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. 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. 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. 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.