Oil and Gas Management: Federal Oil and Gas Resource Management and Revenue Collection In Need of Stronger Oversight and Comprehensive Reassessment
Published: 2009-04-02T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In fiscal 2008, the Department of the Interior (Interior) collected over $22 billion in royalties and other fees related to oil and gas. Interior's Bureau of Land Management (BLM) and Minerals Management Service (MMS) manage federal onshore and offshore oil and gas leases, respectively. Acquiring a federal lease gives the lessee the rights to explore for and develop the oil and gas resources under the lease, including drilling wells and building pipelines that may lead to oil and gas production. This statement focuses on findings from a number of recent GAO reports on federal oil and gas management. GAO has made numerous recommendations to Interior, which the agency generally agreed with and is taking steps to address. However, two important issues remain unresolved. Specifically, GAO made one recommendation and one matter for Congressional consideration that together call for a comprehensive reevaluation of how Interior manages federal oil and gas resources. Interior has not undertaken such a comprehensive review and until this is done, the public cannot have reasonable assurance that federal oil and gas resources are being appropriately managed for the public good.
section_title: What GAO Found
paragraphs: In recent years, GAO has conducted numerous evaluations of federal oil and gas management and found many material weaknesses. Specifically: In September 2008, we reported that (1) Neither BLM nor MMS were meeting statutory obligations or agency targets for conducting inspections of certain leases and metering equipment used to measure oil and gas production. (2) MMS's royalty IT system and processes lacked several important capabilities, including monitoring adjustments made by companies to their self-reported production and royalty data and identifying missing royalty reports in a timely manner. (3) MMS's use of compliance reviews, which are more limited in scope than audits, led to an inconsistent use of third-party documents to verify that self-reported industry data are correct. (4) MMS's annual reports to the Congress did not fully describe the performance of the royalty-in-kind program and, in some instances, may have overstated the benefits of the program. (5) The federal government receives one of the lowest shares of revenue for oil and gas resources compared with other countries and Interior has not systematically re-examined how the federal government is compensated for extraction of oil and gas for over 25 years. In October 2008, we reported that (1) Some states do more than Interior to structure leases to reflect the likelihood of oil and gas production, which may encourage faster development. In June 2005, we reported that (1) BLM has encountered persistent problems in hiring and retaining sufficient and adequately trained staff to keep up with workload as a result of rapid increases in oil and gas operations on federal lands and poor workforce planning. In recent reports, GAO has made a number of recommendations to improve the accuracy of royalty measurement and collections and the overall management of federal oil and gas resources. Interior generally agreed with our recommendations and is trying to implement them but implementation is ongoing and it is too early to assess the effectiveness these efforts.

section_title: Letter
paragraphs: We appreciate the opportunity to participate in this hearing to discuss the  Department of the Interior’s management of federal oil and gas leases. In  fiscal year 2008, the Department of the Interior (Interior) collected over  $22 billion in royalties for oil and gas produced on federal lands and  waters, purchase bids for new oil and gas leases, and annual rents on  existing leases, making revenues from federal oil and gas one of the largest  nontax sources of federal government funds. Within Interior, the Bureau  of Land Management (BLM) manages onshore federal oil and gas leases  and the Minerals Management Service’s (MMS) Offshore Energy and  Minerals Management (OEMM) manages offshore leases, while MMS is  responsible for collecting royalties for all leases. In recent years, GAO and  others, including Interior’s Inspector General, have conducted numerous  evaluations of federal oil and gas management and revenue collection  processes and practices and have found many material weaknesses. These  weaknesses place an unknown but significant proportion of royalties and  other oil and gas revenues at risk and raise questions about whether the  federal government is collecting an appropriate amount of revenue for the  rights to explore for, develop, and produce oil and gas on federal lands and  waters. Specifically, our recent work has found the following:  On September 12, 2008 we reported that
Neither BLM nor OEMM were meeting statutory obligations or agency  targets for conducting inspections of certain leases and metering  equipment used to measure oil and gas production, raising uncertainty  about the accuracy of oil and gas measurement. Specifically, although  BLM and OEMM are statutorily required to annually inspect leases  “producing significant quantities of oil and gas” and those with a  “history of noncompliance”, according to BLM staff, they are not  completing all the inspections required by law and agency policy, in  part because their workload has substantially grown because of  increased onshore drilling.  Similarly OEMM is not meeting its agency  targets for inspections because, according to OEMM staff, inspectors  are still conducting cleanup activities in the Gulf of Mexico--where  almost all of the offshore oil and gas production occurs-- in the wake  of Hurricanes Katrina and Rita. Finally, neither BLM nor OEMM were  consistently and accurately recording data to document the production  inspections that were completed.
MMS’s royalty IT system cannot yet monitor adjustments made to  production and royalty data by companies. While MMS is working to  address this issue, companies may continue to adjust their previously self- reported production and royalty data without prior MMS approval or  review. This includes adjustments made by companies to data after MMS  completes audit work, meaning that while the royalties paid were accurate  at the close of an audit, they may not remain so. Furthermore, MMS is  unable to identify instances, in a timely manner, in which a royalty report  has not been submitted by a company and, as a result, MMS cannot be  entirely confident that it is receiving all the royalties when they are due.  Finally, MMS lacks a clear process to determine that royalties are  accurately paid in instances when OEMM or BLM identify volume  discrepancies during their production inspections and verification work.  For example, when BLM identifies an over- or underreporting of  production volumes, BLM notifies the production reporting section of  MMS. While MMS staff may work to correct the production numbers, staff  do not relay this information to the royalty reporting section so that staff  can check that the appropriate royalties were paid.
While MMS continues to strengthen its compliance efforts, MMS’s use of  compliance reviews, which are more limited in scope than audits, has led  to an inconsistent use of third-party documents to verify that self-reported  industry production and payment data are correct, thereby placing royalty  collections at risk. MMS has historically relied on audits to determine  whether a company accurately paid its royalties by examining third-party  documents that contained information on prices, volumes, and deductions.  More recently, MMS has relied more heavily on compliance reviews, which  assess whether the royalties paid by a company are reasonable, and do not  always include an examination of third-party documents. Furthermore,  while MMS’s compliance reviews of offshore leases include a systematic  comparison between a company’s reported production volumes and  independent pipeline company documents, an analogous process does not  exist for onshore leases. The absence of a consistent check on self- reported data—such as comparing the data with third party documents— when conducting onshore compliance reviews raises questions about the  accuracy of royalty payments.
On September 26, 2008 we reported that     Under the royalty-in-kind program, MMS's oversight of its natural gas  production volumes is less robust than its oversight of oil production  volumes. As a result, MMS does not have the same level of assurance that  it is collecting the gas royalties it is owed. For instance, for oil, MMS  compares companies' self-reported oil production data with third-party  pipeline meter data from OEMM's liquid verification system, which  records oil volumes flowing through pipeline metering points. Using these  third-party pipeline statements to verify production volumes reported by  companies provides a check against companies' self-reported statement of  royalty payments owed to the federal government. While analogous data  are available from OEMM's gas verification system, MMS does not use  these third-party data to verify the company-reported production numbers.
MMS's annual reports to the Congress do not fully describe the  performance of the royalty-in-kind program and, in some instances, may  overstate the benefits of the program. For example, MMS's calculation that  from fiscal years 2004 to 2006 MMS sold royalty oil and gas for $74 million  more than it would have received in cash was based on assumptions, not  actual sales data, about the prices at which royalty payors would have sold  their oil or gas had they sold it on the open market. MMS did not report to  the Congress that even small changes in these assumptions could result in  very different estimates. Also, MMS's calculation that the royalty-in-kind  program cost about $8 million less to administer than the royalty-in-value  program over the same period did not include certain costs, such as  information technology costs shared with the royalty-in-value program,  that would likely have changed the results of MMS's administrative cost  analysis. In addition, these annual reports lacked important information on  the financial results of individual oil sales that the Congress could use to  more broadly assess the performance of the royalty-in-kind program.
On October 3, 2008 we reported thatInterior does less to encourage development of federal oil and gas leases  than some state and private landowners. Interior officials cited one lease  provision that may encourage development––escalating rental rates. For  example, the rental rates for 10-year onshore federal leases increase from  $1.50 per acre per year for the first 5 years to $2 per acre per year for the  next 5 years. Compared to Interior, the eight states we reviewed  undertook more efforts to encourage development on their oil and gas  leases, using increasing rental rates as well as shorter lease terms and  escalating royalty rates. Some states also do more than Interior to  structure leases to reflect the likelihood of oil and gas production, which  may encourage faster development. Specifically, while Interior uses  varying lengths for offshore leases, with deeper waters receiving longer  lease terms, this provision is not explicitly related to the expected  productivity of the lease. On the other hand, five of the states that we  reviewed—Alaska, Louisiana, Montana, New Mexico, and Texas—vary  lease lengths or royalty rates to reflect the likelihood that the lease will  produce. We also found that private landowners have used various leasing  methods to encourage faster development, including lease terms as short  as 6 months.
The annual number of federal oil and gas leases issued and the pace of  development have generally increased in recent years. Over the past 20  years, the total number of oil and gas leases Interior issued has varied each  year but generally increased in recent years, as has the amount of  development activity, and industry officials told us that a range of factors  influence their decisions to acquire and develop leases. The number of  offshore leases issued annually from 1987 through 2006 had two large  peaks—in 1988 and 1997—and has generally been increasing since 1999.  Onshore leases peaked in 1988 and then declined until about 1992,  remaining at these lower levels until about 2003 when they increased,  coinciding with rising oil and historically higher natural gas prices. Drilling  and production activity on federal leases was higher from 1997 through  2006 than from 1987 through 1996, but the increase was more dramatic for  onshore leases. Industry officials told us that several factors influence  their decisions to acquire and develop federal oil and gas leases, including  oil and gas prices; the availability and cost of equipment; the geology of  the land underlying the lease; and regulatory issues, such as limitations on  when drilling can occur.
Development and production activity in a sample of leases issued from  1987 through 1996 varied considerably. We reviewed data on about 55,000  offshore and onshore federal leases issued from 1987 through 1996––those  that have exceeded their primary 10-year lease terms. We then tracked  development activity on that sample of leases through 2007 to determine  what, if any, development activity occurred, and at what point in time. We  identified three key findings regarding development. First, development  occurred at some point during the period 1987-2007 on about 26 percent of  offshore and 6 percent of onshore leases in the sample. Production was  less frequent, with about 12 percent of offshore leases and 5 percent of  onshore leases ultimately achieving production. Second, shorter leases  were generally developed more quickly than longer leases, but not as  frequently during the term of the lease. Finally, for those leases that  eventually produced oil or gas, a substantial amount of the initial drilling  activity—about 25 percent onshore—took place after the scheduled  expiration of the lease, following a lease extension.
MMS and BLM employ different practices for deciding which federal  properties to lease and when, determining the initial length of the lease,  and determining the price at which the leases are sold. In addition, some  states and private resource owners use more tools than the federal  government, including incentives for early development or penalties for  later development, to encourage rapid development, particularly of leases  that are deemed to be likely to contain significant oil and gas resources. In  this regard, we found that Interior could do more to encourage faster  development of certain federal oil and gas leases that are relatively more  likely to have significant oil and gas resources.
On September 3, 2008 we reported that  The federal government receives one of the lowest shares of revenue for  oil and gas resources compared with other countries. For this and other  reasons, the United States is an attractive country for investment in oil and  gas development. Specifically, in 2007, the revenue share that the federal  government collects on oil and gas produced in the Gulf of Mexico ranked  93rd lowest of 104 revenue collection regimes around the world that were  studied. However, despite significant changes in the oil and gas industry  over the past several decades, Interior has not systematically re-examined  how the federal government is compensated for extraction of oil and gas  for over 25 years. In contrast, some other countries have recently  increased their shares of revenues as oil and gas prices rose and, as a  result, will collect between an estimated $118 billion and $400 billion,  depending on future oil and gas prices.
On June 5, 2008 we reported thatIn 1995, a time when oil and natural gas prices were significantly lower  than they are today, Congress passed the Outer Continental Shelf Deep  Water Royalty Relief Act (DWRRA), which authorized MMS to provide  “royalty relief” on oil and gas produced in the deep waters of the Gulf of  Mexico from certain leases issued from 1996 through 2000. This “royalty  relief” waived or reduced the amount of royalties that companies would  otherwise be obligated to pay on the initial volumes of production from  leases, which are referred to as “royalty suspension volumes.” We recently  reported that litigation over this royalty relief for deep water leases sold  between 1996 and 2000 could cost the public in the range of $21 billion to  $53 billion in forgone revenue over the next 25 years, depending on how  much oil and gas is eventually produced on these leases and the prices at  which the oil and gas is sold.
Finally, on June 17, 2005 we reported that  BLM has encountered persistent problems in hiring and retaining  sufficient and adequately trained staff to keep up with an increasing  workload as a result of rapid increases in oil and gas operations on federal  lands. For example, between 1999 and 2004, when applications for permits  to drill more than tripled, BLM was unable to keep up with the  commensurate increase in its workload, in part, as result of an ineffective  workforce planning process, the lack of key data on workload activities,  and a lack of resources. As a result of this staffing shortfall, BLM was  unable to meet its requirements to mitigate environmental impacts of oil  and gas development. More recently, we reported that BLM’s inability to  attract and retain sufficient trained staff have kept the agency from  meeting requirements to inspect drilling and production of oil and gas on  federal lands. This puts federal revenues at risk because when inspections  are made, violations have been found, including errors in the volumes of  oil and gas reported by operators to MMS.
In response to recommendations made by GAO, the Department of the  Interior’s Inspector General, and others, Interior has put into place a wide- ranging plan to significantly modify its current practices. We acknowledge  Interior’s efforts to change and improve many of its current practices as an  important first step to address material weaknesses in the existing system.  For example, OEMM plans to have definitions for leases having  “significant production” and a “history of non-compliance” by November,  2009. Additionally, MMS is developing a system to assist in monitoring  adjustments made by companies to previously entered self-reported  royalty data, and plans to have the system finalized in early 2010. However,  we remain concerned that Interior may lack the resources and skills to  simultaneously address significant changes in its practices while  effectively meeting its routine responsibilities. If steps are not taken to  effectively manage these challenges, the agency may face a decline in staff  morale, continued employee turnover at its senior levels, and ongoing  challenges hiring qualified new staff, further putting federal revenues at  risk.
More importantly, we believe that Interior needs to fundamentally  reexamine the way in which federal oil and gas resources are managed.  Specifically, we recommended that Interior develop a strategy to  encourage faster development of oil and gas leases on federal lands for  those leases deemed to be more likely to produce oil and gas. In  developing this strategy, Interior could benefit from evaluating alternative  leasing practices used by some states and private land owners, as well as  other countries, to determine what changes to federal leasing practices  and the law are needed to speed up development of some specific leases  that are likely to be highly productive. While Interior generally agreed with  our recommendation and is looking at some of these issues in a study, we  do not believe Interior’s study is sufficiently comprehensive to meet the  needs we identified. As a result, we believe this puts at risk the agency’s  mission to effectively manage federal oil and gas resources in the public  interest.
In addition, we believe that a comprehensive reassessment of how much  revenue the federal government collects from oil and gas produced on  federal lands and waters, and in what manner, is long overdue, and we  recommended to Interior that it undertake such a reassessment in our  draft report, Oil and Gas Royalties: The Federal System for Collecting Oil  and Gas Revenues Needs Comprehensive Reassessment. However, in  commenting on this recommendation, Interior stated that such a  reassessment would be premature in light of a study the agency had under  way that was looking at some aspects of these issues. Because we believe  Interior’s ongoing study is too limited in scope and scale, in the final  report we proposed that Congress consider directing the Secretary of the  Interior to convene an independent panel to perform a comprehensive  review of the federal system for collecting oil and gas revenue. In the event  that the Secretary of the Interior convenes a panel, the panel and Interior  should utilize available information about the share of oil and gas revenues  that other resource owners, including states and other countries, collect  and the ways in which they structure these collections to create more  stable investment environments in their oil and gas industries. Until this  comprehensive reassessment is undertaken and completed, the federal  government will not have reasonable assurance that it is collecting an  appropriate share of revenue from oil and gas produced on federal lands  and waters.
Mr. Chairman, this concludes my prepared statement. I would be pleased  to respond to any questions that you or other Members of the  Subcommittee might have.
subsections: section_title: GAO Contact and Staff Acknowledgement
paragraphs: For further information on this statement, please contact Frank Rusco at  (202) 512-3841 or ruscof@gao.gov. Contact points for our Congressional  Relations and Public Affairs offices may be found on the last page of this  statement. Other staff that made key contributions to this testimony  include, Divya Bali, Lee Carroll, Glenn C. Fischer, Jon Ludwigson, and  Barbara Timmerman.
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