GAO 

United States Government Accountability Office

Report to Congressional Requesters

ROYALTY-IN-KIND 

PROGRAM 

MMS Does Not 

Provide Reasonable 

Assurance It Receives 

Its Share of Gas, 

Resulting in Millions in 

Forgone Revenue 

August 2009 

GAO-09-744 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

August 2009

ROYALTY-IN-KIND PROGRAM 

MMS Does Not Provide Reasonable Assurance It 

Receives Its Share of Gas, Resulting in Millions in 

Highlights of GAO-09-744, a report to Forgone Revenue 

congressional requesters 

Companies that develop and 

produce oil and gas from federal 

lands and waters are required to 

report their production volumes 

and other data to the Department 

of the Interior’s (Interior) Minerals 

Management Service (MMS) and to 

pay royalties either in value (cash) 

or in kind (oil or gas). In fiscal year 

2008, MMS estimated that it had 

collected more than $2.4 billion in 

royalty-in-kind (RIK) gas. 

It is important that MMS ensure 

that it receives the RIK gas to 

which it is entitled. The difference 

between the RIK gas owed––MMS’s 

entitled percentage of gas––and the 

percentage it actually receives is 

referred to as a “gas imbalance.” 

GAO was asked to evaluate the 

extent to which MMS can provide 

reasonable assurance that it is 

accurately identifying and 

collecting RIK gas imbalances in a 

timely fashion. GAO analyzed MMS 

documents and data, 

documentation of industry 

standards, and interviewed MMS 

and industry officials. 

What GAO Recommends

GAO is making seven 

recommendations to the Secretary 

of the Interior to help MMS 

improve the accurate and timely 

identification and collection of RIK 

gas imbalances. In commenting on 

this report, Interior agreed with 

four of GAO’s recommendations 

and partially agreed that it should 

audit a sample of leases and 

promulgate program regulations. 

Interior did not agree that daily gas 

imbalances be monitored. 

MMS is forgoing revenues for gas royalties owed to the federal government 

because it does not provide reasonable assurance that it accurately and 

promptly identifies and collects on RIK gas imbalances. GAO found that MMS 

is forgoing revenues for the following reasons: 

• MMS estimates that it is owed a net of $21 million for past imbalances but 

it lacks the information necessary to calculate the full amount of revenues 

due. MMS does not have sufficient data to determine whether it has 

received its full percentage of RIK gas. Also, MMS’s estimate does not 

include interest on some unpaid imbalances because MMS has not 

determined when interest begins to accrue on imbalances, as required by 

law. Further, MMS monitors imbalances on a monthly, rather than daily 

basis, which leaves open the possibility that some companies owing RIK 

gas could provide less gas to MMS when gas prices are relatively high, 

making up the difference by providing more gas when prices are relatively 

low, something that could cost MMS additional revenues because it could 

miss the opportunity to sell gas on the days when prices are high. 

• MMS does not audit gas companies’ production and allocation data, 

therefore it cannot verify that it is receiving its entitled percentage of gas. 

MMS does not audit, in part, because it believes that its verification 

procedures are sufficient. However, other governments and gas 

companies routinely audit their imbalances and uncover inaccuracies that 

would result in lost revenues if left unchecked. 

• MMS lacks adequate policies and procedures for accurately and promptly 

identifying and collecting gas imbalances. For instance, the agency does 

not know how companies allocate gas among all parties having a claim on 

a share of gas produced; this may affect whether MMS receives its 

percentage of gas on a daily basis. In addition, MMS does not compel 

companies to document production and deliveries in a consistent format 

and meet deadlines. As a result, MMS analysts spend time gathering and 

reformatting data instead of identifying and collecting on imbalances. 

MMS also allows companies to negotiate imbalances indefinitely. For 

example, MMS has been negotiating with a company for more than 2 years 

regarding a $900,000 imbalance. 

• MMS’s information system does not provide accurate and timely data on 

RIK gas imbalances. For instance, MMS’s information system cannot 

calculate cash settlements for imbalances or compare various types of 

data that companies submit. Consequently, MMS processes more than half 

of its gas imbalance data manually. 

• MMS has been operating for many years without sufficient staff to 

reconcile gas imbalances, and the staff it has is not sufficiently trained. 

For instance, according to RIK management, MMS does not have 

sufficient staff to dedicate someone to fully review RIK gas analysts’ work 

on imbalances, even though mistakes in that work often occur. MMS 

recently hired one new gas imbalance analyst but has not formally 

assessed staffing needs. In addition, RIK gas imbalance staff lack, among 

other things, training on industry standards on gas imbalance calculations.

View GAO-09-744 or key components.

For more information, contact Frank Rusco at 

(202) 512-3841 or ruscof@gao.gov. 
Page i GAO-09-744 

Contents 

Letter 1

Background 3 

MMS May Be Losing Revenue Because It Does Not Accurately and 

Promptly Identify and Collect on RIK Gas Imbalances 6 

Conclusions 19 

Recommendations for Executive Action 20 

Agency Comments and Our Evaluation 21 

Appendix I Scope and Methodology 24 

Appendix II Analysis of the Relationship between Price and 

Percentage of Gas Production Allocated to MMS 

and the Effect on Federal Revenue 27 

Appendix III Comments from the Department of the Interior 36 

Appendix IV GAO Contact and Staff Acknowledgments 40 

Table 

Table 1: Results of Correlation Analysis 35 

Figures 

Figure 1: Two RIK Measurement Points with Common and Mixed 

Royalty Percentages 11 

Figure 2: Variation in the Daily Royalty Percentage of Gas 

Allocated to MMS 32 

Figure 3: Frequency of the Correlations of the Measurement Points 

in Our Sample 33 

 Royalty-in-Kind 
Abbreviations 

COPAS Council of Petroleum Accountants Societies 

IG Inspector General 

Interior Department of the Interior 

MMBtu million British thermal units 

MMS Minerals Management Service 

OGOR Oil and Gas Operations Report 

PRA Petroleum Registry of Alberta 

RIK Royalty-in-Kind 

Treasury Department of the Treasury 

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Page ii GAO-09-744 Royalty-in-Kind
Page 1 GAO-09-744 

United States Government Accountability Office

Washington, DC 20548 

 

August 14, 2009 

The Honorable Jeff Bingaman 

Chairman 

Committee on Energy and 

 Natural Resources 

United States Senate 

The Honorable Ron Wyden 

Chairman 

Subcommittee on Public Lands 

 and Forests 

Committee on Energy and 

 Natural Resources 

United States Senate 

The Honorable Nick J. Rahall, II 

Chairman 

Committee on Natural Resources 

House of Representatives 

The Honorable Darrell Issa 

Ranking Member 

Committee on Oversight and 

 Government Reform 

House of Representatives 

In fiscal year 2008, the Department of the Interior’s (Interior) Minerals 

Management Service (MMS) collected more than $12 billion in royalties 

for oil and natural gas developed and produced from federal lands and 

waters. These royalties represent one of the country’s largest nontax 

sources of revenue. Companies that develop and produce oil and gas 

resources from federal lands and waters do so under leases obtained from 

and administered by agencies of Interior––the Bureau of Land 

Management for onshore leases and MMS for offshore leases. MMS also 

collects, accounts for, and distributes royalties associated with oil and gas 

produced from leased federal lands and waters. MMS collects royalties 

either through its royalty-in-value program––whereby producers pay 

royalties in cash based on the cash value of the oil and gas produced and 

sold––or its royalty-in-kind (RIK) program––whereby producers pay 

royalties in oil or gas, and MMS in turn sells the oil or gas. In fiscal year 

2008, MMS estimates it collected gas valued at more than $2.4 billion and 

 Royalty-in-Kind 
 

oil valued at nearly $4.2 billion through the RIK program, which is equal to 

more than half the royalties collected by MMS.1

 In September 2008, we 

reported that MMS’s oversight of its RIK natural gas collections was less 

robust than its oversight of RIK oil collections and that the agency lacked 

assurance that it was collecting the RIK gas royalties it was owed.2

Given the financial importance of royalty management, MMS has been the 

subject of considerable scrutiny by GAO; Interior’s Inspector General (IG); 

its own internal reviews; and the Royalty Policy Committee, a group 

convened in 1997 by the Secretary of the Interior and charged with 

advising Interior on managing federal leases and revenues. One 

vulnerability identified by these groups is the possibility that MMS may not 

receive the total amount of royalties to which it is entitled—a situation 

known as an “imbalance.” Interior’s IG first noted this vulnerability in the 

RIK program in 2002. In June 2007, MMS likewise found weaknesses in its 

handling of RIK gas imbalances in its response to the Office of 

Management and Budget’s Circular A-123, which defines management’s 

responsibility for internal control in federal agencies. Based on these 

findings, MMS implemented an action plan to assist in the identification 

and timely resolution of imbalances. Further, the Royalty Policy 

Committee’s Subcommittee on Royalty Management issued a report to the 

full committee in December 2007 that included more than 100 

recommendations to strengthen Interior’s royalty collections, including 31 

directed at the RIK program. Among these recommendations, the 

subcommittee recommended that an RIK subcommittee be formed to 

address, among other things, the verification of RIK gas volumes. This 

subcommittee, established in April 2008, has since noted RIK gas 

imbalances as an issue and has stated that it will be reporting to the full 

committee on its findings and recommendations early in the new 

administration. 

In light of these questions, as well as the potential financial impacts of RIK 

gas imbalances, you asked us to determine the extent to which MMS 

ensures the accurate and timely identification and collection of RIK gas 

 

1

Included in the $4.2 billion in oil collected was $1.6 billion transferred from leases taken in 

GAO, Oil and Gas Royalties: MMS’s Oversight of Its Royalty-in-Kind Program Can Be 

6, 

kind to the Strategic Petroleum Reserve. 

2

Improved through Additional Use of Production Verification Data and Enhanced 

Reporting of Financial Benefits and Costs, GAO-08-942R (Washington, D.C.: Sept. 2

2008). 

Page 2 GAO-09-744 Royalty-in-Kind
 

imbalances. In conducting our work, we reviewed applicable statutes a

documentation of MMS policies and procedures for collecting in kind 

royalties. We also met with officials from MMS, gas production companies,

the North American Energy Standards Board,

nd 

, as 

on 

rals 

ix I contains a more detailed discussion of 

our scope and methodology. 

09, 

. 

le basis for our findings and 

conclusions based on our audit objective. 

s 

ate 

s 

s 

d 

 

3

 and pipeline companies

well as industry experts. To determine daily imbalances, we analyzed 

MMS’s price and delivery volumes data, as well as pipeline producti

statements we received from MMS’s Offshore Energy and Mine

Management division, for a nongeneralizable sample of 32 gas 

measurement points. We restricted our analysis to those measurement 

points that contained leases with the same royalty percentage because 

those were the only points for which we could obtain sufficient data to 

perform our analysis. Append

We conducted this performance audit between June 2008 and August 20

in accordance with generally accepted government auditing standards

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonab

MMS collects gas from in kind leases under the authority of the Mineral 

Leasing Act of 1920, as amended, and the Outer Continental Shelf Land

Act of 1953, as amended, and is required to obtain at least fair market 

value for the RIK gas it sells.4

 Prior to the mid-1990s, in kind royalties were 

generally limited to oil sold to small refiners that did not have an adequ

supply of their own. In 1995, MMS began to study whether there were 

additional circumstances under which taking both oil and gas in kind wa

in the best interest of the federal government. According to MMS, it can 

often achieve greater revenues when it sells gas taken in kind because it i

able to negotiate favorable transportation and processing arrangements. 

MMS believes in kind efforts are a means of avoiding lengthy legal disputes

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

Background 

3

The North American Energy Standards Board serves as an industry forum for the 

development and promotion of standards that will lead to a seamless marketplace for 

wholesale and retail natural gas and electricity, as recognized by its customers, business 

community, participants, and regulatory entities. 

4

Energy Policy Act of 2005, Pub. L. No. 109-58, § 342. 

Page 3 GAO-09-744 Royalty-in-Kind
 

is a way to simplify royalty administration. In addition, MMS concluded 

that it would not need to audit RIK sales because the agency would sell th

gas rather than relying on producers to accurately report their ow

prices, as is done in the royalty-in-value program. The collecting, 

reporting, and auditing of cash royalty payments have been challenging for 

MMS because of concerns about the accuracy and reliability of production

and pricing data submitted by royalty payors and because there are about 

29,000 leases producing oil and gas, many with several companies paying 

monthly royalties. MMS began a series of pilot sales of royalty oil and gas 

in 1998 and, based on the results, dramatically expanded its RIK progr

until 2007. In 2008 and 2009, the volumes taken in kind have, and are 

projected to, decrease as MMS decreases the number of properties tak

in kind, in part because it identified and removed prop

e 

n sales 

am 

en 

erties that had 

lower revenues than a fair market value benchmark. 

o meet 

yalties 

2) 

ived 

rogram costs less to administer than the 

royalty-in-value program. 

ust 

o 

 company owes to MMS is 

determined by the following equation: 

royalty volume = total production volume x royalty percentage 

ut is 

MMS is charged with ensuring that RIK oil and gas are not sold for less 

than market value and that revenues it receives are at least as great as the 

revenues it would have received had it taken the royalties in cash. T

this requirement, MMS compares the estimated benefits of the RIK 

program with the estimated benefits it would have received if the ro

had been taken in cash and reports this to Congress annually. MMS 

estimated that from fiscal years 2004 through 2007, the RIK program 

generated about $150 million more in net value to the government than 

MMS would have collected had it received royalties in cash. Of this $150 

million, MMS estimated that (1) $131 million came from selling RIK oil and 

gas for more than MMS would have received in cash royalty payments, (

$8 million came from interest that accrued because revenues from RIK 

sales were received earlier than cash payments would have been rece

through the in-value program, and (3) $11 million came from savings

accrued because the RIK p

Through the RIK gas program, companies that produce gas on federal 

leases owe MMS a royalty, or a percentage, of the daily gas production. To 

ensure that the government obtains the fair value of RIK sales, MMS m

ensure that it receives the percentage of total production volumes t

which it is entitled. The volume of gas a

The royalty percentage for leases taken in kind varies somewhat b

currently in the range of 12.5 percent to 16.67 percent. Measuring 

Page 4 GAO-09-744 Royalty-in-Kind
 

production and allocating a percentage of that production is relatively

straightforward when one company measures its own output from a 

federal lease and reports its own production to MMS. However, multip

production companies sometimes combine the gas flowing from their

leases at a measurement point in order to share the risks, costs, and 

benefits of gas production. These companies often elect from among 

themselves a single company—called the operator—to allocate the gas 

flowing from each of the companies. Due to the complex nature of the 

natural gas market, operators cannot always allocate each producti

company or royalty owner its entitled amount of gas, resulting in a 

situation known as an “imbalance.” Imbalances—both positive and 

negative—are a common occurrence for MMS and all companies in the

industry because, among other reasons, companies must estimate the 

volume of gas they will produce; in turn operators allocate gas based

those estimates rather than actual production. The operator is also 

responsible for monitoring and reporting gas imbalances––the differen

between the volume of gas owed to lease and royalty owners and the 

volume actually allocated. Currently, there are

le 

on 

 gas 

 on 

ce 

 about 250 measurement 

points and 550 leases in the RIK gas program. 

ys 

ed 

ts, 

rfirm 

se 

 

In its guidance to the operator, MMS requests that the operator submit 

monthly imbalance statements for each measurement point within 60 da

of the last day of production. Imbalance statements report the total gas 

production at a measurement point for the month, the percentage of that 

production that the government is entitled to, the volume of gas deliver

on behalf of MMS, and any imbalances. Additionally, MMS regulations 

require operators to submit monthly production reports to MMS by the

15th day of the second month following the month for which is being 

reported.5

 Production reports contain a large number of data componen

including total production volumes for each measurement point. MMS 

compares all of the data components contained in these two operato

generated reports, as well as third-party online pipeline statements 

indicating the amount of gas delivered to RIK gas purchasers, to con

the accuracy of data on each of the documents. MMS considers an 

imbalance to be “reconciled” if the data components contained in the

reports are consistent. Once MMS reconciles monthly imbalances, it 

determines the total cumulative imbalance by adding the most recent 

5

30 CFR 210.103. Production reports refer to form MMS-4054, also referred to as the Oil and 

Gas Operations Report (OGOR). The OGOR is an operator-submitted form that identifies 

all oil and gas lease production and dispositions. The form is used for all production 

reporting for offshore Outer Continental Shelf and onshore federal and Indian lands. 

Page 5 GAO-09-744 Royalty-in-Kind
 

production month’s imbalance to that of previous months. Operators 

“resolve” imbalances daily by either adjusting future allocated vo

paying in cash. MMS has established a policy that those RIK gas 

imbalances that reach what the agency deems to be an “extraordinary” 

level must be resolved through a payment of cash, either to MMS if the 

operator has given the agency less than its entitled amount of gas or to the 

operator if MMS has received more than its entitled amount.

lumes or 

onally, 

 settled through a cash payment for any 

outstanding imbalances. 

n 

e 

ent staff and training to administer the program efficiently and 

effectively. 

ent 

g 

 

6

 Additi

any lease that ceases to produce gas or is terminated from the RIK

program is required to be

MMS risks losing millions of dollars in revenue because it does not 

accurately and promptly identify and collect on RIK gas imbalances. 

Specifically, MMS (1) estimates it is owed a net of $21 million for gas 

imbalances, but it lacks the necessary information to determine the exact 

amounts; (2) does not audit RIK gas operators’ production and allocatio

data, and thus cannot verify that it receives the correct volumes of RIK 

gas; (3) lacks adequate policies and procedures to reconcile and resolv

imbalances; (4) does not have an information system that can provide 

accurate and timely data for reconciling and resolving imbalances; and (5) 

has insuffici

MMS May Be Losing 

Revenue Because It 

Does Not Accurately 

and Promptly Identi

and Collect on R

fy 

IK 

Gas Imbalances 

y 

e from 

Imbalances 

MMS has made progress in reconciling RIK gas imbalances, and its curr

estimates value these imbalances at $35 million owed to MMS and $14 

million that MMS owes to operators, resulting in a net of $21 million owed

to MMS.7

 In 2007 MMS adopted an action plan to reconcile its backlog of 

RIK gas imbalances that occurred in 2002 through 2006. To date, MMS has 

reconciled most of that backlog and has established the goal of reconcilin

more recent imbalances within 180 days of production. RIK officials told

us that, as of June 2009, the agency has completely reconciled nearly 99 

percent of the imbalances from 2002 through 2006. In addition, MMS’s data

MMS Lacks Information

Necessary to Quantif

Revenues Du

6

We are not reporting the amount of MMS’s extraordinary threshold because the agency 

believes this will compromise its efforts to collect additional revenues associated with 

imbalances in a timely manner. Further, MMS determines when imbalances have reached 

this threshold by applying a fixed rate of $5 per million British thermal units to volume 

imbalances. MMS officials said they will re-evaluate the fixed rate and the “extraordinary” 

level in the future. 

7

This does not include any interest associated with the value of uncollected imbalances. 

Page 6 GAO-09-744 Royalty-in-Kind
 

indicate it has completely reconciled almost 99 percent of the imbalances

for production occurring in fiscal year 2007, almost 98 percent for fiscal 

year 2008, and about 94 percent for fiscal year 2009. 

ciled 

rs 

s that 

ata. 

ted 

es. 

int 

fy that it 

was allocated the entitled percentage from each lease taken in kind. 

es 

re 

cent 

 

However, MMS does not know the exact amount it is owed for imbalances 

because it lacks at least three types of information. First, it does not verify 

all gas production data to ensure it receives its entitled percentage of RIK 

gas from all leases taken in kind. Prior to February 2009, MMS recon

gas imbalances through data from two operator-generated reports, 

imbalance statements and monthly production reports, and online thirdparty data from pipeline companies on the amount delivered to purchase

of RIK gas. This verified whether MMS received the volumes of ga

the operator reported, and whether that volume was the correct 

percentage of reported production according to operator-generated d

However, it did not verify through third-party data that the operator 

correctly reported the total production at each lease in the first place. 

Therefore, MMS could not use this method to verify that the gas alloca

by operators was equal to MMS’s entitled percentage of gas volum

Recognizing this, in 2008, we recommended that MMS bolster its 

verification process for gas volumes owed to the government by using

third-party production information, such as the data collected in the 

Offshore Energy and Minerals Management division’s gas verification 

system, in addition to the third-party delivery information it had already 

been using.8

 MMS’s gas imbalance analysts began using the third-party 

data contained in the gas verification system in February 2009, but 

because these data only include total production at the measurement po

rather than for each lease, analysts cannot use the system to veri

Second, MMS lacks information on how to price gas imbalances and the 

point at which the agency should begin applying interest to the imbalanc

for leases that have terminated from the program or those leases whe

production has ceased. Since the RIK program first began, MMS has 

updated its guidance letter to operators. Although MMS’s most re

guidance letter states that MMS will charge monthly interest on 

imbalances, past guidance letters state that interest will only be charged if 

the operator pays its imbalance later than 60 days after the final month the

imbalance occurred. Interior is required by law to charge interest on late 

8

GAO-08-942R. 

Page 7 GAO-09-744 Royalty-in-Kind
 

payments and underpayments of royalties.9 Further, while MMS’s c

guidance letter to operators specifies that it will price imbalances 

according to its own contract price for the gas during the month the 

imbalance occurred, the previous guidance letters did not contain this 

language. MMS is not actively trying to collect on the imbalances of those 

leases that have been terminated from the program or those leases wh

production has ceased because there have been discussions with the 

Office of the Solicitor for more than a year about these issues. In a January

2008 memo, MMS asked the Office of the Solicitor for an opinion

to charge interest and whether its current methodology to price 

imbalances is consistent with law. In its memo, MMS proposed the

urrent 

ere 

 on when 

following two pricing methods, in addition to its current method: 

editing 

 the price using the value when the last imbalance 

occurred. 

oose 

inated from 

the program or those leases where production has ceased. 

on 

e 

hat 

r 

 

1. Calculating the price of the imbalances based on the value applicable 

to the month before settling the imbalance in cash and after cr

any over-allocations existing since the first imbalance month. 

2. Calculating

Recently, the Office of the Solicitor asked RIK program officials to ch

the most appropriate pricing and interest methods before issuing an 

opinion on those methods. However, those methods have not yet been 

presented to the Solicitor, and MMS is currently not making additional 

requests for payment of imbalances for leases that have term

Finally, MMS could be forgoing revenue because it lacks information 

daily gas imbalances. Section 115 of the Federal Oil and Gas Royalty 

Management Act, as amended, provides that a lessee’s obligation does not 

become “due” until the end of the month following the month in which th

gas is produced.10 In its guidance letter to operators, MMS requests t

deliveries be made on a daily basis equal to the royalty percentage. 

Because the statute authorizes MMS to enforce operator obligations only 

on a monthly basis, MMS believes it appropriate to calculate and monito

imbalances owed solely on a monthly rather than daily basis. However,

this leaves open the possibility that some companies that owe RIK gas 

could provide less gas to MMS on days when gas prices are relatively high, 

9

30 U.S.C. § 1721(a). 

1030 U.S.C. § 1724(c)(2). 

Page 8 GAO-09-744 Royalty-in-Kind
 

and make up the difference by providing more gas on days when prices are

relatively low. Because purchasers of RIK gas bid on two components of 

the amount of gas produced daily—a minimum volume set at a monthly

price and an additional volume, if available, at a fluctuating daily or “spot

price—MMS would lose revenue because it would miss the opportunity 

sell gas on days when spot prices are higher. Because MMS reconciles 

imbalances on a monthly––rather than daily––basis, such an occurrence

could go undetected. MMS guarantees the purchaser of RIK gas the

minimum volume on a daily basis, except in the case of

” 

to 

 full 

 operational 

equipment failure or natural disaster. In contrast, industry officials we 

tal 

 that 

 MMS’s 

ge. 

tion 

ntage and on 8 percent of days the allocation was 

more than 25 percent greater than MMS’s royalty percentage. On average, 

e 

ult in a loss 

d. 

ment 

 gas 

program—there are no data available to MMS to detect this, which could 

spoke with said that they monitor imbalances daily to ensure their 

companies do not lose revenue from daily imbalances. 

To investigate the extent to which MMS has been allocated its royalty 

percentage of RIK gas on a daily basis, we analyzed daily volumes of to

production and allocation to MMS at a sample of measurement points. 

Because measurement points combine the gas from numerous leases

may have differing royalty percentages, it is not possible to determine 

whether MMS received its royalty percentage on a daily basis using

data. We therefore restricted our analysis to a random sample of the 

measurement points that had leases with a common royalty percenta

These points account for about 85 percent of those in the RIK gas 

program. On most days––74 percent of those we examined––the alloca

was within 25 percent of MMS’s royalty percentage. However, on 18 

percent of the days, the allocation was more than 25 percent less than 

MMS’s royalty perce

MMS received 15.9 percent of total production when its royalty percentag

was 16.67 percent. 

In addition, we collected daily data on the differential between the base 

and spot price for our sample of measurement points and identified a 

small correlation between higher prices and a lower percentage allocated 

to MMS. We estimated that the correlation we found would res

of about $1,400 for each measurement point during a 6-month time perio

Further, the common royalty percentage in the leases at the measure

points we examined—which accounts for about 85 percent of 

measurement points in the RIK gas program—makes it easier to detect 

this practice. At measurement points with a mix of different royalty 

percentages—about 15 percent of measurement points in the RIK

encourage such behavior and result in higher revenue losses for these

measurement points. See appendix II for our complete analysis. 

Page 9 GAO-09-744 Royalty-in-Kind
 

Daily imbalances may also be costing MMS because it does not track

transactions called “keepwhole payments.” MMS must make such 

payments if RIK gas purchasers do not receive their minimum daily 

volume of gas. This is because purchasers typically enter into advance

contracts to resell RIK gas, and if they do not receive their expected 

volumes they must buy that volume elsewhere in order to fulfill these 

contracts. Daily gas imbalances may be triggering keepwhole payments, 

but MMS does not know the extent to which this occurs because it does 

ot adequately track these payments. 

ata 

n 

er 

. 

-

mes it is 

 if 

t they use a risk-based 

approach, auditing operators who allocate large volumes of gas because 

 do 

ived 

Operators’ Records to 

Verify RIK Gas Production 

n

MMS also may be forgoing revenue because it does not audit operator d

to ensure it has received its entitled royalty percentage. MMS has 

procedures for reconciling imbalances and uses third-party production

data to verify some of the data it receives from operators. However, it has 

not assessed the risk of forgoing audits at those measurement points 

where it does not have complete data with which to verify that it has bee

allocated its entitled percentage of gas. Although the RIK guidance lett

to operators states MMS’s right to audit operator information related to

RIK gas produced and delivered, MMS has not done so because it has 

considered its verification of operator-generated data to be sufficient

MMS has also claimed that it has saved money as a result of not auditing 

and that this is a benefit of the RIK program. However, other royalty

owners and members of the oil and gas industry regularly audit operator

reported data. According to an industry representative, this entails 

traveling to an operator’s place of business to scrutinize gas production 

documentation. According to an official from the Texas General Land 

Office—the agency responsible for administering Texas’s RIK program—

state audits often find that the office has not received the gas volu

entitled to. Furthermore, the Council of Petroleum Accountants Societies 

(COPAS), a professional organization of oil and gas accountants, 

recommends that any royalty or working interest owner initiate an audit

an operator’s response is unsatisfactory or if a discrepancy is considered 

significant. Industry representatives told us that oil and gas companies 

regularly audit to ensure that they have received the gas they are entitled 

to. Representatives from one company noted tha

MMS Does Not Audit 

there is the greatest risk of error in these cases. 

Additionally, there are cases when available third-party production data

not give MMS adequate information to determine whether it has rece

its royalty percentage. For example, when RIK leases combined at one 

measurement point have different royalty percentages, MMS cannot 

Page 10 GAO-09-744 Royalty-in-Kind
 

determine from the available gas verification system data whether it has 

received its entitled royalty percentage. Figure 1 illustrates this using two 

hypothetical measurement points. Measurement point one has three leases

flowing into it, all with a royalty percentage of 16.67 percent. Regardle

whether each lease has different production volumes, MMS can calcula

that it is owed 16.67 percent of the total production of 10,000 million 

British thermal units (MMBtu). However, measurement point two has 

three leases flowing into it, with two leases owing a royalty percentage of

16.67 percent and one lease owing a royalty percentage of 12.5 perc

Because each lease will have a different volume of production and thirdparty data from the gas verification system only includes the total 

production volume at the measurement point, MM

ercent of the total production of 10,000 million 

British thermal units (MMBtu). However, measurement point two has 

three leases flowing into it, with two leases owing a royalty percentage of

16.67 percent and one lease owing a royalty percentage of 12.5 perc

Because each lease will have a different volume of production and thirdparty data from the gas verification system only includes the total 

production volume at the measurement point, MM

ss of 

te 

ent. 

S is unable to verify it 

was allocated its entitled percentage of RIK gas without examining the 

operator’s production records at the lease level. 

Figure 1: Two RIK Measurement Points with Common and Mixed Royalty Percentages 

Production company three

(operator)

(12.5%; 1,000 MMBtu)

Production company one

(16.67%; 4,000 MMBtu)

Production company two

(16.67%; 5,000 MMBtu)

Measurement point one

(10,000 MMBtu)

MMS can determine if

the operator allocated the

entitled royalty percentage

Measurement point two

(10,000 MMBtu)

MMS can not determine if

the operator allocated the

entitled royalty percentage

Production company three

(operator)

(16.67%; 1,000 MMBtu)

Production company one

(16.67%; 4,000 MMBtu)

Production company two

(16.67%; 5,000 MMBtu)

Source: GAO.

MMS does not have adequate pol

Royalty-in-Kind

icies and procedures to ensure it 

Procedures to reconciles and resolves RIK gas imbalances efficiently. This shortcoming 

Reconcile and Resolve 

Imbalances 

MMS Lacks Adequate 

Policies and 

is apparent in three main areas. 

Page 11 GAO-09-744 
 

First, MMS policies do not adequately ensure that operators allocate 

MMS’s percentage of RIK gas. MMS’s guidance letter to operators reques

that operators allocate to MMS the royalty percentage of gas on a daily 

basis, but MMS believes it does not have the authority to enforce this 

guidance. Further, RIK officials said MMS does not know what method 

operators use to allocate gas. Indeed, our analysis shows that, contrary to

its guidance letter to operators, on many days MMS is not receiving its 

percentage of RIK gas. This could be happening because the operator’s 

allocation method ranks other leaseholders before MMS when allocatin

gas and total production is less than expected. In this instance, MMS cou

receive less than its royalty percentage of gas or no gas at all. According to

COPAS, when the output of gas from multiple leases is combined and 

measured at a single measurement point, it is imperative that all parties 

agree on the method the operator will use to allocate the gas. We lea

ts 

g 

ld 

rned 

from industry representatives that gas companies rely extensively on such 

l 

that 

the 

ntable 

does not 

es for 

Following this guideline, gas companies we spoke with said they have 

agreements to ensure they receive the gas volumes they are owed and to 

minimize the negative impact of imbalances on company revenues. 

Second, MMS does not have adequate policies and procedures to compe

operators to report imbalances promptly and in a standard format. 

Although the RIK gas guidance letter to operators requests that the 

operator provide an imbalance statement to MMS within 60 days of the 

month of production, the guidance is not enforceable and MMS cannot

impose a penalty for failing to submit imbalance statements within 

time period. To allow MMS to take enforcement actions, regulations are 

required. These regulations must (1) go through the public notice and 

comment process, and thus be transparent to the public, oversight 

agencies, and Congress; and (2) carry the full force of the law and hold 

agency implementing the program and program participants accou

to the terms specified in the regulations. RIK officials said MMS has 

operated the RIK program without regulations because of the onerous 

nature of establishing regulations and because industry had been 

cooperative. More recently, RIK officials told us they have recognized that

it is necessary to implement regulations for the RIK gas program in order

for the agency to receive imbalance statements in a timely manner, among 

other reasons, and have begun drafting these regulations. In contrast, the 

provincial government of Alberta, Canada, has regulations in place that 

state a company can be fined a portion of its royalty payment if it 

submit required production data on time. Similarly, COPAS guidelin

the oil and gas industry provide that operators should submit imbalance

statements to appropriate parties within 45 days of the month of 

production, unless other timing requirements have been agreed to. 

Page 12 GAO-09-744 Royalty-in-Kind
 

policies in place to compel timely reporting. For example, one industry 

agreement we obtained states that if an operator fails to submit imbalance 

statements for four consecutive months, the operator could be subject to 

f 

ercent 

e 

alling companies to inquire about missing imbalance 

statements. RIK officials agreed that this was not an efficient use of 

e 

cubic 

as 

balance 

e 

reports must pass data checks. Alberta officials have stated that 

tions. 

y 

been 

 

auditing. 

Our review of MMS’s spreadsheet for tracking imbalance statements 

shows that, from January 2007 through June 2008, at least 35 percent o

expected imbalance statements were received late and about 10 p

remain missing.11 As a result, MMS analysts spend a great deal of tim

repeatedly c

resources. 

MMS also does not have a policy to require operators to submit imbalanc

statements in a standardized or electronic format. Operators submit 

imbalance statements by e-mail, but the statements commonly arrive in 

different file formats—even from a single operator. Additionally, some 

operators report gas volumes in MMBtu, the measurement unit used by 

MMS, while others use different units of measure, such as thousand 

feet. In these cases, MMS analysts must manually convert reported g

volumes to a uniform measurement unit—increasing the chance of 

calculation errors—and must spend additional time combining the 

information from different reports into one format, rather than focusing on 

reconciling imbalances. MMS could require operators to submit im

statements in an MMS-approved standard format.12 In contrast to MMS, th

government of Alberta requires companies to report gas volumes

electronically in a standardized format and measurement unit, and these 

standardized reporting has improved the efficiency of its RIK opera

The third area in which MMS does not have adequate policies and 

procedures is in collecting payment for an imbalance from a compan

when a cash-out settlement between MMS and the company has not 

reached. When there is an extraordinary imbalance, MMS sends the 

11We chose to examine only information up to June 2008 to allow some lag time for the 

revisions companies are permitted to make to previously submitted imbalance statements. 

12Under the Paperwork Reduction Act, agencies may not conduct or sponsor the collection 

of information unless approved by the Office of Management and Budget. The Office of 

Management and Budget is required to determine that the agency’s collection of 

information is necessary for the proper performance of the functions of the agency, 

including whether the information will have practical utility. 44 U.S.C. § 3508. 

Page 13 GAO-09-744 Royalty-in-Kind
 

operator an initial cash-out memo explaining the amount that MMS 

believes the company owes. The operator can either pay for the imbalance 

or dispute it by submitting evidence that the imbalance value is incorrect. 

To pay for the imbalance, the operator submits to MMS a royalty pa

form, which indicates the company’s agreement with MMS’s calculation of 

the imbalance and classifies the imbalance as an open receivable, 

triggering the debt collection process with the Department of the Treasu

(Treasury). The royalty payment form is the only means of triggering

collection, but the operator would not submit this form if it disputes an 

imbalance. With no other bill or invoice to begin the debt collection 

process for disputed imbalances, MMS’s practice has been to allow the 

exchange of supporting evidence with the operator regarding the size and 

value of the imbalance to continue indefinitely. In one instance, MMS se

an operator a cash-out memo in December 2006 for an imbalance valued

nearly $900,000 and, as of February 2009, was still negotiating with the 

operator. In such cases, because MMS has not sent a demand letter to a 

company for payment, it has not referred a company to Treasury.

yment 

ry 

 debt 

nt 

 at 

 with 

e reached the end of their contract term. If 

such debts are not collected within 7 years, the statute of limitations 

h 

 time frame, MMS issues a demand letter for payment. If the 

amount due MMS is still unpaid after 180 days, the issue is referred to 

e 

ose 

 

13 RIK 

officials stated that the agency has avoided debt collection for imbalances 

because it is an onerous process and because it is waiting for the Office of

the Solicitor to issue an opinion on the pricing and interest associated

imbalances for leases that hav

renders them uncollectible.14

In contrast, MMS has debt collection policies and procedures in place to 

collect debt from companies that have purchased and received RIK gas 

from MMS but have not submitted payment for their purchase. According

to MMS policy, a company purchasing RIK gas receives an invoice, whic

triggers the debt collection process. If the company does not pay within

the agreed

Treasury. 

MMS’s information system does not provide accurate and timely data on 

RIK gas imbalances, which reduces the agency’s ability to collect on thes

imbalances. In 2003, MMS acquired a commercial, off-the-shelf software 

product and a custom-built database for the RIK program. The purp

Royalty-in-Kind

n System 

Does Not Provide Accurate 

and Timely Data 

MMS’s Informatio

13Outstanding debts are referred to Treasury as required by the Debt Collection 

Improvement Act of 1996, Pub. L. No. 104-134 (1996). 

1430 U.S.C. § 1724(b). 

Page 14 GAO-09-744 
 

was to integrate all of the program’s information needs in a singl

where it could monitor and track gross gas production, imbalance 

statement data, gas deliveries, and monthly and cumulative gas 

imbalances. However, the information system is not capable of provid

accurate and timely information on RIK gas imbalances. For instance, 

MMS’s RIK Deputy Program Manager told us that the system cannot 

provide accurate information on the number and amount of keepwh

payments MMS has made and cannot calculate RIK cash-out imbalances. 

Therefore, as of June 2009, MMS was entering data manually into a 

spreadsheet and performing calculations based on the manually entered 

data. MMS officials further told us that gas imbalance information

cannot analyze data from the operator-submitted imbalance statements, 

operator-submitted monthly production reports, and MMS’s gas 

verification system to calculate gas imbalances. As a consequence, 

than half of MMS’s gas imbalance work, according to the RIK gas 

imbalance manager, is currently done manually. For example, two 

employees spend a portion of their time logging information from 

operator-submitted imbalance statements onto spreadsheets after which 

gas imbalance analysts manually upload imbalance statement data into

MMS’s informatio

e database 

ing 

ole 

 systems 

more 

n system. An RIK manager said the manual processing of 

RIK gas imbalance data has put a considerable burden on the RIK gas 

g to 

s 

l revenue 

ers 

 

imbalance staff. 

According to GAO’s Standards for Internal Control in the Federal 

Government, transactions from initiation to completion should be 

promptly recorded to maintain their relevance and value to management 

in controlling operations and making decisions. Similarly, accordin

Interior’s Internal Controls Handbook, accurate and timely information i

essential for assuring the safeguarding of assets from waste, loss, 

unauthorized use, or misappropriation, as well as to assure compliance 

with laws and regulations. In its December 2007 report on minera

collection,15 MMS’s Royalty Policy Committee recommended the 

electronic submission of all offshore production records to improve

MMS’s compliance and enforcement activities. According to RIK officials, 

the committee’s recommendation was not specifically directed at, and 

therefore did not pertain to, the RIK program. Yet RIK program manag

also told us that they recognized as early as August 2007 that the system

15Royalty Policy Committee, Subcommittee on Royalty Management, Mineral Revenue 

Collection from Federal and Indian Lands and the Outer Continental Shelf (Dec. 17, 

2007). 

Page 15 GAO-09-744 Royalty-in-Kind
 

needed improvements. According to the RIK gas imbalance manager, 

when MMS alerted the software manufacturer to these problems, there 

was a disagreement as to whether the manufacturer or the support 

services contractor were responsible. In July 2008, MMS contracted with 

ot 

y, 

get. 

, 

th 

ill 

ld have 

t epursue 

ustry. RIK program managers told us that, 

although they believe that a better information system would immensely 

een 

 

the software manufacturer for support services, but this system is still n

meeting MMS’s needs. 

At the time of our review, MMS had planned to enhance the system but 

was also exploring the possibility of acquiring a new information 

management system. According to RIK officials, one candidate system was 

the Petroleum Registry of Alberta (PRA), which the government of Alberta 

uses to manage its RIK program. PRA differs from MMS’s current system

in several aspects. PRA was jointly developed by government and industr

with the government providing about 73 percent of the $35 million bud

According to Alberta officials and the provincial government Web site

PRA improves compatibility by serving as the system of record for bo

government and industry.16 In addition, companies participating in the 

Alberta RIK program are responsible for promptly entering accurate 

production data electronically. If a company does not enter accurate 

production data into PRA on time, one MMS RIK official told us, PRA w

alert Alberta officials regarding the issue and the company can be fined.

This official added that an automated system such as the PRA wou

to be customized to fit MMS’s needs at some unknown cost, but that it 

could save RIK gas imbalance analysts’ hours of time currently spen

mailing and calling companies to submit their operator imbalance 

statements. According to MMS officials, they have decided not to 

PRA in part because customization could cause issues with future 

upgrades and fixes, regulation would be required for MMS to require 

online and standardized reporting, and the system would require 

significant buy-in from ind

improve RIK gas imbalance work, MMS does not have a timeline to acquire 

a more effective system. 

The RIK gas imbalance office, according to various MMS reports, has b

operating without sufficient staff and training to efficiently and effectively 

carry out its assigned duties. As a result, certain tasks—such as gas 

Royalty-in-Kind

Training Remains a LongStanding Issue 

Insufficient Staff and 

16PRA was developed based upon the recommendations of a task force composed of 

government and industry representatives including, individuals from Amoco Canada 

Petroleum Ltd., Shell Canada Limited, and Gulf Canada Resources Ltd. 

Page 16 GAO-09-744 
 

balancing work—have not received sufficient attention, leading to the

development of a backlog of RIK gas imbalances. Effective managem

an organization’s human capital—its employees, as well as their skills

training—is essential to achieving results and an important p

ent of 

 and 

art of a 

program’s internal controls. Human capital has been a long-standing 

al structure 

would need to evolve to fully support the RIK operational activity.17 The 

 2003 report prepared by an MMS contractor noted that, in 

order to support a permanent RIK program of significant scale, specific 

capabilities would be necessary in order to meet the objectives of MMS’s 

 to 

mber 

 in 

g with 

 

problem for the RIK gas program. Specifically, each of the following 

reports found that RIK human capital needed improvement. 

• A January 2001 MMS report indicated that the RIK organization

report also stated that the future RIK activity would require MMS staff 

training in handling imbalances, as well as several other areas. 

• A September

personnel requirements should be identified and filled for all RIK 

personnel.18

• A May 2004 MMS report noted that enhancements to human resource 

RIK business plan.19 Therefore, the report indicated that specific skill sets 

and expertise should be acquired or developed in-house by March 2006. 

These human capital deficiencies continue to be a problem for the RIK gas 

program. For example, an RIK manager told us that, although mistakes can

occur in gas imbalance calculations, MMS does not have enough staff

dedicate someone to review this work. However, beginning in Nove

2008, MMS began reviewing a sample of this work. In addition, according 

to internal MMS e-mails and our discussions with managers, RIK gas 

imbalance personnel have received training in oil and gas revenue 

accounting but managers noted that personnel need additional training

seven different courses, especially a course on industry standards on gas 

imbalance calculations and a communication skills course for dealin

17Department of the Interior, Minerals Management Service, Implementing Royalty in 

Kind Business Processes and Support Systems: Road Map to the Future (Washington, 

D.C., January 2001). 

18Lukens Energy Group, Assessment of the Federal Royalty-in-Kind (“RIK”) Program and 

Development of RIK Business Plan (September 2003). 

19Department of the Interior, Minerals Management Service, Five Year Royalty In Kind 

Business Plan (Washington, D.C., May 2004). 

Page 17 GAO-09-744 Royalty-in-Kind
 

external customers. Our review of employee training records showed, 

however, that RIK gas imbalance personnel received training in n

these two courses and only about half of all the train

either of 

ing identified. 

According to the MMS RIK gas imbalance manager, the training employees 

 tools. 

to 

eliminate or reduce financial reporting risks, an organization should have, 

al training. 

 MMS is in 

 by 

ing 

ees 

s that agencies use training provided to 

employees in other organizations as a source of assessing their staff’s 

g 

ived at the 

d 

ing 

organizations should conduct a staffing needs analysis to determine the 

 

have received is sufficient given their workload dealing with gas 

imbalance improvement actions and current duties. 

According to GAO’s Standards for Internal Control in the Federal 

Government, operational success is dependent on assigning the right 

personnel for the job and providing them with adequate training and

Similarly, according to Interior’s Internal Controls Handbook, in order 

among other things, sufficient resources to perform the various job 

functions and should provide staff with technical and ethic

To MMS’s credit, it recognizes that human capital issues remain.

the process of taking four additional actions. Specifically: 

• In October 2008, MMS reinstituted, after a 15-year absence, the 

requirement that each employee have an individual development plan

the end of November 2008.20 These plans, according to MMS’s RIK train

director, were developed by supervisors sitting down with their employ

and informally discussing their training needs. However, the federal 

government’s Office of Personnel Management’s 2001 Training Needs 

Assessment Handbook suggest

training needs. MMS officials told us they did not do so in developin

individual development plans. 

• In February 2009, MMS hired, after several months of effort, seven 

additional RIK imbalance and invoicing personnel, including one gas 

imbalance analyst. According to RIK officials, management arr

decision to hire seven additional staff based on an internal discussion an

without a formal analysis. However, in our 2002 primer on good human 

capital management practices, we noted that high-perform

 

An individual development plan is a tool used by an employee and supervisor to forecast, 

, 

dividual requirements. 

20

identify, and schedule individual training and development opportunities to meet mission

organizational, and in

Page 18 GAO-09-744 Royalty-in-Kind
 

appropriate number of employees needed to perform an organization’s

work.

(2) 

staffing levels, skill sets, education, and experience are comparable to 

and the 

gas 

dustry 

education annually, MMS officials told us that its RIK gas revenue 

s 

ing 

 leading 

at 

 

21 MMS has not conducted such an analysis. 

• As of March 2009, MMS was in the process of entering into a 6-month 

contract for an assessment of the organization of RIK invoicing and 

imbalance work, procedures, and processes. Included in the tasks to be

performed under this contract is determining whether: (1) staffing levels 

are sufficient to meet current and anticipated future workloads and 

industry. As of June 2009, this contracting effort was still ongoing 

results from that effort were not available to include in our review. 

• Lastly, at our suggestion during the course of our review, MMS is 

reviewing the possibility of enrolling some of its employees in training 

classes offered by oil and gas companies to their employees participating 

in the RIK gas program. In offering this suggestion, we pointed out that 

MMS employees could (1) gain first hand knowledge into how industry 

does its gas imbalance work, (2) make strategic contact with industry 

imbalance employee counterparts, and (3) gain some insight into in

training requirements. With regard to the latter, whereas COPAS requires 

its oil and gas accounting members to receive 10 hours of continuing 

specialists are not required to meet any annual education requirements. As 

of June 2009, MMS had not decided whether to use this industry training. 

Although Interior has made efforts to improve its management of royalties, 

continuing problems with identifying and collecting RIK gas imbalance

have led to forgone revenues and uncertainty about how much gas the 

government is owed. While MMS has made recent progress in establish

policies and procedures for charging interest on imbalances owed the 

government, these policies and procedures are incomplete and are

to forgone revenues. In particular, the agency is not actively pursuing

collection of past imbalances or associated interest. Further, daily gas 

imbalances are common and can lead to forgone revenue for the 

government, because they can trigger keepwhole payments made to 

buyers of RIK gas or because an operator could strategically deliver more

gas when prices are low and less when prices are high. MMS requests th

these operators allocate MMS its percentage of royalties on a daily basis, 

 

Conclusions 

21GAO, A Model of Strategic Human Capital Management, GAO-02-373SP (Washington, 

D.C.: Mar. 15, 2002). 

Page 19 GAO-09-744 Royalty-in-Kind
 

but MMS does not monitor daily gas imbalances and, does not believe it 

could enforce such an allocation under existing authority. In addition, 

despite the fact that audits are commonplace in the gas industry, MMS has

not employed audits in the RIK program, and thus cannot ensure that it i

receiving its entitled percentage of gas. MMS also operates without key 

regulations that define how operators submit imbalance statements and

how operators are to allocate gas owed the government. The absence

such regulations has led to a system in which imbalance statements are

not submitted in a standardized format or in a timely fashion and in whic

MMS has no authority to require an allocation system that is beneficia

the government. In addition, MMS is operating without procedures that 

define reasonable deadlines for resolving and collecting gas imbalances, 

and as a result, some imbalances have remained uncollected for years. 

And because MMS lacks an adequate informat

s 

 of 

h 

l to 

ion system that could 

receive relevant information electronically and effectively identify and 

esolve gas imbalances, MMS staff often must manage data manually or 

with 

nterparts in gas 

companies participating in the RIK program. 

rals Management Service’s oversight of the RIK gas 

program and help ensure that the nation receives its fair share of RIK gas, 

s 

t the correct amount of 

interest is charged. 

 resulting in lost revenues to MMS. To the 

extent that this is occurring, identify and propose specific legislative 

kind 

iting 

IK properties. 

Recommendations for 

r

operate without appropriate internal controls for data management. 

Finally, MMS has been operating without sufficient workforce analysis and

planning, and as a result, training for MMS staff is not clearly aligned 

agency needs or benchmarked against training of their cou

To improve the Mine

Executive Action we recommend that the Secretary of the Interior direct the Mineral

Management Service to take the following seven actions: 

• Complete establishing policies and procedures to ensure outstanding 

imbalances are valued appropriately and tha

• Monitor daily gas imbalances to determine whether the allocation 

practices of gas operators are

changes that MMS believes are needed to require operators to deliver 

MMS’s royalty percentage on a daily basis. 

• Audit the operators and imbalance data of a sample of leases taken in 

and, on the basis of the audit findings, establish a risk-based aud

program for R

Page 20 GAO-09-744 Royalty-in-Kind
 

• Promulgate RIK program regulations that protect the federal govern

interests. At a minimum, regulations should require op

ment’s 

erators to submit 

imbalance statements in a standardized format within 60 days following 

government. 

g and 

collecting all RIK gas imbalances in a timely manner. 

• y 

• ysis and put into place a 

corresponding staffing and training program for MMS staff. 

t. 

r 

g 

imbalances are valued appropriately and that the correct amount of 

m; 

s 

 basis of 

 sample of leases. While we believe this is an important first 

step, we continue to believe it is important to conduct audits of a sample 

r, 

Agency Comments 

the month of RIK production. They should also require the use of gas 

allocation methods MMS deems will ensure a fair return to the 

• Establish procedures, with reasonable deadlines, for resolvin

Determine the information system enhancements necessary to effectivel

identify and resolve gas imbalances and put into practice such a system. 

Conduct an RIK staffing and training needs anal

We provided a draft of this report to Interior for review and commen

Interior generally agreed with our findings and concurred with four of ou

recommendations, partially concurred with two of our recommendations, 

and did not concur with one recommendation. 

Specifically, Interior concurred with our recommendations to: (1) 

complete establishing policies and procedures to ensure outstandin

and Our Evaluation 

interest is charged; (2) establish procedures, with reasonable deadlines, 

for resolving and collecting all RIK gas imbalances in a timely manner; (3) 

determine the information system enhancements necessary to effectively 

identify and resolve gas imbalances and put into practice such a syste

and (4) conduct an RIK staffing and training needs analysis and put into

place a corresponding staffing and training program for MMS staff. 

Interior partially concurred with our recommendation to audit operator

and imbalance data of a sample of leases taken in kind and, on the

these findings, establish a risk-based auditing program. Interior stated that 

it would conduct an analysis of the benefits of conducting risk-based 

audits on a

of leases taken in kind. Although MMS’s verification processes may 

uncover some discrepancies between their entitled percentage and the 

volumes delivered, we have shown that in some instances MMS’s 

verification processes are not sufficient to uncover discrepancies. Furthe

Page 21 GAO-09-744 Royalty-in-Kind
 

industry and other RIK programs audit to ensure they receive the

royalties. 

Interior also partially concurred with our recommendation to promulgat

RIK program regulations that protect the federal government’s interest 

and, at a minimum, require operators to submit imbalance statements in 

standardized format, within 60 days following the month of product

and require the use of gas allocation methods MMS deems will ensure a

fair return to the government. Interior stated that the drafting of 

regulations addressing the operator’s obligation to deliver, report, and 

account for production and to resolve or mitigate production imbalances 

is well underway, which we commend. MMS stated that it will evaluate 

whether it should require operators to submit imbalance stateme

ir entitled 

e 

a 

ion, 

nts in a 

standardized format. We continue to believe that requiring operators to 

hile 

he use 

n 

rators 

ly 

 in 

nthly basis, this leaves open the possibility that operators 

may provide less to MMS on days when gas prices are relatively high, and 

e 

 lose revenue. For these reasons, we 

continue to believe that MMS should begin to monitor imbalances daily 

nd, to the extent that lost revenues are occurring, propose legislative 

submit standardized imbalance statements would allow MMS’s gas 

imbalance analysts to devote more time to reconciling imbalances and 

would reduce the chance of calculation errors. MMS also stated that it will 

evaluate whether to require operators to use gas allocation methods. W

we believe this is a positive first step, we continue to believe that t

of allocation methods will minimize the negative impact of imbalances o

revenues by ensuring MMS receives the gas volumes it is owed. 

Interior did not concur with our recommendation to monitor daily gas 

imbalances to determine whether the allocation practices of gas ope

are resulting in lost revenue to MMS. Interior’s letter states that the agency

believes the operator’s obligation to deliver MMS’s royalty percentage 

should be the same whether royalties are paid in kind or in value. 

However, the in-kind program is different from the in-value program in 

that MMS has an obligation to provide RIK gas to purchasers on a dai

basis. Therefore, in order to provide reasonable assurance that the 

government is receiving its fair volumes of gas and in turn meeting its 

obligations to RIK gas purchasers, receipt of RIK gas volumes from 

operators should be monitored on a daily basis. While we acknowledge

our report that the law authorizes MMS to enforce operator obligations 

only on a mo

make up that difference by providing additional gas when prices ar

relatively low. Further, we found that industry monitors imbalances on a 

daily basis to ensure they do not

a

changes requiring operators to deliver MMS the royalty percentage on a 

daily basis. 

Page 22 GAO-09-744 Royalty-in-Kind
 

Interior’s full letter commenting on the draft report is reprinted in 

appendix III. In addition, Interior made technical comments, which

have addressed as appropriate. 

 we 

interested parties. The report will be available at no charge on the GAO 

Web Site at http://www.gao.gov. 

If you or your staffs have any questions about this report, please contact 

me at (202) 512- 3841 or ruscof@gao.gov. Contact points for our Offices of 

Congressional Relations and Public Affairs may be found on the last page 

ff who made major contributions to this report are 

listed in appendix IV. 

Frank Rusco 

Director, Natural Resources and Environment 

As agreed with your office, unless you publicly announce the contents of 

this report earlier, we plan no further distribution until 30 days from the 

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

congressional committees, the Secretary of the Interior, and other 

of this report. GAO sta

Page 23 GAO-09-744 Royalty-in-Kind
Appendix I: Scope and Methodology Appendix I: Scope and Methodology 

We were asked to determine the extent to which MMS ensures the 

accurate and timely identification and collection of royalty-in-kind (RIK) 

gas imbalances. To address our objective, we reviewed various reports by 

the Department of the Interior (Interior) and Interior’s Minerals 

Management Service (MMS) on the history and current status of 

imbalances associated with the RIK gas program including: (1) a 2002 

internal MMS assessment of RIK gas imbalances; (2) a 2002 report by 

Interior’s Office of Inspector General, which discussed, in part, MMS’s 

vulnerability to underreporting of gas receipts due to RIK gas imbalances;1

(3) MMS’s monthly action plan on RIK imbalances and open receivables, 

first prepared in August 2007; and (4) MMS’s periodic cumulative 

imbalance, cash-out, and keepwhole summary statements. 

We also reviewed various reports prepared on the direction and overall 

performance of the RIK program, including (1) an examination of a 2001 MMS 

report which outlined MMS’s future plans for the RIK program; (2) a 2003 

MMS contractor report that assessed the RIK program; (3) a 2007 report by 

the Subcommittee on Royalty Management, part of the Royalty Policy 

Committee, which reviewed the operations of the RIK program;2

 (4) a 2008 

MMS internal review report on RIK processes; and (5) a 2008 interim report 

by the Royalty in Kind Subcommittee, also part of the Royalty Policy 

Committee, which examined various issues, including imbalances, associated 

with the RIK program. We also examined various reports prepared by other 

governmental entities—including the Alberta, Canada government and the 

Texas state government—regarding their RIK programs. We further discussed 

the issue of RIK imbalances with officials from MMS, gas production 

companies, gas operators, industry experts, and pipelines. 

To examine MMS’s management of RIK gas imbalances, we received a 

detailed walk-through of MMS’s processes for reconciling RIK gas 

imbalances. We reviewed a variety of MMS documentation including (1) MMS 

procedures manuals, (2) correspondence between MMS and Interior’s Office 

of the Solicitor on RIK legal requirements, and (3) MMS’s guidance letters to 

operators of RIK gas leases. We also reviewed federal and Interior’s internal 

 

1

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

to Underreporting: Royalty-in-Value versus Royalty-in-Kind, 2002-I-0044 (Washington, 

D.C., September 2002). 

2

The Subcommittee on Royalty Management. Report to the Royalty Policy Committee: 

Mineral Revenue Collection from Federal and Indian Lands and the Outer Continental 

Shelf, (Washington, D.C., Dec. 17, 2007). 

Page 24 GAO-09-744 Royalty-in-Kind 
Appendix I: Scope and Methodology 

control and management standards and policies, including: (1) GAO’s 

Standards for Internal Control in the Federal Government,3

 (2) Interior’s 

Internal Controls Handbook, (3) MMS’s Training Needs Assessment Process, 

(4) the Office of Personnel Management’s Training Policy and Training Needs 

Assessment Handbooks, (5) Office of Management and Budget’s Circular A130 on management of federal information resources, (6) Office of 

Management and Budget’s Circular A-123 on management’s responsibility for 

internal control in federal agencies, and (7) the Information Technology 

Resources Board’s 1999 lessons-learned report on acquiring commercial-offthe-shelf software. Further, we reviewed various documents issued by the 

Council of Petroleum Accountants Societies such as its 1993 report on oil and 

gas operator and producer roles and responsibilities and its 2001 report on 

producer gas imbalances, and information generated by the North American 

Energy Standards Board.4

 In addition to reviewing documentation, we also 

conducted interviews with MMS officials; gas production companies; 

purchasers of MMS’s RIK gas; the North American Energy Standards Board; 

pipeline companies; and industry experts. Lastly, we reviewed legislation 

pertinent to MMS’s management of the RIK gas program and RIK gas 

imbalances. This included the Mineral Leasing Act of 1920, as amended; the 

Outer Continental Shelf Lands Act of 1953, as amended; and the Debt 

Collection Improvement Act of 1996, as amended. 

Appendix II contains information on the scope and methodology we used 

to analyze the relationship between gas prices and the daily percentage of 

gas production allocated to MMS and the effect of this relationship on 

federal revenue. 

We conducted this performance audit from June 2008 to August 2009, in 

accordance with generally accepted government auditing standards. Those 

standards require that we plan and perform the audit to obtain sufficient, 

appropriate evidence to provide a reasonable basis for our findings and 

conclusions based on our audit objectives. We believe that the evidence 

 

3

GAO, Standards for Internal Control in the Federal Government, GAO/AIMD-00-21.3.1

(Washington, D.C.: November 1999). 

4

The Council of Petroleum Accountants Societies (COPAS) is a professional organization 

comprised of oil and gas industry accountants. COPAS committees produce accounting 

guidelines, interpretations, best practices, and training and reference publications used by 

the energy industry. The North American Energy Standards Board serves as an industry 

forum for the development and promotion of wholesale and retail natural gas and 

electricity standards. 

Page 25 GAO-09-744 Royalty-in-Kind
Appendix I: Scope and Methodology 

obtained provides a reasonable basis for our findings and conclusions 

based on our audit objectives. 

Page 26 GAO-09-744 Royalty-in-Kind
A

between

Product

on Federal Revenue 

ppendix II: Analysis of the Relationship 

 Price and Percentage of Gas 

ion Allocated to MMS and the Effect 

Page 27 GAO-09-744 

Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

To ensure that the government obtains a fair value for the RIK gas it sells, 

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

must ensure that it receives the volumes of gas to which it is entitled. The 

difference between the RIK gas owed––MMS’s entitled percentage of gas––

and the percentage of gas it actually receives is referred to as an 

“imbalance.” As discussed in the body of this report, MMS attempts to 

reconcile gas imbalances monthly. 

The nature of gas production causes some daily variation in volume. For 

example, companies must estimate the volume of gas they will produce on 

any given day and determine allocations based on these estimates. If 

actual allocation volumes differ from the estimated volumes, MMS may 

receive either an under-delivery of gas or an over-delivery of gas. Daily 

imbalances may be resolved through a subsequent day’s under- or overdelivery, resulting in further variation in volume; however, MMS risks 

losing revenue if that variation is associated with a variance in price. 

Specifically, if operators allocate less than the royalty percentage of gas to 

MMS on days when the spot price is high and more than the royalty 

percentage of gas on days when the spot price is low, they could still meet 

the royalty percentage across the month. However, if this occurs, MMS 

may lose revenue because it may miss opportunities to sell the gas at the 

higher price, even if no long-term imbalances accumulate. 

This appendix describes our analysis of the relationship between prices 

and the percentage of gas allocated to MMS, and how it affects the revenue 

that MMS receives. Specifically, it (1) explains, in mathematical terms, the 

potential for lost revenue if the operators allocate less than the royalty 

percentages of gas when the spot price is high; (2) describes the data that 

we used to empirically examine the daily variation in percentage of gas 

allocated to MMS; (3) describes the methodology and results of our 

analysis of daily variation in percentages of gas allocated to MMS; (4) 

describes the methodology and results of our analysis of the relationship 

between the daily variation in percentage of gas allocated to MMS and gas 

prices; and (5) describes the methodology and results of our analysis of 

the potential amounts of lost revenue. 

To explain, in mathematical terms, the potential for lost revenue if 

operators allocate less than the royalty percentages of gas when the spot 

price is high, we examined how this relationship affects the expected, or 

average, return for an MMS lease. 

Potential for Lost 

Revenue 

 Royalty-in-Kind 
Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

The royalties that MMS are owed can be expressed as follows: 

royalty volume = total production volume x royalty percentage 

On a daily basis, the royalty volume can be expressed by the product of 

the daily gas production and the daily volume of gas allocated to MMS: 

(1) RVt

 = Volt x At

where RVt

 is the royalty volume at time t, Volt is the volume of gas 

allocated to MMS at time t, and At

 is the royalty percentage at time t. In 

equation (1), and the equations that follow, t stands for any given day. The 

monetary value of the gas allocated to MMS can then be expressed by 

multiplying the royalty volume and the gas spot price at the time of 

delivery. 

(2) Revt

 = Pt x RVt

Substituting equation (1) into equation (2) results in the following formula: 

(3) Revt

 = Pt x Volt x At

where the revenue MMS receives is the product of the price, volume, and 

royalty percentage at that time. 

To determine how different levels of covariance affect the average 

revenue, we determined the expectation, as shown in equation (4). 

(4) E(Revt

)= E(Pt x Volt x At)

evenue will fall. 

Because the focus of our analysis was the effect of daily variances in gas 

allocated to MMS that was associated with variances in the spot price, we 

assumed that the volume at the time of delivery is independent of the 

product of price and the royalty percentage, and that the volume is 

constant over the period. 

(5) E(Revt

) = E(Volt) x (E(Pt)E(At)+Cov(Pt,At))

If higher prices tend to correspond with higher percentages of gas 

allocated to MMS, then the covariance term Cov(Pt

,At) will be positive, 

and the expected revenue will be higher. However, if high prices 

correspond with lower percentage of gas allocated to MMS, then the 

covariance term will be negative, and the expected r

Page 28 GAO-09-744 Royalty-in-Kind
Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

The covariance describes both the relationship between the variables and 

the absolute variability of each. A substitute for the covariance would be 

to introduce the correlation coefficient. The correlation coefficient 

captures only the relationship between the variables and takes a value 

between negative 1 and 1. A correlation coefficient of zero would indicate 

that there was no relationship between the variables. A correlation 

coefficient close to 1 would indicate a strong positive relationship, while a 

correlation coefficient close to negative 1 would indicate a strong negative 

relationship. Using the correlation coefficient, an alternate expression for 

the equation (5) would be the following:1

(6) E(Revt

) = E(Volt) x (E(Pt)E(At)+Corr(Pt,At) x SD(Pt) x SD(At)) 

From equation (6), it is apparent that, all things being equal, the more the 

price and percentage of gas allocated to MMS are negatively correlated, 

the greater the loss in revenue. However, the size of the effect is scaled by 

the absolute variability in each, SD(Pt

) and SD(At).2

To investigate the extent to which MMS receives its daily percentage of 

RIK gas, consistent with equation (6) above, we analyzed daily volumes of 

total production and allocation to MMS at a sample of measurement 

points. Specifically, we collected data from three sources: 

Data We Used for Our 

Analyses 

• Price data: We collected price data from MMS’s Entegrate database, which 

a contractor updates daily with prices from published sources. The daily 

price of the natural gas the operator delivers is made up of two 

components—the base price and the spot price. The base price is the price 

applied to the baseload of gas, or the amount of natural gas the operator 

allocates to MMS over a given period of time at a steady rate unless an 

adverse or “force majeure” action occurs. The base price remains the same 

throughout the month and is set at the beginning of every month based on 

the first-of-month price published in Inside FERC, a monthly gas market 

report.3

 The spot price is the price applied to the swing volume of gas, or 

 

1

Noting that corr(X,Y) = cov(X,Y)/SD(X)SD(Y). 

2

An analogous argument could be made with respect to swings in percentage of gas 

allocated to MMS with respect to volume: E(Revt

) = E(Pt) x (E(Vt)E(At)+ Corr(Vt,At) x

SD(Vt

) x SD(At)). Therefore, if high volumes correspond to lower royalty percentages, then 

the covariance term will be negative and the expected revenue will fall. 

3

Inside FERC is a gas market report that is published by Platts, a division of The McGrawHill Companies, which is a leading global provider of energy and commodities information. 

Page 29 GAO-09-744 Royalty-in-Kind
Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

the supply of natural gas that is last to be taken and first to be curtailed 

and absorbs production variations. The spot price varies daily. 

• Delivery data: We collected delivery data from MMS’s Entegrate database. 

MMS downloads final delivery volumes from the electronic bulletin boards 

for regulated pipelines, or it receives delivery volumes from either 

operator or purchaser pipeline statements, or both. MMS enters the actual 

volumes into the Entegrate database monthly. 

• Volume data: We collected volume data from the Offshore Energy and 

Minerals Management division of MMS, which collects hardcopy pipeline 

statements. MMS provided copies of the pipeline statements, which a 

contractor keypunched. We checked the keypunched data, and found no 

errors. We then matched the daily production volume data to the daily 

price and delivery data for use in our analyses. 

Because pipeline statements do not report production volume at the lease 

level, we could not analyze allocation percentages at the lease level. For 

all three sources, we collected data at the level of the measurement 

point—the metered point at which gas is measured. A measurement point 

may combine the gas flowing from numerous leases. 

In addition, we excluded from our sample measurement points whose 

leases had differing royalty percentages. For cases in which the 

measurement points had differing royalty percentages, it would not have 

been possible to calculate whether MMS was allocated its share of gas. For 

example, in figure 1, measurement point one has three leases flowing into 

it, all with the same royalty percentage of 16.67 percent. Therefore, 

regardless of whether each lease has different production volumes, MMS 

can calculate that it is owed 16.67 percent of the total production of 10,000 

MMBtu. However, measurement point two has three leases flowing into it, 

with two leases owing a royalty percentage of 16.67 percent and one lease 

owing a royalty percentage of 12.5 percent. Because each lease will likely 

have a different volume of production and MMS will only have the total 

production volume available from third party data, it is unable to 

determine its entitled volume of RIK gas. 

Because of this limitation, we restricted our analysis to a random sample 

of those measurement points that had leases with a common royalty 

percentage. Then, for each of the randomly selected 32 measurement 

points, we obtained 6 months of daily observations––October 2007 

through March 2008––resulting in 5,856 daily observations. MMS officials 

suggested that we use this 6 month time period in order to avoid hurricane 

Page 30 GAO-09-744 Royalty-in-Kind
Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

season, which typically occurs during the summer months, but gas prices 

during these months may differ from those included in our time period. 

However, 677 days had no production, and data for 366 days was missing 

values for allocation volumes to MMS. Because we could not produce a 

percentage of gas allocated to MMS in those cases, our ultimate sample 

contained 4,829 daily observations with values for volume of gas allocated 

to MMS and the differential between spot and base price and 31 

measurement points. 

To determine the extent to which the daily percentage of gas allocated to 

MMS deviated from its royalty percentage of gas for the measurement 

points in our sample, we calculated the daily percentage of gas allocated 

to MMS by dividing the volume of gas allocated to MMS from that 

measurement point on a given day by the volume of gas produced at the 

measurement point. We then counted the days that the percentage of gas 

allocated to MMS differed from the prescribed amount of 16.67 percent by 

a substantial amount, which we defined as more than 25 percentage 

points. 

Methodology and 

Results of Our 

Analysis of Daily 

Variation in 

Percentages of Gas 

Allocated to MMS 

Our analysis of daily data found variation in the percentage of gas 

allocated to MMS; however, on the majority of days, the allocation did not 

substantially differ from MMS’s royalty allocation, as shown in Figure 2. 

Specifically, 3,573 of the 4,829 days––about 74 percent––had an allocation 

that was between 75 and 125 percent of the entitled royalty percentage of 

one-sixth or 0.167. But on many days, the royalty percentage of gas 

allocated to MMS was much less or much greater. For example, on 883 

days––about 18 percent of the total, shown as the sum of the bottom three 

bars on figure 2––the royalty percentage of gas allocated to MMS was less 

than 75 percent of the prescribed amount. On the other hand, on 373 

days—about 8 percent of the total, shown in the top two bars—more than 

125 percent of the royalty percentage of gas allocated to MMS. On average 

MMS received 15.9 percent. 

Page 31 GAO-09-744 Royalty-in-Kind
Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

Figure 2: Variation in the Daily Royalty Percentage of Gas Allocated to MMS 

0 500 1000 1500 2000 2500 3000 3500 4000

Zero royalty allocated

Between 0 and 50

percent of entitlement

Between 50 and 75

percent of entitlement

Between 75 and 125

percent of entitlement

Between 125 and 150

percent of entitlement

More than 150

percent of entitlement

Allocation percentage

Number of days

Source: GAO analysis of MMS data.

211

162

3,573

242

548

93

While there may be inherent daily variation in the percentage of gas 

allocated to MMS, the loss of revenue is determined by the extent to which 

that variation is associated with price. To analyze whether the percentage 

of gas allocated to MMS varies with price, we used the daily data on the 

differential between the base and spot price for our sample of 

measurement points and measured the correlation between these two 

variables for each measurement point. We found a small negative average 

and median correlation between higher prices and a lower percentage of 

gas allocated to MMS. Specifically, the average correlation was negative 

0.014, while the median was negative 0.038. 

Methodology and 

Results of Our 

Analysis of the 

Relationship between 

the Daily Variation in 

the Percentage of Gas 

Allocated to MMS and 

Gas Prices Although the average was slightly negative, we found that correlations had 

a wide range. Figure 3 presents the frequency of the correlations of the 

differential between spot price and base price and percentage of gas 

allocated to MMS for the 31 measurement points in our sample. The 

maximum, or the most positive, correlation in our sample was 0.645. The 

minimum, or most negative, was negative 0.560. As figure 3 shows, the vast 

Page 32 GAO-09-744 Royalty-in-Kind
Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

majority of measurement points had a correlation between negative 0.25 

and 0.25.4

Figure 3: Frequency of the Correlations of the Measurement Points in Our Sample 

0 2 4 6 8 10 12 14 16 18

Between 0.50 and 0.75

Between 0.25 and 0.50

Between 0 and 0.25

Between negative

0.25 and 0

Between negative 0.50

and negative 0.25

Between negative 0.75

and negative 0.50

Correlation

Number of measurement points

Source: GAO analysis of MMS data.

1

1

17

9

1

2

 

4

In its technical comments, MMS agreed that an average correlation of negative 0.014 and a 

median correlation of negative 0.038 indicate a “small” relationship between higher prices 

and lower percentages of gas allocated to MMS. However, it is important to note that we 

found a wide range of variability in the correlations of our sample. 

Page 33 GAO-09-744 Royalty-in-Kind
Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

The potential amount of lost revenue depends on the size and variability of 

the percentage of gas allocated to MMS, gas produced, and the spot-minusbase differential. To estimate the revenue loss that would be associated 

with a certain correlation, we used an hypothetical measurement point 

that had the same average characteristics as the ones in our sample.5

 We 

then generated data that had the same average mean and standard 

deviation as our hypothetical example, but different correlations between 

the variables. We computed the average revenue for that hypothetical 

measurement point during a 6-month time period. We used a wide range of 

correlations, including the median value found in the above example. 

Finally, we compared the revenue to a baseline of zero correlation. 

Methodology and 

Results of Our 

Analysis of Potential 

Amount of Lost 

Revenue 

We estimate that the median correlation we found would result in a 

revenue loss of about $1,400 for each measurement point during a 6-month 

time period, as shown in table 1. Each row of the table is the result of one 

million simulations of data with the given correlation and the mean and 

average standard deviation of the measurement points in our sample. 

However, the common royalty percentage in the leases at the 

measurement points we sampled from––which accounts for about 85 

percent of measurement points in the RIK gas program––would make it 

easier to detect the under-delivering when prices were high. It follows that 

this may introduce a bias into our distribution of correlations. Specifically 

operators at those measurement points may be less likely to link gas 

allocations to price because they fear detection, therefore we would be 

less likely to find negative correlations. At measurement points with a mix 

of different royalty percentages––about 15 percent of measurement points 

in the RIK gas program––the potential for this practice may increase, and 

could result in more negative correlations. As table 1 shows, a more 

negative correlation would result in higher revenue losses for these 

measurement points. For example, a correlation of negative 0.5 would 

result in a loss of about $21,000 during a 6-month time period for that 

measurement point. 

 

5

The average measurement point in our sample had an average (spot - base) differential of 

0.235, with an average standard deviation of 0.522. Although it had an average of 0.170 

allocation percentage, we applied an average of 0.167, with an average standard deviation 

of 0.074. We assumed an average of 0.167 because that is the entitled royalty percentage—

so no long term imbalances in volume of gas would develop. It had an average of 5,826 

decatherms of natural gas produced, with an average standard deviation of 1,527. We 

assumed no correlation between volume and price or allocation percentage. 

Page 34 GAO-09-744 Royalty-in-Kind
Appendix II: Analysis of the Relationship 

between Price and Percentage of Gas 

Production Allocated to MMS and the Effect 

on Federal Revenue 

Table 1: Results of Correlation Analysis 

Correlation between (spot - base) and 

percentage of gas allocated to MMS 

Estimated revenue during 

6-month time period

Difference in revenue with 

zero correlation

-0.90 $4,564 -$36,912

-0.50 21,066 -20,441

-0.10 37,557 -3,973

-0.04 40,154 -1,379

0 41,509 -15

0.10 45,669 4,139

0.50 62,114 20,607

0.90 78,553 37,077

Source: GAO analysis. 

Note: The difference in revenue is computed by subtracting the revenue under the correlation from 

the average differential between the spot and base prices, the average production volume, and the 

assumption that the percentage of gas allocated to MMS is 0.167. The shaded row indicates the 

rounded median correlation of negative 0.038 that we found. 

Page 35 GAO-09-744 Royalty-in-Kind
Appendix III: Comments from the Department Appendix III: Comments from the of the Interior 

Department of the Interior 

Page 36 GAO-09-744 Royalty-in-Kind 
Appendix III: Comments from the Department 

of the Interior 

Page 37 GAO-09-744 Royalty-in-Kind
Appendix III: Comments from the Department 

of the Interior 

Page 38 GAO-09-744 Royalty-in-Kind
Appendix III: Comments from the Department 

of the Interior 

Page 39 GAO-09-744 Royalty-in-Kind
Appendix IV: 

A

GAO Contact and Staff 

cknowledgments 

Page 40 GAO-09-744 

Appendix IV: GAO Contact and Staff 

Acknowledgments 

Frank Rusco, (202) 512-3841 or ruscof@gao.gov

In addition to the individual named above, key contributors to this report 

included Karla Springer, Assistant Director; Robert Baney; Benjamin 

Bolitzer; Melinda Cordero; Cindy Gilbert; Alison O’Neill; Dae Park; Justin 

Reed; Holly Sasso; Ben Shouse; and Barbara Timmerman. 

 Royalty-in-Kind 

GAO Contact 

Staff 

Acknowledgments 

(360977) 
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