Royalty-In-Kind Program: MMS Does Not Provide Reasonable Assurance It Receives Its Share of Gas, Resulting in Millions in Forgone Revenue
Published: 2009-08-14T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Companies that develop and produce oil and gas from federal lands and waters are required to report their production volumes and other data to the Department of the Interior's (Interior) Minerals Management Service (MMS) and to pay royalties either in value (cash) or in kind (oil or gas). In fiscal year 2008, MMS estimated that it had collected more than $2.4 billion in royalty-in-kind (RIK) gas. It is important that MMS ensure that it receives the RIK gas to which it is entitled. The difference between the RIK gas owed--MMS's entitled percentage of gas--and the percentage it actually receives is referred to as a "gas imbalance." GAO was asked to evaluate the extent to which MMS can provide reasonable assurance that it is accurately identifying and collecting RIK gas imbalances in a timely fashion. GAO analyzed MMS documents and data, documentation of industry standards, and interviewed MMS and industry officials.
section_title: What GAO Found
paragraphs: MMSisforgoing revenues for gas royalties owed to the federal government because it does not provide reasonable assurance that it accurately and promptly identifies and collects on RIK gas imbalances. GAO found that MMS is forgoing revenues for the following reasons: (1) MMS estimates that it is owed a net of $21 million for past imbalances but it lacks the information necessary to calculate the full amount of revenues due. MMS does not have sufficient data to determine whether it has received its full percentage of RIK gas. Also, MMS's estimate does not include interest on some unpaid imbalances because MMS has not determined when interest begins to accrue on imbalances, as required by law. Further, MMS monitors imbalances on a monthly, rather than daily basis, which leaves open the possibility that some companies owing RIK gas could provide less gas to MMS when gas prices are relatively high, making up the difference by providing more gas when prices are relatively low, something that could cost MMS additional revenues because it could miss the opportunity to sell gas on the days when prices are high. (2) MMS does not audit gas companies' production and allocation data, therefore it cannot verify that it is receiving its entitled percentage of gas. MMS does not audit, in part, because it believes that its verification procedures are sufficient. However, other governments and gas companies routinely audit their imbalances and uncover inaccuracies that would result in lost revenues if left unchecked. (3) MMS lacks adequate policies and procedures for accurately and promptly identifying and collecting gas imbalances. For instance, the agency does not know how companies allocate gas among all parties having a claim on a share of gas produced; this may affect whether MMS receives its percentage of gas on a daily basis. In addition, MMS does not compel companies to document production and deliveries in a consistent format and meet deadlines. As a result, MMS analysts spend time gathering and reformatting data instead of identifying and collecting on imbalances. MMS also allows companies to negotiate imbalances indefinitely. For example, MMS has been negotiating with a company for more than 2 years regarding a $900,000 imbalance. (4) MMS's information system does not provide accurate and timely data on RIK gas imbalances. For instance, MMS's information system cannot calculate cash settlements for imbalances or compare various types of data that companies submit. Consequently, MMS processes more than half of its gas imbalance data manually. (5) MMS has been operating for many years without sufficient staff to reconcile gas imbalances, and the staff it has is not sufficiently trained. For instance, according to RIK management, MMS does not have sufficient staff to dedicate someone to fully review RIK gas analysts' work on imbalances, even though mistakes in that work often occur. MMS recently hired one new gas imbalance analyst but has not formally assessed staffing needs. In addition, RIK gas imbalance staff lack, among other things, training on industry standards on gas imbalance calculations.

section_title: Letter
paragraphs: In fiscal year 2008, the Department of the Interior’s (Interior) Minerals  Management Service (MMS) collected more than $12 billion in royalties  for oil and natural gas developed and produced from federal lands and  waters. These royalties represent one of the country’s largest nontax  sources of revenue. Companies that develop and produce oil and gas  resources from federal lands and waters do so under leases obtained from  and administered by agencies of Interior––the Bureau of Land  Management for onshore leases and MMS for offshore leases. MMS also  collects, accounts for, and distributes royalties associated with oil and gas  produced from leased federal lands and waters. MMS collects royalties  either through its royalty-in-value program––whereby producers pay  royalties in cash based on the cash value of the oil and gas produced and  sold––or its royalty-in-kind (RIK) program––whereby producers pay  royalties in oil or gas, and MMS in turn sells the oil or gas. In fiscal year  2008, MMS estimates it collected gas valued at more than $2.4 billion and  oil valued at nearly $4.2 billion through the RIK program, which is equal to  more than half the royalties collected by MMS. In September 2008, we  reported that MMS’s oversight of its RIK natural gas collections was less  robust than its oversight of RIK oil collections and that the agency lacked  assurance that it was collecting the RIK gas royalties it was owed.
Given the financial importance of royalty management, MMS has been the  subject of considerable scrutiny by GAO; Interior’s Inspector General (IG);  its own internal reviews; and the Royalty Policy Committee, a group  convened in 1997 by the Secretary of the Interior and charged with  advising Interior on managing federal leases and revenues. One  vulnerability identified by these groups is the possibility that MMS may not  receive the total amount of royalties to which it is entitled—a situation  known as an “imbalance.” Interior’s IG first noted this vulnerability in the  RIK program in 2002. In June 2007, MMS likewise found weaknesses in its  handling of RIK gas imbalances in its response to the Office of  Management and Budget’s Circular A-123, which defines management’s  responsibility for internal control in federal agencies. Based on these  findings, MMS implemented an action plan to assist in the identification  and timely resolution of imbalances. Further, the Royalty Policy  Committee’s Subcommittee on Royalty Management issued a report to the  full committee in December 2007 that included more than 100  recommendations to strengthen Interior’s royalty collections, including 31  directed at the RIK program. Among these recommendations, the  subcommittee recommended that an RIK subcommittee be formed to  address, among other things, the verification of RIK gas volumes. This  subcommittee, established in April 2008, has since noted RIK gas  imbalances as an issue and has stated that it will be reporting to the full  committee on its findings and recommendations early in the new  administration.
In light of these questions, as well as the potential financial impacts of RIK  gas imbalances, you asked us to determine the extent to which MMS  ensures the accurate and timely identification and collection of RIK gas  imbalances. In conducting our work, we reviewed applicable statutes a documentation of MMS policies and procedures for collecting in kind  royalties. We also met with officials from MMS, gas production companies, the North American Energy Standards Board, , as  well as industry experts. To determine daily imbalances, we analyzed  MMS’s price and delivery volumes data, as well as pipeline producti statements we received from MMS’s Offshore Energy and Mine rals  Management division, for a nongeneralizable sample of 32 gas  measurement points. We restricted our analysis to those measurement  points that contained leases with the same royalty percentage because  those were the only points for which we could obtain sufficient data to  perform our analysis. Append our scope and methodology.  ix I contains a more detailed discussion of  We conducted this performance audit between June 2008 and August 20 in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objective.
subsections: section_title: Background
paragraphs: The North American Energy Standards Board serves as an industry forum for the  development and promotion of standards that will lead to a seamless marketplace for  wholesale and retail natural gas and electricity, as recognized by its customers, business  community, participants, and regulatory entities. is a way to simplify royalty administration. In addition, MMS concluded  that it would not need to audit RIK sales because the agency would sell th gas rather than relying on producers to accurately report their ow prices, as is done in the royalty-in-value program. The collecting,  reporting, and auditing of cash royalty payments have been challenging for  MMS because of concerns about the accuracy and reliability of productionand pricing data submitted by royalty payors and because there are about  29,000 leases producing oil and gas, many with several companies paying  monthly royalties. MMS began a series of pilot sales of royalty oil and gas  in 1998 and, based on the results, dramatically expanded its RIK progr am  until 2007. In 2008 and 2009, the volumes taken in kind have, and are  projected to, decrease as MMS decreases the number of properties tak in kind, in part because it identified and removed prop lower revenues than a fair market value benchmark.
MMS is charged with ensuring that RIK oil and gas are not sold for less  than market value and that revenues it receives are at least as great as the  revenues it would have received had it taken the royalties in cash. T this requirement, MMS compares the estimated benefits of the RIK  program with the estimated benefits it would have received if the ro had been taken in cash and reports this to Congress annually. MMS  estimated that from fiscal years 2004 through 2007, the RIK program  generated about $150 million more in net value to the government than  MMS would have collected had it received royalties in cash. Of this $150  million, MMS estimated that (1) $131 million came from selling RIK oil and  2)  gas for more than MMS would have received in cash royalty payments, ( $8 million came from interest that accrued because revenues from RIK  sales were received earlier than cash payments would have been rece through the in-value program, and (3) $11 million came from savings accrued because the RIK p royalty-in-value program.  rogram costs less to administer than the  Through the RIK gas program, companies that produce gas on federal  leases owe MMS a royalty, or a percentage, of the daily gas production. To  ensure that the government obtains the fair value of RIK sales, MMS must  ensure that it receives the percentage of total production volumes to  which it is entitled. The volume of gas a company owes to MMS is  determined by the following equation:  royalty volume = total production volume x royalty percentage  The royalty percentage for leases taken in kind varies somewhat b currently in the range of 12.5 percent to 16.67 percent. Measuring  ut is  production and allocating a percentage of that production is relatively straightforward when one company measures its own output from a  federal lease and reports its own production to MMS. However, multip production companies sometimes combine the gas flowing from theirleases at a measurement point in order to share the risks, costs, and  benefits of gas production. These companies often elect from among  themselves a single company—called the operator—to allocate the gas  flowing from each of the companies. Due to the complex nature of the  natural gas market, operators cannot always allocate each producti on  company or royalty owner its entitled amount of gas, resulting in a  situation known as an “imbalance.” Imbalances—both positive and  negative—are a common occurrence for MMS and all companies in the industry because, among other reasons, companies must estimate the  volume of gas they will produce; in turn operators allocate gas based those estimates rather than actual production. The operator is also  responsible for monitoring and reporting gas imbalances––the differen between the volume of gas owed to lease and royalty owners and the  volume actually allocated. Currently, there are points and 550 leases in the RIK gas program.
section_title: MMS May Be Losing Revenue Because It Does Not Accurately and Promptly Identi and Collect on R IK Gas Imbalances
paragraphs: MMS risks losing millions of dollars in revenue because it does not  accurately and promptly identify and collect on RIK gas imbalances.  Specifically, MMS (1) estimates it is owed a net of $21 million for gas  imbalances, but it lacks the necessary information to determine the exact  amounts; (2) does not audit RIK gas operators’ production and allocatio n  data, and thus cannot verify that it receives the correct volumes of RIK  gas; (3) lacks adequate policies and procedures to reconcile and resolv imbalances; (4) does not have an information system that can provide  accurate and timely data for reconciling and resolving imbalances; and (5)  has insuffici ent staff and training to administer the program efficiently and  effectively.
subsections: section_title: MMS Lacks Information Necessary to Quantify Revenues Due from Imbalances
paragraphs: We are not reporting the amount of MMS’s extraordinary threshold because the agency  believes this will compromise its efforts to collect additional revenues associated with  imbalances in a timely manner. Further, MMS determines when imbalances have reached  this threshold by applying a fixed rate of $5 per million British thermal units to volume  imbalances. MMS officials said they will re-evaluate the fixed rate and the “extraordinary”  level in the future. indicate it has completely reconciled almost 99 percent of the imbalances for production occurring in fiscal year 2007, almost 98 percent for fiscal  year 2008, and about 94 percent for fiscal year 2009.
However, MMS does not know the exact amount it is owed for imbalances  because it lacks at least three types of information. First, it does not verify  all gas production data to ensure it receives its entitled percentage of RIK  ciled  gas from all leases taken in kind. Prior to February 2009, MMS recon gas imbalances through data from two operator-generated reports,  imbalance statements and monthly production reports, and online third- party data from pipeline companies on the amount delivered to purchase of RIK gas. This verified whether MMS received the volumes of ga the operator reported, and whether that volume was the correct  percentage of reported production according to operator-generated d However, it did not verify through third-party data that the operator  correctly reported the total production at each lease in the first place.  Therefore, MMS could not use this method to verify that the gas alloca by operators was equal to MMS’s entitled percentage of gas volum Recognizing this, in 2008, we recommended that MMS bolster its  verification process for gas volumes owed to the government by using third-party production information, such as the data collected in the  Offshore Energy and Minerals Management division’s gas verification  system, in addition to the third-party delivery information it had already  been using. MMS’s gas imbalance analysts began using the third-party  data contained in the gas verification system in February 2009, but  because these data only include total production at the measurement po rather than for each lease, analysts cannot use the system to verify that it  was allocated the entitled percentage from each lease taken in kind.  ata. es.
Second, MMS lacks information on how to price gas imbalances and the  point at which the agency should begin applying interest to the imbalanc for leases that have terminated from the program or those leases whe re  production has ceased. Since the RIK program first began, MMS has  updated its guidance letter to operators. Although MMS’s most recent  guidance letter states that MMS will charge monthly interest on  imbalances, past guidance letters state that interest will only be charged if  the operator pays its imbalance later than 60 days after the final month the imbalance occurred. Interior is required by law to charge interest on late  payments and underpayments of royalties. Further, while MMS’s c guidance letter to operators specifies that it will price imbalances  according to its own contract price for the gas during the month the  imbalance occurred, the previous guidance letters did not contain this  language. MMS is not actively trying to collect on the imbalances of those  leases that have been terminated from the program or those leases wh ere  production has ceased because there have been discussions with the  Office of the Solicitor for more than a year about these issues. In a January 2008 memo, MMS asked the Office of the Solicitor for an opinion  on when  to charge interest and whether its current methodology to price  imbalances is consistent with law. In its memo, MMS proposed the following two pricing methods, in addition to its current method:  1.  Calculating the price of the imbalances based on the value applicable  editing  to the month before settling the imbalance in cash and after cr any over-allocations existing since the first imbalance month.   the price using the value when the last imbalance  occurred.
Recently, the Office of the Solicitor asked RIK program officials to ch the most appropriate pricing and interest methods before issuing an  opinion on those methods. However, those methods have not yet been  presented to the Solicitor, and MMS is currently not making additional  requests for payment of imbalances for leases that have term the program or those leases where production has ceased.
Finally, MMS could be forgoing revenue because it lacks information  daily gas imbalances. Section 115 of the Federal Oil and Gas Royalty  Management Act, as amended, provides that a lessee’s obligation does not  become “due” until the end of the month following the month in which th e  gas is produced. In its guidance letter to operators, MMS requests t deliveries be made on a daily basis equal to the royalty percentage.  Because the statute authorizes MMS to enforce operator obligations only  on a monthly basis, MMS believes it appropriate to calculate and monito r  imbalances owed solely on a monthly rather than daily basis. However, this leaves open the possibility that some companies that owe RIK gas  could provide less gas to MMS on days when gas prices are relatively high,  hat  and make up the difference by providing more gas on days when prices are relatively low. Because purchasers of RIK gas bid on two components of  the amount of gas produced daily—a minimum volume set at a monthly price and an additional volume, if available, at a fluctuating daily or “spot price—MMS would lose revenue because it would miss the opportunity  sell gas on days when spot prices are higher. Because MMS reconciles  imbalances on a monthly––rather than daily––basis, such an occurrence could go undetected. MMS guarantees the purchaser of RIK gas the  full  minimum volume on a daily basis, except in the case of equipment failure or natural disaster. In contrast, industry officials we  spoke with said that they monitor imbalances daily to ensure their  companies do not lose revenue from daily imbalances.
To investigate the extent to which MMS has been allocated its royalty  percentage of RIK gas on a daily basis, we analyzed daily volumes of to production and allocation to MMS at a sample of measurement points.  Because measurement points combine the gas from numerous leases may have differing royalty percentages, it is not possible to determine  whether MMS received its royalty percentage on a daily basis using data. We therefore restricted our analysis to a random sample of the  measurement points that had leases with a common royalty percenta These points account for about 85 percent of those in the RIK gas  program. On most days––74 percent of those we examined––the alloca was within 25 percent of MMS’s royalty percentage. However, on 18  percent of the days, the allocation was more than 25 percent less than  ntage and on 8 percent of days the allocation was  MMS’s royalty perce more than 25 percent greater than MMS’s royalty percentage. On average,  MMS received 15.9 percent of total production when its royalty percentag was 16.67 percent.  ge.
In addition, we collected daily data on the differential between the base  and spot price for our sample of measurement points and identified a  small correlation between higher prices and a lower percentage allocated  to MMS. We estimated that the correlation we found would result in a loss  of about $1,400 for each measurement point during a 6-month time period.  Further, the common royalty percentage in the leases at the measurement  points we examined—which accounts for about 85 percent of  measurement points in the RIK gas program—makes it easier to detect  this practice. At measurement points with a mix of different royalty  percentages—about 15 percent of measurement points in the RIK gas  program—there are no data available to MMS to detect this, which could  encourage such behavior and result in higher revenue losses for these  measurement points. See appendix II for our complete analysis.
Daily imbalances may also be costing MMS because it does not track transactions called “keepwhole payments.” MMS must make such  payments if RIK gas purchasers do not receive their minimum daily  volume of gas. This is because purchasers typically enter into advance contracts to resell RIK gas, and if they do not receive their expected  volumes they must buy that volume elsewhere in order to fulfill these  e triggering keepwhole payments,  contracts. Daily gas imbalances may b but MMS does not know the extent to which this occurs because it does  n ot adequately track these payments.
section_title: MMS Does Not Audit Operators’ Records to Verify RIK Gas Production
paragraphs: MMS also may be forgoing revenue because it does not audit operator d to ensure it has received its entitled royalty percentage. MMS has  procedures for reconciling imbalances and uses third-party production data to verify some of the data it receives from operators. However, it has  not assessed the risk of forgoing audits at those measurement points  where it does not have complete data with which to verify that it has bee allocated its entitled percentage of gas. Although the RIK guidance lett er  to operators states MMS’s right to audit operator information related to RIK gas produced and delivered, MMS has not done so because it has  considered its verification of operator-generated data to be sufficient .  MMS has also claimed that it has saved money as a result of not auditing  and that this is a benefit of the RIK program. However, other royalty owners and members of the oil and gas industry regularly audit operator reported data. According to an industry representative, this entails  traveling to an operator’s place of business to scrutinize gas production  documentation. According to an official from the Texas General Land  Office—the agency responsible for administering Texas’s RIK program— state audits often find that the office has not received the gas volu entitled to. Furthermore, the Council of Petroleum Accountants Societies  (COPAS), a professional organization of oil and gas accountants,  recommends that any royalty or working interest owner initiate an audit an operator’s response is unsatisfactory or if a discrepancy is considered  significant. Industry representatives told us that oil and gas companies  regularly audit to ensure that they have received the gas they are entitled  to. Representatives from one company noted tha approach, auditing operators who allocate large volumes of gas because  there is the greatest risk of error in these cases.  t they use a risk-based  Additionally, there are cases when available third-party production data not give MMS adequate information to determine whether it has rece its royalty percentage. For example, when RIK leases combined at one  measurement point have different royalty percentages, MMS cannot  ived  determine from the available gas verification system data whether it has  received its entitled royalty percentage. Figure 1 illustrates this using two  hypothetical measurement points. Measurement point one has three leases flowing into it, all with a royalty percentage of 16.67 percent. Regardle whether each lease has different production volumes, MMS can calcula that it is owed 16.67 percent of the total production of 10,000 million  ercent of the total production of 10,000 million  British thermal units (MMBtu). However, measurement point two has te  British thermal units (MMBtu). However, measurement point two has  three leases flowing into it, with two leases owing a royalty percentage of three leases flowing into it, with two leases owing a royalty percentage of 16.67 percent and one lease owing a royalty percentage of 12.5 perc 16.67 percent and one lease owing a royalty percentage of 12.5 perc  Because each lease will have a different volume of production and third-ent.   Because each lease will have a different volume of production and third-ent.  party data from the gas verification system only includes the total  party data from the gas verification system only includes the total  production volume at the measurement point, MM production volume at the measurement point, MMS is unable to verify it  was allocated its entitled percentage of RIK gas without examining the S is unable to verify it  was allocated its entitled percentage of RIK gas without examining the  operator’s production records at the lea operator’s production records at the lease level.  se level.  se level.
section_title: MMS Lacks Adequate Policies and Reconcile and Resolve Imbalances
paragraphs: MMS does not have adequate policies and procedures to ensure it  reconciles and resolves RIK gas imbalances efficiently. This shortcoming  is apparent in three main areas.
First, MMS policies do not adequately ensure that operators allocate  MMS’s percentage of RIK gas. MMS’s guidance letter to operators requests  that operators allocate to MMS the royalty percentage of gas on a daily  basis, but MMS believes it does not have the authority to enforce this  guidance. Further, RIK officials said MMS does not know what method  operators use to allocate gas. Indeed, our analysis shows that, contrary to its guidance letter to operators, on many days MMS is not receiving its  percentage of RIK gas. This could be happening because the operator’s  allocation method ranks other leaseholders before MMS when allocatin g  gas and total production is less than expected. In this instance, MMS cou ld receive less than its royalty percentage of gas or no gas at all. According to COPAS, when the output of gas from multiple leases is combined and  measured at a single measurement point, it is imperative that all parties  agree on the method the operator will use to allocate the gas. We lea from industry representatives that gas companies rely extensively on such  agreements to ensure they receive the gas volumes they are owed and to  minimize the negative impact of imbalances on company revenues.
Second, MMS does not have adequate policies and procedures to compe operators to report imbalances promptly and in a standard format.  Although the RIK gas guidance letter to operators requests that the  operator provide an imbalance statement to MMS within 60 days of the month of production, the guidance is not enforceable and MMS cannot impose a penalty for failing to submit imbalance statements within  time period. To allow MMS to take enforcement actions, regulations are  required. These regulations must (1) go through the public notice and  comment process, and thus be transparent to the public, oversight  agencies, and Congress; and (2) carry the full force of the law and hold  agency implementing the program and program participants accou to the terms specified in the regulations. RIK officials said MMS has  operated the RIK program without regulations because of the onerous  nature of establishing regulations and because industry had been  cooperative. More recently, RIK officials told us they have recognized that it is necessary to implement regulations for the RIK gas program in order for the agency to receive imbalance statements in a timely manner, among  other reasons, and have begun drafting these regulations. In contrast, the  provincial government of Alberta, Canada, has regulations in place that  state a company can be fined a portion of its royalty payment if it  submit required production data on time. Similarly, COPAS guidelin the oil and gas industry provide that operators should submit imbalance statements to appropriate parties within 45 days of the month of  production, unless other timing requirements have been agreed to.  Following this guideline, gas companies we spoke with said they have  es for  policies in place to compel timely reporting. For example, one industry  agreement we obtained states that if an operator fails to submit imbalance  statements for four consecutive months, the operator could be subject to  auditing.
Our review of MMS’s spreadsheet for tracking imbalance statements  shows that, from January 2007 through June 2008, at least 35 percent o expected imbalance statements were received late and about 10 p remain missing. As a result, MMS analysts spend a great deal of time  repeatedly calling companies to inquire about missing imbalance  statements. RIK officials agreed that this was not an efficient use of  resources.
MMS also does not have a policy to require operators to submit imbalanc statements in a standardized or electronic format. Operators submit  imbalance statements by e-mail, but the statements commonly arrive in  different file formats—even from a single operator. Additionally, some  operators report gas volumes in MMBtu, the measurement unit used by  MMS, while others use different units of measure, such as thousand  feet. In these cases, MMS analysts must manually convert reported g volumes to a uniform measurement unit—increasing the chance of  calculation errors—and must spend additional time combining the  information from different reports into one format, rather than focusing on  balance  reconciling imbalances. MMS could require operators to submit im e  statements in an MMS-approved standard format. In contrast to MMS, th government of Alberta requires companies to report gas volumes electronically in a standardized format and measurement unit, and these  reports must pass data checks. Alberta officials have stated that  standardized reporting has improved the efficiency of its RIK operations.
The third area in which MMS does not have adequate policies and  procedures is in collecting payment for an imbalance from a compan when a cash-out settlement between MMS and the company has not  reached. When there is an extraordinary imbalance, MMS sends the  y  been  operator an initial cash-out memo explaining the amount that MMS  believes the company owes. The operator can either pay for the imbalance  or dispute it by submitting evidence that the imbalance value is incorrect.  To pay for the imbalance, the operator submits to MMS a royalty pa yment  form, which indicates the company’s agreement with MMS’s calculation of  the imbalance and classifies the imbalance as an open receivable,  triggering the debt collection process with the Department of the Treasu (Treasury). The royalty payment form is the only means of triggering collection, but the operator would not submit this form if it disputes an  imbalance. With no other bill or invoice to begin the debt collection  process for disputed imbalances, MMS’s practice has been to allow the  exchange of supporting evidence with the operator regarding the size and  value of the imbalance to continue indefinitely. In one instance, MMS se nt  an operator a cash-out memo in December 2006 for an imbalance valued  at  nearly $900,000 and, as of February 2009, was still negotiating with the  operator. In such cases, because MMS has not sent a demand letter to a   RIK  company for payment, it has not referred a company to Treasury. officials stated that the agency has avoided debt collection for imbalances  because it is an onerous process and because it is waiting for the Office ofthe Solicitor to issue an opinion on the pricing and interest associated imbalances for leases that hav such debts are not collected within 7 years, the statute of limitations  renders them uncollectible.  e reached the end of their contract term. If  In contrast, MMS has debt collection policies and procedures in place to  collect debt from companies that have purchased and received RIK gas  from MMS but have not submitted payment for their purchase. Accordingto MMS policy, a company purchasing RIK gas receives an invoice, whic h  triggers the debt collection process. If the company does not pay within   time frame, MMS issues a demand letter for payment. If the  the agreed amount due MMS is still unpaid after 180 days, the issue is referred to  Treasury.
section_title: n System MMS’s Informatio Does Not Provide Accurate and Timely Data
paragraphs: MMS’s information system does not provide accurate and timely data on  RIK gas imbalances, which reduces the agency’s ability to collect on thes imbalances. In 2003, MMS acquired a commercial, off-the-shelf software  product and a custom-built database for the RIK program. The purpose  e  was to integrate all of the program’s information needs in a singl where it could monitor and track gross gas production, imbalance  statement data, gas deliveries, and monthly and cumulative gas  imbalances. However, the information system is not capable of provid accurate and timely information on RIK gas imbalances. For instance,  MMS’s RIK Deputy Program Manager told us that the system cannot  provide accurate information on the number and amount of keepwhole  payments MMS has made and cannot calculate RIK cash-out imbalances.  Therefore, as of June 2009, MMS was entering data manually into a  spreadsheet and performing calculations based on the manually entered  data. MMS officials further told us that gas imbalance information cannot analyze data from the operator-submitted imbalance statements,  operator-submitted monthly production reports, and MMS’s gas  verification system to calculate gas imbalances. As a consequence, more  than half of MMS’s gas imbalance work, according to the RIK gas  imbalance manager, is currently done manually. For example, two  employees spend a portion of their time logging information from  operator-submitted imbalance statements onto spreadsheets after which  gas imbalance analysts manually upload imbalance statement data into  MMS’s information system. An RIK manager said the manual processing of  RIK gas imbalance data has put a considerable burden on the RIK gas  imbalance staff.
According to GAO’s Standards for Internal Control in the Federal  Government, transactions from initiation to completion should be  promptly recorded to maintain their relevance and value to management  in controlling operations and making decisions. Similarly, according to  Interior’s Internal Controls Handbook, accurate and timely information is  essential for assuring the safeguarding of assets from waste, loss,  unauthorized use, or misappropriation, as well as to assure compliance  with laws and regulations. In its December 2007 report on mineral revenue  collection, MMS’s Royalty Policy Committee recommended the  electronic submission of all offshore production records to improve  MMS’s compliance and enforcement activities. According to RIK officials,  the committee’s recommendation was not specifically directed at, and  therefore did not pertain to, the RIK program. Yet RIK program managers  also told us that they recognized as early as August 2007 that the system needed improvements. According to the RIK gas imbalance manager,  when MMS alerted the software manufacturer to these problems, there  was a disagreement as to whether the manufacturer or the support  services contractor were responsible. In July 2008, MMS contracted with  the software manufacturer for support services, but this system is still n meeting MMS’s needs.
At the time of our review, MMS had planned to enhance the system but  was also exploring the possibility of acquiring a new information  management system. According to RIK officials, one candidate system was  the Petroleum Registry of Alberta (PRA), which the government of Alberta uses to manage its RIK program. PRA differs from MMS’s current system y,  in several aspects. PRA was jointly developed by government and industr with the government providing about 73 percent of the $35 million bud ,  According to Alberta officials and the provincial government Web site th  PRA improves compatibility by serving as the system of record for bo government and industry. In addition, companies participating in the  Alberta RIK program are responsible for promptly entering accurate  production data electronically. If a company does not enter accurate  production data into PRA on time, one MMS RIK official told us, PRA w alert Alberta officials regarding the issue and the company can be fined. This official added that an automated system such as the PRA wou to be customized to fit MMS’s needs at some unknown cost, but that it  could save RIK gas imbalance analysts’ hours of time currently spen t e- mailing and calling companies to submit their operator imbalance  statements. According to MMS officials, they have decided not to  PRA in part because customization could cause issues with future  upgrades and fixes, regulation would be required for MMS to require  online and standardized reporting, and the system would require  significant buy-in from ind although they believe that a better information system would immensely  improve RIK gas imbalance work, MMS does not have a timeline to acquire  a more effective system.  get.
section_title: Insufficient Staff and Training Remains a Long- Standing Issue
paragraphs: The RIK gas imbalance office, according to various MMS reports, has b een  operating without sufficient staff and training to efficiently and effectively  carry out its assigned duties. As a result, certain tasks—such as gas  balancing work—have not received sufficient attention, leading to the development of a backlog of RIK gas imbalances. Effective managem an organization’s human capital—its employees, as well as their skills training—is essential to achieving results and an important p art of a  program’s internal controls. Human capital has been a long-standing  problem for the RIK gas program. Specifically, each of the following  reports found that RIK human capital needed improvement.
A January 2001 MMS report indicated that the RIK organization would need to evolve to fully support the RIK operational activity. The  report also stated that the future RIK activity would require MMS staff  training in handling imbalances, as well as several other areas.   2003 report prepared by an MMS contractor noted that, in  order to support a permanent RIK program of significant scale, specific  personnel requirements should be identified and filled for all RIK  personnel.
A May 2004 MMS report noted that enhancements to human resource  capabilities would be necessary in order to meet the objectives of MMS’s  RIK business plan. Therefore, the report indicated that specific skill sets  and expertise should be acquired or developed in-house by March 2006.
These human capital deficiencies continue to be a problem for the RIK gas  program. For example, an RIK manager told us that, although mistakes canoccur in gas imbalance calculations, MMS does not have enough staff dedicate someone to review this work. However, beginning in Nove mber  2008, MMS began reviewing a sample of this work. In addition, according  to internal MMS e-mails and our discussions with managers, RIK gas  imbalance personnel have received training in oil and gas revenue  accounting but managers noted that personnel need additional training seven different courses, especially a course on industry standards on gas  imbalance calculations and a communication skills course for dealing with   in  external customers. Our review of employee training records showed,  however, that RIK gas imbalance personnel received training in neither of  these two courses and only about half of all the training identified.  According to the MMS RIK gas imbalance manager, the training employees  have received is sufficient given their workload dealing with gas  imbalance improvement actions and current duties.
According to GAO’s Standards for Internal Control in the Federal  Government, operational success is dependent on assigning the right  personnel for the job and providing them with adequate training and tools.  Similarly, according to Interior’s Internal Controls Handbook, in order to  eliminate or reduce financial reporting risks, an organization should have,  among other things, sufficient resources to perform the various job  functions and should provide staff with technical and ethical training. appropriate number of employees needed to perform an organization’s work.
MMS has not conducted such an analysis.
As of March 2009, MMS was in the process of entering into a 6-month  contract for an assessment of the organization of RIK invoicing and  imbalance work, procedures, and processes. Included in the tasks to be  performed under this contract is determining whether: (1) staffing levels  are sufficient to meet current and anticipated future workloads and (2)  staffing levels, skill sets, education, and experience are comparable to  industry. As of June 2009, this contracting effort was still ongoing  results from that effort were not available to include in our review.
Lastly, at our suggestion during the course of our review, MMS is  reviewing the possibility of enrolling some of its employees in training  classes offered by oil and gas companies to their employees participating  in the RIK gas program. In offering this suggestion, we pointed out that  MMS employees could (1) gain first hand knowledge into how industry  does its gas imbalance work, (2) make strategic contact with industry gas  imbalance employee counterparts, and (3) gain some insight into industry  training requirements. With regard to the latter, whereas COPAS requires  its oil and gas accounting members to receive 10 hours of continuing  education annually, MMS officials told us that its RIK gas revenue  specialists are not required to meet any annual education requirements. As  of June 2009, MMS had not decided whether to use this industry training.
section_title: Conclusions
paragraphs: GAO, A Model of Strategic Human Capital Management, GAO-02-373SP (Washington,  D.C.: Mar. 15, 2002).
section_title: Recommendations for Executive Action
paragraphs: To improve the Minerals Management Service’s oversight of the RIK gas  program and help ensure that the nation receives its fair share of RIK gas,  we recommend that the Secretary of the Interior direct the Minerals  Management Service to take the following seven actions:    Complete establishing policies and procedures to ensure outstanding  imbalances are valued appropriately and tha interest is charged. t the correct amount of    Monitor daily gas imbalances to determine whether the allocation  practices of gas operators are extent that this is occurring, identify and propose specific legislative  changes that MMS believes are needed to require operators to deliver  MMS’s royalty percentage on a daily basis.   resulting in lost revenues to MMS. To the    Audit the operators and imbalance data of a sample of leases taken in  and, on the basis of the audit findings, establish a risk-based aud program for RIK properties.
Promulgate RIK program regulations that protect the federal govern erators to submit  interests. At a minimum, regulations should require op imbalance statements in a standardized format within 60 days following  the month of RIK production. They should also require the use of gas  allocation methods MMS deems will ensure a fair return to the  government.
Establish procedures, with reasonable deadlines, for resolvin collecting all RIK gas imbalances in a timely manner.
Determine the information system enhancements necessary to effectivel identify and resolve gas imbalances and put into practice such a system.
Conduct an RIK staffing and training needs anal corresponding staffing and training program for MMS staff.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to Interior for review and commen Interior generally agreed with our findings and concurred with four of ou r  recommendations, partially concurred with two of our recommendations,  and did not concur with one recommendation.  t.
Specifically, Interior concurred with our recommendations to: (1)  complete establishing policies and procedures to ensure outstanding  imbalances are valued appropriately and that the correct amount of  interest is charged; (2) establish procedures, with reasonable deadlines,  for resolving and collecting all RIK gas imbalances in a timely manner; (3)  determine the information system enhancements necessary to effectively  identify and resolve gas imbalances and put into practice such a system;  and (4) conduct an RIK staffing and training needs analysis and put into  place a corresponding staffing and training program for MMS staff.
Interior partially concurred with our recommendation to audit operator and imbalance data of a sample of leases taken in kind and, on the  basis of  these findings, establish a risk-based auditing program. Interior stated that  it would conduct an analysis of the benefits of conducting risk-based  audits on a step, we continue to believe it is important to conduct audits of a sample  of leases taken in kind. Although MMS’s verification processes may  uncover some discrepancies between their entitled percentage and the  volumes delivered, we have shown that in some instances MMS’s  verification processes are not sufficient to uncover discrepancies. Furthe  sample of leases. While we believe this is an important first  r,  industry and other RIK programs audit to ensure they receive the royalties.
Interior also partially concurred with our recommendation to promulgat RIK program regulations that protect the federal government’s interest  and, at a minimum, require operators to submit imbalance statements in a  standardized format, within 60 days following the month of production,  and require the use of gas allocation methods MMS deems will ensure a  fair return to the government. Interior stated that the drafting of  regulations addressing the operator’s obligation to deliver, report, and  account for production and to resolve or mitigate production imbalances  is well underway, which we commend. MMS stated that it will evaluate  whether it should require operators to submit imbalance statements in a  standardized format. We continue to believe that requiring operators to  submit standardized imbalance statements would allow MMS’s gas  imbalance analysts to devote more time to reconciling imbalances and  would reduce the chance of calculation errors. MMS also stated that it will  evaluate whether to require operators to use gas allocation methods. W we believe this is a positive first step, we continue to believe that the use  of allocation methods will minimize the negative impact of imbalances on  revenues by ensuring MMS receives the gas volumes it is owed.
Interior did not concur with our recommendation to monitor daily gas  rators  imbalances to determine whether the allocation practices of gas opeare resulting in lost revenue to MMS. Interior’s letter states that the agency believes the operator’s obligation to deliver MMS’s royalty percentage  should be the same whether royalties are paid in kind or in value.  However, the in-kind program is different from the in-value program in  ly  that MMS has an obligation to provide RIK gas to purchasers on a dai basis. Therefore, in order to provide reasonable assurance that the  government is receiving its fair volumes of gas and in turn meeting its  obligations to RIK gas purchasers, receipt of RIK gas volumes from  operators should be monitored on a daily basis. While we acknowledge our report that the law authorizes MMS to enforce operator obligations  only on a mo may provide less to MMS on days when gas prices are relatively high, and  make up that difference by providing additional gas when prices ar relatively low. Further, we found that industry monitors imbalances on a  daily basis to ensure they do not continue to believe that MMS should begin to monitor imbalances daily  a changes requiring operators to deliver MMS the royalty percentage on a  daily basis.  nthly basis, this leaves open the possibility that operators   lose revenue. For these reasons, we  nd, to the extent that lost revenues are occurring, propose legislative  Interior’s full letter commenting on the draft report is reprinted in  appendix III. In addition, Interior made technical comments, which have addressed as appropriate.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies of this report to interested  congressional committees, the Secretary of the Interior, and other  interested parties. The report will be available at no charge on the GAO  Web Site at http://www.gao.gov.
If you or your staffs have any questions about this report, please contact  me at (202) 512- 3841 or ruscof@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. GAO sta ff who made major contributions to this report are  listed in appendix IV.
section_title: Appendix I: Scope and Methodology
paragraphs: We were asked to determine the extent to which MMS ensures the  accurate and timely identification and collection of royalty-in-kind (RIK)  gas imbalances. To address our objective, we reviewed various reports by  the Department of the Interior (Interior) and Interior’s Minerals  Management Service (MMS) on the history and current status of  imbalances associated with the RIK gas program including: (1) a 2002  internal MMS assessment of RIK gas imbalances; (2) a 2002 report by  Interior’s Office of Inspector General, which discussed, in part, MMS’s  vulnerability to underreporting of gas receipts due to RIK gas imbalances;  (3) MMS’s monthly action plan on RIK imbalances and open receivables,  first prepared in August 2007; and (4) MMS’s periodic cumulative  imbalance, cash-out, and keepwhole summary statements.
We also reviewed various reports prepared on the direction and overall  performance of the RIK program, including (1) an examination of a 2001 MMS  report which outlined MMS’s future plans for the RIK program; (2) a 2003  MMS contractor report that assessed the RIK program; (3) a 2007 report by  the Subcommittee on Royalty Management, part of the Royalty Policy  Committee, which reviewed the operations of the RIK program; (4) a 2008  MMS internal review report on RIK processes; and (5) a 2008 interim report  by the Royalty in Kind Subcommittee, also part of the Royalty Policy  Committee, which examined various issues, including imbalances, associated  with the RIK program. We also examined various reports prepared by other  governmental entities—including the Alberta, Canada government and the  Texas state government—regarding their RIK programs. We further discussed  the issue of RIK imbalances with officials from MMS, gas production  companies, gas operators, industry experts, and pipelines.
To examine MMS’s management of RIK gas imbalances, we received a  detailed walk-through of MMS’s processes for reconciling RIK gas  imbalances. We reviewed a variety of MMS documentation including (1) MMS  procedures manuals, (2) correspondence between MMS and Interior’s Office  of the Solicitor on RIK legal requirements, and (3) MMS’s guidance letters to  operators of RIK gas leases. We also reviewed federal and Interior’s internal  control and management standards and policies, including: (1) GAO’s  Standards for Internal Control in the Federal Government, (2) Interior’s  Internal Controls Handbook, (3) MMS’s Training Needs Assessment Process,  (4) the Office of Personnel Management’s Training Policy and Training Needs  Assessment Handbooks, (5) Office of Management and Budget’s Circular A- 130 on management of federal information resources, (6) Office of  Management and Budget’s Circular A-123 on management’s responsibility for  internal control in federal agencies, and (7) the Information Technology  Resources Board’s 1999 lessons-learned report on acquiring commercial-off- the-shelf software. Further, we reviewed various documents issued by the  Council of Petroleum Accountants Societies such as its 1993 report on oil and  gas operator and producer roles and responsibilities and its 2001 report on  producer gas imbalances, and information generated by the North American  Energy Standards Board. In addition to reviewing documentation, we also  conducted interviews with MMS officials; gas production companies;  purchasers of MMS’s RIK gas; the North American Energy Standards Board;  pipeline companies; and industry experts. Lastly, we reviewed legislation  pertinent to MMS’s management of the RIK gas program and RIK gas  imbalances. This included the Mineral Leasing Act of 1920, as amended; the  Outer Continental Shelf Lands Act of 1953, as amended; and the Debt  Collection Improvement Act of 1996, as amended.
Appendix II contains information on the scope and methodology we used  to analyze the relationship between gas prices and the daily percentage of  gas production allocated to MMS and the effect of this relationship on  federal revenue.
We conducted this performance audit from June 2008 to August 2009, in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
section_title: Appendix II: Analysis of the Relationship between Price and Percentage of Gas Production Allocated to MMS and the Effect on Federal Revenue
paragraphs: To ensure that the government obtains a fair value for the RIK gas it sells,  the Department of the Interior’s Minerals Management Service (MMS)  must ensure that it receives the volumes of gas to which it is entitled. The  difference between the RIK gas owed––MMS’s entitled percentage of gas–– and the percentage of gas it actually receives is referred to as an  “imbalance.” As discussed in the body of this report, MMS attempts to  reconcile gas imbalances monthly.
The nature of gas production causes some daily variation in volume. For  example, companies must estimate the volume of gas they will produce on  any given day and determine allocations based on these estimates. If  actual allocation volumes differ from the estimated volumes, MMS may  receive either an under-delivery of gas or an over-delivery of gas. Daily  imbalances may be resolved through a subsequent day’s under- or over- delivery, resulting in further variation in volume; however, MMS risks  losing revenue if that variation is associated with a variance in price.  Specifically, if operators allocate less than the royalty percentage of gas to  MMS on days when the spot price is high and more than the royalty  percentage of gas on days when the spot price is low, they could still meet  the royalty percentage across the month. However, if this occurs, MMS  may lose revenue because it may miss opportunities to sell the gas at the  higher price, even if no long-term imbalances accumulate.
This appendix describes our analysis of the relationship between prices  and the percentage of gas allocated to MMS, and how it affects the revenue  that MMS receives. Specifically, it (1) explains, in mathematical terms, the  potential for lost revenue if the operators allocate less than the royalty  percentages of gas when the spot price is high; (2) describes the data that  we used to empirically examine the daily variation in percentage of gas  allocated to MMS; (3) describes the methodology and results of our  analysis of daily variation in percentages of gas allocated to MMS; (4)  describes the methodology and results of our analysis of the relationship  between the daily variation in percentage of gas allocated to MMS and gas  prices; and (5) describes the methodology and results of our analysis of  the potential amounts of lost revenue.
subsections: section_title: Potential for Lost Revenue
paragraphs: To explain, in mathematical terms, the potential for lost revenue if  operators allocate less than the royalty percentages of gas when the spot  price is high, we examined how this relationship affects the expected, or  average, return for an MMS lease.
The royalties that MMS are owed can be expressed as follows:  royalty volume = total production volume x royalty percentage  On a daily basis, the royalty volume can be expressed by the product of  the daily gas production and the daily volume of gas allocated to MMS:  (1) RV = Vol x A  where RV is the royalty volume at time t, Vol is the volume of gas  allocated to MMS at time t, and A is the royalty percentage at time t. In  equation (1), and the equations that follow, t stands for any given day. The  monetary value of the gas allocated to MMS can then be expressed by  multiplying the royalty volume and the gas spot price at the time of  delivery.  (2) Rev  = P x RV  Substituting equation (1) into equation (2) results in the following formula:  (3) Rev  = P x Vol x A  where the revenue MMS receives is the product of the price, volume, and  royalty percentage at that time.
To determine how different levels of covariance affect the average  revenue, we determined the expectation, as shown in equation (4).  (4) E(Rev )= E(P x Vol x A)
Because the focus of our analysis was the effect of daily variances in gas  allocated to MMS that was associated with variances in the spot price, we  assumed that the volume at the time of delivery is independent of the  product of price and the royalty percentage, and that the volume is  constant over the period.  (5) E(Rev ) = E(Vol) x (E(P)E(A)+Cov(P ,A))
If higher prices tend to correspond with higher percentages of gas  allocated to MMS, then the covariance term Cov(P ,A) will be positive,  and the expected revenue will be higher. However, if high prices  correspond with lower percentage of gas allocated to MMS, then the  evenue will fall.  covariance term will be negative, and the expected r The covariance describes both the relationship between the variables and  the absolute variability of each. A substitute for the covariance would be  to introduce the correlation coefficient. The correlation coefficient  captures only the relationship between the variables and takes a value  between negative 1 and 1. A correlation coefficient of zero would indicate  that there was no relationship between the variables. A correlation  coefficient close to 1 would indicate a strong positive relationship, while a  correlation coefficient close to negative 1 would indicate a strong negative  relationship. Using the correlation coefficient, an alternate expression for  the equation (5) would be the following:  (6) E(Rev ) = E(Vol) x (E(P)E(A)+Corr(P,A) x SD(P) x SD(A))
From equation (6), it is apparent that, all things being equal, the more the  price and percentage of gas allocated to MMS are negatively correlated,  the greater the loss in revenue. However, the size of the effect is scaled by  the absolute variability in each, SD(P ) and SD(A).
section_title: Data We Used for Our Analyses
paragraphs: ) x (E(V )E(A )+ Corr(V ,A ) x SD(V ) x SD(A )). Therefore, if high volumes correspond to lower royalty percentages, then  the covariance term will be negative and the expected revenue will fall. the supply of natural gas that is last to be taken and first to be curtailed  and absorbs production variations. The spot price varies daily.
Delivery data: We collected delivery data from MMS’s Entegrate database.  MMS downloads final delivery volumes from the electronic bulletin boards  for regulated pipelines, or it receives delivery volumes from either  operator or purchaser pipeline statements, or both. MMS enters the actual  volumes into the Entegrate database monthly.
Volume data: We collected volume data from the Offshore Energy and  Minerals Management division of MMS, which collects hardcopy pipeline  statements. MMS provided copies of the pipeline statements, which a  contractor keypunched. We checked the keypunched data, and found no  errors. We then matched the daily production volume data to the daily  price and delivery data for use in our analyses.
Because pipeline statements do not report production volume at the lease  level, we could not analyze allocation percentages at the lease level. For  all three sources, we collected data at the level of the measurement  point—the metered point at which gas is measured. A measurement point  may combine the gas flowing from numerous leases.
In addition, we excluded from our sample measurement points whose  leases had differing royalty percentages. For cases in which the  measurement points had differing royalty percentages, it would not have  been possible to calculate whether MMS was allocated its share of gas. For  example, in figure 1, measurement point one has three leases flowing into  it, all with the same royalty percentage of 16.67 percent. Therefore,  regardless of whether each lease has different production volumes, MMS  can calculate that it is owed 16.67 percent of the total production of 10,000  MMBtu. However, measurement point two has three leases flowing into it,  with two leases owing a royalty percentage of 16.67 percent and one lease  owing a royalty percentage of 12.5 percent. Because each lease will likely  have a different volume of production and MMS will only have the total  production volume available from third party data, it is unable to  determine its entitled volume of RIK gas.
Because of this limitation, we restricted our analysis to a random sample  of those measurement points that had leases with a common royalty  percentage. Then, for each of the randomly selected 32 measurement  points, we obtained 6 months of daily observations––October 2007  through March 2008––resulting in 5,856 daily observations. MMS officials  suggested that we use this 6 month time period in order to avoid hurricane  season, which typically occurs during the summer months, but gas prices  during these months may differ from those included in our time period.  However, 677 days had no production, and data for 366 days was missing  values for allocation volumes to MMS. Because we could not produce a  percentage of gas allocated to MMS in those cases, our ultimate sample  contained 4,829 daily observations with values for volume of gas allocated  to MMS and the differential between spot and base price and 31  measurement points.
section_title: Methodology and Results of Our Analysis of Daily Variation in Percentages of Gas Allocated to MMS
paragraphs: To determine the extent to which the daily percentage of gas allocated to  MMS deviated from its royalty percentage of gas for the measurement  points in our sample, we calculated the daily percentage of gas allocated  to MMS by dividing the volume of gas allocated to MMS from that  measurement point on a given day by the volume of gas produced at the  measurement point. We then counted the days that the percentage of gas  allocated to MMS differed from the prescribed amount of 16.67 percent by  a substantial amount, which we defined as more than 25 percentage  points.
Our analysis of daily data found variation in the percentage of gas  allocated to MMS; however, on the majority of days, the allocation did not  substantially differ from MMS’s royalty allocation, as shown in Figure 2.  Specifically, 3,573 of the 4,829 days––about 74 percent––had an allocation  that was between 75 and 125 percent of the entitled royalty percentage of  one-sixth or 0.167. But on many days, the royalty percentage of gas  allocated to MMS was much less or much greater. For example, on 883  days––about 18 percent of the total, shown as the sum of the bottom three  bars on figure 2––the royalty percentage of gas allocated to MMS was less  than 75 percent of the prescribed amount. On the other hand, on 373  days—about 8 percent of the total, shown in the top two bars—more than  125 percent of the royalty percentage of gas allocated to MMS. On average  MMS received 15.9 percent.
section_title: Methodology and Results of Our Analysis of the Relationship between the Daily Variation in the Percentage of Gas Allocated to MMS and Gas Prices
paragraphs: While there may be inherent daily variation in the percentage of gas  allocated to MMS, the loss of revenue is determined by the extent to which  that variation is associated with price. To analyze whether the percentage  of gas allocated to MMS varies with price, we used the daily data on the  differential between the base and spot price for our sample of  measurement points and measured the correlation between these two  variables for each measurement point. We found a small negative average  and median correlation between higher prices and a lower percentage of  gas allocated to MMS. Specifically, the average correlation was negative  0.014, while the median was negative 0.038.
Although the average was slightly negative, we found that correlations had  a wide range. Figure 3 presents the frequency of the correlations of the  differential between spot price and base price and percentage of gas  allocated to MMS for the 31 measurement points in our sample. The  maximum, or the most positive, correlation in our sample was 0.645. The  minimum, or most negative, was negative 0.560. As figure 3 shows, the vast  majority of measurement points had a correlation between negative 0.25  and 0.25.
section_title: Methodology and Results of Our Analysis of Potential Amount of Lost Revenue
paragraphs: The potential amount of lost revenue depends on the size and variability of  the percentage of gas allocated to MMS, gas produced, and the spot-minus- base differential. To estimate the revenue loss that would be associated  with a certain correlation, we used an hypothetical measurement point  that had the same average characteristics as the ones in our sample.  We  then generated data that had the same average mean and standard  deviation as our hypothetical example, but different correlations between  the variables. We computed the average revenue for that hypothetical  measurement point during a 6-month time period. We used a wide range of  correlations, including the median value found in the above example.  Finally, we compared the revenue to a baseline of zero correlation.
We estimate that the median correlation we found would result in a  revenue loss of about $1,400 for each measurement point during a 6-month  time period, as shown in table 1. Each row of the table is the result of one  million simulations of data with the given correlation and the mean and  average standard deviation of the measurement points in our sample.  However, the common royalty percentage in the leases at the  measurement points we sampled from––which accounts for about 85  percent of measurement points in the RIK gas program––would make it  easier to detect the under-delivering when prices were high. It follows that  this may introduce a bias into our distribution of correlations. Specifically  operators at those measurement points may be less likely to link gas  allocations to price because they fear detection, therefore we would be  less likely to find negative correlations. At measurement points with a mix  of different royalty percentages––about 15 percent of measurement points  in the RIK gas program––the potential for this practice may increase, and  could result in more negative correlations. As table 1 shows, a more  negative correlation would result in higher revenue losses for these  measurement points. For example, a correlation of negative 0.5 would  result in a loss of about $21,000 during a 6-month time period for that  measurement point.
section_title: Appendix III: Comments from the Department of the Interior
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, key contributors to this report  included Karla Springer, Assistant Director; Robert Baney; Benjamin  Bolitzer; Melinda Cordero; Cindy Gilbert; Alison O’Neill; Dae Park; Justin  Reed; Holly Sasso; Ben Shouse; and Barbara Timmerman.