Oil And Gas Resources: Actions Needed for Interior to Better Ensure a Fair Return
Released: 2013-12-17T00:00:00

Letter

Background

This section describes (1) the federal oil and gas fiscal system, (2) leasing processes, and (3) the history of oil and gas management challenges. Created by Congress in 1849, Interior oversees the nation’s publicly owned natural resources including parks, wildlife habitat, and crude oil and natural gas resources on millions of acres onshore and offshore in the waters of the outer continental shelf. With regard to oil and gas in particular, Interior leases federal lands and waters (also referred to as submerged lands), issues permits for oil and gas drilling, and is responsible for ensuring that the federal government receives payment from the private companies that extract oil and gas from federal leases.

The Federal Oil and Gas Fiscal System

The oil and gas fiscal system defines the applicable payments to the government from companies that lease federal lands and waters for oil and gas development. These payments include royalties, rents, and other payments—items generally specified within the lease terms. The revenues collected by the federal government on oil and gas development are shared with states, as directed by statute, and the remaining funds are deposited in the U.S. Treasury. In addition to the collection of these payments by Interior, the federal government assesses taxes on the profits companies earn on the sale of oil and gas produced from federal leases. Under the oil and gas fiscal system, companies bid on leases that Interior makes available. Interior awards the lease to the highest bidder generally based on a lump-sum payment called a bonus bid that is due when the lease is issued. The lease is a contract and conveys the rights to explore for and produce the oil and gas in a specified area to a company that holds the lease. The company is then subject to the payment of rental rates until production begins and then to payment of royalties on any oil and gas that is eventually produced on the lease. The royalty rate is a percentage of the value of production, and the royalty owed is the volume of production times the unit value of production times the royalty rate. The federal government receives royalty payments once production starts. In fiscal year 2012, the $9.7 billion in oil and gas revenue collected included royalties (about $8.5 billion or 87 percent), bonus bids (about $947 million or 10 percent), and rental fees (about $272 million or 3 percent).

Currently Interior has the authority to change certain lease terms—such as the duration of the lease, royalty rates, and rental fees—within the overall oil and gas fiscal system. For new offshore leases, Interior is allowed by statute to change the lease terms for the bonus bid structure, rent, and royalty rates. For new onshore leases, Interior is generally allowed by statute to change these same lease terms but with certain limits on flexibility. For onshore leases, Interior’s regulations—issued in the 1980s—currently establish a royalty rate of 12.5 percent. As such, changes to onshore royalty rates would require Interior to revise its regulations. With regard to taxes on corporate profits, only Congress may change the tax components of the oil and gas fiscal system as Interior does not have the authority to do so.

For both offshore and onshore leases, ONRR collects revenue from companies for the royalties, rents, bonuses, and other revenues generated throughout the leasing process. In this regard, ONRR has the responsibility to ensure that these revenues are accurately reported and paid in compliance with laws, regulations, and lease terms. ONRR establishes the regulations for how oil and gas are valued for royalty purposes, which affects the royalties that companies pay.

Leasing Processes

Interior’s processes for issuing federal leases vary depending on whether they are offshore or onshore.

For offshore leases, management of oil and gas resources is primarily governed by the Outer Continental Shelf Lands Act, which sets forth procedures for leasing, exploration, and development and production of those resources. BOEM is the bureau within Interior responsible for implementing these requirements of the act related to preparing the leasing program. The act calls for the preparation of an oil and gas leasing program designed to best meet the nation’s energy needs while also taking into account a range of principles and considerations specified by the act. Specifically, the act provides that “anagement of the outer Continental Shelf shall be conducted in a manner which considers economic, social, and environmental values of the renewable and nonrenewable resources contained in the outer Continental Shelf, and the potential impact of oil and gas exploration on other resource values of the outer Continental Shelf and the marine, coastal, and human environments.” Furthermore, the act provides that the outer continental shelf is a “vital national resource reserve held by the federal government for the public, which should be made available for expeditious and orderly development, subject to environmental safeguards, in a manner which is consistent with the maintenance of competition and other national needs.” The act grants the Secretary the authority to issue leases and states that “leasing activities shall be conducted to assure receipt of fair market value for the lands leased and the rights conveyed by the Federal Government.”

The Outer Continental Shelf Lands Act requires the Secretary of the Interior to prepare an oil and gas leasing program that consists of a 5- year schedule of proposed lease sales that shows the size, timing, and location of leasing activity as precisely as possible. Every 5 years, Interior selects the areas it will offer for leasing and establishes a schedule for individual lease sales. These leases are offered for competitive bidding, and all eligible companies are invited to submit written sealed bids for the lease and rights to explore, develop, and produce oil and gas resources on these leases. These rights last for a set period of time, referred to as the initial period of the lease, which varies depending on the water depth. Interior estimates the fair market value of each lease, and the minimally acceptable bid is derived from this estimate. The bidder that submits the highest bonus bid that meets or exceeds Interior’s minimum bid is awarded the lease. If a high bid does not satisfy any of the required conditions, the bid is rejected. In the event that no bid is received or no bids equal or exceed the minimum bid, Interior may choose to withdraw the lease—possibly offering it again at a future date.

For onshore leases, BLM’s current leasing process was established in the Mineral Leasing Act of 1920, as amended, and the Mineral Leasing Act for Acquired Lands of 1947, as amended. Interior relies on the competitive leasing process required by the Mineral Leasing Act to ensure fair market value for onshore oil and gas resources. In addition, the Federal Land Policy and Management Act, though not specific to federal oil and gas resources, calls for the management of public lands in a manner that protects historical and environmental resources, provides for recreational and other uses, and ensures “fair market value” is received for their use and resources. BLM offers parcels of land nominated by industry and the public, as well as some it identifies. As with offshore leases, Interior initially offers onshore leases through a competitive bidding process; however, bonus bids are received in an oral auction rather than in a sealed written form, and Interior does not evaluate bid adequacy on a parcel-by-parcel basis. Instead, by law, it requires a uniform national minimum acceptable bid of $2 per acre that the Secretary has the authority to raise. If Interior receives any bids on an offered lease, the lease is awarded to the highest bidder. All onshore leases that do not receive any bids in the initial offer must be offered noncompetitively the day after and remain available for noncompetitive leasing for a period of 2 years after the competitive lease sale. Any of these available leases may be acquired noncompetitively on a first-come, first-served basis for the minimum acceptable bid. About 40 percent of existing BLM oil and gas leases were issued as noncompetitive leases. For all competitively issued leases, the winning bidder must pay Interior the full amount of the bonus bid to become the lessee. The lessee then pays a fixed amount of rent each year until the lease begins producing or the lease terminates, expires, is cancelled, suspended, or relinquished.

History of Oil and Gas Management Challenges

In the 1970s and early 1980s, Interior’s management of the oil and gas revenue collection system faced criticism by us and Interior’s Office of the Inspector General. Interior’s Inspector General issued five reports critical of the program between 1969 and 1977 and, in 1981, we reported that Interior was not collecting potentially hundreds of millions in royalties due from federal oil and gas leases. In response, in 1981, the Secretary of the Interior established the Commission on Fiscal Accountability of the Nation’s Energy Resources, better known as the Linowes Commission named for the chairman of the commission, to investigate allegations of irregularities in royalty payments, among other issues. The Linowes Commission raised a number of serious concerns and in its report stated that “management of royalties for the nation’s energy resources has been a failure for more than 20 years. Because the Federal government has not adequately managed this multibillion dollar enterprise, the oil and gas industry is not paying all the royalties it rightly owes.” The report cited a range of problems, including the failure to verify data reported by companies and late payments and underpayments, and concluded that, “n short, the industry is essentially on an honor system.” Among its 60 recommendations for improving the fiscal accountability of onshore and offshore resources, the commission called for raising onshore royalty rates to “appropriate levels.” Specifically, the commission recommended that the onshore royalty rate for oil and gas be raised from 12.5 percent to 16.67 percent generally for new and renegotiated leases consistent with offshore royalty rates of 16.67 percent in place at that time.

Following the work of the commission, Interior and Congress took several actions aimed at improving management of revenue collection. In particular, the Secretary of the Interior, by secretarial order, reorganized the task of administering revenue collection under a new bureau; specifically, the Minerals Management Service (MMS) was created within Interior, in part, from the division of the U.S. Geological Survey—which was originally tasked with administering revenue collection, among other duties—to improve management of federal leasing revenues. In addition, Congress passed legislation aimed at improving the collection of revenue including the Federal Oil and Gas Royalty Management Act of 1982 and the Federal Oil and Gas Royalty Simplification and Fairness Act of 1996.

In 2007, Interior’s Subcommittee on Royalty Management—a subcommittee of the Royalty Policy Committee chartered to provide advice on royalty management issues and other mineral-related policies to the Secretary and other departmental officials responsible for managing mineral leasing activities—reported that a number of aspects of royalty management activities required prompt and, in some cases, significant management attention to ensure public confidence. In particular, the report included over 100 recommendations to improve Interior’s management of oil and gas resources, including those aimed at revising its valuation regulations and guidelines that govern the valuation of oil and gas resources for royalty purposes. According to Interior documentation, as of August 2012, 15 recommendations remain open.

In our May 2007 report, we found that, based on results of a number of studies, the government receives one of the lowest government takes in the world. In September 2008, we found that the fiscal system needed comprehensive reassessment and that Interior did not routinely evaluate the federal oil and gas fiscal system. Interior disagreed with recommendations in the draft report that it perform a comprehensive review of the fiscal system using an independent panel and adopt policies and procedures to keep abreast of important changes in the oil and gas market and in other countries’ efforts to adjust their oil and gas management practices in light of these changes. Thus, in the final report, we suggested that Congress should consider directing the Secretary of the Interior to (1) convene an independent panel to perform a comprehensive review of the federal system for collecting oil and gas revenue and (2) establish procedures for periodically collecting data and information and conducting analyses to determine how the federal government take and the attractiveness for oil and gas investors in each federal oil and gas region compare to those of other resource owners and report this information to the Congress. Actions taken in response to this suggestion are discussed later in this report. In 2011, in part because of the challenges identified in our past work, we added Interior’s management of federal oil and gas resources to our list of programs at high risk of fraud, waste, abuse, and mismanagement. In the 2013 update of the high-risk list, we found that some progress had been made related to Interior’s management of federal oil and gas resources and narrowed the federal oil and gas high-risk area to focus, in part, on the remaining issues related to revenue collection and ensuring that the public is getting an appropriate share of oil and gas revenues.

Interior Has Taken Some Steps to Help Ensure a Fair Return but Does Not Have Procedures for Periodically Conducting Assessments of the Fiscal System

Interior has taken some steps to help ensure a fair return on federal oil and gas resources since our 2007 report, including: (1) changing offshore lease terms, while considering but not making changes to onshore lease terms; (2) contracting for studies of various aspects of the fiscal system; and (3) examining potential regulatory changes that could simplify royalty payments and collections. However, Interior does not have documented procedures in place for determining when to periodically conduct assessments of the fiscal system to ensure a fair return or for determining whether and how to make changes to lease terms for new offshore leases.

Interior Has Taken Some Steps Aimed at Ensuring a Fair Return

Interior has taken some steps aimed at ensuring a fair return, including changing offshore lease terms—such as increasing royalty rates, minimum bids, and rental rates—but onshore lease terms have not changed in recent years though onshore and offshore leasing programs are subject to many of the same market conditions. For example, while onshore royalty rates have remained at 12.5 percent, certain offshore royalty rates began increasing in 2007 to the current offshore royalty rate of 18.75 percent. Figures 1 and 2 depict changes to offshore and onshore royalty rates along with oil and gas price fluctuations, respectively, from January 2000 through July 2013. In addition, Interior has contracted for studies of various aspects of its fiscal system, including an assessment of how the federal fiscal system compared with the systems of other oil and gas resource owners (including owners in other countries); an analysis of policies that affect the pace of leasing in the Gulf of Mexico; and an analysis of the benefits, costs, and economic impacts of raising onshore royalty rates. Interior is also examining potential regulatory changes that could simplify royalty payments and collections.

In recent years, Interior changed some offshore lease terms in an effort to ensure a fair return on oil and gas resources. Since 2007, Interior increased offshore lease terms including royalty rates, rental rates, and the minimum bid for certain offshore leases as follows: Increased royalty rates. From 2007 through 2008, Interior increased royalty rates for new leases by 50 percent. In 2007, Interior increased the royalty rate for new Gulf of Mexico leases from 12.5 percent to 16.67 percent for new leases in water depths greater than 400 meters. In 2008, Interior increased the rate again for all Gulf of Mexico leases to 18.75 percent. As of August 2013, all Gulf of Mexico royalty rates for new leases are 18.75 percent. According to Interior officials and documents, incremental increases in royalty rates were instituted in response to a variety of factors including (1) increased oil and gas prices; (2) perceived improvements in exploration and production technologies, especially in deep water; and (3) the competitive market for offshore leases. Interior estimated that the royalty rate increase from 16.67 percent to 18.75 percent would result in a net increase in the total Gulf of Mexico federal revenues from bonuses, rents, and royalties from new leases of $4.3 billion, a 5 percent increase from $87.4 to $91.7 billion over 30 years. After this 2008 royalty rate increase, Interior documents stated that demand remained strong for newly offered leases in the Gulf of Mexico and that Interior observed strong bidding interest in the three subsequent lease sales.

Escalating and increased rental rates. Interior established escalating rental rates—rates that increase over the duration of the lease—to encourage faster exploration and development of leases, or earlier relinquishment when exploration is unlikely to be undertaken by the lessee. Specifically, in 2007, Interior implemented escalating rental rates for leases offered in less than 400 meters of water—and in 2009, for leases offered in at least 400 meters of water. Also, in 2009, Interior increased rental rates for new Gulf of Mexico leases in all water depths. Interior estimated that the increased rental rates and escalating rent rates in water depths greater than 400 meters would result in five fewer lease tracts receiving bids but an increase in rental revenue of $57 million over the initial lease term for leases resulting from that sale. $27 million of this $57 million was attributed to the increase in base rental rates. In addition, the increased rental rates did not appear to reduce the number of lease blocks to be explored, according to Interior documents.

Increased minimum bids. In 2011, Interior increased the minimum bid for leases offered in at least 400 meters of water in the Gulf of Mexico to $100 per acre, up from $37.50 per acre. According to Interior’s Proposed Final Outer Continental Shelf Oil & Gas Leasing Program 2012-2017, the minimum bid was raised, in part, to account for increases in oil prices and to encourage optimal timing of leasing. Interior officials told us that a review of the minimum bid was initiated because the minimum bid had not been changed in some time. In addition, Interior analysis showed that a minimum bid of $100 per acre would be generally equivalent to the cost of the minimum bid in the past, going back to 1999, adjusted for differences in prices, costs, and royalty rates.

For details on the recent history of lease terms in the Gulf of Mexico, see table 1; changes in lease terms are highlighted in gray.

Interior has also taken actions to encourage the development of oil and gas resources, which reduces the time from when federal leases are issued and the federal government receives its share of revenue from them, in response to our October 2008 recommendation that the Secretary of the Interior develop a strategy to evaluate options to encourage faster development of its oil and gas leases. Specifically, in 2010, Interior shortened lease terms by reducing the duration of the initial period for Gulf of Mexico leases in water depths of 400 to less than 800 meters from an 8-year initial period to a 5-year initial period. For water depths of 800 to less than 1,600 meters, it reduced leases from a 10-year initial period to a 7-year initial period. According to Interior documents, these lease terms can generally be extended if the lessee begins drilling a well during the initial period.

For onshore resources, Interior has considered, but not made, changes to onshore lease terms in order to provide greater assurance that the public is getting a fair return on federal oil and gas resources. Interior acts on behalf of the American people to manage the federal oil and gas system to ensure a fair return to the public for the development of oil and gas resources. Interior officials told us that since 2009 the department has been considering increasing the onshore royalty rate—which is currently established in its regulations at 12.5 percent for both oil and gas. According to the officials, several factors prompted efforts to consider changing the royalty rates, including our September 2008 report, oil and gas prices, and Office of Management and Budget initiatives calling for increased revenue from onshore royalties. Although both onshore and offshore leasing programs are subject to many of the same market conditions, Interior officials are currently unable to make timely adjustments to onshore royalty rates because BLM’s regulations generally establish a set royalty rate of 12.5 percent. This limits the bureau’s flexibility because making adjustments to that rate require going through the rulemaking process, and the process can take several years according to Interior officials. Specifically, officials said that the public notice and comment period required as part of the rulemaking process could take 1 to 2 years, and proposed rules must also undergo review by the Office of Management and Budget.

Interior officials told us that the department planned to publish a notice of proposed rulemaking in July 2012 to change BLM’s regulations to set an onshore royalty rate of 18.75 percent for oil production on new federal competitive leases but leave the royalty rate for gas production unchanged at 12.5 percent. The planned regulatory revisions would have allowed the Secretary to review and revise royalty rates for new competitive leases as appropriate—similar to the authority that the Secretary has for revising offshore royalty rates. Officials told us that including the requirement for periodic review and revision of royalty rates would have given the Secretary greater flexibility to go forward with such reviews and revisions in the future.

Interior discontinued its efforts to pursue the revised regulations because, according to Interior officials, the department does not have enough information to determine how to adjust onshore royalty rates. Rather, Interior plans to ask the public to comment on whether and how royalty rates for new federal onshore competitive oil and gas leases should be revised to better ensure a fair return to the public. Specifically, Interior officials told us they plan to ask for comments on the types of royalty rate structures that should be considered, such as whether BLM should develop a uniform rate for all leases or different rates by region, state, geologic formation, or resource type. Furthermore, Interior officials told us they would also ask for comments on whether sliding scale royalty rates—or rates that vary with the price of the commodity—might be appropriate in specific circumstances. An Advance Notice Of Proposed Rulemaking is under development, but officials told us that higher priority rulemaking initiatives, such as regulations for hydraulic fracturing and revisions to its oil and gas measurement regulations, precede it and that limited resources constrain their ability to meet program demands. As a result of not successfully changing federal regulations to provide itself with the flexibility needed to make timely adjustments to onshore lease terms, Interior’s ability to ensure that the public is receiving a fair return is limited. Moreover, Interior continues to offer onshore leases with lease terms—terms lasting the life of the lease—that have not been adjusted in response to changing market conditions, potentially foregoing a considerable amount of revenue. For example, in 2011, Interior estimated that onshore royalty rate changes could increase revenue collections by about $1.25 billion over 10 years.

Interior contracted for several studies—including a study of how the federal oil and gas fiscal system compared with fiscal systems of other resource owners—that reviewed various aspects of the federal oil and gas fiscal system since 2007. In our September 2008 report, we found that Interior collected a lower government take for oil and gas production in the deep water of the U.S. Gulf of Mexico than all but 11 of 104 oil and gas resource owners whose revenue collection systems were evaluated in a comprehensive industry study, which included other countries as well as some states. We also found that Interior had not routinely evaluated the federal oil and gas fiscal system, monitored what other governments or resource owners were receiving for their resources, or evaluated and compared the attractiveness of federal lands and waters for investment with that of other regions. In response to our 2008 findings, Interior contracted for a study—the 2011 Comparative Assessment of the Federal Oil and Gas Fiscal System study—that compared the federal oil and gas fiscal systems of selected federal oil and gas regions to that of other resource owners. In addition, Interior contracted for two other studies on the effect of different leasing and royalty rate policies on revenue, exploration, and production. See table 2 for a description of these studies.

According to Interior officials, the study conducted in response to our 2008 findings—the 2011 Comparative Assessment of the Federal Oil and Gas Fiscal System—provided some useful information about the fiscal system such as how fiscal terms in the United States compared with other resource owners, but it has not directly led to any changes to the fiscal system or lease terms for new federal oil and gas leases. Similarly, Interior officials told us that the other two studies have not yet led to revisions to the fiscal system or lease terms for new offshore or onshore leases. Rather, according to officials, additional internal analyses and modeling, as well as consultation with stakeholders—including oil and gas companies and the public—will continue to primarily inform future changes to the fiscal system. Moreover, Interior did not document any internal discussions or analysis of the three studies’ findings. As part of the 2011 Comparative Assessment of the Federal Oil and Gas Fiscal System study, officials said that they obtained a model that can be employed in the future to conduct comparative analyses but currently have no plans to update the model or the data inputs used by the model. Officials told us that the study’s findings reassured them that their own internal assessment related to the competitiveness of the offshore fiscal system was appropriate. In addition, officials said that the study provided additional information—mainly raising the issue of whether an appropriate return was being received for onshore resources—but that the study was not adequate to determine next steps for onshore lease terms.

Interior is examining potential regulatory changes that could simplify royalty payments and collections. As we found in our past work, complex valuation regulations can result in inaccurate royalty payments made by industry, and this could increase ONRR’s costs to ensure accurate royalty payments because of the need for potentially detailed and time-consuming audits of records. In May 2011, Interior published an Advance Notice Of Proposed Rulemaking requesting comments to inform potential changes to regulations intended to simplify royalty payments and collections. In addition to our work, others have identified numerous shortcomings in ONRR’s royalty collection programs, in part because of its valuation regulations’ complex requirements for calculating the value of oil and gas and associated deductions and allowances for activities such as transportation.

In December 2007, Interior’s Subcommittee on Royalty Management recommended that, by the end of fiscal year 2008, Interior publish proposed revisions to the gas valuation regulations to, among other goals, simplify the calculation of royalties and deductions for gas transportation and processing. Interior did not meet this time frame due to several factors including the complexity of oil and gas valuation, according to Interior officials. In May 2011, Interior published the Advance Notice Of Proposed Rulemaking in the Federal Register for the proposed rule, which according to Interior documents is intended, in part, to provide greater simplicity, certainty, clarity, and consistency in production valuation; decrease ONRR’s costs to ensure compliance; decrease industry’s compliance costs; and provide more certainty to ONRR and industry that companies pay every dollar due to the government. According to ONRR officials, the proposed regulations were undergoing internal review as of September 2013 and are expected to be published in the Federal Register in 2014.

Interior Does Not Have Documented Procedures for Conducting Periodic Assessments of the Fiscal System or for Supporting Potential Changes to New Lease Terms

Interior does not have documented procedures in place for determining (1) when to conduct periodic assessments of the overall fiscal system or (2) whether and how to make changes to lease terms for new offshore leases.

Interior does not have documented procedures in place for determining when to periodically conduct assessments of the overall fiscal system as a whole. Although Interior recently contracted for such an assessment, it was the first in well over 25 years. Without documented procedures, Interior cannot ensure that it will consistently conduct such assessments in the future, and without periodically conducting such assessments, Interior cannot know whether there is a proper balance between the attractiveness of federal leases for investment and appropriate returns for federal oil and gas resources, limiting Interior’s ability to ensure a fair return on federal oil and gas resources. Internal control standards in the federal government call for agencies to clearly document internal controls and the documentation is “to appear in management directives, administrative policies, or operating manuals.” Documented procedures of when Interior is to conduct such assessments—whether within specific time frames or the occurrence of certain market or industry changes— could help provide the department with reasonable assurance that its staff knows when to conduct assessments of the overall fiscal system to help ensure those reviews are conducted systematically and consistently.

In our September 2008 report, we found that the last time Interior conducted a comprehensive assessment of the federal oil and gas fiscal system was over 25 years ago. Additionally, we reported that, without routinely evaluating the federal oil and gas system as a whole, including monitoring what other resource owners worldwide are receiving for their energy resources or evaluating and comparing the attractiveness of the United States for oil and gas investment with that of other oil and gas regions, Interior cannot provide reasonable assurance that the public is getting an appropriate share of revenues. As mentioned previously, in response to our 2008 findings, Interior contracted for a study that compared the federal oil and gas fiscal system to that of other resource owners. As part of this study, officials said that they obtained a model that can be employed in the future to conduct comparative analyses; however, there are currently no plans to update the model or the data inputs used by the model. Interior officials told us that this type of comprehensive assessment would only be undertaken if fundamental shifts in the market occurred. According to officials, however, Interior does not have procedures or criteria in place for determining when such an assessment of the fiscal system should take place or what changes in the market or industry would signal that such a study should be done. Without procedures for determining when to conduct periodic assessments of the fiscal system as a whole, Interior cannot be reasonably assured that it will consistently conduct such assessments in the future, limiting its ability to be confident that the system is ensuring a fair return on federal oil and gas resources. According to the Office of Management and Budget, rigorous program evaluations can help determine whether government programs are achieving their intended outcomes to the extent possible.

Moreover, Interior’s oversight of federal land and waters is subject to the federal government’s multiple, diverse objectives—fair return, protection of historical and environmental resources, and expeditious and orderly development, among other goals. Thus, Interior is confronted with evaluating these objectives in light of a complex set of factors—including market prices and how development opportunities in the United States compare with those of other resource owners. By having documented procedures, the department could help ensure that its evaluations take all of these factors into consideration. Further, these factors may change over time as the market for oil and gas changes, the technologies used to explore and produce oil and gas change, or as the broader economic climate changes, making it even more important that Interior has documented procedures for conducting periodic assessments of the federal oil and gas fiscal system.

In addition, Interior has conducted some analyses to support changes to offshore lease terms in advance of offshore lease sales, which typically occur a few times a year—but the analyses conducted to support these changes are not a substitute for periodically assessing the oil and gas fiscal system as a whole. Since 2007, Interior has conducted some analyses for offshore lease sales in support of changes to royalty rates, rental rates, and the minimum bid. Based on our review of Interior documents from several lease sales from 2007 to 2011, we found that the analyses the department conducted to support proposed changes to offshore lease terms generally involved estimating the impacts of a proposed change on revenue, bidding activity, and potential oil and gas production. In addition, Interior’s documentation shows that the department took into consideration technological and market conditions; policy goals, such as promoting development or enhancing revenues; and administrative benefits, such as making lease terms consistent across water depths. However, these analyses did not include an evaluation of what other resource owners worldwide are receiving for their energy resources or a comparison of the attractiveness of the United States for oil and gas investment with that of other oil and gas resource owners. In our September 2008 report, we suggested that Congress should consider directing the Secretary of the Interior to establish procedures for periodically collecting data and information and conducting analyses to determine how the federal government take and the attractiveness for oil and gas investors in each federal oil and gas region compare with those of other resource owners and report this information to Congress. Moreover, Interior has not conducted similar analysis for onshore lease sales. Interior officials explained that the mechanism for determining the value of onshore resources is directed by statute to be market-driven. Specifically, officials stated that fair market value for onshore lease sales is determined through the oral competitive bidding process required by the Mineral Leasing Act, rather than an evaluation of the geology and potential value of the oil and gas resource. Because the leasing process is established by statute, Interior officials told us that it has not recently examined whether alternative leasing systems might be more effective in ensuring fair market value.

Interior does not have documented procedures for determining whether and how to make changes to new offshore lease terms—which are specified a few times per year ahead of each lease sale—consistent with federal standards for internal control. Without documented procedures for determining whether and how to make changes to new offshore lease terms, Interior is at risk of making inconsistent determinations about lease terms. Such inconsistent determinations would undermine its credibility and its ability to better ensure a fair return on oil and gas resources. Officials told us Interior does not have documented procedures or criteria for determining whether and how to make changes to offshore lease terms. Rather Interior officials said that they follow an informal process and establish offshore lease terms for each sale but that they do not have the time or resources to evaluate each lease term prior to each lease sale. However, based on our review of Interior documents, the analyses the department conducted to support proposed changes to offshore lease terms were inconsistent in the array of conditions and factors the department considered, and the level of analysis conducted in support of decisions to change lease terms varied and was not consistently or clearly documented. For example, as mentioned previously, escalating rental rates were implemented in two different sales—first, in 2007, in water depths less than 400 meters and then, in 2009, in water depths greater than 400 meters. The rationale provided for the first change was the policy goal to expedite drilling and compensate Interior, while the rationale in 2009 included specific estimates of the effects of an escalating rental rate on potential revenue and bidding, as well as consideration of market conditions. While both justifications may be warranted, because Interior does not have documented procedures specifying whether and how to support changes to its lease terms, Interior’s approach to revising its lease terms appears to be inconsistent.

In addition, our review of documents supporting two separate royalty rate changes in 2007 and 2008—the first in 25 years—found that Interior did not consistently document the justifications and analysis supporting the increases. Specifically, Interior documents for the 2008 royalty rate increase cite reasons similar to the 2007 royalty rate increase—generally significant changes in market conditions—but because the second increase took place less than a year after the implementation of the first increase, it is unclear what significant changes in market conditions occurred to prompt the consideration of the second increase in royalty rates. Internal control standards in the federal government call for agencies to clearly document transactions and other significant events and that documentation should be readily available for examination. While both royalty rate increases may have been warranted, clear documentation of the justifications and analysis supporting royalty rate increases would make Interior’s decisions to change the royalty rates transparent and could inform future decision making related to changing rates. Such transparency can be particularly helpful in the event that key staff retire or leave federal service. Documentation of internal discussions that took place prior to the second royalty rate increase show that prior to being able to assess the impacts of increasing the royalty rate from 12.5 percent to 16.67 percent in 2007, Interior was considering an additional royalty rate increase. In addition, Interior documents show Interior program officials’ concerns about an additional increase in royalty rates; specifically, officials urged the need to analyze the impact of the first increase, and they also noted potential negative effects of an increase including delaying investment and production in certain areas of the Gulf of Mexico. By having documented procedures for determining whether and how to make future changes to offshore leasing terms, Interior could increase its consistency and thus enhance its credibility in the conditions and factors the department considered and the level of analysis conducted.

Conclusions

Interior has taken several steps intended to help ensure that the public receives a fair return on oil and gas produced from federal leases.

However, even with these recent steps, it is not clear that Interior’s efforts, by themselves, provide long-lasting assurance that federal resources will provide a fair return. This is especially true in light of the absence of documented procedures for Interior to determine when it will periodically conduct assessments of the overall federal oil and gas fiscal system and whether and how to make changes to new offshore lease terms, as well as Interior’s limited flexibility to make changes to new onshore lease terms. Ensuring that the federal government is obtaining fair return for the resources it manages on behalf of its citizens is especially important as the country faces ongoing fiscal challenges.

Although leasing programs for both onshore and offshore areas are subject to many of the same market conditions, and Interior has increased offshore royalty rates, officials overseeing onshore leasing are currently unable to make timely adjustments to onshore royalty rates because, in general, BLM’s regulations fix the rate at 12.5 percent, potentially limiting Interior’s ability to ensure that the public is receiving a fair return and potentially resulting in foregone revenue. In particular, while Interior has changed offshore lease terms several times over the past few years in response to changes in market conditions—many of which also affect onshore areas—to better ensure a fair return, Interior has not successfully changed BLM’s regulations to provide itself with the flexibility needed to change onshore lease terms in a timely manner despite considering increasing the onshore royalty rate since 2009. As a result, Interior continues to offer onshore leases with lease terms—terms lasting the life of the lease—that have not been adjusted in response to changing market conditions, potentially foregoing a considerable amount of revenue.

Key among Interior’s efforts to ensure a fair return, to address a GAO recommendation, Interior completed an assessment—the Comparative Assessment of the Federal Oil and Gas Fiscal System—which examined how the fiscal system of selected federal oil and gas regions compared with fiscal systems of other resources owners. Interior officials told us, however, that it has no plans to update the assessment, increasing the risk that this progress may be fleeting and that, as we found in 2008, it could be years before another assessment is completed during which time there could be significant changes in market conditions. Furthermore, without documented procedures in place for conducting periodic assessments of the fiscal system—such as when such an assessment of the fiscal system should take place or what changes in the market or industry would signal that such a study should be done, Interior cannot know whether there is a proper balance between the attractiveness of federal leases for investment and appropriate returns for federal oil and gas resources, limiting Interior’s ability to ensure a fair return.

Finally, while Interior has made changes to its offshore lease terms, for example increasing royalty rates in some instances from 12.5 percent to 18.75 percent, Interior does not have documented procedures for determining whether and how to make changes to lease terms for new offshore leases. Without such documented procedures, Interior’s rationale is not transparent, and it is at risk of making inconsistent determinations about lease terms. Such inconsistency would undermine its credibility and ability to better ensure a fair return on oil and gas resources. Additionally, Interior has not clearly documented the justifications and analysis supporting changes to lease terms, including royalty rate increases. As a result, the department’s decisions to change lease terms are not transparent and, without documentation of these decisions, its future efforts to change rates may be impeded.

Recommendations for Executive Action

To better ensure that the government receives a fair return on its oil and gas resources, we recommend that the Secretary of the Interior take the following three actions:

Take steps, within existing authority, to revise BLM’s regulations to provide for flexibility to the bureau to make changes to onshore royalty rates, similar to that which is already available for offshore leases, to enhance Interior’s ability to make timely adjustments to the terms for federal onshore leases.

Establish documented procedures for determining when to conduct periodic assessments of the overall fiscal system. Such procedures should identify generally when such an assessment should be done or what changes in the market or industry would signal that such an assessment should be done. Additionally, the assessment should include determining how the government’s share of revenue from the federal oil and gas fiscal system and the attractiveness for oil and gas investors in each federal oil and gas region compare with those of other resource owners.

Establish documented procedures for determining whether and how to adjust lease terms for new offshore leases, including documenting the justification and analysis supporting any adjustments.

Agency Comments

We provided a draft of this report to Interior for review and comment. Interior generally agreed with our findings and concurred with our recommendations.

As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies of this report to the Secretary of the Interior, the appropriate congressional committees, and other interested parties. In addition, this report will be available at no charge on the GAO website at http://www.gao.gov.

If you or your staff members have any questions about this report, please contact me at (202) 512-3841 or ruscof@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff members who made major contributions to this report are listed in appendix II.

Appendix I: Comments from the Department of the Interior

Appendix II: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the individual named above, Jon Ludwigson (Assistant Director), Janice Ceperich, Glenn Fischer, Cindy Gilbert, Michael Kendix, Alison O’Neill, Dan Royer, Kiki Theodoropoulos, and Barbara Timmerman made key contributions to this report.