Mineral Revenues: Cost and Revenue Information Needed to Compare Different Approaches for Collecting Federal Oil and Gas Royalties
Published: 2004-04-16T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In fiscal year 2003, the federal government collected $5.6 billion in royalties from oil and gas production on federal lands. Although most oil and gas companies pay royalties in cash, the Department of the Interior's Minerals Management Service (MMS) has the option to take a percentage of the oil and gas produced and sell this product-- known as "taking royalties in kind (RIK)." MMS has taken royalties in kind continuously since 1998 with the goal of achieving administrative savings while maintaining revenue. GAO attempted to (1) quantify the administrative savings that may be attributable to the RIK sales and (2) compare the sales revenues from RIK sales to what would have been collected in cash royalty payments.
section_title: What GAO Found
paragraphs: Although data on administrative savings are limited, there are substantial audit savings attributable to RIK sales, but there are no quantified savings in the overall administration of royalty collections. MMS has anticipated savings in auditing and litigation expenses. While MMS data showed that auditing costs for RIK sales were less than auditing costs for cash sales on a per lease basis, MMS redirected the resources it saved to auditing additional leases. At this time, MMS cannot quantify the benefit from additional auditing. The costs of litigation, which the Solicitor's Office in the Department of the Interior performs for MMS, are not tracked. However, officials with the Solicitor's Office were unable to attribute any savings in litigation to the increased use of RIK and said that future litigation costs are difficult to predict. Finally, MMS must weigh these benefits against additional costs required to conduct RIK sales. Despite limitations in MMS's analyses and revenue data that prevented a more comprehensive assessment of all RIK sales, our estimate of the revenue impacts from RIK sales in three areas indicates a mixed performance. Specifically, RIK oil sales in Wyoming increased revenues by 2.6 percent, for a gain of $967,000 on sales of $37 million. RIK oil sales in the Gulf of Mexico decreased revenues by $7.2 million, for a loss of 5.5 percent on sales of $131 million. RIK gas sales in the Gulf increased revenues by $4 million, for a gain of 2 percent on revenues of $210 million. However, these sales only represent 11 percent of the gas and 57 percent of the oil that MMS took in kind from inception of the pilots through November 2003. MMS does not analyze all sales because there is no requirement to do so, staff considers existing information on sales sufficient, few staff are assigned to analyzing sales, and MMS management has a lengthy review process for finalizing sales analyses.

section_title: Letter
paragraphs: In fiscal year 2003, the Department of the Interior’s Minerals Management  Service (MMS) collected about $5.6 billion in royalties from oil and gas  production on federal lands. MMS traditionally accepts the federal  government’s oil and gas royalties in cash. Under the Mineral Leasing Act of  1920 and the Outer Continental Shelf Lands Act, MMS also has the  authority to take a portion of the actual oil and gas produced, referred to as  “taking royalties in kind.” MMS then sells this oil and gas to the highest  bidders at competitive auctions. MMS established Royalty-in-Kind (RIK)  pilot sales with the intent of testing whether MMS can (1) decrease the cost  of administering royalties and (2) maintain or increase royalty revenues.  MMS began to evaluate the use of federal royalty oil as an alternative to  cash royalty payments through a series of pilot sales in Wyoming beginning  in 1998. In addition, MMS has conducted pilot sales for gas and oil in the  Gulf of Mexico. We estimate that revenue from RIK pilot sales was about  $682 million in fiscal year 2003. Based on MMS estimates for further  expansion of RIK sales, MMS could be collecting between $1.5 billion and  $2.5 billion per year in revenue from RIK pilot sales by 2008.
To address MMS progress toward a more systematic evaluation of MMS’s  RIK efforts, you asked us to (1) quantify any savings in administering  royalty collections that are attributable to the RIK pilots and (2) compare  sales revenues from RIK pilots to what would have been collected under  cash royalty payments.
In responding to the objectives, we discussed the RIK sales program with  MMS officials and oil and gas marketers who are active in Wyoming and the  Gulf of Mexico, where MMS has conducted almost all of its RIK pilot sales.  We initially reviewed documents analyzing RIK sales and the costs to  administer these sales. However, we found at the start of our review that  MMS had only released two draft reports that analyzed the impact of RIK  sales, and these reports and other informal studies only addressed the  revenue impacts associated with 9 percent of the royalty oil sold through  July 2002 and about 44 percent of the royalty gas sold through March 2002.  The reports remained in draft until approved by management in March  2004. While the two studies asserted that RIK sales produce administrative  savings, the studies did not conclusively quantify any savings. Given the  nature of MMS’s limited analysis of administrative cost and revenue  impacts, we attempted to address the objectives by acquiring and analyzing  additional MMS data. However, in the course of our analysis, we found that  sufficiently detailed administrative cost information necessary to compare  RIK to cash royalties does not exist, leaving us unable to completely assess  the administrative impacts.
In evaluating the revenue impact of RIK sales, we obtained royalty data  from MMS’s financial data system. However, this system was designed to  collect and disburse revenues and not to specifically analyze the revenue  impacts of RIK sales; therefore it was not suitable for doing a  comprehensive evaluation of the RIK sales. In addition, some erroneous  and missing data required time-consuming inspections of the royalty data  to ensure their reliability and integrity. As a result, we were only able to  assess the revenue impacts in case studies representing parts of three RIK  pilot sales areas: Wyoming oil, Gulf of Mexico oil, and Gulf of Mexico  natural gas. The sales we analyzed represented about 57 percent of the  royalty oil and 11 percent of the royalty gas MMS took in kind from  inception of these pilots through November 2003. We performed  significance tests on the results of our case studies and found them to be  statistically significant at the 5 percent level. However, it was not possible  to project the total revenue impact of all the RIK pilot sales from these case  studies because the difference between RIK revenues and cash royalty  revenues can vary greatly over time and because the case studies are not  representative samples of all RIK sales. In addition, we were unable to  obtain data that would have enabled us to measure the effects of audits on  revenues from RIK and cash sales, which adds uncertainty to our estimates  in the case studies. Therefore, we are unable to determine conclusively  how well the RIK pilot sales have done compared to what would have been  expected from cash sales over the long term.
We conducted our work from February 2003 through March 2004 in  accordance with generally accepted government auditing standards. For a  more detailed discussion of the scope and methodology of our review, see  appendix I.
subsections: section_title: Background
paragraphs: In general, royalty rates for onshore federal oil and gas leases are 12- 1/2  percent of the value of the oil and the gas produced, whereas royalty rates  for offshore leases are generally 16- 2/3 percent. MMS also administers  programs under which royalties are reduced or suspended to encourage  exploration and production. The administration of cash royalty payments  has been challenging for MMS. MMS relies upon royalty payors to self- report the amount of oil and gas they produce, the value of this oil and gas,  and the cost of transportation and processing that they deduct from cash  royalty payments. With 22,000 producing leases and often several  companies paying royalties on each lease each month, the auditing of these  cash royalty payments has become a formidable task. In addition, payors  and MMS often disagree over the value of the oil and gas and the  transportation and processing deductions, leading to time-consuming and  costly appeals and litigation for those disagreements that they cannot  resolve. MMS claims that compared to cash royalty payments, RIK can  substantially simplify the administration of royalties because it reduces  these disagreements and the time that MMS must spend resolving them.  While RIK offers the promise of simplified administration, MMS must also  consider the revenue impact of RIK. The Mineral Leasing Act of 1920 and  the Outer Continental Shelf Lands Act authorize taking royalties in kind.  These two acts directed the Secretary of the Interior to obtain fair market  value for the oil and gas taken in kind. The Outer Continental Shelf Lands  Act defined “fair market value” as the average unit price for the mineral  sold either from the same lease or, if such sales did not occur, in the same  geographic area. Moreover, the fiscal years 2001 through 2004  Appropriation Acts for Interior and related agencies directed MMS to  collect at least as much revenue from RIK sales as MMS would have  collected from traditional cash royalty payments.
In recent years, MMS conducted three major RIK pilots involving (1) oil in  Wyoming, (2) oil in the Gulf of Mexico, and (3) natural gas in the Gulf of  Mexico. For oil in Wyoming, MMS has taken royalties in kind since October  1998. Although the amount of royalty oil that MMS takes in kind in  Wyoming is less than 1 percent of all federal royalty oil, MMS has gained  valuable experience during these sales. MMS has also taken royalty oil in  kind in the Gulf of Mexico in two 6-month sales between November 2000  and March 2002. Unlike in Wyoming, the amount of royalty oil that MMS  took in the Gulf approached 20 percent of all federal royalty oil during the  second 6-month sale from October 2001 through March 2002. MMS’s RIK oil  pilot in the Gulf was put on hold when the president directed that MMS use  royalty oil to fill the nearby Strategic Petroleum Reserve (SPR). Finally, for  natural gas in the Gulf of Mexico, MMS has consistently taken natural gas  in kind since December 1998. MMS currently takes about 19 percent of  total federal royalty gas in pilots conducted in the Gulf of Mexico, and this  program continues to grow.
section_title: Savings in Auditing RIK Occur, but Overall Impact on Royalty Administration Costs Cannot Be Completely Quantified
paragraphs: While there are substantial administrative savings in auditing royalty  collections that are attributable to the RIK pilots, there are no quantified  savings in the overall administration of royalty collections. MMS’s overall  budget to administer royalties has declined slightly as MMS increased the  use of RIK, but the development of many other changes in royalty  administration during the same time makes it difficult to assess the relative  impact of RIK. MMS only began collecting detailed administrative cost  information starting in fiscal year 2003, so it is not possible to attribute  costs to the different royalty administration activities before then. MMS’s  development of a more specific cost information system in 2003 may help  with future impact assessments, but will not allow any comparison to the  past. MMS claims that the administrative cost savings from using RIK  comes primarily from a reduction in audit and litigation activities that  would have occurred under cash royalty collections. Information collected  by MMS starting in 2003 has supported MMS’s assertion that RIK pilots can  create savings by reducing the costs of auditing royalty payments. While  MMS has redirected auditing resources it saved to auditing more cash  payments, it is not yet able to determine the benefit of this increased audit  effort on overall royalty collection. Regarding litigation savings, no  litigation cost information has been collected nor have any savings been  identified. Finally, these potential savings must be weighed against  additional specific costs that would otherwise not be incurred under cash  royalties, such as operating costs in fiscal year 2003 of $1.7 million to  conduct the RIK sales. MMS also incurred a capital investment of $13  million to purchase information systems.
subsections: section_title: MMS’s Budget to Administer Royalty Collections Has Declined Slightly, but the Impact of RIK Is Not Clear
paragraphs: In October 2001, MMS reorganized and created the Minerals Revenue  Management organization (MRM) within MMS to collect, disburse, and  audit royalty revenues. Since its creation, MRM’s budget has declined by  about 7 percent, from $86.5 million in fiscal year 2002 to $80.4 million in  fiscal year 2004. Approximately 41 percent of MRM’s budget over this  period supported financial management, including the collection and  disbursement of royalty revenues. Nearly all of the remaining 59 percent of  the budget supported compliance asset management, a major function of  which is the auditing of oil and gas royalty revenues. Budget documents  indicate that MRM has maintained about 572 full-time personnel from fiscal  years 2002 through 2004, of which 184 were assigned to financial  management and 388 were assigned to compliance asset management. An  official within the Department of the Interior added that the actual number  of employees on board was 558 in 2004, with some of this difference due to  a decrease in the number of personnel assigned to compliance asset  management. Within compliance asset management is the RIK Office that  oversees RIK pilot sales, the Small Refiners Program, and the filling of the  SPR.
Other developments in the administration of royalty collection have made  it difficult to attribute changes in the MRM budget to RIK activities.  Whereas RIK sales significantly change the processes for collecting royalty  revenues, other developments, including the substantial change in the  duties of the personnel responsible for auditing oil and gas revenues and  for ensuring compliance with applicable rules and regulations, have  ultimately affected the way MMS deploys its personnel—a major  component of MRM’s budget. For example, in June 2000 MMS implemented  new oil valuation regulations that provide more specific guidance on what  prices companies must report to MMS on the sales of oil to their affiliates,  and this should decrease discrepancies between MMS auditors and royalty  payors. Similarly, MMS’s increased willingness to write formal agreements  on these prices is also expected to decrease such disagreements. The  change in the way MMS audits oil and gas revenues since its reorganization  is also expected to decrease its workload. For example, MMS auditors no  longer routinely compare all production volumes reported by the operators  of oil and gas leases against all sales volumes reported by royalty payors to  search for possible underpayments. Instead, MMS auditors now perform  this activity on a case-by-case basis as needed. MMS auditors are also  increasingly selecting the property as the entity to audit rather than  selecting an individual company. Finally, when MMS does select a company  to audit, there are fewer companies to select because of the recent mergers  of the large oil and gas companies.
Prior to fiscal year 2003, MMS lacked the necessary data to conclusively  quantify the difference in administrative costs under different royalty  collection methods. Under Interior’s agencywide initiative, MMS  implemented an activity-based cost (ABC) management system in fiscal  year 2003. The system identifies specific work activities in order to  measure their costs, monitor and evaluate program performance and  results, and improve the way MMS does its work. In essence, MMS  personnel record the hours spent on specific work activities, such as RIK  audits, and convert these hours into labor costs. These labor costs are then  added to nonlabor costs, such as travel and materials costs, to produce  total direct costs for the identified work activities. MMS has captured the  costs of the work activities included in the collection and auditing of  royalty revenues during fiscal year 2003. Such information may help MMS  compare the costs of administering the RIK sales to the costs of  administering cash royalty collections; however, there is no way to make  this comparison prior to fiscal year 2003.
section_title: RIK Reduces Audit Costs, But Overall Impact on Royalty Collection Is Not Quantified
paragraphs: According to MMS, the auditing and compliance effort is significantly  reduced under RIK because MMS and the RIK purchaser agree to a  contractual price before the sale and because transportation deductions  are no longer an issue when MMS sells the oil or gas at the lease. MMS  further explained that auditing RIK leases can be done within as little as  120 days after the sale because it has all the necessary price information at  that time, while up to 3 years transpire before MMS initiates an audit of  cash royalty payments. During such cash royalty audits, MMS personnel  must physically collect and inspect collaborative pricing and transportation  documents, often at the payors’ offices, while similar pricing information  for RIK sales is instantly available in MMS’s information systems.
The data from MMS’s newly implemented ABC management system does  support MMS’s assertion that the auditing of certain RIK sales revenues is  less costly on a per-lease basis than the auditing of comparable cash royalty  payments. A review of the auditing and compliance costs for oil and gas  leases in the Gulf of Mexico and Wyoming—two locations in which MMS  received both cash and in-kind royalty payments during fiscal year 2003— showed that the costs to audit cash sales per lease were substantially  higher than the costs to audit in-kind royalties in both areas. In the Gulf of  Mexico, MMS reported spending $6,765,000 to audit cash sales from 242 oil  and gas leases, or $27,956 per lease, while spending $458,000 to audit all 297  gas leases included in the RIK pilot sales, or $1,542 per lease. Similarly,  MMS reported spending $820,000 to audit cash royalties from 912 oil and  gas leases in Wyoming, or $899 per lease, while spending $38,000 to audit  all 580 RIK oil leases in Wyoming, or $66 per lease.
While the ABC data suggest that the auditing costs for RIK sales revenues  are less than the auditing costs for cash royalty payments, this difference  does not necessarily mean that MMS is spending less money as it moves  more leases into its RIK sales. MMS explained that instead of decreasing its  audit budget, it has used these freed-up resources to audit additional cash  royalty payments that it would not have otherwise audited. In addition,  MMS has stated that auditing additional cash royalty payments could result  in the collection of additional revenues. For fiscal year 2000, the latest year  for which audit data are available, MMS reported that its audit activities,  together with state and tribal audits of federal royalty revenues, generated  about $219 million (or 5 percent) on royalty revenues of about $4.6 billion.  However, MMS will not know the results of auditing additional cash royalty  payments for several years because it takes time to select leases for audit,  conduct the audits, and resolve related appeals and litigation. In the future,  it is possible that MMS may experience different rates of revenue increase,  either upwards or downwards, as it expands its audit coverage because of  the different leases it selects for audit.
section_title: Litigation Costs Are Not Tracked
paragraphs: MMS’s new ABC system provided costs associated with taking royalties in  kind during fiscal year 2003, but it did not capture the costs associated with  specific types of litigation performed by others for MMS. Litigation  sometimes arises after MMS or state and tribal auditing efforts identify a  discrepancy that cannot be resolved by MMS and the payors. Such  discrepancies commonly involve the value of oil and gas or the costs of  transporting this oil and gas to market. MMS has maintained that the taking  of royalties in kind reduces litigation. However, the savings that could  result from avoiding litigation cannot be quantified by MMS because MMS  does not conduct the litigation. Instead MMS relies primarily upon the  Department of the Interior’s Solicitor’s Office, which does not track  specific types of litigation costs for MMS. Officials in the Solicitor’s Office  reported that since fiscal year 1999, between two and four of their  attorneys worked full-time on MMS royalty issues. In addition, these  officials said that attorneys within the Department of Justice represent  MMS in court. Officials in the Solicitor’s Office could not attribute any  decrease in litigation to an increase in the use of RIK. They also stated that  the nature of the royalty litigation could change as a result of RIK; while  litigation over valuation and transportation deductions may decrease,  litigation over RIK contracts and discrepancies over volumes sold may  increase. They also cautioned that future litigation over administrative  decisions and rule making is impossible to predict. Finally, regardless of  the volume of RIK sales, they cautioned that as long as MMS receives some  cash royalty payments, there would always be the potential for litigation on  valuation issues and transportation allowances.
section_title: RIK Sales Require Additional Costs Not Incurred When Collecting Cash Royalties
paragraphs: The administration of the RIK pilot sales includes additional activities that  are not necessary when accepting cash royalty payments and therefore add  to the cost of collecting royalties in kind. Such activities include identifying  properties from which to sell oil and gas, calculating minimum acceptable  bids, awarding and monitoring contracts, billing purchasers, negotiating  transportation rates, and reconciling discrepancies in volumes. In fiscal  year 2003, MMS’s preliminary ABC data showed direct costs of $1.7 million  to conduct activities for the RIK pilot sales that it would not have incurred  had it accepted cash royalty payments. Of this $1.7 million, MMS  reportedly spent $475,000 to identify properties, calculate minimum  acceptable bids, and conduct sales; $464,000 to market the royalty oil and  gas; $176,000 to monitor the credit worthiness of purchasers; $496,000 for  auditing leases and reconciling volumes; and $127,000 for policy  compliance and legal support.
MMS also incurred one-time costs of more than $13 million to acquire three  information systems, part of whose functions are to bill, collect, and report  on revenues from the RIK pilots. When fully implemented, these systems  may help address the management control weakness that we previously  identified involving the manual entry of data into unlinked computer  spreadsheets. The first of these systems, the gas information system, is  wholly dedicated to the administration of the RIK gas pilot sales and cost  $7.3 million. Implemented in January 2003, the system automates the  billing, collecting, and reporting functions. MMS’s second system, the  liquids information system, cost almost $5 million and was implemented in  June 2003. Like the gas system, it is designed to automate the billing,  collecting, and reporting functions, but unlike the gas system it is not  wholly dedicated to the RIK pilot sales, but also supports the Small  Refiners Program and the filling of the SPR. MMS’s third system, the Risk  and Performance Management System, cost about $0.9 million and is  designed to measure the results of the RIK gas sales and the Small Refiners  Program for periods during 2003. In addition, MMS’s preliminary ABC data  shows that MMS incurred direct costs of $682,000 in fiscal year 2003 to  develop and maintain these information systems. MMS will also incur  additional costs in future years to operate and maintain these systems.
section_title: The Revenue Impact of RIK Sales Is Mixed
paragraphs: Our analysis of sales in three RIK pilots indicates a mixed performance  when comparing RIK sales revenue to what might have been collected  under cash royalty payments. Specifically, (1) RIK sales in Wyoming  increased revenues by about 2.6 percent, for an estimated gain of $967,000  on sales of about $37 million; (2) a 6-month oil sale in the Gulf of Mexico  decreased revenues by 5.5 percent, for an estimated loss of $7.2 million on  sales of about $131 million; and (3) natural gas sales in the Gulf of Mexico  produced more revenues than would have been collected from cash royalty  payments—an increase of about 2 percent, for an estimated gain of $4  million on revenues of $210 million. These sales represented about 11  percent of the gas and 57 percent of the oil that MMS took in kind from  inception of the pilots through November 2003. Our attempts to review the  revenue impact of more RIK sales were precluded by specific limitations in  MMS  financial data and the availability of only two independent MMS  draft reports.  As we observed in our January 2003 report, MMS continues  to expand its RIK pilots without analyzing and documenting the revenue  impacts of all its RIK sales. MMS is making some progress in this area, but  still has not demonstrated that it has received fair market value, or at least  as much as it would have received in cash royalty payments.
subsections: section_title: RIK Oil Sales in Wyoming Increased Revenues by About 2.6 Percent
paragraphs: MMS chose to conduct its first RIK oil sales in Wyoming because of the  state’s active oil markets and the cooperative spirit of state officials. MMS  offered for sale the federal government’s royalty share of oil together with  the state of Wyoming’s royalty oil that was for 6-month periods beginning in  October 1998. Bidders offered a fixed amount of money either more or less  than published market prices, such as Wyoming posted prices, Canadian  posted prices, and the oil futures contract on the New York Mercantile  Exchange (NYMEX). The winning bidders, which included companies that  market, refine, transport and/or produce oil in Wyoming and adjacent  states, accepted delivery of the oil at the lease. Although MMS’s RIK sales in  Wyoming accounted for only about 1 percent of total federal royalty oil,  MMS acquired significant knowledge on how to conduct sales and market  oil onshore. For example, MMS determined that companies more  commonly bid on royalty oil from properties that are connected to  pipelines and prefer flexibility in choosing a specific price upon which to  base their bid. In addition, MMS learned in 2002 that it was not profitable to  transport the volumes from many scattered leases to one central location  for sale.
In a draft report issued in March 2001, updated in June 2002, and finalized  in March 2004, MMS estimated that it received slightly more revenue in its  first three RIK sales than it would have received in cash royalty payments.  Specifically, MMS reported that it collected $810,000 more from RIK sales  than it would have received in cash royalty payments, or an increase of  about 2.9 percent on sales of $27.66 million from October 1998 through  March 2000. MMS based its conclusion on a comparison of winning RIK  bids to severance taxes that producers reported and paid to the state of  Wyoming. State severance taxes are calculated as a percentage of the value  of all oil that companies sell, regardless of whether the oil is produced from  federal, state, or private lands. Because the state of Wyoming’s oil valuation  statutes are similar to how the federal government values oil, MMS  assumed that the price that companies reported for state severance taxes  on RIK properties was equal to the price that the government would have  received in cash royalty payments. However, MMS did not demonstrate that  the average sales prices for cash royalty payments were equal to the  average sales prices used to calculate Wyoming severance taxes, initially  creating some uncertainty about MMS’s revenue calculations.
To address the uncertainty in MMS’s assumption about the relationship  between cash royalty payments and severance tax prices, we analyzed the  relationship. For nine federal properties that accounted for about 47  percent of the oil that MMS sold in Wyoming during the first seven RIK  sales, we compared Wyoming severance tax data with MMS’s financial data  for the 33-month period prior to the RIK sales and concluded that Wyoming  severance tax prices are a reasonable proxy for cash royalty payments.  Therefore, based on Wyoming severance tax data, we estimated that MMS  collected $967,000 more from the RIK sales from October 1998 through  March 2002 than it would have collected in cash royalty payments—an  increase of about 2.6 percent on sales of about $37 million. The results of  our analysis of selected Wyoming RIK sales are consistent with MMS’s  conclusion that the RIK sales that it analyzed resulted in slightly more  revenue that it would have realized if it had accepted cash royalty  payments. A more detailed discussion of our analysis appears in   appendix I.
section_title: Six Months of RIK Oil Sales in the Gulf of Mexico Decreased Revenues by About 5.5 Percent, But Long Term Impacts Could Differ
paragraphs: Although MMS has a long-standing history of selling royalty oil through the  Small Refiners Program, MMS did not sell offshore royalty oil directly to  other qualified purchasers until November 2000. MMS sold, through two  separate 6-month sales, up to 20 percent of the federal government’s  royalty share of oil in the offshore Gulf of Mexico to all purchasers meeting  predetermined financial qualifications, whether they were small refiners,  large refiners, producers, or marketers. Winning bidders offered a fixed  amount of money that was more than or less than a formula based on one  of two widely published oil prices—Koch’s published price for West Texas  Intermediate oil in the first sale and the NYMEX futures contract in the  second sale. During the first sale, MMS offered about 39,000 barrels of oil  per day, but awarded contracts for only about 7,600 barrels per day. Only  two companies submitted bids. MMS attributed the lack of interest to the  delivery points for the oil being at market centers onshore rather than  offshore near the lease. During the second sale, which commenced in  October 2001, MMS offered and awarded approximately 48,000 barrels of  oil from six major pipeline systems. Nearly all of the oil consisted of two  types, referred to as the Mars and Eugene grades, produced in water depths  up to about 4,000 feet. The delivery point for the oil was offshore near the  lease, and competition was robust. MMS terminated the Gulf RIK oil pilots  after the second sale when ordered by a Presidential directive to transfer  oil from these properties to the SPR.
As of July 2003, MMS had not evaluated the revenue impacts of either sale.  Because of the larger amount of oil sold during the second sale, we chose  to analyze this sale and estimated that MMS received about $7.2 million less  in revenues than it would have received had it accepted cash royalty  payments—a 5.5 percent loss on sales of about $131 million. We selected 13  of the 26 leases included in the second sale that collectively accounted for  about 89 percent of the oil offered and sold. For the 16-month period prior  to the start of the second oil sale, we compared the average monthly sales  price for oil from each lease to the price as prescribed by MMS’s oil  valuation regulations for sales between affiliated parties (transactions not  at arm’s-length). We then computed a weighted average difference in the  monthly prices for the entire 16-month period and assumed that this  weighted average difference would have persisted over the 6-month RIK  sales period had royalties been paid in cash. A detailed explanation of our  analysis appears in appendix I.
Because revenue from RIK sales and from cash sales can differ  considerably in any given month, a longer period of evaluation is needed to  determine whether a specific type of RIK sales can generate at least as  much royalty revenue as cash sales. The reason that RIK and cash sales  revenues differ month to month is that they are generally based on different  sets of market prices. For example, the formula that MMS used to award  RIK bids in the second Gulf of Mexico sale differs from the formula  prescribed in the oil valuation regulations primarily in two ways: (1) the  bidding formula relies on prices from a period that is almost a month  earlier than that prescribed by the oil valuation regulations, thereby  creating a timing difference and (2) the bidding formula relied on an  adjustment to NYMEX futures price, referred to as “the roll.” The roll is an  adjustment that compensates for differences in oil futures prices for  subsequent months. If futures prices for the next three trade months trend  downward, the roll is a positive adjustment. If futures prices trend upward  for the next three trade months, the roll is a negative number. Rising oil  futures prices that accompanied uncertainty in the financial markets after  the September 11 terrorist attacks resulted in generally lower-than- anticipated RIK royalties caused by the timing differential and a negative  roll, thereby contributing significantly to the negative performance of the  second sale.
MMS officials agree that a 6-month term is an insufficient period of time  during which to evaluate a sales methodology. Specifically, MMS added that  it had intended to continue the oil sales in the Gulf of Mexico but that the  President directed that royalty oil be used to fill the SPR, and royalty oil  from the leases included in the pilot sales was the only feasible source.  Although MMS generally agrees with the magnitude of the revenue impact  that we identified during the 6-month period of the second sale, MMS  believes that we should have examined a longer period of time, even  though the oil that was sold during this sale was thereafter transferred to  the SPR. After learning of our analysis, MMS conducted its own evaluation  of many of the same leases. MMS combined the results of the 6-month  second sale with the following 12 months during which oil from these same  leases was transferred to the SPR. MMS estimated that during this  combined 18-month period, its sales methodology increased revenues by  $4.9 million. This estimate, however, does not mean that MMS collected  $4.9 million more than it would have collected in cash royalty payments.  MMS’s estimate is based on combining cash collections from RIK sales in  the first 6 months with market index prices at the time that MMS  transferred the oil to the Department of Energy (DOE) for filling of the  SPR. MMS estimated that it lost $6 million in cash during the first six  months and that the value of the oil transferred to DOE was $10.9 million  more than it would have received in cash royalties had the RIK pilot sales  continued for the next 12 months.
We do not believe that MMS’s evaluation of the SPR program is necessarily  indicative of how the RIK program would have performed had it been  allowed to continue. The SPR program does not generate royalty income  for the federal government in the same way as the RIK program does. In the  SPR program, the royalty oil, or an equivalent amount from another source,  is pumped into the reserve, and revenues will only be generated upon its  removal and sale at some unspecified period in the future. In addition, the  data that MMS used in estimating the revenue impacts of its Gulf of Mexico  oil sales was problematic in several ways. First and most important, MMS  did not adjust its revenue estimate by quality bank adjustments. Quality  bank adjustments are either positive or negative adjustments to sales  revenues that pipeline companies compute because the royalty oil is of  either better or worse quality than the average quality of oil in the pipeline.  Payors either add or subtract these adjustments from both their cash and  in-kind royalty payments to MMS. Quality bank adjustments can be  substantial—during the second RIK sale, they lowered MMS’s revenues on  the leases we examined by $2.5 million. Second, MMS did not use the actual  transfer volumes to the SPR in its financial database, opting instead to use  volumes recorded in its production database or to use estimates of these  volumes, adding uncertainty to the accuracy of its revenue calculations.  For example, we examined the production volumes for 8 of the 13 leases  we reviewed during the 6-month sale and found significant discrepancies  between these volumes and the volumes in its financial database. Similarly,  independent auditors performing an audit of MMS’s fiscal year 2002  financial statements noted that MMS’s use of estimated volumes did not  ensure an accurate calculation of the SPR amounts transferred to DOE.  Third, we identified some minor discrepancies in the prices MMS used to  calculate the value of the SPR transfers, such as using an index other than  that used during the 6-month sale and assuming that companies bid exactly  the same on the SPR transfers as they did in the 6-month sale, but it is  unclear as to whether these discrepancies would significantly alter MMS’s  calculations.
section_title: Sales of Royalty Gas from Two Pipelines in the Gulf of Mexico Generated Higher Revenues Than Would Have Been Expected from Cash Royalties
paragraphs: After initial experimentation with selling royalty gas in 1995 and  simultaneously with the contracting of gas marketers in 1999, MMS  established sales procedures for offshore royalty gas similar to those in  2003. Beginning in June 1999, MMS tested the sale of offshore royalty gas  from 11 federal offshore leases. Production from these leases flowed  through the Matagorda Offshore Pipeline System or through the Blessing  Pipeline System. MMS entered a cooperative agreement with the Texas  General Land Office to conduct the RIK sales because under section 8(g) of  the Outer Continental Shelf Lands Act, royalty revenues for federal leases  located in coastal waters are to be shared with the state. MMS sold the  royalty gas for 1-month periods at competitive auctions, during which  purchasers who met minimum financial qualifications bid an increment or  decrement relative to applicable published gas indexes. Several months  into the pilot, MMS started dividing the gas into two separate packages—a  larger package (base volume), for which MMS guaranteed that it would  deliver the specified volume at a fixed first-of-the-month price, and a  smaller package (swing volume), for which MMS did not guarantee the  volume delivered and which MMS offered at published prices that varied  daily. Beginning in 2000, MMS began combining its monthly gas sales into  two sales periods for administrative reasons. MMS now conducts gas sales  for delivery from April through October, corresponding to the period  during which natural gas is used extensively for air conditioning, and for  delivery from November through March, corresponding to the period  during which natural gas is used extensively for heating.
In accordance with its cooperative agreement with the Texas General Land  Office, MMS issued a draft report in March 2002 on the analysis of its gas  sales from the Blessing and the Matagorda Offshore Pipeline Systems from  June 1999 through December 2000. The report stated that the RIK sales  increased revenues by nearly $1 million over what it would have collected  in cash royalties—an increase of about 1 percent on sales of almost $100  million. MMS obtained this estimate by comparing RIK sales revenues to  cash royalty sales from 18 other leases located in the same geographic area.  However, because of limitations with its financial data, MMS did not  subtract the costs of transporting the gas to its sales points onshore,  comparing gross unit prices rather than prices net of transportation  allowances.
After reviewing MMS’s study and conducting our own analysis, we reached  conclusions similar to those of MMS—that revenues from the sale of RIK  gas from the Blessing and Matagorda Offshore Pipeline Systems were  higher than MMS would have received in cash royalty payments. We  included additional RIK leases in our analysis, excluded some cash royalty  payments that MMS later identified as not coming from leases on the same  pipeline systems, and extended the time frame of our study to December  2001. We estimated that, including the cost to transport the RIK gas to its  onshore sales points, revenues were increased by about 2 percent. Hence,  we estimate that MMS realized about $4 million more than it would have  collected in cash royalties, or a gain of about 2 percent on sales of about  $210 million. A more detailed description of our analysis appears in  appendix I.
section_title: Data Limitations Prevent a More Comprehensive Analysis of RIK Sales
paragraphs: In analyzing RIK sales, we identified specific limitations in MMS’s financial  data that inhibited our analysis and precluded us from conducting a  comprehensive computer-based assessment of all RIK sales. A small  amount of erroneous, missing, and improperly coded financial data,  together with other anomalous but legitimate financial data, required time- consuming inspections of these data and complex edit checks to ensure  data reliability and integrity. For example, in our analysis of the three RIK  pilot sales, we analyzed almost 60,000 financial transactions, followed at  times by a line-by-line inspection of some of these data, discussions with  MMS personnel, and manual checks of source documents. MMS staff  confirmed that the financial data in their raw form were unreliable in  assessing program performance; in some instances, MMS staff chose to use  contract prices or production volumes in lieu of the financial data because  they lacked confidence in the available financial data. In addition, the lack  of a systematic method to electronically combine data in its financial  database with well, pipeline, product quality, and market center data also  prevented us from analyzing the revenue impacts of all offshore RIK sales.  Although MMS obtains and records these data for individual properties  included in its RIK sales, MMS personnel must manually obtain these data  for each property through time-consuming phone calls and searches of  industry databases. According to its procedures, MMS performs these data  collection efforts each time it expands the RIK program into new areas.  However, MMS’s unsystematic collection and recording of these data may  slow the development of benchmarks against which to compare RIK sales  in the future.
In 2001, MMS took steps to improve its collection and management of  royalty data and to develop the means to identify and correct erroneous  financial data. For example, MMS began to develop a more consistent  coding of RIK transactions, and MMS personnel in the RIK Office began to  take a more active role in entering RIK transactions for the purpose of  ensuring data reliability. In October 2001, MMS revised its electronic form  for collecting royalty data in an attempt to correct erroneous data. More  recently, MMS sought external assistance in developing software to identify  erroneous data that can then be corrected or eliminated. While some of the  data problems may have been resolved by MMS, other problems continue  to be evident. Specifically, the misallocation of SPR volumes to some  individual leases and the aggregating of sales from multiple gas leases will  continue to complicate future analyses unless these problems are  corrected. MMS says that it plans to correct these deficiencies as it further  refines its newly acquired oil and gas information systems. See appendix I  for more detailed information on data problems.
section_title: Lacking Formal Requirements, Many RIK Sales Remain Unanalyzed
paragraphs: Our ability to assess the revenue impact of RIK sales was further limited by  the failure of MMS to analyze and document the results of its sales. We  reported in January 2003 that MMS quantified the revenue impacts of only 9  percent of the 15.8 million barrels of federal royalty oil that it sold from  October 1998 through July 2002 and about 44 percent of the 241 billion  cubic feet of federal royalty gas that it sold from December 1998 through  March 2002. MMS has since sold an additional 201 billion cubic feet of gas  in the Gulf of Mexico and an additional 1.4 million barrels of oil in Wyoming  through November 2003, but has not published an analysis of the revenue  impacts of these sales. In total, we estimate that MMS has analyzed only 8  percent of the 17.2 million barrels of royalty oil and 24 percent of the 442  billion cubic feet of royalty gas sold during RIK pilot sales through  November 2003. This limited analysis of revenue impacts could be a  significant issue as RIK sales expand in the future. Based on MMS’s  estimates for further expansion of the program, we estimate that MMS  could be collecting between $1.5 billion and $2.5 billion per year in revenue  from the RIK pilot sales by 2008.
MMS has not systematically analyzed and documented the results of all its  RIK sales for four main reasons. The first and most significant reason is  that MMS has no requirement that all sales results be analyzed and  documented. Although the Congress directs MMS to (1) obtain fair market  value and (2) collect at least as much revenue from the RIK sales as MMS  would have collected from traditional cash royalty payments, MMS is not  required to document how this directive is met. While MMS does analyze  factors that will affect the revenues of upcoming sales, MMS lacks a  systematic process for analyzing the final results of each of its sales.  Second, staff responsible for conducting sales already believe that they  have enough information on sales results. For example, MMS staff cited the  second 6-month oil sale in the Gulf of Mexico in which market conditions  unexpectedly moved in a manner that resulted in revenue collections that  were less for this period than what would have been expected from cash  royalty collections. MMS stated that they had enough information on the  market conditions that drove the sales results even before completion of  the 6-month sale. Third, insufficient staff is available for analyzing sales. We  observed that staff who conduct sales are busy with identifying properties  for inclusion in sales, establishing minimum acceptable bids, evaluating  bids, and expanding the program. MMS has only one staff member  independent of the RIK Program whose duties involve selectively analyzing  RIK sales results at the direction of MMS management. To ensure proper  management control and to remove the appearance of a conflict of interest,  it is best to segregate the responsibility of a program’s operation from the  responsibility of reviewing the program, which MMS correctly did when it  reviewed the Wyoming oil and the Gulf of Mexico gas sales. Fourth, a  lengthy management review process limits the usefulness of analyses that  are conducted. For example, MMS’s report on the Wyoming pilot sales  dated March 2001 and its report on gas sales in the Gulf of Mexico dated  March 2002 remained in draft form pending final management approval  until March 2004. In addition, a study of subsequent gas sales in the Gulf of  Mexico, completed in April 2003, is still being reviewed and modified under  the direction of MMS management.
section_title: MMS Has Recently Taken Steps to Address Deficiencies in Analyzing Sales Results and Quantifying Administrative Efficiency
paragraphs: Since our last report, MMS has hired an industry consulting group to  develop a strategic plan to guide the transition of the RIK pilots through the  end of 2008. MMS intends to develop a 5-year business plan based largely  upon the consulting group’s plan. The consulting group, among other  things, has proposed that MMS (1) develop benchmarks that are indicative  of fair market value; (2) develop a consistent process for monitoring RIK  sales at regular time periods against these benchmarks; (3) develop a  consistent process for deciding whether to accept cash royalty payments or  to take RIK; (4) track administrative efficiency expressed as the cost per  unit of royalty oil and gas sold; and (5) measure the amount of time it takes  to collect, report, audit, and reconcile RIK revenue collections. The  consulting group intends that the benchmarks satisfy MMS’s congressional  mandates that RIK sales achieve fair market value and generate at least  what would have been collected in cash royalty payments. The consulting  group has developed a timetable for MMS to develop benchmarks for fair  market value by March 2004 and benchmarks for administrative efficiency  by March 2005.
While much of the data collection for developing benchmarks will remain a  manual process, MMS anticipates that overall calculation of RIK Program  performance will be facilitated by MMS’s newly acquired RIK information  systems. MMS stated that while data on RIK sales are available in less than  30 days after the sales month, RIK purchasers continue to submit data on  quality adjustments and volume imbalances after these sales, and MMS  must enter these data into its financial systems and audit the final figures.  MMS believes that 120 days after an RIK sale, it will have completed these  audits and has set this 120-day period as a formal objective. Within 180  days, MMS stated that it would be able to report on the results of these  sales. However, many RIK sales only have a length of about 180 days or  less, so obtaining performance results 180 days after a sale is not timely  enough to use these results to modify the next sale. Recognizing this  limitation, the consulting group recommended that performance be  measured on a monthly or quarterly basis, and MMS believes this will be  possible with its newly acquired RIK information systems.
section_title: Conclusions
paragraphs: RIK can be an important tool for managing the collection of royalty  revenues from federal oil and gas leases. In light of the possibility of  revenue collections from RIK sales approaching $1.5 billion to $2.5 billion  by 2008, it is important that MMS measure and document the revenue  impact and costs of administering RIK relative to cash royalty payments, to  ensure itself and the public that royalties are collected in the most efficient  manner. In doing so, MMS may be able to conclusively show that it has  reduced overall administrative costs or collected more than traditional  cash royalty payments. MMS has made some progress in analyzing the  revenue impacts of some of its sales, but many sales remain unanalyzed,  and MMS has yet to implement a more systematic and timely approach to  analyzing these sales. Also, completely quantifying the administrative  efficiency of these RIK sales continues to be a challenge. While key data  from MMS’s new activity-based cost management system have shed some  light on the difference in costs to administer RIK and cash royalties, MMS  has been unable to quantify any overall benefit that may arise from shifting  resources to auditing more cash royalty payments and from changes in  litigation due to RIK. Unless steps are taken to quantify the impacts of  these changes, MMS and the Congress will be unable to determine the  efficiency of RIK. Because MMS has not systematically assessed and  documented the overall administrative cost and revenue impacts of many  RIK sales, knowledge of MMS’s RIK Program is insufficient to determine  whether MMS should expand or contract the use of RIK.
section_title: Matters for Congressional Consideration
paragraphs: Should the Congress seek a more systematic and timely evaluation of RIK  efforts, the Congress may want to consider directing MMS to implement a  systematic process for evaluating all future RIK sales in a timely manner  and to quantify any changes in the administrative cost and revenue impact  on royalty collections as a result of RIK.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided the Department of the Interior with a draft of this report for  review and comment. Interior generally agreed with our observations and  emphasized the steps that they are taking to improve their measurement of  RIK sales performance. Interior said that the insights and conclusions  contained in the report are timely and will be valuable in their efforts to  improve the RIK Program. Their comments and our response to these  comments are reproduced in appendix II.
As agreed with your offices, and unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days from the  date of this letter. At that time, we will send copies of this report to the  Secretary of the Interior; the Director of the Office of Management and  Budget; and other interested parties. We will also make copies available to  others upon request. This report will be available at no charge on GAO’s  Web site at http://www.gao.gov.
If you have any questions about this report, please call Mark Gaffigan or me  at (202) 512-3841. Key contributors to this report are listed in appendix III.
section_title: Objectives, Scope, and Methodology
paragraphs: To determine the administrative cost savings associated with RIK, we first  examined MMS’s two draft studies on RIK sales—Wyoming Oil Royalty In  Kind Pilot, Evaluation Report (June 1, 2002) and Texas General Land  Office/Minerals Management Service 8(g) Gas Royalty In-Kind Pilot, A  Report (March 27, 2002). We reviewed MMS’s logic and assumptions in  these reports concerning the quantification of administrative savings and  benefits attributable to RIK. We used the data in these reports, MMS’s  budgetary data, and testimonial evidence from MMS officials to identify  which aspects of administrative savings and benefits to investigate. We  then obtained data from the activity-based cost (ABC) management system  for the entire fiscal year 2003 and solicited MMS’s assistance in  understanding the individual activities and in identifying which direct costs  were attributable to RIK sales and which were attributable to cash royalty  collections. We also obtained one-time expenditures for MMS’s new  information systems from MMS officials and supporting documentation  since not all of these costs were reflected in the fiscal year 2003 ABC data.  To calculate costs for auditing cash royalty payments and RIK sales  revenue on a per-lease basis, we used ABC data, together with the numbers  of the different types of leases that MMS audited in fiscal year 2003, as  supplied by MMS. We obtained data on additional royalty revenue obtained  through auditing and compliance activities from MMS’s report entitled  Report of Royalty Management and Delinquent Account Collection  Activities, Fiscal Year 2000. We interviewed MMS personnel on the costs  of appeals, and we interviewed attorneys in the Department of the  Interior’s Solicitor’s Office to obtain information on the impact of RIK sales  on litigation. Finally, we audited revenue from all RIK sales during fiscal  year 2002 to determine the benefit of early collections.
To evaluate all of MMS’s RIK pilot sales, we planned to compare RIK sales  revenues with cash royalties from comparable federal leases. We started  with sales in the Gulf of Mexico by attempting to identify comparable  leases through the electronic matching of attributes, such as type of oil,  sulfur content, market center, well location, pipeline available for  shipment, and distance to the nearest market center. To do so necessitated  combining data on these attributes in MMS’s offshore geographic  information system with data on sales values, sales volumes, royalty  values, royalty volumes, transportation deductions, and quality bank  adjustments in MMS’s financial system. We examined data from January  1997 through July 2003, but we did not independently verify the integrity of  MMS’s financial database. Unfortunately, we could not perform the  intended analysis because of two reasons: (1) we were unable to link the  data in the financial system with data in the offshore geographic  information system, and (2) we identified many data anomalies in MMS’s  financial database. We were unable to link the financial data with data in  the offshore geographic information system because the common link—the  lease number—had been compromised during some RIK gas sales.  Specifically, MMS personnel who entered these data had combined RIK  sales revenue from multiple leases and entered these data under a new  lease number referred to as a “dummy lease number.” We also found that  some data that would be helpful in identifying comparable oil leases, such  as the quality of oil and the sulfur content, were not present in MMS’s  geographic information system. Upon examination of the financial data, we  discovered many data anomalies that prevented us from reliably and easily  aggregating the monthly transactions to the same lease and payor. Within  the data aggregated to the month-lease-payor level, anomalies included  negative sales volumes, missing sales values, negative sales values, and  missing quality measures for gas prior to fiscal year 2002. Some of these  anomalies were obvious errors, but many more appeared to be correct and  legitimate data entries. With no explanations in the financial data  documentation to indicate which anomalies were accurate and which were  not, resolving the anomalies required line-by-line inspection of the data  and, in some cases, manual checks with other documentation. As a result  of the large number of data anomalies and the time-consuming process  required to correct and verify the royalty data, we undertook case studies  of MMS’s RIK pilots in three sales areas: (1) RIK oil sales in Wyoming, (2)  RIK oil sales in the Gulf of Mexico, and (3) RIK gas sales on two pipelines in  the Gulf of Mexico.
subsections: section_title: Wyoming Oil
paragraphs: In analyzing the integrity and reliability of MMS’s financial data that we  used to evaluate RIK oil sales in Wyoming, we selected nine properties that  provided about 47 percent of the oil sold during the RIK sales we analyzed.  We selected properties that produced the three different types of crude oil  that MMS sold in its RIK sales—asphaltic, general sour, and Wyoming  sweet oils. We obtained MMS’s financial data for all nine properties from  January 1996 through March 2002 and aggregated these 32,823 financial  transactions to the property-month level rather than the lease level because  we anticipated that the financial impact of the smaller leases would not be  as significant. We found that 3.3 percent of property months contained  erroneous or missing data, but we were able to correct or obtain these data.
To estimate the revenue impact of Wyoming RIK oil sales, we attempted to  determine if Wyoming severance tax prices were a good proxy for what  MMS would have received in cash royalty payments. We first obtained the  state of Wyoming’s severance tax data for the same nine properties. We  then proceeded to examine the average sales price per barrel and the  number of barrels produced from each property during each of the 33  months immediately preceding the first RIK sale. The Bureau of Land  Management, which leased the nine federal properties in Wyoming,  grouped federal leases into these properties based on the geological  boundaries of the oil fields. Personnel with the state of Wyoming, however,  group producing leases into clusters for tax purposes. At our request, a  Wyoming state official attempted to match these clusters as closely as  possible to the federal properties. However, some clusters included  additional state or private leases that they could not segregate, and in some  instances, the state official could not precisely match the properties. We  then graphed the volumes reported to the state of Wyoming for severance  taxes and the volumes reported to MMS for cash sales for each of the nine  properties. The graphs suggested that seven state properties contained  many of the same federal leases. We then graphed the state severance tax  prices and MMS’s cash royalty prices for each property. We determined that  the severance tax prices and MMS’s cash royalty prices are essentially the  same for eight properties. The severance tax prices for the ninth property  were on average about 50 cents higher than MMS’s cash royalty prices. See  figures 1, 2, and 3 for graphs of these prices that aggregate properties  according to type of oil.
section_title: Gulf of Mexico Oil
paragraphs: To evaluate the integrity and reliability of MMS’s financial data that we used  to evaluate the second RIK oil sale in the Gulf of Mexico, we examined  MMS’s financial data from January 1997 through March 2002 for 16 of the 26  leases in the sale. We removed all transactions involving the SPR and small  refiners so that we could compare sales from the second RIK sale to cash  royalty payments only. We found this initial task difficult because MMS  inconsistently used transaction codes for sales to small refiners and for  transfers to the SPR during the time frame of our study. We aggregated  7,725 transactions to the payor-lease-month level and found that 1.9 percent  of the payor-lease-months contained erroneous or missing data, and about  9 percent of the aggregated data was compromised by payors using  multiple payor codes. Payors also inconsistently reported or did not report  royalty volumes when reporting transportation deductions prior to October  2001 and inconsistently reported or did not report sales values when  reporting quality bank adjustments. We subsequently reduced the period of  our analysis to June 2000 through March 2002, reduced our leases to the 13  that accounted for about 89 percent of the oil sold during the sale, and  corrected the single significant error that we found in this data set.
To estimate the revenue impact of the October 2001 through March 2002  RIK oil sale in the Gulf of Mexico, we first chose a sample of leases  included in the RIK sale and determined the relationship of their cash sales  prices before the RIK sale to the prices as prescribed by MMS’s royalty  valuation regulations for sales to affiliated companies (also known as  transactions not at arm’s length). We analyzed only those leases that  produced Mars and Eugene Island sweet oil because these two oil grades  collectively accounted for 96 percent of the production. We then selected  only the Mars and Eugene Island leases that had cash royalty sales during  at least 8 of the 16 months between June 2000—the first month that the  current oil valuation regulations became effective, and September 2001— the month immediately preceding the RIK sale. These selection criteria  produced the 13 leases for our detailed analysis. Eleven of the 13 leases had  cash royalty sales during all 16 months. For each of the 13 leases, we then  calculated the average monthly cash sales price (net of any transportation  allowances and quality bank adjustments) from data in MMS’s financial  database for each of the 16 months preceding the RIK sale. Next, we  obtained the average monthly price from MMS for Mars and Eugene Island  sweet oils as prescribed in MMS’s oil valuation regulations for sales not at  arm’ length at the market center for the same time period. We then  subtracted these monthly prices from the average monthly cash prices and  multiplied this difference by the barrels of oil sold each month to yield  monthly revenue for each lease relative to MMS’s regulations. Next, we  summed these monthly revenues and divided the sum by the total barrels of  oil sold to obtain a weighted average difference per barrel for the entire 16- month period. This value, -$1.36, indicates that MMS received on average  $1.36 less than the market center price for each barrel of royalty oil  produced from these 13 leases from June 2000 through September 2001. We  attribute most of this difference to the payors’ costs of transporting the oil  to market. Finally, for the 6-month term of the RIK sale, we calculated a  weighted average difference per barrel between the RIK sales price and the  price as prescribed by MMS’s valuation regulations for transactions not at  arm’s length. This value, -$2.24, indicates that MMS received on average  $2.24 less than the average market center price for each barrel of oil that  MMS sold during its RIK sale from October 2001 through March 2002. We  then assumed that if MMS had not conducted this RIK sale, it would have  received cash royalty payments that on average would have been $1.36 less  than the market center price as we previously computed. We subtracted  $2.24 from $1.36 to estimate that MMS lost on average $0.88 on every barrel  that MMS sold during this RIK sale. Since MMS sold 8.2 million barrels  during this sale, MMS lost approximately $7.2 million.
section_title: Gulf of Mexico Gas
paragraphs: In analyzing MMS’s financial data on gas sales in the Gulf of Mexico, we  discussed with MMS officials the financial data limitations that they  identified while conducting their analysis of RIK gas sales—limitations that  prompted MMS personnel to use invoice prices rather than the sales data in  MMS’s financial database. We then obtained 19,211 financial transactions  for all the cash and RIK sales on the Blessing and Matagorda Offshore  Pipeline Systems (MOPS) from January 1997 through December 2001.  Upon aggregating these data to the payor-lease-month level and  researching anomalous data, we found that 6 percent of the RIK summary  data remained anomalous. Consequently, we decided to use the RIK invoice  data, adjusted for transportation costs, to compute net unit prices for the  RIK transactions.
To estimate the revenue impacts of RIK gas sales in the Gulf of Mexico, we  relied on financial data aggregated to the lease-month for all cash sales on  the Blessing Pipeline System and on MOPS from January 1997 through  December 2001. On each of the pipeline systems, MMS determined that the  leases from which it received cash royalty payments were comparable to  the leases from which it collected RIK. For each lease connected to the  Blessing Pipeline System, we calculated the average cash sales price net of  all reported transportation costs per MMBtu for each month and subtracted  it from the average RIK sales price net of all transportation costs per  MMBtu for each month. We then multiplied these figures by the quantity of  royalty gas (in MMBtu) sold in kind each month to obtain the monthly  revenue impacts, and we then summed the monthly revenue impacts to  yield total revenue impacts of the RIK sales on the Blessing Pipeline  System. To determine the revenue impacts of RIK sales on MOPS, we  followed the same procedure as that on the Blessing Pipeline System, using  data specific to sales on that pipeline. We then summed the revenue  impacts from RIK sales on both systems to yield the total estimated  revenue gain of about $4 million on sales of about $210 million.
section_title: Other Factors May Affect Revenue Analysis
paragraphs: Our case studies did not include other overall factors that may affect  revenues from RIK sales. First, differences in the timing of royalty  collections can affect total revenue collections because an earlier  collection of these revenues allows the Treasury to earn interest on the  funds collected. Revenues from the sale of royalty oil are due 10 days  earlier than cash royalties, while revenues from the sale of gas are due 5  days earlier than cash royalties. We reviewed MMS’s revenue collections  from all RIK pilot sales during fiscal year 2002 and determined that 98  percent of the oil and 92 percent of the gas revenues were collected  according to this early schedule. For fiscal year 2002, we calculated the  combined benefit to be about $128,500, or about 0.03 percent on a total of  $454 million collected in RIK pilot sales. MMS may have also realized  relatively small amounts of money from interest on those revenues that  were late. Future benefits will depend upon the amount of oil and gas sold  in kind, interest rates, and the sales prices of oil and gas. Secondly, during  the time frame of our revenue analysis, data were not available on a lease- by-lease basis that would enable us to estimate how much additional  revenue had accrued to MMS as the result of the audit process. Hence, we  could not determine whether any additional funds collected as a result of  auditing were included in MMS’s financial data. For example, Wyoming  state auditors who audit the federal leases in Wyoming that we included in  our revenue analysis stated that they audited some of these leases for some  of the time frame. While any additional audit collections would be expected  to affect unit prices in both MMS’s financial database and the state’s  severance tax database, additional collections were not necessarily  recorded for every lease. We did not examine how any additional  collections resulting from audits were recorded for oil and gas leases in the  Gulf of Mexico because of the difficulty in accessing individual leases in the  information system that tracks auditing efforts. In addition, some of the  time frame that we included in our revenue analyses had not yet been  audited by MMS when we initiated our work.
section_title: Comments from the Department of the Interior
paragraphs: The following are GAO’s comments on the Department of the Interior’s  letter dated April 5, 2004.
subsections: section_title: GAO Comments
paragraphs: 1. We clarified our report to reflect these comments. 2. We included the costs of $496,000 for auditing leases and reconciling  volumes because MMS reported it as a direct cost of the RIK pilot sales,  and because it is unknown how many of these leases would have been  selected for auditing if they had not been in the RIK Program.  3. We acknowledge that there are considerable costs for systems that  support financial and compliance activities. However, the financial  system supports both the collection of cash royalty payments and RIK  payments, so its costs are incurred regardless of whether royalties are  collected in cash or in kind. We acknowledge MMS’s observation that  the compliance system has associated costs and that these costs are  incurred predominantly with the collection of cash royalties. However,  it was not our intent to compare systems costs under different methods  of collecting royalties. We intended only to mention the incremental  costs associated with collecting royalties in kind because MMS will  continue to incur costs associated with collecting cash royalty  payments. 4. We clarified the report by stating that there is only one staff  independent of the RIK Program whose duties involve analyzing RIK  sales results. We acknowledge that additional RIK Program staff and  managers analyze sales results. However, we believe that proper  management controls require that staff independent of the RIK  Program should analyze sales results for MMS management. We also  acknowledge and state in this report that an independent contractor  has assisted with developing a strategy for analyzing sales. We believe  that this is a significant step towards comprehensively and  systematically analyzing RIK sales results. 5. MMS’s technical comments on its Gulf oil sale related to two issues: (1)  removing the effect of quality bank adjustments and (2) the validity of  extending its analysis for an additional 12 months. Because of the  variability of quality bank adjustments, MMS stated that it is necessary  to remove these adjustments before conducting an analysis, and MMS  believes that it has done so. We acknowledge the variability of quality  bank adjustments and also note that transportation allowances  associated with the leases that we reviewed are also variable, albeit to a  lesser degree. However, when we conducted our analysis, there was  insufficient data on quality bank adjustments for the time period prior  to the second RIK sale to effectively remove their effect from our  analysis. To compensate for the variability of both quality bank  adjustments and transportation allowances among the 13 leases we  examined, we chose to establish our relationship between cash royalty  payments and MMS’s royalty valuation regulations for a relatively long  time period prior to the 6-month RIK sale. We assumed that the effects  of variability would be minimized over the 16-month period for which  we established our relationship. Concerning the validity of extending  the time period of analyzing the Gulf of Mexico oil sale, MMS restated  its belief that analyzing the transfer of oil to the SPR during the  subsequent 12 months is a valid technique. We already discussed the  limitations of using this technique in the report.
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to those named above, Ron Belak, Robert Crystal, Art James,  Lisa Knight, Jonathan McMurray, Franklin Rusco, Dawn Shorey, and Maria  Vargas made key contributions to this report.
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