty gas offshore, only three-tenths of

1 percent would cover all of KeySpan’s New York City service territory.

Mrs. CUBIN. I realize my time is out, and rather than going to

a second round of questioning, I wanted to ask one question of Mr.

Cruickshank. It has been alleged or suggested here today that

MMS would have to establish a huge new big bureaucracy to market this gas. I would like your response to that.

Mr. CRUICKSHANK. I do not think that would necessarily be the

case, Madam Chairman. Right now, our operating principle is to

collect the royalties in-kind and get them to a pooling point or a

market center that is close to the producing area. It is not the most

complicated of transactions to do and selling gas at a market center

is also fairly straightforward. I think if we were to get ourselves

heavily involved with going downstream from there, then we would

have to pick up a lot of additional skills and that would become

more complicated. But the way we are operating right now, I do

not think we need to build up too big a bureaucracy to do so.

Mrs. CUBIN. In conjunction with that statement was the statement that MMS does not have the expertise to do this. Would you

agree with that or not?

Mr. CRUICKSHANK. We have been developing the expertise, and

that is part of the reason for the pilots. I think that the folks that

have been working the pilots since 1998 have developed a lot of

that expertise and are operating very well and doing things that

all the other marketers do out there very successfully. That is only

a small number of people, and if we were to grow the program by

a large amount, we would certainly need to train more people and

acquire additional expertise over time. But it is the folks doing the

work now that have developed that expertise.

Mrs. CUBIN. Thank you very much.

The Chair now recognizes Mrs. Napolitano.

Mrs. NAPOLITANO. Thank you, Madam Chairman. First, I would

like to put into the record Representative Maloney’s statement,

Madam Chair. She has not been able to be here.

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Mrs. CUBIN. Without objection.

[The prepared statement of Mrs. Maloney follows:]

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Mrs. NAPOLITANO. It is with great interest that I am listening to

the actual process by which we could accomplish the assistance to

the low-income, and that is of great interest to me, but I still have

concerns whether or not the system will be able to function. Mr.

Cruickshank, you indicate that there are some pilots.

Mr. CRUICKSHANK. We have been operating pilots where we have

been taking royalties in-kind and selling them at the market centers. There has not been a pilot yet to deliver royalty in-kind to the

LIHEAP program.

Mrs. NAPOLITANO. So we are just speculating that that would

work. What would you think would be the most, I would not say

onerous, but what would be the biggest obstacle to be able, to any

of you gentlemen, to be able to put a program that would actually

serve the low-income and still be able to have the government be

able to maintain a fairly good process that would not endanger future programs, because if you realize, once you set it in place, all

you have to do is keep adding to it, and we want to be sure that

there is something that is going to be there for a good number of

years, that is going to be adequate to serve the people that it is

meant to serve, and that it does not infringe upon either the business sector, i.e., the gas companies, or that it does not impact other

areas that will eventually be impacted, because you are going to

have a rise and fall of prices much as you have in gasoline, and

you have seen that increase. In 10 years, you have had a 100 percent increase almost. How would you be able to keep that?

I mean, there are all kinds of questions that come into my mind,

because people on fixed income do not have, generally, a doubling

of their income within a certain period of time. So you are talking

about being able to provide those folks with adequate sources of

gas and still maintain a price that is not going to affect both the

government and private industry. Gentlemen?

Mr. HARPOLE. Can I take the first swing at that?

Mrs. NAPOLITANO. Please.

Mr. HARPOLE. It is a good question, several different questions

in there.

Mrs. NAPOLITANO. A lot of them.

Mr. HARPOLE. A couple come to mind.

Mrs. NAPOLITANO. In my mind, there are more.

Mr. HARPOLE. I will try my best. This, in no way, shape, or form,

is meant to upset the marketplace. In fact, the royalty gas that is

purchased by a marketer or a utility right now is inherent in the

8(a) production that they buy from a producer. So when you think

about it, when they buy that gas and take it to the utility, they

are not allowed to earn a rate of return on the commodity portion

of their gas cost. They have to pass that through. Utilities earn a

rate of return based on their cost of service. If they are allowed to

earn a rate of return on $20 gas, they would buy $40 gas. So it is

a pass-through and so there is no inherent impact on the marketplace from that standpoint.

It is not meant to be a social or a welfare-type program. If the

alternative is to buy gas—if the alternative is to transfer monies

to LIHEAP, LIHEAP can spend up to 10 percent of those monies

on administrative cost. So in my mind, if the top 25 utilities cover

52 percent of the residential customer base and we just solved New

56

York City’s KeySpan service area problem with one deal, imagine

what 25 deals could do in terms of solving 52 percent of the residential customers’ exposure to low-income high heating bills.

And then, in addition, think about what it does when LIHEAP

can reschedule other funds to go to conservation and other programs. It is meant to kind of augment the LIHEAP program and

the ease and efficiency of it is such that if you just took $1 billion

of royalty gas—just $1 billion of royalty gas—but if you took $1 billion of royalty gas in-kind and gave the money to LIHEAP, $100

million of that could be spent on administrative costs. It would not

cost a fraction to audit this program, where you see where the utility says, this is how much I need for my low income. I cannot imagine a utility overstating that so that they can make more money.

This is one where we are kind of all helping—the entire industry

is helping that person lower their energy cost, and the efficiency is,

in part, is the elimination of the administrative overhead.

Mrs. NAPOLITANO. That is great, and Madam Chair, may I just

stress one point, is that I have heard the utilities would not want

to make a profit, but let me tell you, I have had utilities tell me

they have to make a profit for their investors, and I told them I

do not get that kind of assurance from my stockbroker. So it is

kind of like, do we allow it? How much of it? Is it a fair return?

Look at what is happening with the price increases, both in the energy and electricity and also in gas. So to me, it is very open. It

is like anybody can do anything they want until we begin to close

the gaps and the loops. Your statement that the transporter will

not charge because it is a seamless thing, they will make some

money somewhere.

Mr. HARPOLE. They are allowed to earn their cost of service rate

of return on the transportation.

Mrs. NAPOLITANO. That is what we heard of energy, too.

Mr. HARPOLE. But honestly, for me, I would hate to be a utility,

because you are allowed to earn a rate of return, but there is no

incentive for you to go out there and buy gas at a cheaper price,

because if you guess wrong, you cannot pass through that cost to

your customer base. And so they live in a box. These folks from

KeySpan—

Mrs. NAPOLITANO. In other words, it is—

Mr. HARPOLE. Right. It is a no-win situation and there is constant 20/20 regulatory hindsight.

Mrs. NAPOLITANO. But you understand from our vantage point is

we have our constituents saying to us, take care of it. How? And

so we need to find out, how do we best work with the industry to

be able to be sure that we are doing the right thing for them.

Mr. HARPOLE. I think what you have before you, Congresswoman, today is a producer group, an interested party in myself,

and a utility group that are saying, this is a great solution. It is

a seamless-type solution. And the utility is willing to allow their

transportation that is worth a lot more in the marketplace to be

utilized to save money for the low income.

Mrs. NAPOLITANO. Thank you, gentlemen, and I have gotten that

message.

Mrs. CUBIN. The Chair now recognizes Mr. Otter.

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Mr. OTTER. Mr. Harpole, I am interested in your comment that

this was not meant to be a welfare program. What was it meant

to be, then?

Mr. HARPOLE. It is definitely a transfer of wealth right now. This

is—

Mr. OTTER. What would you call it? If you did not call it a welfare program, what would you call it?

Mr. HARPOLE. It is the Federal Government helping step in to

solve a problem that they helped create.

Mr. OTTER. That they helped create?

Mr. HARPOLE. The higher natural gas prices, in my opinion, are

a direct result of more air emissions standards. Now, I am from the

natural gas industry and when I see every utility out there choosing natural gas as a generation of source, I feel like the dog that

was chasing the car and I caught it. So every utility out there—

of the 250 projects, electric generation projects, that are proposed,

all but five are natural gas fired right now nationwide. And so we

have seen the shift, and you can blame it on the Federal Government or just blame it on people that want to try to reduce emissions, but we have seen a shift in the fuel of choice to natural gas.

But at the same time, as a third generation native of Colorado, we

see access to Federal lands where a lot of those unknown and undeveloped reserves, or the undeveloped reserves, are situated.

And so from my perspective, having seen this from the wellhead

to the burnertip, those two Federal issues have helped create a

price increase. We cannot be surprised by the fact that gas prices

have increased when we increased the demand and then also reduced access. At the beginning of the hearing today, the Chair recognized that we do not want to go into issues about why prices

have increased and why we need more access to Federal lands, but

I think that issue is a direct—the pricing that we are realizing

today is a direct result of several different conflicting policies, restrict air emissions, restrict access to Federal lands.

Mr. OTTER. Well, given your enthusiasm for this kind program,

then why would not the Federal Government, why would not this

Committee also include the rights-of-way across Federal ground for

pipelines, for instance, as in-kind as well? Why not allow the use

of Federal lands for rights-of-way and the transmission of pipelines

and use that as sort of a toll. Say, well, we are going to toll you

X-number of dollars per cubic foot and that is going to go into the

in-kind, as well. I can see a tremendous new bureaucracy being

built up in order to keep track of all these little accounts that

would absolutely delight those who believe that government ought

to be the one that is dividing up scarcity.

Why would we not include all these other things? Say, in lowcost housing, if you are going to harvest forests off of Federal land,

then out of every 1,000 feet, say 100 feet of that has got to go to

low-cost housing. Where would we stop?

Mr. HARPOLE. Congressman Otter, I am about as right-wing a

Republican as you will ever find. The gentleman to your left actually is my Congressman and he knows that for a fact.

Mr. TANCREDO. I can attest to that.

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Mr. HARPOLE. There was a time when the Federal Government,

to create an incentive to expand the nation actually awarded every

other section on either side of the railroad.

Mr. OTTER. Yes.

Mr. HARPOLE. We have a problem right now. We have an energy

crisis. It is hitting the people that do not understand the issue the

most, the 58 million residential customers, and we need to come up

with some creative solutions to solve that problem.

What I would like to do, in coming up with this idea, let us release the pressure valve on the people that are the most affected,

and that is the low-income portion of those 58 million customers

that really do not understand the flow of the molecule of gas from

the wellhead to the burnertip. This is a program that you could

dial up and down. If the gas prices return to a 10-year average, the

program is terminated and the— Mr. OTTER. And the bureaucracy goes away?

Mr. HARPOLE. The bureaucracy goes away. And it is not the

bureaucracy that you create in the LIHEAP program. It is a much

more efficient approach.

Mr. OTTER. We have got to have some institutional memory here,

and the institutional memory that I can recollect is that I have

never seen one go away, but that is a subject probably for a different day.

Mr. Cruickshank, have you audited any of these pilot projects for

success?

Mr. CRUICKSHANK. We have done an evaluation of the Wyoming

oil pilot.

Mr. OTTER. Is that an audit?

Mr. CRUICKSHANK. It is not an audit. That would, in essence, be

auditing ourselves in a sense. We are taking the production. We do

use our auditors from the royalty program to verify that the volumes delivered are the correct volumes. But we are selling the

product under contractual obligations with private companies or

with the General Services Administration, and as we verify the volume, since the price is written in the contract, we are able to tell

without a full-scale audit whether we are being paid the right

amount.

Mr. OTTER. I see. What would be wrong with the government

just assuming a working interest in an ore body, or not in an ore

body, but in a gas field? Why would we not just assume a working

interest like if we were the landowner, which I think we are?

Mr. CRUICKSHANK. In a sense, when we take royalties in-kind,

the operators are treating us as a working interest in terms of delivering the production to us and giving the information that one

needs to manage the production one takes off of a lease. We are

not a full working interest in the sense that we are not at the table

to help decide how the oil and gas reservoir is going to be developed and what investment decisions to make, and I think that that

would be the big issue with your proposal. Should the government

be there with the lessee deciding exactly what sorts of investments

to make and when to make them?

Mr. OTTER. But is that not what happens? If Butch Otter owns

a chunk of ground and there is a gas reserve underneath it, there

is a gas deposit underneath it and they drill down and I maintain

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a one-eighth working interest in that well or in that whole field,

do I not then come to the table and say to the folks who would develop it, who are actually getting the resource as a result of their

development and their ability to accommodate the money necessary, the investment and exploratory funds necessary in order to

develop the field, I make those decisions, and the decisions that I

would make, Mr. Cruickshank, would be based upon how much

more return am I going to get for my one-eighth, right?

Mr. CRUICKSHANK. The fundamental difference between a working interest and a royalty interest is that role in the decision making about the operations on the lease.

Mr. OTTER. One more question, then. Are we not the landowner?

Mr. CRUICKSHANK. Yes, we are.

Mr. OTTER. Thank you.

Mrs. CUBIN. The Chair now recognizes Mr. Rehberg.

Mr. REHBERG. Thank you, Madam Chairman. You will note that

I sit to the right of the entire Committee. There is a reason for that

on the conservative meter.

I do not have a problem with your idea. In fact, I think we do

need a short-term solution and we have to be very creative without

masking what created the problem, and that is supply and demand.

As I look at your map, that is a nice pipeline, but it does not do

anything for Montana, and over the course of the testimony, we

have heard that there is a bottleneck at the pipeline. Can it work

in areas where there are, in fact, the inability to get our gas into

the pipeline?

Mr. HARPOLE. Yes. I was hoping someone would ask that question to clarify a statement that Mr. McMahon made earlier. He indicated that it would require additional transportation volumes to

get to California. In anticipation of that question, I pulled down the

list of parties that transport gas on the El Paso pipeline and TransWestern pipeline from the San Juan Basin, predominately Federal

lands, from the San Juan Basin into California, and SoCal has

500,000 MMBTU a day of gas transportation. Similar in concept to

the offshore idea, they could take advantage of that.

As you well know, Montana Power sources gas from all over

Montana. In addition to doing this on Federal lands, that is gas

that is brought in from Montana, you could do it on State lands,

also, but that would be left up to the individual States to solve that

problem. But Montana, as you well know, is surrounded by Federal

lands and one-eighth of that royalty gas would be available. Now,

remember, one-eighth of that royalty gas is transferred to the State

once it is received and one-eighth goes to the Federal Government.

There may be some people in New Mexico that do not want 50

percent of their share going to California to solve a problem, but

in my estimation, the Federal Government has more than ample

volumes of gas to cover the low-income heating needs in Southern

California. You will not be using 80 to 100 MMBTU a day in

Southern California for the low-income just because of the temperature difference there.

Mr. REHBERG. Let us assume I am with you, then. By creating

an opportunity for people to become dependent upon Federal

sources for their natural gas, do we, in effect, then leverage them

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into supporting our additional, not only construction of pipelines,

but also taking land out of production in places like the Missouri

Breaks, which they most recently did under the President’s Executive Order?

Mr. HARPOLE. That was not the initial thought. That was not the

motivation behind the idea. But for once, we might have what I

would characterize as non-producing States. You might finally have

even a Republican that has never voted for lands access issues, his

constituents might finally be impacted by access to Federal lands

by virtue of the royalty gas that is available from Federal lands

that helps his constituents. And so it is a terrific link in the sense

that, again, we just need to educate people as to where the gas resource comes from.

If you want to know where natural gas is consumed, look at a

population density map of the U.S. If you want to know where it

is produced, look at a pipeline map of the U.S. They are not the

same. And so I think, honestly, all Americans need a better appreciation of where we source natural gas and how critical it is for us

to maintain our own domestic energy policy to continue to source

that gas in U.S. waters and on U.S. lands.

Mr. REHBERG. I tried to follow the conversation with Congressman Otter. Do you think there is an opportunity—let me use as an

example Montana again. A lot of our natural gas comes in from

Canada, and so that is clearly not a Federal gas, but it is mixed

with Federal gas, but the pipeline does, in fact, go across Federal

properties. Could we, in fact, then make a connection between the

pipeline going across the Federal properties and use some of the

Canadian gas that is in that line if it is a higher percentage than

would be available under your pilot program?

Mr. HARPOLE. Yes. I actually did some expert witness work on

a case involving Montana Power several years ago and Colorado

Interstate Gas has an interconnection south of Billings that sources

gas in the Powder River Basin and also in the Green River Basin,

and at that time, I think it was responsible for about 20 percent

of the gas volumes delivered into Montana Power. About 80 percent

does come in off of Caraway, the connection in Canada.

But as you saw in New York City, 80 to 100 MMBTU a day, I

mean, honestly, my father was born in Deer Lodge. What is the

usage in Billings? We are not talking about a lot of gas volume

there. So there should be plenty, I mean, in order of magnitude of

100 times more than what you might actually need for the low income.

Mr. REHBERG. Thank you.

Mrs. CUBIN. The Chair now recognizes Mr. Thornberry.

Mr. THORNBERRY. Thank you, Madam Chairman. As you mentioned a few minutes ago, you and I have been dealing with royalty

in-kind issues since we have been here, partly out of a frustration

of trying to put a value on gas and then figure out what that is

so that proper payments can be made to the Federal Government,

and then the continual lawsuits that seem to go on forever after

that is made.

And so we have talked about royalty in-kind as far as figuring

out a way to take the Federal share of gas and selling it on the

market and receiving the money that way. We have also looked at

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ways to use the Federal share of gas to heat Federal facilities.

There, of course, is a little of that going on. There is a State program that does that in Texas, run by the General Land Office. And

we have explored the possibility of military bases or other Federal

facilities that could use this gas in a more direct way.

I think this suggestion kind of takes it even to the next step and

tries to get around all of the difficulties in putting a value on what

that is worth but making some good use. I think you are right. I

think it is creative and it is interesting to me.

Mr. Harpole, I am still trying to understand, and I am sure it

is just me, on the transportation side of this, obviously you have

gas that these utilities will just pass along to the low-income folks.

What is the motivation for them to provide the transportation, or

is that something that we, the Federal Government or the LIHEAP

program, has to pay to get transported?

Mr. HARPOLE. I would like to take a crack at this and then turn

it over to Jim Jacob for KeySpan, if I can, to further answer the

question. But there is in most States, and I would say 95 percent

of the States, State utility commissions require public utilities to

hold upstream firm transportation on interstate pipelines in adequate volumes to cover a peak day need on their system. Now,

there are a lot of thoughts in that one sentence. But again, the only

utility that I know of in the country that has relinquished firm

transportation to the marketplace is Atlanta Gas Light, and if you

have read any paper in the last 3 years, you realize that that was

not necessarily the best program in the country.

Yesterday, I asked some gentlemen from KeySpan how many

utilities on the East Coast have firm transportation all the way to

the Gulf Coast in order to satisfy some of their supply and they

said—they did not hesitate—they said 100 percent, 100 percent.

And so that is transportation that is already in the queue because

those are the customers that they have to cover. They are the last

supplier of resort for that customer base. And so those utilities will

always be able to cover the residential customer base. They will be

required to by their State utility commission.

I do not know, Jim, if you have something to add to that.

Mr. JACOB. I would just like to add that in New York State, we

do have an obligation to serve all customers who ask us for service,

and even in recent hearings for providers of last resort in the

emerging competitive marketplace, it has been determined that

somebody, even if it was not a utility, and that is several years

downstream, it would have to be an entity within the State, either

a marketer or a utility company, who will have that capacity to

supply natural gas and electricity to customers as needed. So I

think that certainly in New York State, utilities will be the provider of last resort for the next several years, and we can certainly

benefit low-income customers in New York State by using a royalties in-kind program at this time.

Mr. THORNBERRY. But you have to be compensated to transport

that gas from production areas up to New York, because it costs

you something to do that, right?

Mr. JACOB. We would already be transporting gas for these customers. This would simply be a lower-price commodity that we

could pass on to consumers. So our cost, and I am not an expert

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on our contract, certainly, but we already have supply contracts, as

John noted, in the Gulf region, and so we would simply be passing

this through the same pipeline system, through our city gate at the

beginning of our territory and to our customers who were enrolled

in this low-income initiative. So for us, it would simply be a mechanism that we could show on their utility bill as a reduction, along

with some of the education programs that we would like to do with

these same customers to help them to understand this changing

competitive marketplace that is the energy world today.

Mr. THORNBERRY. So it would not cost you anything additional

to transport this gas, more than it already costs to get the gas to

each residential home?

Mr. JACOB. It is my understanding that there would not be any

change in those structures. We are already transporting gas from

that region to the New York City gate.

Mr. HARPOLE. And if I could add something to kind of help toot

KeySpan’s horn here, KeySpan is one of the few utilities, if you

unbundle the cost of gas to residential customers, say there is a

commodity cost, there is an interstate pipeline transport cost, then

there is a cost to transport across the utility grid to get it to the

residential customer, that last piece, they have actually cut that

cost for the low-income by 30 percent. No other utility in the country has ever even offered something that large in terms of percentage cuts. And so this is one where they would benefit by the lower

commodity cost, they pass through the same interstate transport

costs under their costs of service, but then again, they even give

that set of customers, the low-income, a 30 percent discount on

what they charge to transport across their pipe.

Mr. JACOB. And if I could just add, as I said in my testimony,

these customers who have benefitted from this 30 percent discount

to date pay much better than the average residential customer base

that we serve, so that once we have addressed an affordability

issue, it really makes a difference in their lives and many of them

have transitioned from public assistance and they are still on the

food stamp program and still categorically eligible for LIHEAP, but

it makes a real difference and we have seen that.

Now, the higher energy costs of the last year are starting to affect that. This program would allow us to reduce that burden by

the commodity cost. We would still retain our discount rate of 30

percent and these customers would benefit and learn about the

process of gas supply and competition at the same time.

Mrs. CUBIN. The Chair now recognizes Mr. Tancredo.

Mr. TANCREDO. Thank you, Madam Chairman, and I apologize

for, first of all, being late and then having to run in and out here.

As a result, I probably will not ask a question that may, in fact,

end up being redundant. I would just say that your particular leadership in this area, Madam Chairman, has been very helpful to me

and elucidative, and although I have not spent the same amount

of time in the Congress or on this issue as Mr. Thornberry and you,

I have come to the conclusion that royalty in-kind is a far better

way of determining the exact value of the royalty that the Federal

Government should be obtaining from the industry than is the

present process that leaves so much up to—that causes so much

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confusion about whether we are talking about wellhead prices or

downstream prices upon which that valuation is determined.

So I have somewhat reluctantly come to the conclusion that royalty in-kind is the best way to go. The only thing I have ever heard

as a major sort of argument against it from a philosophical standpoint is that it puts the Federal Government into the position of

being one of the world’s largest oil and gas brokers if the program

is fully implemented. But it seems to me that if we could direct a

portion of these direct payments to LIHEAP and the Strategic Petroleum Reserve, as has been recommended by the National Energy

Policy, that we could diffuse some of that criticism, and appropriately so.

Along with that, of course, the program does eliminate the middleman that costs all energy consumers additional money, and oil

and gas producers must provide exhaustive accounting, as has been

attested to—I did hear that—valuation paperwork costing millions

of dollars. The Federal Government must process that paperwork.

In a way, we could, I guess, present this as being an energy savings plan, not have to cut down so many trees to produce so much

paper.

But I must say that my added support for this concept is brought

to bear as a result of Mr. Harpole’s analysis and participation in

it. I think he is one of the most knowledgeable individuals in this

field. He has been a leader and a pioneer of the concept in Colorado, and, in fact, I know that Governor Owens, our governor, is

strongly supportive of the RIK to the LIHEAP concept, and his confidence in that, by the way, I am sure, comes to a large extent from

his support and confidence in you, Mr. Harpole. So I think we can

all learn a great deal from your testimony and I look forward to

reading the various testimonies that have been provided for the

record, and I thank you all.

[The prepared statement of Mr. Tancredo follows:]

Statement of The Honorable Thomas G. Tancredo, a Representative in

Congress from the State of Colorado

Thank you Madame Chairman. Your leadership on this Royalty in Kind concept

for oil and gas leases is so strong and well developed, and I applaud you for holding

a hearing which adds a new, and logical, twist to the royalty-in-kind program.

The only criticism I’ve heard regarding royalty-in-kind that holds any weight is

the assertion that the Federal Government would, itself, become one of the world’s

largest oil and gas brokers when the program is fully implemented. If we could direct a portion these royalty-in-kind payments to LIHEAP and the Strategic Petroleum Reserve, as recommended by the National Energy Policy report, we could certainly diffuse some of that criticism. Not to mention the fact that royalty-in-kind

programs should eliminate the ‘‘middleman’’ that costs all energy consumers additional money, as oil and gas producers must provide exhaustive accounting and

valuation paperwork costing millions of dollars, and the Federal Government must

process that paperwork. Who knows? With royalty in kind, we could probably save

a few trees.

No one commands more knowledge on this topic, and the LIHEAP ‘‘twist’’, than

Mr. John Harpole a constituent and friend of mine who is here today. He has been

a leader and pioneer of the concept in Colorado. In fact, I know that Governor Bill

Owens is strongly supportive of the royalty-in-kind-to–LIHEAP concept, and his

support comes largely from his confidence in Mr. Harpole. I think we should all

learn a great deal from his testimony.

Again, thank you Madame Chairman for holding this hearing today

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Mr. TANCREDO. I guess I should say one other thing. If there is

something that we have not asked you that we should, anyone can

go ahead and respond, and this is the time to do it.

Mr. HARPOLE. I think the one that I would just like to reiterate,

would this work for California utilities? Yes, it would. Would this

idea work to maybe perhaps lower electricity costs by taking royalty gas to electric generators? Yes, it possibly could. I really believe in this idea. You can probably tell, I speak about it so passionately. I think it is a concept that is terrific because all the different parties work together. It really would be the Federal Government, the pipelines, the producers, the utilities, kind of working

in conjunction and coming up with a solution for people that are

most impacted by our commodity, and perhaps at the same time

help educate them.

Mr. JACOB. And if I could just add that the LIHEAP delivery network is strained to capacity. It is difficult to administer programs.

In New York State, we only serve 50 percent. We have 12 percent

of the national allocation of funds and we are only able to serve 50

percent of the eligible households. This mechanism, using utilities,

takes that burden off. It allows us to bring direct assistance to the

low-income households who are LIHEAP-eligible or members of

other low-income programs and it does so while allowing the network to redirect its sources to help other fuels, to help other people

in crisis, maybe to mitigate some emergencies, to reduce the number of terminations for non-payment, and perhaps to allow some

additional dollars from LIHEAP to go to weatherization and conservation efforts to solve the longer-term initiatives.

So I think that this is a wonderful opportunity to use the natural

gas that currently goes for valuation as royalties in-kind that

would help low-income customers directly. As a consumer advocate,

that is the piece that I see. This is not to replace the LIHEAP program. Certainly, it needs to be funded and funded appropriately.

But this is a wonderful way to supplement that, particularly during

this time of crisis.

Mrs. CUBIN. Thank you. The Committee thanks the witnesses for

their testimony and for the answers, the good answers to the questions. I think we have had a great discussion here today. I also

thank the members for their thoughtful questions.

I would like to include a statement from Congressman Ron Kind

in the record, without objection.

[The prepared statement of Mr. Kind follows:]

Statement of The Honorable Ron Kind, Ranking Democrat,

Subcommittee on Energy and Mineral Resources

This morning we meet to review and discuss the Federal oil and gas ‘‘royaltiesin-kind’’ or R–I–K program in preparation for Committee consideration of a national

energy bill.

The witnesses today have been asked to focus on the pilot projects currently underway at the Minerals Management Service. And, also to comment on a proposal

sponsored by our colleague, Representative Carolyn Maloney, to utilize royalties-inkind in the Low Income Home Energy Assistance Program.

Let me state at the outset that the proposal to explore using Federal royalty oil

and gas in a pilot with LIHEAP has merit.

This in no way means we would support a proposal to convert the current Federal

oil and gas royalty system from cash payments to a wholesale marketing scheme.

Under current law, the Secretary of the Interior has the option to take royaltiesVerDate 11-MAY-2000 11:51 Mar 18, 2002 Jkt 000000 PO 00000 Frm 00068 Fmt 6633 Sfmt 6621 73043.TXT HRESOUR1 PsN: HRESOUR1
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in-kind at her discretion. Studies by the GAO and CBO have concluded that a nationwide, mandatory RIK system would not be in the public’s best interest.

The oil and gas industry’s abysmal record on underpayments has rendered their

support of a national mandatory RIK system highly suspect. As an April 6, 2001,

editorial in USA TODAY stated, ‘‘By assorted estimates, the industry has shorted

the government on oil-royalty payments alone by about $100 million a year through

a variety of price-fixing and record-fiddling games. That’s almost 10% of the government’s $1.1 billion annual collections.

However, to the extent that we can merge the extraction of our Nation’s natural

resource base with positive social goals, such as providing low-income energy assistance, we are open-minded and interested in hearing the testimony of our witnesses

today.

Mrs. CUBIN. The hearing record will be held open for 10 days in

case there are some other questions that the members come up

with and we would appreciate your response in writing.

So if there is no other business before the Subcommittee, I again

thank all of you for being here and the Subcommittee is adjourned.

[Whereupon, at 11:48 a.m., the Subcommittee was adjourned.]

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