Mineral Revenues: MMS Could Do More to Improve the Accuracy of Key Data Used to Collect and Verify Oil and Gas Royalties
Published: 2009-07-15T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In fiscal year 2008, the Department of Interior's Minerals Management Service (MMS) collected over $12 billion in royalties from oil and gas production from federal lands and waters. Companies that produce this oil and gas self-report to MMS data on the amount of oil and gas they produced and sold, the value of this production, and the amount of royalties owed. Since 2004, GAO has noted systemic problems with these data and recommended improvements. GAO is providing: (1) a descriptive update on MMS's key efforts to improve the accuracy of oil and gas royalty data; (2) our assessment of the completeness and reasonableness of fiscal years 2006 and 2007 oil and gas royalty data--the latest data available; and (3) factors identified by oil and gas companies that affect their ability to accurately report royalties owed to the federal government.
section_title: What GAO Found
paragraphs: MMS has several key efforts underway to improve the accuracy of the payor-reported data used to collect and verify royalties, but it is too soon to evaluate their effectiveness. MMS is in the process of implementing (1) GAO's past recommendations to help identify missing royalty reports and monitor payors' changes to royalty data; (2) recommendations from the Royalty Policy Committee--a group empanelled by the Secretary of the Interior to provide advice on managing federal and Indian leases and revenues--to improve edit checks, monitor the quality of natural gas, revise gas valuation regulations, and improve coordination with BLM; and (3) other efforts on adding specific edits for sales prices and identifying discrepancies in volumes between operators and payors. While much of the royalty data we examined from fiscal years 2006 and 2007 are reasonable, we found significant instances where data were missing or appeared erroneous. For example, we examined gas leases in the Gulf of Mexico and found that, about 5.5 percent of the time, lease operators reported production, but royalty payors did not submit the corresponding royalty reports, potentially resulting in $117 million in uncollected royalties. We also found that a small percentage of royalty payors reported negative royalty values, which cannot happen, potentially costing $41 million in uncollected royalties. In addition, payors claimed processing allowances 2.3 percent of the time for unprocessed gas, potentially resulting in $2 million in uncollected royalties. Furthermore, we found significant instances where payor-provided data on royalties paid and the volume and/or the value of the oil and gas produced appeared erroneous because they were outside of expected ranges. Oil and gas company representatives reported that several factors affect their ability to accurately report royalties, including complex land ownership, administratively combining leases into units, ambiguity in federal regulations that establish gas prices, short time frames for filing royalty reports, and inaccuracies in MMS's internal databases.

section_title: Letter
paragraphs: Royalties for oil and natural gas produced from federal lands and waters  are one of the country’s largest non-tax sources of revenue, accounting for  over $12 billion in collections during fiscal year 2008. The Department of  the Interior’s Minerals Management Service (MMS) is responsible for  collecting royalties from companies that produce oil and gas from almost  29,000 federal and Indian leases. Each month, these oil and gas companies  self-report to MMS data on the amount of oil and gas they produced and  sold, the value of this production, and the amount of royalties owed the  federal government. Over the past 5 years, GAO has found problems with  these data. These problems include missing data, errors in the self- reported amounts of oil and gas produced, self-reported oil and gas sales  value data that, given the reported volumes of oil and gas sold, appear at  odds with prevailing market prices for oil and gas, and a lack of controls  over changes to the data that companies report. Although data accuracy  was not the focus of our previous work, we recommended that MMS  correct some of these data.
Building on our prior work examining MMS’s royalty data, we are  providing (1) a descriptive update of MMS’s ongoing efforts to improve the  accuracy of oil and gas royalty data, (2) our assessment of the  completeness and reasonableness of fiscal years 2006 and 2007 oil and gas  royalty data, and (3) factors identified by oil and gas companies that affect  the ability of these oil and gas companies to accurately report royalties  owed to the federal government. We are addressing only cash royalty  payments; we have a separate engagement underway addressing issues  related to MMS’s Royalty-in-Kind Program—an option whereby MMS takes  a share of oil and gas produced on federal lands and waters in lieu of cash  royalty payments.
To describe MMS’s efforts to improve the accuracy of royalty data, we  reviewed and discussed with MMS officials their action plans to implement  recommendations made by GAO and Interior’s Royalty Policy Committee,  reviewed a demonstration of MMS’s Compliance Program Tool (CPT)—an  automated system that analyzes royalty payments—and discussed with  MMS officials their implementation of the CPT to systemically identify  misreported volumes and missing royalty reports. We made no attempt to  evaluate the effectiveness of MMS’s ongoing efforts to improve the  accuracy of royalty data because these efforts are not fully implemented.
To assess the completeness and reasonableness of fiscal years 2006 and  2007 oil and gas royalty data, we first analyzed MMS’s existing edit checks  and plans for modifying or adding new edit checks. In our subsequent  analyses, we replicated several of MMS’s edit checks but used a different  method. While MMS evaluates each royalty record individually, we  combined all royalty records submitted by a given payor for each month,  product type, and lease, thereby examining the cumulative effect of  changes to original royalty data. We then used our methodology to  evaluate 4.1 million royalty records for fiscal years 2006 and 2007 based on  extensive data reliability work conducted on two previous assignments. In  doing so, we developed a risk-based approach to identify and review key  aspects of data collection, processing, and reporting, and reviewed the  extent to which MMS’s royalty collection system fills those needs. We also  reviewed reports and testimonies on oil and gas royalties to understand  the historical problems associated with the royalty collection process, and  we interviewed key MMS staff and state and tribal auditors that work on  federal oil and gas leases to identify any continuing concerns with MMS’s  royalty reporting process.
To examine factors that oil and gas companies identified as limiting their  ability to accurately report royalties owed to the federal government, we  interviewed a non-random sample of oil and gas company representatives  from the 15 companies that report to MMS the highest amount of royalty  data and from the two largest national oil and gas industry associations.  The 10 companies that responded to our request for information represent  the major companies, large independent companies, mid-size independent  companies, and small independent companies. We chose to interview a  non-random sample because we lack the authority to compel private  companies to participate in such interviews and because we deemed the  cost of trying to convince a large enough sample to participate to make the  results statistically relevant to be greater than the benefits of being able to  make inferences from the sample interviews. As a result, our results for  this objective should not be viewed as a comprehensive list of reporting  difficulties or an evaluative assessment of the validity of all the elements  of the list. A detailed description of our scope and methodology appears in  appendix I.
We conducted this work from July 2008 to April 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 obtained  provides a reasonable basis for our findings and conclusions based on our  audit objectives.
subsections: section_title: Background
paragraphs: Companies that develop and produce oil and gas resources do so under  leases obtained from and administered by the Department of the Interior.  Interior’s Bureau of Land Management (BLM) manages onshore leases,  and Interior’s MMS manages offshore leases. MMS is responsible for  collecting the royalties on all federal and many Indian oil and gas leases.  Royalties on producing leases are a percentage of the value of the  production sold less deductions known as allowances. Together, BLM and  MMS are responsible for ensuring that oil and gas companies comply with  applicable laws, regulations, and policies for more than 29,000 producing  federal and Indian leases, which account for about 23 percent of  domestically produced gas and 26 percent of domestically produced oil.
In some cases, several companies form partnerships to explore and  develop oil and gas leases, thereby sharing the risk, the costs, and the  benefits. These companies often elect from among themselves a single  company, called the operator, to manage the physical drilling of wells and  the installation of production equipment. Operators report monthly to  MMS on the Oil and Gas Operations Report (OGOR) the amount of oil and  gas produced from each well on each lease. In addition, all the companies  that share the proceeds from the sale of oil and gas from federal lands and  waters are required each month to report to MMS on the Form MMS-2014  data about the oil and gas they sold. MMS refers to these companies,  including the operator, as royalty payors. The data on each Form MMS- 2014 are then stored in MMS’s system as a number of records, each of  which consists of many variables, such as the name of the payor, the lease  number, the amount of oil and gas sold (sales volume), the value of this oil  and gas (sales value), allowable deductions for transportation and  processing, and the amount of royalties owed (royalty value). Payors can  legally adjust these data they report for up to 6 years if, for example, they  learn that the data they submitted were incorrect. Almost all payors  submit these data electronically.
Within its 5-year business plan for fiscal years 2008 to 2012, MMS has set  an objective of ensuring timely and more accurate mineral revenue  reporting and payment. According to Interior’s 2009 Budget Justification,  MMS set goals in fiscal years 2008 and 2009 of ensuring that companies  report 98 percent of their data accurately the first time, up from actual  percentages of 97.4 in fiscal year 2006 and 97.3 in fiscal year 2007, and  compared to an actual percentage of 98.3 as reported by MMS for fiscal  year 2008. While we could not find a business entity that performed  identical services to those of MMS for comparing its accuracy of electronic  transactions, we chose the Internal Revenue Service (IRS) for comparison  because of the potential difficulty in interpreting complex tax regulations,  determining allowable deductions, and calculating taxes owed. To this  end, IRS reported in January 2008 that its electronic tax filers have a 99  percent accuracy rate—only slightly higher than the rates reported by  MMS. To help improve data accuracy, MMS subjects payor-reported  royalty data to over 140 edit checks. Specifically, MMS has incorporated  certain up-front edit-checks in its data acceptance tools that help detect  and reject erroneous payor-reported royalty data before MMS’s data  systems will accept them. MMS also incorporates a second level of edit  checks that review payor-reported data for additional errors after data are  accepted. Edit checks must comply with GAO standards for internal  controls in the federal government as required by 31 U.S.C. § 3512(c) and  (d), commonly referred to as the Federal Managers’ Financial Integrity Act  of 1982. These standards identify and address major performance  challenges and areas at greatest risk for fraud, waste, abuse, and  mismanagement. Furthermore, the standards state that automated edits  and checks should help control the accuracy and completion of  transaction processing.
Given the large amount of royalty revenues at stake and problems with  royalty management identified by past GAO, Interior Inspector General,  and other reports, MMS’s processes for ensuring the accurate collection of  royalties have been the subject of continuing scrutiny. For example, in  2003 while examining MMS’s Royalty-in-Kind program, we found that from  1.9 percent to 3.3 percent of the data that we examined for oil leases in  Wyoming and the Gulf of Mexico were erroneous or missing, and that 6  percent of the data that we examined for gas leases in the Gulf of Mexico  were anomalous, meaning that data values fell outside of expected  ranges. Similarly in 2004, we found that 40 percent of the royalty data that  we examined for 10 geothermal projects was either missing or erroneous. In 2006, we examined the relationship between the increases in oil and gas  prices from 2000 to 2005 and the amount of royalties collected during that  time and found that 8.5 percent of the data appeared anomalous. In 2008,  we reported that MMS’s royalty management system lacked several  capabilities that would provide greater assurance that royalties are  collected accurately. These capabilities include readily identifying  changes that companies make to previously entered data, detecting the  absence of royalty reports, and implementing a process for collecting the  proper amount of royalties when MMS identifies that oil and gas volumes  have been incorrectly reported. Among other things, we recommended  MMS identify when royalty reports have not been filed as required and  when companies make changes to data provided to MMS after the  statutory limitation on such changes. We also reported that MMS was  taking steps to address these deficiencies.
In addition to GAO’s work, Interior’s Inspector General (IG) analyzed  MMS’s auditing and compliance process and made several  recommendations in 2007 to improve these functions and the systems that  track them. Also, the Royalty Policy Committee (RPC)—a group  empanelled by the Secretary of the Interior and charged with providing  advice on managing federal and Indian leases and revenues––has  identified numerous deficiencies. In December 2007, the RPC issued a  report that included more than 100 recommendations to strengthen  Interior’s royalty collections by improving BLM’s and MMS’s verification of  production volumes, improving many areas of MMS’s audit and  compliance efforts by establishing a compliance strategy counsel,  improving coordination between MMS and BLM, and improving MMS’s  computer system.
section_title: MMS Has Ongoing Efforts to Improve the Accuracy of Payor- Reported Royalty Data, but It Is Too Early to Assess the Effectiveness of These Efforts
paragraphs: MMS has three major efforts underway to improve the accuracy of payor- reported royalty data used to collect and verify royalties, but it is too early  to evaluate the effectiveness of these efforts. First, MMS is beginning to  address GAO’s recommendations concerning the identification of missing  royalty reports and the monitoring of adjustments that companies make to  their royalty data. Second, MMS is implementing RPC recommendations  concerning edit checks, valuation regulations for natural gas, and  coordination with BLM. Third, MMS is continuing to develop processes to  increase the accuracy of royalty reporting data by improving edit checks  on oil and gas sales prices and using the CPT to identify errors in the  amount of oil and gas reportedly sold by payors.
subsections: section_title: MMS Is Beginning to Address GAO’s Recommendations, but It Is Too Early to Assess the Effectiveness of These Actions
paragraphs: To address a past GAO recommendation, MMS is developing a process to  automatically detect within 6 months those cases in which a company has  not filed a royalty report when it has filed a production report. MMS  officials explained that 6 months is a reasonable timeframe, and that  companies make most corrections to missing or incorrect royalty data  within this time frame. Under the current royalty reporting system, cases  in which a company has not filed a royalty report may not be detected  until more than 2 years after the initial reporting date, when MMS  personnel in their compliance group begin to target leases for a review or  audit. According to MMS officials, personnel in the financial management  group are beginning to identify missing royalty reports by identifying  instances in which the royalty report—the Form MMS-2014—is absent  when a production report—the OGOR—was filed by the operator. With  few exceptions, MMS should receive corresponding royalty reports for  each production report it receives. MMS has additional checks in place  through its CPT for determining when both the OGOR and the Form MMS- 2014 are missing.
Also in response to a GAO recommendation, MMS is developing an  automated process to identify changes that royalty payors make to their  previously entered royalty data that exceed the 6-year statutory limit on  such adjustments or that occur after compliance work, including audits,  has been completed. Although these adjustments may change payors’  royalty payments, prior to this effort MMS’s royalty reporting system could  not monitor them and payors could continue to adjust their previously  reported royalty data without prior MMS approval or review. In addition,  companies could change royalty data after an audit has been completed,  and MMS needs to be able to identify when this occurs, as we have  suggested in our previous work. While adjustments may occur for  legitimate reasons, and identifying them will not prevent them from  occurring, it could facilitate later scrutiny and follow up with company  officials. However, it is too early to evaluate the effectiveness of these  actions.
section_title: MMS Has Developed Plans to Address RPC Recommendations, but More Progress Is Needed before Results Can Be Evaluated
paragraphs: MMS is implementing action plans to address royalty reporting issues  raised by the 2007 RPC Report. The following actions directly relate to  four recommendations for improving the accuracy of the royalty reporting  process out of over 100 recommendations identified by the RPC. First,  MMS is in the process of using its existing edit checks and adding  additional edit checks to examine more data before the data are entered  into its database, instead of examining data that have already been  accepted and stored. Specifically, this change will affect royalty data that  payors submit through the electronic reporting interface—a Web site- based portal through which MMS accepts almost 30 percent of its data.  According to MMS officials, the other 70 percent of royalty records are  accepted through the Electronic Data Interchange (EDI)—a standardized  method of transferring data electronically between computer systems,  such as a payor’s system and MMS’s system. Currently, there are some edit  checks built into the EDI software, but MMS’s goal, as outlined in its  strategic business plan for 2008-2012, is to require EDI reporters to  implement most edits on their individual computer systems before they  submit the data through EDI. If they do not, then payors must use MMS’s  other system for submitting data—the electronic reporting interface— which accepts fewer royalty records at a time, but already has these up- front edit checks built into its system. As GAO has noted in prior reports,  edit checks that prevent potentially erroneous data from entering the  databases offer advantages over efforts to continually clean up erroneous  data allowed into the system. However, it is too early to tell how useful  these specific efforts will be. MMS’s processes for checking data are  outlined in figure 1.
Second, MMS is working on a problem identified by the RPC concerning  the accuracy of reporting natural gas royalties. The RPC recommended  that MMS add a data field on the Form MMS-2014 that identifies the heat  content per cubic foot of natural gas, which is important in determining  the amount of royalties owed. State and tribal royalty auditors with whom  we spoke also identified the need to check on the heat content of natural  gas. In response to the RPC recommendation, MMS officials said that they  developed and recently implemented an alternate plan for evaluating the  information identified by the RPC using data already collected on the  Form MMS-2014 and maintained in its databases. In particular, payors  report to MMS the quantity of natural gas sold (in thousands of cubic feet)  as well as the total heating value of all the gas sold (in millions of Btus, an  industry standard for selling natural gas). MMS officials told us they plan  to calculate the heating value per cubic foot from these existing data  fields, by dividing the total heating value by the quantity sold, and  implement an edit check on the reasonableness of the results of this  calculation. Moreover, MMS officials said that it was too costly to change  the structure of its database to accommodate a new data field and modify  how data are collected. We believe that MMS’s alternative is a reasonable  approach and that it is likely to identify errors in reported gas volumes.
Third, MMS is planning to publish proposed revisions to its gas valuation  regulations and guidelines that they believe will address several problems.  For example, MMS regulations provide a series of benchmarks for  companies to use in establishing the price of natural gas when they sell it  to their affiliates. However, according to the RPC and state auditors, these  benchmarks are difficult to apply and do not reflect how gas is currently  sold so they recommend that MMS should replace these benchmarks with  widely published market indexes. Another problem that MMS intends to  address with its new gas valuation regulations relates to how companies  can take deductions from gas revenues. According to MMS regulations, the  costs for transportation and processing must be properly allocated among  the individual products that result from the processing of gas. However,  gas purchasers can “bundle” all of these charges together, making it  difficult for the payor to determine how to allocate these deductions and  then to calculate what is actually owed in royalties. While MMS has plans  to address these and other issues with its new regulations, they were  unable to give us sufficient details about how this would be done for us to  evaluate the effectiveness of the new regulations. MMS has a target date  for completion of the new proposed regulations of December 2009.
Fourth, in response to RPC recommendations that MMS improve its  interagency coordination with BLM, MMS has taken a first step to improve  coordination. Specifically, the RPC recommended that the Department of  the Interior establish a Production Coordination Committee (PCC) that is  charged with, among others things, defining and coordinating common  processes, defining common data standards, and addressing technical  issues for information sharing between the two agencies. To begin this  process, MMS, BLM, and the Bureau of Indian Affairs held a 3-day PCC  meeting in September 2008, during which a number of key issues  regarding the accuracy of royalty data were discussed, including (1)  placing more responsibility on industry to provide clean data to MMS; (2)  resolving invalid lease numbers; (3) sharing information on rents,  agreements, and Indian leases in a more timely manner; and (4) providing  notices to MMS when wells first start to produce. This meeting was a first  step in improving inter-agency coordination, but it is too early to judge the  effectiveness of the committee. MMS officials said that additional meetings  are planned on a recurring basis.
section_title: MMS Has Other Efforts Underway to Improve the Quality of Payor-Reported Royalty Data, but Their Preliminary Nature Precludes Assessing Their Effectiveness
paragraphs: MMS officials told us they are evaluating a process to incorporate more  detailed market prices into its system to compare sales prices that MMS  calculates from payor-reported royalty data to relevant market prices. MMS  does not require payors to report their sales prices but can calculate an  implicit sales price by dividing the total value of the oil or gas that payors  report (sales value) by the volume that payors report as having sold (sales  volume). Currently, MMS uses for comparison a few oil and gas prices with a  wide range of values for all leases regardless of where the lease is located or  the quality of oil that is produced. MMS officials told us that they intend to  incorporate a more detailed price table into its royalty reporting system by  2010 that will include more specific sales prices related to geographic areas  and specific sales months. We believe that this could be a significant  improvement, but it remains too early to assess MMS’s efforts.
In addition, during the course of our work, MMS officials told us they plan  to expand the implementation of two edit checks. First, MMS plans to  expand the use of an edit check that will calculate the royalty rate from  payor-reported data and compare this with the royalty rate specified in  each lease. As with sales prices, MMS does not require payors to report  royalty rates but can calculate implicit royalty rates from payor-reported  data. MMS can calculate implicit royalty rates by dividing the amount of  royalties that payors report (royalty value) by the total value of the oil or  gas that payors report (sales value). While MMS has checked royalty rates  on Indian leases and prevented erroneous data on these leases from  entering its system since prior to 2001, MMS’s checking of royalty rates  has not prevented erroneous data on federal leases from entering its  system. However, MMS plans to resolve this issue on federal leases by the  end of fiscal year 2009. Second, MMS recently began using an edit check  that ensures payors take processing allowances only on gas that is  processed. MMS reported that in April 2009 it implemented such an edit  check in its electronic reporting interface. This action will affect about 30  percent of data entering MMS’s system, but will not impact potentially  erroneous data that companies submit through the EDI. We believe that  expanding the use of both of these edit checks can improve MMS’s ability  to evaluate self-reported royalty data, but we will be unable to evaluate the  effectiveness of these new processes until they are fully implemented.
In 2008, MMS auditors in its compliance group began to use the CPT to  identify discrepancies—based on certain thresholds—between the  volumes of oil and gas produced that lease operators reported on the  OGOR and the total volumes sold that payors reported on the Form MMS- 2014. When conducting this process, MMS also is able to identify  instances when a royalty payor fails to submit the required Form MMS- 2014. However until recently, these comparisons are not done until over 2  years after royalty data have been submitted when MMS begins to select  leases for audit. While this volumetric comparison had been done much  sooner and routinely for all leases in the past, the process was dropped  when MMS implemented its current information system in 2001 because  the new module that was to perform this function was not yet ready for  implementation and because MMS wanted to expand the comparison to  include an examination of the amount of royalties paid and the value of  the oil and gas sold. MMS officials explained that under the old system,  potential mismatches between OGOR and 2014 volumes often involved  errors in the royalties paid and/or the value of the oil and gas sold, and it  was important to look at all three of these components at once. They  further explained that the new module was never implemented but instead  was replaced with an expanded use of the CPT, albeit at a much later date  than initially anticipated. MMS reported that in January 2009, it began  using the CPT to compare volumes and examine the amount of royalties  paid and the value of the oil and gas sold within 6 to 9 months after payors  submit data. Moreover, in 1992 when we last examined the comparison of  volumes on the OGOR with volumes on the Form MMS-2014, we  determined that it was cost effective to follow up on at least the largest of  the discrepancies and support MMS doing this within an earlier time  frame, such as 6 months after receiving royalty data.
section_title: In Several Instances, Data Used to Collect and Verify Royalties Are Either Missing or Appear to Be Erroneous
paragraphs: While much of the royalty data we examined from fiscal years 2006 and  2007 appears reasonable, we found several instances where key data were  missing or appear to be erroneous. For example, our close examination of  producing gas leases in the Gulf of Mexico indicated that up to 5.5 percent  of the time, royalty reports were missing for these leases. We also found  that from about 2 to 7.4 percent of the time, depending on the group of  leases we examined, either the amount of royalties that payors report due  (royalty value) and/or the total value of the oil and gas that payors report  (sales value) appeared erroneous. In addition, 3.9 percent of sales values  and/or the volume that payors report as having sold (sales volume) from  offshore oil leases in the Gulf of Mexico appeared erroneous while about  6.6 percent of one or both of these data elements appeared erroneous for  offshore gas leases in the Gulf of Mexico.
subsections: section_title: Checks for Completeness of Payor-Reported Royalty Data Indicate That Certain Data Are Missing
paragraphs: Our detailed examination of producing gas leases in the Gulf of Mexico  indicated that 5.5 percent of royalty reports were missing. Using  production reports filed by lease operators, we identified all leases  producing gas in the Gulf from January 2006 through September 2007.  For each month in which operators reported gas production, we checked  MMS’s monthly royalty reports to ensure that payors reported sales of  gas. We found that about 5.5 percent of the time that operators reported  monthly gas production from leases, payors did not submit the  corresponding monthly royalty report. The missing royalty reports for this  production represent potentially about $117 million in royalties that may  not have been collected. However, it is possible that instead of reporting  royalties on the appropriate reports, payors may have misreported these  royalties on reports for other leases, and as such, additional royalties  would not be due. We also observed instances in which the total gas  production on the royalty reports was substantially less than that on the  production reports, possibly indicating that one of multiple payors on that  lease may not have submitted a royalty report for that month. While a  significant number of the almost 1,500 leases in our sample had royalty  reports but no production reports, missing production reports were more  prevalent for the last 3 months of fiscal year 2007, possibly indicating that  these reports had not yet been received or accepted by MMS’s system.  Missing royalty reports are illustrated in figure 2.
section_title: Checks for Reasonableness of Payor- Reported Royalty Data Indicate Errors in Transportation and Processing Allowances
paragraphs: We evaluated all royalty data for fiscal years 2006 and 2007—excluding  royalty-in-kind leases—for obvious errors in key reported royalty  variables, including volumes of oil and gas sold, the value of this oil and  gas, and royalties paid, and found that the error rate for these variables  ranged from 0 percent to about 2.3 percent, with the highest levels of  errors being found in transportation and processing allowances. This  analysis is summarized in table 1, along with subsequent analyses  discussed below. We used a different method than MMS’s edit checks to  evaluate the reasonableness of royalty data. For example, MMS’s edit  checks generally evaluate each royalty record individually, and a royalty  payor may submit multiple records for a given lease each month, including  the original royalty report and often times multiple corrections to the  volumes sold or the royalties paid. However, we combined all royalty  records associated with a given payor for each month, product type, and  lease. Unlike MMS’s edit checks of individual royalty records, our  methodology is able to detect if adjustments exceed the amount of the  original entries. For example, in checking the sum of the sales values, sum  of sales volumes, and sum of royalty values that payors submitted for a  given month, product type, and lease, we found that over 99.8 percent of  the time these sums were positive, as one would expect when payors owe  royalties. However, payors submit one payment per month for all their  federal leases; therefore a negative royalty value for an individual lease  may go undetected if it is small in comparison to the sum of the royalty  values for all their other leases. Although the 0.2 percent of royalty values  that we found to be negative is a small percentage, collectively this  represented about $41 million in royalties that may not be collected if  these instances are not detected in future compliance work or audits.  Further, a check for positive royalty values is not a precise measure of  accuracy. Rather, it is a gross check of reasonableness and some positive  royalty rates, which we did not evaluate, could have been lower than they  were supposed to be.
We found that transportation allowances and processing allowances,  which should always be negative values in the database, were positive 1.73  percent and 0.77 percent of the time, respectively. We also found that  about 2.3 percent of claimed processing allowances were incorrect. These  processing allowances were associated with either unprocessed gas,  which by definition is not entitled to a processing allowance, or coalbed  methane, which is never processed, and therefore should not receive an  allowance. Claiming processing allowances for gas that was not processed  could result in MMS collecting about $2 million less in royalties than are  due for the fiscal year 2006 and 2007 leases that we examined. However,  the gas reported as unprocessed gas could be processed gas that was  improperly reported as unprocessed gas by the payors, and hence, no  additional royalties would be due. Either way, there are reporting errors  that raise questions about the accuracy of royalty collections. In addition,  we checked that transportation and processing allowances did not exceed  regulatory limits and found that they were within limits nearly 100 percent  of the time. Lastly, we checked and verified that payors did not report  sales volumes when reporting transportation and processing allowances  separately from royalty amounts. This is not permitted because the  reporting of sales volumes in this situation would lead to reporting the  volumes sold twice. Table 1 summarizes the types of errors for which we  checked and the percent of times they occurred.
section_title: Significant Amounts of Payor-Reported Data Appear Erroneous as Indicated by Implicit Royalty Rates
paragraphs: We found that, of the key royalty variables self-reported by royalty payors,  either the royalties owed, the value of the oil or gas sold, or both, appeared  erroneous from 2 to 7.4 percent of the time, depending on the group of  leases that we examined. MMS’s royalty system does not require payors to  report royalty rates but rather the amount of their royalty payment— royalty value—and the total amount they received for the sale of oil or gas  from each federal lease—sales value. We calculated an implicit royalty  rate by dividing royalty value by sales value and compared this number to  royalty rates generally specified in federal leases. Because payors are not  required to report the royalty rate that applies to each individual lease and  data were not readily available to us, it was time prohibitive to individually  compare each calculation to the royalty rate specified in the lease. Instead,  we compared the calculated rates to general lease terms, allowing for  significant but common departures from these terms.
We found that either royalty values or sales values, or both, were  erroneous about 2.2 percent of the time for offshore oil leases and about 2  percent of the time for offshore gas leases when we calculated implicit  royalty rates with fiscal year 2006 and 2007 data. We compared our  implicit royalty rates with standard offshore lease terms of either 12.5  percent or 16.67 percent, allowing for some rounding error in these rates.  Our analysis did not identify as erroneous those instances when the  calculated royalty rate was 12.5 percent, but the lease royalty rate was  actually 16.67 percent, or vice versa. We also compared leases for which  the calculated implicit royalty rates were other than 12.5 or 16.67 percent  to actual royalty rates as specified in the federal lease and adjusted our  analysis for those few times when these calculated, but apparently  erroneous royalty rates, were legitimate. As such, a royalty rate that is  different from general lease terms means that either the payor-reported  royalty value or the sales value is erroneous. MMS acknowledged that  erroneous royalty rates could result from payors misreporting the sales  value or the royalty value owed to the federal government.
We found that either royalty values, sales values, or both, appeared  erroneous about 7.4 percent of the time for onshore oil leases and about  4.8 percent of the time for onshore gas leases when we calculated implicit  royalty rates with fiscal year 2006 and 2007 data. We compared our  implicit royalty rates with standard onshore oil and gas lease terms of  either 12.5 percent or a variable royalty rate schedule that depended on  production volumes for certain leases issued before 1988. These variable  rates ranged from 12.5 percent to 25 percent for oil production and were  either 12.5 percent or 16.67 percent for gas production. We also assumed  royalty rates of 5 and 10 percent as being correct because MMS indicated  that these were common royalty rates on certain older leases, and we  verified this by examining a sample of leases. We excluded all oil leases  prior to February 2006 because royalty rates below 12.5 percent were in  effect during that time for low volume or heavy oil production. Our  analysis did not identify as erroneous those instances when the implicit  royalty rate matched standard royalty rates but was nevertheless  incorrect. In addition to misreporting royalty values or sales values, MMS  said that the higher percentage of apparently erroneous royalty data for  onshore oil leases may be due to royalty payors continuing to incorrectly  pay royalties under expired provisions for low volume or heavy oil.  Erroneous royalty rates are summarized in table 2.
section_title: Significant Amounts of Payor-Reported Data Appear Erroneous as Indicated by Implicit Sales Prices in the Gulf of Mexico
paragraphs: We found that either sales values or sales volumes appeared erroneous  about 3.9 to 6.6 percent of the time we used fiscal year 2006 and 2007  royalty data to calculate implicit sales prices in the offshore Gulf of  Mexico. MMS does not require payors to report oil and gas sales prices  (prices per unit sold) but instead requires payors to report the total  amount they received for the sale of oil or gas from a federal lease—sales  value—and the total volume of oil or gas that they sold—sales volume. We  calculated an implicit sales price per unit by dividing sales value by sales  volume and compared this number to prevailing market prices at the  time.
For offshore oil in the Gulf of Mexico, we found that our implicit sales  prices fell outside of a wide range of prevailing market prices 3.9 percent  of the time during fiscal years 2006 and 2007. We used a range of market  prices each month for comparison, the low price being the lowest daily  spot price that month for Mars oil—a low quality, low value oil produced  in the offshore Gulf—and the high price being the highest daily spot price  for light Louisiana sweet (LLS)—a high quality, high value oil. The average  difference between these prices was about $16 per barrel of oil during the  October 2005 through September 2007 period we evaluated. We believe  that this is a conservative approach because the two prices are among the  lowest and highest prices that we found in the Gulf of Mexico. Therefore,  while there may be cases in which prices fall outside of this range for  legitimate reasons, we would expect this to be a rare occurrence.  Conversely, prices that fall within this range are reasonable but not  necessarily correct. This price range is illustrated in figure 3.
In addition to possible errors in reported sales values or sales volumes,  MMS officials said that low oil prices may reflect poor marketing, sales of  low quantities of poor quality oil that settle in storage tanks, or sales of oil  at offshore platforms where the sales price may be discounted for  transportation. MMS officials also said that royalty payors may also be  netting the cost of transportation from their sales value, which is against  MMS regulations. On the other hand, high oil prices may reflect good  marketing. Figure 4 depicts the percentage of our calculated oil prices that  appeared erroneous and distinguishes between when the prices fell below  or above the expected range.
For gas produced offshore in the Gulf of Mexico, we found that our  calculated implicit sales prices fell outside of the range of prevailing  market prices 6.6 percent of the time. We used a range of market prices at  the Henry Hub—a major gas trading center in the Gulf of Mexico—each  month for comparison. To establish a low and a high price, we examined  three specific prices each month and chose the highest and the lowest  price from among the three. These three prices are the maximum mid-day  spot price during that month, the minimum mid-day spot price during that  month, and the First of the Month price. All three prices are common  prices upon which producers sell their gas in the Gulf of Mexico,  according to MMS, and we believe this is a conservative approach. The  average difference between the highest and the lowest prices was about $3  per MMBtu during the period October 2005 through September 2007.  ber 2007.  These prices are illustrated in figure 5.  These prices are illustrated in figure 5.
As with oil prices, being outside of the range does not necessarily mean  that the price is erroneous, but we would not expect this to be a common  occurrence. Conversely, being within this range means that the sales price  is reasonable but not necessarily correct. In addition to possible errors in  reported sales values or sales volumes, MMS officials said that low or high  prices can reflect marketing efforts. Quality does not affect calculated  prices because gas quality is standardized by reporting sales prices per  MMBtu. The percentage that our calculated gas prices appeared erroneous  is depicted in figure 6, distinguishing between implicit prices that fell  below and above the expected range.
section_title: Multiple Factors Affect Oil and Gas Companies’ Abilities to Accurately Report Royalties Owed to the Federal Government
paragraphs: Oil and gas company representatives reported that several factors can  affect their ability to accurately report royalty data, including complex  land ownership patterns, unit agreements, ambiguity in federal  regulations, short time frames for filing royalty reports, and inaccuracies  in MMS’s internal databases.
subsections: section_title: Complexity of Ownership Can Make Accurate Reporting of Oil and Gas Royalties More Difficult
paragraphs: The complexity of unit agreements (units) can impact the accuracy of  royalty data. Upon the request of companies, BLM and MMS can  administratively combine contiguous leases into units to more efficiently  explore and develop an oil or gas reservoir and to lessen the surface  disruption caused by the building of roads and the installation of pipelines  and production equipment. MMS requires payors to report royalties for  each producing lease and, if a lease is assigned to a unit, to provide  information identifying the unit in the agreement data field. If a lease does  not belong to a unit, the agreement data field should be left blank.  However, companies can fail to complete the agreement data field when a  lease belongs to a unit, which raises questions about whether the royalties  paid were for production belonging to a unit or for production outside of a  unit. This complicates the auditing of the royalty data. Figure 7 shows how  federal leases can be combined into a federal unit to explore for oil and  gas, and figure 8 illustrate the complexity of auditing these leases when a  payor fails to complete the agreement field.
Complex ownership patterns of federal leases, particularly those issued by  BLM for onshore lands, may also further impact the accuracy of royalty  data, according to several oil and gas company representatives. For  example, when there are intermingled federal, state, and private leases,  royalty reporting can be challenging because companies said that they  may need to rely on multiple operators to provide royalty information,  which is not always consistent and clear, and because different regulations  and rules apply to federal, state, and private leases. Confusion can  sometimes cause the first royalty payment to MMS to be delayed.
section_title: Industry Representatives Stated That Ambiguous Federal Regulations Can Create Difficulty in Establishing Gas Prices
paragraphs: Representatives from four companies reported that the ambiguity in  extensive federal regulations that establish prices for oil and gas lead to  difficulty in interpretation and hence, calculating the correct royalty  payment. Nine of the 11 state and tribal auditors that we interviewed told  us that the gas valuation regulations published in 1988 are out of date and  that the series of benchmarks within these regulations that prescribe  prices for gas are impractical to apply. Concerning the gas regulations, the  RPC report noted the difficulty of applying these benchmarks and  recommended that MMS consider using market indices to establish gas  prices when companies sell to their affiliates in lieu of the 1988  benchmarks. RPC also recommended that MMS more clearly define  allowable transportation and processing deductions for natural gas in their  regulations.
section_title: Royalty Reports May Be Due before Payors Have All the Necessary Data to Accurately Complete These Reports, Which Necessitates Later Adjustments
paragraphs: In addition, three companies reported difficulty in paying royalties on gas  production in a timely manner because they do not receive data from their  gas purchasers in time to meet MMS’s deadline for filing royalty reports  and must submit estimates and later correct them. For example, a  purchaser of oil and gas may report an adjustment to the volume of the gas  purchased or the quality of the oil purchased after the payors are required  to report, resulting in the payor having to make a correction to the original  data. Reporting on gas is especially challenging, because gas  transportation and processing are usually not reconciled within 30 days.  However, payors are required to report royalties to MMS on or before the  last day of the month following the month the product was sold or  removed from the lease. Therefore, to stay in compliance with reporting  requirements and avoid penalties, some company representatives reported  that they file estimated gas royalty reports and keep funds deposited with  MMS to cover variances in royalties due. This is not problematic as long as  companies correct their original data as necessary and pay the correct  amount of royalties.
section_title: Royalty Reports on New Leases Are Rejected by MMS’s System When BLM Does Not Provide the Lease Information to MMS in a Timely Manner
paragraphs: Oil and gas company representatives stated that BLM data on new leases  and units is not always incorporated into MMS’s system in a timely  manner, resulting in edit checks rejecting correct payor data. Two of these  representatives reported that BLM’s delays in revisions to data on  participating areas––the part of a unit for which participating companies  have agreed to a manner for allocating production––can cause them to go  back and adjust MMS royalty data that is over a year old. This lack of  coordination between BLM and MMS was also addressed in the December  2007 RPC report, which found that incorrect data leads to errors in royalty  receipts and revenue distribution, requiring MMS staff to correct the  information and redistribute the revenue. The RPC report recommended  that BLM and MMS improve data exchanges by establishing a coordinating  committee with representatives from senior management levels, which  would be charged with defining common data standards and developing  solutions for technical issues of coordination and information sharing at  MMS and BLM. MMS is addressing this issue.
section_title: Oil and Gas Company Representatives Generally Understand Key Data Fields, but Better Clarification of Certain Codes Could Improve the Accuracy of Payor Reports
paragraphs: While oil and gas company representatives with whom we spoke reported  that they generally have little difficulty understanding key data required to  complete the Form MMS-2014, most state auditors with whom we spoke  identified some problems with company submitted data. All 10 of the  representatives we contacted explained that the major data fields, such as  the sales value, sales volume, and royalty value, are easy to understand  and complete. Eight of the representatives added that major royalty  reporting codes, such as those that define product types and that provide  more information on the nature of the sale of oil and gas, are also easy to  understand. Only, two representatives reported some difficulty with using  certain codes. However, 8 of the 11 state and tribal royalty auditors that  we contacted identified a specific product code that creates difficulty for  oil and gas companies in reporting royalties. Specifically, state auditors  told us that product code 39 for coalbed methane is inconsistently used by  payors reporting royalties, creating difficulty in auditing leases. During our  analysis of MMS’s royalty data, we also noted that some companies claim a  processing allowance for coalbed methane, which is not processed,  possibly indicating confusion on use of this code. Additionally, these  auditors told us that a certain code used to explain adjustments, known as  adjustment reason code 10, is commonly used by royalty payors for all  types of adjustments. They said that not having specific adjustment reason  codes for volume adjustments, price changes, royalty adjustments,  processing allowance adjustments, and transportation allowance  adjustments, makes it difficult for auditors to clearly determine why a  royalty payment was adjusted.
section_title: Conclusions
paragraphs: Royalties paid to the federal government for the extraction of oil and  natural gas from federal lands and waters remain both a large source of  revenue to the federal government and a key element in the discussion on  how to balance the use of these lands. Our past work has consistently  raised questions about how MMS oversees the collection of these royalties  and ensures that the country receives fair value for the resources removed.
MMS has ongoing efforts to improve the reasonableness and accuracy of  its royalty data. However, the agency still has more to do to ensure that  key data used to report, pay, and audit federal royalties are accurate. In  our view, MMS still lacks some effective controls to (1) prevent erroneous  data on allowances from being accepted into the system, (2) detect errors  in data once they are accepted into the system, and (3) ensure that key  data needed for complex oil and gas units are consistently provided, and  this can make the auditing and other compliance work done by MMS staff  more difficult and could result in the federal government not receiving all  the royalties it is due. In particular, our detailed examination of a portion  of key fiscal year 2006 and 2007 data has identified missing data,  significant errors, and questionable data, raising doubts about the 97  percent accuracy level that MMS reports. In light of our findings, it seems  unlikely that MMS could sustain its goal of 98 percent data accuracy  without taking additional steps.
section_title: Recommendations for Executive Action
paragraphs: To improve the accuracy of royalty data and to help provide a greater  assurance that federal oil and gas royalties are being accurately reported,  to improve the efficiency of audit and compliance activities, and to  increase the likelihood of collecting additional royalties in a timely  manner, we are recommending that the Secretary of the Interior direct  MMS to take five actions.
To better prevent the submission of erroneous data into MMS’s database,  we are recommending that MMS:    share with payors that submit their data through the Electronic Data  Interchange (EDI) MMS’s recent edit check that prevents payors from  submitting data claiming processing allowances for gas that is not  processed, including coalbed methane.
To improve the quality of data that has been accepted by MMS’s database,  we are recommending that MMS:    design and implement additional edit checks to evaluate the net impact of  all adjustments on original entries for critical royalty variables, including  sales values, royalty values, sales volumes, transportation allowances, and  processing allowances, by summing each month all entries for the variable  submitted by each payor for each lease and each commodity and highlight  potentially erroneous submissions to payors and appropriate MMS staff and    use the monthly sums of original and adjusting entries for royalty values,  sales values, and sales volumes to ensure that calculated royalty rates and  unit prices for each payor on each lease for each commodity fall within  expected ranges and highlight potentially erroneous submissions to payors  and appropriate MMS staff.
To simplify the auditing of leases and compliance work, we are  recommending that MMS:    enforce current MMS requirements to populate the agreement field with  the correct agreement number and to populate the agreement field for  leases outside of agreements with a single unique code that is easily  identifiable, and    collaborate with state and tribal auditors on the possibility of adding more  specific adjustment reason codes that describe why payors made  corrections to royalty data on the Form MMS-2014.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to Interior for review and comment.  Interior provided written comments, which are presented in appendix II.  In general, Interior agreed with our findings, concurring with four of our  five recommendations and partially concurring with the other  recommendation. With regard to this latter recommendation, which  involves populating the agreement field, Interior agreed with us that it is  important that MMS improve the enforcement of requirements for  populating the agreement field. However, Interior was uncertain about  how best to achieve this goal and stated that MMS is evaluating the best  methods to ensure accurate reporting for agreements.
As agreed with your offices, 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 appropriate  congressional committees, the Secretary of the Interior, the Director of  MMS, and other interested parties. In addition, the report will be available  at no charge on GAO’s 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  of this report. Key contributors to this report are listed in appendix III.
section_title: Appendix I: Scope and Methodology
paragraphs: To examine MMS’s key efforts to improve the accuracy of royalty data, we  reviewed and discussed with MMS officials their action plans to implement  RPC recommendations, reviewed a demonstration of MMS’s Compliance  Program Tool (CPT), discussed their implementation of the CPT to  systematically identify misreported volumes and missing royalty reports,  reviewed their plan to monitor adjustments, and discussed efforts to adopt  additional edit checks.
To assess the reasonableness and completeness of MMS’s royalty data, we  obtained from MMS an extract from their financial management system  consisting of all oil and gas royalty records from fiscal years 2006 and 2007  and assessed the completeness and reasonableness of key data fields  based on extensive data reliability studies documented in two previous  GAO reports. We removed records related to rental payments, gas storage  agreements, taxes, contract settlements, and geothermal operations by  using transaction codes, and removed sulfur, helium, nitrogen, and carbon  dioxide, using product codes. We also limited our analysis to cash royalty  payments, excluding royalty-in-kind (RIK) payments whenever possible or  appropriate. Our resulting analysis file consisted of about 4.1 million  royalty records.
First, we assessed the completeness of MMS’s data. We developed a  frequency distribution of the number of records per month and compared  these frequencies from month-to-month, looking for abnormal patterns.  We discovered that there were about half as many records for April 2007  as for other months on average. At our request, MMS investigated the  reason and discovered that the contractor who extracted the data  inadvertently excluded records accepted by MMS’s system in June 2007— the month in which much of the data from April 2007 would have been  submitted and accepted. We then obtained from MMS a new file of records  accepted in June 2007 and combined the new data with the rest of the  royalty data, and rechecked the monthly totals. This procedure revealed a  fairly consistent number of records and leases on a month-to-month basis.  We determined that the data we received from MMS were a complete  representation of what was in their data system through our study date  and was therefore reliable enough to allow us to use the extract in our  more detailed review of royalty data. This monthly consistency is  illustrated in figure 9.
To examine the completeness of records in more detail, we analyzed a  subset of MMS’s royalty data—leases that produced natural gas in the  offshore Gulf of Mexico. We chose this subset because of: (1) its relatively  manageable size—about 2,100 leases out of a total of about 29,000  producing federal and Indian oil and gas leases and (2) its financial  significance—the gas royalties from Gulf of Mexico leases in fiscal year  2008 account for almost 30 percent of total federal and Indian oil and gas  royalty revenues. For each lease, we compared gas volumes reportedly  sold by payors on Form MMS-2014 to gas volumes reportedly produced by  operators on MMS’s OGOR. Specifically, for each lease we added together  all sales volumes on the Form MMS-2014 of processed and unprocessed  gas in thousands of cubic feet for each month from January 2006 to  September 2007 and compared these to gas volumes disposed of on the  OGOR-B for the same month. From the Form MMS-2014, we included  volumes for cash sales (transaction code 01), royalty-in-kind sales  (transaction codes 06 and 08), and non-royalty bearing sales under  provisions for deepwater royalty relief (transaction code 41). We excluded  from our analysis October through December 2005 because major  hurricanes disrupted production in the Gulf of Mexico, resulting in many  production facilities being shut down. We also used data from MMS’s  Technical Information Management System (TIMS) to identify all leases  that belonged to unit agreements and excluded these leases in order to  simplify the analysis. This resulted in about 1,500 producing gas leases.  Also, a significant number of these leases had royalty reports but no  production reports, but missing production reports were more prevalent  for the last 3 months of fiscal year 2007, possibly indicating that these  reports had not yet been received or accepted by MMS’s system.
To investigate the completeness of individual royalty records, we  examined key royalty data fields to ensure that they were populated.  These data fields are necessary to match royalty payments to the proper  payor, lease, sales month, and product code. Fields included payor  number, lease number, sales date, and transaction code. We also checked  that product code and sales type were populated. Because nearly 100  percent of these critical data fields were populated, we discontinued  additional tests on assessing the completeness of individual data fields.  However, we examined certain data fields to ensure that they were not  populated when they should not be. These fields included sales value and  sales volume for certain transaction codes, including minimum royalty due  (transaction code 02), estimated royalty payment (transaction code 03),  transportation allowance (transaction code 11), processing allowance  (transaction code 15), and quality bank adjustment (transaction code 13).  Population of these data fields could result in counting sales values and  sales volumes twice.
We then developed tests to investigate the gross reasonableness of certain  data fields that our past work highlighted as being problematic, including  royalty value, sales value, sales volume, transportation allowance, and  processing allowance. We identified royalty-in-kind transactions from  transaction codes (06 and 08) and excluded them from this analysis. We  employed a technique that is different from MMS’s edit checks, which  generally examine only individual royalty lines. We summed the data fields  on all royalty records for each month on each lease for each royalty payor  and product code. This technique aggregated the original royalty record  with all subsequent adjustments, allowing us to examine the net effect and  easily identify negative sums for royalty values, sales values, or sales  volumes, which MMS’s edit checks of individual lines cannot identify.  Since payors generally submit one electronic fund transfer for all the  leases upon which they owe royalties for a given month, a negative sum  can go undetected if submitted along with many other positive sums.  Although we found a relatively small percentage (less than or equal to 0.2  percent) of negative sums, we examined the corresponding royalty lines to  determine if their financial impact was significant.
We used the same technique of summing royalty records to examine the  gross reasonableness of transportation and processing allowances. Being  deductions, these allowances should be negative. We found that  transportation allowances and processing allowances were positive 3.8  percent and 10.1 percent of the time, respectively. However when we  examined individual royalty records, we discovered that many of these  records were associated with royalty-in-kind transactions, and therefore  outside of the scope of our analysis. MMS, who creates the royalty-in-kind  data, did not properly identify these RIK leases with the designated  royalty-in-kind transaction codes (06 and 08), but instead used the codes  for transportation (11) and processing (15) allowances. An MMS official  with the RIK program explained that, due to constraints in their RIK  system, some transportation and processing allowances could be positive  due to their RIK system having populated the transportation and  processing data fields for the current month with changes to prior months  reported by pipelines and processing plants. This official also said that the  RIK system included all revenues and expenses associated with natural  gas liquids from the RIK leases in the processing allowances. These  processes for RIK leases are inconsistent with processes for leases on  which royalties are paid in cash. For cash royalties, adjustments to  previous periods are posted to the specific sales month, not the current  month. Also for cash royalties, revenue is identified as sales value, and  allowable expenses, such as transportation or processing allowances, are  individually identified as transportation or processing allowances for the  appropriate product code. The MMS official said that they corrected this  system problem in July 2007. We were then able to identify the RIK leases  through their payor codes, which are alphanumeric as opposed to the  numeric payor codes of cash royalty payments, and subsequently removed  them. We also checked for transportation and processing allowances  being taken in excess of the maximum amounts allowed by federal  regulations and checked to see if transportation and processing  allowances were taken for transaction codes for which they are not  permitted, such as minimum royalties (transaction code 2), estimated  royalty payments (transaction code 3), quality banks (transaction code  13), and offshore deep water royalty relief (transaction code 41). Lastly,  we examined royalty data to see if payors reported processing allowances  for products that are not processed, such as oil, condensate, unprocessed  gas, and coalbed methane.
We then investigated the reasonableness and accuracy of royalty values,  sales values, and sales volumes in more detail because these royalty data  fields appeared to be problematic in our previous work. Using the same  method of summing these data fields each month for all royalty records for  each payor for each lease and each product, we calculated the royalty  rates by dividing royalty value prior to allowances by sales value. We then  compared our calculated royalty rates to expected royalty rates based on  general lease terms because we did not have access to individual lease  terms for the estimated 29,000 producing federal and Indian leases. For  offshore leases (product codes 01, 02, 03, 04, and 07), we used royalty  rates of 12.5 percent and 16.67 percent for comparison.  We identified the  lease numbers associated with royalty rates outside of expected values  and compared the calculated royalty rates of these 331 leases to royalty  rates for these leases in the TIMS database. Sixteen of these leases had  royalty rates other than 12.5 or 16.67 percent, and we adjusted our analysis  accordingly. For onshore federal gas production (product codes 03, 04,  and 07), we compared our calculated royalty rates to the same royalty  rates as for offshore leases. For onshore federal oil production, we  compared initially our calculated royalty rates to rates of 12.5 percent to  25 percent. According to MMS, this latter interval included a number of  prescribed royalty rates that were common for oil production from certain  leases issued before 1988. However because of the large number of  calculated onshore oil and gas royalty rates that fell outside of expected  values, we selected a sample of onshore leases for MMS to research. MMS  reported that several leases had royalty rates that were either 5 percent or  10 percent—rates that they identified as common for certain older leases.  We adjusted our onshore comparison to include these two rates as  acceptable. Because few other leases had royalty rates that were  uncommon, we did not ask MMS to research additional onshore leases.  For Indian leases, we similarly calculated royalty rates and determined  that few leases had royalty rates of less than 12.5 percent, so we did not  pursue comparing these to actual lease terms.
We further investigated the reasonableness and accuracy of royalty values,  sales values, and sales volumes by calculating unit oil and gas sales prices  with Gulf of Mexico monthly data submitted by royalty payors for each  lease. We limited our analysis to the offshore Gulf of Mexico because this  area has well developed transparent markets where regional prices are  readily available, unlike onshore markets. To compare oil prices, we used  a range of market prices each month for comparison, the low price being  the lowest daily spot price that month for Mars oil (rounded down to the  nearest dollar), and the high price being the highest daily spot price for  light Louisiana sweet (rounded up to the nearest dollar). We investigated  doing similar comparisons onshore but discovered that the price range  onshore, with West Texas Intermediate among the highest priced oil we  found, and Wyoming asphaltic being about the lowest priced oil we found,  created a range that was so wide that it made any comparison  meaningless. To compare gas prices, we examined the maximum mid-day  spot price, the minimum mid-day spot price, and the First of the Month  price at the Henry Hub and chose the highest and the lowest price from  among the three (we rounded the lowest price down to the nearest dollar  and rounded the highest price up to the nearest dollar). In calculating unit  gas prices from MMS royalty data, we used volumes expressed per MMBtu  to remove the effects of quality on price. As with oil prices, we  investigated doing gas price comparisons onshore but found that  exceptionally low gas prices at Opal, Wyoming created a range of prices  that was so wide as to make any comparisons meaningless.
To examine factors that affect oil and gas companies’ abilities to  accurately report royalties owed to the federal government, we  interviewed a limited number of oil and gas company representatives. To  solicit views on oil and gas companies’ experiences with reporting royalty  data to MMS, we used a nonprobability sample. To draw our sample, we  identified the 20 oil and gas companies that submitted the highest number  of royalty lines on Form MMS-2014 in fiscal years 2006 and 2007 and  contacted representatives from the top 15 to request information. The top  20 companies accounted for 63 percent of all the royalty lines reported,  and the top 15 accounted for more than 56 percent. In addition, we  contacted the two largest national oil and gas industry associations— American Petroleum Institute (API) and the Independent Petroleum  Association of the Mountain States (IPAMS)—to request information.  IPAMS describes itself as a non-profit trade association representing more  than 400 independent oil and natural gas producers, service and supply  companies, banking and financial institutions, and industry consultants  committed to environmentally responsible oil and natural gas  development in the Intermountain West. API reports that it is the only  national trade association that represents all aspects of America’s oil and  natural gas industry. API has 400 corporate members, from the largest  major oil company to the smallest of independents. They include  producers, refiners, suppliers, pipeline operators, and marine transporters,  as well as service and supply companies that support all segments of the  industry.
For our semi-structured interview questions, we received a total of 10  responses from oil and gas companies. Specifically, of the 15 companies  with the most royalty lines, 2 responded to our request. From API  members we received two responses, and from IPAMS members we  received six responses. We personally met with two company  representatives at the IPAMS office and discussed their written responses  to our questions. Membership in these associations and being identified as  1 of the 15 companies is not mutually exclusive. Results from this  nonprobability sample cannot be used to make inferences about all oil and  gas companies, because the companies that were not included in our list  of the top royalty payors or members in the associations we contacted had  no chance of being selected as part of the sample.
section_title: Appendix II: Comments from the Department of the Interior
section_title: Appendix III: 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; Ron Belak; Melinda Cordero; Alison O’Neill; Kim Raheb; Barbara  Timmerman; and Mary Welch made key contributions to this report.