Oil And Gas Resources: Actions Needed for Interior to Better Ensure a Fair Return
Published: 2013-12-06T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In fiscal year 2012, companies received over $66 billion from the sale of oil and gas produced from federal lands and waters, and they paid $10 billion to the federal government for developing these resources according to the Department of the Interior. The federal government seeks a fair return on its share of revenue from leasing and production activities on federal lands and waters through the federal oil and gas fiscal system. Under the fiscal system, companies pay royalties, rents, and other payments--payments generally specified in lease terms-- and taxes on profits from the sale of oil and gas produced from federal leases. In May 2007, GAO found, based on several studies, that the government received one of the lowest percentages of value of oil and gas produced in the world. In September 2008, GAO found that Interior had not evaluated the federal oil and gas fiscal system for over 25 years and recommended that a periodic assessment was needed.
GAO was asked to review Interior's collection of oil and gas revenues. This report examines steps Interior has taken to ensure the public receives a fair return on oil and gas resources since 2007. GAO reviewed applicable law and regulations; examined prior GAO studies, Interior policies and documents; and interviewed officials.
section_title: What GAO Found
paragraphs: Interior has taken some steps intended to help ensure a fair return on federal oil and gas resources but does not have documented procedures for periodically conducting assessments of the fiscal system. Specifically, Interior has taken the following steps:
Changed offshore lease terms and considered but has not changed onshore lease terms . Interior changed certain offshore lease terms-- including raising royalty rates twice in response to changing market conditions. For onshore resources, which are subject to many of the same market conditions, Interior has considered but not made changes to royalty rates. Interior officials are currently unable to make timely adjustments to onshore royalty rates. Current regulations generally provide for a fixed onshore royalty rate that limits Interior's flexibility to make timely adjustments.
Contracted for studies of various aspects of the fiscal system . Interior contracted for three studies examining its fiscal system including a study done in 2011, in response to GAO's September 2008 report that compared the U.S. government's oil and gas fiscal system to other resource owners. Interior officials said the reports provided some useful information such as how fiscal terms in the United States compared to other resource owners.
Interior is examining potential regulatory changes that could simplify royalty payments . Interior is examining potential regulatory changes that could simplify royalty payments. GAO found in the past that complex valuation regulations can result in inaccurate royalty payments made by industry, and this could increase costs to ensure accurate royalty payments because of the need for potentially detailed and timeconsuming audits of records. In May 2011, Interior published the Advance Notice Of Proposed Rulemaking for a proposed rule currently undergoing internal review. According to officials, the proposed rule is expected to be published in 2014, and officials explained that it took several years due to factors including the complexity of oil and gas valuation.
Interior does not have documented procedures in place for determining when to conduct periodic assessments of the fiscal system. Although Interior recently contracted for such an assessment, it was the first in well over 25 years. Without documented procedures, Interior will not have reasonable assurance that it will consistently conduct such assessments in the future and, without periodically conducting such assessments, Interior cannot know whether there is a proper balance between the attractiveness of federal leases for investment and appropriate returns for federal oil and gas resources, limiting Interior's ability to ensure a fair return. Further, Interior does not have documented procedures for determining whether and how to make changes to new offshore lease terms. Without documented procedures for determining whether and how to make changes to new offshore lease terms, Interior's rationale is not transparent and may result in inconsistent decisions. Such inconsistencies would undermine Interior's credibility and ability to better ensure a fair return on federal oil and gas resources.
section_title: What GAO Recommends
paragraphs: GAO recommendations include that Interior establish documented procedures for (1) periodically assessing the fiscal system and (2) determining whether and how to change new offshore lease terms. Interior concurred with GAO's recommendations.

section_title: Letter
paragraphs: Production of oil and natural gas from leases on federal lands and waters  is an important part of the nation’s energy portfolio and a significant  source of revenue for the federal government. Domestic and foreign  companies received over $66 billion from the sale of oil and gas produced  from federal lands and waters in fiscal year 2012, according to the  Department of the Interior. Interior reported collecting about $9.7 billion in  2012 from royalties and other payments from these companies, making  oil and gas resources one of the federal government’s largest nontax  sources of revenue. The terms and conditions under which the  government collects these revenues are referred to as the “oil and gas  fiscal system” and generally include royalties and other payments for the  rights to explore, develop, and sell oil and gas resources. However, over  the past several decades, we, and others, have identified problems with  Interior’s management of the federal oil and gas fiscal system. For  example, in 1982, a task force convened by Interior found that  management of the fiscal system needed a thorough overhaul and  provided 60 recommendations for improving the fiscal accountability of  the nation’s onshore and offshore resources. Upon the completion of the  task force’s work, the Secretary of the Interior informed Congress, in  March 1983, that Interior had refined the system and that a “full and fair  return” to the American people would be assured. In May 2007, we found  that, based on the results of a number of studies, the government  receives one of the lowest government takes—commonly understood to  be the total revenue, as a percentage of the value of oil and natural gas  produced—in the world. In addition, in September 2008, we found that  Interior did not routinely evaluate the federal oil and gas fiscal system and  suggested that Congress should consider directing the Secretary of the  Interior to (1) convene an independent panel to conduct a comprehensive  review of the oil and gas fiscal system and (2) establish procedures to  periodically evaluate the state of the fiscal system. In 2011, in part  because of the challenges identified in our past work concerning Interior  not having reasonable assurance that it is collecting its share of revenue  from oil and gas produced on federal lands, we added Interior’s  management of federal oil and gas resources to GAO’s list of programs at  high risk of fraud, waste, abuse, and mismanagement.
Interior has oversight responsibility for the development of federal oil and  gas resources located under over 260 million surface onshore acres, 700  million subsurface onshore acres, and more than 1.7 billion offshore  acres in the waters of the outer continental shelf. Companies that  develop and produce oil and gas from these federal lands and waters do  so over a specified period of time under leases obtained from and  administered by agencies of Interior––the Bureau of Land Management  (BLM) for onshore leases and the Bureau of Ocean Energy Management  (BOEM) for offshore leases. Interior’s Office of Natural Resources  Revenue (ONRR) is responsible for collecting revenues from onshore and  offshore leases.
Interior acts on behalf of the American people to manage the federal oil  and gas system to ensure a fair return to the public for the development  of oil and gas resources. For offshore resources, one of the stated  purposes of the Outer Continental Shelf Lands Act, as amended—which  governs the management of oil and gas resources—is to ensure the  public “a fair and equitable return” on the resources on the outer  continental shelf. The law directs the Secretary of the Interior to conduct  leasing activities to assure receipt of fair market value for the lands  leased and the rights conveyed by the federal government. Further, for  onshore resources, Interior relies on the competitive leasing process  required by the Mineral Leasing Act, as amended, to ensure fair market  value for onshore oil and gas resources. Broadly, we refer to the  government collecting an appropriate share of revenue from leasing and  production activities on federal lands and waters as ensuring a fair return.  Because the revenues these leases generate depend, in part, on the  amounts of oil and natural gas that companies produce from them, the  federal government has sought to design fiscal systems that balance the  goal of providing a fair return with sufficient financial incentives for  companies to commit resources to exploring, developing, and producing  oil and gas from their leases.
You asked us to review Interior’s collection of oil and gas revenues as  part of our ongoing efforts to support congressional oversight of GAO’s  high-risk areas. This report examines the steps Interior has taken to  ensure that the public receives a fair return on federal oil and gas  resources since 2007. To conduct this work, we reviewed applicable law,  regulations, and guidance that govern Interior’s management of oil and  gas resources including the Outer Continental Shelf Lands Act, the  Mineral Leasing Act, and the Federal Onshore Oil and Gas Leasing  Reform Act; examined our prior reports and Interior leasing program  policies and documents; and interviewed Interior officials from BOEM,  BLM, ONRR, and the Solicitor’s Office. We also conducted a high-level  review of the Interior-contracted studies of the fiscal system in order to  summarize the studies’ purpose and goals. We also compared actions  that Interior took to standards for internal control in the federal  government.
We conducted this performance audit from October 2012 to December  2013 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: This section describes (1) the federal oil and gas fiscal system, (2)  leasing processes, and (3) the history of oil and gas management  challenges. Created by Congress in 1849, Interior oversees the nation’s  publicly owned natural resources including parks, wildlife habitat, and  crude oil and natural gas resources on millions of acres onshore and  offshore in the waters of the outer continental shelf. With regard to oil and  gas in particular, Interior leases federal lands and waters (also referred to  as submerged lands), issues permits for oil and gas drilling, and is  responsible for ensuring that the federal government receives payment  from the private companies that extract oil and gas from federal leases.
subsections: section_title: The Federal Oil and Gas Fiscal System
paragraphs: The oil and gas fiscal system defines the applicable payments to the  government from companies that lease federal lands and waters for oil  and gas development.  These payments include royalties, rents, and  other payments—items generally specified within the lease terms. The  revenues collected by the federal government on oil and gas  development are shared with states, as directed by statute, and the  remaining funds are deposited in the U.S. Treasury. In addition to the  collection of these payments by Interior, the federal government assesses  taxes on the profits companies earn on the sale of oil and gas produced  from federal leases. Under the oil and gas fiscal system, companies bid  on leases that Interior makes available. Interior awards the lease to the  highest bidder generally based on a lump-sum payment called a bonus  bid that is due when the lease is issued. The lease is a contract and  conveys the rights to explore for and produce the oil and gas in a  specified area to a company that holds the lease. The company is then  subject to the payment of rental rates until production begins and then to  payment of royalties on any oil and gas that is eventually produced on the  lease. The royalty rate is a percentage of the value of production, and the  royalty owed is the volume of production times the unit value of  production times the royalty rate. The federal government receives royalty  payments once production starts. In fiscal year 2012, the $9.7 billion in oil  and gas revenue collected included royalties (about $8.5 billion or 87  percent), bonus bids (about $947 million or 10 percent), and rental fees  (about $272 million or 3 percent).
Currently Interior has the authority to change certain lease terms—such  as the duration of the lease, royalty rates, and rental fees—within the  overall oil and gas fiscal system. For new offshore leases, Interior is  allowed by statute to change the lease terms for the bonus bid structure,  rent, and royalty rates. For new onshore leases, Interior is generally  allowed by statute to change these same lease terms but with certain  limits on flexibility. For onshore leases, Interior’s regulations—issued in  the 1980s—currently establish a royalty rate of 12.5 percent. As such,  changes to onshore royalty rates would require Interior to revise its  regulations.  With regard to taxes on corporate profits, only Congress may  change the tax components of the oil and gas fiscal system as Interior  does not have the authority to do so.
For both offshore and onshore leases, ONRR collects revenue from  companies for the royalties, rents, bonuses, and other revenues  generated throughout the leasing process. In this regard, ONRR has the  responsibility to ensure that these revenues are accurately reported and  paid in compliance with laws, regulations, and lease terms. ONRR  establishes the regulations for how oil and gas are valued for royalty  purposes, which affects the royalties that companies pay.
section_title: Leasing Processes
paragraphs: Interior’s processes for issuing federal leases vary depending on whether  they are offshore or onshore.
For offshore leases, management of oil and gas resources is primarily  governed by the Outer Continental Shelf Lands Act, which sets forth  procedures for leasing, exploration, and development and production of  those resources. BOEM is the bureau within Interior responsible for  implementing these requirements of the act related to preparing the  leasing program. The act calls for the preparation of an oil and gas  leasing program designed to best meet the nation’s energy needs while  also taking into account a range of principles and considerations specified  by the act. Specifically, the act provides that “anagement of the outer  Continental Shelf shall be conducted in a manner which considers  economic, social, and environmental values of the renewable and  nonrenewable resources contained in the outer Continental Shelf, and the  potential impact of oil and gas exploration on other resource values of the  outer Continental Shelf and the marine, coastal, and human  environments.” Furthermore, the act provides that the outer continental  shelf is a “vital national resource reserve held by the federal government  for the public, which should be made available for expeditious and orderly  development, subject to environmental safeguards, in a manner which is  consistent with the maintenance of competition and other national  needs.” The act grants the Secretary the authority to issue leases and  states that “leasing activities shall be conducted to assure receipt of fair  market value for the lands leased and the rights conveyed by the Federal  Government.”
The Outer Continental Shelf Lands Act requires the Secretary of the  Interior to prepare an oil and gas leasing program that consists of a 5- year schedule of proposed lease sales that shows the size, timing, and  location of leasing activity as precisely as possible. Every 5 years, Interior  selects the areas it will offer for leasing and establishes a schedule for  individual lease sales. These leases are offered for competitive bidding,  and all eligible companies are invited to submit written sealed bids for the  lease and rights to explore, develop, and produce oil and gas resources  on these leases. These rights last for a set period of time, referred to as  the initial period of the lease, which varies depending on the water  depth. Interior estimates the fair market value of each lease, and the  minimally acceptable bid is derived from this estimate. The bidder that  submits the highest bonus bid that meets or exceeds Interior’s minimum  bid is awarded the lease. If a high bid does not satisfy any of the required  conditions, the bid is rejected. In the event that no bid is received or no  bids equal or exceed the minimum bid, Interior may choose to withdraw  the lease—possibly offering it again at a future date.
For onshore leases, BLM’s current leasing process was established in the  Mineral Leasing Act of 1920, as amended, and the Mineral Leasing Act  for Acquired Lands of 1947, as amended. Interior relies on the  competitive leasing process required by the Mineral Leasing Act to  ensure fair market value for onshore oil and gas resources. In addition,  the Federal Land Policy and Management Act, though not specific to  federal oil and gas resources, calls for the management of public lands in  a manner that protects historical and environmental resources, provides  for recreational and other uses, and ensures “fair market value” is  received for their use and resources. BLM offers parcels of land  nominated by industry and the public, as well as some it identifies. As  with offshore leases, Interior initially offers onshore leases through a  competitive bidding process; however, bonus bids are received in an oral  auction rather than in a sealed written form, and Interior does not  evaluate bid adequacy on a parcel-by-parcel basis. Instead, by law, it  requires a uniform national minimum acceptable bid of $2 per acre that  the Secretary has the authority to raise. If Interior receives any bids on an  offered lease, the lease is awarded to the highest bidder. All onshore  leases that do not receive any bids in the initial offer must be offered  noncompetitively the day after and remain available for noncompetitive  leasing for a period of 2 years after the competitive lease sale. Any of  these available leases may be acquired noncompetitively on a first-come,  first-served basis for the minimum acceptable bid. About 40 percent of  existing BLM oil and gas leases were issued as noncompetitive leases.  For all competitively issued leases, the winning bidder must pay Interior  the full amount of the bonus bid to become the lessee. The lessee then  pays a fixed amount of rent each year until the lease begins producing or  the lease terminates, expires, is cancelled, suspended, or relinquished.
section_title: History of Oil and Gas Management Challenges
paragraphs: In the 1970s and early 1980s, Interior’s management of the oil and gas  revenue collection system faced criticism by us and Interior’s Office of the  Inspector General. Interior’s Inspector General issued five reports critical  of the program between 1969 and 1977 and, in 1981, we reported that  Interior was not collecting potentially hundreds of millions in royalties due  from federal oil and gas leases. In response, in 1981, the Secretary of  the Interior established the Commission on Fiscal Accountability of the  Nation’s Energy Resources, better known as the Linowes Commission  named for the chairman of the commission, to investigate allegations of  irregularities in royalty payments, among other issues. The Linowes  Commission raised a number of serious concerns and in its report stated  that “management of royalties for the nation’s energy resources has been  a failure for more than 20 years. Because the Federal government has  not adequately managed this multibillion dollar enterprise, the oil and gas  industry is not paying all the royalties it rightly owes.” The report cited a  range of problems, including the failure to verify data reported by  companies and late payments and underpayments, and concluded that,  “n short, the industry is essentially on an honor system.” Among its 60  recommendations for improving the fiscal accountability of onshore and  offshore resources, the commission called for raising onshore royalty  rates to “appropriate levels.” Specifically, the commission recommended  that the onshore royalty rate for oil and gas be raised from 12.5 percent to  16.67 percent generally for new and renegotiated leases consistent with  offshore royalty rates of 16.67 percent in place at that time.
Following the work of the commission, Interior and Congress took several  actions aimed at improving management of revenue collection. In  particular, the Secretary of the Interior, by secretarial order, reorganized  the task of administering revenue collection under a new bureau;  specifically, the Minerals Management Service (MMS) was created within  Interior, in part, from the division of the U.S. Geological Survey—which  was originally tasked with administering revenue collection, among other  duties—to improve management of federal leasing revenues. In  addition, Congress passed legislation aimed at improving the collection of  revenue including the Federal Oil and Gas Royalty Management Act of  1982 and the Federal Oil and Gas Royalty Simplification and Fairness Act  of 1996.
In 2007, Interior’s Subcommittee on Royalty Management—a  subcommittee of the Royalty Policy Committee chartered to provide  advice on royalty management issues and other mineral-related policies  to the Secretary and other departmental officials responsible for  managing mineral leasing activities—reported that a number of aspects of  royalty management activities required prompt and, in some cases,  significant management attention to ensure public confidence. In  particular, the report included over 100 recommendations to improve  Interior’s management of oil and gas resources, including those aimed at  revising its valuation regulations and guidelines that govern the valuation  of oil and gas resources for royalty purposes. According to Interior  documentation, as of August 2012, 15 recommendations remain open.
In our May 2007 report, we found that, based on results of a number of  studies, the government receives one of the lowest government takes in  the world. In September 2008, we found that the fiscal system needed  comprehensive reassessment and that Interior did not routinely evaluate  the federal oil and gas fiscal system. Interior disagreed with  recommendations in the draft report that it perform a comprehensive  review of the fiscal system using an independent panel and adopt policies  and procedures to keep abreast of important changes in the oil and gas  market and in other countries’ efforts to adjust their oil and gas  management practices in light of these changes. Thus, in the final report,  we suggested that Congress should consider directing the Secretary of  the Interior to (1) convene an independent panel to perform a  comprehensive review of the federal system for collecting oil and gas  revenue and (2) establish procedures for periodically collecting data and  information and conducting analyses to determine how the federal  government take and the attractiveness for oil and gas investors in each  federal oil and gas region compare to those of other resource owners and  report this information to the Congress. Actions taken in response to this  suggestion are discussed later in this report. In 2011, in part because of  the challenges identified in our past work, we added Interior’s  management of federal oil and gas resources to our list of programs at  high risk of fraud, waste, abuse, and mismanagement. In the 2013  update of the high-risk list, we found that some progress had been made  related to Interior’s management of federal oil and gas resources and  narrowed the federal oil and gas high-risk area to focus, in part, on the  remaining issues related to revenue collection and ensuring that the  public is getting an appropriate share of oil and gas revenues.
section_title: Interior Has Taken Some Steps to Help Ensure a Fair Return but Does Not Have Procedures for Periodically Conducting Assessments of the Fiscal System
paragraphs: Interior has taken some steps to help ensure a fair return on federal oil  and gas resources since our 2007 report, including: (1) changing offshore  lease terms, while considering but not making changes to onshore lease  terms; (2) contracting for studies of various aspects of the fiscal system;  and (3) examining potential regulatory changes that could simplify royalty  payments and collections. However, Interior does not have documented  procedures in place for determining when to periodically conduct  assessments of the fiscal system to ensure a fair return or for determining  whether and how to make changes to lease terms for new offshore  leases.
subsections: section_title: Interior Has Taken Some Steps Aimed at Ensuring a Fair Return
paragraphs: Interior has taken some steps aimed at ensuring a fair return, including  changing offshore lease terms—such as increasing royalty rates,  minimum bids, and rental rates—but onshore lease terms have not  changed in recent years though onshore and offshore leasing programs  are subject to many of the same market conditions. For example, while  onshore royalty rates have remained at 12.5 percent, certain offshore  royalty rates began increasing in 2007 to the current offshore royalty rate  of 18.75 percent. Figures 1 and 2 depict changes to offshore and onshore  royalty rates along with oil and gas price fluctuations, respectively, from  January 2000 through July 2013. In addition, Interior has contracted for  studies of various aspects of its fiscal system, including an assessment of  how the federal fiscal system compared with the systems of other oil and  gas resource owners (including owners in other countries); an analysis of  policies that affect the pace of leasing in the Gulf of Mexico; and an  analysis of the benefits, costs, and economic impacts of raising onshore  royalty rates. Interior is also examining potential regulatory changes that  could simplify royalty payments and collections.
In recent years, Interior changed some offshore lease terms in an effort to  ensure a fair return on oil and gas resources. Since 2007, Interior  increased offshore lease terms including royalty rates, rental rates, and  the minimum bid for certain offshore leases as follows:   Increased royalty rates. From 2007 through 2008, Interior increased  royalty rates for new leases by 50 percent. In 2007, Interior increased  the royalty rate for new Gulf of Mexico leases from 12.5 percent to  16.67 percent for new leases in water depths greater than 400  meters. In 2008, Interior increased the rate again for all Gulf of Mexico  leases to 18.75 percent. As of August 2013, all Gulf of Mexico royalty  rates for new leases are 18.75 percent. According to Interior officials  and documents, incremental increases in royalty rates were instituted  in response to a variety of factors including (1) increased oil and gas  prices; (2) perceived improvements in exploration and production  technologies, especially in deep water; and (3) the competitive market  for offshore leases. Interior estimated that the royalty rate increase  from 16.67 percent to 18.75 percent would result in a net increase in  the total Gulf of Mexico federal revenues from bonuses, rents, and  royalties from new leases of $4.3 billion, a 5 percent increase from  $87.4 to $91.7 billion over 30 years. After this 2008 royalty rate  increase, Interior documents stated that demand remained strong for  newly offered leases in the Gulf of Mexico and that Interior observed  strong bidding interest in the three subsequent lease sales.
Escalating and increased rental rates. Interior established escalating  rental rates—rates that increase over the duration of the lease—to  encourage faster exploration and development of leases, or earlier  relinquishment when exploration is unlikely to be undertaken by the  lessee. Specifically, in 2007, Interior implemented escalating rental  rates for leases offered in less than 400 meters of water—and in  2009, for leases offered in at least 400 meters of water. Also, in  2009, Interior increased rental rates for new Gulf of Mexico leases in  all water depths. Interior estimated that the increased rental rates and  escalating rent rates in water depths greater than 400 meters would  result in five fewer lease tracts receiving bids but an increase in rental  revenue of $57 million over the initial lease term for leases resulting  from that sale. $27 million of this $57 million was attributed to the  increase in base rental rates. In addition, the increased rental rates  did not appear to reduce the number of lease blocks to be explored,  according to Interior documents.
Increased minimum bids.  In 2011, Interior increased the minimum bid  for leases offered in at least 400 meters of water in the Gulf of Mexico  to $100 per acre, up from $37.50 per acre. According to Interior’s  Proposed Final Outer Continental Shelf Oil & Gas Leasing Program  2012-2017, the minimum bid was raised, in part, to account for  increases in oil prices and to encourage optimal timing of leasing.  Interior officials told us that a review of the minimum bid was initiated  because the minimum bid had not been changed in some time. In  addition, Interior analysis showed that a minimum bid of $100 per acre  would be generally equivalent to the cost of the minimum bid in the  past, going back to 1999, adjusted for differences in prices, costs, and  royalty rates.
For details on the recent history of lease terms in the Gulf of Mexico, see  table 1; changes in lease terms are highlighted in gray.
Interior has also taken actions to encourage the development of oil and  gas resources, which reduces the time from when federal leases are  issued and the federal government receives its share of revenue from  them, in response to our October 2008 recommendation that the  Secretary of the Interior develop a strategy to evaluate options to  encourage faster development of its oil and gas leases. Specifically, in  2010, Interior shortened lease terms by reducing the duration of the initial  period for Gulf of Mexico leases in water depths of 400 to less than 800  meters from an 8-year initial period to a 5-year initial period. For water  depths of 800 to less than 1,600 meters, it reduced leases from a 10-year  initial period to a 7-year initial period. According to Interior documents,  these lease terms can generally be extended if the lessee begins drilling  a well during the initial period.
For onshore resources, Interior has considered, but not made, changes to  onshore lease terms in order to provide greater assurance that the public  is getting a fair return on federal oil and gas resources. Interior acts on  behalf of the American people to manage the federal oil and gas system  to ensure a fair return to the public for the development of oil and gas  resources. Interior officials told us that since 2009 the department has  been considering increasing the onshore royalty rate—which is currently  established in its regulations at 12.5 percent for both oil and gas.  According to the officials, several factors prompted efforts to consider  changing the royalty rates, including our September 2008 report, oil and  gas prices, and Office of Management and Budget initiatives calling for  increased revenue from onshore royalties. Although both onshore and  offshore leasing programs are subject to many of the same market  conditions, Interior officials are currently unable to make timely  adjustments to onshore royalty rates because BLM’s regulations  generally establish a set royalty rate of 12.5 percent. This limits the  bureau’s flexibility because making adjustments to that rate require going  through the rulemaking process, and the process can take several years  according to Interior officials. Specifically, officials said that the public  notice and comment period required as part of the rulemaking process  could take 1 to 2 years, and proposed rules must also undergo review by  the Office of Management and Budget.
Interior officials told us that the department planned to publish a notice of  proposed rulemaking in July 2012 to change BLM’s regulations to set an  onshore royalty rate of 18.75 percent for oil production on new federal  competitive leases but leave the royalty rate for gas production  unchanged at 12.5 percent. The planned regulatory revisions would have  allowed the Secretary to review and revise royalty rates for new  competitive leases as appropriate—similar to the authority that the  Secretary has for revising offshore royalty rates. Officials told us that  including the requirement for periodic review and revision of royalty rates  would have given the Secretary greater flexibility to go forward with such  reviews and revisions in the future.
Interior discontinued its efforts to pursue the revised regulations because,  according to Interior officials, the department does not have enough  information to determine how to adjust onshore royalty rates. Rather,  Interior plans to ask the public to comment on whether and how royalty  rates for new federal onshore competitive oil and gas leases should be  revised to better ensure a fair return to the public. Specifically, Interior  officials told us they plan to ask for comments on the types of royalty rate  structures that should be considered, such as whether BLM should  develop a uniform rate for all leases or different rates by region, state,  geologic formation, or resource type. Furthermore, Interior officials told us  they would also ask for comments on whether sliding scale royalty  rates—or rates that vary with the price of the commodity—might be  appropriate in specific circumstances. An Advance Notice Of Proposed  Rulemaking is under development, but officials told us that higher priority  rulemaking initiatives, such as regulations for hydraulic fracturing and  revisions to its oil and gas measurement regulations, precede it and that  limited resources constrain their ability to meet program demands. As a  result of not successfully changing federal regulations to provide itself  with the flexibility needed to make timely adjustments to onshore lease  terms, Interior’s ability to ensure that the public is receiving a fair return is  limited. Moreover, Interior continues to offer onshore leases with lease  terms—terms lasting the life of the lease—that have not been adjusted in  response to changing market conditions, potentially foregoing a  considerable amount of revenue. For example, in 2011, Interior estimated  that onshore royalty rate changes could increase revenue collections by  about $1.25 billion over 10 years.
Interior contracted for several studies—including a study of how the  federal oil and gas fiscal system compared with fiscal systems of other  resource owners—that reviewed various aspects of the federal oil and  gas fiscal system since 2007. In our September 2008 report, we found  that Interior collected a lower government take for oil and gas production  in the deep water of the U.S. Gulf of Mexico than all but 11 of 104 oil and  gas resource owners whose revenue collection systems were evaluated  in a comprehensive industry study, which included other countries as well  as some states. We also found that Interior had not routinely evaluated  the federal oil and gas fiscal system, monitored what other governments  or resource owners were receiving for their resources, or evaluated and  compared the attractiveness of federal lands and waters for investment  with that of other regions. In response to our 2008 findings, Interior  contracted for a study—the 2011 Comparative Assessment of the Federal  Oil and Gas Fiscal System study—that compared the federal oil and gas  fiscal systems of selected federal oil and gas regions to that of other  resource owners. In addition, Interior contracted for two other studies on  the effect of different leasing and royalty rate policies on revenue,  exploration, and production. See table 2 for a description of these studies.
According to Interior officials, the study conducted in response to our  2008 findings—the 2011 Comparative Assessment of the Federal Oil and  Gas Fiscal System—provided some useful information about the fiscal  system such as how fiscal terms in the United States compared with other  resource owners, but it has not directly led to any changes to the fiscal  system or lease terms for new federal oil and gas leases. Similarly,  Interior officials told us that the other two studies have not yet led to  revisions to the fiscal system or lease terms for new offshore or onshore  leases. Rather, according to officials, additional internal analyses and  modeling, as well as consultation with stakeholders—including oil and gas  companies and the public—will continue to primarily inform future  changes to the fiscal system. Moreover, Interior did not document any  internal discussions or analysis of the three studies’ findings. As part of  the 2011 Comparative Assessment of the Federal Oil and Gas Fiscal  System study, officials said that they obtained a model that can be  employed in the future to conduct comparative analyses but currently  have no plans to update the model or the data inputs used by the model.  Officials told us that the study’s findings reassured them that their own  internal assessment related to the competitiveness of the offshore fiscal  system was appropriate. In addition, officials said that the study provided  additional information—mainly raising the issue of whether an appropriate  return was being received for onshore resources—but that the study was  not adequate to determine next steps for onshore lease terms.
Interior is examining potential regulatory changes that could simplify  royalty payments and collections. As we found in our past work,  complex valuation regulations can result in inaccurate royalty payments  made by industry, and this could increase ONRR’s costs to ensure  accurate royalty payments because of the need for potentially detailed  and time-consuming audits of records. In May 2011, Interior published an  Advance Notice Of Proposed Rulemaking requesting comments to inform  potential changes to regulations intended to simplify royalty payments  and collections. In addition to our work, others have identified numerous  shortcomings in ONRR’s royalty collection programs, in part because of  its valuation regulations’ complex requirements for calculating the value of  oil and gas and associated deductions and allowances for activities such  as transportation.
In December 2007, Interior’s Subcommittee on Royalty Management  recommended that, by the end of fiscal year 2008, Interior publish  proposed revisions to the gas valuation regulations to, among other  goals, simplify the calculation of royalties and deductions for gas  transportation and processing. Interior did not meet this time frame due to  several factors including the complexity of oil and gas valuation,  according to Interior officials. In May 2011, Interior published the Advance  Notice Of Proposed Rulemaking in the Federal Register for the proposed  rule, which according to Interior documents is intended, in part, to provide  greater simplicity, certainty, clarity, and consistency in production  valuation; decrease ONRR’s costs to ensure compliance; decrease  industry’s compliance costs; and provide more certainty to ONRR and  industry that companies pay every dollar due to the government.  According to ONRR officials, the proposed regulations were undergoing  internal review as of September 2013 and are expected to be published in  the Federal Register in 2014.
section_title: Interior Does Not Have Documented Procedures for Conducting Periodic Assessments of the Fiscal System or for Supporting Potential Changes to New Lease Terms
paragraphs: Interior does not have documented procedures in place for determining  (1) when to conduct periodic assessments of the overall fiscal system or  (2) whether and how to make changes to lease terms for new offshore  leases.
Interior does not have documented procedures in place for determining  when to periodically conduct assessments of the overall fiscal system as  a whole. Although Interior recently contracted for such an assessment, it  was the first in well over 25 years. Without documented procedures,  Interior cannot ensure that it will consistently conduct such assessments  in the future, and without periodically conducting such assessments,  Interior cannot know whether there is a proper balance between the  attractiveness of federal leases for investment and appropriate returns for  federal oil and gas resources, limiting Interior’s ability to ensure a fair  return on federal oil and gas resources. Internal control standards in the  federal government call for agencies to clearly document internal controls  and the documentation is “to appear in management directives,  administrative policies, or operating manuals.” Documented procedures  of when Interior is to conduct such assessments—whether within specific  time frames or the occurrence of certain market or industry changes— could help provide the department with reasonable assurance that its staff  knows when to conduct assessments of the overall fiscal system to help  ensure those reviews are conducted systematically and consistently.
In our September 2008 report, we found that the last time Interior  conducted a comprehensive assessment of the federal oil and gas fiscal  system was over 25 years ago. Additionally, we reported that, without  routinely evaluating the federal oil and gas system as a whole, including  monitoring what other resource owners worldwide are receiving for their  energy resources or evaluating and comparing the attractiveness of the  United States for oil and gas investment with that of other oil and gas  regions, Interior cannot provide reasonable assurance that the public is  getting an appropriate share of revenues. As mentioned previously, in  response to our 2008 findings, Interior contracted for a study that  compared the federal oil and gas fiscal system to that of other resource  owners. As part of this study, officials said that they obtained a model that  can be employed in the future to conduct comparative analyses; however,  there are currently no plans to update the model or the data inputs used  by the model. Interior officials told us that this type of comprehensive  assessment would only be undertaken if fundamental shifts in the market  occurred. According to officials, however, Interior does not have  procedures or criteria in place for determining when such an assessment  of the fiscal system should take place or what changes in the market or  industry would signal that such a study should be done. Without  procedures for determining when to conduct periodic assessments of the  fiscal system as a whole, Interior cannot be reasonably assured that it will  consistently conduct such assessments in the future, limiting its ability to  be confident that the system is ensuring a fair return on federal oil and  gas resources. According to the Office of Management and Budget,  rigorous program evaluations can help determine whether government  programs are achieving their intended outcomes to the extent possible.
Moreover, Interior’s oversight of federal land and waters is subject to the  federal government’s multiple, diverse objectives—fair return, protection  of historical and environmental resources, and expeditious and orderly  development, among other goals. Thus, Interior is confronted with  evaluating these objectives in light of a complex set of factors—including  market prices and how development opportunities in the United States  compare with those of other resource owners. By having documented  procedures, the department could help ensure that its evaluations take all  of these factors into consideration. Further, these factors may change  over time as the market for oil and gas changes, the technologies used to  explore and produce oil and gas change, or as the broader economic  climate changes, making it even more important that Interior has  documented procedures for conducting periodic assessments of the  federal oil and gas fiscal system.
In addition, Interior has conducted some analyses to support changes to  offshore lease terms in advance of offshore lease sales, which typically  occur a few times a year—but the analyses conducted to support these  changes are not a substitute for periodically assessing the oil and gas  fiscal system as a whole. Since 2007, Interior has conducted some  analyses for offshore lease sales in support of changes to royalty rates,  rental rates, and the minimum bid. Based on our review of Interior  documents from several lease sales from 2007 to 2011, we found that the  analyses the department conducted to support proposed changes to  offshore lease terms generally involved estimating the impacts of a  proposed change on revenue, bidding activity, and potential oil and gas  production. In addition, Interior’s documentation shows that the  department took into consideration technological and market conditions;  policy goals, such as promoting development or enhancing revenues; and  administrative benefits, such as making lease terms consistent across  water depths. However, these analyses did not include an evaluation of  what other resource owners worldwide are receiving for their energy  resources or a comparison of the attractiveness of the United States for  oil and gas investment with that of other oil and gas resource owners. In  our September 2008 report, we suggested that Congress should consider  directing the Secretary of the Interior to establish procedures for  periodically collecting data and information and conducting analyses to  determine how the federal government take and the attractiveness for oil  and gas investors in each federal oil and gas region compare with those  of other resource owners and report this information to Congress.  Moreover, Interior has not conducted similar analysis for onshore lease  sales. Interior officials explained that the mechanism for determining the  value of onshore resources is directed by statute to be market-driven.  Specifically, officials stated that fair market value for onshore lease sales  is determined through the oral competitive bidding process required by  the Mineral Leasing Act, rather than an evaluation of the geology and  potential value of the oil and gas resource. Because the leasing process  is established by statute, Interior officials told us that it has not recently  examined whether alternative leasing systems might be more effective in  ensuring fair market value.
Interior does not have documented procedures for determining whether  and how to make changes to new offshore lease terms—which are  specified a few times per year ahead of each lease sale—consistent with  federal standards for internal control. Without documented procedures for  determining whether and how to make changes to new offshore lease  terms, Interior is at risk of making inconsistent determinations about lease  terms. Such inconsistent determinations would undermine its credibility  and its ability to better ensure a fair return on oil and gas resources.  Officials told us Interior does not have documented procedures or criteria  for determining whether and how to make changes to offshore lease  terms. Rather Interior officials said that they follow an informal process  and establish offshore lease terms for each sale but that they do not have  the time or resources to evaluate each lease term prior to each lease  sale. However, based on our review of Interior documents, the analyses  the department conducted to support proposed changes to offshore lease  terms were inconsistent in the array of conditions and factors the  department considered, and the level of analysis conducted in support of  decisions to change lease terms varied and was not consistently or  clearly documented. For example, as mentioned previously, escalating  rental rates were implemented in two different sales—first, in 2007, in  water depths less than 400 meters and then, in 2009, in water depths  greater than 400 meters. The rationale provided for the first change was  the policy goal to expedite drilling and compensate Interior, while the  rationale in 2009 included specific estimates of the effects of an  escalating rental rate on potential revenue and bidding, as well as  consideration of market conditions. While both justifications may be  warranted, because Interior does not have documented procedures  specifying whether and how to support changes to its lease terms,  Interior’s approach to revising its lease terms appears to be inconsistent.
In addition, our review of documents supporting two separate royalty rate  changes in 2007 and 2008—the first in 25 years—found that Interior did  not consistently document the justifications and analysis supporting the  increases. Specifically, Interior documents for the 2008 royalty rate  increase cite reasons similar to the 2007 royalty rate increase—generally  significant changes in market conditions—but because the second  increase took place less than a year after the implementation of the first  increase, it is unclear what significant changes in market conditions  occurred to prompt the consideration of the second increase in royalty  rates. Internal control standards in the federal government call for  agencies to clearly document transactions and other significant events  and that documentation should be readily available for examination.  While both royalty rate increases may have been warranted, clear  documentation of the justifications and analysis supporting royalty rate  increases would make Interior’s decisions to change the royalty rates  transparent and could inform future decision making related to changing  rates. Such transparency can be particularly helpful in the event that key  staff retire or leave federal service. Documentation of internal discussions  that took place prior to the second royalty rate increase show that prior to  being able to assess the impacts of increasing the royalty rate from 12.5  percent to 16.67 percent in 2007, Interior was considering an additional  royalty rate increase. In addition, Interior documents show Interior  program officials’ concerns about an additional increase in royalty rates;  specifically, officials urged the need to analyze the impact of the first  increase, and they also noted potential negative effects of an increase  including delaying investment and production in certain areas of the Gulf  of Mexico. By having documented procedures for determining whether  and how to make future changes to offshore leasing terms, Interior could  increase its consistency and thus enhance its credibility in the conditions  and factors the department considered and the level of analysis  conducted.
section_title: Conclusions
paragraphs: Interior has taken several steps intended to help ensure that the public  receives a fair return on oil and gas produced from federal leases.
However, even with these recent steps, it is not clear that Interior’s  efforts, by themselves, provide long-lasting assurance that federal  resources will provide a fair return. This is especially true in light of the  absence of documented procedures for Interior to determine when it will  periodically conduct assessments of the overall federal oil and gas fiscal  system and whether and how to make changes to new offshore lease  terms, as well as Interior’s limited flexibility to make changes to new  onshore lease terms. Ensuring that the federal government is obtaining  fair return for the resources it manages on behalf of its citizens is  especially important as the country faces ongoing fiscal challenges.
Although leasing programs for both onshore and offshore areas are  subject to many of the same market conditions, and Interior has  increased offshore royalty rates, officials overseeing onshore leasing are  currently unable to make timely adjustments to onshore royalty rates  because, in general, BLM’s regulations fix the rate at 12.5 percent,  potentially limiting Interior’s ability to ensure that the public is receiving a  fair return and potentially resulting in foregone revenue. In particular,  while Interior has changed offshore lease terms several times over the  past few years in response to changes in market conditions—many of  which also affect onshore areas—to better ensure a fair return, Interior  has not successfully changed BLM’s regulations to provide itself with the  flexibility needed to change onshore lease terms in a timely manner  despite considering increasing the onshore royalty rate since 2009. As a  result, Interior continues to offer onshore leases with lease terms—terms  lasting the life of the lease—that have not been adjusted in response to  changing market conditions, potentially foregoing a considerable amount  of revenue.
Key among Interior’s efforts to ensure a fair return, to address a GAO  recommendation, Interior completed an assessment—the Comparative  Assessment of the Federal Oil and Gas Fiscal System—which examined  how the fiscal system of selected federal oil and gas regions compared  with fiscal systems of other resources owners.  Interior officials told us,  however, that it has no plans to update the assessment, increasing the  risk that this progress may be fleeting and that, as we found in 2008, it  could be years before another assessment is completed during which  time there could be significant changes in market conditions.  Furthermore, without documented procedures in place for conducting  periodic assessments of the fiscal system—such as when such an  assessment of the fiscal system should take place or what changes in the  market or industry would signal that such a study should be done, Interior  cannot know whether there is a proper balance between the  attractiveness of federal leases for investment and appropriate returns for  federal oil and gas resources, limiting Interior’s ability to ensure a fair  return.
Finally, while Interior has made changes to its offshore lease terms, for  example increasing royalty rates in some instances from 12.5 percent to  18.75 percent, Interior does not have documented procedures for  determining whether and how to make changes to lease terms for new  offshore leases. Without such documented procedures, Interior’s rationale  is not transparent, and it is at risk of making inconsistent determinations  about lease terms. Such inconsistency would undermine its credibility and  ability to better ensure a fair return on oil and gas resources. Additionally,  Interior has not clearly documented the justifications and analysis  supporting changes to lease terms, including royalty rate increases. As a  result, the department’s decisions to change lease terms are not  transparent and, without documentation of these decisions, its future  efforts to change rates may be impeded.
section_title: Recommendations for Executive Action
paragraphs: To better ensure that the government receives a fair return on its oil and  gas resources, we recommend that the Secretary of the Interior take the  following three actions:
Take steps, within existing authority, to revise BLM’s regulations to  provide for flexibility to the bureau to make changes to onshore royalty  rates, similar to that which is already available for offshore leases, to  enhance Interior’s ability to make timely adjustments to the terms for  federal onshore leases.
Establish documented procedures for determining when to conduct  periodic assessments of the overall fiscal system. Such procedures  should identify generally when such an assessment should be done or  what changes in the market or industry would signal that such an  assessment should be done. Additionally, the assessment should  include determining how the government’s share of revenue from the  federal oil and gas fiscal system and the attractiveness for oil and gas  investors in each federal oil and gas region compare with those of  other resource owners.
Establish documented procedures for determining whether and how to  adjust lease terms for new offshore leases, including documenting the  justification and analysis supporting any adjustments.
section_title: Agency Comments
paragraphs: We provided a draft of this report to Interior for review and comment.  Interior generally agreed with our findings and concurred with our  recommendations.
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 the  Secretary of the Interior, the appropriate congressional committees, and  other interested parties. In addition, this report will be available at no  charge on the GAO website at http://www.gao.gov.
If you or your staff members 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 of this report. GAO staff members who made major  contributions to this report are listed in appendix II.
section_title: Appendix I: Comments from the Department of the Interior
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Jon Ludwigson (Assistant  Director), Janice Ceperich, Glenn Fischer, Cindy Gilbert, Michael Kendix,  Alison O’Neill, Dan Royer, Kiki Theodoropoulos, and Barbara Timmerman  made key contributions to this report.