Report to Congressional Requesters

United States General Accounting Office

GAO

January 2003 MINERAL REVENUES

A More Systematic

Evaluation of the

Royalty-in-Kind Pilots

Is Needed

GAO-03-296
From January 1995 through September 2001, the Minerals Management

Service (MMS) took, in kind, 178 million barrels of oil and 213 billion

cubic feet of gas, or 32 percent of the federal government’s royalty share

of all oil and 3 percent of the federal government’s royalty share of all gas

produced on federal lands. MMS sold the majority of this oil—143

million barrels—to small refiners in accordance with long-standing

legislation. MMS also took 29 million barrels of federal royalty oil to fill

the Strategic Petroleum Reserve. MMS took the remaining 6 million

barrels of oil in kind and all the gas in kind under a series of pilot

projects to evaluate whether there are additional circumstances under

which taking royalties in kind is in the best interest of the federal

government.

MMS personnel have made progress in implementing some components of

management control for its Royalty-in-Kind Program, such as addressing the

risks associated with oil and gas sales and developing written procedures.

However, MMS does not plan to complete and implement all management

controls until 2004, when it will consider the Royalty-in-Kind pilots to have

changed from a pilot stage to a fully operational stage and when it will have

acquired additional systems support. To date, MMS has not developed clear

strategic objectives linked to statutory requirements nor collected the

necessary information to effectively monitor and evaluate the Royalty-inKind Program. Without clear objectives linked to statutory requirements and

the collection of necessary information, MMS cannot systematically assess

whether Royalty-in-Kind sales are administratively less costly, whether they

generate fair market value or at least as much revenue as traditional cash

royalty payments, and thus whether MMS should expand or contract the

Royalty-in-Kind Program.

Estimated Value of Federal Royalty Oil and Gas Taken in Kind by Purpose, Calendar Years

1995 through 2001 and January through July 2002.

MINERAL REVENUES

A More Systematic Evaluation of the

Royalty-in-Kind Pilots Is Needed

www.gao.gov/cgi-bin/getrpt?GAO-03-296.

To view the full report, including the scope

and methodology, click on the link above.

For more information, contact Jim Wells at

(202) 512-6877 or wellsj@gao.gov.

Highlights of GAO-03-296, a report to

Representative Nick J. Rahall, Ranking

Minority Member, House Committee on

Resources, and Representative Carolyn

B. Maloney

January 2003

In fiscal year 2001, the federal

government collected $7.5 billion in

royalties from the sale of oil and

gas produced on federal lands.

Although most oil and gas

companies pay royalties in cash,

the Department of the Interior’s

Minerals Management Service

(MMS) has the option to take a

percentage of the oil and gas

produced and either transfer this

percentage to other federal

agencies or to sell this percentage

itself—known as “taking royalties

in kind.” GAO reviewed the extent

to which MMS has taken royalties

in kind since 1995, the reasons for

taking royalties in kind, and MMS’s

progress in implementing

management control over its

Royalty-in-Kind Program.

GAO recommends that MMS clarify

its strategic objectives for the

Royalty-in-Kind Program and link

these objectives to statutory

requirements. GAO also

recommends that MMS gather key

information to monitor and

evaluate the program prior to

further expansion of the program.

In commenting on the draft report,

the Department of the Interior

generally agreed with GAO’s

observations and recommendations

and emphasized MMS’s future

plans to improve management

control over the Royalty-in-Kind

Program.
Page i GAO-03-296 Mineral Revenues

Letter 1

Results in Brief 2

Background 3

MMS Has Taken Increasing Amounts of Royalties in Kind Since

1995 to Meet Several Objectives 5

MMS Takes Oil in Kind and Sells It to Small Refiners 5

MMS Takes Oil in Kind to Fill the Strategic Petroleum Reserve 8

MMS Is Studying the Increased Use of Royalties in Kind 9

MMS Has Established Some Management Control over Its RIK

Program, but Additional Efforts Are Needed 12

Conclusions 19

Recommendations for Executive Action 20

Agency Comments and Our Evaluation 20

Scope and Methodology 20

Appendix I Comments from the Department of the Interior 22

Appendix II Objectives, Scope, and Methodology 36

Appendix III GAO Contacts and Staff Acknowledgments 38

Figures

Figure 1: Estimated Percentage of Federal Royalty Oil Taken in

Kind by Purpose, Calendar Years 1995 through 2000 and

January through September 2001 6

Figure 2: Estimated Value of Federal Royalty Oil Taken in Kind by

Purpose, Calendar Years 1995 through 2001 and January

through July 2002 7

Figure 3: Estimated Percentage of Total Federal Royalty Gas Taken

in Kind by Purpose, Calendar Years 1995 through 2000 and

January through September 2001 11

Figure 4: Revenues Reportedly Collected from the Sale of Federal

Royalty Gas Taken in Kind, Calendar Years 1995 through

2001 and January through July 2002 11

Contents
Page ii GAO-03-296 Mineral Revenues

Abbreviations

DOE Department of Energy

GAO General Accounting Office

MMS Minerals Mangement Service

RIK Royalty-in-Kind

SPR Strategic Petroleum Reserve
Page 1 GAO-03-296 Mineral Revenues

January 9, 2003

The Honorable Nick J. Rahall

Ranking Minority Member

Committee on Resources

House of Representatives

The Honorable Carolyn B. Maloney

House of Representatives

Federal lands supply about one-third of the oil and gas produced in the

United States. Companies that lease these lands traditionally pay royalties

to the Department of the Interior’s Minerals Management Service (MMS)

based on a percentage of the value of the oil and gas that the companies

produce. In fiscal year 2001, oil and gas royalties to MMS totaled about

$7.5 billion. Determining proper royalty payments, however, has been

costly and administratively difficult for both the companies that lease

federal lands and MMS. The value of the oil and gas, in particular, is often

a source of dispute. For example, during MMS’s recently completed 4-1/2

year process of promulgating new regulations for valuing oil, the oil

industry strongly opposed these regulations primarily because they would

increase the industry’s royalty payments and increase their administrative

burden. In commenting on the regulations, industry officials suggested

that instead of accepting cash royalty payments, MMS should accept a

percentage of the actual oil and gas produced and sell this percentage

itself—known as “taking royalties in kind.”

The Mineral Leasing Act of 1920 and the Outer Continental Shelf Lands Act

of 1953 authorize taking royalties in kind and require that the government

obtain at least fair market value for royalty oil and gas it sells. Under this

authority, MMS has taken federal oil in kind, mainly to fulfill congressional

and executive directives. Specifically, the Congress has directed taking oil

in kind for the Small Refiners Program, whose objective is to supply crude

oil to small refiners that do not have an adequate supply of their own. In

more recent years, the President has directed the taking of oil in kind to

fill the Strategic Petroleum Reserve as a safeguard against disruptions to

the national supply of crude oil. However, in 1995, MMS began to study

whether there are additional circumstances under which taking oil and gas

in kind is in the best interest of the federal government. MMS’s efforts

were encouraged by the Congress as a means of avoiding disputes

between MMS and the oil and gas industry over the value of the oil and gas

produced as well as a way to simplify royalty administration. To this end,

United States General Accounting Office

Washington, DC 20548
Page 2 GAO-03-296 Mineral Revenues

MMS established Royalty-in-Kind (RIK) pilots and is developing

management controls for its RIK Program—a newly created program

under which MMS manages all its RIK activities. Management control is an

integral component of an organization’s management that, if effective, can

provide for the effectiveness and the efficiency of operations, the

reliability of financial reporting, and compliance with applicable laws and

regulations. Key management controls include (1) identifying and

mitigating the risks that could prevent an agency from achieving its

objectives, (2) developing written procedures, and (3) monitoring and

evaluating program performance. In the 2001 and 2002 Appropriations

Acts for Interior and Related Agencies, the Congress provided additional

direction that MMS collect at least as much revenue from its RIK pilots as

it would have collected in cash royalty payments.

As a part of your interest in MMS’s stewardship over federal oil and gas

royalties, you asked us to (1) determine the extent to which MMS has

taken oil and gas in kind since 1995 and the reasons for doing so and (2)

report on the status of MMS’s efforts to implement management controls

for its RIK Program.

From January 1995 through September 2001, the Minerals Management

Service took 178 million barrels of oil and 213 billion cubic feet of gas in

kind, or about 32 percent of the federal government’s royalty share of all

oil and 3 percent of the federal government’s royalty share of all gas

produced on federal lands, and used these quantities for various purposes.

Of the 178 million barrels, MMS sold about 143 million barrels to small

refiners under the Small Refiners Program. MMS also complied with

presidential directives to use federal royalty oil to fill the nation’s Strategic

Petroleum Reserve at various times, transferring about 29 million barrels

to the Strategic Petroleum Reserve from 1999 through 2000. In addition,

MMS selectively took federal oil and gas in kind with the intent of

improving the stewardship of federal resources. Specifically, MMS took

both oil and gas in kind to evaluate whether there are additional

circumstances under which taking oil and gas in kind is in the best interest

of the federal government. The amount of oil that MMS took in kind for

these pilot purposes was small from October 1998 through September

2001. However, over the following 6 months, we estimate that the amount

may have approached 20 percent of the federal government’s royalty share

of all oil produced on federal lands. Similarly, the amount of gas that MMS

took in kind beginning in 1998 was small until 2000 and has averaged

about 10 percent of the federal government’s royalty share of all gas

produced on federal lands from January 2000 through September 2001.

Results in Brief
Page 3 GAO-03-296 Mineral Revenues

MMS personnel have made progress in implementing some components of

management control, such as mitigating the risks associated with the sale

of oil and gas and developing written procedures. However, MMS does not

plan to complete and implement all management controls until 2004, when

it will consider the Royalty-in-Kind pilots to have changed from a pilot

stage to a fully operational stage and when it will have acquired additional

systems support. To date, MMS has not developed clear strategic

objectives linked to statutory requirements or collected the necessary

information to effectively monitor and evaluate the Royalty-in-Kind

Program. Without clear objectives linked to statutory requirements and the

collection of necessary information, MMS cannot systematically evaluate

to what extent Royalty-in-Kind sales should continue.

We are making recommendations to improve the management of the

Royalty-in-Kind Program. These recommendations include clarifying

strategic objectives and obtaining the necessary information to more

effectively monitor and evaluate the Royalty-in-Kind Program. We

provided the Department of the Interior with a draft of this report for

comment.

In fiscal year 2001, the latest period for which data are available, the

Minerals Management Service reported that it collected about $5.2 billion

in gas royalties and about $2.3 billion in oil royalties. There are more than

20,000 producing federal leases located in the continental United States

and Alaska and more than 2,000 producing federal leases in the waters off

the shores of the United States. Despite the larger number of onshore

leases, offshore leases (most of which are in the Gulf of Mexico) account

for 81 percent of all federal oil and gas royalty payments. In general,

royalty rates for onshore leases are 12-1/2 percent of the value of the oil

and gas produced, whereas royalty rates for most offshore leases are 16-

2/3 percent. The government generally distributes about half of the royalty

payments collected onshore back to the states in which the leases are

located. The government also shares with the coastal states a smaller

portion of the royalty payments collected from offshore leases located

within 3 miles of the coast, known as the 8(g) zone. However, the

government does not share royalties from offshore leases beyond the 8(g)

zone, where the majority of offshore oil and gas is produced.

The collecting, reporting, and auditing of cash royalty payments have been

challenging for MMS. MMS relies upon royalty payors to self-report the

amount of oil and gas they produce, the value of this oil and gas, and the

cost of transportation and processing that they deduct from royalty

Background
Page 4 GAO-03-296 Mineral Revenues

payments. There are concerns about the accuracy and reliability of these

data. Although MMS is responsible for auditing these data, with more than

22,000 producing leases and often several companies paying royalties on

each lease each month, the auditing becomes a formidable task. In

addition, there has been considerable disagreement between industry and

MMS over the value of the oil and gas produced and the cost of

transportation and processing deductions, leading to time-consuming and

costly appeals and litigation.

While most companies that lease federal lands pay their royalties in cash,

the federal government can instead take a portion of the oil and gas that

these companies produce—known as “taking royalties in kind.” The

Congress authorized royalties in kind under the Mineral Leasing Act of

1920 and under the Outer Continental Shelf Lands Act of 1953. Standard

leases for the exploration of oil and gas on federal properties reserve the

right for the federal government to take its royalties in kind.

The Federal Managers’ Financial Integrity Act of 1982 directed federal

agencies to develop management control for safeguarding resources and

required GAO to prescribe standards for agencies to follow in establishing

management control. 1 Management control plays a significant role in

helping managers achieve strategic and annual performance goals that are

required under the Government Performance and Results Act of 1993.

Management control consists of several components: (1) an environment

that sets a positive and supportive attitude toward management control

and conscientious management (control environment); (2) an assessment

of the risks that an organization faces from both external and internal

sources (risk assessment); (3) procedures, techniques, and mechanisms

that enforce management’s directives (management control activities); (4)

recording and communicating information to management and to others

that need it within the organization (information and communication); and

(5) monitoring the quality of performance over time (monitoring).

 1

 Management control is synonymous with internal control, which is the term used in the

Federal Managers’ Financial Integrity Act of 1982. The standards that GAO were required

to establish under the act appear within the report entitled Standards for Internal Control

in the Federal Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: November 1999).
Page 5 GAO-03-296 Mineral Revenues

From January 1995 through September 2001, MMS took 178 million barrels

of oil and 213 billion cubic feet of gas in kind primarily for three purposes:

(1) to provide small refiners with a stable source of crude oil, (2) to fill the

Strategic Petroleum Reserve (SPR), and (3) to study alternatives to the

traditional system of cash royalty payments.2

 MMS sold the majority of the

oil that it took in kind to small refineries under the Small Refiners

Program—a long-standing program designed to assist small refiners that

are having difficulty obtaining an adequate supply of crude oil. MMS also

transferred substantial quantities of federal royalty oil to the SPR as a

safeguard against disruptions in the nation’s supply of crude oil. MMS

takes lesser quantities of oil and gas in kind under a series of pilot sales in

Wyoming and the Gulf of Mexico to study alternatives to the traditional

system of cash royalty payments. In doing so, MMS has been testing

whether it can improve the administrative efficiency of royalty collections

and whether it can sell the federal royalty oil and gas for at least as much

as it would have collected from traditional cash royalty payments.

From January 1995 through September 2001, MMS sold to small refiners

about 143 million barrels of oil, or about 25 percent of the federal

government’s royalty share of all oil produced on federal lands during this

time period. The amounts of oil taken in kind each year for small refiners

have ranged from about 10 to 40 percent of the total federal royalty oil, as

shown in figure 1. These amounts were worth from $138 million to $588

million, as shown in figure 2.3

 The majority of federal royalty oil sold to

small refiners since 1995 was produced in the Gulf of Mexico. Other

purposes for which MMS took oil in kind, such as for the Wyoming and

Gulf pilots and the SPR, are also shown in figures 1 and 2.

 2

 For the purpose of this report, 1 cubic foot of gas has a heating value of 1,000 British

thermal units. When MMS reported federal royalty gas as having a heating value greater

than 1,000 British thermal units per cubic foot, we adjusted the volume to compensate for

this difference.

3

 MMS personnel within the RIK Program supplied data on revenues collected from the sale

of oil taken in kind from January 1995 through July 2002. However, MMS personnel were

unable to supply data on total federal oil royalty revenues (from both RIK sales and cash

royalty payments) or the total amount of oil produced on federal lands that were more

current than September 2001. They attributed their inability to obtain these data, in part, on

a court-ordered shutdown of the system that lasted from December 2001 through March

2002.

MMS Has Taken

Increasing Amounts

of Royalties in Kind

Since 1995 to Meet

Several Objectives

MMS Takes Oil in

Kind and Sells It to

Small Refiners
Page 6 GAO-03-296 Mineral Revenues

Figure 1: Estimated Percentage of Federal Royalty Oil Taken in Kind by Purpose,

Calendar Years 1995 through 2000 and January through September 2001
Page 7 GAO-03-296 Mineral Revenues

Figure 2: Estimated Value of Federal Royalty Oil Taken in Kind by Purpose,

Calendar Years 1995 through 2001 and January through July 2002

Under the Mineral Leasing Act, as amended by P.L. 79-506, if the Secretary

of the Interior determines that there are insufficient supplies of crude oil

available on the open market to refiners that do not have their own supply,

the Secretary is required to give preference to these small refiners in

selling federal royalty oil. Accordingly, the Secretary provides small

refiners with a stable source of crude oil at equitable prices so that these

small refiners can compete in areas dominated by integrated oil companies

and large refiners. Although the Secretary has long held this authority, the

Secretary conducted few sales prior to 1970 because of little interest from

small refiners. The Secretary delegated the responsibility to administer

small refiner sales to MMS shortly after its formation in 1982. After MMS

assesses small refiners’ needs for crude oil, MMS identifies federal royalty

oil to meet these needs, and then conducts sales. Often, more than one

small refiner wanted to purchase the same oil, so MMS in recent years

conducted a lottery to determine the purchaser.
Page 8 GAO-03-296 Mineral Revenues

Prior to 2000, MMS relied upon the producer of the oil to report its sales

value and subsequently billed the small refiner this amount plus an

administrative fee to cover the costs of running the program. After billing

the small refiners, however, MMS determined that the producers had

understated the value of the oil, so MMS sent additional bills to the small

refiners. These bills often surprised the small refiners, and in some cases,

large bills threatened their financial solvency. Because small refiners were

dropping out of the program owing to the uncertainty over the value of the

oil, MMS changed its small refiner sales in 2000 from lottery-based sales to

competitive auction-based sales. The bidders and MMS now agree to the

price before receiving the oil, just as they do in sales of other federal

royalty oil.

The Congress established the Strategic Petroleum Reserve to provide

emergency oil in the event of a disruption in petroleum supplies. The SPR

consists of a series of underground salt caverns along the coastline of the

Gulf of Mexico that can store up to 700 million barrels of oil. It is managed

and maintained by the Department of Energy (DOE). Largely to reduce the

federal deficit, the federal government withdrew and sold oil from the SPR

in fiscal years 1996 and 1997.

To replace the amounts withdrawn from the SPR, MMS assisted with the

transfer of about 29 million barrels of federal royalty oil from the Gulf of

Mexico to DOE in 1999 and 2000. This amount represented about 17

percent of the federal government’s royalty share of all oil produced on

federal lands in each of these 2 years, as shown in figure 1. By filling the

SPR, the federal government had forgone the receipt of royalty revenues

that it would have otherwise collected in cash. The Office of Management

and Budget in February 1999 estimated that the total cost of filling the SPR

would be $370 million, but oil prices rose since then, and the total cost

was probably higher. Refilling stopped in December 2000 but commenced

again in April 2002 under presidential directive and is expected to continue

into 2005. From April through July 2002, MMS assisted in transferring to

DOE about 7.5 million barrels of oil, worth about $169 million. MMS plans

to increase deliveries to DOE from 63,000 barrels per day in July 2002 to

about 130,000 barrels per day in 2003.

MMS Takes Oil in

Kind to Fill the

Strategic Petroleum

Reserve
Page 9 GAO-03-296 Mineral Revenues

MMS began studying the use of federal royalty oil as an alternative to cash

royalty payments through a series of pilot sales in Wyoming. Through nine

consecutive sales that began in October 1998, MMS and the state of

Wyoming collectively sold federal and state royalty oil.4

 In doing so, MMS

acquired information on how to group properties for sale and how to

establish a price basis for bidding. Although the federal portion of these

volumes far exceeded the state portion, we estimate that the federal oil

that MMS sold during the 3-year period from October 1998 through

September 2001 accounted for about 1 percent of the federal government’s

royalty share of all oil produced on federal lands. MMS expanded its study

of royalty oil to the Gulf of Mexico with two competitive sales, the first of

which delivered oil to purchasers starting in November 2000. Unlike the

pilots in Wyoming, the amount of federal royalty oil that MMS sold in the

Gulf of Mexico reached significant quantities during the second pilot

sale—about 32 times the amount of oil sold in Wyoming during the same 6-

month period. We estimate that the federal royalty oil that MMS sold

during this second sale, which commenced in October 2001 and ended in

March 2002, might have accounted for about 20 percent of the federal

government’s royalty share of all oil produced on federal lands during the

term of the sale.

MMS first began studying the taking of gas in kind by conducting a gas

pilot in 1995. This pilot assessed the administrative efficiency and revenue

impacts of taking gas in kind relative to cash royalty payments. MMS

accepted about 6 percent of the federal royalty gas in the Gulf of Mexico

and sold it through auctions for about $72.6 million. Although this pilot

showed that MMS could execute the sale of royalty gas, MMS estimated

that these sales resulted in about 6 percent less revenue than MMS would

have received in cash royalty payments, or more than a $4 million loss.

MMS attributed this loss primarily to unforeseen problems in securing

transportation of the gas through pipelines and to industry’s volunteering

the royalty gas for sale, rather than to MMS’s selecting this gas. MMS

continued studying RIK and issued a report in 1997 that concluded that

RIK sales could be administratively more efficient and could generate at

least as much revenue as traditional cash royalty payments. MMS began

testing these conclusions with a series of pilot sales in the Gulf of Mexico

that began in December 1998. The gas that MMS sold during these pilot

 4

 In these sales, MMS and the state of Wyoming sold oil from specified properties for 6-

month periods. The buyer would receive the federal and state royalty share of oil from

those properties for a period of 6 months following the sale. Wyoming participated in all

but the first sale.

MMS Is Studying the

Increased Use of

Royalties in Kind
Page 10 GAO-03-296 Mineral Revenues

sales averaged about 10 percent of the federal government’s royalty share

of all gas produced on federal lands from January 2000 through September

2001, as shown in figure 3. The annual revenues that MMS reported

collecting from the sale of this federal royalty gas are illustrated in figure

4.5

 MMS studied various methods of selling this royalty gas, including

negotiating the sales price, paying gas marketers to aggregate smaller

volumes of gas into larger volumes, and auctioning the gas. As a result of

these pilot studies, MMS decided to sell federal royalty gas through

auctions open to all buyers meeting minimum standards of credit

worthiness.6

 5

 MMS personnel within the RIK Program supplied data on revenues collected from the sale

of gas taken in kind from January 1995 through July 2002. However, MMS personnel were

unable to supply data on total federal gas royalty revenues (from both RIK sales and cash

royalty payments) or the total amount of gas produced on federal lands that were more

current than September 2001. They attributed their inability to obtain these data, in part, on

a court-ordered shutdown of the system that lasted from December 2001 through March

2002.

6

 In these auctions, MMS sells gas from selected properties for specified periods of time.

The buyer receives the federal royalty share of gas for a period of 5, 7, or 12 months

following the sale. MMS initially sold this gas for 1-month periods but discontinued this

process because it was administratively more efficient to conduct sales for greater periods

of time.
Page 11 GAO-03-296 Mineral Revenues

Figure 3: Estimated Percentage of Total Federal Royalty Gas Taken in Kind by

Purpose, Calendar Years 1995 through 2000 and January through September 2001

Figure 4: Revenues Reportedly Collected from the Sale of Federal Royalty Gas

Taken in Kind, Calendar Years 1995 through 2001 and January through July 2002
Page 12 GAO-03-296 Mineral Revenues

Management control is a necessary safeguard to protect against the risks

of fraud, waste, abuse, and mismanagement. MMS has made progress in

establishing some components of management control over its RIK

Program, such as (1) identifying and mitigating the risks associated with

oil and gas sales and (2) developing written procedures for these sales and

for collecting and reporting revenues. However, MMS has yet to develop

several key management control activities and does not plan to develop

them until 2004, when it will consider the RIK Program to have changed

from a pilot status to a fully operational status. Specifically, MMS has not

clearly defined its strategic objectives, linked performance measures to

these objectives, and collected the necessary information to monitor and

evaluate the RIK Program.

The Federal Managers’ Financial Integrity Act of 1982 directs federal

agencies to develop management control for safeguarding resources

against the risks of fraud, waste, abuse, and mismanagement. Management

control is critical to ensure that revenues and expenditures from agency

operations are recorded and accounted for properly and that financial and

statistical reports are reliable. The act also directs us to issue standards

for management control within the federal government. These standards

provide broad criteria for agencies to use, in conjunction with guidance

issued by the Office of Management and Budget. Management control

includes (1) developing strategic objectives, (2) linking performance

measures to these objectives, (3) collecting the necessary information to

monitor and evaluate performance, (4) identifying and mitigating risks,

and (5) developing written procedures and documenting compliance with

these procedures.

Management control also plays an important role in helping managers

comply with the Government Performance and Results Act of 1993

(Results Act), which requires federal agencies to establish strategic goals,

measure performance, and report on accomplishments. The Results Act

shifts the focus of federal agencies away from traditional concerns, such

as staffing and reporting on activities, toward achieving results. There is

no more important element in results-oriented management than an

agency’s strategic-planning process, and establishing formal strategic

objectives can help clarify what the agency seeks to accomplish and can

help unify the agency’s staff in achieving its goals.

MMS Has Established

Some Management

Control over Its RIK

Program, but

Additional Efforts Are

Needed

Management Control Is a

Necessary Safeguard
Page 13 GAO-03-296 Mineral Revenues

MMS has begun to establish management control over its RIK Program by

addressing the risk that oil and gas sales will be unsuccessful, addressing

inherent risks associated with the sale of oil and gas, and developing

written procedures for various activities within the Royalty-in-Kind

Program. These activities include conducting RIK sales, collecting

revenues, and reporting on revenues. MMS also has made progress in

documenting the results of its RIK sales.

MMS has addressed the risk that RIK sales will be unsuccessful by

ensuring that prior to these sales, certain conditions exist for the

properties from which MMS will sell royalty oil and gas. In 1998, we

identified the conditions necessary for successful oil and gas sales by

surveying state governments, universities, and the Province of Alberta,

which, at various times, had programs that took oil and gas in kind.7

 We

identified several conditions that made these programs feasible. In

particular, these programs seemed successful if these entities had (1)

relatively easy access to pipelines, (2) properties that produce relatively

large volumes of oil or gas, (3) favorable arrangements for processing gas,

and (4) expertise in marketing oil and gas. MMS has considered these

conditions in addressing risk. Specifically, MMS’s practice of negotiating

the cost of transporting gas through pipelines helps to secure relatively

easy access to pipelines. Similarly, MMS’s practice of grouping the

properties that produce royalty oil or gas according to the pipelines to

which they are connected helps ensure that properties produce relatively

large volumes of oil or gas. MMS has also arranged for the processing of

natural gas and has increased its knowledge of oil and gas marketing by

hiring consultants and interviewing oil and gas marketers and

representatives of pipeline companies in Wyoming and the Gulf Coast.

MMS has also developed procedures to manage the inherent risks, or

uncertainties, in the selling of oil and gas. Such risks include fluctuating oil

and gas prices, the varying amount of oil and gas that wells produce, and

the credit worthiness of purchasers. To manage the risk associated with

fluctuating prices, for example, MMS does not try to maximize revenues by

guessing which way the market will move but, instead, accepts bids

relative to the fluctuating market prices. Thus, MMS avoids substantial

losses that could result from wrong guesses. MMS also manages the risk

due to the inability of properties to deliver consistent quantities of gas,

 7

 See Federal Oil Valuation: Efforts to Revise Regulations and an Analysis of Royalties

in Kind, GAO/RCED-98-242 (Washington, D.C.: Aug. 19, 1998).

MMS Has Begun to

Establish Management

Control
Page 14 GAO-03-296 Mineral Revenues

which could require that MMS purchase or supply more costly alternative

gas in the event of a shortfall. MMS manages this risk by guaranteeing that

it will deliver only a portion of the gas (base volume) at a stable price and

offering the other portion (swing volume), without guarantee, at published

prices that vary daily. MMS has also developed procedures to monitor the

credit worthiness of oil and gas purchasers and can terminate their sales

contract or demand additional credit guarantees, if necessary. These

procedures led MMS to promptly cancel its contract with Enron, thereby

limiting losses to 1 month’s worth of gas production from the Enron

contract.

MMS has developed written procedures for conducting RIK sales

activities, collecting revenues from these sales, and reporting on these

revenues. Sales activities include identifying properties from which to take

oil and gas in kind, announcing the oil and gas for sale, determining a

minimum acceptable bid, analyzing bids, and awarding contracts. We

examined documents for sales that MMS conducted from October 1998

through October 2002 and found documentation of these activities in all

sales in which they were appropriate. However, we did not determine the

adequacy of MMS’s procedures for collecting and reporting on revenues,

nor did we assess the degree to which MMS complied with these

procedures.8

MMS developed the following seven strategic objectives for the RIK

Program:

• Implement RIK where applicable and when it is an improvement over

traditional cash royalty payments (royalty in value).

• Leverage MMS’s position as an asset holder.

• Take advantage of potential interagency synergies.

• Minimize the cost of royalty administration.

• Reduce business cycle time (the time to collect, disburse, audit, and

reconcile revenues).

 8

 The Department of the Interior’s Inspector General recently reported a problem in

collecting all revenues due from the sale of royalty gas. MMS had not resolved in a

reasonable time frame the commonly occurring discrepancies between amounts paid and

owed due to uncertainties in the gas volumes delivered (referred to as “gas imbalances”).

See Department of the Interior, Office of Inspector General, Evaluation of Vulnerabilities

to Underreporting: Royalty-in-Value versus Royalty-in-Kind, Report No. 2002-I-0044

(Washington, D.C.: August 2002).

MMS Has Not Developed

Clear Objectives and

Linked Performance

Measures to These

Objectives
Page 15 GAO-03-296 Mineral Revenues

• Accelerate timing of revenue collections.

• Adopt energy industry business practices and controls wherever

feasible.

Overall, none of the seven objectives address the revenue impacts of the

RIK sales. The seven objectives do not address requirements in the law

that MMS (1) collect at least as much revenue from the RIK pilots as it

would have from traditional cash royalty payments and (2) obtain fair

market value. The Congress directed MMS in the fiscal years 2001 and

2002 Appropriations Acts for Interior and Related Agencies to collect at

least as much revenue from the sale of royalties in kind as MMS would

have collected from traditional cash royalty payments. Moreover, the

Congress had previously directed the Secretary of the Interior in the

Mineral Leasing Act of 1920 and the Outer Continental Shelf Lands Act of

1953 to obtain fair market value for oil and gas taken in kind.9

 The

Congress defined “fair market value” in the Outer Continental Shelf Lands

Act as the average unit price for the mineral sold either from the same

lease or, if such sales did not occur, in the same geographic area.

Furthermore, the first three objectives are not expressed in either a

quantitative or measurable form. The last four objectives, although being

quantitative, address administrative efficiency only. Without objectives to

guide agency staff in the quantitative evaluation of the revenue impacts of

RIK sales, MMS will be unable to determine whether RIK sales generate

more or less revenue than traditional cash royalty payments; whether

MMS obtains fair market value; and hence, whether it should convert the

RIK pilots to an operational status.

MMS has also not developed any performance measures that it linked to

the seven strategic objectives for its RIK Program. However, MMS has

developed two performance measures—(1) confirm and reconcile, within

90 days, all production royalties taken in kind and (2) accelerate the timing

of revenue receipt by 5 days over traditional cash royalty payments

(royalty in value)—that are linked to the broader agency-wide objective of

“collecting royalties in the shortest time possible.” In addition to

supporting the broad agency-wide objective, these two performance

measures support RIK Program objectives that are designed to improve

 9

 The Mineral Leasing Act uses the term “market price” not “fair market value,” and the

requirement to obtain market price does not cover competitive sales, which, by their very

nature, provide some protection to the federal government.
Page 16 GAO-03-296 Mineral Revenues

administrative efficiency. MMS officials told us that they intend to develop

performance measures that are specific to the RIK Program in 2004, when

the RIK Program changes from the pilot status to a fully operational status

and they acquire and fully implement new information systems that can

better measure performance.

After 5 years of conducting pilot programs and completing 24 oil and gas

pilot sales, MMS’s ability to effectively and efficiently monitor and

evaluate its RIK Program is limited because it has not obtained the

necessary information to do so. This information includes the

administrative costs of the RIK Program, the savings from avoiding

potential litigation and appeals, the savings in auditing properties, and the

revenue impacts of all sales. MMS lacks information largely because it has

not developed an information systems infrastructure to rapidly and

efficiently collect this information. Without quantitative costs, savings, and

revenue information, MMS is unable to determine the program’s overall

cost and effectiveness, whether RIK generates at least as much revenue as

traditional cash royalty payments, and whether the RIK Program should be

expanded or contracted.

MMS has not quantified the costs of administering the RIK Program. Such

costs, which MMS incurs when selling RIK but does not incur when

collecting traditional cash royalty payments, result from identifying

properties from which to sell oil and gas, calculating minimum acceptable

bids, analyzing bids, awarding and monitoring contracts, billing

purchasers, negotiating transportation rates, reconciling discrepancies in

volume, and comparing RIK revenues with traditional cash royalty

payments. MMS has not quantified these costs because its current

personnel, payroll, and budgeting systems do not capture data in sufficient

detail. Although MMS tracks employees’ time charges with these systems,

MMS does not distinguish between time charges that support only the RIK

Program and time charges that support both the RIK Program and the

traditional system of collecting cash royalties. Similarly, MMS has not

decided how to assign the cost of MMS’s financial system and other

significant overhead costs to the RIK Program and to the traditional cash

royalty system. MMS officials told us, however, that they plan to

implement an activity-based cost-accounting system in fiscal year 2003

that will assist in resolving these issues.

MMS also has not quantified anticipated savings from avoiding potential

appeals and litigation by selling oil and gas in kind. MMS officials

MMS Has Not Obtained the

Necessary Information to

Monitor and Evaluate the

RIK Program

MMS Has Not Quantified

Anticipated Costs and

Savings from

Implementing the RIK

Program
Page 17 GAO-03-296 Mineral Revenues

explained that MMS anticipates that it can avoid substantial costs

associated with appeals and litigation involving primarily the valuation of

natural gas and the transportation of both oil and gas. MMS officials have

not estimated the costs of appeals because of problems with implementing

the information system that tracks these costs and because of their

uncertainty that these costs are recorded in a consistent manner. In

addition, the Office of the Solicitor within the Department of the Interior,

which is responsible for litigation concerning MMS’s activities, does not

have an automated system to track litigation costs.

Although MMS anticipates that the cost of auditing revenues will decrease

because of taking RIK, MMS has not quantified these savings. MMS

anticipates substantial savings because verifying the value of oil and gas is

much easier when taking RIK because the purchaser and MMS agree to the

sales price before the sale occurs. Similarly, when MMS negotiates

transportation costs itself, it knows the exact transportation rate that

companies can charge MMS, unlike when companies pay royalties in cash.

In addition, MMS does not need to audit transportation costs when MMS

sells royalty oil or gas at the location of the lease because there are no

transportation costs, since the buyer assumes the responsibility for

transportation. Although MMS has projected decreases in the number of

staff auditors as a result of future RIK sales, MMS has not finalized these

estimated savings because MMS is uncertain of how much oil and gas it

will take in kind in the future. MMS officials also question the reliability of

the time that auditors have charged to the RIK Program in the past—

information that formed the baseline for their projections.

MMS also has not fully quantified the revenue impacts of all the royalty oil

and gas that it sold, preventing a comprehensive comparison between RIK

sales revenues and the revenues that MMS would have received under the

traditional cash royalty system. MMS does analyze factors that affect the

revenues of upcoming RIK sales, including current oil and gas prices;

anticipated market conditions; and transportation and processing, if

applicable. However, MMS does not systematically compare RIK sales

revenues with what it would have received in traditional cash royalties

after these gas sales are completed. Of the 15.8 million barrels of federal

royalty oil sold in pilot sales from October 1998 through July 2002, MMS

quantified the revenue impacts of about 9 percent. Of the approximately

241 billion cubic feet of federal royalty gas that MMS sold from December

1998 through March 2002, we estimate that MMS quantified, either in

whole or in part, the revenue impacts resulting from the sale of about 44

percent of this gas. Although MMS analyzed revenue impacts from 44

MMS Has Not Fully

Determined the Revenue

Impacts of RIK Sales
Page 18 GAO-03-296 Mineral Revenues

percent of the federal royalty gas it sold, almost none of this analysis was

done in a timely manner, thereby precluding the use of this information to

improve or modify subsequent sales. For example, MMS did not complete

the evaluation of the gas that it sold competitively each month over a 19-

month period until after it had discontinued selling gas in this manner.

Similarly, MMS did not evaluate the revenue impacts of using a gas

marketer to aggregate gas volumes until 1 year after it terminated these

sales. If MMS had evaluated these aggregated sales earlier, it might have

discontinued this method of selling royalty gas because it would have

confirmed employees’ suspicions during the initial sale that the manner in

which gas was being sold was disadvantageous to MMS. Instead, MMS let

another three contracts with similar terms, resulting in an overpayment of

almost $3 million on transportation valued at about $13 million.

MMS’s information systems hinder the timely monitoring and evaluation of

the RIK Program and the evaluation of the revenue impacts from

individual sales. The RIK Program’s current system for managing RIK sales

revenues consists of a series of unlinked computer spreadsheets into

which personnel manually enter RIK data. Such a manual system is prone

to errors, which could lead to inaccurate information. Prior to September

2002, RIK Program personnel did not compile basic monthly reports on

revenues collected and royalty volumes sold, which could have been used

to monitor the RIK Program on a periodic basis. Also, limitations of MMS’s

agency-wide financial system—the system that generates agency-wide

accounting reports and maintains and manages all royalty data—currently

hamper the timely comparison of RIK sales revenues with cash royalty

payments. MMS personnel were unable to use the financial system to

produce summary data that were more current than 1-year old. As of

October 2002, for example, MMS personnel were unable to use the

financial system to determine how much total revenue MMS collected and

how much oil and gas had been produced from federal lands since

September 2001. MMS personnel also said that because of missing or

erroneous data in the agency-wide financial system, data extracted from

this system cannot be used in revenue comparisons without timeconsuming checks for accuracy and reasonableness. Furthermore, it will

be more difficult to use RIK gas data in this system to calculate revenue

impacts because MMS personnel do not enter these data at the lease

level.10 Lastly, RIK Program personnel said that because they have to

 10 When sales involve the federal offshore leases whose royalties must be shared with

adjacent states, MMS officials said that they record the transactions for each lease

separately. This facilitates the disbursement of royalty revenue to the adjacent states.
Page 19 GAO-03-296 Mineral Revenues

manually acquire data to evaluate federal properties for prospective sales,

the growth of the RIK Program has slowed.

MMS officials also said that they have not evaluated the revenue impacts

from the sales of all royalty oil and gas largely because they have delayed

the development of performance measures for the RIK Program until 2004.

These performance measures will incorporate benchmarks against which

to compare RIK sales revenues. MMS personnel said that MMS has

generally encountered difficulty in establishing benchmarks against which

to measure the revenue impacts of RIK oil and gas sales because once it

takes all federal royalty oil or gas in kind in a specific area, it no longer

receives any traditional cash royalty payments for comparison. However,

MMS officials explained that by 2004, MMS expects to acquire and fully

implement two additional information systems dedicated to the RIK

Program that will automate the acquisition of necessary information for

attempting revenue comparisons. MMS personnel said that they had not

acquired these automated systems earlier because they believed that they

first needed to process a large number of transactions and sell a large

volume of oil and gas before they could justify the expense of acquiring

these systems.

MMS has begun to establish management control over its RIK Program. It

has initiated positive steps to address the risks that affect its oil and gas

sales and has developed written procedures for various activities within

the RIK Program. MMS has also made progress in documenting the results

of its RIK sales. However, MMS has not established clear objectives for the

program that are linked to statutory requirements. MMS’s current

objectives for its RIK Program are not clearly linked to requirements in the

law that MMS (1) collect at least as much during pilot sales as it would

have collected in cash royalty payments and (2) obtain fair market value.

In addition to the lack of objectives linked to statutory requirements, MMS

is not systematically collecting the necessary information to monitor and

evaluate the RIK program. Such information includes the administrative

costs of the RIK program, anticipated savings from reductions in audit

efforts and from avoiding appeals and litigation, and the revenue impacts

of all sales. Without clear objectives and the systematic collection of

evaluative information, MMS cannot assess and ultimately determine

whether it should expand or contract the use of royalty in kind sales.

Conclusions
Page 20 GAO-03-296 Mineral Revenues

To continue the further development of management control for the

Minerals Management Service’s Royalty-in-Kind Program, we recommend

that the Secretary of the Interior instruct the appropriate managers within

the Minerals Management Service to do the following:

• Clarify the Royalty-in-Kind Program’s strategic objectives to explicitly

state that goals of the Royalty-in-Kind pilots include obtaining fair

market value and collecting at least as much revenue as MMS would

have collected in cash royalty payments.

• Prior to expanding the Royalty-in-Kind Program, identify and acquire

key information needed to monitor and evaluate performance. Such

information, as identified by the Minerals Management Service, should

include the revenue impacts of all Royalty-in-Kind sales, administrative

costs of the Royalty-in-Kind Program, estimates of savings in avoiding

potential litigation, and expected savings in auditing revenues.

We provided the Department of the Interior with a draft of this report for

review and comment. Interior fundamentally agreed with our observations

and recommendations and emphasized MMS’s future plans for improving

management control over the RIK Program. Where appropriate, we have

included additional references to the activities that Interior mentions in its

comments. Interior’s comments and our response to these comments are

reproduced in appendix I.

In reviewing MMS’s RIK Program, we reviewed congressional directives in

pertinent legislation; standards for the development of management

control issued by us and the Office of Management and Budget; and prior

reports and documentation on the Small Refiners Program, Strategic

Petroleum Reserve, and RIK pilots. We also obtained statistical

information from MMS on oil and gas volumes taken in kind and the

revenue that MMS generated by selling these volumes. In addition, we

reviewed documentation pertaining to management control and

interviewed MMS personnel about their efforts to establish management

control over the RIK Program.

We conducted our work from January to November 2002 in accordance

with generally accepted government auditing standards. For a more

detailed discussion of the scope and methodology of our review, see

appendix II.

Recommendations for

Executive Action

Agency Comments

and Our Evaluation

Scope and

Methodology
Page 21 GAO-03-296 Mineral Revenues

As agreed with your offices, unless you publicly announce its contents

earlier, we plan no further distribution of this report until 7 days from the

date of this letter. At that time, we will send copies of this report to the

Secretary of the Interior; the Director, Office of Management and Budget;

and other interested parties. We will also make copies available to others

upon request. This report will be available at no charge on GAO’s Web site

at http://www.gao.gov.

If you have any questions about this report, please call Mark Gaffigan or

me at (202) 512-3841. Key contributors to this report are listed in appendix

III.

Jim Wells

Director, Natural Resources

 and Environment
Appendix I: Comments from the Department

of the Interior

Page 22 GAO-03-296 Mineral Revenues

Appendix I: Comments from the Department

of the Interior

Note: GAO’s comments

supplementing those in

the report’s text appear at

the end of this appendix.
Appendix I: Comments from the Department

of the Interior

Page 23 GAO-03-296 Mineral Revenues
Appendix I: Comments from the Department

of the Interior

Page 24 GAO-03-296 Mineral Revenues
Appendix I: Comments from the Department

of the Interior

Page 25 GAO-03-296 Mineral Revenues

See comment 1.

Note: Page numbers in

the draft report may differ

from those in the report.

See comment 1.

See comment 1.
Appendix I: Comments from the Department

of the Interior

Page 26 GAO-03-296 Mineral Revenues

See comment 1.

See comment 3.

See comment 1.

See comment 1.

See comment 2.
Appendix I: Comments from the Department

of the Interior

Page 27 GAO-03-296 Mineral Revenues

See comment 1.

See comment 1.

See comment 1.
Appendix I: Comments from the Department

of the Interior

Page 28 GAO-03-296 Mineral Revenues

See comment 5.

See comment 4.
Appendix I: Comments from the Department

of the Interior

Page 29 GAO-03-296 Mineral Revenues

See comment 5.
Appendix I: Comments from the Department

of the Interior

Page 30 GAO-03-296 Mineral Revenues
Appendix I: Comments from the Department

of the Interior

Page 31 GAO-03-296 Mineral Revenues

See comment 5.
Appendix I: Comments from the Department

of the Interior

Page 32 GAO-03-296 Mineral Revenues

See comment 7.

See comment 7.

See comment 6.
Appendix I: Comments from the Department

of the Interior

Page 33 GAO-03-296 Mineral Revenues

The following are GAO’s comments on the Department of the Interior’s

letter dated December 13, 2002.

1. We clarified our report to reflect these comments.

2. We acknowledge that the Mineral’s Management Service’s (MMS)

difficulties in obtaining royalty data from its financial system may be due,

in part, to the court-ordered shutdown of this financial system in

December 2001. However, 9 months had passed since operation of the

financial system was restored on March 23, 2002. Additionally, MMS

personnel said that the statistical subsystem designed to generate routine

summary data that we requested for October 2001 through July 2002 had

not yet been deployed and was not expected to be deployed until April

2003 at the earliest.

3. We expressed Royalty-in-Kind (RIK) volumes as a percentage of total

federal royalty oil and gas volumes to show the overall significance of

taking royalties in kind compared with receiving cash royalty payments.

Using percentages also made it easier to show that large percentages of oil

were taken in kind for the Strategic Petroleum Reserve (SPR) and for the

Small Refiners Program relative to the small percentages taken for pilot

purposes. In expressing RIK volumes as percentages, we used actual RIK

sales volumes supplied by MMS but had to estimate the total federal

royalty volumes because MMS does not maintain these data.

4. In this report, we state that MMS’s strategic objectives do not address

the requirements in the law because nowhere in the seven strategic

objectives is there reference to the terms “fair market value” or “collecting

at least as much revenue as would have been collected in cash royalty

payments.” In its response, Interior states that it has intended to

accomplish these legislative mandates, and Interior apparently believes

that these intentions are implied by the strategic objective stating that

MMS will implement RIK “when it is an improvement over traditional cash

royalty payments.” In light of Interior’s agreeing with us that the objectives

for the RIK Program should include achieving fair market value and

collecting revenues at least equal to what MMS would have collected in

cash royalty payments, we continue to recommend that MMS clarify the

language in its strategic objectives to reflect these intentions.

5. We acknowledge that MMS performs substantial analysis prior to

converting leases from traditional cash royalty status to RIK. For oil sales,

MMS generally calculated a minimum acceptable bid that bidders had to

exceed before MMS made an award. For gas sales, MMS relied upon gas

GAO’s Comments
Appendix I: Comments from the Department

of the Interior

Page 34 GAO-03-296 Mineral Revenues

indexes to assess bids. While relying on minimum acceptable bids and gas

indexes prior to a sale is a first step in ensuring that RIK revenues will

equal or exceed cash royalty payments, MMS cannot determine actual

revenue impacts until after the sales are completed. To effectively monitor

and evaluate the performance of the RIK pilot sales, MMS should calculate

revenue impacts in a timely manner after sales are completed and adjust

future sales on the basis of these results.

Relying on codified valuation regulations as an indicator of what MMS

would have collected in cash royalty payments is not as straightforward as

Interior implies, and the application of valuation regulations is often a

source of dispute between MMS and industry. For example, MMS often

does not know which provision of the valuation regulations will apply to

future royalty collections from a given lease until after the sale. Also,

MMS’s market analyses suggests that many of the provisions for valuing oil

and gas sold to affiliated companies may no longer reflect the manner in

which many companies buy and sell oil and gas today. To compensate for

these uncertainties, MMS must use considerable judgment in estimating

revenue impacts prior to RIK sales.

While MMS has evaluated the revenue impacts after some completed sales,

MMS has not evaluated the revenue impacts of all sales. We point out in

this report that MMS evaluated the revenue impacts, either in whole or in

part, of about 9 percent of the oil sold in kind and about 44 percent of the

gas sold in kind. With regards to the Wyoming oil pilots and the Texas 8(g)

gas pilots that Interior mentions in commenting on this report, MMS

evaluated and published the results of 3 of the 8 completed pilot sales in

Wyoming and 19 of the 29 monthly Texas 8(g) sales. Furthermore, only a

few of MMS’s analyses were done in a timely manner, precluding MMS

from using this information to modify subsequent sales. For example,

MMS did not analyze the revenue impacts of the Texas 8(g) monthly sales

or its aggregated gas sales until after it had discontinued selling gas by

these methods. However, we encourage MMS to analyze the revenue

impacts of its Gulf of Mexico oil pilots despite these sales’ current

suspension because the oil from these properties is being transferred to

the SPR. The results of such a study could be useful, should MMS continue

the Gulf of Mexico oil pilots in the future.

6. MMS supplied us with the estimated loss of about $3 million on the

aggregation contracts. We calculated that transportation was worth about

$13 million on the basis of transportation costs and volumes supplied by

MMS. MMS reported that the total value of royalty payments on the

aggregated gas was about $363 million.
Appendix I: Comments from the Department

of the Interior

Page 35 GAO-03-296 Mineral Revenues

7. Our assessment that MMS has difficulty obtaining royalty information

from its financial system is based largely on MMS personnel, who have

used these data to estimate the revenue impacts of RIK sales and told us

that they could not use these data without first performing timeconsuming checks for accuracy and reasonableness. At our request, these

personnel supplied us with royalty data from nine Wyoming oil properties

that we estimate accounted for about 50 percent of the oil sold during the

Wyoming pilots. Although we did not find widespread systemic problems

with this small data set, we confirmed that a small amount of missing,

incomplete, and inaccurate data, in addition to numerous modifications of

data entries by payors (adjustments), precluded using these data for

calculating revenue impacts without first inspecting these data for

accuracy and reasonableness. We confirmed that the manual inspection of

these data was time-consuming. In addition, MMS personnel told us that

RIK gas data are not entered into the system at the lease level, and we

believe this will complicate comparing RIK revenues with cash royalty

payments.
Appendix II: Objectives, Scope, and

Methodology

Page 36 GAO-03-296 Mineral Revenues

In this report, we discuss (1) the extent to which the Minerals

Management Service has taken federal royalties in kind since 1995 and the

reasons for doing so and (2) the status of MMS’s efforts to implement

management controls for its RIK program.

To determine the extent to which and the purposes for which MMS has

taken RIK since 1995, we reviewed legislative directives concerning RIK in

the Mineral Leasing Act of 1920, the Outer Continental Shelf Lands Act of

1953, and the Appropriations Acts for the Interior and Related Agencies

for fiscal years 1995 though 2002. We also reviewed presidential directives

for using federal royalty oil to fill the SPR. We reviewed prior reports and

other documentation on the Small Refiners Program, the SPR, and the RIK

pilots in Wyoming and the Gulf of Mexico. We then asked MMS personnel

to supply data on the amount and values of federal royalty oil and gas

taken in kind and of total oil and gas royalties from January 1995 through

July 2002. Although MMS personnel within the RIK Program could supply

data on RIK revenues and volumes taken in kind during this time period,

they could not supply data on total royalty revenues and the total amount

of oil and gas produced on federal lands that were more current than

September 2001. We did not review the accuracy of these figures.

To review the status of MMS’s efforts to implement management control

over its RIK Program, we reviewed the Federal Managers’ Financial

Integrity Act of 1982, the standards for management control that we issued

entitled Standards for Internal Control in the Federal Government

(GAO/AIMD-00-21.3.1, November 1999), and the implementation guidance

issued by the Office of Management and Budget in OMB Circular A-123.

We also reviewed our tool for assessing an agency’s management controls

entitled Internal Control Management and Evaluation Tool (GAO-01-

1008G, August 2001) and our guide for assessing an agency’s strategic plan

entitled Agencies’ Strategic Plans Under GPRA: Key Questions to

Facilitate Congressional Review (GAO/GGD-10.1.16, May 1997).

Standards for Internal Control in the Federal Government establishes

the criteria that agencies must meet in developing and maintaining

management control, which is not one event but a series of actions and

activities that occur throughout an agency’s operations on an ongoing

basis. Our review focused on MMS’s efforts to address risks that could

affect the RIK Program and on some management control activities that

we identified as being critical to MMS’s implementation and management

of the program. These management control activities are (1) developing

strategic objectives, (2) linking performance measures to these objectives,

(3) obtaining the necessary data for making management decisions and for

monitoring and evaluating the RIK Program, and (4) developing written

Appendix II: Objectives, Scope, and

Methodology
Appendix II: Objectives, Scope, and

Methodology

Page 37 GAO-03-296 Mineral Revenues

procedures and documenting compliance with these procedures. We

assessed MMS’s efforts to establish these management control activities

by reviewing relevant documentation and interviewing MMS personnel.

We reviewed MMS’s efforts to mitigate the risks associated with

differences in the properties that produce federal oil and gas, fluctuating

oil and gas prices, disruptions in production, and credit worthiness. In

assessing strategic objectives and linked performance measures, we

reviewed these objectives and measures for their results-orientation,

clarity, specificity, ability to be expressed quantitatively or in a measurable

form, and consistency with congressional directives. In reviewing the

availability of key data for management decisions and monitoring and

evaluating the RIK Program, we assessed the extent to which MMS had

determined the revenue impacts of all RIK sales, the administrative cost of

operating the RIK Program relative to collecting cash royalties, and the

expected savings from avoiding litigation and appeals and simplifying

auditing. We also examined whether MMS had compared revenue impacts

from each RIK sale with expected revenues from traditional cash royalty

payments or other benchmarks and assessed whether MMS had collected

monthly RIK revenues and sales volumes for monitoring purposes. In

reviewing MMS’s efforts to develop written procedures, we determined if

written procedures existed as of January 1, 2002, for conducting sales

activities, collecting revenues, and reporting on these revenues. We

determined major sales activities to be the selection of properties from

which to sell RIK, the announcement of the sale, the calculation of a

minimum acceptable bid, the evaluation of bids, and the determination of

the winning bidders. For each sale completed as of October 2002, we also

reviewed whether MMS documented these major activities. However, we

did not assess the adequacy of written procedures to collect and report on

revenues, nor did we assess MMS’s compliance with these procedures.

Because at the time of our review, MMS had not implemented an

automated system to support the RIK Program, we reviewed its current

manual system and its efforts to acquire automated systems.
Appendix III: GAO Contacts and Staff

Acknowledgments

Page 38 GAO-03-296 Mineral Revenues

Jim Wells (202) 512-3841

Mark Gaffigan (202) 512-3168

In addition to those named above, Letha Angelo, Ronald Belak, Robert

Crystal, Cynthia Norris, Frank Rusco, Dawn Shorey, Jamelyn Smith, and

Maria Vargas made key contributions to this report.

Appendix III: GAO Contacts and Staff

Acknowledgments

GAO Contacts

Acknowledgments

(360167)
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